Startups – The Essential To Do List
This post is dedicated to a team of promising young entrepreneurs who asked me recently if they could all just “put some money in a bank account” to launch their startup. I wanted to say 'yes' because I know how much other work they have to do to build a successful company. But instead I had to warn them that there were several essential elements of their corporate structure they had to get right now to maximize their probability of success.
This question comes up frequently, so I started this list to help other entrepreneurs ensure they don't miss one of the essential structural components.
Why it's not easy to structure a startup
Structuring a startup correctly is a challenge. In the early days, companies don’t have money to hire excellent lawyers and tax advisors. Startups can’t usually attract experienced mentors or advisors. As a result, crucially important elements of the structure often get missed or are done the wrong way.
Structuring builds the foundation and the corporate DNA
Structuring errors often cause companies to fail. The most heartbreaking examples are when the company continues for several years, often showing great promise, and then the structuring flaws, built in during the startup phase, cause it to collapse.
Here’s a good analogy - rebar is the network of steel reinforcement bars inside structural concrete. Imagine someone constructing an apartment building. In the early days, there are no renters, so there is no revenue. The builder wants to save as much money as possible until the building is at least partially occupied, so he decides to save money on the foundation by leaving out the rebar - hoping he can come back and add it later. He finishes the building, and from the outside it looks just fine. Tenants start to move in and revenues increase. The builder now has the money to add the rebar to the foundation, but of course, it’s no longer possible. But it still looks fine. More tenants move in. The additional weight causes the foundation to crumble and the building to collapse.
The reason this is a good analogy is that many of the structural inadequacies in a company are also very difficult to fix after the company is launched - especially if there are external investors. The company will often still look just fine, often for years. But the flaws, like the missing rebar, are still there – genetic defects in the company’s DNA. Invisible failure mechanisms that often cause the company to collapse.
Structuring problems scare off investors
As an angel investor, I do due diligence on every aspect of a company before I invest. In the majority of cases, I see serious structural flaws. Experienced angels know how difficult, and expensive, these are to fix.
Most of the time, the investors will just go on to look at the next investment opportunity rather than try to help rectify serious structural flaws. In many situations, the investors won’t even explain the flaws to the entrepreneurs because even the explanation can be a lot of work, and it’s never enjoyable to explain to a group of aspiring entrepreneurs that their company has problems.
It would be easy to write an entire book just on the situations I have seen where structuring errors caused companies to flounder or fail completely. But it would depressing to write and not much more fun to read.
Instead, in the hopes of helping the next generation of startups avoid these problems, this is a list of the things that are essential for every startup to build into the structure of the company to ensure it has a strong, stable foundation.
Startup Structuring To Do List
In approximate chronological sequence:
- Build a startup team (if it’s still just you, repeat step 1).
- Agree on an idea (the idea is much less important than the team).
- Agree that you want to start a company together (the next several dozen steps will test this).
- Start with the end goal – the founders need to agree on the exit strategy now. (I know that’s not intuitive, but it’s one of the most common flaws.)
- Agree on intellectual property ownership. (This is essential to get right from day zero and it’s not as easy as it looks.)
- Agree on the time and money each of the founders will contribute.
- Agree on how you will handle personal guarantees, credit cards and other personal liabilities. (Creates a lot of problems if not done now.)
- Agree on founder compensation and equity allocation.
- Agree on vesting. (It’s actually reverse vesting, and if you don’t know the difference please ask now.)
- Agree on the capital structure at year three. In other words, project what the capital structure and share register will look like after three or four financings. (Again not intuitive, but the important thing is to not to agree on the startup structure, but what the structure will look like three to five years later.)
- Think hard about whether steps 6 through 10 are fair and equitable. Try to imagine whether they will still seem fair and equitable in a year, or three years. If everyone in the founding team is not absolutely in agreement, stop and try to work it out. If you are not successful, go to step 12.
- Ensure the startup team is still in alignment. (Get someone outside the team to do a Phase 1 alignment check. If the alignment is not perfect, consider having the first offsite strategic planning retreat with a really great facilitator.)
- Confirm the previous eight steps by signing employment agreements and Protection of Corporate Interest Agreements.
- Agree on company Articles. (Change the standard articles so a 51% vote is required to sell the company. Also be sure you provide for electronic communications for statutory shareholder requirements. I very nearly lost everything in my first company after ten years of hard work because I was not paying attention when the Articles were finalized. It's not fun, but you must read and understand your articles now. The next time you read them it may be too late.)
- Select a corporate jurisdiction.
- Agree on the company officers and directors.
- Check Phase 2 alignment among the founders.
- Find a least one very experienced advisor, mentor and/or coach who can review and confirm the previous five steps.
- If alignment is not perfect, it may now be time for the first offsite strategic planning retreat with an excellent facilitator.
- Celebrate the success of confirming Phase 2 alignment. (It looks like you really do have the ingredients of a promising company.)
- Select the year end to be December 31. (There is a dangerous conspiracy in the accounting profession where they try and talk entrepreneurs into any other date except the right one.)
- Incorporate the company - it really can't be finalized before the previous 20 steps.
- Have the first shareholders meeting and the first Annual General Meeting to elect the board.
