So you want to launch a business...

Who owns your website?

This could happen to you!

After several years of increasing activity on his website, Dave decided to move it from a local hosting company to the "cloud."  He didn't want to take a chance on downtime disrupting the lucrative online arm of his import business.

He made all the necessary arrangements with one of the big cloud hosts and then instructed his local host to transfer everything.  Then the hammer fell.  "No problem," they said, "as long as you pay us $100,000 for the copyrights to the site."  "Wait," replied Dave.  "I paid you to develop that site.  It's mine."  "Yes, you paid for the development, but not for the copyright."

Mad scrambling followed to no avail, and very shortly Dave heard his lawyer say these fateful words.  "The work you paid for does not fall under any of the "work for hire" provisions that automatically transfer copyright.  Your contract with the developer/hosting company does not contain any transfer of ownership language.  They are correct.  Since there is no separate licensing agreement that signs the work over to you, they own the copyright."

Dave had to pay up.

How might your business be damaged if somebody else "owned" your website?

If your contract with your web developer is missing one short, but very important, paragraph, you probably do not own the copyright.  I checked this out with The Creekmore Law Firm PC.  They confirmed this hidden business risk.

You might want to check with your attorney, too.  And you might want to read your web development deal document.

And never forget - everybody is your friend until there is real money involved.

Bet the jockey, not the horse. Or not.

Way back in 1999, the Fast Company Consultant Debunking Unit did a MythBusters job on the old saying, "bet the jockey, not the horse."  Here's an excerpt...

"At the 1998 Fall Meet -- 24 days of races at Churchill Downs -- Hall of Fame jockey Pat Day raced 163 horses and won 43 times, winning 26.3% of his races. Jockey Calvin Borel raced 184 horses, and won 35 times, posting a 19% winning percentage. If you were betting on the jockey, you'd bet on Day. But, says Asher, if you had placed $2 to win on every horse that Day rode, you would have lost money -- $40.80, to be exact. And if you had placed $2 to win on every horse that Borel rode, you would have come out ahead -- by $58.80. That's because the odds reflect the quality of the horses. So much for betting on the jockey."

What does that mean with regard to early stage investing today?  Should investors really bet on the management team rather than the business proposition?  In practice, do they really follow the "bet the jockey" rule of thumb?

Studies of angel investing behaviors generally indicate that the entrepreneur and the management team are dominant factors in decisions to invest, or not.  A Richard Sudek study, published in the Journal of Small Business Strategy, names as the number one consideration "the passion and commitment of the entrepreneur."  Omigosh, that's MOXIE.  Second comes trustworthiness of the founder.  Third comes the remainder of the management team.

So, if you're going to the race track, bet the horse.  But if you're involved in startup businesses, either as an entrepreneur or as an investor, the common wisdom remains "bet the jockey."

Why?

My own opinion is that investors bet the jockey because they are well aware that nothing goes according to plan.  More often than not, the business proposition must be altered to respond to fresh knowledge coming from the marketplace.  The horse itself must be changed.  Yes, the entrepreneurial jockeys have to change horses in midstream.  This understanding of the startup world argues in favor of passionate, fully committed leadership, surrounded by a competent, experienced team.  A group like that can catch, train, and ride whichever horse best suits the racing conditions.

Start with MOXIE!

Angel funding - a stairway to heaven, or someplace else?

A few months ago, as a bootstrapping entrepreneur, Jeffrey was his own boss; and his first and only daily priority was to delight and amaze his clients - at a profit.  Now, as an angel-funded business manager, Jeffrey reports to his brand-new Board of Directors; and his first and only daily priority is to prepare his company for near-term acquisition by some unknown set of new bosses. 

If his company is acquired, Jeffrey will, indeed, enjoy a very nice monetary payday.  He will also enter contractual involuntary servitude for three years or more, because the new owners always want to lock up the key talent as part of the deal.

Jeffrey is satisfied with his situation.  The trade-offs are acceptable.  But not all stories end this way.

 

If you want to fly with the angels, you have to fulfill all the entry requirements for heaven.

Financial angels do not dispense charity.  They invest in early stage, risky businesses with the clear expectation of extraordinary returns.  They mitigate their risk by considering many, many alternatives, selecting only a few.  And they often attempt to limit their risk further by actively participating in the management of their portfolio companies, almost always at the Board level and sometimes beyond.

