When I started Loudcloud, I hired the best people that I knew—people whom I respected, trusted and liked. Like me, many of them did not have deep experience in the jobs that I gave them, but they worked night and day to make it work and they made great contributions to the company. Yet for many of them, there came a day when it was clear that I needed to hire someone with more experience to run the function I had previously entrusted to my loyal friend. Damn. How do you do that?

Should you do it at all?

The first question that always comes to mind is: “Do I really need to do this?” Who could I possibly hire who will work this hard and bleed the company colors like this?” Sadly, if you’re asking the question, you very likely already know the answer. If you need to build a worldwide sales organization, your buddy who did the first few deals is almost certainly not the best choice. As hard as it may be, you need to take a Confucian approach. You must consider first all of the other employees and second your friend. The good of the individual must be sacrificed for the good of the whole.

How do you break the news?

Once you make the decision, breaking the news will not be easy. It’s important to consider two deep emotions that the employee will feel:

• Embarrassment – Do not underestimate what a large factor this will be in his thinking. All of his friends, relatives and colleagues know his current position. They know how hard he’s worked and how much he’s sacrificed for the company. How will he possibly explain to them that he will no longer be part of the executive team?
• Betrayal – I’ve been there from the beginning, I’ve worked side by side with you. How could you do this? It’s not like you’re perfect in your job either? How can you be so comfortable selling me out?

Those are some powerful emotions, so get ready for an intense discussion. Ironically, the key to an emotional discussion is to take the emotion out of it. To do that, you must be very clear in your mind what you’ve decided and what you want to do.

The most important thing to decide is that you really want to do this. If you walk into a demotion discussion with an open decision, you will walk out with a mess: a mess of a situation and a mess of a relationship. As part of that decision, you need to be OK with the employee quitting the company. Given the intense emotions he will feel, there is no guarantee that he will want to stay. If you cannot afford to lose him, you cannot make this change.

Finally, you must decide the best role for him in your company. The obvious thing is to have him continue under his new boss, but this may not be the best thing for him, his boss, or his career. Your loyal employee will continue to have lots of knowledge about your company, competition, customers, and market that his new boss lacks. On the one hand, this can be a good thing—he can help get the new boss up to speed. On the other hand, when mixed with the intense emotions of embarrassment and betrayal, you might end up with a sabotage cocktail.

Another problem with this approach is that there is no way to paint him reporting to his old boss as anything but a demotion from a career path perspective. An alternative, if appropriate, would be to move him to another area of the company where his skills, talent, and knowledge will help. This kind of move will give him a chance to develop a new set of skills and help the company while he’s doing it. For young employees, getting experience in different areas can be super valuable.

Sadly, this is not a silver bullet since he might not want to work in another job; he might be hell bent on keeping his current job, so prepare for that as well.

Once you’ve decided to hire someone above your friend and decided on the alternatives that you’d like to offer him, you can have the conversation. Keep in mind that you cannot let him keep his job, but you can be fair and you can be honest. Some keys to doing that:

• Use appropriate language – Make clear with your language that you’ve decided. In fact, use phrases like “I have decided” rather than “I think” or “I’d like.” By doing this, you will avoid putting the employee in the awkward position of wondering whether or not he should lobby for his old job. You can’t tell him what he wants to hear, but you can be honest.
• Admit reality – If you are a founder/CEO like I was, it probably won’t be lost on the employee that you are just as under-skilled for your job as he is for his. Don’t dodge this fact. In fact, it’s fine to admit that if you were a more experienced CEO, you might be able to develop him into the role, but two people who don’t know what they are doing is a recipe for failure.
• Acknowledge the contributions – If you want him to stay in the company, you should say that and make it crystal clear that you want to help him develop in his career and contribute to the company. Let him know that you appreciate what he’s done and that your decision is a result of what’s next more than what’s previous. The best way to do this, if appropriate, is to couple the demotion with an increase in compensation. Doing so will let him know that he’s both appreciated and valued going forward.

Through all of this, keep in mind that it is what is and nothing you can say will change that or stop it from being deeply upsetting. Your goal should not be to take the sting out of it, but to be honest, clear, and effective. Your friend may not appreciate that in the moment, but he will appreciate it over time.

