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The Most Common Human Resource Challenges Faced by Startup Companies and Recommended Approaches to Deal

with Them

Bachelor Paper I

Submitted by: Kristína Paulovič Matriculation No.: 1210633869

at Bachelor Programme

Business Consultancy International

(International Human Resource Management)

Supervisor: Dr. Josette Winkler

Wiener Neustadt, 22.December 2014

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Table of Contents

1 Introduction ............................................................................................... 1

2 Defining the concepts .................................................................................. 1

2.1 Defining a Startup ................................................................................. 1

2.2 Defining Human Resource Management .................................................... 2

3 Startup challenges ....................................................................................... 2

3.1 HR Blueprint ......................................................................................... 2

3.1.1 Dimensions of Employment blueprints ................................................. 3

3.1.2 Typology of Employment Blueprints .................................................... 4

3.1.3 Impact of Blueprints on the Role of HR ................................................ 5

3.1.4 Impact of Changing Blueprints on Labour Turnover ............................... 6

3.2 Attracting and selecting competent personnel ............................................ 6

3.3 Compensation ....................................................................................... 8

3.3.1 Creative benefits .............................................................................. 8

3.3.2 Free benefits ................................................................................... 9

3.3.3 Benefits as investment ...................................................................... 9

3.3.4 Equity and stock options ................................................................... 9

3.3.5 Better pay than the CEO ................................................................... 9

3.3.6 Part-timers, interns and volunteers ................................................... 10

3.4 Leadership and development ................................................................. 10

3.4.1 Transformational Leadership ............................................................ 11

3.4.2 Transactional Leadership ................................................................. 11

3.4.3 Laissez-Faire Leadership ................................................................. 11

3.4.4 Picking the right style ..................................................................... 11

3.5 Money versus Power Dilemma ............................................................... 13

3.5.1 Preference for Money ...................................................................... 14

3.5.2 Preference for Power ....................................................................... 15

3.6 Mergers and Acquisitions ...................................................................... 15

3.6.1 Defining Mergers and Acquisitions .................................................... 15

3.6.2 The Role of HRM in M&A .................................................................. 15

3.6.3 The “Acqhire” phenomenon .............................................................. 18

4 Conclusion ............................................................................................... 19

List of Figures ................................................................................................ 21

List of Abbreviations ........................................................................................ 22

Bibliography ................................................................................................... 23

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Abstract in English: Startup companies are often faced with many challenges throughout their life cycle – from the point they are born until the end of their startup phase when they change into fully grown-up firms, merge, get acquired or become extinct completely. These challenges include developing a human resource blueprint, issues regarding compensation, determining the best leadership style, solving the dilemma of picking either money or power, and finally addressing the growth of the startup and the challenges it faces when deciding whether to get acquired or merge with another business. The importance of each of the challenges is first explained into detail and then possible strategies are introduced to address the issues in order for them to remain competitive and become successful. Keywords Human resource management, Startup, Challenges, Issues, Entrepreneur

Abstract in German: Junge Unternehmen, die auch als “Start-ups” bezeichnet werden, sind oft mit verschiedensten Herausforderungen während ihres Lebenszyklus konfrontiert. Besonders in der Gründungsphase, aber auch bei wichtigen Ereignissen wie Übernahmen und Fusionierungen, müssen sich Start-up-Unternehmen vielen schwierigen Aufgaben stellen. Diese Herausforderungen beinhalten unter anderem die Entwicklung eines sogenannten “human resource blueprints”, Angelegenheiten bezüglich Personalentlohnung, die Ermittlung des passenden Führungsstils, Dilemma der Entscheidung zwischen Geld und Macht, aber auch Herausforderungen bezüglich des Firmenwachstums und Entscheidungen über eventuelle Übernahmen oder Zusammenschlüsse. Zu Beginn dieser Arbeit wird jede dieser Herausforderungen im Detail erklärt. Anschließend werden mögliche Strategien herangeführt um etwaigen Problemen entgegenwirken und konkurrenzfähig und erfolgreich bleiben zu können. Keywords Human resource management, Startup, Herausforderungen, Angelegenheiten, Unternehmer

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1 Introduction In the past few decades it has become increasingly more attractive to set up startup companies. One of the main reasons for this occurrence is the all-time low and still decreasing cost of entry to the market. The inexpensive possibilities of creating a website and popular digital marketing and social media advertising now enable young entrepreneurs to build brands and grow their businesses very easily. Furthermore, startup companies are gaining more and more attention due to their innovativeness and flexibility, in comparison with large corporations. Some of the successful ones later become acquired by these large corporations while others continue on the success path on their own (Forbes 2013). At the early stage of their lives, however, they all share a common challenge: Human Resources (HR).

The purpose of this paper is to determine what human resource challenges startup companies are facing throughout their life cycles. In addition, the paper aims to discover what strategies are recommended to cope with these challenges in order for the startups to remain competitive in the market and become successful.

2 Defining the concepts

2.1 Defining a Startup

First of all, before getting deeper into this topic, it is necessary to define the word “startup”. According to Business Dictionary, a startup company can be described as an “early stage of the life cycle of an enterprise, where the entrepreneur moves from the idea stage to securing financing, laying down the basis structure of the business, and initiating operations or trading”(Business Dictionary:  Startup 2014).

Taking into consideration different aspects of a startup, Investopedia defines it as a young firm that is starting to develop, offering products or services that are new to the market and having one or few founders who initially operate and finance it. Furthermore, startups tend to be highly risky, since in their early stages, when the firms are practically unknown, their expenses usually exceed the revenues. (Investopedia: What exactly is a startup? 2014).

