Recently I’ve run into several situations when mentoring student ventures where they have run into difficult issues with their colleagues because they don’t seem to understand the difference between a team and a company.
Teams have members, who are all basically equals. Companies have officers and staff, where officers generally have more authority than executives, managers, and staff.
Companies are business entities. For the purpose of startups that means that they are corporations: S-Corps, LLC (Limited Liability Corps), or C-Corps (venture backed companies virtually always must be C-Corps). Disclaimer: I am not now, nor have ever been a lawyer. I’ve never even played one on TV. So for legal advice on what type of business entity your startup should form, see a lawyer. But once you decide to go into business you need to form a corporation. You are no longer a team.
I see so many teams come in to be mentored with team members carrying the titles of CEO and COO. There are no such things in a team! In a corporation the CEO reports to the Board of Directors. Other CxOs, such as the CTO and CFO, report to the CEO. So teams – please stop it with the high falutin’ titles! “Team leader” and “Team members” are sufficient titles before you form a company.
A bigger problem is confusion about equity. I literally have seen a team come in for mentoring that had no founders’ agreement and were not a business entity – they were not incorporated – yet they were arguing about how much equity each person should get! Equity is shares issued by a company that represent ownership. Without a company there are no shares, there is no equity.
Another major issue where young entrepreneurs get confused is the difference between a project, an idea, and a product. Teams are formed to work on a project, usually a short term task which may be related to their academic work. Teams may come up with an idea for a product but ideas by themselves have no value – they can not be patented nor copyrighted. Only the expression of an idea can be copyrighted or patented. Yet I’ve seen a team fighting over who owned the “idea” that their venture was working on. Yet they had no demo, no prototype – no tangible expression of that idea.
Projects are often school assignments or outgrowths of academic work. Projects are usually time-limited and resource-limited. A project may turn into a product, but only if that project is owned by some type of business entity.
It is this phase change from team to company and from project to product where young entrepreneurs seem to get confused. I think this is an unfortunate outgrowth of the proliferation of startup contests. Teams enter these contests and then get the idea that they are actually a company and start handing out titles and deciding how much equity each owns.
So how do young entrepreneurs who have been on a team avoid these issues?
- Decide who to go into business with. Often not everyone on a team is suited to or wants to be in the business. So the first issue is who will be the founders of the business.
- Create a founders’ agreement. The founders’ agreement spells out who is in the venture, what their role and responsibilities will be, the method for deciding who gets how much equity, what happens if a founder decides to leave and similar business issues. It is a good idea to decide who will be in charge – where the buck stops. You will need someone to act as CEO or president. You can put off that decision, but should have a time frame for deciding and a method (majority vote of the founders, unanimous vote of the founders).
- Form a business entity. If you plan to raise venture capital you may want to form a C-Corp from the get-go, the form that VCs insist upon. Or your lawyer may recommend an LLC, which is cheaper and simpler to set up. LLCs can be changed to C-Corps once you start raising investment funds. One big advantage of corporations is that they protect your personal assets. Generally speaking someone can sue the company but they can’t sue individuals in that company
- File a provisional patent. If you have an idea which you believe is truly unique, consult a patent attorney. Otherwise you can copyright your work. You might want to trademark the name of the product or service you are working on as well. The time to protect your company’s IP is at the earliest stage of the company, before your intellectual property is disclosed to others.
The bottom line is if you plan a startup plan on hiring not just a good lawyer, but a good lawyer who is experienced with startups and all they entail: intellectual property, founder’s agreements, stock agreements, raising venture capital, etc. Tempting as it is, don’t use Aunt Jane! Forming a corporation is simple, but protecting your IP and dealing with venture capital require specialized expertise and experience. Many universities offer office hours with attorneys free of charge as part of their entrepreneurship programs. You can take advantage of these services to get started. But eventually you will need your own lawyer. Some firms have specialized groups that serve entrepreneurs and if they think your venture has real potential to get funded will defer their fees until you raise capital. Remember, in a startup you need to stretch the dollar, so try to get your legal fees deferred until your investors’ checks clear the bank.
One last issue where entrepreneurs get confused is who the lawyer works for. See my post Who do you think our lawyer works for? to clear up this confusion. Hint, it’s not the CEO!