William Carleton, Counselor @ Law

Founder Institute Seattle

The Seattle chapter of the Founder Institute graduated a class Tuesday night this week.

Each represented company gave a five minute pitch using slides, except, most expressly made the point that they were NOT looking for financing at this time!

This seems to reflect a programmatic approach, part of the Founder Institute's training: bootstrap, launch, pivot, gain traction, then fundraise.

In the dot com era, we were more inclined to seek seed funding based on a power point deck. The order of the day is of course to bootstrap to a working prototype. I just thought it was interesting to hear each entrepreneur, to a person, giving the typical pitch (they were all very good), while disclaiming being ready to seek funding.

Pictured: Eric Huang of SkyGlue. As with other of the companies that presented Tuesday night, SkyGlue has a working product in beta.

Bootstrapping to Success

Awesome to see John Cook's Q&A with Chad Brown of IdentityMine in TechFlash on Friday. 

This is the second time in a month that an IdentityMine founder has been featured in a PSBJ publication. A few weeks back, the focus was on Mark Brown, IdentityMine's CEO, in a piece about mobile apps. (Full article is behind a paywall, unfortunately.)

As is evident in both articles, IdentityMine (a client) is probably best known these days for their UX design and software on Windows Phone. I bought a Winphone last week just to enjoy IdentityMine's work on the Twitter app.

But the part I liked best about Friday's TechFlash Q&A is what Chad had to say about bootstrapping the company's growth:

"How did you finance the business in the early days? 'It was out of pocket. Thankfully, Mark and I were pretty successful -- not only in our (prior) businesses -- but also in saving money. And so we were able to go about eight months without any income, and that's what we did. We brought David Meunier on board, and we consider him one of the founders as well. And all three of us dipped into our finances to make it happen, and put our houses on the line and signed personal guarantees against credit and we made it happen. It was not easy.'

"So, did you ever consider taking outside funding? 'We really didn't want that. It would have been tough timing as well since there was a pull back around the same time. We didn't go out and pursue it. We felt optimistic.'"

Moral of the story for tech startupers: you can skip angel and VC financing and make it!

Struggling to Raise $$? Who Says You Need $$?

Today's post is a relay to an interesting Q&A on the Xconomy blog between Gregory Huang and Zappos CEO Tony Hsieh. 

Here's the bit I really liked:

X: What is your philosophy about blending one’s personal life with business?

TH: Well, I think they should be the same. That’s the great thing—if you just start doing stuff you’re actually passionate about, then it’ll somehow magically blend together. Especially in today’s world where anyone can start their own website or whatever.

X: That’s all well and good, but what about the entrepreneur who is struggling to raise money and make ends meet?

TH: I think there’s a lot of assumptions built into that question. Like that you need money. Maybe it was true 10 or 15 years ago. At LinkExchange in ‘96, we were spending probably $50,000 a month for servers and high speed internet and all that. You get better connectivity and computing power today for $50 a month. 

I like the nerve of Huang's second question and the equanimity of Hsieh's answer.

Bootstrapping can also be thought of as the art of managing when to raise outside capital, an art of timing. You bootstrap so that you may act not a minute before you perceive an acceptable match between investor perception of risk, on the one hand, and insider assessment of how much upside is too much to sell, on the other.

Startup Law 101: When to Incorporate

Extreme bootstrappers sometimes decide to put off incorporating until they have a service or product to release, an investor to bring in, or employees to hire.

Delaying the decision to incorporate (or to form an LLC) can save costs and can also save distraction while the viability of the project is tested.

But if there is more than one founder, to delay is almost always to put the fledgling venture at risk. This is because if one of the presumptive founders bails before there is a company from which to leave, she probably takes her contributions with her (or demoralizes those left with her expectations). But some founders insist that they trust one another implicitly, and embrace this risk. (I've even seen putative founders, pre-incorporation, re-work their original understanding gracefully when one of them decides to bow out.)

The "distraction" of organizing a business into a company is necessary business, vital to the potential value of the company. Eventually, it will be confronted, if not always when optimum.

Here are times when it is almost too late:

• The service or product is out there and it is a hit. It is now going to be an almost impossible task to have every contributor sign assignments of invention and restricted stock agreements. Even if the key founders do so, more likely than not there is a contractor or other contributor who has a different view about his contributions or about his freedom to reuse or replicate them for someone else. 
• An investor is ready to write a check, but she insists on putting a valuation to the company that is yet to be formed, and in taking equity. Unless you can afford to send her away, it is now going to be tougher to utilize 83(b) elections to avoid draconian tax consequences down the road when increments of founder vesting lapse. 
• The service or product is out there and it is a hit. You've promised options to programmers who've spent nights and weekends helping, but you didn't set up an option plan or price the grants.