Last but not least, startups can be easily confused with small businesses and thus a distinction between these two needs to be made. The U.S. Small Business Administration characterizes small businesses as “independently owned and operated, organized for profit, and not dominant in its field” (U.S. Small Business Administration 2014). In comparison, startup companies are not expected to stay small, but rather aim for high growth, conquering new markets and becoming the leader of the industry. The startup phase of these firms tends to last only temporarily, until they reach milestones such as initial public offering or cease to exist completely as a result of a merger or acquisition (General Assembly Blog 2014).

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2.2 Defining Human Resource Management

Human resource management (HRM) is a concept that describes the way people should be managed within organizations (Reid et al. 2002, 245). Pinnington and Edwards (2000) argue that HRM is not simply a single theory that is always applicable, but rather can be viewed as a set of competing theories. They claim that HRM theories and models can be subdivided into two schools of thought – “hard” HRM and “soft” HRM. The “hard” HRM refers to trying to achieve organization’s goals by managing and controlling employees. The “soft” HRM, on the other hand, takes into consideration the employees’ needs and focuses on the importance of their commitment to the organization (Reid et al. 2002). In the following paper, the term HRM will be used to refer to both of these concepts.

In order to specify what exactly HRM involves, we can have a look at a business dictionary definition. According to that, HRM includes all the tasks connected to recruitment process, such as conducting job analysis or screening, through decision-making regarding compensation, incentives and benefits, to concern for personnel needs, training and development, dispute resolving or leadership choice (Business Dictionary: Human Resource Management (HRM)).

Now, being familiar with both of the concepts, it is possible to move on to the real challenges concerning human resources that startup companies have to deal with. This paper will then not only identify the most often perceived challenges, but also propose a possible strategy for coping with each of them.

3 Startup challenges There are numerous obstacles regarding human resources that firms in their startup phases need to overcome. It all starts at the very founding of the startup. The company has to define its HR blueprint, which it may intend to keep for the rest of its existence along with its culture. Further problems arise as the company is expanding and recruitment decisions such as whether to hire and if yes, then who, have to be resolved. For young entrepreneurs it is also rather difficult to obtain sufficient funding for their new businesses, which makes compensation decisions a substantially challenging issue. Picking the suitable leadership style as well as deciding between money versus power is another challenge that must not be neglected. Finally, each startup is ultimately heading to one of the three endings – getting big, getting bought or dying (Harvard Business School Blog 2014) and thus, the choice of getting acquired by a larger corporation often seems to be a favourable and easier alternative. However, even in this case, challenges regarding human resources arise and need to be solved to assure smoothness of the process. Therefore, to gain a better understanding of these issues and ways of handling them, they will be described into a greater detail in the following sections.

3.1 HR Blueprint

When starting up a new venture, the founders often have the tremendous task to deal with various issues such as initial capitalization, business operations, marketing and sales, and of course, the products or services that it offers (Communities Digital News

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2014). Trying to cope with all of that, the problem of human resource management is often neglected or even overlooked. HRM is considered to be “a useless diversion of leaders’ time and energy away from more important and immediate concerns” (Baron and Hannan 2002, 8). Others view HRM as only something that takes care of the day-to-day activities and administrative duties and believe it could easily be managed by the founders themselves or by distributing the tasks among some of the employees (Firmology 2013). The persuasion that HRM should rather “take the back seat” is further supported by those who perceive it as not really cost effective. Indeed, it may be hard to justify the hiring of a person (HR specialist) to the small starting business, which is not generating any feasible revenue (Communities Digital News 2014).

Despite all what was said, the role of HRM at the first stage of a firm is very important and should not be underestimated. On the contrary, the founders should be very cautious when launching their businesses and picking (maybe even unconsciously) the HR blueprint for them. As the research group – Stanford Project on Emerging Companies (SPEC)– has examined, the blueprint chosen at the birth of the firm does have an immense impact on its success in the future (Baron and Hannan 2002, 8-28).

3.1.1 Dimensions of Employment blueprints

The SPEC group started their research by trying to find out what ideas the founders of startups had when they were launching their businesses about how it may look and feel like organizationally. They were interested in knowing if the entrepreneurs had some visions of their companies, such as what to aim for or even, what to definitely avoid. Their findings showed that the founders’ visions on how the overall work and the employment should be organized was concentrated around three main dimensions – attachment, selection, and control and coordination.

Figure 1: Dimensions of Employment Blueprints (Source: Baron and Hannan 2002, 10)

The attachment dimension encompasses three sub-dimensions which the SPEC group named “love”, “work” and “money”. Some chief executive officers (CEOs) imagined there should be a strong emotional bond among the organizations’

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employees – “love” – that would create a family-like atmosphere, inspire effort and help to retain the core members who are strategically important for the firm. Other CEOs believed the work itself should be the primary motivator that would help to attract and retain their employees. In comparison with the “love” orientation, the founders that placed emphasis on “work” did not expect the employees to be loyal to the firm and their co-workers, but rather to a concrete project. Last but not least, some executives viewed the employee-firm relationship as a mere “exchange of labour for money” (Baron and Hannan 2002, 10).

The second dimension concerned the selection criteria used when hiring new employees for the company. Also this dimension can be seen through three elements that matter the most to the startup founders – skills, exceptional talent/potential and team/organization fit. The first group of CEOs emphasized that the employees they were looking for had to have the right skills and experience to effectively carry out various tasks required by the company. Their main concerns were money and time, therefore the employees were selected based on how quickly and cheaply they could get on board. The other group of CEOs focused more on the long-term potential of the employees, by envisioning the employees’ performance on a series of projects over time. The third group was primarily interested if the newly hired employees were able to connect well with the current organization’s employees. Therefore for them the main concerns were the values of the employees and the question whether they would be a perfect fit into the organization’s culture (Baron and Hannan 2002, 11).

