Sometimes there is a stark difference between what you think founding a startup might look like compared to the actual experience of the early days. In this blog Clara takes a look at five thoughts every founder has about their startup versus the reality, as well as some of the fundamentals every founder should always consider.
1. Founders – “We all know what we’re working towards, and everything is great right now”
In the early stages of your business everything is exciting. Sure, there are stressful moments, but working towards something with others who are equally passionate about getting your business up and running is a great feeling. It’s always going to be like this, right?
Sometimes things go wrong. Your idea might not be successful, a co-founder might side-step you on a decision, a co-founder might want to leave, maybe you want a co-founder to leave or maybe not everyone’s clear on what it is they need to deliver. One way to help with these issues is to have a Founders Agreement in place. It can help you avoid issues later down the line, as it sets out things like deliverables, duties and even vesting for shares to make sure that any reward is rightfully earned. Think of it as the pre-nuptial agreement for your startup!
2. Intellectual property – “I don’t need to take any steps right now as I’m at a very early stage”
As an early-stage startup, you assume that you don’t have a lot that needs legal protection right now. It’s tempting to just wait until you have more of a solid product or when your business has a few customers or clients on the books to worry about all that – because that’s when your idea is likely to be copied by others, right?
Protecting your Intellectual Property (IP) rights deters others from stealing or copying your idea, company name and/or developing a similar product. You might even have accidentally breached someone else’s IP that you weren’t aware of. As you go through the stages of growing your startup, you should re-evaluate what IP you have and what protections you need.
For example, have your team members signed IP Assignment Agreements? Is your IP properly protected in the jurisdictions you’re operating in? Have you done a trademark search globally in addition to the usual Google searches? Making sure that your IP protections are adequate can also help attract investors as it helps them minimise risk.
3. Investors and funding – “Having a great business idea is enough to attract investment”
You’re ready to start looking for investment in your business. Or at least you think you are. Your idea is brilliant, you’ve done all your research, you have your business plan nailed and your elevator pitch is good to go. What’s not to love?
The reality is that having an idea and doing all the research for your business plan is just a small part of attracting investment. Even if your idea is something brilliant and effectively services a gap in the market, an investor still might pass if they deem it to be too risky due to untidy corporate structure, if you don’t have the right legal agreements in place or if you haven’t reached the necessary stage for them to invest.
Investors like to see a tidy cap table to show proper governance. This can be things like reverse vesting for founders, IP protection and agreements for all your team members and that you’re set up in an investible jurisdiction that protects everybody’s rights. See tip number five for more on that!
4. Share Options – “I’ll just issue shares to my team members straight away”
Reaching the point where you’re ready to hire your first team members is an exciting stage. You’ve grown your business enough that you can’t manage it yourself, or you just need somebody who knows more about that area of business than you do – great stuff. As part of their package, you want to incentivise them to stay with you, so you’ll just issue them some shares as a part of their contract.
The reality is that you want to give your team members options, not shares. You can do this as part of a Share Incentive Plan (SIP), also known as an Employee Share Option Plan (ESOP). These plans reward team members with a number of options released to them over time like a bonus, incentivising them to help build your startup and create value over the long term. SIPs also ensure protection to your business by setting out a cliff period. This acts as a kind of probation period that you can use to make sure that anyone you work with is a good fit before they receive any shares in your startup.
FYI – You can also issue options to consultants and advisors, not just employees.
5. Setting up a holding company – “I don’t need a holding company because I already have an operating company set up that can receive funding”
The basics of setting up your business are done, and you’ve set up the legal entity in the place where your business will be operating. Your corporate structure is tidy and you’re ready for any questions. You’ve even got a business bank account ready and some paying customers to prove it’s working. Any investment you receive will just go into your operating company. Bring on the investors!
As part of any decision, an investor will look at where your business is incorporated. Investors don’t like risk – having a holding company to receive funds that owns your operating company can help minimise risk for both you and your investors.
A holding company own shares in other companies (called “subsidiaries”) and the assets used by its subsidiaries (including your startup’s intellectual property) but it doesn’t participate in the daily operations of the business. Holding companies are usually set up in common law jurisdictions that offer a wide range of legal protections for investors.
If you don’t have a holding company set up, this might not mean an immediate ‘no’ from investors – they could just ask you to set one up – but generally it’s always best to be prepared and make your opportunity as attractive to investors as possible the first-time around. Just because one angel investor accepts investment into an operating company does not make it investable to other more sophisticated investors.