So you’ve just started your company, and as with most entrepreneurs, you have very limited money for service providers of any sort.  That said, you have heard in the past that it is always best to get a lawyer involved in the company sooner rather than later, especially if you’re looking to raise capital in the near future.  You’ve decided to bite the bullet and hire a lawyer, but you want to spend wisely. Lawyers can provide a large portfolio of services, but for the entrepreneur on a limited budget here are some suggestions for targeting your legal dollars:

1. STOCK OPTION PLAN.  In order to attract and retain the best executives and key employees, particularly in the technology industry, you will need to be able to offer attractive equity packages.  Potential hires respond to offers of cash for sure, but if that’s in limited supply, giving an equity stake in the future success of the company will make an offer more attractive.  However, if not done properly under an option plan, grants of equity are fraught with pitfalls for the unwary—unintended ambiguities in the grant language, failure to implement vesting, a lack of compliance with securities laws, unintended tax consequences to the company and its employees, and the list goes on and on.  These issues often lead to costly disputes.  At an extreme, they can make a company unfinanceable, for investors will rarely put money into situations where the capitalization of a company is unclear or in dispute. A properly drafted stock option plan is money well spent.

2. FOUNDER ARRANGEMENTS.  Preparing the appropriate arrangements between the company and the founder is an important step and should be done before capital investment is made.  These arrangements typically include the purchase of founder’s equity, assigning intellectual property from the founder to the company, documenting founder loans to the company, and putting in place a founder employment agreement with the company.  Often, founder’s stock is subjected to vesting similar to stock options.  Investors like to see vesting for founder’s stock because this gives the investors comfort that the founders will be around for awhile or at least until their stock is fully vested.  It is also important to put in place legal arrangements amongst multiple founders.  Fact is, it is the rare management team that is 100% the same from inception to exit event.  How will you feel if your 50% partner leaves the company but keeps his stock while you continue to build the company’s success?  Co-founders need to put in place legal arrangements, most typically either through a simple vesting schedule or else through a more detailed buy-sell agreement, setting forth what will happen to the equity of the company in the event the co-founders’ participation in the business changes over time.

3. EMPLOYEE AND INDEPENDENT CONTRACTOR AGREEMENTS. Clarifying in writing the terms of employment and contractor relationships is one of the best ways to ensure your company is protected and avoids disputes and litigation down the road.  Ask your lawyer for a form employee offer letter and a form independent contractor agreement.  Particularly if you are a technology company, you also want a form employee proprietary information and inventions agreement (see intellectual property below).  The forms you use should be geared toward entrepreneurial companies and therefore include appropriate language for making stock option grants and covering other issues unique to emerging growth companies.

4. INTELLECTUAL PROPERTY ARRANGEMENTS.  Any intellectual property created by one or more of the founders should be properly transferred and assigned to the company such that the company now owns that intellectual property.  With respect to employees and contractors, it is important to document terms such as confidentiality and the assignment of intellectual property developed by the employee or contractor while working for the company, including those of any founders that are also employees.  Any future investors or potential buyers will want to have assurance that the intellectual property of the company is in fact owned by the company and not by one of the employees or contractors.  Accordingly, preparing the documents to evidence such terms is one of the most important steps in “getting your ducks in a row.”   Likewise, if you hire software developers or others to help you code, you need appropriate legal arrangements to ensure that the end product will be 100% owned by the company.

5. FINANCING TERM SHEET.  Experienced emerging growth attorneys have seen hundreds if not thousands of financing term sheets.  What likely looks like a foreign language to you is actually standard fare for your lawyer.  Your lawyer can walk you through an Angel or VC term sheet to help you understand where the risks and areas of opportunity for negotiation are.  This is time well invested.  It does take some time for new founders to come up to speed on this stuff, and you are best to begin your education regarding financing terms in advance of negotiations with potential investors.  With a solid foundation of the impact of various terms, and the knowledge of the range of what comprises market, you will be able to negotiate a financing deal that emphasizes the terms that are most important to you and also is reasonable and attractive to investors.

In my next post I’ll talk about the top five worst uses!

As promised in my last post, here’s a brief checklist and some rules of thumb to determine if a patent is right for your business. Before you go through the time and expense of filing a patent application, go through the following checklist and honestly answer the questions.