Do you need angel investment, or just want it?  Are you just trying to reduce your risk by transferring it to others?  Or is there a clear strategic need for a cash infusion?

Once you are sure you need outside funding, be ready for a long grind.  It wasn't easy for Jeffrey to secure his investment.  Locating, attracting, and convincing a double digit number of angels is a grueling process.  And if you succeed in raising the money, your life changes forever - just like Jeffrey.

Once you take a single dollar of somebody else's money, your job is to sell your company, quickly and at a high multiple.  If that quest goes well, and stays on the timeline, you may have a nice ride.  If it does not, ouch!

Startup heaven can be transformed into a much less appealing place almost overnight.

Angel investment arrangements always include covenants that give the investors more and more control in case of missed milestones.  These covenants may all be quite reasonable and equitable, but they are nonetheless painful if they are invoked.  Some good friends of mine were squeezed all the way out of their company by disappointed angels.  That doesn't happen often; but it's not a pleasant experience if you are on the receiving end.

So - angel investment should be strategically important and acceptably risky, not only to the angels, but to you, the bootstrapping entrepreneur.  They might lose their money.  You might lose your company.

Don't pay bills with equity!

Equity for services is a risky deal for everybody.

Bootstrapping is a trendy topic right now because early stage investment is hard to find, particularly for businesses that do not promise extraordinary growth potential.  One of the bootstrap financing techniques often suggested is the trading of stock in the enterprise for products or services needed by the start-up.  I have a strong opinion on this practice. 

It's a terrible idea.  Here's why...

As I have pointed out in other posts, equity is forever.  Swapping shares in your company for one-time needs might be compared to paying for an oil change by giving the mechanic partial ownership of your car.  Without the oil change, your car might eventually grind to a halt; but do you really want to enter into a long-term relationship with the mechanic?

Let's get specific.  Suppose you offer an attorney a share of your company for preparing incorporation  papers, and she accepts.  Now, as a shareholder, the attorney has permanent access to your corporate records and the right to participate in all ownership activities.  The dream, of course, is that the company is on a fast track to outside investment and on to liquidity.  The lawyer will get to draw up all the financing documents and then the merger or IPO papers for a healthy fee; and the tiny share of ownership that you gave her will be insignificant to the fortune you will make when you sell the business. 

Here's what really happens most of the time.  The company, if it survives beyond its first year or two, grows nicely, but slowly.  It doesn't need, or warrant, serious outside investment.  The best way for you to make real money is not through a liquidity event, but through handsome personal compensation.  You have occasional need for a lawyer, but you try hard to avoid those inflated fees whenever possible.  They are, after all, money right out of your pocket.  The lawyer now has a marginally profitable client relationship and a meaningless share of a company that will not be sold.  BUT she also has all those pesky rights I mentioned earlier.  If she gets grumpy, she is in a position to create some real pain.  This is not a good deal for you, and its also not a good deal for the lawyer.

Now suppose, instead of trading for legal services, you trade for a salesperson, as proposed by more than one author.  The dream this time is that the salesperson will be a huge success and a liquidity event will occur on schedule.  The reality, more often than not, is that the salesperson has some early success, but not enough to foster venture capital or an early liquidity event.  Then the company's growth settles in to the typical modest upward trend, and the commissions earned by your minority-shareholder-salesperson do not meet his financial needs or aspirations.  The bloom is off the rose.  You're unhappy with the results.  He's unhappy with the results.  You part ways.  BUT he still owns a piece of your company and has all those pesky rights, including the right to assert that you are over-paying yourself to the detriment of minority shareholders.  Does this still sound like a good deal?

Jim Flowers (that's me) has said this before:

Cash is the recommended medium for acquiring 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 use of equity in bootstrapping is sometimes very smart, and it is sometimes unavoidable.  It is, however, always risky.  I strongly recommend that it be employed only as a last resort and only for strategic requirements, not commodities. 

How big is big?

Question from a reader: A big company wants to sell my flagship product under private label.  How can I be certain that I'm getting a fair deal?

Short answer - you probably can't.  But - it doesn't have to be a fair deal to be a good deal.  That is a useful distinction that is often overlooked.

