How to spot the faultlines that could ruin your start-up

22 January 2020

By John Lyon

Starting an entrepreneurial venture is a risky business, statistically most fail. I should know I have been an entrepreneur, venture capitalist and angel investor over several decades now.

Most companies go bust because of cashflow problems, but that is the symptom. One of the primary factors that leads to a firm running out of money is its inability to make swift and consensual decisions - essentially the executive team has fallen apart.

Running a new venture is not just about the innovation, finance, marketing and all those business essentials, but working together as a team. If the executive board can’t function as a team, the business has no chance.

The softer skills around how a team functions, how it makes decisions and how it disagrees are, I believe, just as important for an entrepreneurial venture as finding the finance and how the executive team use the money.

An executive team is bound to disagree at some point, but it still needs to make decisions and move forward, so reaching a decision, and the process in doing that, is hugely important. Thus, trust is huge, because some in the team might disagree, but with trust they can accept it and move forward. If there is no trust then there is a danger of no decision being made and the firm stagnating. This lack of trust is usually because of a faultline.

Every member of the executive team will have social, economic and cultural capital, which could see them divide into groups that align around those three aspects, such as all attending public school, while the rest of the board are from state school. This is a potential faultline. Another, more common faultline, is between the idea-conceiving founders and equity-based investors.

Nearly all teams have potential faultlines that remain happily intact during the good times, but when the tough times come they open up and destroy companies. But with training and education these faultlines can be identified, managed and mended.

Faultlines can vary in strength. A strong faultline, and thus the most problematic, is one where the two subgroups involved are equal in size, the members of each group are very similar, and thirdly, and each subgroup is very different from the other; if the founders are all married women in their thirties and the investors are white men in their sixties, then this looks like a very strong faultline.

When these faultines become activated, people tend to revert to their defensive positions in terms of who they align with.

And yet most business decisions are about compromise, so these subgroups need to come together on an agreed position that is right for the business. But many fail because the team can’t work together and this is often down to a degradation in trust.

If they can’t come together to make a decision or the decision-making process becomes more protracted and fractious the venture is more likely to exhaust its investment and limited resources, leading to failure.

There are four phases of degradation in decision-making in entrepreneurial ventures:

  1. Sense-breaking: This is the destruction and breaking down of meaning, where the subgroups’ debate becomes an argument and both sides take entrenched positions, refusing to compromise. The heated boardroom debate fails to come to a conclusion or any decision being made. Both subgroups start to restrict the information being shared, with only selective data being shown.
  2. Sense-freezing: Little or no meaningful interaction between the subgroups with information flowing just from one of the groups. For example, a discussion about directors bonuses is not allowed due to the insistence of one subgroup that is not a valid topic for the board.
  3. Sense-forcing: No interaction between the subgroups with decisions imposed on managers, forcing them to comply with one subgroup. For example, the founders could be frozen out with investors now detailing decisions to managers. Trust has been totally lost.
  4. Sense-hiding: The subgroups now don’t talk, communicating only with external parties outside of the board, with little or no information shared. There may be some attempt to repair mistrust, but by now it rarely works.

This process of degradation is often irreversible. This is why it is imperative that potential faultlines are identified by the chair before they become active. The chair needs to intervene before the process of degradation begins, or at least, at its very earliest stage.

Thus, the chair needs to be aware of the subgroups in the board and of the sensemaking process; that is the debate, discussion and process towards making a decisions. This process can often take place outside of the boardroom as well, so the chair needs to be aware of the meetings and discussions being held in the pubs, cafes and corridors outside by the various factions.

They will have a sense of this in the boardroom meeting and if debate is being shut down and questions are not being asked, then the chair needs to intervene to make sure all voices are being heard. If quiet discussions are being held in dark corners, the chair needs to bring these out into the open to make sure decisions are made in the boardroom, not outside of it.

The chair has to understand and be aware of the power games going on inside the company, the politics that often drive people in different directions. Thus, the chair needs to be fully aware of the economic, cultural and social capital of each member of the board, they need to ask where does the real power lay?

Powerful directors, who perhaps have a bigger stake in the venture and hold most of the economic capital, may not be prepared to listen to other stakeholders, believing they hold the decisive power. The chair needs to make sure this is mediated and open debate is allowed.

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Indeed, the chair needs to be strong at mediating the debate and ensuring everybody has a fair hearing in meetings and that decisions reach a consensual realisation, otherwise degradation could easily begin along a faultline.

The first step for a chair to mediate the power games in a boardroom is to be fully aware of the faultlines and to actively manage them, while making sure decisions arrive through open sensemaking, where debate is accommodated and questions encouraged.

If they do not, they could be overseeing the downfall of a once promising business and the loss of millions of pounds of investment.

 

Find out more about entreprenurial ventures on the Entreprenurial Finance in Practice short course.

John Lyon is Professor of Practice in Entreprenuership and has held non-executive and chairman appointments spanning more than 25 years as both a venture capitalist and a personal investor. He is course director for Entrepreneurial Finance in Practice.

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