So you want to launch a business...

Who gets a piece of the action?

Question from a reader: Four friends helped me put together a prototype of a new product I dreamed up.  If I start a company, should they all get stock?

You are not alone.  I hear this question, in one form or another, quite regularly. 

Equity is forever - or at least until you sell the company.  And it is typically reserved for people or institutions that are active in the business, as long-term, strategic participants or financial risk takers. 

Cash, on the other hand, is the universally recommended medium for acquiring commodity products and services that are not strategic to the business.  Bestowing equity on any entity in lieu of cash payment amounts to paying forever for products or services that may not even remain relevant a short time into the future.

The following questions may help you with your deliberations.

Will your friends be key employees in your new company?  Or did they simply provide some free labor for you when you had no money to pay anyone?

Did one or more of them contribute a significant idea that improved your product?  Or did they merely help you execute your ideas?

Have you already led them to believe that they have earned some ownership share in your invention?

Since you have four friends involved, I am tempted to guess that you may have one or two who might be considered strategic, and others who are not.  As tough as this may seem, now is the time to bite the bullet and make such distinctions clear.  It will take some Moxie; but it's absolutely the correct thing to do.  Here's why.

Any equity given to non-strategic players clearly devalues the equity of the true strategic participants, including you, both financially and psychologically.  Consider this line of thinking: "I did a mountain of inventing and weeks of work for my shares.  All he did was turn a few screws one Saturday afternoon."

Minority shareholders have the right to inspect the books of the corporation.  That means that they constitute a potential leak of sensitive information to non-shareholder employees, competitors, suppliers, or others.  They can also formally object to compensation plans that may seem to unreasonably favor owner-executives.

Minority owners can create difficulties with important shareholder actions downstream, particularly equity financing and re-structuring for merger or acquisition.  Laws vary from state to state, but there are potentially annoying anti-oppression provisions in force almost everywhere.

So - when in doubt, pay cash.  And when there is potential mis-understanding, clear it up quickly.

How to deal with lawyers

Question from a reader:  I just got a $3,000 bill from my lawyer that I wasn't expecting.   What should I do?

Above all, remember this.  Good legal advice is a good investment.  Time and again I hear sad stories of good companies seriously damaged, or even destroyed, by the fine print.  We all wear seat belts when we drive.  Your attorney is one of the seat belts of your business.

Unfortunately, unlike seat belts, attorneys are not simple to operate; and they do not come come with owner's manuals.  The good news is, however, that they are like computers.  They will do what you tell them to do - quite literally.  Clear and precise instructions are crucial - in writing.  And the instructions have to be clear to them, not just to you. 

If you tell your attorney to protect you from any possible danger, you will get a document for the ages, and a bill to match.  Seat belts do not protect us from infectious diseases.  Likewise, complex contracts cannot remove all business risks.

Here's what I do.

First, I do my homework.  The business deal belongs to me, not to my lawyer.  It's my responsibility to get it right.  So, I rough out the agreement I think I want, usually just with bullet points.  Then I ask my lawyer to review the points, to let me know whether they are reasonable, and whether there are any specific issues I may have overlooked.  That doesn't take long and doesn't cost much.  Sometimes I even specify the number of hours I want her to devote to the review.

Once the review is complete, and I have a complete list of bullets, I ask how long it will take and how much it will cost to create an appropriate legal document incorporating all the bullets.  I do my best to avoid open-ended work assignments for my lawyer.

Any request I make to an attorney is a work order.  Attorneys sell time.  The hourly price depends on the experience level of the particular attorney.  I try to remember that I am buying hours of work, just as if I were hiring a teenager to do odd jobs around my house.  So I set boundaries, in writing.

If I have a surprise, like an unexpected bill, I remind her of the boundaries.  Her firm can make a client service mistake, and they can also correct it.  But, if it turns out that I was the one who inadvertently modified the boundaries, because I gave bad instructions, I pay the bill.

My lawyer wants my business.  I want reliable legal counsel.  We work together to create a relationship that is mutually comfortable and sustainable.

You and your attorney can do the same.