I'm reminded of the good old story of Steve and Charlie haggling over the price of a fish.  (I love good old stories.)  "I'll give you $5", said Charlie.  "Not a penny less than $9," replied Steve.  "$6," said Charlie.  "$8," Steve replied.  And, of course, they settled on $7.  As they parted Charlie called out, "Ha, I would have paid $10."  Not to be outdone, Steve's response was, "Ha, yourself.  I would have let it go for $3."

So, how hungry was Charlie?  How badly did Steve need fast money?  How much pride was at stake?  Was it Steve's first sale of the day or his last?  Was the fish really fresh?  Aaagh.  In the face of so much uncertainty, how can we ever define fair?

Only one thing is totally clear from the story.  Once Charlie offered to pay $5, the price was never going lower.  If Steve had spoken first and offered to sell at $5, the price would never have gone higher.

The various surrounding circumstances are not clear in the fish story; but in your own story you have the opportunity, in fact a personal obligation, to ferret out as much information as possible about the marketplace and your prospective customer.  Why, for instance, the big company wants your product is a key determinant of deal goodness to them.  They may be adding it for strategic positioning, rather than for the direct profit it might generate.  If so, they will likely pay a premium.

The same logic holds on your side of the transaction.  If you're doing fine without the proposed deal, you are in a position to hold out for a higher price.  But if that drives the big guy to do a similar deal with your chief competitor, you might be in serious trouble later.  Hmmm.

It's easy to say that it's all about the money.  But others say that timing is everything.  Etc.  Etc.  And so on.

You may never know whether a deal is fair.  But there are plenty of ways to make reasonably certain that the deal is good, at least for you and your business.

I recommend Jim Camp's book on negotiating - Start with No.  Go to the web, or to a bookstore.  Look it over.  If it's a good deal, buy it, whether it's a fair deal or not.

NOTE:  If you have a question, just email it to me, Jim Flowers, jimflowers@startwithmoxie.com. 

                                                                                                                                                   

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.

Price and Value

"It's not enough to create magic. You have to create a price for magic, too."

                                                Eric A. Burns

I love this quotation, of course, because it addresses the value of Magic, one of the Four Fundamental Factors governing the success of a business launch.  Every entrepreneur has to make some magic, and that magic must deliver substantial value.  It is one of the supreme challenges of entrepreneurship to attach a price to that value, to position the Magic financially so that it results in both a sale and a profit.  Over-price and there's no sale.  Under-price and there's no profit.  Deliver real value and you have a happy customer.

On January 13, 1981, I, Jim Flowers, solemnly vowed that I had taken my final lukewarm shower. 

At the time I owned an old house with galvanized iron water pipes.  For those of you who have never dealt with old plumbing, iron pipes rust on the inside.  Eventually that rust constricts the flow of water, often to a mere trickle.  That's truly annoying, especially in the winter, when a hot shower is like a first-class ticket to heaven.

I searched out (pre-internet, mind you) and engaged a free-lance plumber who vowed vast experience with old piping.  He looked at the location of my second floor bath, went to the basement, and quietly surveyed the various lines running from the hot water heater.  After what seemed like only a few moments, he reached up and tapped on one of the pipes with a wrench, not hard at all, just four or five gentle taps.

"Please go upstairs and try your hot water now," he said quietly.

I returned to report free flow of nice, hot water.  "OK," he chuckled.  "That will be $75."

In 1981 $75 was serious money, especially for 5 minutes of work.  Charging $75 for 5 minutes work took a lot of Moxie.  As I did an obvious double-take, he added, with a broad grin, "That's $5 for my time, and $70 for knowing where to tap.  Enjoy your shower tomorrow morning."

I nodded and cheerfully wrote out the check.  To tell the truth, I'd have been happy to pay much, much more.

Oh, and by the way...  The shower was fantastic!!

Six reasons to sell out early

Your company will probably be sold earlier than you expect, and for less than its maximum value.  Here's why.

1-  You will create a problem for a large competitor and they will offer to buy you out – to get you out of their hair.  Your alternative to selling at their price is to wait for them to grind you to a pulp.

2-  You will get divorced and the settlement will require liquidation of all your assets.

3-  You will suffer an untimely death; and your heirs will not want to run the business.

