Start-ups are all Naked in the Mirror

This is part of my ongoing series Startup Lessons

Building companies is hard work.  I started my first company in 1999 in London at the height of the dot com craze.  We also had facilities in Dublin, Ireland where our company was initially founded.

We went through the euphoria of massive exposure at the time of our launch due to an article that ran in the Financial Times.  We were unprepared.  Our software wasn’t fully baked.  We hadn’t even thought about having a customer support line or who would staff it.  Our phones rang off the hook.  Our company was completely euphoric.  We drank our own Kool Aid.

We had one of the largest US software companies talk about buying us.  Goldman Sachs (an investor in our company) told us we’d IPO within 18 months for $1 billion so not to take any offers.  My competitors from those days STILL love to talk about how much money we raised in February 2000 (get over it already!).  I acknowledge it was a mistake.

We were hot.  Until we weren’t.

As the economy soured and people grew wary of buying Internet software (we were SaaS as early as 1999 – our buyers were certainly “early adopters”) and life grew more difficult.  Our product releases took longer to ship than we had hoped.  Our customers were generally happy but they were pushing us hard for promised features.  Our business development discussions took longer than planned.  Reporters were no longer interested in talking about B2B eCommerce.  Our sales forecasts were revised downward – many times.

But still we made progress.  We had things to be proud of.  We were working hard and becoming a real company.  We downsized, developed processes and found our groove.  Everything I learned about entrepreneurship I learned in this period.  I think the fondest memories and bonds in life are developed between people who go through shit like this all together and come out survivors.  We developed deep kinship.

Yet there was one thing that was despirting in this time.  Our competitors seemed to be flawless.  We kept reading about their customer wins, their product releases and their biz dev deals.  Buzzsaw (owned by Autodesk) raised $90 million and was making weekly noise in the market.  Our largest US competitors merged and even European customers said that this proved this would be the knock-out blow.  The largest Germany construction firms announced that they were going to launch their own initiative and therefore not use 3rd-party vendors.  Shit.  SHIT!!!

These were stressful times.  My staff kept asking me about these competitor moves and I didn’t have answers.  I could tell some of my best people were losing confidence.  One of my closest friend (our CFO) left the company.  It didn’t add up to me.  How could they being doing so well in these difficult times?   And then it dawned on me.  I figured it out.  And I made a version of this company-wide speech to our employees:

“Look.  I know that you keep reading about how our competitors seem to been going from strength-to-strength in the press.  I know that we’ve made some mistakes.  I know that we haven’t brought in revenue as quickly as we had hoped.  I know it sucks that we had to reduce staff.

But here is the problem.  You’re only reading our competitor’s press releases.  Your reading the good stuff.  And you’re looking at ourselves naked in the mirror.  You see all of our flaws.  And I acknowledge that there are many.  But when you see them they’re wearing their fancy outfits, look stylish and ready to go out on the town.  They’re masking their internal flaws.  And you know that they have many flaws, too.  I’m betting more than we have.

I promise you that inside their offices they’re reading our great press releases, wishing life was as easy for them as it was at our company.  They’re looking at themselves naked in their mirrors, too.  Believe me.  They haven’t hit their revenue targets.  They’ve had staff defections.  They’re working evenings and weekends.

You need to stop comparing our internal issues with their press releases.  Every company has growing pains.  Every competitor is resource constrained.  We’re all scared that the next round of funding won’t come.

So please try to keep your confidence.  We’ve assembled a great team of people that are each expert in what you do.  If we all stay focused on serving our customers and delivering as best we can every day then we’ll be fine.  The minute you lose confidence we’re finished.  Bad morale is the enemy of any company let alone a start up.”

Why did I come to this conclusion?  Because I had started reaching out to competitor CEO’s.  I figured we had much in common with them and we could benefit from a support system.  Our biggest problem was market traction not each other.  It was uncanny how when I spoke openly with them about my concerns how similar their issues were.   Sometimes it is nice to have enemies to motivate you, but it’s also nice to have peers.

