11 Nov 5 Common Mistakes Startups Make in Structuring for Scale
With many startups recently hitting the news for successfully hitting funding rounds, it’s easy to believe that startup success happens overnight. As with all success stories, it’s usually the result of many years of hard work, solid foundations for business growth and having great people behind you. Those of us who advise startups go through the ups and downs of these growth cycles with our clients. We are the legal architects helping to build the foundations of the business at each stage to ensure its successful growth to the next. From deal flow to elegant resolution disputes, we have a unique perspective of the underpinnings of the business world from all parties perspectives. In other words, we’ve seen it all (not that we can really ever talk about it…) What we can tell you is what we’ve observed.
1. No agreement between Founders
By far the most common mistake that is made by founders, is not having a formal agreement in place until well into the business development. It is imperative that founders have an agreement, even prior to incorporation, covering their equity structure, their roles, milestones, and exit options from the very get go. Roles, contributions, even people change and sometimes do not reflect the value that a particular founder may have brought by a certain milestone. How do you account for financial contributions vs labour/time /IP contributions? How does the initial idea value vs the execution of the idea creating the valuation get evaluated between founders ? What happens when someone wants to leave – do good or bad circumstances matter to the exit valuation? Is there a plan for new shareholders coming on board? Is all this in a Shareholders Deed or written down somewhere? Put in on paper. We’re just sayin’.
2. Chasing the Money, Not the Vision (and giving up lots of Equity in the process)
Most startups in the early years are highly focused on product development, market testing, prototyping and marketing all of which heavily impact cashflow. The temptation when things are lean, and perhaps not moving as quickly as many would like is to seek equity – any kind of equity. The problem with accepting any kind of money from an investor is that it comes from a place of fear of the startup failure, rather than acceleration of the business model. It also places the founder in a weaker negotiating position, as he or she can become blind to whether the investor is a good fit for the business to help it reach the next stage. Giving up too much equity for too little cash reserve to stave off a shorter cashflow problem is a common problem we see. To avoid this, founders need to thoroughly review the options available. Is there debt finance available? Can you boot strap for longer ? Is there a grant available? Is the cash injection right for the business right now? It’s also critical to if considering taking on investors, that founders thoroughly review the investors themselves to ensure a values alignment. Don’t accept any term sheet – ask around. What has the investor done with other companies? What are the classic elements of a good deal with this investor? Doing a little due diligence on the options and focusing on the business needs can actually help the business achieve its goals in the long run.
3. Not finding the right people for the right stage of growth
There are about 1000 different workshops on why you need to make the right hires in terms of “culture fit”. However, it’s also important to ensure you have the proper agreements in place to not only reflect the culture you are creating, but also to give you flexibility to engage and disengage people during different growth cycles of your business. Your agreements need to be updated as your business culture matures.
For example, during early stages, you may have needed self starters who performed multiple job roles, and simple one page outline was sufficient. As new roles are created, job descriptions envitably change and with them, so people’s expectations. Your agreements must cover those scenarios. You may have more contractors or casual agreements, the tone of which must reflect your culture in addition to protecting you and your employees and contractors.
4. Forgetting to protect your IP
Too often, a startup on an upward trajectory will reach a point where they are confronted with that dreaded reality: Did we trademark our name? With so much spent on building a brand, it makes sense to protect it through a trademark or domain renewal. A simple date lapse of a domain name, could potentially be a huge headache – remember the guy who bought Google.com for $12US if only for a minute? (It was a glitch apparently). Contrary to what many think, trademarks are a relatively straight forward process and not expensive if you have an IP protection strategy. For example, you may want to change your logo down the track so only trademarking the name without artwork may be appropriate in the early stages. If you have plans for entry into different market, you can also register the trademark in those chosen jurisdictions via the Madrid Protocol, once you have registered in Australia.
In the alternative, many startups fall in love with names they have come up with for their products and have simply forgotten to due research on whether there are others with a trademarked name in the same market. So, check the trademark and domain register, in more than one country if necessary.
5. Not considering what expanding globally means in practice
Companies are often told they need to be globally competitive or scale quickly, but in reality leapfrogging into new markets is a long sometimes expensive process, especially from a legal perspective. Setting up in the US for example, requires knowledge of the local laws, visas, and enough runway to make a meaningful dent in the market. It must make business sense to move to the market, that is, you have customers who will buy your product, service or experience in the new market, rather than moving with the sole aim of attracting finance from that market. Nevertheless having an idea of the legal structures in the market you wish to enter and how that will affect your Australian legal structures, and/or investors is critical in your corporate expansion planning.
Whilst we’d all love to have a crystal ball to know with certainty where we’ll be, the best thing we can do is future proof our businesses for each growth cycle. You don’t need to spend a fortune on legals to do this. Smart lawyers will look at what you need next and ensure that you have the appropriate legal building block in place, with a plan for what takes priority and when. This way you can create a organic legal framework which grows when you do, to support your startup journey.
Rania Tannous, General Counsel, will be speaking on Structuring Your Business from Seed to Scale on Friday 20 November at Hub Sydney. Register here.