How to structure your early-stage startup: founder equity, legal stuff, financial plans…
By Rama Katkar (Co-Founder, Hipiti)
When you first set out to start a new company, it can be easy to get bogged down learning about all the things you didn’t even realize you needed to know. Serial entrepreneurs have an advantage, because they have been there and done that, so they can easily sidestep some of the early hurdles.
But if you’re a first-timer, you can waste a lot of energy focusing on seemingly small things that distract you from what you really want to be doing – building and executing your business idea.
When my co-founder and I recently set out to start our first company, Hipiti, we quickly realized that we would have to divide and conquer if we were going to manage all the learning required to make a business idea come to life.
Luckily, we had each built up years of experience in our respective fields, so we brought distinct skill sets to the table: Kristin was a strategy consultant at Bain focused on retail and e-commerce companies. I had spent much of the past decade investing in and advising high-growth companies, so I’d seen some of the pitfalls around finance and structuring that can hinder early-stage companies as they raise outside funding and build their teams.
Just as we’ve turned to others with technical and product expertise to round out our company’s skills, we’ve realized that some of the other first-time entrepreneurs we’ve met might benefit from tapping into our recent experience and research.
When we set up the legal structure, partnership agreements, and business plan for Hipiti, we drew on my past experience as well as advice and insights from some helpful Valley contacts. A few major concepts for structuring and managing a startup kept emerging.
It’s not just the amount of equity, it’s also the timing.
It’s quite common for founding partners or teams to have their equity vest on a monthly schedule rather than getting their equity outright in the beginning. A year or two down the road, a given founder may decide to move on, and the company should be able to re-purchase the unvested portion of that founder’s stake.
For example, let’s say you have three founders and they’re each granted 33.3%, and each stake vests over three years. At the end of the first year, if one founder leaves, she would only take with her 11.1% of the company, and the business would be able to buy back her remaining 22.2% stake at a pre-determined price. Why is this important? Unfortunately, founders often part ways – perhaps they have different visions for the business, or they may leave for personal or financial reasons.
Whatever the case, you should set up a structure from the outset that enables a smooth exit, one that compensates the original founder for her time and risk while allowing the company to allocate that un-vested equity to her replacement(s).
Legal stuff is boring, but it matters.
If you don’t understand terms, don’t sign. A few years ago, I worked with an early-stage company that almost went bankrupt because they signed a credit agreement that the founder didn’t fully understand. As an early-stage founder, it’s pretty unlikely that your core competency is complex legal and structuring language. And as a cash-constrained, small company, it can be really hard to justify spending tons on expensive legal advice. But that doesn’t mean you should just gloss over the details.
More than likely, there is someone in your extended network that can help you make sense of incorporation documents, term sheets or partnership agreements. You might have to do a little legwork to find this person, but keep in mind that many of these documents are pretty standard. They may seem dense and full of jargon, but it’s quite likely that many of the startups in your sector have similar docs … and someone on their team can walk you through them.
This may not be the most fun way to spend an afternoon, but a little knowledge can go a long way in giving you comfort that you’re making good long-term decisions.
Financial plans are really financial guesses.
I have never worked with a private company that exactly met its revenue and expense forecasts. (And if they had, I would have immediately wondered how they had fudged their books.) You should build a revenue and expense plan; but ultimately, the how and why behind those numbers are going to be more important than the numbers themselves.
As a founder, the purpose of your financial plan should be to hold yourself and your team accountable to certain milestones, and to help your team recognize if it needs to change course. For example, when you’re building your revenue forecast, you should continuously modify the unit economics behind that forecast (e.g., revenue per user, sale price per item) as you learn more about your market and add new customers.
Similarly, your expenses should be your best educated guesses right now, and you should expect to revise them often. When you find yourself revising a revenue assumption or a cost estimate, you’re making the plan better and, hopefully, improving how you execute it.
Editor’s note: Got a question for our guest blogger? Leave a message in the comments below.
Photo credit: Lukas on Flickr.
About the guest blogger: Rama Katkar is Co-Founder of Hipiti, an online sale and shopping organization platform. Prior to Hipiti, she spent about 10 years in finance, including growth equity investing at General Atlantic Partners and TPG Growth, where she worked closely with retail and IT services portfolio companies on strategy and ops initiatives. She holds a B.A. in Mathematical Methods in Social Sciences and Economics from Northwestern and an MBA from Stanford. Follow her on Twitter at @ramakatkar.