Big post today! There is much to bring you up to date with and I’ll do so as fast as possible. We are working at a feverish pace and that’s delayed my postings. Here we go.
You’ve met the co-founders, how the idea was formed and how I came on board. So the two original cofounders took their idea and started developing. In short order, they developed a functional site and a Facebook API. Pretty impressive honestly. I was attracted to these early “raw” elements and that led to my involvement. However, once I jumped in full time I started to uncover gaps in the start up. Every start up has its gaps; the key is knowing what they are and having a plan to fix them. Let’s go over what I found and compare it to your start up.
Corporate Structure
- Set up quickly as a partnership between the two co-founders and I was added down-stream. Low to no cost to set up and obtain a FEIN tax id. Very brief document that basically says, “We’re partners and this is our percentage ownership in the company”.
- No shareholder or operating agreement established at this point. There is no detailed document explaining the agreement made between co-founders, other than the percentage of ownership.
Development
- A developer in India is hired to build the site. No contractual agreement is made with this person to be hired as a contractor. No NDA, no agreement as to ownership of the intellectual property created.
- The developer does not document anything created. The co-founder simply describes what he wants and the developer codes. No wire frames, mapping or other documentation is created.
Basics
- No business plan written.
- No accountant or legal firm involved at this point.
- No bank account established.
- One partner (the major shareholder) is a Canadian citizen and ramifications are not researched.
Co-Mingle of Funds
- All of the expense being made to date are done out of pocket. Not recorded in central location.
Many of you may say, “big deal, why are these items above gaps”? We’re doing the same thing. Well, they are more than gaps, they are problems! But problems many start ups encounter in their early days. Remember, the co-founders both work day jobs and went from idea to a functional product in six months and launched a beta site with 1400 users. Now it is time to clean things up to be prepared for growth, become a real company and seek funding. Let’s look at the gaps again, see why they are a gap and how I corrected them or at least plan to correct them.
Corporate Structure
- Set up as a partnership.
A partnership is not terrible, but it fails to insulate the founders from liability. Now that we are ready to go to market we need to legally separate ourselves from the business entity (choice is to a LLC, S or C corporation). We know our highly scalable, fast growth potential company will require funding to help us take advantage of the market opportunity. That said, investors will likely require us to be a C corporation. Any entity type with pass through income reporting (i.e. LLC, S) are cumbersome and restrictive to the professional investor. Further, having a foreign citizen as an owner excludes us from being a S corporation.
The process of incorporating as a C will address the informalities the partnership presented. Using a well researched law firm, we will take into consideration vesting, share price, number of authorized and issued shares, shareholder rights and how this all sets up for a professional investor’s expectations and requirements. My first company was an S corp, second was a LLC and now this will be a C. Each had unique requirements and reasoning for the corporate structure selected and that was dependent upon the planned journey I expected to take with each. Each time, professional advisors helped me select the right structure up front, helping me to avoid headache and expense downstream.
Development
Yieks, this is probably the biggest concern I jumped on first. Our entire company is dependent upon the IP we create. It is how we address the problem our target customer has. It is the secret sauce that investors will clamor over and position them for a successful exit. Here are the steps I have taken to protect our ID, establish a solid operational procedure, and pass the due diligence mustard when applicable.
- All developers hired as contractors are required to sign a NDA.
- All developers hired as contractors are required to sign a work for hire agreement to establish corporate authorship that all works are owned by our company. Basically, we own the code.
- Conduct all steps to demonstrate and maintain that contractors are just that contractors and not employees of the company. We do this several ways including; through the agreement created, requiring them to submit invoices to our company, not allowing them to use our email address, requesting them to establish themselves as some sort of company by which we contract with versus an individual.
- We will start to request the developer to properly document anything they create. If the developer can not comply, we will have to find a new developer.
Basics
- No business plan written.
Now many will say, “The hell with business plans, just start”. I however, need and require a business plan. We are going somewhere unknown. We need a plan to get there and we need direction. It’s like taking the time to put an address into a GPS so it can lead you to the destination. Now that we have a destination, it is time to write a business plan. It starts being created for our team internally to understand how to execute. It is then transformed into an investor deck/presentation.
- No accountant or legal firm involved at this point.
I went back to my previous accountant that I worked with for ten years. The important aspect is ensuring that our accountant has worked with and understands C corporations and firms that have solicited and received outside investor funding. The law firm had to have the same qualifications and even more emphasis placed on their understanding of IP and the high growth start up.
- No bank account established.
Once we incorporate, we can open a bank account properly. That alleviates the issue of co-mingled funds and allows shareholders to purchase stock, where proceeds are deposited. Further, it allows us to start doing business with customers. The customers we target would be hesitant to work with a Partnership and certainly one without formal banking procedures in order. We will compliment this with a monthly license for QuickBooks to record our transactions properly.
I apologize for any shortness in grammar, but I had a lot to update you on. Next week we’ll talk about development and product features and validation. Also, we are starting to go to market to generate some revenue – wish us luck. As a mentor for Future Founders, I am sharing my experience in greater detail with 12 Chicago entrepreneurs who are getting ready to create and launch their companies right now. If you want more details or have questions, give me a shout. I hope you find this helpful.
Now, back to wire frames!