Two years ago we invested $250,000 in Instagram. Thanks to the spectacular vision and effort of Kevin Systrom and the Instagram team, the investment will be worth $78,000,000 when the Faceboook acquisition closes. The work that Kevin and team did will go down as legend in the industry and we thank them immensely. We also thank our co-investors Steve Anderson of Baseline and Matt Cohler of Benchmark.

Despite Instagram’s awesome performance and our monstrous return, a number of articles have come out criticizing us for not making even more money on our investment. Ordinarily, when someone criticizes me for only making 312 times my money, I let the logic of their statement speak for itself. However, in this case, the narrative that some critics put forth has the nasty side effect of casting two outstanding entrepreneurs—Kevin and Dalton Caldwell—in an unfair light and glosses over an important ethical issue that we faced. As a result, I will clarify what happened and why we didn’t make even more money.

When we invested in Instagram, it wasn’t actually Instagram. It was a company called Burbn, and the idea was roughly to build a mobile micro blogging service. Technologically, it was also different: an HTML 5 application rather than a native app. As Kevin iterated on Burbn, we made another investment in an excellent entrepreneur, Dalton Caldwell. Dalton’s company, Mixed Media Labs, initially built a product called PicPlz. PicPlz aimed to be a mobile photo sharing service built on its own social graph. Furthermore, the graph would be public like Twitter rather than private like Facebook.

Subsequently, Kevin noticed that while Burbn wasn’t taking off, the photo-sharing component of it was doing quite well. As a result, he pivoted Burbn into Instagram, which then competed directly with PicPlz. It’s important to note that Kevin did not steal Dalton’s idea—Kevin came to it organically based on the Burbn data.

Still, we needed to make a decision. Should we fund the venture round of PicPlz, Instagram, both or neither? We loved both entrepreneurs, but they were building the exact same product. Since we were less than a year old ourselves at the time, this kind of conflict—which happens frequently in the venture capital business as companies evolve—was brand new to us.

Here’s how it looked then:

• We liked both entrepreneurs very much, so there was no issue there—we would gladly back either.
• Instagram’s numbers were much better at the time as it had already begun its rocket run.
• From the perspective of the entrepreneurs, we’d invested in Dalton when he planned to build a photo sharing service, but we’d invested in a different initial product from Kevin.

After speaking with both entrepreneurs and much internal discussion, we concluded that funding Kevin to compete with Dalton would be a violation of the original implicit commitment we made to Dalton—to not fund competitors to PicPlz. On the other hand, funding Dalton did not violate our implicit agreement with Kevin because he changed his business—we’d funded Burbn not Instagram.

So our choices were: a) invest in Dalton b) invest in neither or c) invest in Kevin and violate our commitment to Dalton. As soon as we fully recognized those were the choices, we ruled out option c and elected option a.

However, we still had a problem: because we had invested in Kevin’s seed round, we had both information rights and pro rata rights to the series B. These are important and valuable rights, but it seemed completely unethical to us to exercise them since we funded a competitor. As a result, we unilaterally and without compensation or consideration gave Kevin back those rights and did not invest further in Instagram.

And that’s the thing that we did that many writers think was really stupid. Despite that, if we had to do it again, we would.

As an epilogue, Dalton later pivoted out of PicPlz and is now building an exciting new service called App.Net.

I’d like to make two things absolutely clear that some writers, in their zeal to find something wrong with our investment, have gotten completely wrong:

1. Kevin absolutely did not steal Dalton’s idea. He pivoted to Instagram because that’s where his users were—period, end of story.
2. We are excited and enthusiastic investors in Dalton’s company. Several reporters implied that we regret funding Dalton, because he did not sell his company to Facebook for $1 billion after two years. News to world: it generally takes longer than two years to create a billion dollars in value. What Kevin and team did was special and unique. We expect great things from Dalton and look forward to another massive return from his new idea.

So, write what you will about us, but please get that right.

