How to start up successfuly
I. STARTING UP YOUR START UP
What kind of entity should you use for your start up? There’s not a lot to choose from–it’s generally either an LLC or a C Corporation. My entity of choice for a start up is an LLC– I love the tax benefits. In very rare circumstances, I might suggest a C Corporation.
A. START-UP FOUNDERS’ BUSINESS RELATIONSHIP
The operative document for an LLC is called the LLC Operating Company Agreement. It spells out the obligations and sharing arrangement between the Company founders. Many questions arise–how will founders contribute capital to the start-up, how will the business be managed, how will cash be distributed, etc… The link below is to a list of issues that arise most frequently in these early conversations. Answering all of these questions helps to translate the founders’ relationship into an LLC Operating Company Agreement.
B. SOME HELPFUL DOS AND DON’TS FOR START-UPS
There’s so much to keep in mind as you launch your start-up–from selecting the right entity type to making sure that the Company owns everything your tech team develops to properly incentivizing your employees. Here are some general guidelines.
II. HOW CAN I RAISE MONEY FOR MY START-UP
It’s best to bootstrap your start-up for as long as possible, to create value and prove your business model. That makes it easier to fund raise. The first funding round most people raise is from their friends and families. If you’re fortunate enough to have wealthy friends and families AND you can sleep at night taking money from them, they’re the right place to start. Otherwise, angel networks might present a viable option. Later stages are typically for Venture Capital funds.
A. EXECUTIVE SUMMARY FOR VENTURE CAPITAL
The best way to get the attention of a potential venture capital investor for your start-up is to have a mutual contact make an introduction by sending an Executive Summary/Teaser document, which should be no longer than 2 pages. It should be very simple and to the point. Remember–your intended audience has a very limited attention span! If they’re interested after reading the Executive Summary, they’ll come back to you for more.
B. KEEPING AHEAD OF THE DUE DILIGENCE CURVE
Once you capture the interest of an investor (or hopefully several), at some point in the process, they will likely email you a due diligence checklist a lot like the one below. Imagine how impressive it is to simply send them a Dropbox link to an existing data room within a day or two of receiving that checklist (I’ve seen companies take weeks to assemble all the information). And imagine how much credibility it earns you for creating the impression that your corporate house is in order. I typically recommend my clients go through this checklist and start assembling such a data room very early on.
C. PROTECTING YOUR INTELLECTUAL PROPERTY
Often, entrepreneurs are hesitant to share details about their intellectual property with potential investors. And a venture capital investor will almost never sign a non-disclosure agreement until you are close to the term sheet stage (biotech and life science VCs are an exception to this rule). Filing patent applications or even provisional patent applications can solve this dilemma, as can “black boxing” the IP and limiting the early discussions with a potential investor. Take care with employees and independent contractors as well–make sure each signs a Proprietary Information and Invention Assignment Agreement, effective as of their start date. See the link below for more information.
III. VENTURE CAPITAL LINGO
Negotiating with a venture capital investor may be like trying to communicate in a foreign language. Especially when it comes to math. It’s very important that you understand the difference between pre-money value and post-money value and what it means to calculate shares on a fully diluted basis–each of these terms impacts your dilution from an investment. The link below contains a general discussion of Investor Math. The second link is an interactive chart that will allow you to calculate the price per share in an investment, your dilution from that investment and the set-aside, if necessary, for an option pool. The third link is to a “Venture Speak” dictionary–it will help you figure out all the lingo.
IV. DEALING WITH A BOARD OF DIRECTORS
After your first round of outside money, it’s usually a good time to start thinking about creating a Management Committee (if you’re an LLC) or a Board of Directors (if you’re a corporation). A Board of Directors governs your Company, so appointing an investor or other outsider can significantly impact Company dynamics. A venture capital investor will generally insist on at least one board seat and likely voting control over several extraordinary matters, such as raising additional monies (though debt or equity), acquiring an interest in another company, selling your Company, declaring a dividend or other distribution, etc… I’ve found that the best way to manage a board is to have regular meetings, keep them informed between meetings and create an atmosphere (or at least the perception) of transparency.
V. EMPLOYEE COMPENSATION IN START-UPS
You may ask yourself how you’re supposed to cover salaries for your employees when you’re barely staying above water. Employee compensation in the start up world is not just cash–stock options (or profits units if you’re an LLC) are expected. In general, in the first 3 years of a Company’s existence, up to 20% of the Company may be issued in stock options to employees. Standard venture terms are 4 year vesting with a 1 year cliff–that means that a grantee will not vest in any portion of the grant until her first anniversary of the date of grant. It gives you the chance to make sure you’re satisfied with her as an employee. The chart below sets out general parameters for compensating employees in the C-Level. It is based solely on my experience and should not be viewed as fact or legal advice.