In his blog, VC Deal Lawyer, corporate transactional attorney Christopher McDemus observes that everyone in the venture community can share a horror story about a start-up or emerging growth company that stumbled early. Sometimes these blunders can be fixed, but often they represent a death blow, says McDemus, who offers this list of 15 common mistakes that high growth start-ups should avoid:
- Making poor hires early and not firing fast enough. Avoid the “C-level hire” with an incredible Fortune 500 resume but zero start-up or emerging growth experience. “Never hire someone solely on the basis that listing their former employer on your pitch slides looks great,” McDemus writes. In addition, beware the hire who claims to bring strategic assets that can only be realized after joining the company. If someone professes to have the contacts to help you raise $3M or land the 10 largest clients in your target market, condition his or her compensation on delivering that promise. If you do hire someone who isn’t working out, move on quickly. “It may cost you, but not as much as it would in the long run,” McDemus says.
- Failing to assemble the correct management team. Invest in the jockey over the horse. “Investors don’t want you learning on their nickel,” McDemus points out. Demonstrate that you have talent that knows the space and can make lemonade out of lemons, if necessary.
- Promising equity to individuals up front. Never strike a deal for a lead employee to work “for 10% of the company.” Instead, ask hard questions: What kind of stock does the employee think he or she is getting? When and how is the 10% measured? Is the number of shares represented by the 10% calculated on a fully diluted basis or not? And get the deal in writing.
- Failing to properly structure founder shares. If a founder receives all of his or her shares up front and fully vested, there’s no incentive to stick around and help build the company. Vest founder shares gradually and issue them as restrictive stock grants — for example, 400,000 shares of common stock, vesting annually/monthly/quarterly over four years. If the founder stays four years, he or she keeps all of shares. If the founder leaves early, he or she keeps some and the company buys back the remainder at the same price the founder paid.
- Selecting the wrong type of business entity and structuring early ownership 50/50. If you plan to seek outside investors, go with a corporate structure, McDemus advises. “You avoid the issue of VC funds requiring blocking entities — a result of some of their limited partners being non-profit companies — and the possible need to convert your limited liability company to a corporation at a later date.” In ventures with two founders, “find some difference between yourselves to rationalize one person taking 51% of the ownership,” he adds. Absent complicated provisions to break a deadlock, 50/50 deals result in a standoff the minute the founders disagree.
- Failing to consult experienced advisors at the beginning. Avoid many novice mistakes simply by hiring experienced start-up and emerging growth attorneys and accountants from the get-go. You’ll save time and money in the long run because you’ll eliminate an expensive clean up down the road.
- Not having a clear business plan. Focus, focus, focus. If you try to become all things to all people, you’ll end up being nothing to nobody.
- Raising too much or too little money. Too much money buys complacency — along with many of the mistakes cited here. Too little money cuts short your runway before you can launch your product. “Look into the future as best you can and consider how much money you will need to reach the next fundraising stage,” McDemus says.
- Failing to properly document early agreements. Hire experienced counsel to help you prepare shareholders’ agreements between the founders; founder share agreements and possible 83(b) elections; non-competition, non-solicitation, confidentiality, and invention assignment agreements for employees; and appropriate equity compensation, or stock option, plans. Seek guidance on external agreements such as customer contracts, service agreements, licensing agreements, and office leases to ensure they contain appropriate protections.
- Raising early money without complying with securities laws. No matter how you slice or dice it, if you sell a stake in your company — from the issuance of founder shares to the issuance of stock to VC funds — you must comply with federal and state (blue sky) securities laws. Poorly structured transactions can derail future fundraising or cost the company tens of thousands of dollars to rectify.
- Poor cash management and spending money on the wrong things. California Historic Landmark No. 976 — the modest “garage” where Bill Hewlett and Dave Packard started Hewlett-Packard in 1939 — epitomizes boot-strapping. Think about every dollar that goes out the door and what you receive in return. Show investors you have the discipline to manage your cash to reach positive cash flow.
- Failing to identify a market for the product or service. Don’t invest time and money into building a product or service before you’ve considered who will buy it, and don’t focus on product capabilities without considering whether potential customers need them.
- Failing to re-invent on the go. “Improvise, adapt, and overcome” is the perfect mantra for an early stage start-up, McDemus says. Have the ability to turn the ship on a dime and take a different tack on a problem.
- Getting stuck on valuation rather then getting committed funds. Place a higher negotiating priority on liquidation preference and dilution than on valuation. Don’t let hang-ups over valuation stifle your chance of closing on committed funds. “Without funds, there is no business,” McDemus points out.
- Failing to build a sustainable business around the IP. The only way to monetize IP is to build a sustainable business around it. This is the gap university TTOs try to overcome on a daily basis by partnering with entrepreneurs who can license the IP and take it to market.
Source: VC Deal Lawyer