A few months ago, my friend Joe Green sent me a video titled, “The Internet is My Religion”:

In it, Jim Gilliam gives us a short tour of his life’s story. I encourage you to watch the entire mind-blowing twelve minutes. In it, Jim tells the story of how after contracting life-threatening cancer, he went from following a popular movement—Jerry Falwell-branded fundamentalist Christianity—to creating two of his own. First, following the tragedy of September 11, 2001, Jim became an activist for a better America and produced a series of compelling documentary films to further his cause. In order to promote these films, Jim developed a series of techniques using the Internet to basically create a movement—i.e. to organize a group of people to do something. In this case, learn from his films and strive to improve the country. Later, we find that the cancer treatment that Jim received earlier in the story burned out his lungs requiring that he receive a double lung transplant or die. Finding a donor for two healthy lungs and a doctor willing to perform the insanely risky surgery is the mother of all long shots, so Jim had to start a new movement to get new lungs. Organizing people to save his own life profoundly impacted Jim’s view of how he should spend the rest of it. So much so that his personal domain is called 3dna.us to represent the 3 different DNAs that combine to keep him alive, a constant reminder that he cannot do it alone.

After recovering from the operation, Jim had a defining revelation. He realized that everything good comes from people working together to accomplish something important and, furthermore, that the Internet would be the great enabler of the most important endeavors. Unfortunately, harnessing the power of the Internet to start a movement turned out to be extremely complex. Nobody knew this better than Jim because he had to coordinate everything from email to social networking to blogging to rally people to his own cause. Being a world-class inventor and entrepreneur, he felt that it was up to him to step up and solve the problem. Furthermore, he believed that a company was probably the best vehicle to do it.

So Jim created a company to develop software to organize communities and get results and he called it NationBuilder. By the time NationBuilder was ready to raise money, Jim’s software implementation of his vision became ultra compelling. So much so that my friend Joe Green, who had an important history of organizing groups of people through his work as founder/CEO of causes, was so impressed that he joined NationBuilder as its president.

The product’s initial results were as impressive as the vision. Before getting to 10 employees, NationBuilder had over 300 paying customers. More importantly, the customers kept getting stunning results. Alex Torpey, a twenty-four-year-old with a breakthrough vision for using technology to improve government, ran for mayor of South Orange, New Jersey and defeated the far older incumbent. Alex is now the youngest mayor in the history of New Jersey. And he ran with no party affiliation.

But it was not really the early results that compelled me to invest in NationBuilder and go on the board; it was Jim’s vision that people connected and focused on a goal create everything great in the world. As he described the vision, I thought of every musician that needed to organize her fans, every author that needed to reach readers, every pastor that needed to encourage his members, and every person who wanted to make a difference, but didn’t know how. And then I thought of Jim’s personal story and I was in.

Never doubt that a small group of thoughtful, committed citizens can change the world; indeed, it’s the only thing that ever has.
―Margaret Mead

When a company starts to lose its major battles, the truth often becomes the first casualty. CEOs and employees work tirelessly to develop creative narratives that help them avoid dealing with the obvious facts. Despite their intense creativity, many companies often end up with the exact same false explanations.

Some familiar lies

“She left, but we were going to fire her, or give her a bad performance review” – High tech companies tend to track employee attrition in three categories:

1. People who quit
2. People who got fired
3. People who quit, but it’s OK because the company didn’t want them anyway

Fascinatingly, as companies begin to struggle, the third category always seems to grow much faster than the first. In addition, the sudden wave of “semi-performance-related attrition” usually happens in companies that claim to have a “super high talent bar”. How do all these superstar employees suddenly go from great to crap? How is it possible that when you lose a top-rated employee before you can say “unwanted attrition”, the manager carefully explains how her performance fell off? 

“We would have won, but the other guys gave the deal away” – “The customer selected us technically and thinks we are the better company, but our competitor just gave the product away. We would never sell so cheaply as it would hurt our reputation.” Anybody who has ever run an enterprise sales force has heard this lie before. You go into an account, you fight hard, and you lose. The Sales Rep, not wanting to shine the light on himself blames the “used car dealer” Rep from the other company. The CEO, not wanting to believe that she’s losing product competitiveness, believes the Rep. If you hear this lie, try to validate this claim with the actual customer. I’ll bet you can’t.

