The Four Instruments
The core essence of a venture builder lies in its ability to provide tangible and differential value to startups within its portfolio. The effectiveness of a venture builder is contingent upon its staff's capability to transfer technology and knowledge efficiently. Additionally, robust control and supervision are vital. Failure in these areas signifies a fundamental failure of the venture builder itself.
This necessitates a more stringent evaluation of a venture builder's performance compared to that of entrepreneurs or investors. Entrepreneurs contribute immense effort and dedication yet typically hold a minority share in a venture builder's startup. Meanwhile, investors inject substantial financial capital in exchange for company stakes. This symbiosis is designed to enhance the team's prospects for success. Why? Because the venture builder contributes the most crucial elements for each startup's success: knowledge, technology, and most importantly, the experience to make strategic, financial, and technological decisions accurately.
However, "with great power comes great responsibility." If a venture builder's management fails to adequately support a startup or, worse, impedes an entrepreneur's work, the resulting damage can be swift and devastating, rapidly devaluing the companies and the entire portfolio. This is the inherent risk in the asymmetric nature of the venture building model.
Recognizing the urgency and importance of correctly deploying and communicating the promised differential value, a venture builder must not only provide but also effectively communicate this value to its partners, highlighting the benefits of this collaboration.
To aid in these critical functions, we have developed the model of the four instruments.
What Are the Four Instruments?
We have pinpointed four instruments that encapsulate the venture builder's role in fostering a portfolio of valuable companies. These instruments are akin to the lifeblood of the builder, ensuring the startup's vitality and the seamless flow of managerial expertise. Without these instruments, there would be no discernible difference between a venture builder-backed company and any other ordinary company.
These four instruments encompass all vital interactions that should transpire between the venture builder and its portfolio startups. They also serve as a benchmark for the management to assess its performance and articulate to investors and entrepreneurs the critical, ongoing — and occasionally unseen — work being done within the startups.
The following table presents a comprehensive inventory of resources and assets provided by the builder, categorized under the four instruments: Control, Transfer, Motivation, and Externalization.
The control instruments are pivotal for the venture builder to maintain oversight of the startup's activities. These tools safeguard against decisions that could harm the interests of the partners, such as incurring debts or transferring assets to third parties. They also protect the partners from potential naivety or malfeasance on the part of the entrepreneurs.
Transfer instruments are essential for conveying the knowledge, resources, and technology from the builder's management to the startups. These assets can range from technological elements like application source code or specialized equipment, to financial resources or commercial reputation. Transfer instruments are the most visible and defensible aspect of the builder's contribution as a partner.
Motivation instruments are established by the builder to incentivize entrepreneurs and modulate the distribution of wealth, reputation, and knowledge generated from entrepreneurial efforts. While financial distribution is a common form, the spectrum of motivational tools is broad and varies with each case.
Outsourcing instruments enable startups to delegate certain operational aspects, allowing entrepreneurs to focus on critical activities such as business development or product creation. Examples include facilitating startups to outsource tasks like grant writing, accounting, or space leasing.
Without the seamless functioning of these four instruments, the builder's effectiveness as a co-founder is significantly compromised. Conversely, if all instruments operate effectively, even if they occasionally require fine-tuning, the venture builder can provide immense value to its partners, substantially enhancing the startup's prospects for success.
In the following sections, we delve into each of the Four Instruments, detailing their operation and providing illustrative examples for each.
Control Instruments
Control instruments are pivotal in garnering investor trust in startups. They form the bedrock of the builder's ecosystem, making it organized, secure, and controlled. These tools are especially crucial in mitigating risks associated with first-time entrepreneurship, as they create mechanisms that shield partners from potential naivety or malfeasance of the involved parties.
Here, we outline the key control instruments.
Shareholder Majority
The most straightforward and often contested control mechanism is the builder's majority shareholding. Typically, the builder holds the majority of shares in a company, which might be unexpected for less experienced entrepreneurs.
There are various reasons for this majority ownership, which might not be immediately apparent to entrepreneurs. These reasons are multifaceted and extend beyond the short-term planning horizon that entrepreneurs often focus on. This situation underscores the importance of the builder's majority ownership: their deeper understanding of corporate matters and ability to make long-term, strategic decisions for the company's benefit.
