Smart Startups Have Smart Cap Tables

Every company has a cap table – i.e., a record of the pro-rata stock ownership of the company’s founders and other shareholders. A fully-diluted cap table also includes rights to acquire or convert into stock ownership – such as options, warrants and preferred shares. As a startup, your cap table – not the written representation of it, but the actual ownership and rights to acquire ownership in your company – is the most important “asset” you have. Manage it wisely and guard it carefully, because no matter how valuable your company becomes, that value belongs to the people in the cap table.

I am continually amazed at how carefully some startups protect their IP and business plans but how careless (or sometimes, carefree) they are with their cap tables – handing out stock like it’s a free sample at the grocery store or a sale item in the bargain bin. The problem is, those free samples and discount prices entitle the recipient to a permanent stake in the company and all of the related upside.

Think of stock as the lifeblood of your company. It’s not something to pass out to impress or thank your friends or to issue the landlord in lieu of rent. It’s not a cheap substitute for money just because your company is cash poor – all startup companies are cash poor. It IS money; but it’s money that will hopefully increase in value exponentially over the life of your company as a result of your ideas, dedication and hard work. Make sure you retain enough ownership to enjoy the fruits of your labor.

Let me be clear – I’m not suggesting that it’s realistic to believe most startups can (or should try to) succeed with the founder retaining 100% ownership. What I am suggesting is that you carefully manage your cap table and only share ownership with those investors and key employees who provide the essential ingredients for your success.

Teamwork and Communication Versus Too Many Cooks in the Kitchen – Part 1 of 2

Team approaches in contract negotiations can be very effective. In fact, for some contracts, a team approach is essential – particularly when the contract will impact various divisions or facets of a company’s overall existing and future operations.

Consider hypothetical ABC Manufacturing Company (ABC) that has multiple divisions (including Aeronautics and Renewable Energy) operating independently, but within the same general industry groups. Further assume that ABC’s Aeronautics Division wants to license certain technology to Third Party Company (3P), but only for use in wind turbines – not in aeronautics or aerospace – because ABC has plans for use of the technology in those fields, but not in turbines. In this circumstance, it’s likely critical that ABC involve numerous parties in the contract process (although not necessarily in the actual discussions with 3P – see Part 2 on this topic). Who might those parties include, and why?

• Obviously, the heads of the Aeronautics and Renewable Energy Divisions – so that the precise scope and nature of the license can be considered, along with its impact on those divisions (now and in the future). Also likely those who are not division heads, but who may have a deeper understanding of certain products, projects and relationships.
• Research and Development – so that those negotiating the contract terms know what the current state of the technology is, where it may be headed, what rights are licensable, and what rights should be excluded/retained.
• IP – so that there is a clear understanding of what protections exist currently, who will be responsible for maintaining those protections, who has rights to derivative technology, etc.
• Strategic Planning – so that something that seems unimportant now doesn’t “unexpectedly” become important in the future – especially if there are parties within ABC who already knew it’s important.
• Legal – so that rights granted in this contract don’t conflict with rights previously granted to other parties, and the current contract ultimately says what the business people intend.
• Others – there may be any number of others that should be consulted or at least kept informed as to the discussions with 3P – accounting (budgeting and cost), marketing (brand and image), etc.

The point is, many contracts have far reaching and (sometimes) difficult to foresee implications for a company. Involve as many people and divisions as necessary to make sure you are aware of and consider all of these implications.

In Part 2, I’ll discuss the importance of speaking with one voice, notwithstanding the involvement of multiple parties.

The Risks and Costs of Non-Compliance

Paying lawyers for important tasks such as drafting contracts, preparing employee handbooks, providing securities law advice, and adopting procedural safeguards for export compliance, is expensive. However, prudent companies understand this is simply a cost of doing business and avoiding the catastrophic consequences that can result when you “get it wrong.” So, here’s my question – why do so many companies pay to “get it right” and then fail to follow through – thus exposing themselves to the very risks they paid to avoid? Unfortunately, the answer is typically, carelessness.

