There are a few provisions that may trip up a company that doesn’t read the language closely or fails to understand the impact of certain provisions.  Here are a few provisions to pay close attention to:

•    Ownership of Intellectual Property.  In the event you are looking to enter into a contract with a consultant, an employee, or any other third party, you should be certain to consider how any newly created Intellectual Property will be owned.  For many companies, they will want to be certain that they retain ownership rights to the intellectual property.  However, for more complex joint development projects, there may be cases where you will assign all or some portion rights to the intellectual property to another party.

•    Assignment Provisions.  Assignment provisions will require a company to get permission from the other company in the event that they wish to assign or transfer the contract to another party.  This is particularly important in the event a company is acquired or sold because it may require the company to obtain consents from all third-parties before the acquisition can be completed (which is sometimes difficult).

•    Exclusivity or “Most Favored” Language.  The Exclusivity provisions will require you to limit your actions in some way — perhaps that the other party is the only one who can distribute the product or has first rights to distribute.  The “Most Favored” provisions will require you to give the other party the best terms you give to any other customer — such as the lowest price, the best discounts, etc.  These may seem like harsh provisions (and in some cases they are), but it may be restrictions you can live with if they have limitations as to geography, industry, time, etc.

•    Attorneys Fees.  Be aware of any provision that requires either party to be responsible for attorney’s fees associated with negotiating or finalizing the agreement.

•    Use of Trademarks or Customer Names.  In the event you want to be able to publicize a customer list, be certain there are no restrictions on use.

•    Termination and Renewal Provisions.  Be aware of any provisions that allow the parties to terminate the contract early, particularly provisions that allow for termination in the event of even a minor breach without the opportunity to rectify the breach.  In addition, be aware of any provisions that allow for the automatic renewal of the contract.

•    Compliance with reporting provisions.  Some contracts will include language obligating the other party to provide certain ongoing reports or information to various parties such as federal or state agencies.

•    Obligations on Employees.  Contracts will sometimes require all employees that interact with the other party to be screened or drug tested.  Ensure that complying with these requirements will not breach any contracts you have with your employees.

•    Access to premises.  Be aware that contracts may permit the other party to enter your facilities.

•    Payment Terms.  Look for the terms of payments due as well as whether any payments due will be accelerated in the event that either party fails to perform certain activities.

Be sure to read every contract you sign — language that may seem harmless can come back to bite you.  And, if you have questions, ask someone such as your attorney, an advisor, a board member, etc.

Ah, taxes… few people (if anyone other than my wife, who going to be a PhD in accounting…) like to do their taxes.  It means you have to hunt around for old receipts, try and remember what some expenses were, and even pay in more money than was already withheld.  No doubt that it is a pain.  So why do a post about taxes during the summer months when tax day seems so far away?  Simple: Any efforts you make now to get organized can save you time (and probably money) down the road.

So, how can you minimize the pain?

A bit of filing and organization can go a LONG way to prevent some pain down the road.  (Think about it like flossing… will save some drilling in a future visit to the dentist).  And although it may seem fairly obvious, proper recordkeeping is one of the most important considerations for any startup company, especially in the early stages when you are do not have an established set of policies, an experienced accounting staff, or chief financial officer. Recordkeeping for tax purposes should be integrated into an entire document retention policy for the company. Most of the items discussed below will be key documents for accounting purposes — thanks to the help of my wife Allison for her tips.

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An entrepreneur recently asked what he should look for in a potential director on his board.  That’s a pretty tough question as any entrepreneur can tell you.  As I started listing off all the potential traits that would be important – prior startup experience, industry contacts, mentorship, leadership, board experience, operational expertise, etc. – I realized I may be describing a person that could never exist…

So instead of looking at all the traits a board member should have, I thought it was valuable to the entrepreneur to describe the key roles a board plays.  By understanding what a Board of Directors is responsible for (and is involved with) in a company, hopefully you can identify the right mix of people to round out your board.  So if you board is full of people with lots of industry contacts, perhaps you need to look for someone with prior startup experience or perhaps someone with finance and accounting skills.

There are five key roles a board of directors’ play within the company, and particularly play with respect to a high technology startup company. Those roles are:

• Legal Role
• Representative Role
• Strategic Role
• Advisory Role
• Service Role

The Legal Role played by the board of directors is determined by federal and state laws (primarily state laws governing the state of incorporation, but other laws may also be implicated), rules and procedures set forth in your corporate Articles or Certificate of Incorporation and corporate Bylaws, and additional rules and statutes from the Securities and Exchange Commission, Financial Industry Regulatory Authority or other entities that regulate certain stock exchanges.

