Random Questions for a Startup Lawyer

Random Questions for a Startup Lawyer

As an attorney in Seattle who represents a lot of startups, I get asked some of the same questions over and over.  I selfishly wrote the following to save myself some breath.

I’m ready to get started, what issues should I think about when deciding on the best structure for my business?

As with any decision you make, you need to have clear goals and realistic expectations to be able to make the right decisions with respect to your business structure.  Some things to think about along these lines:

  1. Clear goals
    • What is your exit strategy and time horizon?  Do you plan on passing the company to your kids, or do you want to sell the business in five years to a strategic partner?
    • Do you want a consulting business, a brick and mortar, or are you building a high-technology company?
    • Do you plan on keeping the business closely held, or do you want to take it public and have a large ownership base?
  2. Realistic expectations
    • What are your realistic fundraising opportunities?  Is your business something that would be attractive to venture capital or angel investors?  Do you have collateral of some kind (revenues, personal residence, etc.) that could be used to secure a traditional bank loan?
    • What does your revenue and expense picture look like?  Will the business be sustainable from day one, or will you need $5 million and 24 months before you can ship your first product?
    • Do you have income from other sources that can supplement the business or from which you may offset losses from the business?
    • What are the things of value that the owners will contribute to the business, other than their time and energy (e.g., intellectual property, cash, other assets)?
  3. Best structure – even within the concept of “structure,” there are multiple things to consider:
    • Should you be an LLC, or a Corporation (S-corp, C-corp)?
    • Should you consider “vesting” of founder’s stock in anticipation of a future angel or venture capital financing?
    • What happens when a founder leaves the company?
    • How do you protect your personal assets from the liabilities of the company?

There’s a lot more to cover on this topic.  As always, you should ask your legal counsel (and your tax advisor and/or accountant) to walk you through these considerations to make sure you understand the issues involved and to help ensure that you and your fellow owners have the best structure that works for everyone.

Should I apply to incubator/accelerator X?

Accelerators like TechStars, 9Mile Labs and 500 Startups, and incubators like SURF Incubator, Founder’s Co-op and Ycombinator offer training programs, mentoring, office space, and (sometimes) cash to startups in the high tech industries (and some incubators are opening up for other industries as well, such as design and consumer products).  Here is a list of incubators around the world, put together by the innovative startup platform Startup Weekend, which is itself a mini-incubator crammed into one weekend of startup mania.  The companies I know that have graduated from accelerator or incubator programs tend to have had very positive experiences.  They’ve gained help building their product or service, honing their business model, and have gotten important mentoring and opportunities networking with investors.  Accelerator and incubator programs may not work for every startup, though: programs often require a significant commitment of time and energy, you may need to relocate to a startup hub like Seattle, New York or Silicon Valley, most programs have very limited enrollment capacity and are only offered at certain times per year, and many programs are technology-specific.  Be sure to do your due diligence to make sure the program is a right fit for your company.

Can you just give me a template/form of the contract/document that I can change myself?

I guess, but 99 times out of 100 it will not completely serve the purposes you need it to, and you run the risk of doing more harm than good.  As with any service or product, you get what you pay for.

My startup is about ready to have initial meetings with investors, what should I do now to prepare my company for raising money?

First of all, thanks for speaking with me before you meet with investors, I appreciate it (and you will too).  Preparing an entrepreneur for a fundraising round is all about lowering expectations, because chances are that if this is the first time the entrepreneur has gone through the fundraising process, he or she has no idea what to expect.

  1. Process: The fundraising process is time-consuming, energy-draining, and you will need significant attention to detail to get the job done.  Plan on setting aside a lot of time and energy to focus on the process.
  2. Disclosure: You will have to tell investors a lot of things about you and your business that you’d rather not, and in most cases a sophisticated investor will never sign an NDA.
  3. Build a Budget: You will have to spend money to raise money, so build a realistic budget and stick to it.
  4. The Little Things: You will all of a sudden stress out about things you previously disregarded as trivial, like getting signed copies of agreements, cleaning up option grants, etc.  These seemingly little things can and do hold up the process and cause hassles, so get your legal counsel involved well in advance to help you prepare and execute on due diligence and clean-up of corporate records.
  5. Be Realistic: Don’t oversell your company and your plans for it.  Be open and honest with prospective investors.  Chances are they’ll be able to see right through you in any event.

The fundraising process can be very different depending on our sources of capital (bank loan, venture capital, friends and family, etc.), so be sure to involve your advisors (including legal counsel) early and often to give you more specific advice.

What is the valuation of my company?

I have no idea.

How can I determine the valuation of my company?

It is often more art than science.  You can work with your accountant, talk to other entrepreneurs and consultants, survey your industry or even hire an independent valuation firm to provide a fair market valuation.  Some good local valuation firms are Moss Adams, BDO Consulting, and WTAS.  For a financing, your pre-money valuation will often ultimately come down to what your prospective investors are willing to pay.  For an acquisition, your enterprise value will ultimately be determined by what the buyer (or buyers, in an auction scenario) is willing to pay.  Other times when you may need a business valuation include when a founder departs, when you grant stock options and when you are restructuring the company.

I’m getting ready to sell my company in 3-6 months, and I have interested buyers, what should I be thinking about?

Possibly even more so than raising money, the acquisition process will be a tremendously stressful and difficult one for the entrepreneur.  If you’re just now beginning the process, here are some tips:

  1. First figure out your priorities (and those of your investors, board and employees).  This is often the missed step in any deal negotiation.  Negotiating an acquisition is always going to involve compromise, and you need to first figure out what’s important to you and your stakeholders before you talk to potential acquirers.  Doing this will give you clarity about what you want to accomplish, and will help avoid headaches as you get into the finer points of negotiating the deal.
  2. Don’t plan any vacations until after the deal closes.  Don’t even think about it – you’re on lock-down.  And remember, deals always take longer than expected.
  3. Consider hiring a banker.  Investment bankers do more than just help you find a buyer, they provide invaluable advice during every step of the process, from diligence, through negotiation, to post-closing.  They can make a usually difficult process go much smoother.  Some great local investment bankers and advisory firms include Cascadia Capital, Green Holcomb Fisher, and Meridian Capital.
  4. Get signed copies of everything.  The legal and business due diligence process can be a huge bottleneck in getting to closing, and you’ll be doing yourself a big favor by keeping good records as you go along.  That means (a) getting agreements in writing, (b) making sure you track down copies of all signatures and counter-signatures, (c) creating fully-signed copies of the final version of each agreement, preferably in PDF format, (d) maintaining complete and up-to-date corporate records (including holding regular board meetings (with minutes) or obtaining written consents to approve material corporate actions and papering all stock issuances (including stock option grants) and transfers), and (e) keeping electronic versions of all agreements and other corporate records in a logical and organized storage system.
  5. Keep your perspective.  Acquisition transactions are stressful, and on several occasions you may feel like you want to throw up your hands.  When that happens, go back to tip #1 and focus on your priorities.  That will give you some perspective to hack it out through the tough times.

What is the one thing you’d tell an entrepreneur he or she MUST do, and what should he or she MUST NOT do?

DO build a team you know and trust.  This includes not just your co-founders but your legal counsel, your accountant, and your other mentors and advisors.  You can’t do this alone, and a good team is essential. 

DON’T obsess over dilution.  100% of zero is still zero.  Deals have quickly gone sideways and companies have gone belly-up because the founders were too concerned about dilution.  Dilution is a consideration, but it should almost never be a reason to kill a deal.

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