Question 1:  Is the invention (product or process) different in any way from information that has been available to the public for more than a year (e.g., described in a printed publication, offered for sale, used to produce a product)?

Significance:  “The public” means anyone who does not have a confidential relationship with you.  The information can be in any form, for example a product, a written publication (including for example, a U.S. or foreign patent, a scientific or trade journal, or a trade brochure), a publication on the Internet, or a display at a trade show.  A sale, or offer for sale, of the new product, or of a product of the new process is also “information”.

Question 2:  Does the invention provide us a competitive advantage?

Can it do something not done before?

Can it do it cheaper?

Can it do it better?

Significance:  If the answer is no, it’s not worth filing since a competitor can practice an equally good option.

Question 3:  How large is the potential market?

Significance:  If the market is less than $50,000 per year, then it is possible no one will compete.

Question 4:  How long will the market exist?

Significance:  If the market will not exist two years from now, patent protection may not make sense since it generally takes at least two years to get a patent.

Question 5:  How likely is it that there will be competitors in the market?

Significance:  If there will be no competitors, there is no reason to file.

Question  6:  Can I contractually prevent all customers from doing it themselves or purchasing from a competitor?

Significance:  If the answer is yes, there may be no reason to file.

Question 7:  Is this an invention that can be licensed to third parties?

Significance:  If the answer is yes, then most likely file since royalty rates are generally higher for a patented invention.

Question 8:  Can I protect this as a trade secret?

Would it take considerable effort to reverse engineer the invention?
Will disclosure to the customers be unnecessary for them to use the invention?
Will disclosure to the government be necessary (which may destroy trade secret protection)?
Does anyone already know the invention such as consultants or university researchers (which may destroy trade secret protection)?
Can I protect the invention from ex-associates and partners and ex-spouses?

Significance:  If the answer is yes, trade secret protection may be the way to go.  An option is to file a patent application, and reserve the trade secret vs. patent decision for later.

Question  9:  Will filing a patent application and satisfying the “best mode” requirement require disclosure of valuable trade secrets

Significance:  A “yes” answer may mean no filing.

Question  10:  Can I protect this with a copyright or trademark or trade dress rights?

Significance:  If the answer is yes, there may be a cheaper and easier way to obtain protection than through a patent.  Consult an attorney regarding these options.

Question  11:   Is this invention unobvious compared to what came before it?

How different is the invention from the prior art?
How long have people been trying to solve the problem?
How much effort and time did it take to solve the problem?

Significance:  To actually receive a patent, it is necessary that the invention be unobvious.  However, I recommend that a patent application be filed for any commercial product that is “different”, even if “obviousness” is problematic.  The “patent pending” notation generally slows down competitors enough to more than justify the cost of a patent application.

Question  12:  Has anyone who does not have to assign his or her rights to me contributed to the invention?

Significance:  If third parties will have the right to practice the patented invention, it may not be worth filing.

Question 13:  Can I obtain an enforceable patent? Can I detect if someone is infringing?

Significance:  If the patent is not enforceable, there may be no reason to file.  For example, if the invention is a new process for making a product, but the product is indistinguishable from products made by the old process, it may not be possible to detect infringement.

There are multiple types of applications for patent protection that are available.  Two of the more common are Utility (Provisional and Regular) and Design.  The difference between design patents and utility patents is that design patents only protect the non-functional appearance of a product, while utility patents cover how your invention works.  For some products both patent types may be available.  The main advantage of design patents is they are relatively inexpensive to obtain.  The main disadvantage of design patents is the scope of protection is generally narrow – they only cover the appearance of the product shown in the drawings, and not the product’s function.

If a utility patent is appropriate for your invention, then you need to decide whether to file a regular application or a provisional application. Because of their lower initial cost, provisional patents can be more attractive to start ups. Some of the more significant pros and cons of filing a provisional patent include:

ADVANTAGES OF A PROVISIONAL APPLICATION

1. Slightly Lower Initial Cost. The initial cost of preparing and filing a provisional patent application generally is lower than that of preparing and filing an actual patent application. This is because of the lower PTO filing fees and the more limited requirements of a provisional application.

2.  Delay of Examination Costs. Since a provisional application is not examined by the PTO, examination costs are delayed during the pendency of the provisional application.

