Once upon a time there were two engineering PhDs who were clueless about how to start a company. All they knew how to do was code. They were so desperate for money and adult supervision that when an experienced businessperson showed interest and offered to help raise money, they, in their own words, “followed him like dogs.”
However, this adult didn’t know much about tech startups and caused them to make many mistakes in legal and financial matters. They parted ways but only after much aggravation and the significant legal expense of undoing incorrect decisions.
This is not an unusual story, and it’s an understandable one. First-time entrepreneurs are looking for any particle of positive feedback, reinforcement, and advice, so they jump at the first sign of interest. The demand for adult supervision in the form of advisors, board members, and investors far exceeds the supply, so you may need to take a chance with people who are untested in these roles. If no one will dance with you, the temptation is to dance with the first person who asks.
Here is a test to separate the contenders from the pretenders. These questions will help you identify good advisors, board members, and investors (if you have the luxury of choosing investors).
- What kind of corporation should we form? Answer you’re looking for: “C corporation” assuming the goal is to create the next Google.
- In what state should we incorporate? Answer you’re looking for: “Delaware.”
- Do our investors have to be accredited investors? Answer you’re looking for: “Yes.” Answer that should scare you: “No.”
- Should two founders split the company right down the middle? Answer you’re looking for: “No, you should allocate 25 percent to future employees and 35 percent to the first two rounds of investments. That leaves 40 percent for the founders to split amongst themselves.”
- Should we sell common or preferred stock to investors? Answer you’re looking for: “Preferred.”
- Should all employees, including founders, go through a vesting process? Answer you’re looking for: “Yes, everyone should vest because you don’t want a founder to leave with a significant percentage of the company after a few months.”
- Should we pay consultants with stock options? Answer you’re looking for: “No, stock options are for long-term employees, not short-term consultants. If you can’t afford consultants, do the work yourself.”
- Can we get a bank loan to start our business? Answer you’re looking for: assuming it’s a tech business, “No.” Tech businesses don’t have liquid assets to use as collateral.
- Should we use an investment bank, broker, or finder to raise seed capital? Answer you’re looking for: “No, angel and venture-capital investors view early-stage entrepreneurs who use a banker, broker, or finder as clueless.”
- What do we need our revenue projections to look like in five years to attract investors? Answer you’re looking for: “No investor will believe them anyway, but they should be as good as the closest comparable successful company that has already gone public.” Also, you don’t want money from investors who do believe your projections because they are clueless.
- How long should our business plan be? Answer you’re looking for: “You shouldn’t write a business plan. You should get customers.”
- Is there someone else you would also recommend who could be a good advisor? Answer you’re looking for: “Sure, my expertise is narrow, but let me come up with a list of other possibilities.” Answer you’re not looking for: “No, you don’t need anyone else; I know everything you need to know.”
- Do you think we need a real CEO? Answer you’re looking for: “Maybe, someday. But probably not right now. What you really need right now is a great product.”
- Should we use a headhunter to recruit people? Answer you’re looking for: “No, at this stage, you don’t have the money and can’t afford to spend what little you have on headhunting fees.”
- What should we tell investors when they ask us for the valuation of the company? Answer you’re looking for: “Find out what three or four investors think is fair, and then get more market traction to push it up.” Wrong answers: “Price it high and negotiate down.” “Price it low and negotiate up.”
These questions are relevant to US companies with Google-esque ambitions, but the same kinds of questions apply in other circumstances. Run away from anyone who wants to advise you who can’t answer most of these questions.
This post is a tiny part of Guy Kawasaki’s latest book, The Art of the Start 2.0. Read it and reap…
Great tips for online business.
Guy, I must say, I’m stumped with #11. An adviser who says not to write a business plan would send me in the opposite direction. I get your point that having customers is the most important aspect of starting a business, but what if you don’t know enough about your business? I’m a serial entrepreneur in the publishing and media fields. Every time I come up with an idea, I write a business plan so that I understand revenue streams and opportunities. There have been times when the business plans revealed opportunities which I didn’t know existed. Something as simple as the number of revenue streams you can have will be revealed in a well-done business plan. For example, I owned a marketing company which primarily catered to musicians and athletes, but then learned I could also tailor my expertise to the government sector. Writing my business plan helped me to see the potential in a “different” customer.
I haven’t had the type of financial success you’ve had, yet, so I’m not critical of you, but I don’t think I would have made it this far without doing business plans and marketing plans for my businesses. As I seek to grow and bring my businesses to another level, I desire to learn how to be better in many respects. So, I thank you for your insight. But, I would love your opinion on the relevance of business plans in starting and building successful businesses.
Wise and clear words. Many thanks for the post Guy. I am an advisor myself (although we typically help companies that have surpassed the very early-stage) and I think there’s a copy and paste mentality amongst many advisors to the way they run any deal at the expense of their client. In the very early days I agree with you that its the product and customers that ought to take centre stage and in any case, many advisors will not have run a business themselves to know of the importance of executing on, and delivering commerciality.
I looked at exactly this topic on my blog and approached it from the perspective of what entrepreneurs need to consider if they really, really think an advisor is what they need with their fundraise. There are many risks in appointing advisors just due to the rigid way they operate and the ‘process’ they are so keen on running. I would agree that for many, going direct to the funding source makes sense. I do however believe that later on when there are a number of shareholder interests to be managed and company metrics are clearer then advisors have more of a role to play and they can add value then.
Yasmin, I think that what Guy means to say here is that you should stay away from bureaucracy. There are some advisors and investors who expect you to spend months working on a Business Plan that looks good and neat. Problem is, it does not make sense to spend that precious time you might have (most of the time, you evenings after work or weekends if you are an entrepreneur who is working somewhere else) composing a document that most of the times is far away from reality. It is more useful to use instead that effort to work on a product that people will love and which will eventually provide you all the input you need to know if it is viable or not. Creating prototypes, making “Voice of the customer” research, talking to people, will definitely tell you more about the viability of your idea than books and data you can get from Internet…
I think however, you are right in that you need to do some research before jumping into a project. Business Plan might be just a good excuse that forces you to read a lot and analyze the market, but maybe you could just do those without all the hassle of creating a nice PDF and spending hours on the font and paragraph format, or adding data you already know. There’s the Business Canvas for example (http://www.businessmodelgeneration.com/canvas/bmc). Filling it will be enough for you to realize the key aspects of your venture. Many investors and advisors work with it and it is usually a good sign if they ask you for this instead of the BP. Same for financials forecasts for the next 5 years… no need to spend time on something we all now is bull..it
A very interesting read. And I especially like #11. It’s not about time. It’s about being firm. Having that solid foundation. And having customers assures you that.
Awsome !! I agree we should stay away from bureaucracy.
i completely agree…this article is as amazing as your other ones guy !!!!
well this is akash ( impulse4men.com a great place for Motivation, quotes, success advice).
A great article, thank you for sharing it with us. This is a good hand-out for start-ups as also entrepreneurs which want to check fast if they thought about everything.