The Representative Role relates to the relationship between the corporate shareholders and the board of directors. As discussed previously, the board of directors historically had been elected by the shareholders as representatives and acted out the will of the shareholders. And while that relationship does remain in some senses, particularly in that the shareholders continue to elect the board, the power has shifted in many cases to the hands of the directors. Even so, it is still important to recognize that the board does represent the interests of the shareholders and is responsible for providing oversight in the interest of all shareholders of the corporation. This relationship can be at issue in cases where a shareholder (oftentimes a holder of a sizeable stake of stock) believes the board is not acting in the best interests of the shareholders, but courts have tended to give substantial deference to the board.

The Strategic Role largely stems from the role the board plays in corporate decision-making. Due to the fact that a board will be responsible for approving decisions from potential acquisitions to option grants to new hires, the board will hold an important role with respect to certain strategic decisions. The challenge that some corporations is the balance between the board and management in these strategic decisions. However, there has been research that suggests there is a positive relationship between a board’s involvement in corporate strategy and the performance of the company.

The Advisory Role for a board of directors is most often seen in the earliest stages of corporate development. Early investors in the company, oftentimes who represent venture capital funds or other serial startup investors, will provide capital for the corporation, but may also view their role to guide and assist the company in its earliest stages. The experience many of these directors will have of working with numerous companies in a similar market, at a similar development stage, or facing common market conditions gives the board the ability to provide advice and insights to the company.

The Service Role of the board and its members come as a result of the fact that many small and early stage companies will not pay their board members until the company matures or will only pay a nominal fee for board service. Compensation will usually be in the form of stock options, reimbursement for travel expenses or stipend for meeting attendance. At least in some senses, the board and its members will be providing service to the company and its contributions will be aimed at adding long-run value to the entity.

When selecting anyone to join a board, remember the varied roles the board fills — and look to create a board with the right mix of personalities, skills and backgrounds to fill the roles.  Ultimately, a board can be a key extension of the management team and instrumental to the business’ success.

For many technology entrepreneurs, raising venture capital is an important part of their business strategy and may be a goal in and of itself.  As a result, I’m often asked: “What are my chances of being able to raise money from venture capitalists?”

Obviously, I’m not a venture capitalist (we lawyers, don’t pretend to know what exactly a venture capitalist is looking for and what they will require before making an investment).  However, you start to get a fairly decent sense of what a VC won’t fund.  I’ll save that list for another post and another time…

So my general answer to that question about whether or not an entrepreneur could raise VC funds is: it depends. It depends on the team you’ve assembled, the technology itself, the market for your technology, the right timing, and a little bit of luck. And while that may be the case, if you believe Sam Altman, the founder of Loopt, “If you’ve got a good idea, market, and team, raising money won’t be your problem.”

So, what are the odds then?

The truth is, the “it depends” answer isn’t very satisfying to most people. Entrepreneurs want to know their chances.  In a prior post, I wrote about the VC “Fit” Test.  That is one way to gauge if you may be a good fit or not (although, again, lots of subjectivity there).  The other way to gauge interest is to sit down with a few partners at funds and see the reaction (but that means you can get those meetings or are far enough along for them to be truly interested).

So, what about some more data into the chances of an unnamed startup?  Well, anecdotal evidence suggests that between two and three percent of businesses seeking venture capital financing will ever receive institutional funding. The majority of these cases are because venture funding is not the right type of funding for the business (not passing the VC “Fit” Test….). Sean Wise looked further and interviewed a number of venture capitalists to find out where their deal flow came from and the sources of deal flow that had the highest probability of closing. While these are not scientific numbers, these figures should offer some insights into the way VCs see the sources of their deals.

What are the odds of getting a meeting with a VC firm based on:

• an unsolicited business plan submission? Approximately 1 out of 100.
• a solicitation from an unknown agent? Approximately 1 out of 50.
• direct contact from venture fairs, financing forums, and other industry events? Approximately 1 out of 15.
• referral from professionals with fund relationships (accountants, lawyers, and market dealers)? Approximately 1 out of 3.
• referral from current and future investors? Approximately 1 out of 2.
• referral from executives of a portfolio company in the VC’s fund or other stakeholder in the VC’s funds? Nearly 1 out of 1.

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I recently had a terrific conversation with a soon-to-be entrepreneur.  He had pretty much everything set — a unique idea, the right set of skills, co-founders who would bring a nice mix of talent, enthusiasm, connections, etc.  If you asked me, this seemed like a pretty good start to a startup.

Then I asked the question — “So what are you guys doing for startup capital?”

