Warren Buffett on People: Three Things to Look For

Just a short post that includes some words of wisdom on people from Warren Buffett. While Buffett’s thoughts are generally applicable they are also very applicable to entrepreneurship and venture capital. I look for Buffett’s three qualities in any entrepreneurial team we look to back and, as Buffett says, if they don’t have the last one, forget the other two. Hat tip: Farnam Street blog

“You’re looking for three things, generally, in a person,” says Buffett. “Intelligence, energy, and integrity. And if they don’t have the last one, don’t even bother with the first two. I tell them, ‘Everyone here has the intelligence and energy—you wouldn’t be here otherwise. But the integrity is up to you. You weren’t born with it, you can’t learn it in school.”

Buffett and Munger were fortunate. They were both smart and worked hard to improve that advantage. The integrity, however, they chose.

“You decide to be dishonest, stingy, uncharitable, egotistical, all the things people don’t like in other people,” argues Warren. “They are all choices. Some people think there’s a limited little pot of admiration to go around, and anything the other guy takes out of the pot, there’s less left for you. But it’s just the opposite.”

Employee Stock Options – The Big Catch

As I mentioned in my post yesterday, the compensation discussion is in full swing. This morning, Dan Primack wrote about one of the key issues with employee stock options in his Term Sheet newsletter (if you aren’t subscribed – go do it now):

If the employee leaves the company after his options vest, he often is required to exercise the options within a few months or else they are terminated. And exercising the options can create a big up-front tax bill.*

One solution to this issue is the employee can exercise her options and then sell some of the shares on the secondary market or back to the company to cover the amount owed to the IRS. However, this is an issue with this solution – many of the high-flying startups don’t allow it.

Many companies are restricting stock sales on secondary markets. There are good reasons for this, of course, but it leaves an employee with only one other solution – sell stock back to the company. Some companies allow this but they set very low tenders. Apparently, these are the good companies as it seems now that a number of companies don’t offer tenders at any price (to be fair, some companies just don’t have a lot of cash available to buy back stock).

This leaves the employee between the proverbial rock and a hard place. Seems like an unfair situation to put someone in that took a lower-than-market salary and a flyer to join a company and then presumably created a lot of value in the intervening time. This is especially brutal when you consider that most early employees don’t get all that much in the way of stock options relative to founders.

I’m not sure how to fix this issue, but it is something that folks in the startup world need to think about. If we’re not smart about employee compensation eventually it’ll be hard to find really great people to help build the next big thing.

[One idea: Perhaps high-flying companies like Uber, AirBnB and Pinterest could have a line of credit that could facilitate stock buy backs – perhaps provided by Silicon Valley Bank or a similar entity – given that it seems clear the company will have a solid exit at some point in the future. This would work in situations where companies and the VCs don’t want to use capital in the company for stock buy backs – they’d rather use it for growth – but they do want to treat early employees well and wouldn’t mind buying back some of the stock since they believe it will go up in value.]

[Second idea: This one is a stretch to say the least. Perhaps the IRS could amend their rules to delay payment of taxes on privately held stock until an exit event – acquisition or IPO. If needed, they could add a little more granularity by choosing to delay payment only for individuals whose net worth is below a certain threshold.]

Let’s not get into the 83(b) election this time around. That’s for another post. In the meantime, here’s a good outline of the 83(b) election.

The Compensation Question: VCs, Entrepreneurs, Employees, etc.

Every so often a discussion ensues about compensation in the tech space. This conversation has picked up again after a tweet from Jonathan Abrams where he quoted a recent HBR piece on venture capital compensation:

You can read the litany of responses if you’d like. They are varied and worth a look.

VC Compensation

Let’s take a look at VC compensation first. It seems like a lot of the angst comes from the idea that some VCs want founders to take relatively small salaries in favor of the upside in their businesses while some VCs (maybe the same ones, maybe not) make millions each year in management fees whether nor not they drive appropriate risk-adjusted returns for their investors (LPs). In other words, VCs are “paid like asset managers rather than investors” as the HBR article states.

