Fall From Grace

By Andrew Sessa

To the casual observer, it may look like a rough time to be a founder-CEO. Stories of startup founders behaving badly have filled the pages of the Wall Street Journal and the airtime on CNBC. Disruptive companies that once promised to deliver good returns and change the world for good have seen their tremendous valuations drop precipitously, if not disappear entirely, as a result of their founders’ actions. WeWork’s Adam Neumann, Theranos’s Elizabeth Holmes and Uber’s Travis Kalanick became household names — first cited as visionary leaders, now as cautionary tales.

Each of these messianic figures rose to fame, power and riches on the strength of their moonshot ideas, their compelling stories and their charismatic personalities. They attracted abundant funding and fawning attention from investors, the media and the public. But many of their seeming strengths — and the control they wielded as a result — proved both blessing and curse. Previously seen as their companies’ greatest asset, these founder-CEOs proved to be their businesses’ biggest liability.

False Promise

The latest scandal played out at WeWork, where a $47 billion valuation dwindled to $8 billion before the company called off its late-2019 IPO plans. Prior to his ouster, Neumann had spent nearly a decade claiming that his co-working company would create a moneymaking communitarian utopia — a “capitalist kibbutz” as the Israeli-born entrepreneur put it — that could expand into apartments (WeLive), finance (WeBank), schools (WeGrow) and more. Energetic to the point of frenzy, with the charisma of a cult leader, and, at 6’ 5,” physically dominating, Neumann famously charmed Japan’s SoftBank into making an initial $4.4 billion investment in his company after just a 12-minute tour of its headquarters.

At the same time, Neumann was leading tequila- and marijuana-fueled retreats, spending lavishly on such items as a $60 million corporate jet, and, perhaps most gallingly to investors, personally profiting from rents WeWork paid to lease space in buildings he partially owned. As the managing member of a private company that trademarked the word “We,” he also forced WeWork to fork over nearly $6 million for the rights to the word.

His erratic behavior and the company’s questionable financials came home to roost on the eve of the now-scrapped IPO — whose prospectus, The New York Times noted, “was quickly ridiculed for its incoherence.” Within weeks, Neumann parachuted out of the company on a $1.7 billion exit package and SoftBank took over.

For early investors who thought they were about to ride a unicorn to sky-high stock gains, WeWork failed to follow through on its magical promise. The same can be said of Theranos, whose value crashed from $9 billion to zero after founder-CEO Elizabeth Holmes’ grandiose claims turned out to be nothing more than smoke and mirrors — and she was charged with fraud. Uber's Kalanick, for his part, built his business based partially on his rule-breaking brashness, driving the company's valuation upwards of $70 billion, but his bad-boy style led to his leaving the company amid accusations that he fostered a workplace plagued by sexual harassment, gender bias and other unacceptable behaviors. Uber still IPO-ed, but it never went up much past its initial $45 share price, and was recently trading in the $20s.

“God’s Gift to Technology”

All of these cases are different, but each centers on the erratic and even narcissistic behavior, unconventional management style, personal eccentricities and corporate maleficence of CEOs who at first seemed infallible — until they failed. And those failures didn’t just affect their own fortunes. Because they’d become so synonymous with their corporate brands, their downfalls dragged their companies down as well.

Although these are extreme examples, they are hardly isolated incidents. Recent research by Yan “Anthea” Zhang, Fayez Sarofim Vanguard Chair Professor of Strategy at the Jones Graduate School of Business at Rice University, found that more than half of startups that received venture capital funding between 1995 and 2013 had replaced their founder with a new CEO by the time they launched their IPO. Other studies, meanwhile, have shown that some traits common among entrepreneurs make them prone to the sort of unpredictability that can be their downfall.   

John Gartner, a Baltimore-based clinical psychologist and assistant professor at Johns Hopkins University Medical School, offers an explanatory diagnosis: “As a group — and there are exceptions, though relatively few — entrepreneurs have hypomania.”

“Hypo is Greek for ‘lesser,’ so it’s not that they have bipolar disorder,” explains Gartner, who wrote “The Hypomanic Edge: The Link Between (A Little) Craziness and (A Lot of) Success in America.” “I like to say that, ‘If you’re manic, you think you’re Jesus; if you’re hypomanic, you think you’re God’s gift to technology.’”

Hypomania isn’t entirely a disadvantage for entrepreneurs; it carries strengths as well, Gartner explains. Those include extraordinary creativity, confidence, charisma, energy and drive, which allow them to have big ideas, to act on them and to bring others on board. They have the messianic ability, he says, to “create buzz around a movement that didn’t exist before, to make it seem inevitable.”

The downsides of hypomania, however, include impulsivity, irritability, and impatience, which can cause entrepreneurs to jump into action without thinking, demonstrate poor judgment, be arrogant about the value of their ideas and fail to consult with others, Gartner says. “Something that differentiates successful entrepreneurs from unsuccessful ones,” he says, “is the ability to listen to non-hypomanic individuals.” 