The third dimension regarded the means of control and coordination, which according to the founders would be most effective in their startups. These were by the SPEC research group divided into four main categories – direct monitoring, peer and/or cultural control, reliance on professional standards, and formal processes and procedures. The first group of founders expressed they would prefer to control and coordinate the work performance personally – by direct oversight. The second and most often occurring case was when the founders indicated they would prefer to rely on “informal control through peers or organizational culture”. Some founders intended to use some kind of “professional control” in their organizations that would emphasize the autonomy and independence of the workers. They would be committed to excellence and as a result put on an outstanding performance. The last group of CEOs decided to implement a more traditional approach by creating formal processes and procedures for control and coordination of work in the organization (Baron and Hannan 2002, 10-11).

3.1.2 Typology of Employment Blueprints

Now that we have defined the three dimensions, it is necessary to point out that each company could choose any combination of their sub-dimensions to create their own HR blueprint. However, what the SPEC research group observed was that some of the sub-dimensions occur more often together than others. After thorough analysis the group then realized that, in fact, there were only 5 different, most often appearing dimensions combinations - as the employment blueprints (summarized in figure 2).

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Figure 2: Typology of Employment Blueprints, Based on Three Dimensions (Source: Baron and Hannan 2002, 11)

The first model – Star – involves attachment based on challenging work, where employees are selected based on the top talent criterion and long-term potential. The employees are given a good deal of autonomy and the founder relies on professional control. The second model – Engineering – also keeps the employees attached through challenging work, however, they are not selected based on their potential but rather based on their unique knowledge and skills that can help them perform the given task. The engineering model uses control through peers and organizational culture, and is the most common type among high-tech startups. The third model – Commitment – expects strong sense of personal belonging and affection towards the organization and uses peer-group control. When hiring new employees the firm focuses on the question of cultural fit and after that expects the people to form an emotional bond and only leave when they retire. The fourth model – Bureaucracy – relies on attachment based on challenging work and chances for personal development. When hiring new employees, the bureaucracy model expects them to have the right skills and qualifications for the job, and to control and coordinate the work in the firm, it uses formalized control. The last, fifth model – Autocracy – is the only one that is based on monetary motivations as well as the only one to rely on direct oversight when controlling the performance of the employees. The people for firms with this blueprint are chosen based on their professional skills and abilities that would enable them to perform pre-specified tasks (Baron and Hannan 2002, 11-12).

3.1.3 Impact of Blueprints on the Role of HR

In their study, the SPEC group found out that the blueprint, which each CEO choses to apply to their company, has an apparent impact on the way HRM is perceived in the company and on the roles that are assigned to it. First of all, they observed that Star and Commitment firms were the first that started to care about HRM at all and sensed the need to bring in some HRM experts. The Stars felt the need for HRM, since their most valuable assets are top-talent employees and recruitment and selection were a crucial breaking point for their success. The key HRM challenge for Commitment

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companies was to create a strong organizational culture and attract hires that match this culture. In companies based on the Engineering model, the key function of the human resource department was supposed to be keeping the employees energized and buying “the beer, chips and dip for the Friday afternoon festivities” (Baron and Hannan 2002, 14). The Bureaucracy companies understood the role of HRM as creators and promoters of rules and procedures that needed to be done. Finally, the Autocracy model tried to avoid HRM completely, perceiving it only as a cost item. These autocratic entrepreneurs in these companies preferred to take the control over the employees in their own hands, sometimes delegating the “human resource” tasks (referring mostly to payroll processing) to their secretaries (Baron and Hannan 2002, 15).

3.1.4 Impact of Changing Blueprints on Labour Turnover

For startup companies with lack of resources, the people are the key to success and therefore being able to retain them is very essential. The study carried out by SPEC found considerable evidence that changing the HR blueprint has a destabilizing effect on the company. They claim that by changing the blueprint the firm rapidly increases its employee turnover, particularly of the employees that have stayed with the company the longest. The SPEC also observed that turnover is driven by the “changes in the nature of employment relationships” which are often a result of a CEO succession. However, they do not consider the entry of a new leadership to be the cause of the turnover, but rather a mere accompanying factor (Baron and Hannan 2002, 21-22).

The companies that were confronted with higher turnover were further found to have experienced much slower revenue growth in comparison with those with lower turnover rate. The SPEC researchers proved this to be true even after taking into consideration various external factors that could have had influence on the revenue growth such as past performance of the firm, employment growth or access to venture capital. Therefore turnover, its effects as well as the powers that cause it, such as the change of the HR blueprint, must not be neglected (Baron and Hannan 2002, 22).

3.2 Attracting and selecting competent personnel

Even though there is a notable difference between startups and small businesses, at the beginning of their existence they have one thing in common: the size. According to Zotto and Gustafsson (2007), recruitment can be considered one of the most challenging human resource management tasks for small businesses and therefore it is necessary to have closer look at this issue.

Every startup begins its journey as an unknown small entrepreneurial firm usually with a lack of financial resources, however, during its lifetime it develops and moves through different phases. Based on the findings of Leung et al., in each of these phases, the firm uses different network pools to acquire new employees. Therefore it is not possible to generalize the recruitment process, but rather necessary to analyse the startup’s behaviour in both them – the startup phase and the growth phase.

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In the very early stage of a startup, the firm is handicapped by two factors, which potential employees find very important when applying for a job – lack of organizational familiarity and unknown employer’s image (Williamson, Cabel and Aldrich 2002, 86-88). The familiarity is quite necessary when attracting the potential employee’s attention in the first place, while perceived organizational image is an important determinant that differentiates one firm from another (Williamson, Cabel and Aldrich 2002, 86-88). Since startups are quite new to the business, they offer a rather high level of uncertainty and therefore cannot rely solely on talent markets as their employee pool. Furthermore, due to lack of financial resources, they can rarely afford to employ sophisticated recruitment and selection programs or provide potential employees with well-defined job descriptions (Leung et al. 2006, 669-670). Therefore in the first stage of the startup the most commonly used practice is the recruitment through networks (RTN).