4-  You will be hit by a bus and disabled.  By the way, disability is much more likely than early death.

5-  You will have a falling-out with your partner(s).

And the biggie...

6-  You will simply tire of it and decide to quit.

I wrote about this particular phenomenon a few weeks back.  Here's an excerpt from that post.

In a recent post on Inc.com, Joel Spolsky recalls asking Jessica Livingston (author of Founders at Work) to speak about why start-ups fail.  "That would be boring," she told him. "They all fail for the same reason: People just stop working on their business."

Spolsky goes on.  "The more I thought about it," he says, "the more I realized Jessica was onto something. Why do start-ups fail?  As she pointed out, it's usually a collapse of motivation -- everyone wanders back to civilian life, and the start-up ends, not with a bang but a whimper."

Think about that.  "People just stop working on their businesses."

Wow.  They just plain run out of gas.  They exhaust their supplies of MOXIE.

So, you will probably sell out earlier than you planned, and realize less money than you expected.  UNLESS, of course, you anticipate the various contingencies and protect yourself and your business from their possible ill-effects.

Vendo ergo sum

Please quote me.  Vendo ergo sum.

With all due respect to René Descartes, pictured at left on one of his better days, his famous declaration of existence does not apply to businesses. 

"I think, therefore I am."  Or in Latin, "Cogito ergo sum."  Some careful translators and students of philosophy have rendered it from its original French as, "I am conscious, therefore I am."

For me, certainly.  For my business, not so much.

A business must be more than merely conscious.  To exist as a business requires that a sale be made.  Vendo ergo sum. 

An enterprise without a sale is at best a proto-business.  It might be an institute.  It might be a hobby.  But it is not, I repeat, NOT a business, at least not yet.

So, when in doubt, sell something.  It will amaze your friends, delight your family, impress potential investors, and get the attention of your targeted marketplace.  It's a really cool thing to do. 

Stop thinking.  Stop talking.  Stop over-developing.  Sell something.

GPS for entrepreneurs

Rule of thumb:  Without a Map, you WILL get lost.

And by Map I mean a well-conceived strategic plan, carefully vetted by your Mentors.

Now don’t get me wrong. I am not a big fan of inch-thick business plans, especially early in the process.

But I am definitely a fan of a clearly articulated set of  “rules to live by.” This where you lay out in a nicely organized fashion the bullet points that describe your Market, focus the power of your Magic, and communicate your Model, your Management system, and the way you handle the Money.

Begin with the Four Fundamental Factors Self-Check.  That will get you started on the right track. 

A simple guidebook will be incredibly useful, not just to you, but to everyone else in the company. They will read and use bullet points. They won’t read or use your version of The Encyclopedia Britannica. Later, when the time comes to prepare a big fat plan in order to raise serious money, you can just fill in the space between the bullets and re-order them a bit to fit the latest trendy format for formal plans. That’s not hard, just a task along the way to outside funding.

Search on "business plan."  Starting with the Small Business Administration, you'll find a gold mine of free resources to assist you in the mapping process.

You can also buy my little book.  It's not free, of course; but it's a good read at a fair price.  At least I think so.

Bootstrapping is strategic under-development

Velocity is great, if you are on the correct vector.

A while back I talked about strategic under-development as a cheap and fast way to get your product right.  Release 1.0 really is the ultimate market survey.  Bootstrapping, too, can be viewed as strategic under-development - for your entire business model.

Brian Armstrong offered this great tidbit on his blog about "how to quit your 9-to-5 to build a business and lifestyle you love."

Quoting Bijoy Goswami, Brian tells us

"Getting funding can be the death of a company. It’s like adding gasoline to your rocket ship. If it’s pointed in the right direction (i.e. you’ve got your business model right) then it can be great but otherwise it’s just going to take you in the WRONG direction faster."

Brian goes on.

"Bootstrapping is all about testing and refining your business model constantly. You’ll know when you’ve got it right because your customers will start PAYING you. It doesn’t matter if they SAY they like it, wait until they actually “vote with their dollars”. It pays to get this right before seeking any funding."

This is precisely why, by the way, many, if not most, early stage investors want to see real sales before they invest.  They want to have proof that the market will respond as you have predicted.  They want you to be on the correct vector before they fund your increase in velocity.