Platt Perspective on Business and Technology

Balancing resources and needs in the startup and early stage business – 1

Posted in startups by Timothy Platt on June 7, 2011

I recently received a request from a colleague in Japan that in fact closely meshes with my own thinking. This request was from an entrepreneur who has found interest in at least some of my postings on startups and early stage businesses and he asked me to consider adding more postings there, more fully covering the issues involved. I had already been thinking along the same lines with a set of puzzle pieces in mind that I would identify here.

• Startups in many if not most cases begin from an idea, absent any organized structure for fulfilling it. Franchise system startups can and do generally come with a lot of tested and validated template patterns, processes and resources to turn to and that is at least as much of why entrepreneurs would pay franchise fees, as are established brand and name recognition that they could start with. Going further, a franchise system that does not provide structured startup support and guidance in exchange for those fees is much more likely to see outlets fail for this absence so their brand will not show as much value to the aware entrepreneur who does some due diligence anyway. But for the purpose of this posting and those to follow, I will assume an independent entrepreneur building from scratch to promote, develop and gain profit from their own business ideas and product or service concepts.
• Founding entrepreneurs may or may not have business management experience going into this, but I set that set of issues aside here, simply noting that I will deal with it in my Guide to Effective Job Search and Career Development.
• Founders and any founding partners they can bring in will have only so much liquid capital they can invest in this effort, and this is where terms like burn rate come in – the rate at which liquidity available to the startup is expended from day one until cash flow coming in matches cash flow going out and break-even is achieved.
• When you build a startup you need to effectively cover a wide range of skills and experience requirements, some of which are relatively stable and independent of the business stage (e.g. accounting and bookkeeping standards, processes and protocols – see GAAP) and some of which are quite stage-specific (e.g. developing complex systems like IT in realistic, cost-effective stages where everything will have to be done that is done, by one person to start.)

There are a lot of trade-offs inherit in this list, some of which may not be initially apparent. One of them involves covering all of the essential here-and-now skills sets needed to successfully build and launch, for the initial and early here-and-now stages. A well balanced founding team will include people with experience if not in-depth expertise in all of the core functional areas needed for startup, but it is likely that issues will arise that call for skills and experience not available strictly within the founder’s team.

• Should the founding team be expanded?
• Should non-founder staff be brought in and how will their compensation issues be handled?
• Should certain tasks be outsourced or handled by consultants, and if so what, for how long, and on what compensation terms?

Liquidity issues come in here, and so do ownership and equity issues. The more you expand the founder’s pool, the more you dilute ownership share that any one member holds, and regardless of what proportions of ownership each individual member of the team can claim. You start with 100% to divide up and that is not going to change – and its overall value is not going to expand until you both reach break-even and also go cash-flow positive and start generating a profit. And even there at least at first, it is usually going to be necessary to defer any profits-based compensation, primarily rolling any positive cash flow back into the business to keep it going.

Founders may be willing to enter into pure future equity agreements and defer anything short term in the way of compensation, but any non-founder who comes in as an employee should be compensated more directly for services provided.

I have worked with colleagues who provide specific consulting support to startups and early stage businesses, offering interim CXO services, and particularly interim CFO and COO services – I even helped a group of startup consultants set up a business to provide this type of service once. Their basic business model was not to take equity stake for compensation, requiring contractually agreed to fee for service or retainer compensation.

• Consultants ask for cash up front, even if they do sometimes accept a portion of their compensation deferred or even as equity share – if they are willing to take a chance on that startup business and risk losing a part of their compensation on it as a bet.
• Non-founder early stage employees, coming in pre-break even should get at least some of their compensation as salary, and pre-revenue employees definitely should be receiving cash payments. Otherwise they are assuming the risk of a founder without the potential returns and long term gains that founders are working towards.

Both can significantly add to burn rate and a startup or early stage that runs out of liquidity fails.

I know I over-simplify here where for example pre-revenue employees per se are not going to be asked to contribute to the liquidity fund – or at least they should not be unless they are specifically invited to become founders and owners, with both owner’s stake and owner’s potential for long term gain. But the basic principle holds: owners and founders, and I add anyone else entering into involvement with a startup or early stage face a lot of trade-offs and balance point decisions.

I am going to respond to my Japanese colleague’s request, and my own at least half-formed planning by posting a short series on this set of issues, and my next installment will delve a bit into the issues of what skills to cover in-house, and the decision processes of what to bring in at liquidity cost and what to defer or do without.

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