Although it’s a well-established practice for CEOs of U.S. listed companies to be replaced fairly regularly – between 11% and 12% of all CEOs in the Russell 3000 were replaced in 2020, for example, in line with the trend for previous years – in smaller private companies, this is far less the case, particularly where the original founder is the CEO. But are these companies not disadvantaging themselves by retaining CEOs for long periods, and when is it time for a new CEO?
While there are many very successful businesses that were led by the founders for many years – companies such as Amazon, Facebook, Microsoft and Netflix among them – the consensus is that founder CEOs should step down in favour of a professional CEO as the company starts to scale. This does not necessarily mean the founder leaving the business – in many cases they take up a different executive role, often being responsible for things like product development.
In fact, research into US start-ups that listed in the 1990s and 2000s showed only 50% of founders were still CEO after 3 years, dropping to 40% in the fourth year and less that 25% led their company’s IPO.
The reasons for this stem largely from the founder viewing the business as a ‘labour of love’ and believing that nobody else could have the vision and ability to run it. While this might be true when the business is still a start-up, as it grows so, too, does the nature of the business itself and professional leadership needs to be brought in. Potential investors recognise this and generally want to control the board (and, therefore, the choice of CEO) in return for investing.
Interestingly, research again shows that those founders that give up equity to attract investors build a more valuable company than those that try to retain all/most of the equity, so the value of their holdings, although smaller in percentage terms, is greater, too. This is sometimes referred to as the “Rich versus King” dilemma – whether the founder wants to retain control of the business (the ‘King’) or has a primary focus on building value (‘Rich’).
Established Business CEOs
Once the business is in the scaling phase and growing steadily, the question of when, and how, to replace the CEO changes.
Ideally, the company now has a professional board of both executive and non-executive directors. The board has the mandate of, amongst other things, performance management of the CEO. An important note here is that in family businesses, the CEO is often the majority shareholder (and founder), and the lines between shareholding and board votes become blurred. It is critical to understand the different roles of shareholder, director and executive (manager) in such cases and to ensure the board is empowered to carry out its duties.
The Institute of Directors South Africa identified five warning signs that a CEO might need to be replaced by the board. These are:
- Corporate performance – whether through falling (or flat) revenue, or other factors such as inability to attract / retain the right calibre of staff (often marketplace reputation decline precedes revenue drops). When the numbers are moving in the wrong direction, a change is indicated.
- Executive team performance / attitude – as mentioned above, the board is responsible for performance management, particularly of the CEO, but often including the whole executive team. Feedback from peers, staff, customers, suppliers and other stakeholders should form a part of this and will often highlight the need to replace a CEO.
- Circle of friends – if a CEO tends to surround themself with weak executives, or a circle of ‘friends’ and ‘yes-men’ this is a clear warning sign that a change is needed. The board needs to assess and monitor the calibre of the executive team and ensure that they are of the right calibre.
- Innovation – one of the key components of ongoing growth and success in a business is that it is constantly innovating – not just new products and services, but more efficient and effective ways of running the business, of attracting and retaining customers, and so on. Where innovation is stagnating, the company will generally start to suffer, so this is a good indication that change is needed.
- Corporate culture – the board should, as a part of its overall performance management, have feedback loops and other ways to interact with staff to understand how the leadership is perceived and how staff feel about the company as a whole. An unhealthy culture with dissatisfied staff is a clear sign of the need for change.
In all cases, it’s critical that the board properly understands the drivers of the business and are not simply reacting to a demand by shareholders for better performance when achieving such might be not feasible under current conditions. Many such replacements fail to deliver the performance expected and even lead to further declines, simply because the board did not properly understand the business and what could be expected.
Of course, there are also the obvious reasons for replacement, including malfeasance and breaching the duties of directors, but these are generally less common, although far more serious and require a very quick response by the board – remember it is the board, and the board alone, that can terminate the CEO.
And then there are the genuine reasons of retirement (‘early retirement,’ though, is more often a euphemism for being forced out) and the end of a defined contract period.
So, if you’re a founder-CEO, are you more focused on being “King” or “Rich” and how does this impact your business and personal goals?
If you’re a shareholder what are your goals for the company in terms of the performance of your investment – not just financially, of course, but from a broader stakeholder perspective – and how do you interact with your board on these matters?
And, if you’re a board member, does your board have active performance management and succession planning processes?
In all cases, whether a founder-CEO or a professional CEO is being replaced, for whatever reason, great care is needed with the process of finding and hiring the replacement which is why succession planning is such a critical function of the board and why high-performance boards maintain a list of pre-identified candidates.
Next week I will cover the issues of CEO succession – why many fail and how to maximise the chances of success.
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Some related posts and columns that might be of interest:
- The Role & Responsibilities of the Company Board
- 6 Temptations of a CEO
- What Happens to My Business IF…
- Pointers to a Successful Future for Your Business
- Proper Preparation for Productive Boards
- Does Your Business Own You, Or Do You Own It?
- Directors – Are You Risking Your Assets?
- The evolution of business
- The critical importance of boards to company success
- When is it time to replace yourself as the CEO of your startup?
- Replacing Oneself as CEO
- If, Why, and How Founders Should Hire a “Professional” CEO