Core members of a startup are usually recruited from social and business networks of the founders (Zotto and Gustafsson 2007, 4), such as family, friends or acquaintances which may be convenient due to easier approachability and greater trust. The problem is, startup CEOs often underestimate the importance of such HR decisions, and by relying only on the RTN, they lose the chance to get the best talents on the market. Furthermore, if the new employees do not fit the culture, they can destroy it easily and since they are close acquaintances of the founders, it may be difficult to get rid of them as soon as they realize their mistake (Communities Digital News 2014).

There are several strategies that can help a startup to combat these early-stage problems. According to the Brand-Marketing Approach, suggested by Williamson et al., the recruitment effectiveness is strongly tied to job seekers’ organizational knowledge and therefore it is imperative to increase this knowledge through brand marketing. To conquer legitimacy issues, the same author also suggests a method called Strategic isomorphism. Underlying logic of this strategy is that small businesses can improve their credibility and be more likely perceived as legitimate by copying the pattern of recruitment practices used by larger organizations. Although this imitation may be constrained by the available financial capital of the startups, incorporating the core features of these practices proved to be highly beneficial (Williamson, Cabel and Aldrich 2002, 94-100).

If the company already moved from the inception and survival stage to the growth stage, the recruitment practices change notably. It already started attracting more media coverage, has a significant customer base and expanded business networks which make attracting the talents on the market much easier. Furthermore, the style of hiring also changes focus from generalists, who are committed and willing to exert great deal of effort into the new venture, to professionals, who rather contribute to the startup with their knowledge and expertise in a certain area and help the business grow further.

The problem in the growing stage in startups may still arise from the inability to foresee the individual’s fit within the next level of growth (Zotto et al., 2007), which may later result in increased turnover. High turnover can be detrimental for startups

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not only because it carries the cost of finding a replacement for the employee, but also due to the loss of knowledge. The firm is thus condemned to a so-called “start-up cost”, which refers to a comparative lack of productivity of new employees, who are significantly less efficient than the experienced ones. Moreover, the new employees require considerably more supervision by experienced staff, which creates additional cost due to reduction of contribution of the supervisors (Sutherland and Canwell 2004, 246).

In order to avoid mindless hiring that ends up with the “wrong fit”, a CEO of a successful US startup advises not to only look for people when the firm needs them, but rather, take the opportunity as soon as it comes. This means, when seeing a person who seems to be a perfect fit, the company should hire her straight away rather than waiting until the firm needs her and risking that by the time she would employ her talent for someone else (LinkedIn 2014).

3.3 Compensation

For a startup company with a relatively small size and limited resources at its early stages, compensation comes as the next great challenge after recruitment that has to be dealt with (Zotto et al. 2007, 4). Since recruitment is a lengthy and costly process, a starting firm must make sure that once it manages to attract the right talent, it is able to retain it. Unfortunately, unlike established companies, for new-born firms it is complicated and uncomfortable to come up with compensation schemes. This can partially be due to the fact that their organisational structure is relatively flat, which leads to rather egalitarian employee treatment (Graham et al. 2002, cited in Zotto et al. 2007,5). In contrast, large corporations with high level of hierarchy tend to form their own compensation structures that might be expensive to create, but pay off when determining the salaries of the employees and other benefits. Since these structures seem inefficient for startups, there is a strong need for the founders to be very creative when designing suitable compensation packages.

3.3.1 Creative benefits

In the case of possible benefits that startup can decide to offer to its employees, uniqueness is more valued than imitation. Therefore radical departure from industry norms can provide a great competitive advantage (Barney 1991 and Alexander 1999, cited in Cardon and Stevens 2004, 303). The offered benefits can vary greatly. There are the basic ones, such as medical insurance, paid time-off, timely payrolls etc. They, however, cannot differentiate one startup from the others, that’s why further power-ups are necessary to stay competitive. These can include yours-to-keep notebooks and cell phones, discounted gym and sport facilities membership or shopping vouchers, reserved parking spots, free food and drinks during the work time, or company parties and events (Quora 2013). All of the above-mentioned benefits sound very attractive and can help startups retain their employees, but it has to be admitted, even these extras cost the company some money. Luckily, there is a solution also for startups unable to spend additional money for benefits.

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3.3.2 Free benefits

People often tend to value some perks much more than is their actual financial value. Some employees, for example, appreciate the possibility to take their pets to work (Mashable 2012). The cost of providing this option is next to nothing, while for the employee it can be invaluable. Further inexpensive, but appreciated possibilities include allowed casual dress code, company hikes or outgoings or simply transparent and orderly job performance metrics or regular feedbacks and performance reviews, to show that the management does care about its employees.

3.3.3 Benefits as investment

In addition, there is also the kind of benefits that may seem to be costly, but eventually pays off as a convenient investment - continuing education (Tomasz Tunguz 2014). This powerful retention tool attracts young potential talents and encourages them to develop their knowledge and skills, while also contributing to improved performance of the firm. On one hand the employees have the positive feeling of being invested into and on the other hand managers can this way assure their loyalty.

3.3.4 Equity and stock options

Returning to the compensation issue itself, apart from the benefits, in fast-growth startups, also called “gazelles”, there is a tendency to offer financial incentives and stock options to the top-performers in order to keep them on board (Zotto and Gustafsson 2007, 4-5). For the entrepreneur offering modest salaries and generous bonuses is a cunning way of shifting a large portion of the organization’s risk to the employees (Barringer, Jones and Neubaum 2005, cited in Zotto and Gustafsson, 2007, 5). By providing profit and stock sharing options in the compensation package, the founders are also able to motivate their employees to a better performance and encourage creativity and innovation. Furthermore, for people with low level of risk-aversion, this reward system full of uncertainty but also full of chances may add up to the perceived feelings of the compensation offered, resulting in greater sense of responsibility and satisfaction (Graham, Murray and Amuso 2002, cited in Zotto and Gustafsson 2007, 5).