Here are my take aways from that experience:

1. Be careful about believe everybody else’s good press and drawing any judgment on your own internal performance.  Judge yourself against your own expectations for yourself and your customer feedback.

2. Let your compass be based on your customers.  Get feedback, find out whether they are happy and serve them well.  Over communicate with them.  Don’t obsess with product releases of competitors or biz dev deals.  In the scheme of things they come and go.  Google announced Google Wave and people are worried about the impact on your business?  Don’t.  Product announcements come and go.  You need to understand the impact of your competitor developments and learn from them.  Just don’t obsess with it.  And don’t let it be your compass.

3. Remember to communicate with your team frequently and openly.  Point out the naked mirror syndrome.  It is the elephant in the room anyways.  Believe me they’ll all have Google Alerts out on the competition and will read their announcements with interest.  If you don’t address it they’re minds are shaped by competitor PR.

4. Be careful about not over expressing your deepest concerns to your team.  You need to be open but not instill panic.  It’s OK to talk about fund raising challenges or customer losses.  You should.  But most people aren’t wired to deal with the nerve racking daily grind of life as a CEO.  If you shared every deep seated fear (that I know you have) and over hyped every victory (that never pays off as much as you had hoped) you’ll have people on your roller coaster ride.  Remember that most people aren’t wired this way.

5. Don’t underestimate the impact of good PR on your competitors.  You need to be sure that you’re constantly communicating with the market.  Having a conversation.  Getting your company news out.  Believe me your competitors are watching.  Reading.  Good PR can help slow down your competitors initiatives as they naively try to follow you.  No news from you strengthens their internal morale.

6. Reach out to the competitors.  Get to know them.  Be open and many will be open back.   Realize as a start-up you have much more in common with them in driving the industry adoption.  I think it’s best to have friendly competition the way you’d hope to in sports.  Compete to win – don’t get me wrong.  But in a gentlemanly way.  If you feel the need to have an “arch enemy” to motivate the team (as some CEO’s feel the need) then make it just one firm and befriend everyone else.  Reach out to the founders, not the staff.  Keep your conversations confidential.  I wouldn’t even disclose to the team that you’re having them.  They then start to think sinister thoughts.

7. Your strategic initiatives are unlikely to deliver knock-out blows – Just as most people overplay their competitors strengths, they also tend to overplay their own.  No matter was killer next feature set we were releasing that we thought would completely change the game in our market it was uncanny how every major competitor I had was (in retrospect) working on the exact same set of features at the same time.  They had all the same customer feedback and had they all had smart people around the table.  I believe winning is about constantly executing, year-in, year-out.  Not about some knock-out feature set, biz dev deals , pricing drops or market positioning.

8. Don’t overset expectations for your employees on the way in. I learned this the hard way.  Imagine calculating what 0.25% of your company is going to be worth when you go public 18 months after inception.  I know it sounds silly to those that weren’t around in the late 90’s.  But when that doesn’t pan out then people look to the door.  After a while I starting telling people on the way in, “join because you’re passionate about what we do.  Join because you’ll make a good not great salary.  Join because as we succeed so will you.  Join because every year we’ve improved your CV to have an even better job in the future.  And, oh, by the way.  We do hand out stock options.  If they’re worth something some day that would be gravy.  But if you’re joining for just that reason it would be better to work somewhere else.”

The Best VC Meetings are Debates not Sales

This is part of my blog series “Pitching a VC.”

I’ve sat through a lot of VC pitches and having been CEO of an enterprise software firm for many years I’ve also sat through many customer meetings with sales teams.

There is one classic mistake that I see across both types of meetings – “the tell & sell”  presentation.  This involves a person who leads a PowerPoint presentation in which the presenter feels more comfortable racing through pre-practiced slides and rattling off charts & bullet points than having a discussion.

