Note: This post was originally written by TechAlliance EIR Colin Macaulay.
I have been using my biotech startup experience to encourage new life-science entrepreneurs to develop their own technologies and to avoid some common pitfalls in their startup journeys. Through this mentoring process I have encountered several common issues that I try to explore in a series of short blogs. These are my own opinions and do not represent those of any institute, company, or client I may have worked with.
In Part-1 of this series, I discussed how it is a great time to be a new entrepreneur and how there is abundant support to create startups that bring new technologies to market. As a startup advisor, I was all set to help entrepreneurs through the innovation process, the core components of their business models, and the competitive analysis that is crucial for life-science startups. Surprisingly, these questions were not a priority for some new entrepreneurs. Instead of focusing on how to move their business forward, they were sidetracked with questions about how to deal with hostile or lazy co-founders or other problematic shareholders. These startups had barely begun, were not financed let alone close to commercialization, and yet were already seeking advice about shareholder or co-founder relationship issues that can sink a company before it really begins.
There are innumerable reasons why relationships fail, and it is a shame to see a startup with a great technology and a workable business model not fulfil its potential because relationships between founders break down. No one wins in that scenario, especially the customer. I am not a lawyer and I don’t provide legal advice, but early legal advice is crucial. I always recommend new entrepreneurs seek out a good legal advisor with startup experience who will take the time to understand the nature of the business and lead everyone through the difficult conversations that founders should have. This can act as a form of “premarital” or pre-incorporation counselling to establish realistic expectations. Everyone can then focus on the ultimate goal of launching a great business and delivering that new valuable product or service to their customer.
To be fair to new entrepreneurs, legal advisors and startup programs could do a better job of delivering educational resources and translating what are often new and foreign legal concepts. The new entrepreneur usually does not know what to ask, let alone what situations to avoid. A good law firm should set up their clients for success by providing a startup package that focuses on advice and education; provides multiple meetings that deal with the difficult co-founder conversations, and then includes all the standard startup incorporation documents and contracts as part of the package.
It generally takes a few meetings with your legal advisor, combined with extensive background reading, just to understand some of the legal issues to be able to ask questions appropriate for your startup situation. Work with your legal advisor and invest the time to anticipate potential problems that could arise between co-founders, with new investors, or with minority shareholders (employees, advisors, etc.), and how these may best be mitigated through your agreements. As you work with your legal advisor on your own questions, you may also consider discussing some of the following:
- What are the different roles and responsibilities of directors, officers, employees, advisors, and shareholders of a corporation?
- Who controls a corporation, how can that change over time, and is that good or bad?
- Who controls or manages the shares, options and vesting process, and where is it documented?
- When a startup is created, who should get shares, how many, and why?
- What is sweat equity and who gets to have it?
- Are shares provided to founders for past services, or for future services required to create a successful startup?
- Should the shares that founders receive vest over time?
- What happens to their equity if a founder (or anyone else) leaves earlier than expected?
- What happens to their equity if a founder (or anyone else) can’t perform as expected?
- Should inventors, or tech-transfer offices, who are not officers or directors of the corporation and do not manage day-to-day operations of the startup be granted shares when a company is founded? Does it matter if they are also compensated through royalty-bearing agreements?
- Should shares or options be used to compensate key advisors, contractors, employees, officers or directors?
- What is the difference between a board of directors and an advisory board?
- What are the tax implications of providing shares or options?
- When should a unanimous shareholder’s agreement be in place?
Not all new entrepreneurs seek or heed the legal advice they need, often because they don’t realize they need it. Many new entrepreneurs are cost sensitive and want to minimize the time a lawyer may spend with them setting up a new corporation. What some new entrepreneurs do not always appreciate, is that early legal advice is not just about the incorporation documents, it’s about the advice. It’s about understanding the legal issues you are dealing with as a corporation. I can’t tell you how often I see resentment created by equal share distributions among co-founders that never represent the level of effort that goes into making the startup a success. These co-founder conversations should have happened with a legal advisor before incorporation and share distribution. It is better, faster, and cheaper to prevent relationship problems upfront than to try and fix them afterward.