As a point of reference, let's consider that the builder initially holds 55% of the shares in a startup. This leaves the remaining 45% to be divided among the entrepreneurs. The rationale behind this distribution is that, following a 10% dilution in subsequent financing rounds, the builder's stake reduces to 50% — a percentage that still allows for significant control, as we will discuss later. Conversely, as shown in the table below, this leaves each entrepreneur with 20% in scenarios where there are two entrepreneurs involved:
Furthermore, this ownership structure is strategically designed to accommodate the future entry of a new investor in exchange for a 10% stake. In such a scenario, the builder's share would decrease to 45%, leading to a loss of majority control at the shareholders' meeting.
However, this loss of majority is not particularly concerning in this context. As the company evolves and attracts new investors, it validates the entrepreneurs as competent and trustworthy partners. This progression lessens the necessity for the builder to maintain majority control. Essentially, the business's growth and the interest from new investors serve as endorsements of the entrepreneurs' capabilities and reliability.
This scenario underscores a key rationale behind why the builder initially holds the majority: the builder is often seen as the most trustworthy partner by both entrepreneurs and investors. With the most to lose from any malpractice, the builder's majority stake ensures stability and trust during the early, more vulnerable stages of the startup.
As the company matures and additional partners join the board and shareholders' meetings, this influx of new oversight and supervision further alleviates the need for the builder to maintain stringent control. The evolving dynamics of the board, coupled with the startup's growth, create a more balanced and self-regulating environment.
Board of Directors
The company's administration is a fundamental aspect of its control. While certain decisions are made at the General Meeting based on shareholding, it's the administrative body that handles day-to-day operations, such as managing bank accounts or signing commercial agreements.
The Board of Directors is a crucial control mechanism for the company's success. Therefore, careful consideration should be given to the design and structure of the Board for each startup. This involves determining the appropriate members and the type of administrative body best suited for the startup's needs.
We advocate for a Board of Directors consisting of three members: two from the venture builder and one being the entrepreneurial CEO of the startup. In terms of company representation, the ideal setup would include two supportive CEOs: the entrepreneurial CEO and one builder member.
This configuration offers several advantages and fewer drawbacks compared to other models, although it highly depends on each startup's specific circumstances.
The benefits of this approach are multifold. Firstly, managing through a Board of Directors allows for more sophisticated administrative control, which becomes increasingly important with the entry of external investors. Secondly, it facilitates dual representation of the company, eliminating the need for both individuals to be present simultaneously. Furthermore, this setup empowers both the CEO and a builder member to act independently, reflecting the essence of the partnership between the builder and the entrepreneur. It acknowledges the responsibilities each party holds, balancing control with entrepreneurial freedom.
The Tasks of a Board Member
Serving on a board of directors is both a privilege laden with responsibility and an opportunity to significantly influence a business's future. It's vital that management members appointed to this role understand their responsibilities and what is expected of them.
Fundamentally, the board of directors is the body responsible for managing and administering a company, with its primary goal being to create value for its partners. Key functions of a company's board of directors include:
- Defining the company's strategy.
- Establishing and controlling annual budgets.
- Supervising senior managers' work (formally, it's the General Shareholders' Meeting that approves or disapproves their management, often upon the board's recommendation).
- Setting the remuneration policy for senior managers.
- Authorizing share transfers.
The healthiest relationship between a director and an entrepreneurial CEO is one of mutual respect and collaboration. An effective director is understanding and supportive, yet honest and transparent about their vision for the company, encompassing both opportunities and challenges.
When advising the CEO, sharing examples or anecdotes from other successful ventures can be a powerful tool. Success stories often have a profound impact on a CEO's mindset and decision-making.
How to Conduct a Board Meeting
Board meetings are the council's primary instrument, serving as forums to discuss the most pertinent issues for the company and its partners.
In terms of conducting a board meeting, it's crucial to prepare and agree upon the agenda beforehand. All too often, board meetings devolve into impromptu decision-making sessions. This approach is flawed for several reasons. Firstly, strategic decisions demand contemplation and consultation. Secondly, the formal nature of these meetings means that discussions are recorded and have legal implications.
Therefore, it's recommended that directors align on discussion topics and resolve any differences before the meeting, ensuring a focused and effective session.
