Annual financial audits are a cost of doing business for many tech startups. While they aren’t the most fun, they do provide great third-party validation of the books and oversight for how the business is being managed financially. Most entrepreneurs should not spend the $10k – $30k on an annual audit.
Here’s when an annual financial audit makes sense:
- Institutional investors (like VCs) or other sophisticated investors are involved — they’ll require it
- A bank line of credit or senior debt in the business requires it
- There’s a business goal to be able to sell the business in the next three years — most buyers will require three years of audited financial statements
Most of the time an annual financial review, which acts like a lightweight audit, but without all the guarantees by the accounting firm, is a much more affordable way to engage a third-party to review the books. Entrepreneurs should understand when it does, and doesn’t, make sense to pay for an annual financial audit.
What else? What are your thoughts on startups and financial audits?
Most entrepreneurs I know that have been successful tell me that their real success came on at least their second venture, and well after their learning phase. Phase one is learning from another successful entrepreneur or business leader and gaining serious domain expertise. This could be in the form of starting a company that doesn’t succeed or it could happen working with someone else — it doesn’t matter. What matters is that the entrepreneur works hard and learns as much as possible.
Mark Suster has a great post up titled Is it Time to Earn or Learn where he outlines this phenomenon in greater detail. The earning phase of being an entrepreneur is when you co-found a company and have a serious equity stake. Most employees, even in a wildly successful startup, don’t make enough money to retire. As a co-founder that owns a meaningful chunk of equity, raises a modest amount of money, and the startup turns into a base hit or double, there’s a very real chance of making enough money to never have to work again. Now, making money isn’t always the goal, but it’s an important component for many people.
The next time you talk to an entrepreneur, ask if they’re in the learning phase or the earning phase as there can be a serious disconnect between reality and wishful thinking.
What else? What are your thoughts on the learning and earning phases of an entrepreneur?
Recently I’ve been exploring different buildings and areas for an Atlanta Startup Village (see Physical Atlanta Startup Village Idea and Physical Atlanta Startup Village Components). This is a nice-to-have type project that would be great to do but would have to be a no-brainer financially (e.g. a really good deal). So, assuming the area and building have the desired components, how would the actual structure work? Here are a few ideas:
- Large co-working space with one interior conference room and one phone booth room for every 15 desks
- Full event room that supports 100 attendees
- Complete training lab with laptops and large screen TVs
- Individual office pods with between 1,000 and 4,000 square feet per area including:
- LED screen outside the pod entrance with company name and logo
- Mini kitchen
- Interior phone booths with glass walls (1 per 1,000 ft)
- Interior conference room with glass wall and large LED screen (1 per 2,000 ft)
- 5 desks on exterior windows
- Moveable, large sliding glass doors between pods with locks on each side that can be opened to combine pods as startups grow (see moveable glass walls)
Overall, the goal is to be a central village for the startup community as well as provide flexible space for startups to grow from one founder to dozens of employees, all with minimal effort and minimal customization. Too much money is wasted by startups on ill-fitting long term leases and heavy customization (most offices have traditional layouts that are inefficient and not startup friendly). The startup village building would have to be designed unlike any building currently available.
What else? What are some other considerations for a building to be startup friendly and efficient?
Midtown is the undisputed king of the Atlanta seed stage startup scene with the ATDC, Hypepotamus, and Georgia Tech (see Rob’s post). ATDC alone has dozens of startups in the building. With the seed stage being defined as under $1M in revenue and under 10 employees, it’s especially helpful to be in an area with great startup density. As startups grow from the seed stage to the early stage (10 or more employees with $1M or more in revenue), the ATDC becomes more difficult due to space constraints (there’s a waiting list for space) and the three year term limit (startups have to move out after three years) resulting in the startups that are most likely to be successful long term having to leave and move out.
Most ATDC startups that hit the early stage move north to the Buckhead, Vinings/Galleria, or Perimeter area — extremely large geographical areas with little startup density. Buckhead is the clear winner due to the central location between in-town neighborhoods and the northern suburbs. Here are some early stage and growth stage software companies in Buckhead:
Unfortunately, even with those software companies and more, there’s little serendipitous interaction as there are so many office buildings and such little walking around. Buckhead has great resources like access to interstates, train stations, restaurants, retail, and residential that it should become the heart of the early and growth stage Atlanta startup scene. This is even more true since it is centrally located to the metro area, more accessible to the northern suburbs (tech professionals eventually get married, have kids, and want an affordable house in a good school district), and more affordable than Midtown (Buckhead has many buildings with free parking).
What else? How can we make Buckhead more cohesive as an early and growth stage startup community?
At Pardot, one of my favorite things to do is to show guests the office and talk about many of our quirky and unusual ways. As you might expect, most of the ideas were generated via R&D (ripoff and duplicate) from others. We continually look for new ideas, try out the ones we like best, and keep the ones that feel right.