3.3.5 Better pay than the CEO

Despite having the constraint of financial resources, some startups still offer very high and competitive salaries. This is possible due to one remarkable fact: Not all the startup CEOs earn the largest salaries within the company. According to Noam Wasserman’s study, where he examined compensations in startups set up between years 1996 and 2002, “51% of entrepreneurs made the same money as—or made less than—at least one person who reported to them.” (Wasserman 2008, 3) One might find this illogical at the first sight, however, it makes perfect sense once we take into consideration the relationship the founders have with their newly set up ventures. As Wasserman puts it in his article, the founders have the tendency to build strong emotional connections to their companies, often referring to them as “their babies”. As a result of this unconditional love, as well as fear of losing “the baby”, the entrepreneurs are willing to sacrifice their portions of salaries in order to increase the

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salaries of their talented employees, so as to retain them. Consequently, the top talents usually are in the position to negotiate their compensation conditions, which is also enabled thanks to

the flat organizational structure and missing formal HR policies (Zotto and Gustafsson 2007, 5).

3.3.6 Part-timers, interns and volunteers

Asheesh Advani, in his article on Entrepreneur.com, suggests another solution to the startups that are unable to pay regular employees – the use of part-time workers, or interns and volunteers (Entrepreneur 2014). Part-time employees, especially stay-at-home mothers and fathers seem to be the “secret weapon” for startups. This way the companies are able to attract qualified employees and cut their compensation costs by more than half. The only risky matter to beware when deciding for this kind of employment is the fact that these people are really doing it only part-time and therefore may prioritize their personal issues over the ones of the business.

Even though this option is often overlooked, hiring interns and voluntary workers is a great way to save money while getting the necessary jobs done. University students and college graduates are an invaluable source of potential talents, all eager to gain experience, willing to work part-time or full-time and all that for little or no money. However, when taking interns on-board, the startup needs to pay attention to one fact: they are really not doing it for the money, but for the experience. Therefore offering them menial or inferior work is not an option. They will only be willing to work for the startup for free if they see they can gain the practical experience which they have been looking for in the first place. The startup should also take into consideration that time of the employees who will be coaching the inexperienced interns is needed. Not only do they have to educate them into the job, but regular supervision is required. In spite of this inconveniences, these costs still remain lower in comparison to employing full-time workers (Entrepreneur 2014).

3.4 Leadership and development

One of the main liabilities of startups is their newness. It is associated with “lack of experience, and a high degree of flexibility and dynamic” (Zäch and Baldegger 2014, 4). This liability can, however, in the case of leadership be seen as an opportunity rather than a threat. In comparison with established firms, who face the problem of overcoming the liabilities of aging and have to fight against constant resistance towards change or transformation processes, young enterprises are much less prone to such behaviour and more open to embrace new ideas for improvement (Zäch and Baldegger 2014, 4; Aldrich and Auster 1986, 188). The challenge, though, still remains picking the suitable leadership style and being able to implement it. The direct involvement of the founders therefore plays an essential role in the success of the new venture.

First of all, let us define the three key leadership styles from the Full Range of Leadership Model, whose effects on startups were observed in a study by Zäch and Baldegger (2014, 1-17). These styles are: transformational, transactional, and

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laissez-faire. It is important to understand these concepts, since each of them has its own impact on the overall organization’s performance and growth.

3.4.1 Transformational Leadership

This leadership style can be described as the most effective and active one, generating performance beyond the original expectations. The leaders adopting this style are exemplary roles for their subordinates and represent a compelling vision and values which guide the decisions of their followers. They are able to inspire motivation and encourage team spirit so as to improve the achievement of each individual. They also try to stimulate their followers’ innovation and creativity by providing exceptional challenges and promoting critical thinking and problem solving. Last but not least, the transformational leaders tend to act as coaches and provide individual consideration and support to their subordinates, thus helping them to reach their personal as well as organizational goals (Northouse 2013, 185-187).

3.4.2 Transactional Leadership

Transactional leadership is according to the Full Range of Leadership Model depicted as an active but only medium effective style. In comparison to transformational leadership which aims to act proactively, transactional is viewed as rather responsive. It works within the organizational culture and does not try to implement new ideas or to change it in any way. Whereas transformational leaders provide their subordinates with the combination of external and internal motivation incentives, transactional leaders prefer to rely on the power of contingent rewards. This means that all the activities which lead to the organizational goals are linked to some kind of external rewards. These leaders usually clarify their expectations, provide necessary resources and then actively monitor the performance of their followers by watching out for deviations or taking corrective action. However, unless there is a problem with not meeting the given standards, the transactional leaders do not intervene the performance of the subordinates (Northouse 2013, 186-187).

3.4.3 Laissez-Faire Leadership

The least effective and most passive of the three leadership styles is laissez-faire, also called the “nonleadership”. In contrast with the two previously mentioned styles, laissez-faire leaders do not actively engage in the whole leadership process. They do not participate in decision-making and avoid taking responsibilities which often results in lack of direction of the group and therefore underperformance. By “doing nothing” these leaders delegate the chances to make decisions on their subordinates, which can be effective in case the individuals are highly skilled, motivated and capable of setting and meeting deadlines (Griffin and Bone 2014, 205), but may also turn out to have disastrous effects if they are incompetent and unexperienced (Northouse 2013, 196).

