Segment 17 - Negotiating for Success
Now we get into the serious stuff remember earlier the big fears you had about raising capital from angels or investors loss of control was ah high point a big concern what if I said to you most of the initial and the most shocking and the biggest, most debilitating loss of control happens because of what founders d'oh they lose control because they've lost control and they've made a few decisions that don't even involve investors all by themselves? I have three top reasons or ways that you can lose control or your business or needlessly have to fork over and ever big ing chunk of your business to investors who you'll turn teo for rescue capital number one on my do not go their list is it's usually starts out with just giving away can you imagine giving away a chunk of your business and not getting anything in return at least with investors? You give away a chunk of your business and check goes into your account so how does this happen? Three buddies or at a bar let's go into business ...
together you handle marketing you handle sales, I build the product we're all partners each will own a third a third and third of the business okay you form a corporation you hand over a third of the outstanding shares teach you your two partners and the partners do nothing once the shares air out there you can't get them back number one whose mistake isn't yours doesn't involve investors here's and those air the flame mails I get help get me get out of this! How can I fire my partner? How can I get the stock back that I gave to that for doing nothing? This is how trauma this is real drama one is a spender. One isn't one's a duer ones. Well, maybe he might show up today makes sense. This is where the first pain starts and it's within your control. One partner gets a divorce and in certain states, because of how you started your business without partnership agreements, those equity shares are now owned by somebody else who is not at lead at all working in the business, and they make it tougher for you to build your business all within your control because you don't insist that they do something for this stock. Now granted at the time you start your business, you may say, well, it doesn't mean anything yet, but you bust your butt, you complete product development, you go out and raise investor capital and you've got ball and chain former partners that do little to nothing that adds value to your business. This is where you lose a big chunk of your company for no reason big time it happens too often so what's the antidote how do you minimize the risk but also maximize the upside that maybe you are going into business with some plain where somebody who can really add that firepower and is worth that stock corrective action steps first of all the business entity if you were going into business with anybody, I want you to have a partnership agreement if you were the lead dog be the lead dog I have not ever found a true partnership where there is not not one person who is truly the lead the lead technologist or bringing the lead amount of money the big driver who keeps the trains running on time who is staying up late to make sure everything gets done that person if it is you should own a majority of the outstanding shares because you're doing the work maybe you don't yet know if your body can do the job, but if you give shares without putting some restrictions on it or ways to earn that stock, you can't get it back. So why not instead of gifting stock and you can all three of you were both of you both have to earn shares granted I like one driver some people in this room you're the key driver but if there is value in bringing a partner in who also wants to build the value of the company in the same way you do let's have them vest their shares maybe they earn it over four years in equal increments, but if you give those shares out and they leave a year later can you get him back now create motivations may be they earned those shares for building your website and the tool the platform you decide what creates that value where they earn it if you don't there is a possibility that they never will earn it you're in control sweat equity is a phrase that we have addressed if they're vesting shares I would like people to spend a little bit more time I never like tax implications for contractors or partners that relate we're all of a sudden they have to pay income tax on shares that they quote earned for services and this falls under the eighty three b I r s elections write this down I don't have time to go into it today but if you were developing agreements and you have ambitious plans for growth and are likely going to involve angel investors or vcs and again are going to require people to earn their stake in your business that is, um away a work around a completely legal work around to minimize the tax implications of employees or contractors who earn shares over a vest a period of time. A few other things issue a certain number of shares of your company shares to you and your founding partners don't wait to do it down the road do not a very common mistake that eventually you half tone wine is if you authorized at the time you incorporate your total share pool of a million shares don't hand out a million shares to you you know, five hundred thousand to you in five hundred thousand to your partner because then they're no shares for investors to buy him yes, he's and corporations well on the eighty three b usually investors especially veces strong preference is to invest in c corporations, not limited liability companies. In fact, most will require you to change, and there are a lot of reasons for it. Ultimately at the time of the sale, there's some tax advantages is selling a corporation to a corporation it's easier to issue stock options? Hunter corporations see corporations a lot of benefits of it, so let's assume because there is such a strong preference c corporations that I'm talking about see corporations here I don't want to hear so proprietors at all at all and you document the issuance of your shares at the board level at the time of issuance. Why you're demonstrating that you keep track of the books and records of your shares don't make promises or hint to promises to employees or contractors or anyone else that could come back to haunt you your future investors they're going to want to know and ask, has anybody else been promised shares we've all heard about what happened in facebook right but if you promise it made lead tio needless ah litigation make it black and white who gets shares and for what consideration either cash or something they're going to deliver of value to your company you decide the terms and come up with a shareholder's agreement work with an attorney on partnership agreements and share issuances it will be worth it to you in fact it means your documents will be in really good order that will pass the investor due diligence tests very easy with the least potential for having reduce