Thoughts on When to Form the Company
First time entrepreneurs often ask me “when should I form the company?” What does form the company mean? Does it mean come up with the idea for the core product/service for the company? Does it mean making a decision with a co-founder(s) to do a start up and then brainstorming ideas? Does it mean actually pulling the trigger on the legal formation of a newco? The answer to the “when” question is that it depends on how you define “form.”
Forming the legal entity is probably the last thing that you will do assuming that you will do what is most important first. Here are a few guides to help you decide when and how to form a company.
- Rather than think about a company, think about the problem that you are trying to solve: do you see a clear market need? If yes, can you provide/build a product or solution?
- If yes to the above, can you build in competitive barriers, unfair advantages? You need to really ask yourself, “can this be the basis for a company or is it something that should be licensed to an existing company?”
- If you believe that your innovation warrants a company, do you want to do this alone? Alternatively, you may have already answered this by using others to brainstorm about the marketplace problem and the solution.
- If you have or want co-founders, how many, how do you find them, and how do you split the equity?
- A total of two to three co-founders is optimal. More gets complicated with defining roles and commitment.
- You have to recruit co-founders like you do investors. You have to tell a great story and convince people of your opportunity. This means that you don’t wait until you have the co-founders to research and identify the opportunity; you move forward and get better, more articulate, and more convincing as time moves on. Finding co-founders is best done via networking: tell everyone what you are doing and ask people for referrals. Given the six (or fewer) degrees of separation inherent in the entrepreneurial world, networking will help you will find others that are happy to adopt your vision.
- There are some great thoughts on how to split equity that are already out there. Noam Wasserman has some good thoughts in his “Founder Frustrations” blog or on the Project Olympus Entrepreneurial Corner. Frank Demmler’s Founders’ Pie Calculator is also one of the better methodologies. In his calculator, Frank (adjunct professor of entrepreneurship for Carnegie Mellon University and Director, Entrepreneurial Executive Teams for Innovation Works) provides a rationale for equity splits that are based on contribution. My advice? Decide and agree upon an equity split relatively early – before you go too much further and end up with a nasty breakup as a result of mismatched expectations!
- Put it in writing! Throw into the equity discussion ongoing roles and responsibilities and you have the beginnings of a shareholders’ agreement, which will document in writing what happens in the event of a divorce between the co-founders, or other situations that might occur in an uncertain future. You need a document that outlines what happens in this and other situations because you need to protect yourself and the company.
- Conduct the market research by talking to potential customers to validate that your solution will be accepted in the marketplace. Stay customer focused! A business is only a business IF it has a product/service that customers will buy!
- Build an initial business plan, not to prove that you know how to write an award-winning plan, but so that you have some thoughts and direction on paper that validate your assumptions.
- Interview several start up lawyers based on referrals and pick one. Make sure that the lawyer is VERY experienced with start ups and their unique issues. Make sure that you are clear on billing and pricing. A good start up lawyer should attend your board meetings sans charge! Ask for estimates for particular tasks (entity formation/filing, stock option plan creation, CDA, consulting agreement, employment agreement). And do your homework on the various legal entities. Come with questions rather than a blank page about C corporations, Subchapter S corporations, Limited Liability Companies (LLC), etc.
- Do the same (interview and pick one) for an accountant or accounting firm that is VERY familiar with start ups. Get an understanding up front of what will be required in addition to tax preparation (who is doing the day-to-day bookeeping, payroll, etc.).
- Pull the trigger on the legal formation when something occurs which necessitates having a company:
- Landing a customer which means revenue or a contract.
- Hiring an employee or consultant (sometimes you can get by with the latter even before you form the entity).
- Raising financing.
10. Along with incorporating, form your initial board of directors (see “Thoughts on boards,” a previous post in this blog).