Tabu: The Freerider Problem

Many startups will encounter the Freerider problem during their evolution at one point or the other. I have encountered it myself in several companies; it is more common than people realize. It is also very rare to hear anybody talk extensively about these kinds of problems and people seem reluctant to elaborate on how they have solved such issues.

In brief a "Freerider" or "Free rider" is somebody who doesn't quite pull their weight in startup and they are more of a problem than a solution in the path of the startups development.

This kind of problem can arise from any number of circumstances, including:

1. Multiple founders typically with equal (or near-equal) share, some (or one) of which start slacking and underperforming,

2. Co-founder that founds a company with you, but then leaves or is somehow occupied with other tasks not really contributing at all, but still getting the benefits of your hard work.

3. One cause can also be hard-to-verify-n-deal-with personal problems, such as drugs or alcohol abuse and underperformance as a result of that. If this keeps on going long enough you might end up with a Freerider owner that's also on drugs.. not a very happy place to be for a startup.

Founding and developing startups isn't always rosy and groovy, and since people are just people they will have their serious shortcomings occasionally. You could also argue that the kind of personalities that establish startups are far from "risk free" in terms of unexpected bumps in their lives, and are certainly not immune to overdoing the classic "sex, drugs and rock'n'roll" routine up to a point where it starts to hurt the business. How many dot-com "millionaires" you saw repeating this same pattern in the crazy old days? I lost count, and the joke wasn't as funny as it used to be pretty fast.

Freeriders tend to radiate destructive energy and negative vibes in a startup environment. People who actually work their asses off to get the company flying will (sometimes very strongly) think that it is absolutely unfair and unethical for someone else to be a negative influence to the success effort and still reap a big share of the benefits. You could argue the they are wrong: owners are just owners and would an executive in a public corporation feel bad about working his ass off for a pension fund that's the largest owner of his corp? Probably not. But people are emotional up to the point where it becomes irrational and if there's one thing they feel strongly about its the Freeriding and seeing that every day up close. Quite simply Freeriders eat away motivation from the people who perform the most valuable work in your startup: they are usually the first to feel demotivated. You can compensate this with paying them higher salary or coming up with any tricks you can think of: but none of it really solves the problem until the Freerider is gone one way or the other.

Getting a startup to succeed is hard work and everybody needs to pull their weight nearly 100% of the time. If you have 10 people working for you and 1 of them is a Freerider; then 10% of your entire workforce is slacking and causing the others to be demotivated -> startups cannot handle this for very long and the situations are pretty destructive and unbearable. Also any financier or VC investing in your company will almost certainly find out about your "little personnel problem" there (during the DD phase), if nothing is done about it.

Before taking any definite actions towards a Freerider you should first let him/her know about the problem and allow him the chance of fixing it. There are cases when people just go through a rough personal period in their lives and can recover after a while to rejoin the team in the competent and contributing side. If this fails or isn't possible due to the circumstances present, then it is time for action.

If you end up with a permanent Freerider amongst you, what to do?

A) the situation needs to be resolved asap. The sooner the better. Never wait it out, ever. It's like drinking poison and then waiting that it will probably go away, it won't.

B) In many cases you need to get rid of him/her no matter what. Nothing else will help as much as seeing the Freerider leave for good.

C) buying a freerider out is the most common thing to do: get an investor to buy him out. Get a new partner to buy his share and replace him. Buy his share yourself. Be creative. If the situation is bad enough this should not be that much about price and valuation: the company with a severe Freerider probelm can soon be a company worth zero Icelandic Crowns, and any implied valuation for example is better than zero, right?

D) you need to tell your team that you consider this to be an important problem to solve, and will work actively in solving it. You can even propose that you pile up the money together and buy the Freerider's share jointly.

E) If the Freerider owns less than 10% there might be couple of legal-financial ways to get rid of him: organizing a scheme where somebody temporarily owns more than 90% of the company and then forcibly buying the Freeriders share, after which you can reorganize your ownership etc. This is quite rare and often there's no chance of doing this; as the most typical Freerider, unfortunately, is a co-founder.

How have I solved Freerider problems in the past?

I have fired Freeriders from the company, even founders. Then later tried or succeeded in buying their shares. I have sent people home to do nothing for a few months to recover and give them a chance to rethink their priorities and possibly return to work as a contributing team member (if they are really competent, that's better than loosing them forever). I have also seen cases where somebody isn't pulling their weight fully, and that person gets bought out rather quick, solving the issue and making him/her a normal employee of the startup.

Prevention is far better than reacting to an acute problem that has already caused damage. How to prevent a Freerider problem? Here's a few tips:

i. Talk about this specific problem amongst all owners. Make sure everybody understand what it takes to make a startup successful. Make sure that everybody knows crystal clear that their contribution is expected and vital - there's no such option as suddenly starting to slack or not to perform.

ii. As soon as you see the first signs of this problem; react right away. Talk to people, call a meeting, go talk to the person who looks like he/she might become a Freerider soon. Fix performance issues, re-shuffle responsibilities and roles if you have to. Get the team working, eyes on the ball and motivation high. Don't leave them alone with their problems or "behind" with a mountain of work to climb.

iii. Consider having a vesting schedule even for the founders stock. Some US VCs use this mechanism and it quite effectively solves potential Freeraider problems. There's a good post about that here in the Lightspeed Venture Partners blog.

iv. Consider having a good leaver/bad leaver clause in your SHA (ShareHolder's Agreement) that way you can prevent the "our co-founder just left, and still owns 35% of the company" -problems from happening.

I would love to see more talk about this issue. Usually the only moment where you encounter this topic is when you talk about the new SHA with a VC who is about to invest into your venture. There exists just about nil discussion about the topic, and I'm sure many startup founders haven't even encountered it (yet). I hope to start a discussion by this blog entry.