Consider the following hypothetical:
• Seller (a U.S. based manufacturer of non-military heavy equipment) contracts to sell “customized” bulldozers equipped with bulletproof glass and gun turrets (no guns) to a new international Buyer. Unbeknownst to Seller, Buyer is a known terrorist.
• Seller’s lawyers have previously prepared (a) an intellectual property manual (that would require foreign patent protection before shipping to this country), (b) an export compliance manual (that would not allow shipment of these goods to any buyer, or any goods to this buyer), and a contract where Buyer is responsible for shipping, insurance, risk of loss, and posting a letter of credit to eliminate payment risk to Seller.
• Despite those procedural and contractual protections, Seller did not review or follow the contract or the IP or export manuals, paid for shipping, did not confirm that either insurance or the letter of credit was in place, and simply shipped the goods.
• Buyer received the goods, and Seller did not get paid.

So, what are the risks/costs to Seller? Likely, the following:
• Seller has certainly violated U.S. export laws and perhaps the laws of the country to which the goods were shipped, exposing Seller to civil fines and penalties and even potential criminal charges;
• Seller has paid shipping charges that were Buyer’s responsibility;
• Seller has not been paid and has no insurance or letter of credit coverage;
• Seller has lost the ability to protect its IP in the country to which the goods were shipped;
• Seller has paid for legal advice that it didn’t follow; and
• Seller has suffered a loss of reputation, opportunity costs, and a potential devastating blow to its business.

The point is simple – if you’ve paid for the advice and protections, follow them.

Approach Every Contract Like a Construction Project

It struck me recently as I worked on a multi-million dollar construction project that parties would be well served if they approached each contract (at least initially) like a construction contract. So, why do I say that, and what does it mean?

A construction contract is the beginning of a project and a process – one that requires (a) careful planning, (b) trust and cooperation by multiple parties, (c) segregation of duties, (d) faithful performance and execution, and (e) recognition that circumstances will arise that may be beyond the parties’ control and will require flexibility, problem-solving and often change. These factors are actually present in most projects and transactions – not just construction projects – which is why I think the construction approach makes sense.

Here are the most basic elements of a construction project/contract that I believe should be considered and addressed in most contracts.

• Scope/Nature of the Project – what are we doing here? This should be defined as clearly as possible (even where, as in the construction process, this will change and develop as the project progresses)?
• Responsibilities – what is each party required to do, how and when? Again, this should be defined as specifically as possible.
• Standard of Care/Performance – is there an objective or subjective standard which a party must meet (e.g., codes, industry standards, the best or accepted practices in the relevant geography, the other party’s discretion)?
• Legal Compliance – who’s responsible?
• Subcontractors – who will actually perform the work, and can it be subcontracted?
• Communication/Authority – who has authority to bind each party, and how do we ensure constant communication to avoid misunderstandings?
• Foreseeable Risks – if they’re foreseeable, define them, how they will be addressed, and who bears the risk.
• Unforeseen Risks – since they’re unforeseen, they likely can’t be defined, but you can still do your best to allocate responsibility.
• Changes/Change Orders – how will we handle changes? The best answer – see Communication/Authority above. If your deal has to be changed, communicate and make the change in writing as promptly as possible.
• Disputes – how will we (hopefully) avoid, and in any case deal with disputes?
• Insurance/Bonds, Indemnification and Guarantees – how do we protect against the downside?
• Completion – how do we know, and who determines, when a party has completed its task satisfactorily?

There are other elements of a construction contract, but hopefully you see my point – think construction.

Don’t Forget the Laws of Human Nature

It strikes me that both lawyers and clients get so wrapped up in the business, legal and technical issues of a deal or situation that they often forget what I will refer to as “the laws of human nature.” True, these are not the laws I studied in law school, but I can tell you this – failure to understand these laws can often result in the failure of a deal. And what’s so sad about that is it’s completely avoidable in most circumstances.

So what do I mean when I talk about the laws of human nature? Obviously, I’m not talking about statutes or regulations. Simply put, I mean those aspects of the deal-making process that have more to do with human behavior, values, interaction and communication than with the specific parameters of the deal. Failure to understand these “laws” and acknowledge the fact that they fundamentally affect business transactions is just as often the cause of a failed deal as the laws on the books.