Reserved Matters of the Shareholders Agreement
Reserved matters in the shareholders' agreement serve as an effective control mechanism in scenarios where the venture builder does not hold a majority of shares or has a minority presence on the board of directors.
To counterbalance these minority situations, partners can stipulate reserved matters for the council or board. These are critical issues that a partner, such as the venture builder, can veto when necessary.
For instance, in a company with a five-member board where the venture builder has only two seats, the shareholders' agreement could specify that certain decisions require approval from four out of the five members, rather than the simple majority of three votes.
This arrangement ensures that for decisions classified as reserved matters in the shareholders' agreement, the builder retains a decisive vote.
Below are examples of typical Reserved Matters of the Board of Directors:
- Signing contracts or commercial relationships with Related Persons.
- Determination of remuneration for directors, administrators, or executives of the Company.
- Granting or revocation of individual, joint, or general powers.
- Company indebtedness, financing, or operations exceeding TEN THOUSAND EUROS (€10,000) per year.
Similarly, for matters under the General Meeting of Partners' jurisdiction, the shareholders' agreement might require a 70% majority for certain decisions, as opposed to a simple 50% majority.
Some examples of Reserved Matters of the General Meeting of Members include:
- Modifications to the structure of the Company's administrative body and the number of its members.
- Approval of annual accounts and distribution of results.
- Request for bankruptcy declaration of the Company, except when mandated by law.
- Dissolution and liquidation of the Company, except in mandatory cases under current legislation.
In all instances, the purpose of reserved matters is to safeguard the entire startup. They are not designed to favor the builder but to protect the startup and ensure its continuity and stability.
Transfer Instruments
Transfer instruments are the most visible aspects of the builder's contribution as a co-founder. They add significant value to the partners and expedite processes that might otherwise be delayed, leading to inefficiencies and resource wastage.
We emphasize that the builder facilitates two types of transfers: from the builder to the startup, and between startups. These flows of knowledge and resources are crucial for the success of the builder's startups. Therefore, the venture building model employs various mechanisms to ensure these transfers are regular and efficient.
Below are some key transfer instruments utilized by the builder to support startups.
Money
The provision of financial resources is a fundamental transfer instrument. It enables startups to make investments and acquire talent. While the transfer of money is often the most noticeable aspect for entrepreneurs, it tends to become less critical as the company matures.
The builder's financial contribution typically occurs at the company's inception. However, there are models where the builder invests in different phases, contingent upon the startup reaching specific milestones.
Investing money is a primary activity of the builder, meriting a detailed discussion in a separate section.
Debt
Financial loans are an extraordinary transfer instrument, assisting startups in navigating particular challenges. Commonly, the builder lends money to address temporary liquidity issues or to facilitate the acquisition of a resource.
Debt is an extraordinary measure, generally requiring the approval of the venture builder's board, as it often represents an unforeseen expenditure. When implemented, it significantly eases the financial pressures on the startup in a timely and effective manner.
Another method for builders to support a startup's finances is by underwriting guarantees for the startup's bank loans. Again, this is considered an extraordinary measure.
Customers
Transferring commercial contacts is a frequent and highly beneficial instrument. It significantly accelerates the startup's commercial development.
For a new team forming a startup, initial customers are essential for product development and problem research. Within a venture builder environment, the builder's management often can provide an existing network of clients or facilitate sales processes.
Early access to potential clients enables the startup to quickly uncover the keys to business success. Hence, these initial customer networks are invaluable in speeding up the startup's validation process, making it a crucial transfer instrument.
Reputation
Transferring reputation, although an intangible instrument, provides a tangible competitive edge over startups beginning from scratch.
In a venture builder setting, new startups can leverage the reputation of the builder or its partners. This is especially valuable in the early stages when a startup lacks recognition, and potential clients might be wary of its capabilities.
The presence of an experienced and reputable team behind a new startup instills greater confidence in clients and suppliers. Therefore, the transfer of reputation addresses a gap that would otherwise be challenging to bridge.
Startups often highlight their association with prominent builder partners on their websites. They may also present themselves as a spin-off from one of the builder's corporate partners. These practices exemplify how the transfer of reputation from the builder to the startup is actualized, with each builder adopting unique strategies for this transfer.