A blank stare came back at me.  “Startup capital?  We don’t need any yet.  Well, I mean we’ll probably do an angel round or something… but we don’t need that for a while.”

Well… you may not think you need startup capital, but odds are nearly every business requires something to startup (more than just sweat equity of the founders).  The question isn’t whether you’ll need it (you will), but is how much (typical range is $15-75K) and where to find it (check the mirror).

What is “startup capital?“

Some people call this seed money; others call it startup capital or initial capital; and still others use terms like founder capital. The short of it is, that this cash represents what you needed that can’t be paid for with your sweat and your time.  Real cash expenses.

Unfortunately, what this promising entrepreneur I’d been speaking with failed to recognize is that it takes money to start a business — really nearly any business, even the most lean, bootstrapped business takes some cash to get it going.  And that isn’t the type money you raise from angels or the like.  This is real startup capital to buy things like office supplies, business cards, software, laptops, test equipment, licenses, paying for a developer or designer, etc.

How much startup capital does a business need?

Obviously, that depends — and it depends on what period of time we are talking about.  If you plan to bootstrap the entire way through, you may be talking one amount or if you are just trying to get setup and have a seed investor or angel investor lined up, then it could just be a month’s worth of startup costs.

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It’s not too early for some in the media to start speculating that the recession is already over thanks to a few good days in the stock market (thanks CNN).  So, next up, job opportunities for some of our best and brightest startups, right?  Not so fast, unfortunately (thanks Congressional Budget Office).  But those rays of hope may mean light at the end of the tunnel — companies will be looking to hire again (sometime) and others will start looking to bring on consultants.

For that reason, it may be time for companies to start considering the costs of adding a new employee and thinking about strategic hires sometime in the near future (perhaps there is a talented individual who was laid off from another company that might be a perfect fit).  What some new managers fail to recognize is that the cost of the employee are more than just their salary (and even more than salary and benefits).  Think laptops, rental space (if you need office space), lunches, taxes, training, travel, and everything else that goes into an employee.

There is no set number on the full cost of an employee and in fact it usually depends on the job itself and what types of “add ons” the company offers.  But estimates range from 1.5x to 3x of salary for the ‘fully-baked’ cost of an employee — the cost including things like benefits, taxes, equipment, training, rent, etc.  While bringing on an employee may only cost you $30,000 in salary, depending on the other costs, this could actually result in additional costs to the business of $90,000.

So how can you determine the true “fully-baked” cost of an employee?

The cost to add each new employee represents more than just the salary you’ve agreed to in the offer letter. You’ll be responsible for costs from taxes and benefits to rent and equipment.

The Department of Labor provides information on the costs an average employee costs to the employer (these don’t factor in things like equipment costs, rental costs, or other costs not directly tracked by the DOL). According to the DOL, an average employee costs $25.93 per hour when you factor in costs of salaries, benefits, and taxes. While these figures represent useful information, you should note that these numbers represent a broad range of employees across all industries in the U.S. economy.

Private Industry Employer Compensation Costs

U.S. Department of Labor’s Bureau of Labor Statistics (June 2007)

Employer Costs of an Employee

# Paid leave benefits includes vacations, holidays, sick leave, and other leave.

* Legally required benefits include Social Security, Medicare, unemployment insurance, and workers’ compensation.

So while the Department of Labor information represents aggregate data, the information can be quite helpful to gauge what it will really cost to hire another employee. If you’d like to estimate the real cost of adding a new employee, you may consider multiplying the employee’s base salary by a multiplier that would reflect their salary, benefits, rent, equipment, training, and other general expenses associated with another team member.

For instance, looking at the chart below, you could see that if you planned to add two programmers at salaries of $50,000 each and one manager at a salary of $100,000 for the following year, you could be looking at an increase of expenses of up to $540,000. When making your budget to add headcount, it is important to include costs associated with the employee in addition to their salaries. This is just a helpful “big picture” tool and each company will likely need to adjust its calculations to fit its own operations, however it is helpful in gaining a quick sense of the true costs associated with increasing headcount.

As you consider whether to bring on a consultant or hire a new employee, be sure to compare apples to apples — which usually means the full-baked employee costs versus the consultant’s rate.  There are oftentimes other “benefits” to hiring an employee over a consultant (perhaps a greater sense of loyalty).

There are rays of hope out there — some companies (hopefully yours) is looking to hire.  Plan ahead for the cost of an employee to be sure your hires don’t break the bank.

Pass-through entities are a common entity choice for early-stage businesses (largely because it permits the losses of the business to ‘pass-through’ to the owners of the business for tax purposes.)  If you choose to go this route, you now have another choice — the LLC or the S-Corp.  How do you decide which is best?

