Things I'm working on...

There is a ton going on in the Birmingham startup ecosystem, some that is public knowledge and some that isn't.

Here's a small sampling of some at least semi public stuff that I've been working on and think is worth supporting...if anything seems like a fit, give me a buzz, we can always use good help.

1. Expanding our BAN Mentorship Program
2. Creating a Culinary Startup Incubator
3. Proposing and Passing a Startup Capital Tax Credit
4. Getting regularly scheduled PR for the Startup scene
5. Supporting and expanding Birmingham Startup Drinks
6. Creating a Deal Flow Clearinghouse for non-startup related alternative investments
7. Brainstorming on ways to fill the "concept validation" gap

That's probably a good start.

If any of that strikes your fancy...come on down.

***This post probably also shows that we could use an initiative that keeps track of the various ways to get involved, but that will have to wait till another day.

A VC: Difficult Is Good

After reading a great article (Build Something People Need: On Raising Venture Capital And Creating Startups That Matter) about proper entrepreneurial focus on the FastCompany Blog by Rod Ebrahimi, it reminded me of another article (A VC: Difficult Is Good) by Fred Wilson that I had saved earlier this year and meant to write about before now.

Both of these articles touch on two essential characteristics of successful entrepreneurs...they focus on value to customers and work incredibly hard. When those two characteristics are coupled with talent and a dash of luck big things can result and, as an investor, that is the canoe I want to be in.

Entrepreneur Resources - Getting an Education

So you are an entrepreneur wanting to learn about starting and running a high growth company or about the angel/vc finance world. Where do you go?

Right here:

1. For Videos - (LINK) YouTube
2. For Books - Check out the recommended reading list - (LINK)
3. For BAN information - check out our website (http://www.birminghamangels.com/)
4. For current topics/articles follow BAN on:

Facebook - (Page LINK)
Twitter - (Profile LINK) @bhmangelnetwork
LinkedIn - (Group LINK)

Organized for success...

Many new (and even some experienced) entrepreneurs seem to struggle with the dizzying array of business entity choices and their various combinations. To name a few there are: proprietorships, partnerships, limited partnerships, LLPs, LLCs, Trusts, Corporations and S-corporations. Each entity has its place and time, but for high growth potential businesses I will choose a corporation almost every time. The reason is mainly tied to tradition and corporate governance.

"Tradition" you say...why in the world would that be a big deal? Well, the reason is rooted in a desire to maximize available resources and standard corporations have been the traditional entity of choice for high growth entities for a long time. That has resulted in most of the resources being created with a heavy Corporation bias and that bias runs the gamut from internet articles to professional expertise.

Corporate governance is the other reason and it is probably the biggest. By corporate governance, I mean the structure of how the entity develops, authorizes/makes decisions and holds people accountable.

Corporations have three main levels of authority to get these things done: (1) Board of Directors ("Board"), (2) Shareholders and (3) Officers. The basic process flow is: Shareholders elect the Board; the Board approves strategies and major decisions, including hiring/salaries of Officers; and Officers suggest strategies and actions to the Board for approval, then work to implement. As payment for their respective parts Shareholders receive profits, Officers (and employees) receive salaries and Board member compensation varies, but they typically receive a stipend of some kind.

By having the Board to focus on overall strategy and wade in on major decisions the company can ensure that planning is occurring (i.e. "doing the right things") while Officers focus on the day to day activities (i.e. "doing things right"). Meanwhile, Shareholders hold everyone else accountable for the end results.

This division of labor is critical in a high growth entity because, without the checks and balances, the high volume of necessary work makes it very easy for the favorite activities of the founders to take dominance to the detriment of other necessary activities. The typical result....Chaos and frustration reign.

In very small companies (startups or otherwise) maintaining a proper division of labor is complicated as well, which can be double trouble for a high growth startup. Small companies by definition don't have a lot of people involved, so it is easy not to properly maintain the division of labor because there aren't actually different people performing each function. When small size is combined with entities that do not legally require such a division of labor it is easy to understand why it may never occur at all and in companies where planning, implementation and accountability are not all treated with due respect (which can certainly happen in a corporation too) the results are going to be sub optimal.

So the net-net is that I usually recommend corporations for high growth potential companies, but I would always recommend that companies think hard about what structures are in place to address planning, implementation and accountability regardless of the entity choice.

Moonlighting (and IP transfer provisions)

As we are working with a number of deals at the moment, but without a lot ready to report, I thought it would be a good time to talk about one issue that has been a thorn in my side on past deals.  Moonlighting...

Now, don't get me wrong, I am not in the "you aren't committed if you don't quit your day job" camp, in fact, I think keeping the cash flow pressure off of the newco until it is ready is a sign of good thinking.  However, I have had situations where founders did a lot of work moonlighting on the front end only to realize that they had broad intellectual property ("IP") transfer provisions in their employment agreements.  What a disaster...and those provisions are very common for technical employees.