The presenter comes out of the meeting proud at having gotten through all 30 slides (and maybe even a demo) with a bunch of smiling faces and nodding heads and no discussion.  After the sales meetings I would ask the exec afterward, “how do you think it went?” and always be surprised when they’d say, “great, I think they really liked it.  They seemed to agree with everything I said.”

In our internal sales training sessions I would always teach our young sales execs that this seemingly good meeting was probably not as good as they thought.  People are much more likely to buy into you as a person and us as a firm when they’ve been involved in a discussion with you about their problems, your solutions, who else has been using your product, etc.  They might even like to challenge some of your assumptions.

The advice I gave to my sales execs is the same advice I would give to you:  smiling, nodding heads are normally not a great sign.  In the best case they might prefer to ask you questions but you didn’t prompt them and they’re being polite (although this is less likely in VC who are not known for being wallflowers!).

The VC might have tried a few times to prompt a discussion and you didn’t take the cue but instead reverted back to slides.  This happens often and I bet most presenters never realize it.  Most worryingly, many times it means that they have decided that they are not interested in your product (or investing in your company) so why bother having a debate / discussion with you.

It is easier for them to finish up 45 minutes, politely shake your hand and say, “we’ll get back to you”  once they’ve had a chance to “noodle on it.”  Ever heard that?  Far better that you noodle with them.  I believe that the best meetings are debates.  The following are some tips for the discussion style VC meeting

UPDATE: My initial post talked more about a debate than a discussion.  David commmented here that the problem with my phrasing it as a debate is that I don’t want to encourage any entrepreneurs to think that they should try to “win” the discussion by proving they are right (as you might do in a debate).  So I’m softening my message to “discussion.”  See note at the end of the post for a funny story on this.

Tips in a discussion led VC Meeting

1. Tee up your slides to prompt questions – The best way to avoid racing through your slides in a tell & sell style is to tee up your slides to prompt questions.  We used to do this in our sales slides.  After walking through the “problem statement” slide, the build on the bottom of the slide would always say, “Have you experienced similar issues in your company?”

It was just a way to remind the sales rep to create a dialogue.  If you get nervous in meetings or have a hard time remembering to stop you can simply build the prompt into your slides.

2. Stop often and seek feedback on direction – In addition to asking questions to prompt a debate you should always check for feedback from the VC.  Examples are “would you like me to go into more details about how we calculated the market size?”, “would you like me to tell you more about the team members who aren’t here,” or “would you like me to jump into a product demo now or tell you more about our market first?”  Be careful not to jump into a long-winded discussion on any topic without seeking cues from your audience on whether they’d like to go deeper on the topic or move on.  I think this is one of the single biggest mistakes that presenters make.

3. Be careful about the way you ask questions – I’ve sat through many meetings with groups of people where the presenter would say something like, “Do you know what REST is?” or “You know the company Constant Contact, right?”  Questions like this in a crowd often elicit “yes” answers even when people haven’t heard of the technology or company.  Most people in general don’t want to admit in front of peers that they haven’t heard of something that they think they should know.  If your presentation requires an explanation of RSS vs. ATOM always best to say, “let me quickly state how RSS and ATOM are different.  I know you might be aware of the differences but let me quickly cover it and if you want me to go deeper I’d be happy to.”  If the VC knows the difference TRUST ME they’ll tell you.

4. Don’t be defensive – Don’t view any question by a VC as an affront to you.  I know that they could have worded it more politely and in a less condescended tone, but view the question as an opportunity to have a great discussion.  View the question as engagement!  Remember that a VC doesn’t always care that you have “the right” answer provided that you have a high quality thought process.

Having a discussion is a great way to build rapport with the person asking the question.  It’s OK to say things like, “I could see why you might think that Google would go into our market.  It’s a valid concern and we worry about it, too.  Here’s why I think Google won’t initially be a threat to us and how we would respond if they entered our market …”. So the next time you get a zinger from a VC – be thankful.