Several other mental health conditions are more common among entrepreneurs as well, according to Michael A. Freeman, a psychiatrist and University of California San Francisco School of Medicine professor. Freeman coauthored a 2015 study in which 72% of entrepreneurs reported mental health concerns, compared to 48% of the non-entrepreneurs surveyed. Those in the entrepreneurial group were significantly more likely to say they were affected by depression, attention deficit hyperactivity disorder (ADHD), substance use conditions and bipolar disorder.

As with hypomania, however, these conditions also come with advantages. Depression, for example, has been linked with empathy, which could help a CEO engage more meaningfully with those around them, Freeman notes, and with realistic judgment, which can lead to more grounded decision-making. When it comes to the entrepreneurial personality profile, Freeman cites characteristics that could easily describe Neumann, Holmes and Kalanick: Though they can prove open-minded, creative and flexible, they’re also driven, mission-focused, action-oriented, assertive, self-sufficient and open to more risk than the general population.

Minimal Oversight

Gartner and Freeman’s work helps explain why some entrepreneurs might excel at coming up with disruptive ideas, launching innovative businesses and developing cult-like followings — even if they then prove constitutionally unfit to run those companies. But it doesn’t explain how they manage to convince investors to buy in, and to the tune of hundreds of millions, if not billions, of dollars with seemingly minimal oversight.

Alessandro Piazza, a Rice Business management professor who studies high-tech entrepreneurship and corporate scandals, chalks this up to two key factors: an overabundance of capital at all levels and a reliance on a startup’s and its founder’s story rather than the business fundamentals.

“It is both difficult and time-consuming to evaluate ventures,” he explains, “and most of the due diligence stuff is profoundly boring.”

What we prefer instead, Piazza continues, are good stories. And those narratives, rather than a business’s actual viability, are what often drive investment these days. “Increasingly, founders must be good storytellers,” Piazza says. WeWork and Theranos, especially, used strong rhetoric and compelling stories — “Israeli kibbutiznik creates communitarian utopia”; “Stanford dropout disrupts lab testing” — to cover up weaknesses.

Lately, Piazza observes, the expectation around startups seems to be that a strong, charismatic founder will build a mission-driven company around him or herself, sell the idea of the mission with a compelling story and then cast themselves as the sole person who can accomplish that mission.

“That creates a situation in which unruly behavior is accommodated,” he says. “What I find interesting about all this is that the whole system of corporate control and governance in America — the separation of the management running the company from the board of directors who they report to — is designed to make sure this doesn’t happen. These new startups have weak oversight by design. Founders don't recognize the value of an independent board that keeps you in check.”

Greg Putnam, an investment manager and lecturer at the University of North Carolina, believes a sense of “VC FOMO,” fear of missing out on the next big opportunity, also contributes to the lack of pre-investment due diligence, which leads to the unbridled entitlement of modern founders.

So what’s the solution? How can investors stop hitching their wagons to unhinged unicorns? Perhaps, Putnam and Piazza suggest, it’s all in how you train your unicorn.

“These examples,” says Putnam, “are calls to the folks providing that next-step capital —  the SoftBanks, the J.P. Morgans of the world, the VC funds — to say, ‘Founder X, Founder Y, we need to have some corporate controls written into how this is going to work.'" In other words, the TED Talk and the promotional video and the glossy marketing collateral aren’t enough. They don’t stand in for a real business plan, or governance structures, or standard operating procedures.

Putnam calls for a return to first principles — the fundamentals of business — and to previous levels of corporate oversight and governance. “In the old days, people used to talk a whole lot more about Excel spreadsheets, the internal rate of return, what the cash flow looks like,” he says.

“We have boards for a reason: to separate management and ownership. If we allow boards to become an extension of the CEO — and we see more and more that are stuffed with the CEO’s friends — it’s not good for the shareholders, and it’s good not for the company either,” Piazza argues. “The things CEOs do now wouldn’t have flown 20 or 30 years ago, when boards did a better job of monitoring their behavior.”

Part of the issue, he notes, is that these messianic startup CEOs are increasingly identified with the company — they don’t just lead the brand, they are the brand. So boards are afraid that the market might react negatively if the CEO resigns or is fired.

“How Do You Make Money?”

Zhang’s research shows that there is at least some measure of oversight often enough. She and her colleagues discovered that 41% of CEOs — both founders and non-founders — are replaced after a company gets its first round of VC funding. Still, she notes that founders are less likely to be replaced than non-founders, a fact she attributes to founders’ personal connection to their businesses and their significant share of ownership.

Her research also revealed that VC funds frequently make what she calls “calculated decisions” about changing CEOs. They replace those with the lowest human capital — in particular, the least experience with management and leading publicly traded companies. When they do, the CEO switch both increases a company’s value at the time of its IPO and its performance immediately after. “The higher the human capital of the CEO, the better the valuation and the operating performance,” she says.

And the relative human capital of founder-CEOs? Theirs tends to be lower rather than higher, she found. As companies like WeWork demonstrate, the charisma of a founder, the persuasiveness of a company’s origin story and mission, and the flashiness of its marketing materials can be inversely proportionate to the actual value of the company.  

At the end of the trading day, Zhang says, all we really need to know is: “What is the business? How do you make money? In business, we talk about business.”

Andrew Sessa is a Boston-based writer and editor.