10. May 2018
Think Smart at the Start of Founding a Company
Hurry up! Quickly found a company, sign a contract with the first investor that we met, and start doing business. Why this approach is not paying off is what we talked about with the UP21 co-founder Alena Nekovářová.
What should be the first step in doing business? What should you watch out for?
The first step is establishment of a legal entity. At the beginning, it is good to clarify what I want to achieve and based on that set up an agreement and matching conditions in the company. When creating a company, keep in mind that the fewer co-owners, the easier it is to find an investor later on and negotiate with them. Investment funds only sign deals with companies that have a maximum of two owners.
What should startups that have more co-owners do?
There are different solutions. One way is to create a tradeable option when setting up a company, in which you define the terms of the claim for a share. This share should not exceed 10% of the company. If you opt for a co-distribution option for more people, I recommend creating an agreement among co-owners that sets out how they will handle stakes in the event of an investor's entry (for example, if they will all reduce their percentage equally or in a different way). As long as there is no money in business, everything looks simple, but disputes may arise as money comes. It is not important to set everything up perfectly, but you can avoid a lot by thinking ahead.
Once the company starts doing business, it starts seeking investment. How should the owner(s) proceed?
When looking for the first investor, you should remember that this is the first investment to help start a business so that another investor can come. After the first investment, the founder should have a majority share in the company, so that in case of further investments (share dilution), they still keep a majority share. An investor does not always need to have a majority stake in order to have control over the investment of money. They can also negotiate a contract, in which, for example, they order the startup to ask them for approval of certain things.
Do startup founders make many mistakes in this area?
Yes. For example, they set the ownership structure of the company in such a way that it is unacceptable for investors. Or, they make a wrong estimate of how much money they will need and they run out of money before they can ask for another investment.
How should I proceed if I don’t have a sufficient share for a new investor, but I need the investment?
In this case, there is no other way than to redefine the existing agreement. This means that all owners must jointly conclude an agreement with a new percentage share in the company. If redefining is necessary, it is ideal to set the new conditions in such a way that they include agreements with a new investor. It is much easier to think about everything at the beginning so that you avoid these problems in the future.
What impact on business can poorly negotiated conditions have?
You might not be able to find an investor. Or, you can find an investor, but co-owners will not be able to reach an agreement on the new conditions, or it may take a long time. This can slow the company down and lead to its complete closure.
What other problems do you see in agreements?
People do not take into account the value of their work.
What do you mean?
Imagine that you have a startup. When somebody offers to give you money, you are thrilled. The investment means everything to you at that moment. I think that before looking for an investor everyone should realize what value their company has, whether they don’t accidentally underestimate or overestimate it and include all time spent on work in calculations.
In which other areas of law do people make most mistakes?
Mainly within the scope of contractual rights and obligations. There are two extremes. On one side you have people who do not care about anything at all. And on the other, you have people who overanalyze everything and create 30-page documents that try to define all possible scenarios and are very restrictive. It is good to write a reasonable agreement that defines basic things. You should also count on the fact that when the investor enters, the contract will probably change to include agreed-upon terms.
Can it be due to to the fact that founders try to solve legal issues themselves instead of hiring a lawyer?
When a company is founded by only one person, it is possible to do it without a lawyer. However, when the investor comes, or we are speaking of a more complex agreement among multiple owners, having a lawyer is definitely an asset. But a reasonable lawyer (laughing). I have experienced lawyers who made situation incredibly complicated. They did not look for a way to solve the issue, but a way to make more money... You know, one must be perceptive and reasonable. This concerns lawyers, investors, and co-founders.
What recommendations do you have?
You will experience many new situations in which the only thing you will know and you have experience with will be yourself. Therefore, when are sitting with a future co-owner, investor, or colleague and you don't feel comfortable during the meeting (for example, you will feel confused, that you have no other option, or that you are forced to do something.), it is a reason to stop and consider whether it is the right investor and co-owner, or whether the conditions are set up well and whether there is not another option. In short, do not jump into everything and consider the pluses and minuses.