5. Answering with a question – Another suggestion is the “answer a question with a question” technique.  First, you must actually answer the question that was asked with you before you ask a question back.  It’s really annoying in any meeting when you answer a question directly with a question.  But it’s OK at the end of your statement and it’s a great way to get people talking.

Example:

VC, “Do you really think that customers will pay $5,000 / month for your product when there are free versions of X,Y,Z on the market?”

You, “We’re not too worried about the free products because they target a lower-end segment than we’re targeting.  We tested the $5k price point with a handful of customers and they didn’t seem price sensitive … From your experience do you think $5k price point will likely be an issue for us?”

6. Don’t be afraid to say “I don’t know” – I don’t think any VC is looking for the entrepreneur who knows everything.  In a way I think most VC’s want to see that you’re mentally flexible, sufficiently humble and not afraid to admit when you’re wrong or don’t know something.  For many difficult or unknowable questions don’t be afraid to say “I don’t know.”  Some obvious things that are not acceptable for the don’t know answers: “how will you spend the $2 million once you raise it?”, “Who are your competitors” or “Who do you need to hire first after fund raising.”  You’d be surprised how many people don’t answer these questions confidently.

7. Get back  with an answer – There are two great things about saying you don’t know the answer to a difficult question.  The first is that you have a chance to ask, “do you have any views on the topic?” and thus hit the goal of getting the VC talking.  Even more importantly you have the ability to say, “that’s a great question.  I’m not actually sure what the answer is.  I’ll look into it and get back to you.”  It gives you an opportunity to email the VC after the meeting with more information and the potential to continue the dialog.

UPDATE:  We once had a company present to us in a full partner meeting.  The presenting team had a partner champion at GRP that was advocating the deal so we were positively predisposed to seeing the pitch.  It mid 2008 and one of my partners asked what they were going to do about costs given the recession.  The COO of the company said that he had read some economic council’s forecasts and technically we weren’t in a recession.  My partner shot back with data of his own.  A real debate ensued.  It wasn’t pretty.  I kept wondering, “why would this guy want to have a debate over a topic like this that had no relevance to proving whether his business idea was sound?”  In the end we didn’t invest.  A large determinant was this gentleman’s lack of EQ in this situation.

Founders, Ownership and Prenuptials

This is part of my ongoing series, “Startup Lessons.”

Yesterday I wrote a blog post (here) in which I urged people to not have too many founders.  Best case scenario in my mind is just 1, but at most I recommend 2.   I knew this topic would be controversial because when I tell people this in person it always elicits shock.   To be clear – it is not about being stingy with or hoarding equity – it is about having a prenuptial agreement.

Let me give you some scenarios that do happen in real life:

You start a company 50/50 with a good friend.  If it becomes the next YouTube you always stay friends.  99.99% of companies do not become the next YouTube.  In fact, most go through tough times at some point.  Or maybe it’s not a good friend but you’re a business guy and hooked up with a technical guy you know through the network and you think you’ll work well together or vice-versa.  

If you’re not an overnight success or if you do struggle what happens?  

– What if one guy needs to pay bills and takes a full time job somewhere.  Should he/she keep 50%?

– What if you have to make really tough calls on cutting costs, biz dev deals, fund raising and you violently disagree on direction? Who prevails?

– What if the person performs OK, but not great and you need to hire above him?

These situations are only compounded if you have 3 or more founders.  I know that many people reading this will be in companies with 3+ founders and aren’t having any friction.  That’s great.  I have even invested in companies like this.  I know that conflict doesn’t always happen.  It’s just that when it does it usually comes after much time and expense.

