Once upon a time there were two engineering PhDs who were clueless about how to start a company. All they knew how to do was code. They were so desperate for money and adult supervision that when an experienced businessperson showed interest and offered to help raise money, they, in their own words, “followed him like dogs.”
However, this adult didn’t know much about tech startups and caused them to make many mistakes in legal and financial matters. They parted ways but only after much aggravation and the significant legal expense of undoing incorrect decisions.
This is not an unusual story, and it’s an understandable one. First-time entrepreneurs are looking for any particle of positive feedback, reinforcement, and advice, so they jump at the first sign of interest. The demand for adult supervision in the form of advisors, board members, and investors far exceeds the supply, so you may need to take a chance with people who are untested in these roles. If no one will dance with you, the temptation is to dance with the first person who asks.
Here is a test to separate the contenders from the pretenders. These questions will help you identify good advisors, board members, and investors (if you have the luxury of choosing investors).
- What kind of corporation should we form? Answer you’re looking for: “C corporation” assuming the goal is to create the next Google.
- In what state should we incorporate? Answer you’re looking for: “Delaware.”
- Do our investors have to be accredited investors? Answer you’re looking for: “Yes.” Answer that should scare you: “No.”
- Should two founders split the company right down the middle? Answer you’re looking for: “No, you should allocate 25 percent to future employees and 35 percent to the first two rounds of investments. That leaves 40 percent for the founders to split amongst themselves.”
- Should we sell common or preferred stock to investors? Answer you’re looking for: “Preferred.”
- Should all employees, including founders, go through a vesting process? Answer you’re looking for: “Yes, everyone should vest because you don’t want a founder to leave with a significant percentage of the company after a few months.”
- Should we pay consultants with stock options? Answer you’re looking for: “No, stock options are for long-term employees, not short-term consultants. If you can’t afford consultants, do the work yourself.”
- Can we get a bank loan to start our business? Answer you’re looking for: assuming it’s a tech business, “No.” Tech businesses don’t have liquid assets to use as collateral.
- Should we use an investment bank, broker, or finder to raise seed capital? Answer you’re looking for: “No, angel and venture-capital investors view early-stage entrepreneurs who use a banker, broker, or finder as clueless.”
- What do we need our revenue projections to look like in five years to attract investors? Answer you’re looking for: “No investor will believe them anyway, but they should be as good as the closest comparable successful company that has already gone public.” Also, you don’t want money from investors who do believe your projections because they are clueless.
- How long should our business plan be? Answer you’re looking for: “You shouldn’t write a business plan. You should get customers.”
- Is there someone else you would also recommend who could be a good advisor? Answer you’re looking for: “Sure, my expertise is narrow, but let me come up with a list of other possibilities.” Answer you’re not looking for: “No, you don’t need anyone else; I know everything you need to know.”
- Do you think we need a real CEO? Answer you’re looking for: “Maybe, someday. But probably not right now. What you really need right now is a great product.”
- Should we use a headhunter to recruit people? Answer you’re looking for: “No, at this stage, you don’t have the money and can’t afford to spend what little you have on headhunting fees.”
- What should we tell investors when they ask us for the valuation of the company? Answer you’re looking for: “Find out what three or four investors think is fair, and then get more market traction to push it up.” Wrong answers: “Price it high and negotiate down.” “Price it low and negotiate up.”
These questions are relevant to US companies with Google-esque ambitions, but the same kinds of questions apply in other circumstances. Run away from anyone who wants to advise you who can’t answer most of these questions.