“Just because we missed the intermediate milestones doesn’t mean we won’t hit our product schedule” – In engineering meetings where there is great pressure to ship on time—a customer commitment, a quarter that depends on it, or a competitive imperative—everybody hopes for good news. When the facts don’t align with the good news, a clever manager will find the narrative to make everybody feel better—until the next meeting.

“We have a very high churn rate, but as soon as we turn on email marketing to our user base, people will come back” – Yes, of course. The reason that people leave our service and don’t come back is that we have not been sending them enough spam. That makes total sense to me, too.

Where do lies come from?

To answer that question, I thought back to a conversation that I had years ago with the incomparable Andy Grove.

Back at the tail end of the Great Internet Bubble in 2001, as all the big technology companies began missing their quarters by giant amounts, I found myself wondering how none of them saw it coming. One would think after the great dot-com crash of April 2000, companies like Cisco, Siebel, and HP would realize that they would soon face a slowdown as many of their customers hit the wall, but despite perhaps the most massive and public early warning system of all time, each CEO reiterated strong guidance right up until the point where they dramatically whiffed their quarters.

I asked Andy why these great CEOs would lie about their impending fate.

He said they were not lying to investors, but rather, they were lying to themselves.

Andy explained that humans, particularly those who build things, only listen to leading indicators of good news. For example, if a CEO hears that engagement for her application increased an incremental 25% beyond the normal growth rate one month, she will be off to the races hiring more engineers to keep up with the impending tidal wave of demand. On the other hand, if engagement decreases 25%, she will be equally intense and urgent in explaining it away: “The site was slow that month, there were 4 holidays, we made a UI change that caused all the problems. For gosh sakes, let’s not panic!”

Both leading indicators may have been wrong, or both may have been right, but our hypothetical CEO—like almost every other CEO—only took action on the positive indicator and only looked for alternative explanations on the negative leading indicator.

So if you read this and it all sounds too familiar and you find yourself wondering why your honest employees are lying to you, the answer is they are not. They are lying to themselves.

And if you believe them, you are lying to yourself.

Major technology platforms tend to last about 25 to 30 years. This gives them time to gather sufficient developer momentum, enable a set of transformational ideas, build those ideas, and form a large industry around it. The platforms then sustain for an additional 5-10 years due to inertia and lock-in. Finally, when the shortcomings of the old platform become too much to bear — ­as with the Mainframe, Hierarchical Databases, and more recently the PC — a new platform emerges to take the old platform’s place and bring the future forward.

When I was a young man in 1990, I designed and deployed Silicon Graphics’ first wide area network using technology from a little known networking startup called Cisco Systems. The technologies and techniques that I used would prove to be the basis for the next 2 decades of networking architecture. Through the years, the platform that I grew up on has served the world extremely well, enabling the massive build out of the Internet itself. However, certain characteristics of the platform have remained remarkably closed and stagnant over the years.

The hubs and routers I first worked with did little besides forward packets. Switches have become smarter and smarter over time, but the dark side of these advances is that they have been made in an exceptionally proprietary and brittle way. As a result, only a select few companies have any ability to add new functionality and those that do, do so in a manner that makes customers wary to make even the simplest changes to their networks.

To make matters worse, the brittle nature of today’s networking platform severely hamstrings cloud computing. Amazon’s AWS, the largest cloud offering in the world, runs an embarrassingly feature poor network in order to maintain enough flexibility to support its service. Networking functionality that has been around for over twenty years such as multicasting, traffic isolation, and security isolation are absent from Amazon’s offering. When people ask me why more enterprises haven’t moved to the cloud, I point out that doing so would require reversing out the last 15 years of networking features from their applications.

This is why the data networking architecture of the past 30 years — characterized by extremely smart but highly propriety switches that are closed to 99.99% of would-be network developers — has finally run its course.