Real world story – a friend of mine used to work at Google.  He started a company with 2 others.  They agreed to all be co-founders.  Now nearly 2 years of hard work have been put into the company (not to mention a lot of their savings) and they have had to have the discussion about who should be CEO.  2 of the 3 want the job.  They each own 33%.  There is no mechanism for deciding.  They agreed to let the VC’s decide once an investment comes in.  That sucks because VCs will want to know that you have all the difficult stuff worked out before you come to them. You’re just giving the VC one more reason to potentially so “no.”  In many cases these things get worked out and I’m optimistic in my friend’s scenario.  But … do you want to risk it AFTER you’ve sunk in years and hard-earned $$$?

Why does someone need to be CEO?  In many businesses you end up needing to make tough decisions.  Consensus does not always build.  

In yesterday’s post; however, I did not advocate being greedy.  To the contrary.  I believe that it very important to spread the equity.  I believe that you should have a “partner” or 2 in the company.  I believe you should treat them as partners.  They should have access to all the same information.  They should be involved deciding in all the difficult issues.  They should have huge upside in the economic potential of your business.  

But if you set up a company by yourself and give a large % in restricted stock or stock options to a partner and for some reason you fall out of love, you have a pre-nuptial agreement in place.  If they stay 2 years and then leave – great.  They only walk with half of their position.  I know that this could be achieved with simple vesting schemes, but there is a rub.  What if you decide that they need to leave?  It’s far better than you have some leverage that doesn’t end up torpedoing the company. 50/50 partnerships sometimes end with a bang.

There, I’ve said it.  I know it’s controversial.  But I still think it’s right for many a founder / entrepreneur.  Yes, there are exceptions.  No, it’s not the end of the world if you’re 50/50 or 33/33/33.

A friend and respected colleague, Bryce Benjamin (of TechCoast Angels)  wrote to me after my last post.  He was concerned that I had set the impression that founders should hoard their equity or that there were prescribed numbers to hand out.  He authorized me to post his comments:

“We’re in sync on so many start-up/entrepreneur issues that I may have knee-jerked a bit too harshly on this one.  But it is the “founding team” size and “percentage ownership” advice in this post that I feel you’re being too prescriptive about.  After re-reading, I see you have qualified your comments, but one of the things readers really like about your blog is that you give specific, actionable advice in it and your qualifiers will be ignored just as I read right past them last night.

One of the mistakes I see entrepreneurs commonly making is too much focus on their ownership % and not enough recognition of the various core competencies and expertise they’ll actually need to create a successful biz.  Generally a founder (or founding team) has strong core competencies in “a” discipline, but lacks the breadth needed to build the business.  First time entrepreneurs, especially, tend to need more than one other “key” team member/partner to help them be successful.  And to be able to attract the expertise/experience they require, they should be willing to give up pretty sizable chunks of the company.  Experienced entrepreneurs who know the ropes won’t need the same kind of support and will be able to build a team by giving up less of the ownership.

In terms of %’s, my advice to entrepreneurs is to focus on value and fairness.  I agree that “fairness” doesn’t always mean equal, but sometimes it does.  Again, though, the key for the entrepreneur is to focus on what individual(s) is(are) essential to expanding the size of the pie and getting the right people, not specifically on the size of his or her piece.”

I agree 100%.  I hope that this post clears that up a bit.  I don’t advocate being stingy.  I advocate, to steal Bryce’s words, “fairness and value.”  Many solo founders who have spent time with me would confirm that I often tell them, “you need to find a “co-founder” to work with if you want this to be successful.  And you need to be prepared to part with 10, 20, 30% of your company or more to make this happen.”

Most Common Early Start-up Mistakes

This is part of my ongoing series “Start-up Lessons.”  If you want to subscribe to my RSS feed please click here or to get my blog by email click here.

In the Beginning …

This is a very important post to me because I find myself giving this advice all the time and if you don’t follow the basic advice here you can cause yourself much heartache down the line – even if your company ultimately becomes über successful.

I often talk with entrepreneurs who are kicking around their next idea.  Sometimes they’re working full time at a company or sometimes they’ve already left their employer and they’re bouncing around ideas with friends.  These periods of time can leave a founder very vulnerable in the future.

