Get it right before you start-up

When Glenn and I went our separate ways many years ago, I felt it was because he wanted our business to be more about lifestyle than I did.

 He wanted the office to have New York attic style windows and be above a coffee shop. I felt we had to keep our belts a lot tighter so that I could go all Scrooge McDuck. Of course now that Glenn is the owner of his own software engineering business, he cares about the money, not so much where the coffee shop is.

Ten years later and we still maintain a casual friendship catching up twice a year for lunch. But yesterday he emailed me, taking me to task over my use of apostrophes in the Churchill Cub Newsletter. He also mentioned at the bottom of his email, “I’m currently working through the due diligence for an online idea for which I’ve been approached to perform web development hours in exchange for equity in the company”.

Glenn isn’t exactly an investment banker, and the deal isn’t large enough to warrant fees to third party advisors. So I gave Glenn a bit of feedback on it since I have been on both sides of these deals a couple of times and have advised on some arrangements as part of a Flinders Pacific project. Glenn thought it was good feedback, so without going overboard I thought I’d flesh it out and share it.

Why you?

• So family, friends and fools generally invest in new start-up ideas. Which are you and how do you feel about it?
• Are you the first person they asked to do the work, and if not, why did others knock it back?
• Do they want you at the table because of your skills, network and resources? Or just because you’ll do the work for the right price. If the latter, it’s unlikely to have a happy ending.
• Do you think you are the right person to manage this investment once the job is done?

How much do you Charge?

• What is the price of the work if you just charged for it?
• Is there an opportunity cost here that you need to account for?
• How much a loading do you need to account for the risk?
• How much of a loading do you want to account for the delay in getting a return on your investment (think discounted cash flow)?
• The other side of the equation is “what is the value of the work you will do, in the eyes of the other party”? (Are they just bringing an idea to the table?)
• What non-cash components are you going to include in the deal (Are you locked in as a supplier and at what price?)
• How are you charging for scope creep, extensions and ongoing
  maintenance?

Undertaking the Work

• Make sure you have the work very, very, very clearly defined. Exactly what are you doing and what aren’t you doing. Enthusiastic people tend to evolve a start-up without documenting changes. There is sure to be an ugly customer expectation gap unless you keep things tight.
• Who will actually do the work and are they the best choice?
• How are you going to ensure your team acts professionally and follows good process (including managing scope creep) if they think it’s a “kind of freebie” for the boss?
• At what point is ownership of your code and IP transferred or are they just getting a license, or a hybrid?

Managing your Investment

• How much equity are they offering, and how is it going to be protected overtime (and not watered down dramatically in a couple of months)?
• Are there any other material things going on that you need to know?
  How are they valuing the business at the point where you deliver the solution?
• Are they open to alternative offerings such as a convertible note?
• If you were making a cash investment (because it’s the same) would you be happy with business idea and the people managing your investment?
• What is their plan to actually get you a return on your investment, and are you happy that it’s clearly articulated and achievable? And what’s your plan B, C & D? (Can you sell your equity in three months time)?
• What arrangements are in place so that you can monitor/govern your investment (financial reporting regime, briefings, board slot)?

But when things don’t work out as planned?

• Things always turn out differently, especially in start-ups that are bootstrapping, and remember that people have difficulty valuing something they get for free. So how do you protect your position if they change direction dramatically and/or resent your stake?
• What if they dispute you have satisfied your side of the contract? (This just happened to a mate of mine after he had tripled the sales of a business with an equity deal.)
• How will you know if things are going off the rails?
• How do you get a return if things go into liquidation?
• How do you protect yourself if the others “act without integrity”?

All these things for him to have a think about and I haven’t even really asked whether their idea is a good one in the first place. We are going to have to do that one over lunch, somewhere with New York-attic style windows.