The Time is Now

In order to overcome the massive inertia associated with a dominant platform technology, two conditions must exist. First, there must be new, overwhelmingly important functionality that the old platform cannot support in a reasonable way. Second, the new platform must be able to coexist and interoperate with the old. Until recently, neither of these pre-conditions held for networking, but in past few years, changes in the surrounding ecosystem have made both true:

1. The Rise of Cloud Computing – The current architecture was developed to deliver packets between two stationary hosts, in a network under unified administrative control. Thus, globally distributed routing protocols along with manual configuration and scripting were largely sufficient. Today’s datacenter networks must cope with multiple tenants, each requiring stringent performance and isolation guarantees for their migrating VMs. The current architecture simply cannot handle these requirements.
2. The Rise of Server Virtualization – Previously, introducing new network functionality in a datacenter required a forklift upgrade. In a modern virtualized environment, all traffic passes through a software switch in the hypervisor before entering the physical network. By controlling these software switches at the edge, a new platform can assume control of the network without requiring a customer to change any parts of the physical networking infrastructure. Thus, the new architecture can be introduced without displacing the old platform.

Clearly, the time is now.

Enter the Innovator

Martin Casado began his career auditing networks at a government intelligence agency.  While trying to secure our nation against terrorist attacks, he became increasingly frustrated that current networking technology prevented him from solving mission critical problems. He needed a better platform that was so radically different that he knew that he’d have to build it himself. To do so, he journeyed to Stanford University where he connected with like-minded people in Stanford Professor Nick McKeown and UC Berkeley Professor Scott Shenker. McKeown and Shenker were equally frustrated with the current state of the networking art, but for a different reason. They taught network innovation, but it was almost impossible to innovate on the network. You see, real network innovation requires being able to work with real networks – i.e. real production traffic. Sadly, today’s networks are so fragile that no right-minded network administrator would ever allow experimental traffic and programs on her production networks. In fact, even the network administrators at Stanford said “no” to experimental traffic.

Once they joined forces, Casado, McKeown and Shenker sought a platform that:

• Completely virtualized the network making the network every bit as flexible as a virtualized server
• Decoupled networking software from proprietary hardware, so that any company could add any kind of functionality to the network – not just the major networking companies.
• Was infinitely scalable using commodity hardware

Building this new platform was a humongous effort – too big an effort to fund at the University level, so Casado, McKeown, and Shenker started a company, Nicira Networks.

Today Nicira Networks publicly unveiled its widely anticipated first product, the Network Virtualization Platform along with 5 major customers – AT&T, eBay, NTT, Rackspace and Fidelity Investments, who are currently deploying NVP.  I am thrilled to be a part of it and welcome all of you to the future of networking.

Disclaimer: Andreessen Horowitz is the major investor in Nicira and I am on the Board of Directors. 

Since Marc and I founded Andreessen Horowitz three years ago, we have raised $2.7 billion. That statement begs a few questions. The two most obvious are:

• Why did such a new venture capital firm raise so much money?
• How did such a new venture capital firm raise so much money?

To get to the answers, it’s useful to go back to the original motivation for starting Andreessen Horowitz.

After raising our first round of funding for Loudcloud in 1999, we went to visit our new venture capital firm and meet their full team. As founding CEO, I remember being quite excited to meet our financial backers and talk about how we could partner to build a great company. That excitement took a sharp downhill turn when one of the top partners said to me, in front of my co-founders, “When are you going to get a real CEO?”

I was completely stunned—the comment knocked the wind out of me. Our largest investor had basically called me a fake CEO in front of my team. I said, “What do you mean?”—hoping he would revise his statement and enable me to save face. Instead he pressed on: “Someone who has designed a large organization, someone who knows great senior executives and brings prebuilt customer relationships, someone who knows what they are doing.”

I could hardly breathe. It was bad enough that he undermined my standing as CEO, but to make matters worse, I knew that at some level he was right. I didn’t have those skills.  I had never done those things. And I did not know those people. I was the founding CEO, not a professional CEO. I could almost hear the clock ticking in the background as my time running the company quickly ran out.

Could I learn the job and build my network fast enough or would I lose the company? That question tortured me for months.