Here are some lessons to avoid common traps.  Please remember to read my disclaimer (it’s not long) – I am not a lawyer and my advice should not substitute getting formal legal advice.

1. Moonlight Responsibly – If you are still employed please be very careful not to use your company’s resources to produce your product and please do not work on your next idea during business hours.  It’s hard enough to build a successful company.  Imagine you pour 5 years of your life into your next gig and it starts to become successful.  Would you want to run the risk that your former employer could have a claim against the intellectual property you’ve created because you broke company policies and developed your ideas on company resources?  Not worth it.

To the best of my knowledge US law allows you to work on your own resources and in your own hours and let you personally own your IP.  I don’t know 100% that this is true in all 50 states (if any lawyers read this please put notes in comments section) but I’m pretty darn sure that this is statuary law in California.   In some countries outside the US (the UK for example) employers can specify in an employment contract that ANY IP you develop while you’re employed by that company is owned by them.  If you live somewhere where this is the case you’re better off discussing with your employer that you may from time-to-time work on private projects outside of work hours and you want their clearance in writing that this is OK.

NOTE: Luckily my first lawyer friend weighed in.  Please see these important comments by Dave Young at DLA Piper re: IP ownership

2. Register a company. When I hear entrepreneurs say that they’re kicking around ideas with friends  I ask, “have you legally registered a company?” Many times the answer is ‘no.”  The problem is that you’re opening yourself up to a claim by one of these people that you somehow stole their ideas.  I know it sounds crazy because you’re talking about friends or colleagues here.  And you’re probably right.  BUT … if you do create the next MySpace, Facebook or Twitter there will be much money at stake.  Where money is at stake sometimes things get crazy.

Don’t believe me? See here for the Facebook story.  Register a company before you do anything else.  Even if you keep it dormant for 2 years while you work on your idea.  It isn’t expensive and the admin isn’t too great.  You can find a good start-up lawyer to help or if you want to do it on the cheap there are tons of websites you can find on the Internet to help.  Here is just one (I don’t endorse them – there are many).  You can probably get loads of information on Legal Zoom also.

UPDATE: See important comments on company registration from Scott Walker, a corporate lawyer here.

3. Pick the founding members. This is advice that I give people all the time.   I’m reluctant to put it into writing because people get so passionate about this issue and many disagree.  But I’m so certain that this is one of the single most important areas for you to preserve your future wealth creation opportunity that I feel compelled to write it:  your founding team should never have more than 2 people total (including you).

Why?  I know that your goal in creating a company is to “change the world” or create something really cool and enduring that has a positive impact on some group of people.  Presumably you also want to make a bit of money over time.  If you start a company with 4 people you’ve just given away 75% of the value of the company.  It is hard enough to have a great financial outcome when you start with 100%.  Starting with 25% is even harder.  Assuming normal valuations at fund raising rounds you’ll be down to 6-12% after you’ve created a stock-option pool and raised capital.

I know that 6-12% is more than most senior executives who join start-ups get.  But these people seldom make retirement money from the stock options on these companies.  I know it happened in the late 90’s and there are some very wealthy minority shareholders from Google’s early days.  But many people win the lottery every week also.

The fact is that most people lack the willingness, ability or nerve to start a company from the very beginning with just an idea or a desire to start a company.  These same people will join you and your one other co-founder (maximum) 6 months later when you’ve established the company, done your Powerpoint deck, built a prototype or product and started fund raising discussions.

They’ll happily join for 5% or less and they’ll have options and not stock.  That’s the difference between a founder and a non-founder.  You’re the one who gets paid extra rewards for taking the extra risk and more importantly taking the initiative.  The world is much safer for non-founders.  There is nothing wrong with non-founders – by design they are the overwhelming majority of companies.  But the worst case scenario in my mind is more than 2 co-founders where everybody sub-optimizes.  That said, if you’re already in a company with more than 2 founders – put it behind you.  The decision is already made.  Your next business will have less ;-)

4. Research your market.  I know it’s obvious but I’m always surprised how many people just start building products without thinking enough about the market.  You need to do some analysis.  Start by evaluating areas that you have domain expertise in.  Make sure that you’ve identified a problem that you believe exists.  Calculate how much time or money this is causing the people involved.  Sketch out your solution.  Find out what solutions they’re using today.  Use all of this for the basis of a plan that defines your company strategy.