Processes
Process transfer, though often underappreciated by entrepreneurs, plays a pivotal role in the medium-term success of a startup.
This mechanism involves the venture builder imparting established processes to the startup. Designing processes can be a time-consuming and challenging task for any company, and neglect in this area can lead to significant inefficiencies. Therefore, having access to pre-established processes is a boon for entrepreneurs, sparing them the trial-and-error phase of developing these systems.
Moreover, these processes are designed by an operating company with foresight into organizational and technological aspects not yet envisaged by the entrepreneurs. This allows the entrepreneur to benefit from a momentum they may not fully understand but is highly advantageous.
The design and implementation of standardized processes are critical in a builder's management, warranting a dedicated section in this guide:
Technology
Technology transfer is highly valued by entrepreneurs partnering with a builder and is a key advantage of companies incubated within a venture builder environment.
Technology can be transferred in various forms, such as sharing source code, licensing APIs, providing specialized equipment, granting access to exclusive programs, or offering discounts on development outsourcing.
The approach to technology transfer varies among builders, depending on their technological capabilities. Builders lacking in technological assets should consider investing efforts in accumulating or creating technology to enhance their value as a partner.
It's important to note that technology should be accounted for as an asset, as detailed in the section on account assets. This means technology transfer should be reflected on the balance sheet, contributing to the startup's valuation.
Suppliers
The transfer of suppliers is an instrument that entrepreneurs might undervalue initially, yet it plays a crucial role in a startup's early success.
Navigating the supplier landscape is challenging but pivotal for any startup's success and scalability. Usually, identifying suitable suppliers under favorable terms is the culmination of years of negotiations and comparative analyses.
For a new company, working with pre-vetted suppliers chosen by the builder, under pre-negotiated terms, can be incredibly advantageous. This transfer spares startups from the headaches and production pitfalls that could be detrimental to their progress.
Talent
The transfer or assignment of talent by the builder or its partners to startups is a common practice. Sometimes, this is a deliberate action: a startup in need of staff may utilize development hours from the builder's or partners' technical team. Additionally, partners may provide their employees with opportunities to join startups.
Spontaneous talent transfers also occur, where startup employees attract new talent into the builder's ecosystem, leading to their employment by other startups.
Venture builders focusing on specific technologies may even conduct specialized training programs for professionals. These programs not only enhance skills but also draw talent into the ecosystem. It's common for trainees to find placements within the builder's startups, either as interns or full-time employees.
In essence, a startup incubated within a venture builder benefits from the pull of specialized talent that the ecosystem naturally attracts, enhancing its chances of finding the right personnel.
Space
The transfer of physical space is a fundamental instrument in a venture builder's operations. Typically, venture builder offices double as coworking spaces, hosting all their startups. This not only benefits the startups but also becomes key to the success of the ecosystem as a whole.
Transferring space saves on the cost and effort of finding an office and fosters significant synergies between the builder and startups, as well as among the startups themselves. Sharing a workspace is crucial for engaging in spontaneous, often pivotal, conversations crucial to startup management.
Moreover, a shared space enhances the builder's ability to supervise, control, and transfer knowledge, technology, and equipment. It also aids in transferring reputation, as the office environment contributes to the company's visible image.
Motivational Instruments
Venture builders utilize various motivational instruments to ensure stable and lasting co-founder relationships and to provide psychological support to entrepreneurs facing the formidable challenge of starting a business.
From our experience, these motivational instruments are highly valued by entrepreneurs in hindsight, despite being challenging to appreciate initially due to their intangible nature.
Below, we highlight the four most significant motivational instruments in venture builder management.
Community
The human need to belong to a community is fundamental, especially so for entrepreneurs embarking on the extraordinary journey of starting a business. Often, an entrepreneur's family and friends might not fully grasp the challenges they face, making the builder's startup community an essential source of moral support.
Communities of entrepreneurs organically emerge from builders' activities. Sharing similar experiences and a workspace, entrepreneurs often develop friendships and support each other through tough times.
This aspect is particularly beneficial for builders focused on a specific technology or industry, as it fosters exchanges of specialized knowledge that wouldn't occur among entrepreneurs from disparate sectors.
