The Myth of the Superstar CEO: When VCs invest, should replacing the founder with a superstar CEO really be the first order of business? –

Oct. 1 turned out to be a pretty interesting day in the tech business. First, the board of directors of PeopleSoft stepped up and canned Craig Conway, its CEO since 1999. Then, the enterprise software company took the highly unusual step of replacing him with none other than Dave Duffield, its founder and chairman.

Replace a “superstar” CEO with a company founder? Now that’s a new one. VCs are often more comfortable doing it the other way around-kicking the founder aside and bringing in a fresh CEO to take his place-particularly when it comes to early stage companies!

Yet, PeopleSoft’s CEO shuffle raises an interesting point: Does a brand name CEO, one with credibility and credentials, really make a difference-in either a Fortune 500 company or an early stage startup? More importantly, is a superstar CEO truly worth all of the time, effort and additional equity required to retain (some might even say “retrain”) him or her? And do VCs ever actually retrieve that value?

In Denial

Objectively, it’s a great achievement for any of us to attract a superstar CEO to one of our companies. If nothing else, it gives peace of mind that our investments are in good hands. Yet, if we truly considered the questions above, we might find there are just as many advantages to sticking with our founding CEOs as there are in finding the right executive to come in and take their place.

In his Harvard Business Review article, “The Curse of the Superstar CEO,” Rakesh Khurana, writes: “Our fervent and often irrational faith in the power of charismatic leaders seems to be a part of our human nature. … The charismatic illusion is fostered by tales of white knights, lone rangers and other heroic figures who rescue us from danger.”

Danger, indeed. In fact, nothing seems more dangerous these days than investing in a private equity deal while worrying that the founding CEO may or may not be able to take our investment to the next level. Such worries have admittedly led to a VC fascination with, if not an addiction to, superstar CEOs: seasoned executives with, preferably, at least one liquidity event under their belts, who are equal parts smart, strategic, and sales oriented, not to mention incredibly gifted at raising money. If they are technologically competent, so much the better.

Yet, the last thing we often ask ourselves is: “Does this make sense?” Does bringing in a superstar CEO from the outside really yield more value for the company and its shareholders in the long run? As many companies have found, and as Khurana puts it, “There’s a downside to superstar CEOs. … Like its close relative, romantic love, their charisma can be blinding. And the consequences of that blindness can be severe.”

With that warning in mind, how often have we been blinded by superstar CEOs who’ve wound up being nothing more than tragic failures as leaders and managers? Think of Jeff Skilling at Enron or Dennis Kozlowski at Tyco. Moreover, despite often believing we were doing the best thing for our limited partners and shareholders by bringing in a top- notch CEO to run a company (giving him or her a large equity stake and a long leash to lead as he or she wishes), how many of us have found out later he or she had run the business straight into the ground?

As a result, the balance sheet of bringing in an outsider to run one of our companies usually has as many disadvantages as advantages, and often, we do not factor in the downside as much as we should. I’d suggest it may benefit us to be as analytical as we sometimes are with other key company decisions when weighing the pros and cons of a CEO change, while understanding the risks that bringing in a new person entails. I suspect the answers we come up with may be surprising.

Pluses & Minuses

On the pro side of the equation, there are many reasons why it’s made sense to replace an early stage founder with a seasoned executive. Here’s why:

* They bring contacts and credibility to an early stage company, two commodities that are often in short supply.

* They hopefully bring a level of business management experience, technology expertise and the ability to scale a business (or a combination of the three) that founders sometimes lack in one cohesive package.

* They bring visibility to a company that can become essential for future fund-raisings and securing key customers and partners.

* Bringing in a new captain of the ship can often free up the founders to concentrate on building out the raw technology and actually getting product to market.

What we don’t do as thoroughly is consider why hiring an outside CEO makes no sense at all. Among the strongest arguments against recruiting a new CEO are the following:

* The costs of bringing in an outsider and the impact that that has on organizational change may be too high. This is particularly true at the earliest stages of a company, when things like loyalty, morale, dedication and inspiration are as important (if not more so) as technological expertise or supply chain management. In other words, do we really ask: Is this particular ship a fit for this particular captain? A star former VP of sales at a Fortune 500 company may be ultimately useless in a startup where the technology build of a next-generation product hasn’t yet been fully completed. Success in one venue is not necessarily a precise predictor of success in another.

* Companies inherently change from when a founder runs the show to when a new CEO takes over. And much to our dismay, burn rates often climb, sometimes precipitously. A new CEO brought in from a much larger enterprise is used to making big bets and has the tendency to do so even within a much smaller startup. In fact, because boards of directors can become cautious about rocking the boat, they often give a new CEO far more leeway to spend larger amounts of money. That’s something most founders would naturally hold back on, as they’ve likely grown accustomed to stretching their pennies as far as they can go.

* Changes in salary, management team, reporting structure and equity can automatically shift the workplace environment within a company-and often not for the better. Two camps can form (the old guard vs. the new guard), creating a moral hazard where, ultimately, the new guard is seen as not having the same emotional connection to making the company work as the old guard. If things fall apart and the brand name CEO leaves, the company might even be worse off than before.

A Gray Matter

There’s no perfect answer as to who might make a great CEO and when it is the right time, if at all, to replace a company founder. As one industry recruiter puts it: “We’re always looking for CEOs and yet we run away from candidates who’ve had any failures, which unfortunately is 90% of the people out there.” However, according to the same recruiter: “VCs are often some of the most difficult people to please because what they’re often looking for is illogical. Some VCs think they need a product-centric person, others a sales-oriented guy, and others want someone who can raise money. They want a known entity but they each want to be able to have some control over the guy.”

Then there’s the issue that CEOs are used as scapegoats when things go bad and, further, that some businesses are unsalvageable no matter who’s at the helm. As Khurana and other industry analysts have consistently pointed out, there remains no direct correlation between recruiting a superstar CEO to run a company and the likely future success of that same enterprise. Says Khurana: “Most academic research that has sought to measure the impact of CEOs confirms Warren Buffett’s observation that when you bring good management into a bad business, it’s the reputation of the business that stays intact.”

Which is why, in high tech especially, some of the industry’s biggest success stories buck the notion that outsiders must be brought in for a company to reach its next level of success. Microsoft’s Bill Gates, Apple’s Steve Jobs, Oracle’s Larry Ellison, Amazon’s Jeff Bezos and Sun’s Scott McNealy have all remained at the helm of their respective companies long after helping found them. The Meg Whitmans and Eric Schmidts of the world-the CEOs who’ve taken over at eBay and Google, respectively-are often more the exception to the rule.

In fact, if we were to be completely honest with ourselves, we’d realize that George Shaheen’s implosion at WebVan or Michael Armstrong’s colossal failures at AT&T are far more common examples of what can happen when God-like CEOs are brought in from the outside. It’s time we started being more tough-minded before bringing in new management talent (“superstars”) and perhaps more open to bucking the conventional wisdom that too often makes sense only on paper, but more often than we’d like fails in practice.

Ravi Chiruvolu, a general partner of Charter Venture Capital, is a regular technology columnist for VCJ. Send him feedback or ideas to Chiruvolu specializes in enterprise software, software infrastructure, e-business and wireless. He sits on the boards of Ellie Mae, ManageStar, Niku (NASDAQ: NIKU), Quantum3D, Talaris, Verano and Winery Exchange.