I agree that VCs should make the bulk of their compensation on the returns they generate for their LPs (I’d say the same of any investor in any asset class). Large salaries can be counterproductive to the ultimate aim of venture investing. VCs should make a solid salary commensurate with some of the opportunities they could otherwise take and taking into account the large potential upside they have. This will help to ensure quality people enter in the VC business and that those people can focus on their job without having to worry about providing for their family. Given a reasonable base salary and benefits, the rest of the comp needs to come from investment returns. Carry checks need to matter for VCs in the same way exits matter to entrepreneurs.

Ultimately, LPs need to get serious about this to make it happen. The high salaries that do exist and the ability for fund managers to raise ever larger funds (even though we know it negatively impacts performance) is the result of a clearing price in the market. If LPs can get together on this things will start to change. In the meantime, some funds will do the right thing despite the clearing price in the market (a lot of firms do already) but the issue will persist.

Entrepreneur Compensation 

Recently, the lens that folks have used to evaluate entrepreneur compensation is that of entrepreneur comp relative to VC comp. I am not sure the comparison is helpful given the different nature of the roles. Also, this comparison tends to focus on a small number of VC partnerships where the partners make millions in salary each year that are not tied to returns. I think those are likely outliers and that many of the seed and early stage VCs have much more reasonable salaries (e.g. see Dave McClure’s tweet in the stream linked above).

In addition, there are different choices entrepreneurs face. Entrepreneurs may want to keep their salaries low in order to reduce burn and keep their ownership in the company as high as possible. Others may need to take a little more in salary to ensure they can provide for their families as they build their companies.

Either way, it seems that we should try to find a way, if possible, to achieve a level of comp for founders that allows them to focus on building their companies rather than wasting time and energy worrying about their living expenses and that takes into account their potential upside. In my experience this is typically achievable, but it does require tradeoffs like any other decision. 

(Early) Employee Compensation

While VCs and entrepreneurs discuss and debate their relative compensation I can’t help but feel that one of the most important constituents in this ecosystem is left out – employees (particularly the very early ones). Sam Altman wrote about this issue recently on his blog. He worries less about cash comp and more about stock comp, which I agree with. Stock comp for early employees is really where the issue is.

Sam lists four key issues relative to early employee stock comp:

  1. Employees usually don’t get enough stock.
  2. If an employee leaves the company, he or she often can’t afford to exercise and pay taxes on their options.
  3. Employee options sometimes get unfavorable tax treatment.
  4. Employees usually don’t have enough information about the stock or options.

I’ll focus on the first one here as I believe it is the most important at this point in time, but Sam outlines proposed solutions for all four of these issues in his post if you are interested.

The solution to the first issue is, you guessed it, give early employees more stock.* The reality is that the value of a company is built over a number of years. While the founders, who did take the most risk, should get a premium for starting the business it probably shouldn’t be, as Sam notes, “100x – 200x  what employee 5 gets.” 

I like Sam’s general solution that looks at the comp package in total using an expected value for the stock piece of the comp. In addition, I also like the idea of splitting distribution the equity in a tiered system like Sam suggests. I am not sure at where I would place the numbers but Sam’s suggestion is the following (and a good starting point):

As an extremely rough stab at actual numbers, I think a company ought to be giving at least 10% in total to the first 10 employees, 5% to the next 20, and 5% to the next 50.

Compensating early employees in a more appropriate manner should help to do a couple of things: 1) improve the quality of the people willing to join startups; and 2) provide more capital to early employees after exist, which should, in turn, lead to a larger group of people that can invest their capital back into the ecosystem as angels and/or start their own company now that they have some capital to see them through the lean startup phase.

Compensation in this ecosystem, as in any, will always be hotly debated, but I hope that we are in a place to start making progress on some of these ideas in the near future.

* Note: Vesting timelines should likely be elongated if employee stock compensation is increased. The typical vesting period is four years today but, as Sam states, companies typically take longer that that to exit and if more equity is going to be given out to early employees the vesting timeline should better match the time to a liquidity event.

