Category Archives: Organizational Structure

Startup Hack – Go Best of Breed

What is best-of-breed?

In business, best-of-breed is a term used mostly to describe high quality firms and relationships. For instance a best-of-breed law firm would be a larger, more established company with a brand of which many people are aware. Best-of-breed is a very important concept to consider because it will give your startup credibility. And by definition since startups are early-stage, credibility is unbelievably important as you move your company forward. However there are a trade-offs (below), which must be considered when you are deciding to go best-of-breed or not. Generally best-of-breed firms are more expensive, so you’re trading dollars for credibility.

Examples of startup best-of-breed relationships:

  • Law firms
  • Accounting firms
  • Venture capital firms or angel investors
  • PR firms
  • Office locations (City or area within a City)
  • Suppliers/Vendors
  • Partners

To provide some real world examples, I will illustrate how a software company in Silicon Valley might look for best-of-breed relationships. This list is used just to provide some examples and is by no means complete or exhaustive. There are plenty of best-of-breed firms across every industry so the best-of-breed list below is only a small percentage of great companies out there:

Law firms

  • Cooley – https://www.cooley.com/index.aspx

Accounting firms

Venture capital firm or Angel Investors

Investment Banks

PR firms

Office locations (City or area within a City)

  • In Silicon Valley, an early stage best of breed location could be anywhere from Morgan Hill to San Francisco. Even some East Bay locations like Fremont can work. The key is if you want to go best-of-breed, you need to have an address in an area where people believe you will be able to succeed. A suggestion might be to take an office either in an area known for early-stage culture, or if there is not one available nearby, taken office in one of the larger cities. It will help for credibility. A best-of-breed example is Sand Hill Road. Most people know that the top-tier venture firms are located on that street in Menlo Park.

Suppliers/Vendors

  • This is completely industry-specific. However, if you’re choosing a supplier, if they have a brand name and are known to be the best at supplying that service or product, it will be helpful. As an example, I was working with a company that manufactured a consumer product. We chose a medium-sized manufacturing partner that had enough of a brand, people believed that the partner would be able to produce the number of units, and at the right quality and price we needed. Also the partner was in the United States so our argument was that we could go and visit the manufacturing plant to make sure that everything was on track. The choice was to stay in the US and then look at possibly off-shoring manufacturing at a later date. Investors like this strategy because they felt that we would have more control initially, even if the costs were slightly higher. We’ve all heard horror stories for startups and larger companies, where products were delayed in shipping or at the port. For an early stage company this could be a fundamental problem (see my article on “hard times” which describes how to handle fundamental problems).

Partners

  • Partners are also industry-specific. For instance if you’re going to have a database partner, you might want to think about going with Oracle or SAP. If you’re going to use cloud services, obviously Amazon is a good choice. I think you get the idea.

Best-Of-Breed Tradeoffs

Negatives

Higher Cost

As mentioned above, by choosing best-of-breed partners, you are making trade-offs. First, usually best-of-breed partners charge more. The reason is they are trying to protect their brand. So in the event that you are not satisfied, they realize that negative sentiment social media can harm the brand so they will work harder to ensure that they meet the agreed upon expectations. Therefore, theoretically best-of-breed partners should provide higher levels of service and be very responsive in the event of problem crops up. It is assumed that best-of-breed partners are larger and have grown to be that size due to the fact that they were able to provide high value and quality to a lot of other companies prior to yours.

Slower Speed

Second, sometimes best-of-breed partners may operate at a slower pace. Generally they are busy with more customers, and therefore you may or may not get the speed and attention that you may really want. However, if the relationship is “good enough”, then it’s worth staying best-of-breed. I found that working with larger best-of-breed partners sometimes can be slow, but if you work with the partner and let them know your concerns, sometimes you can speed things up. As an example, one of the larger law firms used by a startup I was advising, seem to be slow. So we brought on an additional attorney from a single office to help speed some of the work that needed to be done so that the larger firm could focus on more strategic issues (and continue to provide brand, via best-of-breed). To give you some metrics, when trying to set calls or meetings with the larger firm it would take from 3 to 5 days to accomplish the call or meeting. The smaller firm would simply pick up the phone and usually we could get the same meeting within a few hours. You will have to decide how to manage the situation to make sure you can keep your startup moving at the appropriate pace.

