SME News March 2018

6 SME NEWS / Q1 2018 , By Jana Nevrlka, author of Cofounding The Right Way (£14.99 Panoma Press) The Top Reasons for Business Collapse Building a successful and lasting business is hard. It is especially in the early 3-5 years of the life of a new business venture, which is critical. And it is a known fact, that majority of business do not make it. The top reason, which is wildly underestimated – and therefore unaddressed (until it is too late), is the people – their roles and relationships. Most often, this issue stems from the cofounders. From the majority of business failures, it is estimated that around 60-70% of business collapses are caused by issues within the cofounding team1, 2. At the same time, it is known that businesses started by cofounding teams have long-term stronger growth and performance than businesses started by solo founders. To summarize – cofounding teams are stronger and over time deliver better results but it is very hard to get it right. Knowing what are some of the common risk elements and addressing it as soon as they appear can make the difference between the make or break of the business. In my years of experience working with 100+ cofounding teams, the most frequent red flags and cofounding team issues are the following: • Decisions deadlock: many (first time) cofounder pair teams decide to split the ownership of their business 50:50. This also, unless explicitly regulated otherwise, affects the decision-making rights. The 50:50 equity split is usually wrong also for other reasons – often the inability or unwillingness of the cofounders to go through the sensitive discussion on the equity / ownership split. One of its direct consequences is the possibility of decision making deadlocks. This should be mitigated by beforehand agreed mechanisms (that both cofounder feel comfortable about) – how a deadlock will be resolved – should it happen. This could include third person counselling or veto right of one of the cofounders – along their roles and responsibilities. • Cofounder underperformance: Having clear expectations and role responsibilities for each member of the cofounding team is a necessary element to evaluate and diagnose the issue. Here the key is also striking the right balance between being specific enough, so you can use it as an evaluation and being flexible enough to accommodate the dynamic realities of early stage venture. Dealing with the issue as soon as you detect it, is another mitigating factor. The underperforming cofounder should have a chance to correct it. Clear and specific communication on the underperformance is essential, together with a clear indication of the time frame for correction and how the cofounder is expected to achieve it. If the cofounder does not correct the performance within the set framework, it is time for an exit discussion. Critical to protect your business is to include equity recovery frameworks – with some type of good / bad leaver clauses – in the cofounding agreement. • Incorrect equity allocation: One of the most frequent and unfortunately most difficult to correct mistakes are wrong equity splits. This can happen due to multiple reasons – the equity split is not done even though the cofounders are already working together – and each has a different expectation what a future equity split looks like. Another – probably most common – reason – is that the fixed equity split was based on wrong assumptions. Believe it or not, but fairness plays a main role in here. If the equity split is not fair – over time it will lead to tension, underperformance or break-up of the cofounding team. The reason why many equity splits are not fair in the long term though, is the inherent inadequacy of the fix split. In the beginning of the business, cofounders tend to overestimate past contributions (compared to future once) and base the equity split on assumptions about the future contributions - that very often change. If there is no mechanism to correct the equity split if the situation changes, the risk of the unfair allocation affecting the performance of the cofounding team is very high. Many entrepreneurs devote a lot of their resources to developing the right idea, the right product, the right service, the right business plan – the