So, here are 10 lessons I’ve learned as to these laws:

1. It’s important to know what you AND the other party to the negotiations need, what you want, and what you’ll accept – and how these may change during the course of negotiations.
2. Nobody needs to “win” a negotiation – the best deals are win-win.
3. It’s ok (and in fact, it’s often productive) for the other side to like you.
4. It is imperative that the other side respect and trust you.
5. Emotion is rarely productive in a business discussion.
6. Professionalism enhances the likelihood of success.
7. There’s no value in frustrating or embarrassing the other party or wasting their time.
8. It’s important to know when you’ve pushed far enough.
9. Miscommunication leads to failure just as often as disagreement.
10. The deal is never final until it’s signed.

Consider the laws of human nature the next time you negotiate a business deal, and I’m confident you will enhance your prospects for success.

Get it Right the First Time

Ever hear the expression – “you never get a second chance to make a first impression”? It’s true in business transactions, and particularly in contract negotiations.

So, what’s my point? After all, many contract negotiations go on for weeks, or even months, and countless drafts are exchanged. So, don’t you really get many opportunities to “get it right”? The answer is, generally, no. Let me explain.

Twice in the past week, I’ve had clients send me a contract for “final review,” only to find out that the contract had actually originated with my client and had already been provided to the other side for review and comment. The problem was, in each case, the contract provided to the other side had substantial problems for my client. By problems, I don’t mean language that I preferred had been worded differently or minor clerical errors. I mean material issues that were overlooked or improperly drafted in such a way that it put my client at substantial risk – business and legal.

This scenario causes problems for a number of reasons. First, it limits your options. Do you (or really, can you even) go back to the other side and ask that substantial changes be made to the contract? If so, do you now have a lack of trust or credibility? Do you give the impression that you are disorganized, or worse yet, unprofessional?

Second, assuming you do go back with changes, do you highlight issues that may have been perfectly acceptable if they had been in the original draft, but that now are subject to strong objection? After all, the initial proposed contract was all about mutual give and take and compromise, whereas these changes are now almost certainly entirely in your favor. Will you have to give something back in return?

Third, by going back, do you delay the process, and perhaps threaten the deal entirely?

And finally, have you placed yourself in a position where you really can’t go back to the other side, and instead simply have to accept the contract as-is?

The moral of the story is, carefully consider the deal (hopefully in cooperation with legal counsel) before you present the first draft of the contract. If you don’t, you may find that you never get the deal that you wanted – or at all.

How to Handle Partners Who Are Bullies

Bullying and bullies are in the news a lot these days. Usually these are kids who physically or mentally torment and intimidate their classmates. In business partnerships, we frequently see a different kind of bully – the partner (who never should have been a partner in the first place) who refuses to listen to other points of view, puts his own interests ahead of those of the partnership, and generally wreaks havoc on the business. So, how do you deal with these bullies?

The first and most effective way is not going into business with them in the first place. There are plenty of articles warning you to choose your partners carefully, so I won’t belabor that point, but it’s worth noting once more – there is virtually no business decision that will affect you more than the decision of who you go into business with – choose well.

Second, have clear, detailed and well thought out organizational and governing documents that all partners understand and agree to at the outset. These documents should cover such basic issues as: (i) who gets to be an owner; (ii) who participates in management and how management decisions are made; (iii) what your general business objectives are; (iv) what happens if the company needs more capital; (v) how you avoid or address disagreements; and (vi) how and when you will make the decision to sell, merge, dissolve or otherwise exit the business or the owners’ partnership.

The third strategy follows logically from the second – having those governing documents in place is not enough – follow them. The easiest way to handle a difficult partnership disagreement is to simply follow the rules that you’ve laid out for the business.

The final strategy is more of an admonition – do NOT allow your difficult partner to bully you into making bad decisions or otherwise treat you or the business unfairly or act unwisely and then claim to be a victim! I see this frequently, and it is NOT an excuse to simply say your partner is a bad person and made you do these things that were bad for you or the company. You’re the caretaker of your business, and no one said it would be easy. Stand up to the bully!