Delegation/Abdication

Another problem going best-of-breed is usually that you will sign with one of the brand name partners or company leaders, and then you could get delegated, relegated or abdicated to a junior. This happens a lot and you need to be very aware of it. I had a company that was going public recently and we hired a PR firm. We hired the firm specifically for the capabilities of the practice leader who was well known in the industry. It wasn’t long when the practice leader no longer joined the weekly conference calls and we were relegated to his underling. Due to our own mismanagement, we then found that over 50% of the weekly calls were then further delegated further so that we only had the junior associate participating. So we went from the practice leader through one of the directors, down to the least experienced person. Again this was our fault for not managing the situation and demanding that we stay in touch with people at the right level. Realize that any best-of-breed service firms are there to optimize their own margin while providing the highest quality service. Optimizing margin means if you can put a junior associate on an account without requiring hours from your top leaders (at higher costs), you will drive more to the bottom line. As a startup, you need to be aware of this practice and manage the situation closely to ensure that you get all of the attention you deserve.

Positives

Investors like It

By choosing a best-of-breed partner, you are establishing credibility for your company. First, investors will like the fact that you have chosen name brands assuming the costs are affordable. For example, I use Wilson Sonsini in a lot of deals because they provide top intellectual property and corporate guidance, but additionally investors really like the fact that Wilson is involved. Of course you could use some of the other firms above which are best-of-breed just the same. I use BayTech Web design for my digital properties as they are best of breed in Silicon Valley.

Realize that investors are looking to reduce risk. In any early stage company there are a variety of risks including market risk, technical risk, management risk, legal risk and more. As an investor looks towards a company, the first and foremost question is “will I lose my money?” This is a fundamental question that needs to be answered. We have all seen the scams that seem to continually occur.

Investors want to know that their risks are mitigated (as much as possible)  and for example, legal risk is significantly reduced by a firm like Wilson Sonsini. Wilson will ensure all of the investment paperwork, intellectual property, and corporate structure is locked down and in place. Now, you could choose a small firm, or maybe an individual attorney who could be excellent. Their work might be outstanding, fast and less expensive. However they don’t carry the brand. I have also used strategies where I have used specific individual attorneys in combination with larger best-of-breed firms. This way you can offload a lot of the more inexpensive, more mundane legal work to the individual attorney, and save the more important strategic legal work (such as intellectual property), for the brand based firm.

Best-Of-Breed – Breeds Best-Of-Breed (sorry, I just had to say that)

In many cases it’s hard for an early stage company to attract best-of-breed firms. Just because you are willing to pay a best-of-breed firm, does not mean they will take on your case. I recently had an experience with an enterprise software firm that was white hot as a startup. In other words they were becoming a “Silicon Valley darling.” However, when we approached some of the top Silicon Valley or San Francisco offices of a variety of PR firms, four out of the five of them either said they were too busy or not interested in taking on the project based on the company’s early stage status. I’m sure they questioned whether or not the startup was willing to pay their fees, and whether or not the startup would eventually succeed. So, startups are risky so in some cases best-of-breed firms may be less interested in associating with the firm in that early stage and would be happy to jump on the opportunity once the company has seen more success.

The point here is that if you have a best-of-breed partner, the other partners will realize and also believe that you must have something good or important if the other best-of-breed firm signed on. For example, if you sign a top law firm, and you let your potential venture investors know about it, they will be more comfortable that you have made some initial, right moves. Also, if you sign top venture, then the PR firms might be more interested in working with your firm. I think you get the point here. The more best-of-breed partners you attract, the more credibility you have, and thus it’s easier to attract the best-of-breed outliers that may not otherwise have been interested in you at that moment.

High Cost Should Generally Equal High Quality

When you go best-of-breed, you expect the highest quality and you also expect to pay for it. Now, there are plenty of exceptions where this does not occur, however if you manage the relationship correctly you should get the results you deserve. Note that just because a firm is best-of-breed, it’s not “automatic”. With any good relationship, it requires solid management and expectation setting on both sides.

Best-Of-Breed Has Your Back

Again, if you manage the situation correctly, and you’re utilizing all of the right people, processes and systems from your best-of-breed partner, the cost-benefit trade-off should be positive. You may find that best-of-breed partners actually begin to think strategically for you. They bring you solutions and strategies that you may not have thought of, or they may improve your existing solutions and strategies. A top partner should be an expert in their area and therefore you are getting the best advice possible. They should be able to predict landmines ahead, and optimize your resources for the best result. Startups are by definition, resource constrained. Therefore any partner that can help you ensure that your resources and assets are deployed correctly and optimally is valuable.