Don’t worry if it isn’t perfect from day 1 – just make sure it appears to be a good idea.  You will confirm that later on.  Putting your thoughts into spreadsheets, PowerPoint, HTML, etc. forces you to come to grips with whether you really have a good idea or not.  DO NOT start with product, start with the market.

5. Get customer input. This is another big mistake.  People design their products in a box assuming that they’ll show customers later and get feedback.  Get feedback before you start building anything – else you might be wasting your money.  Interview customers to better articulate their problems.  Show them multiple solutions to their problems and find out which ones resonate.  Ask if they’d be willing to pay for a solution like that if it existed.  Ask them how much they think such a solution would cost them.

6. Build prototypes and/or product. Start building out your product.  It you have a great software engineer that’s awesome.  If not, at least find someone really technical that you trust to help act as an adviser to you.  If you can’t find somebody any technical resources at all through networking please consider keeping your day job.  I’m not being flippant (OK, maybe slightly) but seriously it isn’t hard to network your way into someone technical.  If you can’t do this it is highly likely that you lack some of the basic entrepreneurial skills to be successful in your own company.

If you need a cheap way to get a prototype build consider the following options: student interns, people willing to work for stock options rather than cash or some mix, doing the work through oDesk, eLance or Rentacoder.com.

7. Make sure you own your IP.  This is a BIG mistake many early stage companies make.  They have developers or friends help code their software without having legal agreements in place.  You MUST have a legal agreement that stipulates that anybody working on the design, coding or testing of your system assigns any and all intellectual property (IP) created to your company.  Otherwise you run the risk that in the future somebody claims that the programming work that they did for you represents their IP and not yours.

8. Assemble a team. As you know my preferred route is the start the company, register it, get the basic plan in place, sketch out wireframes and/or start getting your product built AND THEN assemble your team.  You can be talking with potential employees all along the process getting them excited.  But best to bring some of your team members on as your plan starts to solidify.  If you started the company yourself consider bringing on a “partner.”  By this I mean somebody who has a large and meaninful percentage of stock options – but nowhere near 50%.  There is no specific % – it is different in each case.  But for the sake of my example – say 20%.  Treat this person like your true partner where you share all information with them and involving them in the decision-making processes.

You also need to get other people around you.  Teams create companies – not individuals.  Teams raise money – not superstar CEO’s.  Start building your team early.

9. Founder vesting.  Yesterday I wrote a blog posting on founder vesting (see here).  You should implement restricted stock with vesting at the earliest stages in your company -even before the VC’s ask.  The reason is that if you found a company with a partner (or 2) and somebody decides to leave the company do you really want them to be able to walk away with half of the value when they may have only worked with you for 9 months and all the hard work is ahead?  Founder vesting is an insurance policy for all team members involved.

This post isn’t meant to be a comprehensive guide on starting a company so I think I’ll stop here.   I just wanted to list some of the most value destroying mistakes I see many early-stage entrepreneurs make.  It’s a shame because these mistakes are often made in the first 12 months when all the work still lies head.  I’m sure there are many more early-stage mistakes – please feel free to add comments or send me a twitter message @msuster

First Round Funding Terms and Founder Vesting

This is part of my ongoing series “Pitching a VC“.

There’s a great meme developing this morning on the need to simplify funding terms and documents.  The meme was kicked off by Chris Dixon with this post saying that term sheets need to be simplified and align investor / founder interests.  That prompted Fred Wilson’s blog post appealing to the industry to make these simplified term sheets standard.  Last to weigh in was Brad Feld whose blog post argues that the only 2 terms that should be negotiated are amount raised & valuation.