3.4.4 Picking the right style

According to Zotto and Gustafsson (2007, 5) entrepreneurial leaders must be able to engage in new opportunities, break new grounds and go beyond the known. These

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leaders must have an exciting and contagious vision and be able to inspire their followers to commit to the organizational goals. Already now it is then obvious that the leaders, who adopt lasses-faire style, cannot be effective in startup companies, since they usually do not have a clear vision and even if they had, they are unable to communicate it to the followers. Without inspiration and proper coaching of the employees the business is sentenced to simply operate aimlessly in the market until its complete decline. Furthermore, unlike established companies, due to their usually small size and young age, startups do not yet have any developed structures or processes that would be able to substitute the lacking leadership behaviour (Zäch and Baldegger 2014, 8). Both transactional and transformational styles contribute actively towards the firm’s performance and have the capacity to communicate the goals to the subordinates, therefore further differentiation between these styles has to be made in order to determine the most suitable one for new entrepreneurial ventures.

Figure 3: The Full Range of Leadership Model (Source: Northouse 2013, 192)

When trying to define an ideal startup leader, Darling et al. argue that he or she must be able to understand the dynamics of the organizational setting and deal with emerging opportunities effectively. A failure can occur if the organization is over-managed and under-lead, which happens when the entrepreneurs excel in handling the daily routines, while forget to pose the question whether this routine is still applicable and necessary at all (Darling, Gabrielsson and Seristö 2007, cited in Zotto and Gustafsson 2007, 5). Having said this, it is becoming clear that transactional leaders with their routine problem-solving approaches may not be the right solution for startups.

In order to stimulate creativity and innovation, which are essential elements of successful startups, “openness and dynamic contact between individuals, teams or departments within the organization” is necessary (Martin Treblanche 2003; Mumford

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et al. 2002 cited in Zotto and Gustafsson 2007, 5). Furthermore, delegating decision making to the employees and challenging them to solve stimulating tasks can contribute immensely to their internal motivation. Since encouraging team spirit and inspiring internal motivation are the features of a transformational leader, it implies that this style will be the most effective one to adopt for startup companies.

Transformational leaders are able to create organizational cultures which are based on trust, tolerance, learning and effort. However, these leaders sometimes have the tendency of becoming too authoritarian and trying to do all the decision-making on their own. This kind of behaviour can have discouraging effects especially on highly competent and experienced employees (Drumm 2003, cited in Zotto and Gustafsson 2007, 6). Therefore the entrepreneurs must be able to delegate responsibilities, despite thinking they would be able to do it better by themselves and need to provide their employees with sufficient amount of autonomy. However, while granting autonomy to the subordinates, the leader must not neglect to control whether the firm is going the right direction and be careful so as not to slip to the laissez-faire leadership style.

Good leaders must be able to provide sufficient training to develop knowledge and skills of their subordinates. A problem may arise when they do not regard it as important enough and neglect it. When taking into account the high costs of formalized trainings – in terms of money as well as the loss of immediate working time, the entrepreneurs sometimes see it as an expense, when, in fact it is an investment. In new and small companies, employees’ skills and knowledge can be considered as the most valuable asset (Banks, Bures and Champion 1987, cited in Zotto and Gustafsson 2007, 6).

Last but not least, startups with very little employees could take the advantage of so-called “networked leadership”. In this case, the entrepreneurs act as mentors in order to develop their employees’ leadership skills, by providing them with professional and psychological support (Comelli and von Rosenstiel 1995; Swiercz and Lydon 2002, cited in Zotto and Gustafsson 2007, 6).

3.5 Money versus Power Dilemma

For startup founders knowing which leadership style to apply and even being able to apply it is very important, however, even this cannot always assure the success of the business. Sometimes they have to make decisions which are not exactly in accord with what they wish for. Sometimes the founders even have to step down and leave their position of the company leader in order to allow the business to flourish. The issue that causes this to happen can also be referred to as “the founder’s dilemma”.

The HRM challenges that have been addressed so far mostly concerned the founders and the way they should approach their employees. In contrast, now the problem regards the CEOs and the decision they may have to make about themselves. The impact on the overall company’s performance and therefore also on the staff is nevertheless immense. The challenge of the founders is to determine, what matters for them most – money or power.

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Every startup entrepreneur is obviously aiming for both, being rich and being in control of their business. However, as the company grows, it is inevitable to realize that only a small fraction of “the chosen ones” can actually bring that off. The rest of the businesses have to sooner or later face the question of money vs. power, depicted in Figure 4. The reason is simple – every startup needs some financial resources to launch, run or grow the business and when deciding how to raise the money as well as how much to rise, the founder has to understand, which of the two is of a greater significance (Wasserman 2008, 1-8).

Figure 4: The Trade-Off Entrepreneurs Make (Source: Wasserman 2008, 4)

3.5.1 Preference for Money

If the entrepreneur thinks it is the money that is of the most crucial importance, he or she can easily raise the financial capital through investors even if they gain a greater share of the company. What the founder also has to realize is that when owning a minor share of their company, he or she is losing the power over it and may be forced to descend from the CEO position to a managerial chair. This can in turn have great impact on the overall performance of the startup. From the financial point of view, the situation for the whole company and its employees should improve by having nominated a new CEO who is more competent in the field. However, the case can also deteriorate if, for example, the founder CEO was a charismatic leader who was inspiring them not only through his or her deeds but also through a unique personality. The employees may lose their trust in the company, lose their internal morale or become disengaged and start underperforming (Cubiks 2014). Therefore the founder needs to judge very carefully the way he or she is seen by the employees before taking the decision. It is not just the leader himself but all the people in -in the organization that get affected.

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3.5.2 Preference for Power

Some entrepreneurs refer to their businesses as being “their babies” and therefore, despite having the chance to accept external funding, giving up on equity and earning a huge amount of money, they prefer to stay in the game. By keeping the equity these entrepreneurs are able to retain their CEO positions and remain in control of their startup businesses. This way, unfortunately, the company is very unlikely to raise as much as it could have if the CEO gave up their power (Wasserman 2008, 1-8). This can therefore also have negative consequences on the employees. They may view the founder’s behaviour as selfish due to the preference of own interest and ego to the financial prosperity of the organization. The discrepancy may then again lead to disengaged employees generating poor results, and spoiling of the company’s performance.

