Are Companies Led by MBAs Overvalued? 

It’s dangerous to stereotype. But after conducting due diligence on hundreds of technology companies, one trend we’ve repeatedly seen is the stark quality difference between MBA-led tech startups and those led by a CTO. Let’s take a look at the tech differences between the two, and the diligence risks of each:

MBA-Led Tech Startups

The typical pattern for MBA-led startups is idea first, tech team second. And once the CTO is hired and the tech team in place, two largely unstoppable effects take over. Effect number one: MBAs tend to see their tech team as both a source of competitive advantage and a cost center. And in the balance between dollars (which MBAs emphatically do understand) and some vaguely higher-quality and better tech approach (which non-techies, MBAs included, don’t really understand), cost invariably wins. It’s simply hard to spend money (and time) on something when you don’t really know what it is. The result is lower-quality technology that’s costly to maintain and hard to update. But left to their own devices, most tech teams would over-build and miss deadlines. At its root, the problem is that no single person is responsible for both quality and cost, often resulting in poor choices with long-term consequences.

The second effect relates to the CTO the MBA hires. Top CTOs commonly have their own startup dreams and typically have little patience for implementing someone else’s, especially under the budget thumb of someone who doesn’t understand tech.

MBA-led startups demand greater tech diligence for two reasons. First, to understand just how much corner-cutting has taken place and to assess the damage. The damage is often hidden. That is, the current version works … even if barely, and only because of high-cost, non-scalable manual work behind the scenes. The second reason for tech diligence is often more important: accurately and impartially quantifying the money and time needed to pay down the “technical debt” incurred by those MBA-imposed cost-cutting choices. Any acquisition of an MBA-led startup should expect tech diligence to reveal significant increases in OpEx. The question is: How much?

That’s not to say buyers should walk away. An MBA’s choices are defensible: It’s good for startups to have budget discipline. Indeed, it’s central to the Lean Startup movement and Minimum Viable Product concept. Moreover, the approach has achieved its goal (at least from the MBA’s perspective!): a hefty payday if the deal closes. And deals only close because the MBA has built something of value. But a buyer first needs to factor into financial models the frequently higher tech costs of MBA-led startups, which can be significant enough to force a lower valuation.

CTO-Led Tech Startups

CTO-led tech startups tend to have better tech, for the simple reason that CTOs generally understand both money and tech quality. CTO-led startups must still make cuts, but it’s a question of which cuts. In overly simplistic terms, CTO-led companies might have made 20% fewer cuts, but achieved 60% more quality, flexibility, and efficiency, all of which can have a real impact on value, as well as the ability to quickly execute on any post-close pivot.

But money is the simplest of business concepts. CTOs often underperform at more nuanced ones, such as correctly reading the market, and genuinely listening to customers. They also may lack the emotional maturity needed to let go of their oh-so-wonderful code when it’s clearly time to chase the new. In short, CTO-led companies have better implementations, but often in pursuit of an opportunity that’s not the highest and best fit for the tech they’ve built or could quickly pivot to.

That’s where the opportunity comes in. CTO-led startups tend to be weak in areas where acquirers are strong. Indeed, many acquirers are good at solving pretty much any corporate malady other than tech. The target is too stubborn to listen to customers? Fixable. The target lacks marketing? Solvable. Needs better management? Not unusual. Assuming valuation of a CTO-led tech startup is based on its current financial performance, there are often opportunities for redeploying such well-built and flexible tech to larger opportunities and/or adjacent markets.

The reason good tech diligence is trickier for a CTO-led startup is that the most important diligence is hypothetical. The critical question isn’t “Does the code work for the current market?” Instead, it’s “Can the code and team work in this similar-but-different market that is larger/different/adjacent?” And that implicates a range of more nuanced issues that require more sophisticated diligence. The most common concern is the team’s personality and its tolerance for change. Also worth wondering about is how well the tech will perform under new and different loads – ones for which the tech wasn’t built, and about which the tech team hasn’t thought. All of these hypotheticals should be vetted to avoid the false comfort of pre-pivot performance as a valid proxy for post-pivot risk.

Switch Hitters and Worst of Breed

One caveat: It’s not always obvious which is which. We’ve seen startups led by CTOs who are also wise in the ways of business – a rare and invaluable combination. But sometimes as the CTO takes on more CEO duties, something (perhaps ego?) won’t let him or her relinquish CTO duties. The result can be unqualified tech-team members making many tech decisions ad hoc as the need – or more accurately, the crisis – arises. Such a CTO-led company may present like an MBA-led startup, with the risks outlined above. Or, as we’ve unfortunately sometimes seen, it may wind up as a worst-of-breed hybrid: The not-so-good tech of an MBA-led startup coupled with only the partial market fit of the CTO-led startup — because the CTO/CEO was too overworked to get either right.

Michael Kauffman is a Principal at Tech DNA, a global leader in technology due diligence.