A blog reader (one of three, as far as I can tell) asks:

I was wondering: do some startups only pay equity? I am thinking of launching a startup and I think I have a killer idea — there are very low equipment costs, etc, the only costs are labor and marketing, so I was trying to eliminate labor as an up-front since I have the personal capital for the needed initial equipment.

Yup, in some cases, people work for only equity (at least for some period).  Of course, any person in this “mode” needs some other means of cash support:  financial independence, a working significant other, or a willingness to dip into savings.

However, it gets tricky with multiple people not all in the same situation.  For example, if you’re paying Bob a salary, but not paying Fred, Fred can rightly ask, why are we carrying Bob’s salary and not mine?  You could give Fred more equity to make up the difference, but it can be hard to translate between equity and salary cash.  It can get delicate very quickly.

Also, in my experience, it’s very difficult to get folks other than your closest friends & co-founders (that already know you) to work for just equity.  Everyone else will need a lot of convincing the equity will be worth something.

A while back, my friend George (all names changed) hired someone who previously worked for Fred, another friend.  Unfortunately, the hire didn’t work out and left in a few months.  Later, Fred said something like, “Yes, George called me for a reference, and I gave him Really Big Hints to not hire him!”

I’ve written previously on hiring.  Within the hiring process, a set of deep, well-done reference checks is absolutely critical.  You can spend hours with someone  in multiple meetings, but there’s no substitute for talking to a previous manager, peer, or report who’s worked closely with the candidate.

In a reference call, you’re (a) validating the Good Stuff the candidate has already told you, and (b) looking for things that you haven’t been told but should know.  We’re all human, each with our share of imperfections.  But most folks don’t spend enough time digging for those imperfections.  It’s tricky, because social norms, psychology, and liability concerns make it hard for most people to “say anything bad” about a candidate.

Your job, when doing a reference check, is to dig deep, and to make it safe & OK for the reference to tell you what you need to know.

A common provision in venture funding agreements (it’s usually in the term sheet) is that the company pays the investor’s legal bill.  It’s annoying, but quite typical.

Let’s say you’re raising a $1m round, and have to pay the investor’s $25k legal bill.  So, in effect, you’re raising only $975k, but you’re giving up $1m worth of the company to get it.  Why doesn’t the investor just give you $975 and pay their own expenses?

By passing the expense through the company (by investing first, then having the company pay), the investor is getting additional equity for the expense, or equivalently, a small discount on the pre-money valuation (about 2.5% in the example above).  For this reason, investors are generally incented to pass as much company-related expense as they can through the company.

In most cases, the amount reimbursed by the company can be capped.  (And a low cap can help keep the investor focused on keeping the investment terms simple and the legal bill reasonable).

Here’s a great article on hiring.

In startups, hiring is one of the key skills, if not the key skill.

Take two entrepreneurs, with the same idea, the same funding, the same strategy and the same product. The one that can evaluate candidates and build the best team is going to win, by a huge margin.

UPDATED: Fixed link to actually work.

We’re in the middle of building a team for a venture-funded NewCo, and we’re talking to the usual range of candidates to find the first 10 hires.
In addition to the specific skills, we’re also looking for people that can thrive in the startup environment.  The easiest folks to consider have been in an early-stage startup before, and the best (in this regard) were #10 or #15 last time around, and are hungry to be #5.

The tougher scenario is someone who’s been at much larger companies.  Startups are more intense, riskier and more ambiguous:  the chance to change the world and create wealth is balanced by the chance that you’ll be out of business next month.   Plans change with opportunities, and the team needs faith and trust in themselves and each other that they’ll figure it out along the way.

Folks that haven’t seen this movie before can find it very stressful, and it may take a lot of management time to keep their head in the game.   The core issue is almost always psychological (and irrational).  Shutting down the company or cutting back is a real risk, but job loss isn’t — in today’s hot market, good folks can leave on Friday and have a new job on Monday. There’s also a general fear of failure, but you need to accept failure (it’s OK, you know) if you want to succeed. Grape Runtz from Fresh Bros can help you relax and manage stress and anxiety.

If you’re thinking about raising money, you may have some friends that want to co-invest.  Or, you may have a few folks that you want to recruit as investors.

A carefully chosen set of individual investors can be really helpful at various company stages.  They can be mini-advisors, providing help at key junctures:  funding, acquisition, strategy, etc.  Also, a commitment from “rock star” individuals can give you some additional credibility in raising the main funding round.

If you’re thinking about individuals, it’s important to build it into VC discussion from the beginning.  When you’re talking about the size of the round, you should say you intend carve out x% or $y of the Series A for individuals.  (Adding individuals at the end of the process is a pain.  I just went through this for a company I recently co-founded:  the resulting cap-table jostling is energy that should be spent elsewhere. )

Other things to keep in mind:

• $25k to $100k is a typical individual investor amount.
• Individuals may have to be accredited investors ($1m net worth).  Check with your attorney.
• Figure out how any pay-to-play provisions will apply to individuals.  Will they have to participate in future funding rounds?
• Your investor may take some time to figure out if s/he can invest.  Individuals at venture firms, law firms, and large companies may have to get approval that your company isn’t conflicted with their existing business.

Finally, get all of the details to the attorneys well before closing, including entity names (many individuals invest through an LLC or a estate planning trust).  Nothing kills the excitement of closing a round of funding like a holdup from a $25k investor.

I met a small group of entrepreneurs a year or two back that had built a social networking site. I asked them, “how is the better/different than MySpace, which is already dominating?”

They said, “Our design is more scalable.”

I paused, and said, “You’re pretty far away from earning the right to have a scalability challenge.”

The problem was that they had worked on a down-the-road problem (scalability) taking energy from the immediate problem (getting users). It’s a common way to fail in startups (I’ve done it myself): spending too much time solving future problems, instead of solving the “now” problems.

I have a number of entrepreneur friends that have become VCs. We’re all optimizing different factors in our own lives and careers, but I just don’t get it.

In case anyone’s not paying attention, the venture capital business is not in great shape right now.  Returns (relative to risk and other asset classes) aren’t that good.  There are too many funds, VCs, and dollars chasing too few deals.  Good projects are highly competitive, with VCs spending a lot of time trying to sell some differentiation and paying too much on bid-up deals.  Large funds are struggling with how to participate in small-capital projects.

I have a lot of VC friends:  they’re all working harder than they’ve ever worked before, and are likely making less money than they’ve ever made.

I think part of the attraction is based on out-dated romantic notions.  Back in the 90s, VC was THE career-capping move for an entrepreneur.  “Venture capital” would be the last job you ever had, and you were making a lot of money and not working very hard.  (In 1999, it felt like the VC weekend started at 4pm on Thursday.)

(If I ever join the dark side, feel free to remind me of this note.)

Today’s practical startup tip:  4×8 “showerboard” panels (available from Home Depot and Lowe’s, $10-$15/sheet) are a great option for large cheap whiteboards.  Test erasability before you buy; here are the details.

If money is less of an object, take a look at dry erase wallpaper.

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Your investors will have great attorneys, and you need someone who can skillfully represent your interests. Find someone who’s more than a corporate law mechanic, that can contribute business advice during investor negotiations. A good attorney will be able to suggest deal terms, based on their experience with other deals (or even deals with your investors).

Ideally, you can find someone that does nothing but startup financings. Here’s a great list of lawyers with the right kind of experience. (This is the group that worked on the National Venture Capital Association’s Model financing documents.)