A first-time entrepreneur often questions whether or not they should form an LLC or go the route of the S-Corporation. In a prior post, I wrote about general “Rules of Thumb” in picking a business entity.  Several people asked for a bit more clarification on the differences between an LLC and the S-Corporation.

Both are pass-through entities (which will be treated similarly for tax purposes).   Some of the reasoning for your choice will come down to your future plans for fundraising (are the planning to take VC money?) or the type of investors you plan to have early on (will you have investors who are all “natural persons” or could you need to have a corporate entity, foreign party or other entity as an investor?) or the flexibility you require in your entity structure (do you need to have a very unique/custom structure?)

Before you make any choices, it is always best to talk to your own attorney or accountant who can be sure you make the right choice for your own business and its specific circumstances.

The LLC vs. The S-Corp

If you’ve decided to take the plunge and operate your business as a pass-through entity, how do you choose between the LLC or the S-Corporation? Many high-tech entities find that if their business qualifies for the S-corporation election, it may be the better choice in the long run (given the ability to migrate to a C-Corporation with relative ease). However, in the event that your company will be unable to comply with the IRS’s S-corporation restrictions, you’ll find that LLC represents the next best choice.

To help understand the “downsides” of each of these choices (which hopefully will help you to identify the better or “right” choice for your business entity), the table below lays out some of the problems associated with each of these pass-through entities.

For another excellent resource, visit the Nolo website for an article on the differences.

This article is an excerpt from What Every Engineer Should Know About Starting a High-Tech Business Venture, available now.

You’ve got a great idea (or what you at least think is a great idea), but you don’t have a co-founder or a full founder team to help develop that idea.  Not an uncommon problem — and something that is very important.  Researchers have found that one of the key factors identifiable to success in raising funds is the “connectedness” of your founder team — those founder teams with lots of connections tend to be more successful in raising venture capital.   That’s why you are looking — finding a co-founder matters and building a business in isolation is oftentimes much more difficult.

So, then where do start your search?  Fortunately (or unfortunately) a large number of founders will find one another through current work, social or academic circles.  This means that you may be able to identify people you already know or have met — and the trick is simply convincing them to join your team.  On the other hand, if you’ve pitched your idea to you entire social circle, finding someone you’ll work well with and trust from the outside could be a challenge.

The research of Chuck Eesley at MIT focused on founding teams to identify where founders had met one another. Eesley’s research looked into founding teams from recent graduates (less than five years following graduation) and established alumni (more than five years following graduation).

Among founding teams of recent graduates that had formed companies since 2000:

• approximately 30% of the founding teams grew out of their MIT research,
• 20% grew out of work relationships, 20% from extracurricular activities, and
• 30% from social activities.

For founding teams of established alumni that had formed companies since 2000, a larger number of founding teams grew out of work relationships. For these teams:

• less than 15% grew out of MIT research,
• 40% grew out of work relationships,
• 40% from social activities, and
• less than 5% from extracurricular activities.

As graduates advance in their careers, a greater number of founding teams will grow out of work and social relationships, while for recent graduates more startup teams will be formed based on prior research and extracurricular activity relationships.

In many cases, a founding team will grow out of personal relationships or a working relationship (for example, Paul Allen and Bill Gates of Microsoft, who became friends in high school in Seattle, and Larry Page and Sergey Brin of Google, who met as Stanford University graduate students). In those cases, you may have a self-contained team in place ready to begin efforts to develop the organization. You may desire to add additional talent to your founding team to round out the relevant talents and skills of the founders; you will need to closely evaluate the current needs you’ll have during the formation and early stage funding phases of the organization.

In other situations where you do not have a readily identified co-founder (for example, Steve Jobs convinced an initially skeptical Steve Wozniak to join him after Jobs had proposed selling a computer as a fully assembled P.C. board), you may need to begin searching your social network to find additional key members to join you.

As you begin to consider how to form a team of founders for this new business venture, you should put yourself into the seat of a potential investor. What are they going to want from a two to five person team to tackle the problem you’ve signed up to tackle? Obviously, they are not expecting you to address every area of this challenge, but what is the key talent that needs to be at the table?

Sometimes founders have likened the early experience with their co-founders to a marriage. After all, remember that when forming a team you will need to be able to work well with these individuals in an intense environment.

Think smartly about your domain name (not only if it is available on godaddy.com)

Nearly every company now has a website – it is a standard practice to reach potential customers, employees, and partners through the web. Today’s technology companies utilize features like blogs, comment boards, and e-commerce to create interactive forums with their customers. Many technology companies rely on the web as their first (and sometimes only) sales tool.