I totally agree but want to cover a different issue.  If you’ve read any of my blog posts before you’ll probably recognize that I’m from this school of thought where founders & investors need to be more aligned and I’ve been very cynical of historic VC practices.

2006 was the last time I went out to raise venture capital.  I had multiple term sheets to do my Series A financing.  Many had the typical investor-friendly terms where entrepreneurs would get screwed and not even understand how they got screwed until many years later.  This was pre Venture Hacks so not a lot of help on terms on the Net.  The best series was done by Brad Feld on his blog here.   But it was my second company so I had already learned all o f the lessons the hard way.

There was one firm that offered me an entrepreneur friendly “vanilla” term sheet and that was True Ventures, which is why I believe they are attracting great early-stage entrepreneurs.  They said they believed in aligning investor and entrepreneur incentives.  I told another potential investor that I was accepting True’s term sheet.  They immediately agreed to match True’s terms.  I thought to myself, “OK, you were willing to F me when you thought I didn’t understand these terms and now you’re going to be friendly?  I wonder what will happen 3 years from now when we hit our next contentious issue?”

I believe that there is a new breed of VC emerging including True Ventures, Founder’s Fund, Union Square Ventures, Foundry Group and several others that have this founder / investor alignment ethos.  I have this mentality, too.

One very important item from Chris’s original post that wasn’t picked up by Fred or Brad is founder vesting.  Chris writes that early-stage deals should have:

Founder vesting w/ acceleration on change of control.  I talk about this in detail here.   If your lawyer tries to talk you out of founder vesting (as some seem to be doing lately), I suggest you get a new lawyer.

I totally agree.  Unfortunately I’ve lost two deals in the past 18 months over this issue.  I don’t think that entrepreneurs properly understand the issue.  Having spent way more time on the entrepreneur side of the table I believe I am a good arbiter of the issue.  I sum it up here (but read Chris’s link above)

• I’m putting millions of dollars in your company.  My thesis is YOU.   I need some protection that you’re not fully or mostly vested where you could simply walk away with a large stake in the company, screwing not just me but the entire employee base of the company.  I’m not Sequoia.  I’m not looking to bring in a new team to replace you.  If you leave my thesis is largely out the door.
• Without proper vesting you also place a risk on all other co-founders.  In my first company there was no vesting in the seed round.  One of  the co-founders walked within the first year.  He walked with 1/3rd of the company.  It was naive and stupid on my part.  I didn’t understand the issue back then.
• I do believe in protecting the founder.  The most common way is to grant acceleration on change of control.  That means if the company is purchased all of your shares become fully vested.  Usually it is done as a “double trigger” meaning if your company is bought AND you’re asked to leave the company.  Chris described the “single trigger” scenario.  I regularly bring this up with founders as I want them to be protected.
• You can also cement rights for yourself in the case where you’re fired without cause to protect some or all of your shares.  In my experience this issue is likely to be a source of negotiation.
• If you have founder vesting and protection on change of control + protection against losing your shares of you’re fired then we’re completely aligned.  I’m protected against your walking (as are your co-founders protecting each other).  You’re protected against my asking you to go or a company buying you and taking away your value.

I tried to argue my views on vesting to a company I tried to invest in 2 years ago.  It was an A round deal but the founder was already 75% vested.  They had brought in a new CEO who was 66% vested.  They eventually took money from non-traditional VC based in the UK.  Founder vesting was one of the emotional hot buttons for them.  When the markets turned sour and they didn’t hit their objectives the non-standard investor decided not to follow its investment.  They now own 100% of worthless stock.

I more recently lost another deal where this was a major issue.  So I’m trying to reconcile it all in my head.  I believe the trade I described above is not only fair but protects everybody’s interests.  If you feel differently, please weigh in with comments.