3.6 Mergers and Acquisitions

3.6.1 Defining Mergers and Acquisitions

First of all, it is necessary to define mergers and acquisitions (M&A). According to Investopedia, these terms both refer to consolidations of companies. The difference is that while mergers practically combine two different companies to create a new one, in acquisitions one, bigger company purchases another, smaller company, but as a result, no new organization is formed (Investopedia: Mergers and Acquisitions 2014).

Every startup founder tries to maximize the growth of their company straight from the launching of the business. Usually, this growth is pursued through building and selling more products or services, while also expanding to a greater number of geographic locations. This kind of growth strategy is called “organic growth” (Startup Professionals Musings 2013). Of course, when taking the right steps, this growth is sustainable. However, many startups have a much higher growth potential than just the organic growth and it would be a crime not to take advantage of it. The potential can usually stem from two options – to merge with another company or to get acquired by a bigger player on the market. The challenge of the startup firms is to be able to find the right balance between the growth strategies. On one hand, relying on organic growth can turn into a straightjacket and lead to limited horizons and lack of innovation (Startup Professionals Musings 2013). On the other hand, putting too much emphasis on growth through alliances or mergers can make the startup more vulnerable and lead to potential conflicts of interests. Last but not least, young companies must be very cautious when deciding about getting acquired, since their employees may get demotivated and in turn deliver poor performance.

3.6.2 The Role of HRM in M&A

The KPMG International survey monitoring performance of companies after being part of a merger or acquisition came to a surprising conclusion: When tracking the value created through M&A, the majority of the companies did not enhance it. This means they either stayed on the same level as they were before the M&A or, even worse, their value was, as demonstrated in Figure 5. This leads us to an observation that probably something is not alright; something important must have been neglected.

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Our interest is to analyse this fact from the HR point of view and then demonstrate its importance and applicability to startups.

Figure 5: Tracking Trends in M&A Value Enhancement over the Past 12 Years (Source: KPMG 2011, 6)

According to a 1999 Global M&A survey conducted by KPMG “Unlocking shareholder value: keys to success”, there are six “keys” used by companies to unlock value from deals that they take part in. Three of the keys are “hard” and include synergy evaluation, integration project planning and due diligence. The other three skills are called “soft” and refer to management team selection, addressing of cross border cultural issues, and internal and external communication (KPMG 2011, 18). The soft keys are the ones that are of great importance when investigating the role of human resource management in mergers and acquisitions. In fact, the results of the above mentioned survey came to the conclusion that organizations that took into consideration the soft factors when carrying out their transactions were 26% more likely to succeed with their deals. Despite this striking evidence that one should pay attention to HRM, as can be seen in Figure 6 due diligence on human resources issues is still given a low priority.

The human resource issues that are referred to in Figure 6 include retention, cultural differences and redundancy processes, as being the three most important matters. Other people issues that were assigned lesser importance by the companies were for instance terms and conditions, communication, recruitment or integration (KPMG 2011, 19). In order for the company to succeed all of these issues have to be addressed in all the phases of a merger or an acquisition. The four stages of M&A are pre-deal, due diligence, integration planning and implementation. Based on the findings of a survey made by a group of human resource professionals, in the most M&A cases, HRM did not get involved until the pre-deal and due diligence phases were over. In successful cases, the human resource unit had the tendency to get involved

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much earlier (Giffin and Schmidt 2002, 8). Therefore this paper will analyse the HRM role in each of the four M&A stages.

Figure 6: Types of Due Diligence Done by Companies (Source: KPMG 2011, 6)

In the first, pre-deal stage, the task of HRM is to evaluate the culture of the two companies that are about to become one. The cultures as well as the success requirements in the lines of business that will be combined should be compatible. The HRM must for example pay attention to risk-aversion of the groups to be merged. Some people might like to take risks and pursue aggressive strategies while others prefer to take steady, careful steps when making decisions (Giffin and Schmidt 2002, 8-9).

In the second, due diligence stage, the M&A partner is already chosen. This assigns HRM an important role to assess its culture, regarding management or leadership styles. They may for example consider whether there is a difference of power distance between the two groups. Some people with high power distance are used to strong hierarchies and autocratic leadership while others with lower levels may find this unacceptable, which may cause problems. The HRM unit also needs to analyse potential financial issues such as differences between pension plans, retirement benefits (Giffin and Schmidt 2002, 9).

The third and fourth stages – integration planning and implementation can be considered to be the most crucial task for HRM. It can include activities such as developing employee communication strategies, programs for retention of top talents and staffing plans. However, probably the most critical HRM task is to address change. People have a natural fear of change, since it makes them feel insecure. The role of HRM is to help the employees overcome their anxiety and answer all their questions

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regarding the happening M&A – from changes in benefit programs, through job security and relocation questions to information about the other’s culture. It is important to provide the employees with the sense of security, otherwise the company might be facing loss of their key personnel and increased turnover. Not only the HRM unit, but also the CEO has to step in right from the beginning. Their role is to clarify the tasks of human resources in the M&A process and grant them competencies for executing the necessary procedures before it is too late (Giffin and Schmidt 2002, 9).

3.6.3 The “Acqhire” phenomenon

Now when it is obvious that HRM plays an irreplaceable role in mergers and acquisitions, one might be wondering, how this all connects to startups. The answer actually lies in the HRM challenges that established companies are facing. For them hiring and retaining of talented human resources is becoming ever more elaborate in the current market. Therefore, in the search for competitive advantage, the dominant companies are increasingly engaging in a so-called “acqhire” strategy. The portmanteau was created by combining the words “acquire” and “hire”, and refers to a human resource strategy used by bigger companies to procure talented people through acquisition of startup companies (Mayer and Selby 2013, 1).

