Quick Test: Should I Form a Startup?

“You can do it!” – line made famous by Rob Schneider in “The Waterboy.”

Being a big fan of the entrepreneurial space, I love to encourage people to get involved in new ventures. Forming something new or making what is there bigger and better can have a profound change on the world, and being a part of that is both exciting and daunting. I talk to owners every day and for those just starting out with an idea, I have a little test that I use to see if they should be encouraged or just continue to dream. Keep in mind a true entrepreneur knows the difference between an idea and an opportunity – thank you, Jeff Timmons – and you have to determine early on which of the two describes your journey.

So here is the quick, five-step test:

  1. Do you have a viable, unique idea? A baseball mitt for ambidextrous players may be unique, but viability may be a question. You should also be able to create a logical one page summary of your idea. It is amazing what happens when you have to put something down in writing. If you doubt this, try this little exercise – write down what you would like written on your tombstone.
  2. Do you have some money? Regardless of what you want to do, it will cost money. You may be able to minimize the cost, but you need to have some available money to get started. When I went into my own consulting business, I knew the most frugal way to incorporate, register, get a website and business cards, etc. but it still took a few bucks.
  3. Would you like to do this for the rest of your life? Next to sleeping, we spend most of our time working. If this is going to be your “job,” do you really like it? And please make sure you are not running from something, like a job you hate, but to a life you will enjoy more.
  4. Can you take the heat? Being the boss is the good news and bad news. Every new hire is another family you are responsible for so you have to be ready for that role. The road is full of stories about the team and sharing responsibility, but in the end, the buck will stop at your door and some people are not built that way.
  5. Can you make money doing it? Having your own business is great, but you need profits to pay salaries and make it worthwhile. This can involve difficult decisions on resource allocations. Be ready for that eventuality.

So there it is. If you have answered yes to these questions – and I think they all have to be yes answers – then you are ready to seriously commit to forming your new venture. Harness your passion and enthusiasm and get started. Just keep in mind that “you can do it.”

Go to the Light – Start Exit Planning Now

“I don’t know where I’m going, but I’m making good time.” – Quote from a former client.

I just completed a series of discussions with some mature business owners on potential exits from their businesses. As usual, I tend to take away common themes and I thought of this quote from a former client. He used it to describe people he had encountered who were so absorbed in what they were doing, they thought they were making progress.

Through his eyes, he thought they were lost. The latter tended to describe these owners. Each had a valid reason to address the need for exit planning – age, paradigm changes, timing – these were all present and culprits in raising the very thorny question as to “What’s next?” There is an abundance of tools to help an owner through the exit process, but getting started – now there’s the rub.

I hear loads of excuses as to reasons to delay. Many who advise in this space have what are perceived of as ulterior motives – money managers who want owners to sell so they can manage their liquid assets, life insurance sales people who want to make sure owners and their families have the annuity or insurance to cover them as they go on their journey, etc. Unfortunately, while well intended, they give the owner an out by raising questions regarding true intent. I have had some success in this space because I do not care what the result is, I just want to make sure that an owner has all the facts before they make their decision. But I will admit, it is a tough battle.

Having said that, I believe the major reasons for delay are psychological. Fear is often downplayed and yet I think it is one root cause of most owners becoming part of the majority who either have no exit plan or start to plan too late. In his 2000 Year Old Man albums, Mel Brooks cited fear as the great motivator for everything from transportation to the development of the handshake and dancing. One problem for the owner is often the absence of someone they can confide in to discuss their fears. Often seen as the patriarch or matriarch, showing fear is often perceived by them as a sign of weakness. So, they seek solace in finding a solution. This keeps them busy and avoids the need to discuss the obvious – starting an exit plan.

The absence of a “life” after the business is gone is also an issue. Often left with little time to develop hobbies or other interests, the lack of something to go to leads the owner to complacency about staying where they are. Making the business stronger is a great defense and considered “progress” perhaps ignoring at times risks like the paradigm shift which may be too great to overcome.

