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Friday, December 12, 2008
Startup founders: Success requires risk and sacrifice
In their own words: Chris Dyl, CTO, Turbine Inc.
In their own words: David Chang, co-founder/VP of marketing, Snapmylife.com
In their own words: Michael Bayer, CEO, Utterli
In their own words: Sanjay Vakil, founder, LuckyCal Inc.
In their own words: Thomas Summit, founder, Genotrope Corp.
In this time of economic uncertainty, what can a founder of a startup do to increase his chances of attracting an outside investment and maximize the likelihood of his ultimate financial success? The answer may be counterintuitive: founders should not try to “hedge” their commitment to their new business in an effort to minimize downside risk. Without the founders taking on some risk, making sacrifices and giving an unfettered commitment to their startup, they will have a much harder time attracting investors and achieving their ultimate goals.
Founders sometimes ask whether they can license the technology to their new company rather than transfer it outright, so that they retain their individual ownership in the event things go south for the company. For any technology-based business, this step will be a non-starter for investors. Ownership will always provide more significant value and certainty for a business than a license, even an exclusive one.
Given the uncertainties surrounding starting a new business, it is understandable that many founders don’t give up their day job while they start the planning and development work for the new entity. This can lead to a tricky “limbo” period that results in a taint on the ownership of the technology created during this time, which any prospective investor will find alarming. If there are lurking issues relating to your prior employer’s rights to your developments, or noncompetition restrictions that might be an issue, clear them up before establishing the new company so that you can make a fresh, unencumbered start.
Another way founders fail to fully commit to their new company is by issuing themselves founders’ stock that is fully vested up front. If you are starting a company with one or more co-founders, ask how you would feel if your co-founder walked out the door after a month, and took all her stock with her. Subjecting the founders’ shares to vesting provides an appropriate incentive for founders to continue giving the company their full attention, and mitigates the likelihood of an unjust outcome when a founder has stopped contributing. As a result, it is likely to be a requirement of any potential investor.
At the very outset of a company’s life, prior to significant revenues or a financing, founders should expect to receive little to no salary. At this stage, every dollar the company brings in (if any) will be needed to fund operations, product development, marketing and sales efforts. It may be possible to accrue a “reasonable” salary on the company’s books as a company liability, in the hopes of getting it paid at some point in the future once the company has been financed. However, this will likely be a negotiation point with future investors, who may not want to see significant investment dollars going out to the door and into the founders’ pockets.
Once a company is financed, the investors will place limits on the salary the founders can receive. Founders should not be in the business of starting companies as a means of making a large salary. Founders need to be in the game because they are passionate about their company’s technology and products, which they believe will result in a phenomenal return to investors and founders upon a liquidity event. When a founder asks for a large salary, he is sending a strong signal that he is not willing to make the necessary sacrifices to bring about the company’s ultimate success.
People often bandy about the phrase “skin in the game” when describing what investors expect of founders, to ensure they are properly motivated for the success of the company. This is why investors are encouraged when they see founders writing personal checks to invest in their startups. Starting a new company is not for the faint at heart, and founders need to put a stake in the ground, take on some risk and make some short-term sacrifices. This is vital if founders want others to believe in them, and support their idea and their company.
Sarah C. Richmond is a partner at Gesmer Updegrove LLP, a Boston law firm focused on entrepreneurial companies and their investors. She can be reached at Sarah.Richmond@Gesmer.com.
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