Business Start-Up Toolkit- A Guide to Lean Startup Legal & Advisors

I was reading an article in this month's (June 2012) Entrepreneur magazine by Ann C. Logue entitled "Beyond the Handshake- Having a business partner can be valuable.  Having the wrong-or no-partnership agreements can be disastrous."  It details the experiences I hear every day by founders, entrepreneurs, and startups.  Most know they need quality legal and business advice in the early stages of their growth, but don't want to spend the money on it.  With the advent of online document and template sharing, discount legal document prep companies, and companies out there like LegalZoom and RocketLawyer offering low-cost or free legal documents, I very often hear and see the impact that is having.  I have worked both in the trenches of many a cash-poor startup and also as an attorney advising these same type of companies or founders and wanted to give some additional guidance and solutions from both perspectives.

Education and information are some of the most critical areas for any start-up.  They need to know their product, know their market, learn how to commercialize their product or service, and how to go from idea to a functioning business.  I put together a handbook with some of the common areas operationally, administratively, financially, and legally in my Startup Bootcamp 101 e-Book (Click to download free pdf) to provide some basic education on those aspects of business start-ups.  There are web resources that I have tried to compile as well at this Blog, but there are tons of resources in the form of books and online materials.  Some recommended books are Venture Deals by Brad Feld, the Lean Startup by Eric Reis, and the Startup of You by Reid Hoffman.  I will discuss some of the do's and don'ts when trying to stay within a "lean startup" mentality, but also when you do yourself a disservice by trying to cut corners to save money.

Having worked inside a lean startup right out of law school, I saw how limited the cash was and how much needed to be done to move the company to earn its first dollar, much less become profitable and grow.  We raised several million dollars from a group of angel investors to take our first product to market; however, I learned a lot from the founder and CEO about lean startups.  This was many years ago before the whole idea of a lean startup and was actually in the times of the dot com bubble where startups were spending like crazy.  The CEO had lived on almost nothing and had been bartering stock and stock options for services from engineers, accountants, manufacturers, and just about any other service he needed.  Even after the money came in, he was still hesitant to spend a dime on anything without understanding exactly how it was absolutely necessary for the business.  In fact, half of the company's initial workforce were all interns working for credit or basically minimum wage.  Having founded companies before, I knew it was wise to watch your cash closely, but he took that to an extreme.  It was interesting to watch because he would spend large sums of money on things he felt were extremely important.   Initially, most of that would relate to R&D, engineering and manufacturing since he was an inventor at heart.  However, once he started trusting the new angel investors and new board members, he started using their years of experience and taking their advice.  He was told to protect his ideas and intellectual property, so he hired a good IP law firm.  He then bought a top of the line server and computer systems with all kinds of redundant backups.  It was like mission impossible there with a specific procedure for all the types of backup procedures.  There was enough battery backup power to run the place for like weeks without power and the digital backup tapes were stored in a several thousand pound bomb proof safe.  I think he still has that safe and keeps his newest inventions in it.

The point of my story is to try to illustrate that there are times to be frugal and there are times to spend the money WISELY.  This founder wanted to spend money on cool things like 3d plastic modelling CNC machines and re-tooling for every little design change that many times were not really necessary.  He slowly learned how to trust experienced advisors and spend the money in areas where and when it was necessary in the best interest of the business, not what he personally thought was best.  That is part of the difficulty with founders, they often have no problem with spending thousands on their passions, but don't think from a business-as-a-whole point of view.  For example, a product marketing/sales type loves spending on PR firms, trade shows, product differentiation, and advertising; however, an inventor/engineer type will spend on top of the line computer systems, hardware, and software to aid in design.  For either of those individuals to agree to spend the company's money in the other's area is like pulling teeth.  The wise startup will analyze what the company's current needs are and budget in each area accordingly.

So if you have made it this far, you are probably wondering, "okay, so when is he going to tell me how to do my own legal forms?"  The first question is, when from a business standpoint (not just legally) do I need to put things in writing? Documenting a process flow, organizational chart, or procedure for dealing with customer feedback don't really deal with anything legal, but they are things that often need to be put in writing for the best interest of the business.  What if a co-founder dies suddenly or leaves to work somewhere else and doesn't care about the existing business anymore?  Having things properly documented can help save that business.

In many cases, founders think of legal documents as a hassle that is expensive and too time consuming for their light speed venture.  "When we become the next Facebook, we will have so much money, we can sue whoever and defend any lawsuit against us, so we don't need to worry about those things right now."   However, even two app developers talking about a project and deciding to talk more with each other about it over coffee is a point where legal issues and documents are already in the mix.  Intellectual property rights can be lost or diminished in these very early stages.  Many co-founders don't really have a solid agreement in place for their working together.  Clients come to me and when asked what their agreement is with each other, they simply say we agreed to just split everything 50/50.  As Ms. Logue writes,

"One fundamental error made by many startups is failing to have essential business documents and agreements in place from the beginning.  Partners often hold off on putting key terms in writing because in the early stages...they interfere with the thrill of getting a new business off the ground."  Just like in the early stages of a romance, business partners "are filled with starry eyes and optimism."

