Complementary theoretical perspectives on the dismissal of new venture team members

Abstract This article is for venture capitalists (VCs) and managers belonging to a new venture team (NVT) who are interested in understanding factors that lead to NVT dismissal. Because dismissals can be a costly and ineffective way to improve venture performance, it is in a VCs interest to know when to avoid funding ventures that are likely to be impacted by dismissals. However, from an NVT perspective it is also essential that they avoid making costly mistakes that could lead to their dismissal. If NVTs could recognize signals that their actions were viewed as being detrimental to the venture, this recognition could enable them to take corrective actions and avoid being dismissed. Most importantly, if we understood the factors that were driving NVT dismissals, we could begin to evaluate how dismissals might be used to create long-term value for a venture's backers. Contractual covenants limiting salaries paid to venture managers were found to be related to fewer dismissals, which supports the view that clearly signaling the consequences of underperformance may motivate managers to perform better. We may also infer that contractual covenants can effectively align an NVTs financial incentives with those of the VC and the venture's board of directors. However dismissal covenants that force a change in the new venture team were an ineffective means of preventing dismissal. It may be that individual managers can only imagine dismissal covenants being used against other team members and not against themselves. Or it is possible that the use of explicit contractual covenants to signal the adverse consequences of underperformance may not eliminate dismissals if the signals are misunderstood or disbelieved. Moreover, these signals could be costly investments with uncertain returns. Practically speaking, we learn that specifying the conditions that will lead to a change in management is an ineffective mechanism for aligning the VCs interests with those of the NVT. This study found a negative relationship between sales improvement per employee since first-round funding and dismissal. This result is consistent with studies of large firms—dismissal occurs when firms perform poorly. Increasing the total number of seats on a venture's board of directors was negatively related to NVT dismissals; however, the effect reversed itself when the antecedent was the number of VC appointees on the board. This result raises the question of when VC appointees should borrow authority from their positions on the board to sanction (or even push for) a dismissal and when they should cooperate with other board members in being patient with an NVTs performance, even though as insiders they could band together to force a change in management. Before committing itself to fund a deal, a VC ought to consider how the structure of the board of directors will limit its power to affect changes in the composition of the management team. The larger the board, the more difficult it will be to make changes unless VC appointees occupy most of the seats. This study also found a negative relationship between procedural justice in the VC-NVT relationship and NVT dismissal. There is apparently a need to demonstrate that NVT dismissals are carried out fairly and are in the best interests of the venture, the NVT survivors, and the VC. Otherwise, survivors could be less enthusiastic about any success the venture might enjoy, because they might fear that they would not be employed long enough to enjoy it.