of documents or turning off investors altogether but the upshot of what we're talking about here is if you're partnering what are you getting out of it imagine this is my number one way you lose a big chunk of your business and get nothing in return so this means all of this relates to how you can best maintain control without losing control so that's item number one we do this yes we insist on value we give away nothing for free even if it is to the best buddies if you give it away for free and your best buddy doesn't do anything don't complain about it who set up the situation you know better if you're worried about it in sultan your friend or whatever then maybe you're not ready to be the boss and make the tough decisions you're running a business if you're involving friends keep your friends with maybe they're not if you can't make a black and white decision or have to worm your way or afraid of making a decision and you're the lead entrepreneur and involving a friend if you're unable to make the tough call don't involve the front it would lead to too many compromises that will cost you more shares I guarantee it number two hiring we touched on this a little bit before if it takes an extra million dollars to complete product development because your employees don't get their jobs done on time and within budget what do you have to d'oh you have to go out and raise more money to get that job done whose fault is it you your employees were the investors so higher from a point of precision don't compromise here when the big chunks of cash are involved you have to give away the biggest component biggest percentages of your company at this start up in early stage level if you want to be loosey goosey on hiring doing it later when you're profitable not here when mistakes beginners mistakes which may not be yours but your employees mistakes cost cash within your control but you have to be ready to say no yes I will out hire you or by the way you're now fired you're not producing I walk into too many venture back businesses that do not do employee reviews they might do it after ninety days of hiring in start on purpose. I have a very specific way for start up entrepreneurs to review employees that's actually fun and empowering I don't encourage it, you review once a year, how about once a quarter change happens? The best way to keep everybody focused on what you want them to dio is to create very specific things that you want deliver that's the way to keep your company on time on budget. No budget surprises because you can't afford it, because then you have to spend more of your time raising more money, and I know that's not your favorite thing to do in a work day. Your people can cost you money, hire the people who have been there, done that experience. If you want to launch your product in china, hire people who have already launched products in china. I don't care when you're hiring, and I used to think when I was younger, it mattered more. I've learned through experience that somebody may have the will and the want in the desire to do a good job, but if they don't have these skills or experience to do a good job, they may not be able to, I may want to be a top professional golfer in the united states, I don't have the skills or the experience. To be a top professional golfer in them no matter how much I wanted and want to do that I can't so don't fall into the trap of somebody convincing you that they can the on ly way you can tell if they can is if they've done it before so if someone says I want to run a marathon yes have you ever run a marathon before if they shake their head? Yes ok good that's the way to higher with precision been there done that they have the skills and the experience and they've already done that don't compromise it will cost you hiring too fast could mean you end up having to spend more of your time to get more cash shocking some other attributes I'd like to talk about of who tend to be great employees in startup companies I love employees that air the uber organizer's sometimes there's that person who just brings order to the workday processes in start ups you might need somebody who thinks ahead about customer service or thinks ahead about products systems those were good people. So if you're interviewing people people who create systems and love that and don't seem like they're a disorderly mess they may bring that added value a putting in systems that will make it easier as you grow to feed off of thie order they create that's an extra check mark I give to people in hiring a personal preference is I like to hire people provided they have that been there done that experience who our competitive I love to hire people who love sports grant and I really love sports but what does somebody who participates in sports bring to the table in general they have won games and lost games but they come back with a fight toe win harder you are competing for customers you were competing for cash against other entrepreneurial companies from vcs and angels why not surround yourself with people who love to sickles and beat them and exceed them that kind of mentality is that extra something that might help you complete a project on time and maybe be in less budget that kind of person can be motivated let's see if we can beat this and that kind of person is accustomed to making mistakes but recovering that kind of person has probably worked with the coach before and is willing to be coachable to perform better this one is a perfect personal preference I get a lot of flak on this but if I on ly can hire four or five people and I want the best plus I want something more I like those orderly people who do that system's creation things that I don't like to dio and I want people fighting for customers with the same vigorous intent that I have I also like people who have worked in a start up our small company before it is a culture change to go from a thirty thousand company employee company into a five person company a marketing exact who handles a budget it toe launch a product is very you know with a massive budget lots of people that they can delegate action steps to is a very very different scenario than launching a new product in the marketplace with not a big ad budget, pr budget and all the people in characters who have helped them succeed in the past can they adapt to this kind of world it's a big change and just because they've been it and done that in a big entity may mean it is a very different skill set in a small company without the same resource is don't confuse been there down that up here when you're down here this is the kind of thinking that creates smarter hiring and getting more out of your employees and of course don't hire the weiners and if a whiner is in your room get him out because entrepreneurial companies change all the time if they don't adapt to change or hate change complain about change and you know who I'm talking about why are they changing this? Didn't they just say last month and