Startups – When Things Go Wrong…..

 

quote-Winston-Churchill-success-consists-of-going-from-failure-to-759

There are plenty of people that will help you build a company but sometimes you need help when things go drastically wrong. This post is designed to help entrepreneurs get through some of the rough times.

Decide If the Problem Is Fundamental or Not

First, determine if your problem is fundamental or not. By fundamental, we mean that it could significantly harm or kill the business. Fundamental problems come disguised a variety of ways but some are financial, others are legal, and some are product/service related. Problems that are not fundamental do not require drastic approaches but usually can be solved simply, or at a relatively small cost.

Examples of fundamental financial problems include untenable debt, cap table problems, a high burn rate without offsetting income (or access to new capital), and more. Fundamental legal problems range the gamut from product liability issues to any disclose-able or large lawsuit where your company has liability, and will most likely lose the case, have to settle for a large amount, or will take on significant legal fees that are not affordable by the business. Legal problems can also be employee related.

Examples of fundamental product related problems have to do with products that don’t work as intended, or are not satisfying customer expectations. The fact is that some of the best laid product plans sometimes do not come to fruition. Additionally, with the rapid development environments that exist today, a competitor can decimate a product in what seems like a few weeks or months. Witness what happened to MySpace once Facebook came onto the scene.

If your problem is not fundamental, then there should be easier ways to solve the situation and we won’t address those types of issues here.

Stay Calm

Regardless of the fundamental issue, the 1st order of business is to keep calm. The worst thing to do is begin rash decision-making and get crazy with your constituents in and around the company. So by remaining calm, you can make logical business decisions which could range from putting the company into bankruptcy or insolvency, all the way to selling the company in a “fire-sale” or drastically changing strategic direction.

Surround Yourself with, and Listen to, Your Advisers (You can find more on Advisers and Boards Here)

In a time of crisis, it’s very important to surround yourself with solid advisers, and to listen to your board of directors. We suggesting that you reach out to your best advisers who may have been through something like this before. You may have a variety of advisers willing to help including your existing Board of Directors, advisory board members, your investors, friends and family with strong business acumen, legal counsel, your CPA and more. Or, any of these advisors could lead you to somebody who has faced the same issue. Crisis usually demands new thinking. By bringing in more opinions, you should be able to generate more choices. Many have gone before you, and there is a 90% chance that if you talk to an advisory who has worked with more than a few businesses, they will have been through a situation like this before.

Look in the Mirror

Be realistic about your own participation in the problem. In my experience, entrepreneurs well visionary, can also be stubborn and continue supporting a problem until it becomes fundamental. The hardest thing for auditors to admit is their role in a fundamental problem. We all make mistakes, but the biggest issue is how quickly you can address the issue, not the fact that the mistake was made. In the case of a fundamental mistake, the entrepreneur may look to advisors and possibly even step aside and bring new leadership in. I have seen on more than a few occasions where new leadership comes in and gives the company another chance. Sometimes by being the sacrificial lamb, creditors, upset investors, or even customers might be patient enough for you to turn the company around These are all very hard decisions for the board and the entrepreneur. Listen to your advisers.

Don’t Be Stubborn

Even if entrepreneurs did not cause a problem, sometimes they are stubborn to bring about the necessary change. If a product isn’t working, it needs to change as soon as possible. I have witnessed situations where all of the advisers were suggesting that the best route was to file bankruptcy, but the entrepreneur would have no part of that. Instead of just reorganizing to get back in the playing field, the entrepreneur tried to complete the project but really had no chance, and the situation ended up much worse. As we know with entrepreneurs sometimes they are blinded by their own vision, and cannot let go of an idea or a certain direction on which they have decided. This is one of the biggest failing points we have seen with entrepreneurs. Some of their greatest assets, which include their vision, enthusiasm and work ethic, ends up being their greatest liability when times get hard. The fact is that 90% of businesses fail. A percentage of this failure is due to entrepreneurs not willing to change direction, or restructure a company as needed.

