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Internal Conflict: Killer of Businesses

 

 

 

“It’s unfortunate but true: if entrepreneurship is a battle, most casualties stem from friendly fire or self-inflicted wounds.” – Noam Wasserman, The Founder’s Dilemmas

The entrepreneurial experience is often highly-romanticized by those who write about it; however, a more apt description might be something closer to the “solitary, poor, nasty, brutish, and short” experience of a life lived outside of a societal setting—and, thus, in a perpetual state of war—as posited by Thomas Hobbes in Leviathan.  Of course, the statement that entrepreneurial efforts take place in a conflict-laden environment should come as a surprise to no one: as new entrants jockey themselves into position to contend with and disrupt the positions of existing firms, aggressive push back from the competition should be expected given that businesses, personal fortunes, livelihoods, and even personal health, among other things, are at stake.  What may come as a surprise, however, is that many of the most destructive conflicts in which firms can become engaged are those which only involve internal parties: co-founders quarreling over control, direction, or credit; shareholders and management becoming misaligned and incompatible in their core interests; and managerial and employee tendencies towards shirking, absconsion, and the misallocation of firm resources—just to name a few of the possibilities.  Internal conflicts of these types impact most operations and are a significant factor in the failure of entrepreneurial efforts.  In light of this, the purpose of this post is to explore the existence and sources of internal conflict; discuss the potential implications of the mishandling or mismanagement of these matters; and to identify and evaluate potential solutions for their mitigation (if not outright elimination) to facilitate the realization of better entrepreneurial outcomes.

The Existence and Sources of Internal Conflict in Entrepreneurial Settings

Conflict in an entrepreneurial context can take many forms; however, the following three serve as the basis of concern for this note: co-founder tensions; misalignment of shareholder and managerial interests; and managerial and employee tendencies towards shirking, absconsion, and the misallocation of firm resources.

Co-Founder Tensions

Starting a firm can be an exhilarating experience—especially when all active parties are aligned in their interests and expectations.  But, the honeymoon is generally fleeting.  In the absence of success, this is probably to be expected as excuses and accusations start to fly; however, it is quite common for co-founders to drift away from one another even in firms that successfully find their footing.  Sometimes, a partner (or clique of partners) may feel that he or she has shouldered and/or is shouldering a disproportionate load.  At other times, a partner may believe that he or she has been unfairly pushed aside.  Across-the-board, the interests of different founders quite simply have a tendency to diverge over matters such as control, direction, compensation, and exit, among others.  Inevitably, this will lead to conflict.

Misalignment of Interests between Shareholders and Management

Conflict is made more likely in firms that have material separation between ownership and management—even if management has a material stake in the company.  Though this opinion is not accepted across disciplines, finance (the field in which I have the most training) posits that a firm exists solely for its shareholders and that the single overriding role of management is to maximize shareholder value.  Are managers likely to meet this expectation?  No.  It is common for managers to have interests that differ from those of shareholders—and, to a degree, it is understandable.  Alternative concerns often include personal levels of compensation as well as nonpecuniary things like perquisites, reputational standing, and ego-driven expansion efforts.

Shirking, Absconsion, and the Misallocation of Resources

The threat of shirking, absconsion, and the misallocation of resources in entrepreneurial endeavors is particularly severe given that the controls and processes necessary to minimize these types of behaviors are generally non-existent in early stage firms.  These threats are particularly potent when some or all shareholders are disengaged from day-to-day operations as that information which does make its way to them is likely to be supplied by those with disproportionate access.  In such an environment, it takes very little for within- and cross-stakeholder relationships to rapidly deteriorate into distrust and dysfunction.

The Implications of Internal Conflict

The implications of internal conflict can be and oftentimes are severe: loss of institutional focus, wasted resources, and undesirable end games.

Loss of Focus

Internal conflicts inevitably distract participants (and internal observers) from what matters most to an operation—which is always something other than infighting.  This loss of institutional focus is arguably due to several factors: the availability of internal issues exaggerating their perceived importance; the tendency of such issues to elicit strong emotional responses by the affected parties; and the attractiveness and simplicity of being able to wage war against a clearly defined and hated enemy relative to the more complex and faceless grind of day-to-day business.

Wasted Resources

Generally speaking, time and resources spent on internal conflict do little to nothing to help a business grow in the short- to medium-term.  This is not to say that such expenditures should be avoided at all costs as there are times when engaging in conflict may be the only viable option for a firm to eventually be able to move forward; however, in all cases, the existence of internal conflict forces a misallocation of resources away from core operations.  As most entrepreneurial ventures are already severely resource constrained, all this does is make it that much harder to succeed.

The End Result

Though not all internal conflict takes us to the extreme of organizational failure, it almost always leads us to underperformance.  It is a rare firm that can endure substantial inner turmoil while concurrently managing to drive and achieve maximum success in its core operations.  More common is a firm that becomes distracted, disoriented, and dysfunctional—sowing fear and uncertainty, driving away good people, squandering opportunities, and hemorrhaging value in the process.

Preventing and Mitigating the Impact of Internal Conflict

Internal conflict is inevitable in all organizations; however, there is much that can be done to prevent and mitigate (if not fully eliminate) the likelihood of disaster-type outcomes in entrepreneurial settings including the recognition of the sources of internal conflict, the establishment of open lines of communication between important stakeholders, and commitment to solid corporate governance practices.

Recognition of the Sources of Internal Conflict

The simplest way to handle internal conflict is to recognize its sources and prevent it from starting in the first place.  Founders need to be extremely choosy—especially when it comes to selecting partners, hiring critical managers or employees, and taking on external finance, among other things.  Consider, for instance, the matter of co-founders.  Mindsets (if not skillsets) should be fully aligned when a venture is first launched.  If one of the parties is money driven and another simply wants to create new things regardless of the short-term financial feasibility, such divergence could quickly create problems if financial conditions get tight—which they generally do in a startup setting.  In physics, opposites attract; however, in business (much as in love), it is a decidedly more complicated situation.

Open Lines of Communication

In the beginning stages of an entrepreneurial effort, all parties may very well have the best of intentions; however, as time goes on, conditions will change—opening the door for conflicts of all kinds, depending on the exact circumstances.  The inevitability of such shifts necessitates open lines of communication between all relevant stakeholders: from founders to managers to non-managing shareholders.  It is from a foundation of silence that crises are frequently conjured in the mind of an informationally disenfranchised party—even if such a perception fails to match objective reality.

Corporate Governance

Conflicts of interest, informational asymmetries, and selfish temptations are all unavoidable elements of day-to-day business.  One of the most sure-fire ways to minimize the likelihood of bad outcomes driven by internal conflict is by instituting a solid foundation in corporate governance.  Corporate governance broadly consists of the systems of rules and processes by which a company is directed and controlled.  It is incumbent on the shareholders of a firm to ensure that critical stakeholder interests remain aligned through the utilization of thoughtfully constructed contracts, the implementation of incentive arrangements that tie managerial compensation to firm value, and by maintaining adequate controls to uncover managerial errors, incompetence, laziness, malfeasance, and opportunism before they do irrecoverable damage.  An additional and oft-overlooked mechanism to ensure good governance involves utilizing a high-leverage (or debt-heavy) capital structure to force management to act quickly and aggressively in carrying out business operations.  The success of this approach is well-established in the track record of private equity (one of the few active approaches to investment that seems to generate positive risk-adjusted returns)—albeit, in more traditional entrepreneurial settings, the necessity of personal guarantees may make it a non-starter, especially when material stakes are controlled by non-managing shareholders.