Startup Law 101 Series – Tips From a Business Lawyer on Becoming a Founder

Introduction

Why become a founder? What are some things you can do to become a successful founder?

Having worked extensively with founders as a startup business lawyer in Silicon Valley for many years now, and having built my own business as well, I have a few tips to share on these points.

Tips on Why You Should Become a Founder

Why become a founder?

1. If you succeed as a founder, you will make far more than you would as an employee. Obvious, but worth repeating.

Founders want the large upside that will come from a successful venture. The goal is very hard to achieve but the rewards can be great.

2. If you succeed as a founder, you keep more of what you earn.

As an employee, you will get hit with ever-increasing taxes on your compensation.

Forget about the rich. It is the average employee who gets soaked. You pay, say, up to a third of what you earn for federal, state, and local income taxes. Add another nearly 10% for payroll taxes. Now assume that inflation bumps you into higher tax brackets. Rates are then raised for those brackets. Then payroll tax rates go up. And the social security cap lifted. And new taxes added to fund future health benefits. You will be left with an ever-diminishing net amount from your pay. Welcome to being the employee of the future.

As a founder, however, your largest reward by far will come not from salary but from a liquidity event at which you cash in your chips. At that point, you pay a one-time capital gains tax for the vast part of the economic reward you derive from your venture. You pay less income tax because the capital-gains rate is lower. And you pay no employment taxes at all. With capital gains, you also control timing somewhat and this can further help minimize what you pay.

It all comes from the same effort. You sweat for what you earn. You can take your reward as ordinary income or, as a founder, convert a big part of it into far more advantageous equity gains. With success, you not only earn more but you keep more as well.

3. Being a founder can be not only financially but also psychologically rewarding.

When you venture out, you get the chance to realize a vision for your company and to benefit not only yourself but also your co-founders, your investors, your employees, your customers and the public generally. You get to watch your enterprise grow and prosper. You get to watch it have an impact on others for good.

The satisfaction you can derive from success is a great intangible reward.

4. Finally, being a founder gives you the independence of being your own boss. You will rise or fall by your own merits. This is a great opportunity and a great challenge. This is the one advantage that most entrepreneurs will ultimately say they value most.

Tips for Becoming a Successful Founder

What does it take to be successful as a founder? Here are a few thoughts.

1. Above all else, build from strength.

Be prepared before you venture out. Get a strong education. Work with the best to get excellent training in your field. Master your craft. Build relationships. Take what you do best and improve upon it. That is the key to innovation. And this is the best path for most founders.

Or you might build on the strength of exceptional entrepreneurial talent alone. Or a specialized skill that lets you team with others who supply what you might lack. Nothing formulaic here. But you do need to build on some form of strength.

This also means that you do not venture out based on a bare idea. Try this one from the bubble era: “I have worked one year in manufacturing and know how to revolutionize that field through an idea I have for a website.” Sorry, but abstract ideas get you nowhere.

It also means you do not do something just because you are tired of something else. Think twice about that romantic little tea shop. That is, unless you know about the business of tea shops. Others do, and they will make you pay. Know what you are doing before you step into something.

No one will carry you when you go out on your own. Therefore, be ready to build on something you do exceptionally well. That is your primary key to success as a founder.

2. Count the cost before you venture out.

You need the right temperament to go into business for yourself. If you crave security and certainty, being a founder is not for you.

Don’t romanticize the process either. Business is tough. You will lose the certainty of a regular paycheck. You will have bills to pay, whether or not you are making money. You will face a non-stop array of challenges, everything from people issues to financial pressures to competitor challenges to legal disputes to huge psychological pressures to all manner of other obstacles. When you get past all of this, or at least most it, you will have built “good will” — that is, a going concern value for your venture. Good will is really nothing more than the advantages you gain from the blood you have spilled. It is a huge plus that makes your business better than others. But you will have to spill blood over it. Understand this up front and be prepared to pay the necessary costs.

It follows, of course, that if you are not ready to pay the costs you should stick with the steady job.

3. When you launch, try to do so with a multi-talented team.

There is no fixed rule here. Experience confirms, though, that a team will be far more likely to succeed than will a sole founder. This may be just another way of saying that, if something is truly good, others will be drawn to it. More likely, it is another way of saying that launching and building a successful venture is hard to do and you need a multi-talented team to make it happen. Where you cannot supply everything, others will supply what you lack.

4. Make sure you have a sound business model.

Technical innovations are great but, in themselves, cannot normally sustain a venture. Sometimes, they can be sold or licensed to a large company. Nothing wrong with that. In most cases, though technology will not be enough.

With or without key technology, if a venture is to be successful, it must have a sound business model that allows it to build and sustain a meaningful competitive advantage that makes it consistently profitable.

Without that, you will go nowhere, no matter how innovative this or that element of your venture may be.

5. Watch your expenses.

Wasteful spending is perhaps the single biggest fault of early-stage companies.

Small business entrepreneurs have far less difficulty with this than do startup founders. Why? Because they usually are dealing with their own money. If you know what it took to earn it in the first place, the odds of your being profligate with it are greatly reduced.

One aspect of wasteful spending is simply extravagance. You get funded and you go out and get the best that money can buy. Expensive offices. Extravagant salaries. Lavish parties. And on and on. In early-stage companies, you will regret such spending when you hit the bumps in the road where you wish you had that cash. Inevitably, you will hit such bumps. Plan accordingly.

Another side to wasteful spending, though, comes from not focusing your efforts properly in the early stages. You have ten great things you want to do as a company. You don’t make good judgments about which of these to focus on. You spend on all of them. In short order, your funds are dissipated before you can build a reasonable revenue stream.

Use good judgment about where you can best use your limited funds and use them wisely.

6. Plan your legal roll-out carefully.

Don’t front-load unnecessary legal expenses. When you are ready for a meaningful launch, though, do your setup properly.

If you have a founding team, make sure you give serious thought to using restricted stock as opposed to outright stock grants when making grants to founders. In other words, keep strings on the stock until it is earned unless there is some exceptional reason not to. Use cheap stock to avoid tax problems. Get the IP into the company. Get employment and consulting agreements in place, making sure all IP from such arrangements goes to the company. Review your trademark issues in connection with any branding you will do. File provisional patents as applicable. When you are ready to bring on a broader team, set up an equity incentive plan.

Work closely with a good business lawyer to do the legal steps right.

7. Fund your company incrementally where possible.

The worst trap an early-stage company can fall into is one where it gets over-extended. Plan intelligently to avoid this trap.

Work with early-stage investors or have a reserve of your own funds to carry you through the phases before you have meaningful revenues.

Don’t put yourself in a position where you are out of options except for shopping your opportunity to VCs. You will either not get funded (the most likely outcome) or you will get slaughtered in the terms of the funding.

Conclusion

Think carefully before venturing forth as a founder. The rewards can be great but you need to be ready to deal with the challenges. If you believe you are, a big, open world of opportunity awaits you.