3.  Shift of Patent Term. The end of the patent term can be shifted one year into the future, an important advantage for inventions, such as drugs, whose commercial value may be at the end of the patent term.

DISADVANTAGES OF A PROVISIONAL APPLICATION

1.  Delay in Issuance of a Patent. A provisional application cannot result in a patent— an actual application will eventually have to be filed.  Accordingly, the initial filing of a provisional application, instead of the immediate filing of a regular application, necessarily delays the issuance of any resulting patent.

2.  Higher Total Cost. The overall cost of initially filing a provisional application and then following up with the filing of an actual application will necessarily be more than the immediate filing of a regular application.

3.  Accelerated Foreign Filing Costs. Filing a provisional patent application starts the one-year period within which foreign patent protection must be applied for.

In next week’s post I’ll provide an entrepreneur’s checklist for determining if a patent application is required (or appropriate for your product or invention.

Periodically we will have posts from local entrepreneurs that provide some sound advice from a slightly different perspective. Today’s post is from Jason McDowall, a local serial entrepreneur that I’ve had the opportunity to work with and get to know over the last couple of years.  Jason was previously the co-founder and CEO of Adhoc Mobile, a developer of a sophisticated mobile ad and content delivery platform, that raised $3M in Angel financing. Jason is now the VP of Product Development at Benchmark Metrics, an angel funded developer of web-based business analytics tools.  Just a brief editorial note…the angel investors he describes below were not from the Pasadena Angels. 

By Jason McDowall

You’ve  shaken the loose change from friends and family, and now you’re desperate for cash to get your startup to the next level.  Do you think any check that doesn’t bounce belongs in your checking account?  In my experience, I believe you should be picky about who supplies the cash.  If your investors aren’t helping your company, they’re hurting it.  Here’s what can go wrong:

Risk: the investor does nothing

Who cares?  At least you’ve got some extra time and resources to build your dream, right?  That hasn’t been my experience.  Sure that convertible debt or silent investor may have bought you extra time, but your milestones and plans are probably wrong to begin with.  You’ll need even more time and more resources to execute than your business plan indicates.  For seed-stage companies, there is so much work to be done, so many adjustments to make, so many relationships that need to be established that you need your investors working for you.  Why waste your time or equity on an investor who cannot contribute essential customers, contacts, or credibility?  Your competitor is already better funded and has that support.

Risk: the investor promises a lot and does nothing

This is even worse than the risk above because you have misplaced expectations and end up wasting a bunch of precious equity/cash/time on a non-delivering member of the team.  If you are lucky enough to have someone offer you money, you owe it to your company/team to do some reference checking on the source of funds.  Talk to other companies that have received investments from the same source, and find out if they have they delivered on similar promises in the past.  If the investor is taking a role in the company (e.g., temporary C-level exec, VP of anything) check the investor’s work references just as you would for any other hire.

Risk: the well runs dry…or loses interest

Chances are the specifics of what your company does and how it makes money will change between the start and the declaration of success.  And to make it more challenging, it will take longer and cost more than you think to get there.  An unsophisticated investor or one unfamiliar with your industry may not have the appetite for the inevitable trial and error process.  You definitely need to be smart about market validation and finding ways to try/learn/adjust quickly

But you also need an investor who appreciates the need for, and can supply or quickly facilitate, additional funding to get you to that next major milestone (assuming you deserve the chance).  Finding an angel who made a bunch of money in real estate to invest and take a board seat in your web widget software startup is probably not the best move.

Risk: adversity strikes and visions begin to differ

At the beginning, everyone is full of excitement and enthusiasm.  But as you struggle to make your milestones and find yourself tweaking the business model, things can quickly get contentious.  It can be hard enough to keep the founding team on the same page, motivated, and making progress.  Having to deal with investors who have different visions of how and where to make necessary adjustments can make life miserable.  I’m not suggesting investors should all be drinking the same amount of Kool-Aid and believe all of the hopeful assurances of the founder.  But you should make sure financial incentives are properly aligned and voting procedures clearly in place to help deal with the hard times.  Also ask other portfolio companies how the investor has dealt with hard times in the past.  If you’re looking for strategic money at the seed stage, understand how that will likely restrict your growth options in the future.  If you’re looking for angel money, he or she needs to understand the likely dilution of ownership and power that will come if you end up needing another round.  And when things begin to diverge from the plan, be clear, be honest, and be prepared to make some concessions.