Notice that in each of these three scenarios, whether the founders trust one another or not is irrelevant. These are situations where success catches up to the decision to put off organizing a company, and passes it on the left. And to the person looking at that decision from her rearview mirror, it appears the success of your project has caught you by surprise!

Here are the things you won't go wrong in attending to, weeks or months before you release anything:

• Form an entity. Don't do it yourself unless you are really into learning the intricacies of the corporate code in the jurisdiction in which you incorporate. If you are going to do it yourself, borrow a charter from a law firm or lawyer or serial entrepreneur. If you do it yourself and you don't first make yourself an expert, then you're going to end up with cumulative voting or preemptive rights by default or other things you are not going to want, and you are going to miss out on flipping some switches that ought to be flipped in order to opt in to certain things that you do want. I'm not saying you have to pay much attention to your charter, just that if you're going to do it yourself, you're actually going to have to pay a ton of attention to your charter. 
• Assign to the company all inventions that are related to the venture. Make sure you know whether you and your fellow founders are legally able to do this (check agreements with prior employers and ventures). You can use a good form to do this but check with a lawyer friend as to: exactly when to do this and what consideration to recite; notices that may be required by the state you live in: and how to handle catching IP that both pre-dates and post-dates the assignment document.
• Figure out the reverse vesting schedule for yourself and your fellow founders. Issue stock to the founders, and file your 83(b) elections immediately thereafter. If you can do this months before generating revenue or taking any investment, so much the better.
• About a month prior to granting any options, set up a written option plan and have a lawyer make any necessary blue sky filings. This should be do-able for a flat fee.

Your bank might want some resolutions, and the state is going to want to know the names of officers and directors, but that's pretty much it for legal stuff to start. You can even skip the bylaws till someone asks to see them.

Will the Last Startup Leaving Dodd's America Please Turn Off the Lights?

Senator Dodd's legislation has to change. It simply has to. Otherwise, we have to contemplate that startups will be possible only for those who (a) can bootstrap their way, all the way, with no outside investment, or (b) are very, very rich.

BusinessWeek has some data on how the angel community will be hit, and the numbers are not just sobering, they are devastating (see the article for better context):

• By one measure, the number of accredited investors would drop 77%;

• By another measure, the pool of active accredited investors (people who made a friends-and-family or angel investment in the previous three years) could drop from 528,000 to 756,000 (currently), to from 121,000 to 174,000 people.

Remember: "Most entrepreneurs get their first real investments from angels, not VCs." (The quote is from a post by Fred Wilson on his blog.)

Not that VCs will do any better by Sen. Dodd. As I noted yesterday on the Save Reg D site, the BusinessWeek article goes on to describe the negative downstream effects on venture capital financing.

The retiring Senator Dodd wants to leave a mark, all right. If someone doesn't take notice, step up and change that bill, Senator Dodd may well lay waste to startup land.

The Founder Institute: An Incubator of Persons Rather Than Companies

I went to an informational session held on the Seattle campus of the University of Washington this evening for the Founder Institute's upcoming Winter 2009 Seattle Area training program. I'm guessing I was the only attorney there, but, hell, I was invited (perhaps because I am a paying member of the affiliated organization, TheFunded.com). And I'm curious about how the organization is expanding outside of the Bay Area.

There were about 70 people there. (Re-sensitized to the issue of under-representation of women in the field from having attended the TechFlash Women in Tech event last week, I noted that only about 10 of the attendees were women.) The Founding Member of the TheFunded.com, Adeo Ressi, kept the audience engaged and repeatedly asked individuals to identify their passion. My impression is that all of the attendees were entrepreneurs or pre-entrepreneurs; most seemed keenly receptive to the concept of a four-month training program put on by founders, exclusively for founders.

A distinguishing feature of the Founder Institute's mission, I think, is a single-minded focus on the founder. Whereas other incubators or programs might be said to assist startups, or entrepreneurs with respect to their evolving companies, Ressi's passion looks to be advocacy of the founder, his or her interests, his or her control of what he or she has set out to do. (A terrific interview of Ressi by John Cook, published today on TechFlash, can be found here; see especially John's last question in the piece.) Having seen Ressi in action, I can better appreciate the thesis behind the Class F Common Stock concept I have critiqued previously on this blog.