So, to owners, I say start the process now. Have others tell you it is too early, but I never think it is. My advice has always been not to get into a business without knowing how you will get out. Also, find an advisor you can trust. They do not have to be skilled in the exit process, but they have to be capable of listening and telling you things you may not want to hear. With some guidance, you will know where you are going and have a successful completion to your journey.

Profit is Not an Ugly Word

Leo Bloom: “Heh, heh, heh, amazing. It’s absolutely amazing. But under the right circumstances, a producer could make more money with a flop than he could with a hit.” – quote from the movie The Producers by Mel Brooks.

Some of you may recall this memorable line which was the premise of this classical movie. The plan was to raise a significant amount of money, find a play that would “flop” on opening night and keep the unused funds. An ingenious ploy; save for the fact that the play was a hit, more than 100% of the equity had been sold and the main characters ended up in prison.

So, let me begin by apologizing for the somewhat dour tone of this blog. I think of this line as I see pitches that seek to raise more and more capital with an apparent disregard for the spend or “burn rate,” with entrepreneurs chalking up their expenses to the investment needed to grow. Every entrepreneur I ever met believed they could grow faster with more dry powder. But the successful ones realized that just like one’s personal finances, at some point, you must “pay the piper” (face the music, come to Jesus, yada, yada, yada).

I would have thought we learned our collective lesson from the dot com boom / bust. Back then, despite substantial losses, valuations were sky high and investors began to focus on other “metrics” which soon took the place of the old reliable P & L. Just like the Cabbage Patch Kids, one day someone decided that these companies were in fact ugly, and shortly thereafter, most were trashed and entrepreneurs were sent home to live with their parents.

I want to be clear here; if you are running any type of business, you need a clear path to profitability. I saw a recent article with an entrepreneur calling out investors for just asking when the company would turn a profit, which the author interpreted as just stifling growth. How dare they? Well I ask, how dare you build a business model without such a pathway and put your stakeholders (especially employees) at risk with the hope that someone will be smitten with your traction or stickiness and rescue you with an acquisition deal? That’s not building a viable business; that’s the equivalent of legalized gambling.

Please do not get me wrong. I am not implying that one must be profitable to attract investors. If I believed that, I would not be so respectful of angels and VCs that make the early-stage ecosystem work. Thank goodness for them. But if you think investors do not believe that a sustainable business is nirvana, you just have not asked the right questions. That path to profitability must not only be clear but in sight.

The great entrepreneurs I know are better than that. They realize that this not a Max Bialystock shell game. They need to seek profitability and realize the clearer the path to this goal, the more likely it is their journey will be successful.

Stages of a Business Life Cycle – Why It Matters Where You Are

“Where you stand depends on where you sit.” – quote attributed to Rufus Miles of Princeton University

I have been privileged to serve businesses in all stages of their life cycle. For example, I am now helping an owner sell the business I helped him to acquire over 30 years ago. Over the years, I have helped companies deal with a wide variety of issues and realize the commonality is often the current stage of the life of that business. More importantly, focusing on “where you stand” in the cycle can help an owner address the typical issues they will probably face not only in this stage but the next. It’s the old “I am more afraid of what I don’t know” syndrome I see so often. So while a complete listing of what to consider at each stage is way beyond the scope of any blog or article, some brief highlights will get you thinking.

It may have been the Boston Consulting Group or another organization which introduced this concept (or a derivation thereof) years ago, but to me there are typically four stages of the business life cycle:

  1. Startup
  2. Emerging
  3. Growth
  4. Mature

Startups are characterized by developing proof of concept, they are pre-revenue, may have a minimum viable product (MVP) and the owners are usually trying to define themselves. Challenges are funding, funding, funding (angels, friends and family), sharing equity and recruiting team members (usually centered around those that believe in the founder(s) vision.)

Emerging companies do have an MVP, some traction, and are looking to develop an effective approach to the market. They have raised funds from friends and family and are looking for that next round. Challenges are more sophisticated funding (VC’s, etc.), honing the customer experience, the product and approach, expanding the team, more disciplined equity grants and trying to keep control over everything – – being a bit more “directed” but monitoring culture.