Creating a successful company is hard.  It requires a market insight, hard work, tenacity, flexibility, and some luck.  And it requires a lot of help.  In addition to cash, seed investors (and board members) should bring or be at least one of the three essential C’s: contacts, customers, or credibility. Remember that due diligence goes both ways.

Now if you could just elicit enough interest to actually have a choice….

This week one of our firm’s clients got a call from a promising VC for a first meeting. Although many of the posts on this site address putting together the optimal investor presentation, there are often times when you’ll meet one-on-one with a prospective investor. These meetings may be a precursor to pitching to the group or due to a chance encounter at a conference (or even the parking lot). Here are some words of guidance that may be helpful—whether it’s with an Angel or VC.

For starters, check out their stable of portfolio companies to see if the firm has funded anyone in a similar field. If so, it will increase the likelihood that they will really get what you are doing. But if they have directly competing portfolio companies, it will also add an element of caution to what you discuss with them. While generally you’ll get nondisclosure agreements from those with whom you share company info, Angel groups and professional venture capital firms won’t sign them.

A first meeting with a Angel/VC will be focused primarily on his understanding your technology–what it is, the problem it solves, and the size and scope of the market it serves. Before you delve into the technology details, be sure to clearly explain the answers to each of those questions in the first two minutes of the meeting. You’ll want to show them why this is the next big thing, if only for the capital that could help bring it to market and scale it into a much larger enterprise. Getting that across (and succinctly in the first few minutes) is much more important than demonstrating the bells and whistles of your technology.

Although it won’t be the focus of the conversation, he/she may start to sound out some investment related factors. Be prepared to talk about your funding needs and what you would accomplish with that money (not just what you would spend it on, but rather what business milestone it would enable you to accomplish). They may or may not ask you what you’re thinking in terms of valuation, so be prepared to answer with a range. Build in some negotiating room but keep the valuation range realistic also, for he is mentally ascertaining whether you’re reasonable and whether or not there is a deal to be made. It’s also helpful for them to know about IP protections like patents you may be seeking. He may sound you out to see if you are open to a CEO or other seasoned management. Express a willingness to embrace that expertise. Aside from these basics, most of the focus in the first meeting will likely be on your technology and the scope of its potential.

First steps if they’re interested will be to request a bunch of diligence items from you. Great sign if they proceed along that path and good likelihood of proceeding to the next step in the process.

I’m not a fan of using Trade Shows and / or lures at trade shows for marketing purposes. So I was hugely impressed by CPC, an industrial coffee kitchen catering company, when they appeared at LegalTech.

Why? On the face of it, their presence made no sense. The trade show was about technology for law firms – servers, software, storage. It was attended by IT professionals. Why should a bunch of coffee-stockers attend?

The answer was of course brilliant, which was that for the majority of small law firms, their entire infrastructure (including facilities, eg the purchasers of coffee-stocking services) reports to the same decision-maker.

Who was at this show, because tech decisions are expensive.

So CPC had just positioned themselves to meet directly with the decision-makers, all at once, in a venue where CPC faced no competition.

Additionally, CPC’s execution was flawless. They set up at the entrance / exit to the main floor, and their booth looked like an actual coffee vendor… but with a big price-board declaring the price of each item listed to be “one business card”.

So picture yourself as a tired executive. You want coffee. It’s there in front of you, it’s free, and all you need to do is trade a business card. And chat with the nice servers, who are also salespeople.

You rest a moment, the coffee is great, the people are nice, and the cost of their service seems quite reasonable in comparison to the technology you’ve just seen.

I believe that CPC sold more at that show than most other vendors there. Brilliant marketing… and not a bad cup of hot chocolate, either.

A patent may not be the appropriate type of protection to seek for your invention for multiple reasons. First, not everything invented qualifies as patentable subject matter– thus a patent may not even be available. Second, there are other types of protection available that may better suit your business goals or may be less costly than a patent.

One alternative type of protection to consider is copyright protection. Copyright protection is available for original works of art, software code, books, fabric patterns and the like. Copyright protection is automatic, registration is inexpensive, and copyright protection lasts much, much longer than patent protection. So if your invention is something like a new doll with an original appearance, a copyright may be a viable alternative. Similarly, if your invention is implemented with software, a copyright on the software code may provide adequate protection. Although the copyright in software does not protect the method implemented by the code, no one can copy the protected code.