Venture Capitalists: Entrepreneurs Misunderstood Best Friends

“Entrepreneurs are not here to serve venture capitalists. We are here to serve entrepreneurs.”  – David Hornik, August Capital *

David’s quote above says it all. All too often it feels like entrepreneurs are here to serve venture capitalists, but that is just not the right way to think about things. VCs exits to serve entrepreneurs. Entrepreneurs are the ones that take the risk. They don’t have a net. They don’t have a portfolio to diversify them. As VCs, we can’t lose sight of this.

Back in 2008 at the first TECH cocktail conference, Dick Costolo referred to VCs as “[entrepreneurs’] misunderstood best friends” because he knows well that good VCs who recognize the VCs role (as service provider and partner to entrepreneurs) can bring a lot of value to a new venture.

While there are many things VCs bring to the table like operational experience, additional viewpoints, strategic thinking, capital etc., one of the most interesting is what VCs refer to as “pattern recognition.” Even the most prolific entrepreneurs will only start a handful of companies in their careers. VCs on the other hand invest in dozens of companies per fund and have many funds (if they are lucky enough). Through that exposure they generate many data points that can help the decision making process in any one venture they are invested in or working with. This knowledge transfer can help to grow the startup ecosystems the VCs serve and help the VCs become great service providers and partners to entrepreneurs.

At the end of the day, we’re not running the companies. We are there to help, guide and hopefully provide unfair advantages to our entrepreneurs. We exist to serve.

* From the book “Give and Take” by Adam Grant

Kubrick on the Meaning of Life

I recently came across a 1968 interview with Stanley Kubrick where he discusses the meaning of life. I really enjoyed his thoughts on the matter. I hope you will too.

The very meaninglessness of life forces man to create his own meaning. Children, of course, begin life with an untarnished sense of wonder, a capacity to experience total joy at something as simple as the greenness of a leaf; but as they grow older, the awareness of death and decay begins to impinge on their consciousness and subtly erode their joie de vivre, their idealism — and their assumption of immortality. As a child matures, he sees death and pain everywhere about him, and begins to lose faith in the ultimate goodness of man. But, if he’s reasonably strong — and lucky — he can emerge from this twilight of the soul into a rebirth of life’s elan. Both because of and in spite of his awareness of the meaninglessness of life, he can forge a fresh sense of purpose and affirmation. He may not recapture the same pure sense of wonder he was born with, but he can shape something far more enduring and sustaining. The most terrifying fact about the universe is not that it is hostile but that it is indifferent; but if we can come to terms with this indifference and accept the challenges of life within the boundaries of death — however mutable man may be able to make them — our existence as a species can have genuine meaning and fulfillment. However vast the darkness, we must supply our own light.

Read more from this interview

Why now? A key question for new ventures

Whenever a pitch deck comes across my desk I have a handful of key questions running through my mind. One of those is: Why now?  I am continually surprised by how many entrepreneurs don’t have an answer for this question or have not thought it through. Often, ideas have been tried in the past and have failed. Answering the question “Why now?” forces one to think about why things are different this time around. The YouTube story is instructive here and fortunately we have Botha’s investment memo so we can get to YouTube’s “Why now?” quickly.

In his investment memo, Botha highlights two key drivers of YouTube’s future growth:

  1. Digital video recording technology is for the first time cheap enough to mass produce an integrate into existing consumer products
  2. Broadband internet in the home has finally reached critical mass, making the internet a viable alternative delivery mechanism for video

Those two points answer the “Why now?” question clearly. Previous to those two trends hitting their stride, video was hard to capture (for consumers) and the internet was not a viable delivery mechanism (too slow). Folks still tried to distribute video online prior to YouTube, but they were sailing into a headwind. YouTube, on the other hand, had the wind at their backs.

When thinking about your company it is worth thinking through the “Why now?” question if only to help you understand potential headwinds and tailwinds. Also, savvy investors will be thinking about this question whether they bring it up directly or not.