Investors tend to prefer start-ups that agree to be managed by a professional CEO. Founder-managers can be simultaneously good and bad for their organisations. They have unique expertise and passion for novel business models, but their inflexible vision can threaten growth and survival. Olga Ryazanova, Peter Mc Namara and Niall Connolly describe how founder-led small businesses can loosen the grip of an initial mission when the market requires it.

In many businesses, there is an expectation for founders to step away, once the company has grown, and be replaced by professional managers who have stronger expertise in scaling up operations. When start-ups seek external funding, investors often require that a professional CEO steps in to manage the growth of the firm. The question of succession, however, is not always on the table. Many small and medium-sized companies continue to be led by their founders long after these companies have grown out of the initial start-up stage (Pahnke et al., 2022). Globally, recent figures show that 30 per cent of firms filing for initial public offering (which means that they have outgrown the start-up stage) are led by founders.

Having a founder at the helm brings about a paradox. Founder-managers can simultaneously be uniquely good and uniquely bad for their organisations. They have a deep passion for their firms, inspire the entire organisation with their vision, and can work tirelessly for business success. At the same time, the strength of their vision often creates strategic rigidity when a company needs to innovate its way into new markets or change its business model.

Strengths

Founder-managers usually have no problem in aligning the company’s strategy with its mission. Since they have created the mission in line with their view of the world, they understand it at a deep, almost subconscious, level. They are able to communicate it consistently to the organisation’s employees, customers, investors and other external partners. Consequently, companies led by founders are less likely to experience mission drift – situation where a company’s actions start to diverge from its core identity, alienating stakeholders and creating reputational damage.

Having built their company from scratch, a founder has a unique depth of knowledge regarding its resources and capabilities. While professional managers might have a deeper knowledge of external best practices and benchmarks, they might lack understanding of the company’s history and path-dependent processes that stem from it. Current processes might seem inefficient and messy; however, by trying to “fix” them, professional managers might alienate some key stakeholders within and outside the organisation. In most companies, organisational histories do not exist in a formalised manner, so a professional manager interested in uncovering the roots of current problems has to spend a lot of time putting the pieces together. Founder-managers, on the other hand, do not have this problem at all. They know everything about legacy products and technologies, have built strong relationships with employees whom they hired early in the start-up days, and can navigate organisational change with higher sensitivity to the disruption to the status quo. The founders have also been on a journey of discovery and experimentation as they were developing the current working business model. Along the way, they have accumulated a library of successes and failures, which gives them a good insight into what their company can and cannot do, given its current resources and capabilities.

Weaknesses

Unfortunately, the same mechanisms that create beneficial outcomes of having a founder-manager also create the challenges for the company’s ability to innovate in a radical manner. Radical innovation leads to the destruction of current capabilities or business models, brings companies to markets with different rules of the game, and is, consequently, more risky than incremental innovation. Sometimes this type of innovation is proactive, but often it is a response to the consistently negative feedback from the external environment or an environmental shock (such as change in regulations or sudden competitive threat).

Our experience studying founder-managers of established small and medium enterprises in Connected Health showed that these managers are more likely to cling to the original mission even if the information cues from the external environment indicate that this mission is flawed and needs readjustment. Even the founders who have created their companies with radically new business models in place could be reluctant to make any substantial changes to their strategies later on. Since the founder’s identity is embedded in the original mission (Grimes, 2018), changing that mission requires them to admit that their initial vision was flawed. This is a difficult psychological process, which many founders try to avoid by selectively filtering out negative feedback in a process akin to “double filtering”. This means that negative feedback which can be addressed through incremental changes is taken on board, and the feedback which requires radical changes is discarded. Founder-managers also seek information that aligns with their original vision and attribute any business problems to circumstances beyond their control, for example, macroeconomic trends or the behaviour of supply chain partners.

That is not to say that professional managers do not attend equally selectively to the negative feedback from external environment. However, the nature of selectivity is fundamentally different. Professional managers are looking to make changes that would allow them to achieve visible and externally valued results within the average time frame of a standard executive tenure (no longer than five years). Founder-managers are looking to make changes that would improve the business while still keeping it within the boundaries of initial vision they had at the inception.

Founder-managers fundamentally perceive business failure as a personal failure that threatens their professional identity (Ucbasaran et al., 2013). Entrepreneurial failure brings about a very real sense of grief to founder-managers, who seek to delay the moment of failure even if this is financially costly to them or other stakeholders. Because a probability of business failure is highly stressful for founder-managers, the companies led by them are more prone to threat rigidity. Threat rigidity is a situation in which a company fails to take acceptable risks to implement changes in response to negative performance feedback because the status quo (being unsuccessful, but somewhat alive) looks less threatening than the outcome of failing in the risky endeavour (going bankrupt). Research showed that small organisations are more prone to threat rigidity in response to negative performance feedback, because their lower financial resources poorly protect them from the risk of failure when they initiate change (Greve, 2011). Additional psychological cost of failure makes founder-led small companies even more risk-averse, and reluctant to engage in radical innovation.

Having deep personal relationship with customers can also constrain innovative activity of founder-led companies. This is particularly the case in B2B context, where founders are likely to have personally onboarded the early adopters of their company’s product and now can feel an emotional obligation to keep those customers happy, as a gratitude for their much-needed trust and financial support during early years. However, serving those customers can lock the company in with their legacy product or technology, shifting limited resources towards incremental adjustments rather than more radical product innovation or business model change.

Resolving the paradox

The benefits of having founder-managers leading established companies in technology-oriented sectors are numerous, from their unique expertise to their passion for truly novel business models. Yet, the inflexibility of their vision can undermine the company’s long-term growth or even survival prospects. For example, recent statistics by the Startup Genome project shows that 90 per cent of all new ventures fail (with 65 per cent failing within the first ten years), and that the key reason for failure is the excessive focus on the inner dimensions of the company.

That does not mean we should get rid of founder-managers. We celebrate those people and their ability to lead with passion and authenticity. We, however, acknowledge that few companies can be successful in the long term without evolving in line with the changes in the external environment. This means that, at some point, founder-managers have to construct a new identity for their companies and for themselves, if they are to continue being successful leaders. In our research we observed the following strategies that helped founder-led SMEs loosen the grip of an initial mission when the market required it:

1. Collaboration with trusted partners that are not perceived as potential competitors. Try joining consortia or collective research centres (an example of such centre in tech industry is Sirris).

2. Embracing technological complexity and letting the development of technology lead the company to new, unexpected places. Put more trust in your technical experts and avoid micromanaging the technology side of your business.

3. Expanding the search for new products and revenue streams beyond the boundaries of the firm. Combine the crowdsourcing of innovative ideas (for example, through platforms such as Wazoku) with disciplined experimentation to test the viability of these ideas for your business.

• This blog post represents the views of its author(s), not the position of LSE Business Review or the London School of Economics and Political Science.
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