My guest post today is by Susan Amat, executive director of the University of Miami's Launch Pad, who writes this monthly column called Entrepreneurship Tools for the Miami Herald. Here is her column.
Find earlier columns by Susan here and here.
By Susan Amat
Two friends are sitting at a bar. John is waxing on about how much email he receives and how much time it takes to sort through the junk. Six months later, his friend Jane releases an email sorting application that learns your interests and makes associations from past actions. Should John have an equity position in Jane’s product? What if John had said one solution was developing an intelligent sorting program? Does your perspective change if John has no technical background and Jane is a skilled computer scientist and serial entrepreneur? What value does an idea have when it isn’t coupled with execution?
Many entrepreneurs develop their "change the world" business ideas talking with friends or family. When you have a shared a-ha! moment, the next questions you ask may save your relationship and avoid time-consuming and expensive problems down the line.
"In start-ups, friends and family members are generally excited about developing and/or marketing a product or service, and underestimate the need for proper legal documentation, tax considerations and solid corporate governance," says Brent Friedman, IT counsel to large and small companies including GE Healthcare, Citrix, Carnival Corp., CareCloud and many startups. "At a minimum, they must ascertain who will invest what, who will own what, and who decides what pertaining to the business."
One of my favorite former students wrote a business plan with a couple of classmates for a graded project. At the end of the semester, they were all gung-ho on making the business a reality. While she has spent more than 200 hours this summer doing research, making contacts, designing marketing materials and more, the others haven’t spent a dime or a minute on the product. In an email chain they all agreed to an equal partnership with no discussion of "what if" scenarios as other opportunities and distractions come into play. Now what?
Whether the company is a startup or a large firm, Friedman approaches issues such as organizational structure and capital contributions of stakeholders in a similar fashion. "It is critical up front to define specific individual or corporate contributions to an enterprise, joint venture, strategic alliance or partnership. I always start by asking who is contributing what, and who will end up with what." If my former student had discussed expectations and set clear roles and responsibilities with her teammates, the momentum she has created would be something to celebrate instead of causing more hurdles as she renegotiates the corporate structure.
Another friend brainstormed with a college buddy for months and decided they would be partners in their new startup. One is very driven and has a clear vision for the business based on his experience and education. The other had some computer science development experience. They defined their roles as CEO/CFO and the other would act as CTO. When it came time to start developing the software, the CTO’s skill set could not offer anything to further the company from a technical standpoint. They had to outsource all of their development and support needs at a time when their limited resources were already being stretched.
While it is easy to pull in a friend to partner on your dream, make sure that person has the skills and shares the vision to execute on your idea. If your friend has experience in that industry, or skills to scale a business and a great network, that sets the tone of the business for your future employees and potential investors. Allocating equity to key team members makes sense — their stake aligns their interests and may attract executives with more experience to accept a significant salary reduction. Being stuck with someone who owns a large stake of the company and can only offer skills that are redundant to another member in their team of three may limit their growth and may cause issues as they seek investment and have to defend a weak founding team that outsourced a key component of their value proposition.
Friedman suggests that the "organizational documents contain readjustment provisions that allow for a recalculation of the equity participations of the parties in the event that disparities arise on the value of their contributions over time." That means even when the founders agree to who owns what, any investments of time, money or milestones that were documented in the agreement must then be met over a specified period of time for the full amount to be "earned."
Had my friend’s team put that in place, even if 10,000 founder’s shares were assigned to the "CTO," the fact that he was able to offer less value than was expected may have resulted in only 1,000 shares ultimately being earned over the first year of his working with the firm.
A close friend of mine is an experienced financial services professional and saw a great opportunity to solve a major pain point for her clients, as well as her competitor’s clients. She spoke to another friend who developed a basic website and intake system, spending less than $10K of billable-time altogether. She is about to quit her job to run this business full-time while the developer spent a few evenings and a weekend of his time making the site. At this point, the business has her reputation and experience, her software licenses and equipment, her clients, a great name, and a website.
To guard against imbalances of contributions, Friedman suggests that his clients "retain an interest in specific assets or products that they are contributing to the enterprise, so that they retain ownership of the assets that they contributed by merely providing the enterprise with a revocable license to the products. This protects the contributing party in the event of a dispute among principals or the demise of the entity."
While it is fun and exciting to brainstorm your business, giving the same energy to defining roles and documenting the structure and ownership with the help of an experienced lawyer may be the most valuable use of time. Those hours may shed light on facets of your partner’s personality you may not see otherwise.
Susan Amat is co-founder and executive director of The Launch Pad at the University of Miami, which has helped hundreds of entrepreneurs develop skills, make connections and launch businesses. She also leads Startup Florida**. Follow her on Twitter: @SusanAmat