Growth is when you start to hit stride. Product is developed and is appealing to the sweet spot of the market. Financing is less of an issue and you probably have cash flow to fund basic growth: your balance sheet is your friend. Team members are now recruited with more specific objectives in mind. Equity is more guarded (like a fine wine) and delegation and timely reporting of Key Performance Indicators replaces informal chats as to “how things are going.” Discipline works its way into almost all aspects of the business and controls (versus control) is the key word of the day. Organic versus acquisition growth is a constant subject of discussion.

Mature companies have usually achieved stability in market presence, financial rewards and in management team composition. Thoughts turn to succession planning, risk management (protecting what you have built) and perhaps an exit plan. Processes are helping keep the business intact and acquisitions and dispositions are a more frequent part of the conversation.

So there are issues to address at each stage in the life cycle, and at times, owners get a bit ahead of themselves like adolescents tend to do. Hopefully, by identifying where you are in the process and understanding that where you stand depends on where you sit, you will be able to successfully see your way through it.

Stock Books Are Not Checkbooks

Leo Bloom: “She also owns 50 percent of the profits.”
Max Bialystock: “Mrs. Alma Wentworth.”
Leo Bloom: “She owns 100 percent of the profits.”
Max Bialystock: “Leo, how much percentage of a play can there be altogether?”
Leo Bloom: “You can only sell 100 percent of anything.”
Dialogue from Mel Brook’s 1968 classic The Producers

When I first started consulting with owners on equity sharing (a long time ago in a galaxy far, far away) I never thought that four decades later I would still be giving advice on the same subject. But to quote Ronald Reagan, “There you go again.”

I was just brought in to consult with an early stage company that has concluded (and I agree) that the time is right to join forces with a larger organization in order to “ramp up” and maximize the potential of the product they have developed. We are helping with the efforts to prepare the company for sale. Quite honestly, in most cases the task at hand relates to analyzing and summarizing financial data. I am always amazed that so many (almost every) early stage companies I go into have an array of valuable financial data that could really help the owners more effectively run their business, but most do not want to spend the money to get it. So it is usually up to the accountants to either verify the data by completing an audit or analyzing the data as part of the due diligence process. But I digress.

One of the first questions I raised was if the company had any contracts with key employees or vendors. The first answer was no. Well, I soon learned that while in the owners’ minds there were no contracts, they did have letters outlining deferred pay and stock ownership for at least 12 current and former employees and vendors; everyone from an old landlord to the ex-CIO. As we started to put together a rough “cap table,” the dialogue above came to mind. We finally herded all the stray cats and assembled a very ugly picture. In addition to the dilution, it was fraught with business, tax and (dare I say it) accounting issues. A great deal of time and fees later, I sat down with the owners to understand how this had happened.

Their response harkened back to what I heard 40 years ago; they did not have the cash so they offered ownership instead. So here are my three reasons why this is a bad idea:

  1. Lack of faith – in most cases, these “deals” are exchanges on a 1 to 1 basis; like exchanging $5,000 of rent or pay for an equivalent number of shares in the company usually at or near founder prices. If you really believe in your company, how does this demonstrate your faith in its future value?
  2. Tax issues – without getting into the gory details, unless you do the right things at right time, there can be unforeseen tax consequences. Nothing says I appreciate you more than a tax bill with no cash to pay it.
  3. Control – unless you follow the right discipline, you can end up with stock ownership in the hands of someone who has underlying interests which may not be consistent with yours. This is never a good thing.

So if you are an owner, please treat your equity like a precious child and only use your stock book as a checkbook as a very last resort.

Show Me The Money – The Question Early Stage Fund Seekers Are Afraid to Ask

“Fundraising is the gentle art of teaching the joy of giving.” Quote from Henry A. Rosso – fund raising master

Over a long Holiday weekend, I had the chance to read through and comment on a handful of pitch decks. It may have been my good mood, but I really think the quality of these decks is getting better especially as it relates to early stage fundraisers including most of the basic components of a solid deck. There are plenty of guides out there to show what the contents of a deck should be – – in fact we have a good one at our Withum website if you just go to withum.com and search for “pitch deck.” So as Mona Lisa Vito from My Cousin Vinny would say, “So, what’s the problem?”