Another type of protection that’s available is trade secret protection. Maybe you can keep your invention secret. How many decades has the formula for Coca Cola been maintained as a trade secret? Trade secret protection is only useful if you can maintain your invention secret. If your product can be reverse engineered once it’s on the market, trade secret protection is not effective since there’s no “secret.”

Don’t consider using a trademark for protecting an invention. All that a trademark protects is the name or logo under which you market your product. It provides no protection for how the product works or appears. Thus any trademark you have will keep others from selling your product under the same name; it won’t keep others from selling the same product under a different name.

Another type of protection to consider is trade dress protection. If the appearance of non-functional features of your product becomes recognized by consumers as distinctive, i.e. they come only from a single source, trade dress protection is available. The problem with this type of protection is that it takes many years in the marketplace and high sales volume to accomplish. It doesn’t keep someone from copying your product right after it is introduced to the marketplace. Also, it doesn’t protect how your product works; it only protects what it looks like.

Also consider whether multiple types of protection can be used. Maybe you can use a combination of patent protection, copyright protection, and trade secret protection. There may be aspects of your invention that are suitable for all types of protection. As an example, a computer implemented invention might have copyrightable code, copyrightable screen shots, and the invention as a whole may also be patentable.

Why is it that so many marketers apparently can’t calculate the time value of money?

The math involved is fairly simple.

Take, for example, an executive earning $500 per hour.

If you want them to fill out a six-minute survey, that’s $50 of their time.

Do they receive something that’s worth at least $50 (in their eyes) for that six-question survey? If not, why would you expect any significant number of people to take that survey?

As Abraham Lincoln said, “You can fool some of the people all of the time, and all of the people some of the time, but you can’t fool all the people all the time”. So sometimes you can trade time for golf balls (for example, at trade shows, where people get caught up in the hype and alcohol) – but most of the time you need quid pro quo.

[Consider: the type of person whose time value of money is low enough to make your survey-for-golf-balls worthwhile is probably not your target customer.]

My favorite recent example of this sort of situation was Infoworld magazine, a favorite of mine since their gossip column published my comment on Dell’s customer service hotline (“Please hold, we are currently servicing other customers”. Yikes!).

Infoworld will happily send you a free subscription if you’re a “qualified” professional – eg, if they can lease you as part of their advertising mailing list.

To obtain the free subscription, however, you had to fill out a multi-page survey, which ended up taking me about thirty minutes.

I didn’t know it was going to take 30 minutes. In fact, it was 15 minutes into the survey, as I was starting to get frustrated at how much time it was taking, that I calculated the time value of that survey.

I was shocked to realize how much I was “paying” for my subscription. And of course, by the end of the survey, I was filling in random answers just to finish quickly, so Infoworld was actually doing themselves a dis-service with such a long survey, reducing the specificity and value of their list…

So the good news is that they seem to have wised up. Infoworld’s latest renewal survey was just seven questions long. I have to suspect that as a result of their changes, their lists are cleaner, and their volume of subscribers higher as well.

So check for yourself. How much are you worth per hour, and how much are your customers worth? Do you really need to give ‘em the third degree up front? Or can you lure them in a bit first?

My thinking: be patient. Wait for the second date, ok?

Every startup faces the question of who to hire for their first sales position. Do you look for that fantastic VP of sales who is not only a great closer, but also a master strategist? Do you hire that friend of the founder who is young but promising? How do you decide?

Start by considering what you really need. Most startups have several specific needs that your first sales hire must fulfill. Hiring a salesperson is no different than building a piece of technology. Your management team should agree on a specification for the position, and then hire to that spec. Otherwise, you risk “falling in love” with candidates that may or may not bring the skills your company needs.

The likely list of needs:

1. Sales Momentum
Every startup simply needs to begin making sales. Look for someone who has sold a similar product successfully in your space, and who has some small company/unit experience. Dropping a successful corporate salesman into a startup can be a disaster. You need someone who shows evidence of self-sufficiency, not a prima donna. Have they pioneered a new geographic market or launched a new product? Started a new department? Look for the clues. Ask your candidates to cite examples of creating momentum in their past jobs.