Solutions to Fundamental Problems (a Partial List):

  • bankruptcy or insolvency – seek financial and legal counsel
  • new investment capital at a lower valuation or down–round
  • new strategic direction for the company – go to your board of directors for advice
  • new product direction – utilizing product assets in a new way to develop a product the market needs – think of other uses for the product or the assets that make up the product. Perfect example is Twitter. Designed for an internal communication mechanism, Jack Dorsey then discovered that it could be used as a major communications platform. Now it’s a multi-billion dollar company.
  • merger or acquisition -selling the company or merge it with another synergistic company – this could be a competitor or a complementary company
  • shutter the company, and sell off the assets – try to return some percentage of investment
  • significantly downsize – reducing headcount and/or salaries – possibly ask employees to work for equity until you can turn things around
  • renegotiate debt
  • use equity anywhere you can instead of cash

As a final note, and we cannot stress this enough, do everything possible to keep the entity alive. I have seen companies that have been decimated but have gone on to survive and even thrive because the corporate entity was able to continue. This is of key importance in many businesses since the entity may have an established brand but not be operationally sound. We personally sold a company that was failing to another group that purchased the entity for a very low rate but then turned it into a viable business. While not the original outcome we intended, certainly better than some of the draconian choices we faced at the time.

If we can be of assistance please contact us.

 

 

 

 

 

 

 

 

Going Public – The Types of Advisers you will Need

In order to go public, you will need the following types of advisors:

Legal – hiring the right attorney or law group is critical. There is no way to successfully get through this process without having solid legal advice. Your decision will be to either hire an individual attorney, smaller firm or larger national firm. Each comes with its trade-offs. For instance, a smaller attorney will be less expensive, but may not give you the brand component you will need to raise capital. On the other hand, larger law groups are more expensive but their brands carry so much weight with investors, there is a lot of comfort there. Either way, you want to make sure that your attorney has a lot of expertise in taking companies public, and if you are in the small cap space, be sure they have experience with smaller IPOs, reverse merges etc.

Finance – you will need capital to go public or reverse merge. So you want to lineup financing, or choose an investment bank that will take your case on.

Accounting/Audit – a public company will need audits and solid financial statements. It’s best to find an auditor that is PCAOB compliant. This means they have the right processes and methodologies as well as certifications to file your public financial documents.

Business – it’s always good to have a general business advisor who has had a lot of experience with smaller companies. Find someone who is worked on reverse mergers or small IPOs who can help you along the way. This type of business advisor will look across your company and give you advice on ensuring that your company is structured and ready for the process.

Investor Relations – you will need an investor relations firm. After you are public, this firm will kick into gear and help create interest and distribution for your stock. There are a lot of choices of IR firms out there, so be sure to interview more than a few.

Specialty advisor – Be sure to find an advisor who has worked on more than a few small cap IPO’s and understands how to build a program that will keep your stock price supported. This would include going over all of your upcoming plans for the year to make sure that when you go public, you are hitting your milestones and metrics. The plan includes your product or service, marketing, finance, IT, sales/distribution and more. This is really an art. This person will help you write your SEC filings as well.

IPO/Public Company Basics

So you are thinking about an IPO for your company?

Well certainly don’t take this lightly as it is a major decision for your company. I call this a “fundamental” decision since it encompasses a path that should take a lot of thinking before executing, and also it’s difficult to turn back once it started.

IPO Pitfalls

What to think about if you are considering an IPO, reverse merger, reverse triangular merger, or reverse takeover:

1. Advisers – Seek out proven, trusted advisers who can help you with this process. Taking a company public is not for the faint of heart, and the amount of resources necessary to get it done should demand that you get the best advice possible. This includes financial, legal, accounting/audit, business, and more. For the companies that we’ve taken public, we’ve always sought out the best possible advisers.

2. Size/state of your company – There are reasons to have a public company and their reasons that you should not take your company public. For larger companies, that have valuations over $100 million, you can look towards some of the large investment banks such as Goldman Sachs or Morgan Stanley. They will give you an assessment as to whether or not you should go public and if they can help. For smaller companies, it’s more difficult as sometimes the decisions aren’t as clear. For instance, you may have a reason to go public that includes the fact that you want to use public markets to bring in capital. Or you may want to use equity to buy another company.

3. Going public costs money – yes, it takes money to make money. Even for a small cap company to go public you should probably have at least $100,000 set aside to cover legal, accounting, and other advisory expenses. In some cases if you have an interesting offering, some of your service providers will take equity in lieu of cash. This will keep your cash burn down. Either way, you have to have enough money to get through the process which can take anywhere from four months to one year, and cost anywhere from $100,000 up to $1 million.

