Rites of Passage

Today I released “Rites of Passage: Managing CEO Transition in Venture-Backed Technology Companies”.  This is my second white paper on best practices in VC board governance and follows “After the Term Sheet: How Boards Influence the Success or Failure of Venture-Backed Technology Companies”, which I co-authored with Dr. Dennis Jaffe and released in October 2003.

Rites of Passage…” directly addresses the sensitive topic of how to properly manage CEO transition—a subject that many VCs and entrepreneurs consider “off-limits” for discussion in public forums because it delves into what some of my fellow VCs like to call the “sausage making” of venture capital. 

Rebecca Buckman of The Wall Street Journal wrote a story featuring “Rites of Passage…” in today’s paper (page B-5).  The paper itself includes two unnamed case studies that illustrate other aspects of the challenges associated with managing CEO transition.  A brief summary of the paper follows:

Executive Summary

Most venture-backed companies experience at least one chief executive officer (CEO) change as they evolve from a start-up to a fully integrated company. Initiating and managing this transition is the most important decision a venture capitalist (VC) makes as a director. If the process is handled effectively, it can have a major positive impact on the company’s future; mismanaging it, however, can lead to operational turmoil and defections from key team members. CEOs and VCs may have different perspectives on CEO transitions; however, this paper makes the case that the key for VCs in successfully managing CEO change in venture companies is to anticipate it; monitor the relationship for familiar, early-warning signs of leadership problems; and initiate a professional and swift transition before CEO shortfalls create serious, even irreparable, harm to the company. This paper represents collaboration between VCs, CEOs, and other technology industry investment professionals who are acknowledged at the paper’s end. The objective of this paper is to enhance the body of knowledge for entrepreneurs and VCs alike and to offer prescriptive best practices for the benefit of the venture capital industry.

CEO Behavioral Warning Signs

In the white paper, I identify six warning signs that a start-up CEO may need to be replaced:

    1. Staying the wrong course: Rejection of board input
    2. Offsite and out of touch: Disengaging from daily operations
    3. Indignation: Emotional and combative behavior
    4. The silent treatment: Cutting off information flow to the board
    5. Buck-passing: ignorance of key details and blaming other executives for unexpected shortfalls
    6. Pulling up the drawbridge: Directing his or her management team to deflect board inquiries

Two other key business indicators that may signal the need for a transition: consistently inaccurate revenue and expense forecasts, and the departure of top performing executives while mediocre employees hang on.

How CEOs View the Situation

I do sympathize with CEOs and am aware of the pressure they are under. In interviewing CEOs for this report, I found that almost all had identified their own warning signs that they were not longer right for the job. These signs include a loss of passion for the job, a feeling as if they had run out of ideas for addressing critical issues, and exhaustion at trying to reconcile differing expectations among board members or between the board and themselves.

Best Practices for Managing Transition

To help both CEOs and their venture backers better manage CEO transitions, the paper develops a set of best practices, including:

    • Setting explicit expectations for CEO performance and conducting periodic review
    • Identifying fair and aggressive corrective plans when reviews reveal that there are problems 
    • Being honest about answering a host of questions about how the company is operating,
       including whether it is truly on a success path, whether the CEO’s skills are contributing to the        company’s success, and whether the CEO is largely operating from strength or weakness
    • Communicating clearly when the board has decided on a transition plan
    • Not blaming past management for the company’s problems when the new team is in place

Rites of Passage…” is freely available and can be downloaded in English and in Hebrew from the following link: www.levp.com/news . 

I want to thank the twenty contributors to the paper and the executives who agreed to be interviewed by The Wall Street Journal for being willing to go on the record on this important subject and for their valuable advice over the past eight months.   

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