In the years that followed, I remained CEO, for better or worse. I worked incredibly hard to close the gap between what the partner had described and where I was at the start. Thanks to a lot of effort and help from friends and mentors, especially Bill Campbell, the company survived and ultimately became quite successful and valuable.

However, not a day went by when I didn’t think about that interaction. I always wondered how long I had to grow up and how I could find help to build my skills and make the necessary connections along the way.

Marc and I discussed this often. We wondered aloud why as founders we had to prove to our investors beyond a shadow of a doubt that we could run the company, rather than our investors assuming that we would run the company we’d created. This conversation ultimately became the inspiration for Andreessen Horowitz.

Marc and I share a simple belief that became the basis for our new venture capital firm: in general, founding CEOs perform better than professional CEOs over the long term, and a venture capital firm that enables founding CEOs to succeed would help build the best companies and yield superior investment returns.

As we set out to design a venture capital firm that would enable founders to run their own companies, we began by asking: In what ways are professional CEOs superior to founder CEOs?

Professional CEOs bring two core advantages to the table:

• Superior skill set – Being CEO requires vast know-how that is very difficult to gain without extensive experience actually being CEO. Founders with no CEO experience naturally make many critical mistakes during their “on the job training” period. Excellent professional CEOs already have those skills.
• Superior network – Great professional CEOs know lots of outstanding executives and employees. They also know key reporters and analysts, important potential customers and top industry players. Founders tend not to have enough industry experience to know all these people and need to build their networks almost from scratch.

Next, we asked: How might a venture capital firm help close those gaps?

Addressing the skill set issue proved to be difficult because sadly the only way to learn how to be a CEO is to be a CEO. Sure, we might try to teach some skills, but I know from experience that learning to be a CEO through classroom training would be like learning to be an NFL quarterback through classroom training. Even if Peyton Manning and Tom Brady were your instructors, with no experience, you’d get killed the moment you took the field.

We decided that while we would not be able to give a founder CEO all the skills she needed, we would be able to provide the kind of mentorship that would accelerate the learning process. As a result, our first requirement for General Partners is to be an effective mentor for a founder striving to be a CEO. This is why so many of our General Partners are former founders or CEOs or both, and they are all highly focused on helping founders become outstanding CEOs.

Of course, not all founders want to be CEO—there are companies for which the right thing is to bring in a professional CEO. For those companies, we focus on helping the founders identify the right CEO, and then helping the CEO successfully integrate into the company and partner with the founders to retain their unique strengths.

Next, we went after the network.

Existing venture capitalists with whom we had worked with had important industry relationships, but we found them to be lacking in the following ways:

• Siloed – As an entrepreneur, you can often count on the General Partner on your board to introduce you to customers or executives, but you can’t count on the venture capital firm itself. Each General Partner has his own distinct network, and it’s not really feasible or practical to access the other partners’ networks because those partners prioritize their own companies and in practice you will never see them—they are not available to help you. So, there is no firm-wide network you can plug into.
• Hard to access – As CEO it’s always a bit weird to say to your VC, “Please introduce me to some potential customers.” First, it seems like an inconvenience—VCs are clearly busy people with many other things to do. Second, there isn’t any easy process to execute that introduction. Where will this introduction take place? Will the VC set up the meeting? Will you have to fly out to see the prospect? Will the VC come with you? Will the prospect be qualified well enough to do that? If not, then should you even ask? To make matters worse, the need to meet customers is not a one-time event. How do you ask your VC the second, third and tenth times? And at what point does your VC start to judge you as incapable of reaching customers (or partners, distributors, suppliers, investors or acquirers) on your own?
• Incomplete – Finally, VC networks tend to be incomplete. A certain General Partner might know a certain type of customer like telecom carriers, but not others like pharmaceutical companies or government agencies. They may know customers, but not have deep relationships with key reporters. They may know key reporters, but not know executives you would want to hire. They might know executives, but not engineers. As founding CEO, one tends to be busy. If you spend time trying to tap a network and come up empty, you probably won’t bother trying again.

To address these issues, we designed Andreessen Horowitz’s network to be firm-wide, dead simple to access and comprehensive—supported by operating partners who work full-time to develop and manage each branch of the network.