4. Reverse merge or IPO? For smaller companies wanting to fall forward on public markets, you will need to make a decision as to whether or not you go public via a reverse merger (also called a reverse takeover or triangular merger) or to conduct a standard IPO. Reverse merge will require that you find a public vehicle, either in operating company, or a non-operating company that already has a ticker symbol. Make make no mistake, this is a very dangerous area and I would highly advise that you gain significant counsel when looking at buying a company that is already public. Many of these companies are wrought with financial landmines and legal traps that not only could have you losing all of your money, but also you may owe money that you didn’t even know about. Again, find an expert who can help you.

5. What are the steps to going public? Since we are largely talking about the more difficult small cap companies (if you call Goldman Sachs or Morgan Stanley they will take care of most of it for you), here is a list of items to think about:

  • Make your initial decision – IPO or Reverse merger?
  • If a reverse merger, locate a shell company and secure it
  • With either of the above, hire legal counsel and merge your company into the shell, or have an attorney file you S-1 with the securities and exchange commission. If you reverse merge you may have to file a super 8K with the Securities and Exchange Commission as well.
  • Find someone to help you market the company such as an investor relations firm or small cap IPO expert who can help you understand what the markets will do with your stock.
  • Be aware that once your stock is public, and there is liquid stock available, any number of people in the market can start buying and selling it. You will have no control over this. So it is important that you have a very strong strategic direction to ensure that your company is successful while your shares are being traded.
  • Again seek out expertise to make sure that your stock doesn’t get decimated by somebody buying large chunks and dumping them.

Here are some successful small-cap reverse merge companies that we’ve worked on:

Software Toolworks:
– Initial reverse $0.01 per share
– 908,000,000 shares outstanding
– Raised $2,000,000 plus warrants
– Reverse Split 150:1 when the stock was at $0.04 to get to $6.00
– Split 2:1 when the stock was $22.00 (after $100 million raised at $17.00)
– Sold for $462 million, (all cash) April 1994.
Intermix (Myspace)
– Raised $7 million at $1.00 plus warrants
– $10 million pre-money April 1999
– Sold for $580 million, (all cash) to Rupert Murdoch, September 2005.
Interclick
– Capital raise at $1.00 per share plus warrants
– $10 million pre-money April 1999
– Sold to Yahoo at $9.00 per share (all cash) November 2011.
Propell
– Raised $600,000 at $0.01 in April 2012
– Stock now at $0.17.
Zagg
– Raised $3 million plus warrants at $10 million valuation, August 2007
– Currently trades at $175 million market cap.
Akeena Solar
– Raised $6 million at $20 million market cap, May 2007
– Traded at $400 million market cap, Jan. 2008
– Currently trades at $4 million market cap.

 

 

Team

Choosing the correct team members at the appropriate time is the most important set of tasks you will ever take on with your startup. We can tell you from experience that over 80% of the issues that we have seen with early-stage companies have to do with expectation problems between team members. When your startup is operating on limited resources and time is against you, you cannot afford to run into too many personnel and staffing issues (although you can never fully avoid people problems).

Unfortunately, this is probably the hardest thing to get right in a startup.

We recommend adding team members slowly. What we mean by this is you need to really know your team members or partners so that there is no doubt as to how they will perform and react under pressure. Many of the problems we see occur because team members are hired to quickly and the appropriate time is not taken to understand cultural fit and performance capabilities. We suggest that you interview all team members multiple times under different circumstances to really get to know them. For senior members, you should spend time with them in the office, at lunch or dinner, and even in a 3rd scenario. We have had personal experiences in hiring team members to quickly and have had everything from unmitigated disasters to slight problems that could’ve been avoided.

Strengthen your weaknesses – The best advice we can give you is to bolster your own capabilities when hiring other team members. In other words, if you are weak at finance, hire somebody that understands finance, raising capital, accounting and more. If your’e weak in technology, be sure to bring on a good chief technology officer. We think you get the idea.

What will you do? – First decide what role you are going to play in the organization. Generally, you will take on a roll of “founder”, and in most cases CEO. We suggest that you run your company until it is determined that you need to bring on somebody with more talent across the organization. In some cases you may want your company with a partner and you will each have to take on C-level roles.

Team members you will need in order to successfully launch and initially run your startup:

CEO – has complete operational responsibility for the organization

CFO – your chief financial officer plays a critical role not only in finance but sometimes also running other administrative tasks possibly including human resources

CTO – the chief technology officer deals with both outward facing technology and internal systems. This would include your website and apps, hosting infrastructure and enterprise software and cloud-based systems.

CMO – the chief marketing officer has responsibility for all marketing mechanisms, communications, and in some cases sales and revenue. Additionally, the CMO usually handles product marketing and is integrally involved with product development.