So if I need to think about these things from the get-go, what if I don't have any money?  People need to understand the value brought by any advisor, whether a CPA, business consultant, board member, financial consultant, or attorney.  It is their experience, network, and connections, not just knowledge of how to physically do something, that you are paying for.  Using LegalZoom to incorporate is fine, but people miss the point.  You could go to the secretary of state's website and figure out how to incorporate on your own for free (other than the state filing fee) just as easily.  When people assume that hiring LegalZoom or getting template documents from an attorney or their friend who used an attorney is the same as hiring an advisor are sadly mistaken.  You can use Series Seed documents for your financing transaction and probably be covered; however, a lawyer will (a good one at least) make sure you comply with securities laws which involve state and federal exemption filings, put the proper board resolutions in place, and tell you what you need to do in the future to avoid losing the limited liability protection of a corporation by failing to follow corporate formalities.  Do you need to file a trademark, patent, or register a copyright to protect some of your ideas or intellectual property?  Do you need a shareholder agreement, intellectual property assignment, co-sale agreement, registration rights agreement?  There are a myriad of possible things that a company should have in place.

Good entrepreneurs are not afraid to spend money when it is in the best interest of the company and we assume the company will succeed and need those items taken care of.  If you approach the matter from the perspective of "those agreements might only become an issue down the road when we have lots of money and people want to cash in," you have already set yourself up for failure.  You are assuming you won't be in that successful position or that somehow you can clean everything up at some point in the middle which will end up costing way more than it originally would have cost.

Some of the keys in my opinion to lean-but-wise startup are:

• Templates and DIY type services are ok, but not the best-  Attorneys rarely start from scratch and re-invent the wheel when drafting documents and agreements.  They often share documents among themselves, so you can use things like Series Seed finance agreements or other templates.  You should still at least go over the transaction and documents with an attorney or tax advisor.  Draft a term sheet, letter of intent, or similar document to outline the material terms of the relationship.  If you have a template, put together a draft for an attorney to review along with the term sheet to be sure the agreement covers everything you need and some things you may not have thought about.  If you do it yourself, hire someone after you raise some money or have revenues early on to go back through things to save yourself a much larger headache down the road.  It is better to at least have something in writing, than nothing at all, at least in most cases.

• Ask for a free consult-  Many lawyers, CPAs, and other advisors will give you some of their time for free.  You can also setup an hour or so and pay for that time only with them.  Prepare drafts and all your questions up front.

• Ask for recommendations and a proposal-  Many lawyers or CPAs may not understand how to do that properly, but they should be able to meet with you to hear your business or transaction and come up with a list of questions, concerns, and recommended action items for you to take or for them to help you take.

• Negotiate Legal Fees-  It is not bad form to discuss the costs.  Some people assume you just walk in and whatever they bill you for, you are stuck with.  If you follow the prior step, any experienced attorney can give you a ballpark for the total amount of time and cost for each item they may propose.  Explain you financial circumstances and ask for a discount.

• Put the ball in their court to earn your business and come up with alternatives to large up front retainers-  Realize that a law firm is a business like any other and they have to be flexible with their customers.  I often work arrangements with my clients to defer some fees at an hourly rate to be paid upon cash flow from revenue or funding.  I offer flat fee arrangements so clients know up front exactly what they get and how much it will cost.  You can often get someone to complete a large number of items you need if you apply a volume discount theory to them.

• Don't offer all kinds of future business or part of your company that will be the next big thing-  Lawyers or other advisors will work for stock or stock options in a company, but don't try selling them on just how big you will be.  Any experience startup lawyer can evaluate a business' potential without you having to toot your own horn.  Lawyers understand that if they provide valuable service, you may refer your future business or other business to them, so you really don't need to remind them.  To me, when I hear these things pushed on me, I appreciate any referrals or the potential to make money from your business, but I already plan to provide the best service I can, so I assume if you see the value, you would refer business anyway.

• Ask your board or other experienced advisor or friend for connections or referrals-  You can often get a very seasoned attorney, CPA, or other advisor through these sources and they may give you a discount or be more willing to apply a friends and family discount.

• Utilize your advisors-  Any CPA, lawyer, or other advisor is going to have connections, networks, and referrals for you.  If you need help raising money and don't know where to start, ask them.  If you don't know how to get your product into a big box store or manufacture your product in China to save costs, ask them.   The other part of their value is those connections.

• Put a good finance person and operations or legal person on your board of directors-  Some people love the title of Director or Board Member and will probably give some free or low cost advice and services just by being on the board.

I have more ideas, but this post is already too long, so I will follow up with more down the road.  Happy Lean Starting-Up!