2. Raw Sales Talent
Don’t trust resumes—make the candidate demonstrate their sales technique. The best interview “test” I was ever given was being asked to formally present my tentative sales strategy to the entire management team of a startup. I stood up with my PowerPoint presentation, pitched it to the management team, and then took questions on why I choose that approach. That management team got a thorough demonstration of my abilities to make enterprise sales.

Ask your candidate to give you a sales pitch—either for their current product or a rough version of the pitch they’d use for your product.

3. Market Intelligence
Your first sales hire is going to bring back critical market feedback on your product as he sells. The right salesperson will be a very important member of your product development team.

Check their abilities by talking to past or current clients. Does he/she listen well? Can the client describe a situation where the salesperson went “above and beyond” to make their product really work for the client? Talk to at least 2 clients and find out.

4. Process Building
Your first sales hire is going to build version 1.0 of your sales process. They will develop the sales message, build pipeline tracking and forecasting, and lay the foundation for scaling up the sales team as you grow.

The right candidate will be able to show you examples of how they have done each of these tasks in the past. Can they give you a crisp “elevator pitch” for their current product? How accurate has their pipeline reporting been in the past? Look for examples.

The overarching message is this—hiring a sales candidate is no different than building your product. Build a spec, and hire to that spec. Don’t be afraid to test your candidates—have them do presentations, talk to clients, find out why they win and lose accounts. Don’t become obsessed with finding the (probably mythical) perfect VP that you will keep on the team for all time. Just find someone who can get the job done right now.

Parting thought—“Hiring with Your Head” by Lou Adler will help you formulate your thoughts. You can find it at Amazon.

After starting 5 successful companies including 2 acquisitions, 1 IPO and my last company, StrongMail Systems… The first few weeks of starting my newest company, the Rubicon Project, reminded me of how critical it is to have the right team. I have been absolutely amazed by what an A++ team can produce in short periods of time. It has reaffirmed every thought I have ever had about my philosophy that great companies are built by great people.

To me, bringing together the right team has always been a product of trusting my instincts and my initial gut on people. So, I decided to spend some time trying to document what it is that I look for.

Here is what I came up with:

1. Trust
If you can’t trust someone 100%, don’t bring them on to your team. Period. If you do trust them, support them 100%.

2. Winners
Once someone has had a taste of success, they can never shake it. No one wants to do something less than their last win. So, those who have been part of a winning company have set the bar and anything less than exceeding that bar, in their mind, is failure.

3. Fire in the Belly
Hire people with an insatiable appetite for getting things done. You can generally tell who these people are because they can’t sit still in their seats.

4. Good Athletes (versus Good Resumes)
Things are constantly evolving at a startup. It’s more important to hire quick learners that can adapt versus deep experience. Smart people figure things out and will help evolve the business. Plus, they bring a fresh perspective.

5. No Egos
Strong egos will kill the culture of an early stage company. They will bring out the negative egos in everyone. Kill it fast, otherwise it will spread like a contagious, mutating disease. All for all and none for one.

6. Active Communicators
Communication is contagious. The more “in the flow” communication, the better.

7. Diversity
While it is good to have like minded individuals, it is equally important to balance that with people who have different perspectives and points of view.

8. Entrepreneurs
People who are driven to build something, will. Don’t be afraid to hire people with high ambitions to start their own company. These people will be your best leaders.

9. Hard Working
Speed is one of the core strengths of an early stage company. Hard working people that are committed to winning will spend the extra time to learn. It allows them (and the company) to make more mistakes (on the path to finding the right answer).

10. Pride
You can’t teach people to take pride in their work, so find people that do. Pride trumps all other motivators to do a superb job.

11. Purpose Driven - Focused on Results, Not Methods
All too often, people focus too much on the methods and not enough on the results. Find people that are driven by the results and are bored by the methods.
Warning: Stay away from people who talk about things like planning and architecture before they talk about purpose (the end goal). The most productive people start every plan by clearly stating the purpose first.

To me, these are the minimum requirements; all are required without exception. This is not a case where 10 out of 11 is good enough.

Another thing to note, is when bringing a founding team together, ensure that you all share the same criteria and values in people. Great people attract more great people.