Your first step in developing a web presence is selecting your domain name – and this choice does raise certain intellectual property issues. For some companies, their domain names represent one of their most valued assets. Domain names are unique designations used to identify a particular computer on the Internet. In order to communicate with each other on networks, computers must have individual identifications. A domain name is a way to identify and access a computer to a unique site on the Internet. Domain names typically consist of letters, numbers and hyphens. An example is www.google.com or www.yahoo.com.

Domain names can be registered with any one of the over 150 registrars accredited by the Internet Corporation for Assigned Names and Numbers (“ICANN,”) a non-profit corporation that manages the Internet domain name system. Anyone can register a domain name in the .com, .info, .net or .org scheme. Registering a domain name does not, however, give one trademark protection over the domain. Domain name registrars are not liable for trademark infringement, dilution, or contributory infringement merely because they issue a domain name that is claimed to infringe.

Because a domain name on the Internet is a unique address designating an Internet site, it may be a trademark or service mark, and have legal protection. However, the Patent and Trademark Office has stated that if a domain name is used solely as an Internet address, and not to identify a source of goods and services, it is not protectable as a trademark. A business may be wise to include its domain name in advertising its goods or services in order to obtain trademark protection.

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Eureka! You bolt upright in bed… you’ve got it.  The perfect business idea.  Finally.  Yes.

Wasting no time, you run to your computer and start searching to see if anyone else has done it… page 1 of your search… well, looks like maybe someone else might be.  But, let’s assume they aren’t doing it well.  Page 2… oh no, three more hits.  Page 3… dang it, Microsoft has a team and Google is ready to launch next week, and looks like three new startups just got VC funding last year.

You sulk back to bed, and hope another idea will strike you…

The First Idea might not be the Best Idea Anyways

Successful entrepreneurs note that the early stages of developing their business concept are a struggle between obstinacy and flexibility. On one hand, the entrepreneur wants to stick to his or her vision in spite of the criticism and doubts. But, on the other hand, the entrepreneur recognizes the importance of adapting the initial idea as research, experience, and understanding increases.

Researchers Hills and Singh asked the entrepreneurs in their study about the change in their original business idea since its beginning. Over 50% of the entrepreneurs said that their idea is about the same, while the other half said the idea or opportunity has changed a “little” to a “great deal”.

• Idea/Opportunity has changed a great deal – 13.2%
• Idea/Opportunity has changed a little – 36.4%
• Idea/Opportunity is about the same – 50.4%

According to the results of a survey by Launch Pad, a marketing consulting company, 44% of the high technology companies they surveyed in 2003 said the company had made a significant change in their business model in the prior year – changes ranging from a new product line or target market to pricing or sales model (and that is a significant change made in just the prior year). The ultimate lesson for entrepreneurs is to recognize that there is a balance in play between obstinacy and flexibility. Recognizing when the idea, focus, model or strategy needs to be changed, in any amount, is an important skill. However, the flipside of the discussion is that an entrepreneur also must recognize when to stick to their vision even in the face of outside pressures or scrutiny.

What is the lesson here?  Find an idea that you think is good, but don’t hold out for a perfect idea — since it may well change and change dramatically in the early stages.  Ideas are just the start — you can’t build a business on just a bright idea!

Why are you waiting around for a brilliant business idea?

Don’t be discouraged if you don’t have that “big” or “perfect” idea yet.  In fact, it may be better if you don’t, as you could find out that your ‘big’ idea really wasn’t that big at all or your ‘Eureka’ moment was only half the story.  Truth is, as you can see — many businesses (nearly half in fact) undergo change from that initial idea or opportunity, and the business itself will undergo a series of changes through its lifecycle.  If you are searching for the “perfect” idea or an idea no one can find fault with before you even start the business, you’re probably going to be looking a long long time…

We’ve all heard the story about what investors look at in a business — team, technology, and market (or some derivation of that combination).  Idea seems to be missing from that list… perhaps you could say it is part of technology, but the truth is, the big ideas aren’t the key to business success.

Missing that “big” or “perfect” idea can be holding you back from starting your business.  But perhaps what you are really missing is the right team around you to refine or enhance your idea to make it a ‘big’ or ‘perfect’ idea.

If you are waiting around for that perfect business idea to strike you in the middle of the night, I hate to tell you this, but look at these success stories that refocused or retooled their business idea during the process.  I’m sure very few of us would fault the Paypal founders now for starting down one path only to shift away from cryptography to “discover” the secret that led to its $1.5 billion dollar acquisition by ebay in 2002.