Despite the better quality, I was amazed to see that except for one deck, there was reluctance for these companies to address the “proverbial elephant in the room” – – namely stating how much money they are looking for and how they are going to use it. It appears to be like the fear of asking someone out on that first date.

So for our fundraising friends out there, here are five simple Dos and Don’ts when it comes to covering the “ask” in pitches:

  1. Do tell investors how much money you are looking for. Be clear about how much and how you are willing to layer rounds in, say as you achieve certain milestones.
  2. Do support this amount with summary (and detail if requested) calculations including a reasonable reconciliation to your basic cash flow. Provide a summary phrase that is descriptive of each major goal. A phrase like “develop a mobile app” is more helpful than “ramp up operations.”
  3. Do indicate to investors your flexibility as to form of investment. If you are comfortable with convertible notes, or SAFE documents or prefer a straight common stock investment, help guide a potential investor.
  4. Don’t show funds will be used to settle old debts or for significant owner salaries. Paying off old problems like existing debt or back pay does not move a business forward. Setting aside an amount for some minimum salary / payment to owners for their survival is not fatal but it probably helps if this can be avoided.
  5. Don’t imply this amount of funds is all you will need unless your projections clearly indicate this to be the case. Nobody likes the gift that keeps on giving. It is a frustration for investors and it is better to state upfront where you expect to be once the money is spent and how you will be positioned for the next stage of your growth.

The punchline here is not to forget the punchline. Just think about telling a long story and leaving that all important ending out. Listeners will look at you quizzically – – they expect – – in fact they demand you bring the story to a close. It is the same with your pitch deck. Potential investors want to know the punchline – – what do you need and how are you going to use it? Teach them the joy of giving.

Equity Plans Part II – Are We There Yet?

Most of you will recognize this oft repeated question which parents have heard for years. Popularized in the movie and television show by the same name as well as the movie Shrek, it is the question that sends a chill down any parent’s spine; especially when asked by a 5-year old on a long road trip. So why do I use it here especially considering Part I of this blog cited “the time has come” from Dr. Seuss? Well as they say, timing is everything and so it is with Equity Plans as well. So let me explain.

Very few people would ask someone to marry them after just one or two dates, even if they believe that person may be the “love of their life.” Yet I deal with loads of startups where the second conversation an owner has with a key potential hire turns to sharing ownership. Worse yet, without thinking through what they are offering, many offer too much equity only to find they lack enough for others (fast forward to “The Producers” by Mel Brooks – “what percent of Springtime for Hitler do they own?”) or worse yet; that key hire does not work out.

So I spend a great deal of time fixing these issues and there is nothing enjoyable about it. Legal agreements are usually incomplete; the process turns into a he said he said deal and then there are tax consequences to muscle through. It always comes down to having a well-documented equity plan and in all cases, the company “wasn’t there yet.”

So what do I advise? Very simply, have a plan. (You can look at my blog of December 19, 2013 Equity Sharing 101 for Startups for more guidance.) Of course a good attorney is the key here and while many of the documents are somewhat “boilerplate,” you must have a handle on the key provisions. So two quick cases.

In the first, a CTO was brought into a startup, and within a month, the CEO thought enough of him to offer him 10% of the Company in “Founders’ Shares” (no vesting). The CTO was focused more on coding than job satisfaction and within a year, realized he did not want to be there anymore. Fortunately, the CTO was so focused on getting out he never considered the potential value of what he had, and he basically gave back the shares and moved on. No agreements were in place; that CEO just lucked out.

In the second case, it was a similar fact pattern except the key person granted equity had been there a bit longer and felt he had substantially contributed to the Company in the five years he was there. This was another case of an early grant of equity and no provisions for separation. There was a falling out and a “settlement” is still in process. The CEO is spending a great deal of emotional time addressing this not to mention legal and consulting bills. It is not a pretty sight.

So please consider a bit of a delay to provide time for thought to make sure “you are there” before you enter an equity plan. But once you decide, move quickly and purposefully in concluding your plan and getting it all signed and delivered.