Venture capitalists look at businesses from many angles. Is the market big enough? Do the founders have good founder-market fit? Is the problem worth solving, does the solution make sense, and is the product a half-decent implementation of the solution? The diligence goes deep, too: calls with potential customers, market experts and character reference calls.
However, I’ve worked with a lot of pitch coaching clients and have realized that actually doing technical diligence is remarkably rare. It seems that investors will often look closely at what they understand well, which means poring over the financials and potential of the business. Less time is spent where there’s less expertise, which, for many investors, means that they’re just looking for a check box to check. If there’s a technical co-founder — literally any technical co-founder — on the team, it’s solid.
The problem, of course, is that there are as many CTO roles as there are companies. Each startup needs a different degree of technical oversight and expertise, and there’s definitely an argument to be made for being stage appropriate. Premature optimization isn’t helpful to anyone, but having a CTO with the right experience, knowledge and expertise for the stage a company is at appears to be examined only rarely in the investment process.
Kyle Wild, founder at Root System, spotted this pattern before I did, and we spoke at length about how investors’ blind spot for technical skills is pervasive across the ecosystem.
“Paul Graham has written a lot about technical co-founders,” Wild told me. “But Paul Graham happens to be an engineer. When he says words like ‘technical co-founder,’ that has a lot of meaning to him, but it’s not universal. When he’s evaluating startups, he’s not just saying ‘you need a technical co-founder,’ like it’s a check box, nor does he say it’s binary, like either you have one or you don’t.”
The upshot is that a lot of very smart investors are running blind when it comes to technical co-founders and essentially hoping for the best when they invest at the earliest stages of investment.
“Investors have internalized this process where they look at the founder list and see if one of them is an engineer. That’s just about all they really look for,” Wild said. “The thing is, there’s only a very small subset of great engineers that have the full skill set, including leadership, strategy, management, engineering, financial strategy, etc.”
The reason why this matters is that if having a technical co-founder on the team is a check box exercise, you end up with some pretty detrimental dead weight on the company’s cap table. Listing someone as a technical co-founder with 30% to 50% ownership stake in the company is not a good move when, realistically, all you needed was a 10x engineer working as an independent contributor to build the first prototype of the product.
In my time, I’ve worked with some CTOs who were truly excellent and some who weren’t. The problem was usually a skills mismatch: The person who is skilled at hacking together a first version of a product often has a different mindset than someone who builds an application for scale. That is again a different skill set than making strategic platform and tech stack decisions and building out an engineering org. At the later stages, building for scale, security, resiliency and compliance, and doing all of that with a budget is a more complex set of skills. Some founder-CTOs may be able to pick up all of these skills as the company grows, but the question is, in part, if they would even want to. People who thrive at one stage of a company often get overwhelmed at another.
But when you’ve given someone a significant ownership stake in the company, they are on the cap table for life. Shares are often vested over four years, and I’m struggling to think of a CTO who can deliver full value to a company that’s trying to grow from 2 to 400 people over that time.
“It’s possible that a person can build the prototype and do phase one of a company; it’s slightly less likely that they can hire up and build the team. It’s way less likely they can do the stuff at the later stages, effectively a board-level, C-suite role,” Wild said.
The way this plays out is that the CTO often gets managed out or sideways into the organization as an individual contributor. In other words: They were a great programmer for the first stage of the company, but ultimately they were a code-wrangler who now owns 30% of a company. Developers are expensive and worth the cost, don’t get me wrong, but if a startup sees a $1 billion outcome, it’s hard to argue that a $300 million programmer makes sense.
In a way, you could liken the process of evaluating a CTO to how enterprise sales are sometimes done, where the procurement process is a series of check boxes. Does the company have business insurance? Does it have a privacy policy? Is there a GDPR plan in place? It becomes a binary consideration: If they tick the boxes, great — but there is rarely any scrutiny as to whether the business insurance is adequate, whether the privacy policy makes sense, or whether the GDPR policies are implemented correctly.
When investors are investing in software, the CTO is effectively the equivalent of the head of R&D at a product company. And you’d better believe that that job role is scrutinized closely come investment time. “It’s remarkably uncommon for there to be a code review, even for Series A and Series B investment. There will be a full-on clinical inspection of the books,” Wild told me. “I remember doing a Series A with Sequoia. They brought in a pretty solid engineer from Google [to] walk through tech stuff and meet a couple of people on the team. But, first of all, that’s Sequoia, and most VC firms are not Sequoia. When I say VCs, I’m not really talking about the top 2%.”
The remaining 98% of VCs, though, should maybe pay a little bit more attention. Giving up a third of a company to solve a problem that could be solved by a freelancer wouldn’t fly in any other part of the business — why does it happen so often here?