CRO – a relatively new title, the chief revenue officer as complete responsibility for all revenue from customers, partners and affiliates. You’ll need to contrast this with the CMO position above to optimally execute your strategy

Product or service development – this position is critical to developing and delivering the best product or service. Generally most businesses fall into other products or services, although some can be categorized as knowledge. No matter what, you’re going to need somebody who heads up a very focused and driven team. In many cases the founders start out with this role because it was their idea to begin with

Board of Directors – your board should be a combination of C- level members, people familiar with you in your organization, and outsiders. You can see more on our thoughts about Boards here.

Advisory boards – advisory boards are very interesting ways of bringing more people into your organization to support any and all aspects. You can create multiple advisory boards which give you the ability to tap into greater resources. See our advisory board article here.

When should I hire or bring on the above staff members? There is no standard way to determine when staff members should be added. Generally you add based on need, and capability to pay. In other words, you may want a chief marketing officer but if you are not yet funded, you may have a hard time finding the ideal candidate. However some cases you can trade equity in the company for dollars and thereby hire more quickly. You will have to prioritize what you need 1st and figure out a way to bring that person on.

Company Structure: C-Corp, S-Corp, or LLC?

We get a lot of questions about structuring early stage companies. You will need to decide on  the type of entity which is optimal for your startup.

Generally most of our comments are geared towards startups that are going to raise capital. If you’re going to bring in outside investors, certain structures will work in your favor, while others will be sub-optimal.

This article is designed for those who are going to raise money from outside investors. If you are launching a small business and don’t intend on raising equity capital, you can even use a sole proprietorship structure.

In order to create the best company structure, you should consult both your legal counsel and your accountant or CPA. The advice we give here is not designed to displace certified professionals but rather give you guidelines.

Generally if we are asked about a corporate structure for startups where equity capital will be raised from outside investors, we suggest a C corporation.

What are the advantages to using a C corporation?

1. Limited liability – a C Corporation provides protection for officers, shareholders, directors and employees. This way if there is ever a liability issue, a C corporation acts as a separate legal structure that can shield your personal assets from judgments against the company. One caveat – the corporate veil can be broken if you don’t maintain the C Corporation with all of the required quarterly and annual filings.

2. Credibility for investors – with a C Corporation, investors never question the structure. With other forms they may ask why you are using an LLC or an S corporation.

3. Shareholder Scalability – a C Corporation has no limit on the number of shareholders. This is why all publicly traded companies are C corporations. All things being equal, if you ever plan an IPO for your company, you may as well start with a C Corporation.

4. Tax advantages – C corporations have certain tax advantages that you need to discuss with your CPA or financial advisor. Depending upon your personal situation and your status within the company, you will need to review tax liability by using the structure.

5. Survivorship – a C Corporation will survive even if you or other founders leave the company. This means it can be an ongoing entity without being damaged by exits from large shareholders.

What are the advantages of using an S corporation?

Taxation – Pass-through: An S corporation operates much like a C Corporation, above, however an S Corporation passes most of its income and losses to its shareholders. This means that shareholders report income and losses on their personal income tax returns. This may or may not be an advantage for you, as the entrepreneur, but again it’s always best to check with your CPA or tax attorney.

Asset protection: S corporations have a lot of the same asset protections as a C Corporation in that if there are judgments or issues, outside parties cannot go after personal assets of the shareholders. Compare this protection to a sole proprietorship or general partnership, and you will find that personal assets are exposed in proprietorships and some general partnerships.

Reduction of self-employment tax liability: shareholders can be both employees of the business and also receive dividends from the corporation.

Transfer of ownership: S corporation ownership can be transferred without adverse tax consequences.

While the above seems advantageous, and you might question why choose a C Corporation when an S corporation seems to have more advantages, the one key disadvantage is that an S corporation can only have one class of stock. Typically when you raise equity capital, investors are looking for preferred stock, which gives them liquidation rights as well as other rights, so an S corporation is not really a good vehicle if you are going to go through typical equity capital raises such as seed round, series A, series B etc.

How about an LLC?

The limited liability company, has the capability to use characteristics of a partnership, a sole proprietorship, or a corporation. Typically know an LLC is not considered a corporation. This type of structure is very well suited for a small group of partners or even an individual shareholder.
Advantages of an LLC:

Tax – an LLC can elect the to be taxed as a C Corporation, an S Corporation, a partnership, or sole proprietor which provides a lot of options for ownership. Also, LLC members may be able to distribute their share of incomes losses or deductions in various ways. As you can see an LLC is a complex structure so we would advise consulting with your CPA or tax attorney.