Here are my tweeted notes from the session:

• #fisw09 The Founder Institute makes applicants take a test, in part to get data to be able to eventually predict what makes a successful founder. about 2 hours ago from Tweetie
• #fisw09 Adeo Ressi says about a third of the founders in the program have no intention of ever raising outside capital. about 2 hours ago from Tweetie
• #fisw09 Adeo Ressi speaking of Class F Common Stock (which I've critiqued on wac6.com) as bargaining chips, to trade v crazy investor terms. about 2 hours ago from Tweetie
• #fisw09 Adeo Ressi says if critical mass starts to use the Class F--"& there are CRAZY terms in there"--then founders have arrows in quiver. about 2 hours ago from Tweetie
• #fisw09 Adeo Ressi fielding q's re the Founder Institute. Says the program negotiates startup legal fees down to $1,000 now, rest deferred. about 3 hours ago from Tweetie
• #fisw09 Adeo Ressi says goal is to start 1000 companies per year. about 3 hours ago from Tweetie
• #fisw09 thinking about #tfwomen event last week; there are maybe 10 women here out of a total of maybe 70 attendees... about 3 hours ago from Tweetie
• #fisw09 plenty of collegiate AV in the room. http://bit.ly/1YkvUa http://yfrog.com/bexqyj about 3 hours ago from Tweetie
• #fisw09 Adeo Ressi says founder mistakes today have even direr consequences (cites 409A, 83(b)); & fleecing more sophisticated now, to boot. about 3 hours ago from Tweetie

Should Web Entrepreneurs Hang on to Their Companies?

Chris Matthews said something on his Hardball TV show last night that I found disarming. The set up is what makes the payoff satisfying, so I’ll quote his entire lead-in to a particular segment of the show:

"We all studied in school, those of us who took economics, the Marxist theory. It‘s called the labor theory of value. You get paid for your labor, and there shouldn‘t be any extra money made. Now, of course, we have all gone beyond that with neoclassical economics. And we say, no, there ought to be some money for entrepreneurial — entrepreneurialism. If a guy or a woman starts a company, they risk money, they risk most of their lives to get a company going, whether it‘s a laundry or it‘s a big bank, whatever it is. They deserve to make a big profit and live better than anybody else. That‘s the way the system works. But these guys who make money off money...is that necessary? I mean, I have got [to] like anybody you can think of, whether it‘s Iacocca, Spielberg, anybody who makes something, whether it‘s a movie or it‘s a car, you say, great, he ought to make money. But this money that is being made just off of money, is it necessary for our system to have people that make [money off of money] — and, by the way, are the entrepreneurs losing the money that they should be getting from this money?" 

This resonated with something a friend, a veteran venture investor, told me a couple months ago. I won’t convey what he said nearly as precisely as I nailed the Chris Matthews’ quote (thanks to the show’s transcript), but my friend said something like this:

“Wall Street’s pitch to the entrepreneur for the last fifty years has been: you go build your business and operate it and make it valuable. Once you’ve done that, sell it, liquidate it, and turn the cash over to us; we will diversify your wealth, spread it around, extend it, because we know how to do that really well and you don’t. Your money is not only safe with us, it’s safer with us than it would be if you stayed in the game running a business somewhere out there in the middle of America.”

And the Great Recession has put the lie to that pitch, my friend said. From here on out, I’m re-constructing more than paraphrasing:

"Those who bought the Wall Street pitch have lost forty to sixty percent of their wealth. And so it will become clear once again that the way to gain wealth, keep it and expand it is to do it the way the robber barons of the 19th Century did it — by owning and controlling operating businesses. It’s fine to hire others to come in and manage them, but if you want to keep your wealth, you have to own businesses that turn on the lights (real or virtual) every day. Diversification doesn’t mean stocks and bonds, it means owning and operating several or many different businesses. This is also the best hedge against inflation, because you will always be paid in the current currency; and you won’t be having Wall Street taking its cut, coming and going, up years and down."

This is well and good for tycoons and would-be tycoons, but most entrepreneurs I work with still need liquidity because, first and foremost, they are restless; having succeeded, or failed, or succeeded-and-failed-at-the-same-time with a given venture, they will invariably, at some point, need to move on to the next thing.

Can you pull some liquidity from your venture, keep running it, and hire management into it while you go focus on the next one? This is a model that I think we may see play out here in the next few years:  the serial entrepreneur who stays a shareholder, and perhaps a board member, as he hands off the day to day operational responsibility, and draws cash from one business to seed the next one. This may be a model that is unique to software, social networking and other Internet-oriented ventures, however. This may be a byproduct, a benefit, of those who’ve learned to bootstrap during the Great Recession.