The acqhire strategy is becoming more and more popular because of various benefits it provides for the acquirer companies. Probably the most significant advantage lies in the opportunity for the large corporations to gain easily the whole team of talents, instead of just a single person though demanding hiring process. Moreover, these people have worked together before, are an already established and highly skilled team. By acqhiring the startup, they can be preserved as a cohesive resource bundle and keep the dynamics of the team. Besides that, the new team brings new innovation potential to the acquirer company and is also convenient since the star employees have more incentives to remain in the company in order to stay with their teams. In addition, the trust in the team can positively impact the motivation of the employees and make them work harder. For this reason acqhire can be viewed as a useful retention tool (Mayer and Selby 2013, 1-16).

As Mark Zuckerberg, the founder of Facebook once said: “Facebook has not once bought a company for the company itself. We buy companies to get excellent people.” (Mayer and Selby 2013, 2) it is necessary to realize that it really usually is the human resources the large companies are interested in, not the products or services offered by the startup. Therefore, besides all the above addressed HRM issues connected to M&A, the startup founder must also realize that by getting acquired by another company, their products, services and all the projects may possibly be ignored or get abandoned. The entrepreneur should cautiously consider for example the “attachment” dimension of the HR blueprint of the firm. In case it is “love”, staying in the same team should not affect the employees’ performance in any way, since the team remains the same. However, if the chosen blueprint dimension is “work”, which means being devoted to a project rather than the team, the performance may deteriorate after the project is taken away from the employees. In

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case the picked dimension was “money”, as long as the acquirer company offers a competitive compensation, the performance of the employees should stay the same.

4 Conclusion The main goal of this paper was to determine, what are the most common human resource challenges that startup companies have to face, and to suggest strategies that are recommended to deal with them. After an extensive literature research that covered paperback books, journal articles, popular business magazines, websites and blogs, it was possible to identify the challenges, which the startup companies are most likely to come across in some of their life cycle stages as well as approaches how to deal with them.

The paper first examined the challenge that startups have to deal with right at the beginning when they are founded – picking the organizations’ HR blueprint. Many new businesses find the HRM issues at the birth stage unimportant, however, the facts state the opposite. The HR blueprint proved to be quite essential factor having an impact on the future success of the firm. Therefore this paper draws attention to the mistake of ignoring HR at the first startup phase and suggests that every new business should create an HR blueprint that they will be able to stick to in the future.

The second challenge that was discovered to be vital for startup companies to cope with correctly was attracting and selecting competent personnel. According to literature sources it was found out that the recruitment process cannot be generalized since it differs in various life cycle stages of the companies. Therefore both of the stages were analysed. In the startup phase startups have to overcome the liabilities of lack of organizational familiarity and unknown employer’s image. The recommended tactics in this phase was therefore recruitment through networks. At the same time, it proved to be imperative for the startup to increase the job seekers’ knowledge through brand marketing and improve its credibility by incorporating core features of recruitment practices used by larger organizations.

The third issue that every startup has to deal with is the compensation decision. In order to attract the best talents the startups have to offer competitive compensation. However, with the liability of newness, smallness and thus lack of financial resources, the task can get pretty challenging. Therefore this paper compiled several smart and cost-efficient ways to attract and retain top employees, which include various creative benefits, some of them in the form of equity and stock options, or even investment into continuing education. The paper also highlights the often overlooked option of taking in part-timers, interns and volunteers as a source of high-quality and low-cost work. Last but not least, the findings showed that it is not always the CEO who has to earn the highest salary and therefore, when necessary, they might even be willing to give up a bit more in order to retain the best employee.

The next challenge that all the startups must be aware of its leadership and development. It is essential to know what kinds of leadership styles exist, which is the most effective one for startups and then, of course, to be able to adopt this style. The paper provides the basic guidelines for all the startup founders on how to approach

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this issue. In addition, it draws the attention to the fact that leaders must not neglect to provide training and development for their subordinates, since their skills and knowledge are undoubtedly the startup’s most valuable assets.

Another question the startup founders have to ask themselves is whether they have preference for money or rather power. Many entrepreneurs think they can have it all, but the reality is different and therefore the paper highlights the importance of being able to decide either for money, which may result in giving up the CEO position in order for the business to flourish, or for power, which may end up in inability to raise enough money and slower growth. Unless the founders figure out which matters to them more, they might “end up being neither rich nor king” (Wasserman 2008, 2).

Last but not least, with the expansion of the acqhire phenomenon, where startups are targets of acquisitions by larger corporations, it is necessary for them to realize the challenges that go hand in hand with this decision. The paper explains the role of HRM in mergers and acquisitions and points out the major people issues that should not be neglected.

To sum up, the paper addresses the major challenges startups face and the strategies to cope with them that were discussed in the reviewed literature. However, each startup is a unique entity and therefore might come across a unique set of challenges which require unique solutions that may differ from the ones mentioned in the paper. Therefore it is necessary to realize that the paper does not serve as a manual but rather a guide for startup founders to help them understand what to consider when faced with the words human resource management.

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List of Figures Figure 1: Dimensions of Employment Blueprints ................................................... 3 Figure 2: Typology of Employment Blueprints, Based on Three Dimensions .............. 5 Figure 3: The Full Range of Leadership Model .................................................... 12 Figure 4: The Trade-Off Entrepreneurs Make ..................................................... 14 Figure 5: Tracking Trends in M&A Value Enhancement over the Past 12 Years ........ 16 Figure 6: Types of Due Diligence Done by Companies ......................................... 17

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List of Abbreviations CEO = Chief Executive Officer HR = Human Resources HRM = Human Resource Management KPMG = professional service company specialized on audit, tax and advisory; the KPMG stands for Klynveld Main Goerdeler that merged with Peat Marwick M&A = Mergers and Acquisitions RTN = Recruitment through Networks SPEC = Stanford Project on Emerging Companies

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