Thus, the community serves as a vital motivational instrument for entrepreneurs, indirectly influencing the startup's chances of success.
Ownership
Ownership is a complex motivational instrument in venture building, potentially leading to contention during the startup creation process, yet it's also an essential element in managing a venture builder.
Open and transparent discussions about startup ownership between the builder and entrepreneurs are crucial from the outset. The primary drive for most entrepreneurs is the aspiration to own their own business, making share ownership a key motivator. However, the venture builder must maintain a degree of control to ensure business continuity and be cautious about granting political rights to entrepreneurs.
Balancing the entrepreneurs' need for ownership with the builder's investment strategy is a delicate task, especially when the entrepreneurial team expands, reducing individual ownership percentages.
From our experience, scenarios where each entrepreneur holds less than 15% are not ideal, as they can lead to long-term frustration. Additionally, external parties, like investment funds or public institutions, might perceive such entrepreneurs as not being the genuine driving force behind the startup, potentially excluding it from support programs or investment opportunities.
Stability
Stability, although not immediately apparent to the builder, is a highly valued motivational instrument among entrepreneurs, especially in the early stages of their entrepreneurial journey.
In a study conducted in Spain with 164 entrepreneurs from various venture builders, we explored why they considered partnering with a builder advantageous. Some of these entrepreneurs didn't receive significant technological or financial support from their builders, yet they still positively valued their association.
Many entrepreneurs highlighted the “structure” and “stability” provided by a builder as crucial differences compared to starting a business alone. They felt more secure and less isolated in their entrepreneurial endeavors.
A common thread among these entrepreneurs was past experiences with failure, emphasizing the challenge of driving a business forward alone. Having an experienced co-founder, even one not contributing technology or funds, was seen as highly beneficial.
Sharing the entrepreneurial journey with the builder's management or sharing decision-making responsibilities significantly reduces stress and enhances learning. Therefore, stability is a motivational instrument that builders should manage consciously and deliberately.
Salary
Salary as a motivational instrument is subject to debate and can be a source of contention if not managed transparently. Therefore, the builder should establish and communicate a clear policy regarding financial remuneration and handle each case with foresight.
Entrepreneurs within a builder typically expect a salary sooner than they would in independent ventures. Thus, salary becomes a significant motivational factor. However, it's essential to remember that entrepreneurship is fundamentally an investment. The primary motivation should be the long-term financial opportunity, not immediate monetary gain.
In practice, startups usually forgo salaries until they generate sales. Many venture builders, however, advance the timeline for entrepreneurs to receive a salary, which surveys indicate is a strong motivator.
Regarding salaries, differentiation between the compensation offered to CEOs or CTOs is common. Technical profiles might receive a salary earlier, but this often correlates with a smaller equity share.
It's crucial to clarify to entrepreneurs that founding a startup is not akin to a regular job. Misunderstanding this can lead to conflicts. Founding a startup with a builder is an investment where the entrepreneur contributes through work, just as the builder invests with capital, technology, and equipment.
Managed effectively, salary can be a powerful motivational tool, significantly enhancing entrepreneurial performance.
Outsourcing Instruments
Outsourcing instruments allow startups to delegate certain operational aspects, enabling entrepreneurs to concentrate on core activities.
Here are some common outsourcing instruments, which can vary among builders.
Accounting
Accounting, often seen as tedious and complex, is a critical aspect of any business. Many builders take on the accounting tasks for their startups, providing this service like an external consultancy but at a more reasonable cost and with a comprehensive approach.
While CEOs should have a basic understanding of accounting due to its strategic importance, the bulk of the work involves data processing tasks, which can be efficiently outsourced. By offering accounting services, venture builders alleviate a significant administrative burden from startups.
Grant Writing
Outsourcing grant writing to the builder or a partner company is hugely beneficial for startups. This task requires deep business knowledge and familiarity with the technical and legal aspects of grant applications.
Startups often outsource this to specialized firms. In a venture builder setting, the management can undertake this task, leveraging their knowledge of the startups and the grant processes. This avoids duplicating efforts across multiple companies applying for the same grant.
Given the builder's intimate knowledge of its startups, it can produce more accurate grant applications than an external consultant, increasing the chances of success.
Grant writing is thus one of the most advantageous outsourcing instruments for startups within a builder.