Real estate specific – LLCs are used for real estate companies quite often. The reason is that the LLC not only shields partners and owners, but also shields the assets or the properties.

Single ownership – an LLC can be set up with one owner which is advantageous if you’re not going to take on any partners. S corporations and C corporations require multiple officers, and multiple board members etc.

LLCs have disadvantages as well. 1st, LLCs are operated differently across a variety of states. So you need to check state laws regarding LLCs before making a decision to form your company. Fee structures vary, state tax situations very etc.

Also LLCs cannot be used as structures for IPOs. So if you plan on taking your company public, you would have to convert your LLC to a C Corporation before doing so.

Operating agreements – most states require LLCs to have operating agreements. These are formidable documents that explain how the LLC will be operated and include all of the detail on how the partners will interact with the entity. While not overbearing, operating agreements do require additional legal work.

Again – before deciding on the correct structure be sure to consult your legal and financial counsel.

Board Members

One of the most important things you will do as a startup entrepreneur is to choose your board of directors. Key is to make sure that you choose your board very carefully and give out board positions only once a great deal of thought, communication, and trust has been created. I have seen many mistakes in my days were entrepreneurs gave board positions without the foresight necessary to really understand if the Board member was a good fit. Asking someone to leave the board is a painful process that you want to avoid. Of course there are times when things go sour even with the best planning, but the idea is to make sure that you put in the effort necessary to ensure your board works effectively for you.

What is the role of a Board member?

Board member roles vary to some extent depending upon the size of your company and the structure of your board. I have seen very active board members who will do everything including pickup the phone to generate business for you, and I have seen other board members that meet once per quarter or year to review the company. Obviously there are a lot of duties and tasks between those two extremes where Board members added value.

Board members provide overwatch on the CEO, watch finance and stay involved with the strategic direction of the company. On the negative side, Board members are not there to get involved in day-to-day operations and help run your company. One of the few times where this could occur is when there is a management change and (for instance) the CEO is asked to leave the company. In this case a Board member may have to step in to run operations. Generally though, Board members are there to advise, and usually meet once per month to help you with strategy and direction. They will also look over your reports and documentation to make sure the company is running correctly. Board members will certainly get involved with the financials and the legal structure of the company to ensure that cash is being spent correctly and that items like stock options are handled appropriately.

How are Board members compensated?

Generally, Board members are paid in equity/ownership of your company and are therefore an incentivized to make the company an overall success. In some cases, Board members get some money for expenses if they have to travel to Board meetings. In other cases, especially with large companies, board members will earn a cash allotment annually. For startups however, I would not suggest paying Board members any cash, and if a Board member is asking for cash, they are probably not who you want on the Board.

I would suggest as a startup entrepreneur you offer each Board member somewhere in the neighborhood of 1/10 of 1% of your stock up to 3/10 of 1% of your stock. So, if you have 10 million shares outstanding, you might issue a board member anywhere from 10,000 shares up to 30,000 shares for serving on the board with your company. Also the Board members’ options vest over time just like employee options.

How many Board members should I have?

Usually, for startups I recommend not less than 3 but not more than 7 Board members. Less than 3, and it’s not really an effective Board, and more than 7 is simply too much to handle. If you have friends of the company who want to serve in an advisory capacity, and don’t have room on the board, I would suggest that you add the extra folks to your Advisory board.

Who should be on the Board?

First, as the the CEO and founder, you HAVE TO BE ON THE BOARD. Never, never, never, give up your Board position, no matter what may happen. Let’s face it, sometimes bad things do happen and founders/entrepreneurs are asked to leave the companies they have founded. While unlikely, either way, you need to stay on the Board until you sell the company or exit via IPO.

If you are not the CEO, then you should invite the CEO to be on your Board with you, the founder. So you would have 2 Board seats as a result. There is no need to add additional officers to the board. The rest of your board should be a combination of talented confidants and outside professionals who will add operational strategic value or corporate development value. Sometimes you may add a Board member just because they are a huge name or recognized individual and they build confidence in your company just from using their name. However, usually this is not the case and you should look for Board members who want to and are able to provide value.