- Have the first board meeting to ‘hire’ the officers and give them the authority to conduct business. (I’ve seen companies that got this wrong and ended up having to re-sign every documents in the company’s history before they could close on a financing.)
- Agree on the amount of equity for future employees and directors.
- Set up the equity trusts for future employees and directors. (This has to be done at the startup, before money goes in to avoid tax problems later.) Using Options is far, far less desirable now.
- Create a legal share register (strict legal requirement).
- Have a board meeting to approve the capital structure and share register - another essential legal procedure.
- Create an electronic minute book. (For a number of reasons this really should be a folder on a hard drive, not a physical binder. (There is a conspiracy in the legal profession to try and talk you out of doing this electronically.)
- Create a 12 month budget and three year financial projections. (It can be extremely simple at this stage; it will be way off, but it’s another essential alignment check.)
- Check that your projected capital structure still makes sense now that you have thought more about the numbers - update if necessary - at this stage you still can.
- Check again that you still have team alignment on the exit strategy.
- Write a business plan. (Not to raise money, but to check founder alignment. May only need one page of text, 12 month budget, three year projections and capital structure.)
- Think carefully about whether there is anything else you need in a founding shareholders agreement. (There usually isn’t, but now is the time to check, before your money goes into the company. Get someone outside the founding team to do a check.)
- Agree on signing authorities for treasury management, checks and other important documents. (I once lost my entire investment because this wasn’t done right.)
- Phase 3 alignment check. Get someone external to test the alignment with all of the team members. In one of my startups we could not quite agree on whether there should be an ‘s’ in the company name (to make it plural). I forced a decision without perfect alignment. It turned out to be an indication of a very, very serious alignment failure that festered for years. Be very sensitive to any misalignment at the early stages. Get help if necessary to reach perfect alignment now. (It will never again be as easy to do.)
- Schedule an offsite strategic planning retreat to perfect alignment if necessary. (Choose an excellent, experienced facilitator to maximize chances of success.)
- Celebrate Phase 3 alignment. (May not seem important, but it is for psychological reasons.)
- Open a bank account at a bank with good online access and an interface to pay your taxes online.
- Get a simple subscription agreement for the founders' investment.
- Now the founders can write the checks to contribute their startup capital.
- Set up your accounting system if you haven't already. (Get someone with lots of gray hair and tax experience to check your chart of accounts. This can be fixed later, but getting it right now saves a lot of time at your year end.)
- Learn about all of the taxes your company will have to pay. Do not rely on your accountant to make the decisions; they cannot understand your business well enough to do this entirely themselves. You must understand taxes well enough to ensure you are paying all of the taxes the company owes and that you are not creating personal liability for your directors. As your business changes in the early days, recheck your tax assumptions regularly. In Canada, all startups need corporate tax, payroll tax and GST tax accounts on Day One. Many will also need PST – this one is most often overlooked.
- Make sure none of your employees think they can be contractors.
- Understand the SRED program well enough to capture the information to make your first claim. I often see startups losing lots of money by missing this. (This is an excellent R&D tax rebate available in Canada.)
- Get insurance (that you really need, not what the broker wants to sell you).
- Get an alarm system before you move the computers into the office. (The stories I could tell would break your heart.)
- Start planning your friends and family financing round.
- Be sure you are complying with all of the securities regulations for a friends and family financing.
- Agree on a fair valuation for friends and family. Get an external advisor to check and correct the capital structure and share register if necessary. (It's still easy to fix this but that window is closing fast).
- Celebrate completing all of the absolutely necessary steps in building a successful startup.
- As soon as the hangover clears, start working on the product, marketing, sales, recruiting, strategic relationships and exit strategy - the fun part.
Please help complete this list
When I started this list, I didn’t think it would be this long. If you can think of a step I’ve missed, please send me an email or post a comment, to help out that next generation of entrepreneurs. Thanks.
From Robert Heggie, BMT Systems - September 8, 2008
Commenting on: Start Up To Do List
This To Do list is like an entire start up management guide, most would have taken this, had an entire book ghost-written, and had a potential best-seller. :) One more item that I would add (somewhere at the start) is:
Make sure you and your partners speak the same language and understand the differences in culture between you. This may seem like a no-brainer, but in this day-and-age of global trade it is very tempting to partner up with someone from, oh say SE Asia, with a great offer. Review Pt #2 on alignment and goals.
You may think you are aligned, but let me tell you - in some cultures - vetting issues up front is not considered polite. I found this out the hard way when I partnered up this year with someone originally from Vietnam. Even though my partner had lived in Canada for 20 years he still did not understand NA culture and was stuck in the old ways. I found out later what his attitude to corporate debt was when I negotiated a credit line for the company. This was a show-stopper; I ended up selling my portion of the company to him, just to get out of it.
Fortunately, I structured the company properly, set up the books properly and got the transfer of ownership/ board resignations paperwork done properly. I lost money, but I tell you, I learned a valuable lesson.
Re Startup To Do List
Your list presumes that there is a viable business model that is worth going about the tasks of setting up a company structure. Before anyone sets up a company, s/he should ask (1) What is the problem? i.e. What is the market opportunity?, (2) What is the solution? i.e. What is the value proposition?, (3) Why do you think you would succeed? i.e. What is your competitive advantage?, and (4) How do you plan to succeed? i.e. What is your business model and how are you going to execute it?