Of course, there are arguments that can be made and the founders may end up succeeding in court, but the cost/risk is significant and probably more damaging, the cloud from potential litigation can (and often does) run off any would be investors.

So, with that in mind... PLEASE, if you have a great idea, make sure and read your employment contract before you spend a bunch of time/money developing that idea.  Furthermore, if you find out that you do have language in your contract that is problematic, go see a proper employment law firm and talk to them about it because you may be able to fix it.

The three musketeers is best for co-founders...

Anyone starting a business with someone else will eventually have to tackle relative ownership and compensation questions.

For some founders the answers are simple, but for most it is a sticky issue that creates a lot of stress and runs the risk of ruining both friendships and the business.

With the possible risks in mind, these are certainly issues that don't need to be avoided. They need to be discussed openly and honestly. Many situations have been made worse by trying to avoid the thorny issues... you may be able to, at least, until they just blow up.

To try and take some of the emotion out of the negotiations I like to lay out some initial thoughts:

1. The initial founders should have the "skills"/"essentials" necessary for the core business plan;
2. if someone is not "essential" they don't really need to be part of the original founders; *(no one is "in" just because they were at lunch the day it was discussed)
3. if each founder is truly "essential" then lean toward more even splits;
4. shareholders should earn "profits" and employees should earn "wages"; and
5. once the core team is in place it's "pay to play" for equity.

With that in mind, I do tend to favor a 1/x approach to "equity" splits among founders in most startups, unless there is a compelling reason to do otherwise.

I don't, however, think that all founders need to receive the same "wage" unless their relative job functions would demand a similar wage on the open market. For founders wages, I am in favor of creating a specific wage and keeping track, even if there is no money to pay initially (just keep it on the balance sheet as a liability).

How to set that specific wage for each founder is another negotiation. I like using Monster.com (and the like) as a starting spot because I can get reports for average wages based on specific job functions. It's also good to think about how particular jobs are typically compensated (ie - salary, hourly, commission, etc.) and to try and stay in keeping with industry standards, unless there is a compelling reason not to.

Certainly, it is easier if all the core parties can put in equal skills, effort and resources then just split everything equally, but in most instances that is not sustainable (maybe even on the front end), so it is important to think about what is fair to all parties involved for both the beginning and the years ahead.

Who can be a successful entrepreneur?

During a discussion today with a colleague, the topic came up of "what makes a successful entrepreneur?"

We discussed lots of attributes and reminisced about books and studies we have read on the topic, but when we finished it seemed that we only had two characteristics left...Vision and Practicality.

1. Vision because the entrepreneur needs to be able to see the big picture and create.

2. Practicality because they need to see where the big picture vision intersects with reality, so they can plan and follow through with the steps required to create the vision.

Of course there are a million other things that are either related too or can support those characteristics, but those two are cornerstones.

Salary in a pre-revenue deal....to be or not to be?

Dad and I were working on a deal not too long ago and he made the comment that:

"a deal where one party can succeed where the other party fails pretty much guarantees that is what will happen, but if a deal is set up where everyone has to succeed for anyone to succeed, then it has a chance."

At the time we were talking about a deal that just didn't feel right, even though there was a lot to like. Ultimately, we passed on the deal and the founders moved on to another investor I know (who drove a different deal altogether), but I was frustrated that we couldn't put it together. I never want to see a deal fail to launch simply because of deal structure, or worse yet, a deal fail because of poor structure, but it happens all the time and I think Dad hit on a pretty common reason.

Often in start-ups, I see deals where the founder(s) has spent a lot of time developing from idea into a legitimate business opportunity and is ready to monetize that effort or they are ready to jump into the business full time and need to replace the income from their job.

The scenario usually is played out with a founder inserting a "living wage" salary into the pro-formas and hoping to raise enough money to cover it and the launch plan. Unfortunately, that salary creates a form of exactly what Dad was talking about...all the future risk of failure is on the investor because the founders are now covered (so long as they get a new job lined up before the company goes belly up). With that arrangement, until the company is cash flow positive the founder and investor will be out of sync, which inevitably leads to tension. Even most novice investors will sense that likely outcome and shy away...maybe to the point of not doing the deal, even on a good core opportunity.

A few other (and more investor friendly) options are:

1. The founder receives only a percentage of revenue (up to his salary level); or
2. the founder receives salary, but only out of net cash flow of the business; or
*(That still could leave open the possibility of encouraging a lifestyle company that doesn't ever net much to the investor, but that is a lot better than encouraging a full flop.)
3. founders and investors split any net cash flow (splits can vary).

This is not to say that no deal should have pre-revenue salary for the founders, because some deals just cannot get done any other way, but it is always something that needs to be carefully considered and probably avoided unless it is truly necessary.