The Essentials – Directors and Officers Insurance

Board members have a fiduciary responsibility to your organization and therefore have some liability for the organization. Recall the Enron and Worldcom disasters of early 2000 and you will know that Board Members were scrutinized at least, and held responsible at best. So, you need to acquire Directors and Officers insurance (called D&O insurance) in order to attract Board members as they want insurance against liability. In addition you should secure errors and omissions insurance which also covers officers and board members. This insurance is typically called “E&O” insurance.

What Happens at Board Meetings?

As stated above, Board meetings are held on a monthly or quarterly basis so the Board can interact with the CEO to guide and direct company strategy. On occasion, you might have some of your VP’s attend a Board meeting to report on their given department or duties.

In most cases, you, as the CEO, should build the agenda for the Board meeting. It should be built with the Board in mind, having items that you wish to cover and they want to see and discuss. You should cover all areas of the company so that the Board can provide input and guidance: Sales, Marketing, Business Development, Product Development, Engineering, Manufacturing, Finance, Operations, HR and Administration and more. The meeting should last 1-2 hours unless you meet less frequently (quarterly or annually) or there are extreme circumstances (you need to discuss a merger or acquisition).

Startup Hack – Create A Strong Advisory Board

One of the secrets I learned early in my startup career was the value of having a strong set of advisers. This article will give you some insight on how to create an effective and impactful advisory board.

There are many reasons to add Advisors to your startup:

  • They bring needed expertise in your given industry
  • Sometimes their name will carry credibility for your company
  • Advisors can make meaningful contacts and introductions for the company
  • You need extra help with a certain aspect of the business such as operations, finance, sales and marketing or technology.
  • Advisors should be compensated via equity thereby preserving cash
  • They can help raise capital

I would suggest creating a number of advisory boards based on the needs of your company. For instance, you can have a technology advisory Board, a financial advisory Board, an industry advisory Board, and other advisory boards. By bringing on a variety of advisory board members, it enhances your viability since anyone who looks at your company will be intrigued by the fact that you attracted so many interesting and talented people.

Advisory Board compensation

People always ask me “how do I compensate my advisory Board members?” Usually advisory Board members are compensated in equity. On very rare occasions, where an advisory board member is able to add significant value, you might consider a small cash stipend. But generally advisory board members should provide anywhere from a few hours up to 10 hours per month to help your company.

How should I use advisory Board members?

First, you will need to have advisory board agreements that outline the relationship with your company, and what is expected of the advisory board member. Be sure to set up your advisory board agreements with expectations that are reasonable. You’ll want to use your advisers sparingly, unless they have more time available to help. The key is to make sure that if you engage in adviser, your requests of them are meaningful and impactful. Most advisers will be happy to help since they want to be part of a winning company. You can make a big mistake here by bringing on a great advisory team, but not utilizing them to the fullest extent. So be sure to understand each advisers’ value, and have a plan to help them move your company forward. I have found that if advisers are not asked for help, they probably won’t speak up, and you will miss opportunities to utilize their skills, contacts and advice.

Are advisory board members liable for any issues that arise for your company?

Unless there is a specific incident where a advisory board member causes material damage to your company, generally Advisory Board members aren’t liable. They do not hold the same role as a board member. Board members have fiduciary responsibility for your company, and advisory board members usually don’t. This is also one of the main reasons why they are easier to recruit. Board members are getting harder to recruit because many of them don’t want to take on liability for the company, even with directors and officers (D&O) insurance. Remember when one of the board members of Hewlett-Packard was accused of using underhanded tactics to spy on the board? Advisory board members usually are not implicated in these situations unless there is proof that they have actively participated.

How many advisory boards should I have?

Always start with a single advisory Board. While advisers can be important to your company, it still takes time to recruit them and bring them into the fold. So start with one advisory Board, and then as you grow you might add more advisory boards for specific areas of the company. Also, as mentioned above, you’ll only want to take on as many advisers as you can manage. It doesn’t do any good to have advisers whose skills go underutilized.

How many members should be on an advisory board?

Generally, a minimum of three and a maximum of seven. With less than three advisory board members, it’s not really a board. At the same time you really don’t want more than 7 advisory board members on any given board, as it will become too complex to handle all of the maintenance that goes in to having advisory board members. Remember that you can have as many advisory boards as you would like, and can utilize effectively.

How often should advisory boards meet?

It all depends. If an advisory board is extremely active and necessary, you might consider meeting once per month. If the advisory board is more for brochureware, meaning that you are listing names to establish credibility in your company, you might meet once per quarter or once a year. However, you should feel free to call on your advisory board members often to help your company.