This approach has already lead to some stunning results:

• In 2011, we hosted over 600 portfolio presentations to corporate customers and partners at our office in Menlo Park. These presentations resulted in more than 3,000 introductions between portfolio companies and prospective Fortune 500/Global 2000 senior executives.
• We’ve built relationships with over 4,000 engineers, designers and product managers, and we’ve made more than 1,300 introductions to our portfolio companies, resulting in 130 hires within the portfolio.
• We added over 550 executives to our network in 2011 and made more than 300 executive introductions to our portfolio companies.
• We’ve had nearly 400 interactions with media on behalf of our portfolio companies.

Through these practices, we’ve been able to help founders develop critical CEO skills and wield networks as broad and powerful as the best professional CEOs. And that is why we have become a popular firm among founders.

Our reputation with founders has then enabled us to invest in great entrepreneurs building the great new technology companies. Interestingly, the demand from entrepreneurs has come in all stages and sizes. From seed stage entrepreneurs like JR Rivers at Cumulus Networks to entrepreneurs with fast growing enterprises like Brian Chesky at Airbnb, great founders everywhere want to be the best CEO that they can be and work with us to help them do that.

And that’s both how and why we raised $2.7 billion. We are uniquely positioned to help the greatest technology entrepreneurs in the world build the best technology companies in the world, and that’s just what we’re going to do.

Many years ago, I encountered a particularly tricky management situation. Two excellent organizations in the company, Customer Support and Sales Engineering, went to war with each other. The Sales Engineers escalated a series of blistering complaints arguing that the Customer Support team did not respond with urgency, refused to fix issues in the product, and generally inhibited sales and customer satisfaction. Meanwhile, the Customer Support group claimed that the sales engineers submitted bugs without qualification, did not listen to valid suggested fixes, and were alarmists who assigned every issue the top priority. Beyond the actual complaints, the teams genuinely did not like each other. To make matters worse, these groups had to work together constantly in order for the company to function. Both teams boasted superb personnel and outstanding managers, so there was nobody to fire or demote. I could not figure out what to do.

During this time, I miraculously happened to watch the motion picture classic Freaky Friday starring the underrated Barbara Harris and the incomparable Jodie Foster—note: there is also a high quality remake starring Jamie Lee Curtis and the troubled, but talented Lindsey Lohan. In the film, mother and daughter grow completely frustrated with each other’s lack of understanding and wish that they could switch places and they do:

Through the course of the movie, by being inside each other’s bodies, both characters develop an excellent understanding of the challenges that the other faces. As a result, the two women become great friends when they switch back. After watching both the original and the remake, I knew that I had found the answer: I would employ a Freaky Friday management technique.

The very next day I informed the head of Sales Engineering and the head of Customer Support that they would be switching jobs. I explained that, like Jodie Foster and Barbara Harris, they would keep their minds, but get new bodies. Permanently. Their initial reactions were not unlike the remake:

However, after just one week walking in the other’s moccasins, both executives quickly diagnosed the core issues causing the conflict. They then swiftly acted to implement a simple set of processes that cleared up the combat and got the teams working harmoniously. From that day to the day we sold the company, the sales engineering and support organizations worked better together than any other major groups in the company—all thanks to Freaky Friday, perhaps the most insightful management training film ever made.

Thanks to Ward Cunningham, the metaphor technical debt is now a well-understood concept. While you may be able to borrow time by writing quick and dirty code, you will eventually have to pay it back—with interest. Often this trade-off makes sense, but you will run into serious trouble if you fail to keep the trade-off in the front of your mind. There also exists a less well-understood parallel concept, which I will call management debt.

Like technical debt, management debt is incurred when you make an expedient, short-term management decision with an expensive, long-term consequence. Also like technical debt, the trade-off sometimes makes sense, but often does not. More importantly, if you incur the management debt without accounting for it, then you will eventually go management bankrupt.