we're doing this but suppose you have to adapt to a new customer reality who can adapt who can change who is not going to whine about change so in your interviews asked them the biggest change they had to adapt to how they handle it were they a leader or a complainer? And if you end up having made a mistake and you have the complaint or get rid of the complainer because the whole nature of entrepreneurship and setting yourself up and getting vc money is all about taking you here to hear that is massive change change is your reality and what the definition of success is in a venture back business. And if you hire people who just don't acclimating well to change, you've created a ball and chain something that will slow you and your company and your company's mojo down. These are my preferences. You'll add your own as well but know that if people are slugs, it will cost you if you hire the wrong consultants, you didn't get any value for your cash you have to stay on it and insist on performance. If you don't don't complain when you need to raise capital before you ever expected to. All of this is in your control totally within your control. I'm going to show this slide again because until you were cash flow break even and if you don't have cash to invest in your business, you were dependent on investors or lenders the longer it takes you to reach cash flow break even in profitability, the more you will have to turn to investors that's when it gets easy this is when you must be precision based more precision less precision you have less margin for error in the beginning less decisions that should be made by the seat of your pants because that's how you'll get skinned up this slide says it all of what you have to lead your company to greatness third problem waiting too long to raise capital you are great shoppers for cash if you approach your company at the eleventh hour to angel investment clubs to lenders to veces and you pro procrastinate you're not going to raise cash on the best deals terms possible we're going to be addressing deal terms shortly but your negotiating power if you're on the static cash in a month it's not that high who was in control of the decision toe wait and procrastinate who was in control in the decision to assume their first investors will automatically be in a position to write a check on demand this happens way way too often so even at the v c level let's stay say you take the first five hundred thousand in from veces and you are so wrapped up in the performance of your company that you forget about the cash oh my gosh we're almost out of cash you phoned the investors who's in control not you not you you'd be amazed at how many companies that have raised first rounds of capital from angels and vcs I think oh, I can do this again but suppose the stock market pulls back angels tend to go dormant right now is a great time to pursue angels because their public company investments have done really, really well. If a calamity happens in the economic marketplace, it causes some angels to retreat veces have to keep doing their job don't wait until you're out of cash the eleventh hour means you blew it you may raise cash but remember feces they're going to take a good six months by the time all the investor documents or done in the deal terms or done it takes time and you're not the only one on their plate you are assuming you come first they may have ten different companies that they're involved in you're not first it is up to you to start raising cash before you need cash. So if you have just raised a million dollars to complete product development that's where that team comes into play that you must rely on to do their jobs while you start raising more cash we had a great comment how much what percentage of my time should I spend raising cash? But if you are not a cash flow break, even it should be at the top of your list I love it where each week you try and come up with some new potential investors to just start wetting their appetite getting to know them suppose you have to fly to new york meets amaury early stage investors start networking it is never off your list. If you are not cash flow positive, we're even profitable because then you have the luxury of choosing the deal and maybe turning to death sources to boost your company's cash flow. Those are the big three reasons why entrepreneurs lose controller the business because they've lost big chunks of equity and they didn't need to now somebody some nay sayer could say she comes from the venture finance world and it's true, I d'oh, but I do see those eleventh hour pitches and you're desperate, you're not presenting your best foot forward. You worry about gm, I gonna have to start laying off employees. I see that pain, but I also know from an institutional perspective we can't speed up just because of you. And I would say to clarify, in the last eight years, I've moved more to spending more of my time just doing this kind of stuff to warn you, so don't go there, because this is what will happen. So I don't want you to think I'm telling me this and the reason why investors are not number one two and three on this beware listen, the reason why I've just handed over and lost a big chunk of my company. This is where it happens most and especially if they cede an early stage level so if you want to keep the biggest percentage equity stake in your business don't do one two and three and then by doing and taking a different route you're going to have better employees were going to perform better hearing to reach your goals faster your business is going to be worth more you won't be raising money from being behind you're going to be ahead of the game and guess what? You will have set the stage from getting the highest possible valuation for your business whenever you need equity capital so by doing this better you will put yourself in a position to get even a better deal because you were great shoppers for cash makes it this is too easy this is what you have to remind yourself the most important is probably one in three the big chunks go out where you have to say to yourself ok, so and so has ten percent of my company and they've never earned a you have to just ok mentally get on with it then learn from it down to it again suck it up waiting to the eleventh hour is the next one that'll hurt you big time questions on this any questions from our our chat rooms? I think people are really thinking about this very clear miss it seems very, very straightforward but I think it's something that people haven't considered, that this is the way to go. You know, this is just it's, an easy step. And, you know, usually, when veces talk, they're not going to be talking about this. And they're focused on the deal. And part of this is just awareness of talking to so many business owners with big regrets and piecing together where? What are the real trends here in the underlying problems that led to this and it's this that's? After eight years of research, it's this.