Best practices is something that’s going to encompass much more than just legal documents and financing.
The following list offers some general guidelines we tell entrepreneurs at LawTrades to will help them understand the larger picture, and therefore steer them in the ‘right’ direction.
Generally, the right direction is one where you have more clarity, better focus, and an enhanced vision that builds a more robust company.
1. Join forces with knowledgeable investors. Founders need to be prepared to tackle complex questions, often spontaneously. Having an experienced investor by your side can help a founder respond more effectively to important decisions and inevitable challenges. While you don’t want your investor to necessarily be overly involved in the minutia of daily operations, having access to a knowledgeable investor can be a valuable resource for dealing with strategic issues. Let them know you’d like to use them as a resource moving forward.
2. Start with good communication. This includes providing your investor with a realistic assessment of all the pertinent information. You want to build trust and a strong foundation, so make sure that you are prompt in submitting important data and honest with both the positives and negatives. Be proactive and diligent in your communications.
3. Be compliance conscious. By not cutting corners and demonstrating a commitment to meeting minimum compliance standards - possibly even reaching beyond compliance - you’ll inspire confidence. Inform your investors that you’re thinking along these lines. You’ll boost your trust quotient and appear more professional.
4. Be transparent. Make sure you divulge all strategic information, while not compromising confidential information. Distinguishing between the two can be tricky and require some legal guidance. LawTrades can guide you through this process with confidentiality agreements or other best practices support.
5. Think: Investor=Resource. Investors will often have a fairly well developed network. They can help founders create value by introducing you to potential customers or future investors. Don’t be shy about asking your investor for introductions to important stakeholders such as those who could be valuable strategic partners, advisors, customers - and additional investors. Let them know you’ll be relying on their expertise and connections.
6. Be self-disciplined. Be prudent about your expenditures: founders with a lot of accessible capital at their fingertips can make some imprudent spending decisions “in the best interest of business.” Those pricey dinners, memberships (even professional ones), and marketing costs add up quickly, so look for value and distinguish between ‘needs’ and ‘wants.’ Be cautious with your time: time management is more crucial than you realize. You don’t need to attend every event, accept every lunch invitation, or even look at every invitation as an opportunity. Again, let your investor know that you’ll be counting on them as a resource.
7. A solid term sheet. Along with your letter of intent, the term sheet facilitates an understanding between founders and investors as to what’s expected regarding debt vs. equity considerations, BOD participation, liquidation preference, future financing and valuation, and what the parties can anticipate in the event that the company is acquired prior to a loan’s maturity. While a term sheet is more than just a handshake, it is still not a financing commitment. It - along with your negotiation - sets a tone, so make it a positive one.
8. The right financing structure. In order to sell equity, you need to know the company’s valuation. Since figuring out a startup’s value is usually impossible (it’s just starting up, so it typically doesn’t have any value in the beginning - no assets, revenue or customers), determining equity would be arbitrary. It would also likely impair a more fair assessment later, after the company does achieve positive cash flow. Convertible debt notes were innovated to enable a startup without a valuation to raise capital quickly and less expensively than equity, and as a feasible alternative to obtaining an ordinary bank loan.
A convertible debt instrument is a loan from an early round private investor (angels or VCs). VCs and angel investors are high net worth individuals who offer startups private loans with the expectation that at some point later down the road (e.g., 1-2 years), the debt changes into equity ownership (stock) in the company.
They were pioneered to allow founders to get a quick loan from private investors, in exchange for promising to repay those investors with equity (stock) at a later time when equity could be determined - normally, after a Series A funding round. In other words, company founders get fairly quick, inexpensive (low interest) cash, which they repay with ownership equity at maturity.
9. A sensible business structure. Delaware isn’t always the best option for incorporating, whether as a C-corp or some other type of business entity. Also, it can be tempting to incorporate yourself since many states now offer immediate, online incorporation for less than $100. If you haven’t yet incorporated or are changing structures, do not DIY this vital aspect of your business. Engage a knowledgeable attorney to help you decide on where and how to incorporate. Another important consideration is to avoid being top heavy with too many co-founders.
10. Build a strong team. Hire key recruits who can offer your company not only product and process expertise, but a different way of thinking. You aren’t committing to adopting their views as much as incorporating their ability to push your team’s thinking in new directions. What I’m aiming at here is essentially incorporating design thinking into your corporate culture. Design thinking is a problem-solving technique that’s fundamentally dissimilar to traditional, linear approaches. Instead, you start with a goal in mind rather than the notion of solving a particular problem. Traditional analytical thinking limits creativity and the explosion of ideas that can result from a nonjudgmental brainstorming session. Design thinking allows for unlocking a solution or inviting a critical ‘but-for’ tweak that takes the company or a product in a direction that couldn’t otherwise occur if your team was constrained by self-imposed restraints. Educate your investor about your team-building and problem solving approaches. It can distinguish you from your competition.
Tying Together the Loose Ends
As is often the case, many of these practices don’t have neat borders. You’ll find that nurturing these practices prior to closing and continuing to promote them as values after closing will serve you throughout the company’s lifecycle.