Like technical debt, management debt comes in too many different forms to elaborate entirely, but a few salient examples will help explain the concept. For this post, I choose 3 of the more popular types among startups:

1. Putting two in the box
2. Over compensating a key employee, because she gets another job offer
3. No performance management or employee feedback process

Putting two in the box

What do you do when you have two outstanding employees who logically both fit in the exact same place on the organizational chart? Perhaps you have a world-class architect who is running engineering, but she does not have the experience to scale the organization to the next level. You also have an outstanding operational person who is not great technically. You want to keep both in the company, but you only have one position. So, you get the bright idea to put “two in the box” and take on a little management debt. The short-term benefits are clear: a) you keep both employees, b) you don’t have to develop either because they will theoretically help each other develop, c) you instantly close the skill set gap. Unfortunately, you will pay for those benefits with interest and at a very high interest rate.

For starters, by doing this you will make every engineer’s job more difficult. If an engineer needs a decision made, which boss should she go to? If that boss decides, will the other boss be able to override it? If it’s a complex decision that requires a meeting, does she have to schedule both heads of engineering for the meeting? Who sets the direction for the organization? Will the direction actually get set if doing so requires a series of meetings?

In addition, you have removed all accountability. If schedules slip, who is accountable? If engineering throughput becomes uncompetitive, who is responsible? If the operational head is responsible for the schedule slip and the technical head is responsible for throughput, what happens if the operational head thrashes the engineers to make the schedule and kills throughput? How would you know that she did that? The really expensive part about both of these things is that they tend to get worse over time. In the very short-term you might mitigate these effects with extra meetings or by attempting to carve up the job in a clear way. However, as things get busy the mitigation will fade and the organization will degenerate. Eventually, you’ll either make a lump sum payment by making the hard decision and putting one in the box or your engineering organization will suck forever.

Over compensating a key employee because she gets another job offer

An excellent engineer decides to leave the company because she gets a better offer. For various reasons, you were undercompensating her, but the offer from the other company pays more than any engineer in your company and the engineer in question is not your best engineer. Still, she is working on a critical project and you cannot afford to lose her. So you match the offer. You save the project, but you pile on the debt.

Here’s how the payment will come due. You probably think that your counteroffer was confidential because you’d sworn her to secrecy. Let me explain why it was not. She has friends in the company. When she got the offer from the other company, she consulted with her friends. One of her best friends advised her to take the offer. When she decided to stay, she had to explain to him why she disregarded his advice or lose personal credibility. So she told him and swore him to secrecy. He agreed to honor the secret, but was incensed that she had to threaten to quit in order to get a proper raise. Furthermore, he was furious that you overcompensated her. So, he told the story, but kept her name confidential to preserve the secret. And now everyone in engineering knows that the best way to get a raise is to generate an offer from another company then threaten to quit. It’s going to take awhile to pay off that debt.

No performance management or employee feedback process

Your company is now 25 people and you know that you should formalize the performance management process, but you don’t want to pay the price. You worry that doing so will make it feel like a “big company”. More so, you do not want your employees to be offended by the feedback, because you can’t afford to lose anyone right now. And people are happy, so why rock the boat? Why not take on a little management debt?

The first noticeable payments will be due when somebody performs below expectations:

CEO: “He was good when we hired him, what happened?”

Manager: “He’s not doing the things that we need him to do.”

CEO: “Did we clearly tell him that?”
Manager: “Maybe not clearly . . .”

However, the larger payment will be a silent tax. Companies execute well when everybody is on the same page and everybody is constantly improving. In a vacuum of feedback, there is almost no chance that your company will perform optimally across either dimension. Directions with no corrections will seem fuzzy and obtuse. People rarely improve weakness that they are unaware of. The ultimate price you will pay for not giving feedback: systematically crappy company performance.

In the end

Every really good, really experienced CEO that I know shares one important characteristic: they tend to opt for the hard answer to organizational issues. If faced with giving everyone the same bonus to make things easy or sharply rewarding performance and ruffling many feathers, they’ll ruffle the feathers. If given the choice of cutting a popular project today, because it’s not in the long-term plans or you’re keeping it around for morale purposes and to appear consistent, they’ll cut it today. Why? Because they’ve paid the price of management debt and they would rather not do that again.

Special thanks to my friend Joanne Bradford who came up with the idea for this post and coined the term “management debt”.