Here are ideas we like and their source:
One of the reasons I enjoy reading and talking to other entrepreneurs so much is that there are always new ideas. Most ideas I encounter are ignored but many are tried out and a few stick — you never know when you’ll come across a new idea.
What else? What are some ideas you like and their source?
Recently I was talking to a successful professional who’s looking to make a transition and wants to be an entrepreneur. Of course, as a person thinking about being an entrepreneur, the best thing to do is to just do it (see JFDI). In reality, most people are measured and won’t jump in unless they feel like they have the right idea, team, and timing.
My recommendation is the same as Jason Fried’s of 37signals in his article How to Get Good at Making Money. The approach is super simple: test the waters of being an entrepreneur by going to local garage sales and spending $100 on stuff that you think will sell well on online followed by actually selling them on eBay. Here are a few of the benefits getting started this way:
- It takes physical, manual labor to buy the products, list them on eBay, package them up, and ship them out — entrepreneurs have to roll up their sleeves and get stuff done
- There’s a margin, or spread, between what the product costs and what it sells for, making it readily apparent what it takes to make a profit
- Tools like eBay and Paypal aren’t hard but it takes time to learn them and make everything work
- Spending $100 and 10 hours of time is a low cost way to test the enjoyment level of being in business for yourself
- If you like it, try the whole process multiple times and see if you can make more money off your $100 each time
There’s an infinite number of things an entrepreneur can do to get started. Building an actual micro business with products and revenues is one of the best ways to start the entrepreneurial journey.
What else? What are your thoughts on how to get started as an entrepreneur?
One area that I don’t spend too much time worrying about is competitors. Most markets are not winner take all or winner take most such that there’s the opportunity for several successful companies to emerge. Email marketing is a great example of a market without winner take all/most (see email marketing companies with 100+ employees). Instead of worrying about competitors, I do think it’s worth tracking them for a few reasons:
- Having competitors is important to validate that other people believe in the idea
- Competitors provide a proxy for the level of market development (look on LinkedIn to see how many employees they have to get approximate company size)
- Investors in competitors show the venture firms that care about certain markets, and provide third-party validation
- Analysts that cover competitors can also provide reports and insight as well as segmentation
Competitors are a necessary part of the startup world but should not be obsessed over. The best thing to do is to stay close to your customers and provide a great solution.
What else? What are your thoughts on startups and competitors?
A little over two weeks ago ExactTarget acquired Pardot (see ExactTarget and Pardot Join Forces) and things have been a blur ever since with congratulatory phone calls, in-person meetings to tell the back story, and kind email notes. Throughout it all there have been a number of common questions that have repeatedly come up.
Here are common questions founders get asked after a startup exit:
- Did you approach them or did they approach you?
- Was it a competitive bidding situation?
- Why did they pay the valuation they paid?
- Did you think the business would sell for that amount?
- How long did the acquisition process take?
- How stressful was it?
- What did your family think when they found out?
- What are you going to do to celebrate?
- What are you going to splurge on?
- What are you going to buy your spouse as a thank you gift?
- What’s next?
There has been a number of other questions but these were the most common. Selling a business is an emotional experience and it’s fun to talk through the details.
What else? What are some other common questions for a founder after the sale of the business?
One of the most common, and tax efficient, entity types for startups is a Limited Liability Corporation (LLC). LLCs don’t have double taxation on profits and have much less paperwork when compared to standard C Corporations. Now, institutional investors will want to invest in a C Corp (or setup a blocker C Corp that then invests in the LLC) since they don’t want to deal with pass through entities as many of their investors are non-profits (e.g. large endowments and pension funds). LLCs have a governing document called an operating agreement that outlines the most core rules for the business.
Here are a few thoughts on the operating agreement:
- Take the time to get it right and agreed to by the co-founders
- Include scenarios like if a co-founders leaves the company under good and bad circumstances
- Incorporate how money invested or loaned by the co-founders is handled, especially when it comes to allocating losses (if applicable)
- Document what’s required to sell the company (e.g. can minority shareholders dissent or are there drag along provisions) as well as to buy or sell units (stock) in the company
Operating agreements are part of startup life for co-founders and should be drafted and implemented with the help of an experienced startup attorney (pay the legal fees for a good lawyer, it’s worth it).
What else? What are your thoughts on operating agreements and startups?
One of the challenges for cash-strapped startups is paying market rate salaries. In lieu of standard salaries, equity is often a strong component for alignment of interests, upside in the event of an exit, and to compensate for lower salaries. Only, in areas outside of Silicon Valley, equity is often not viewed as being worth much due to so few exits and such little lore of millionaires created from stock options.
What might the trade off between salary and equity look like? Here are some questions to ask:
- What’s the market rate salary for this position? What’s the difference between the offer and expected salary?
- What’s the value of the company now and what could it be worth in four years? Example: the company is worth $1M now and expected to be worth $21M in four years (best case), so .1% of the equity might be valued at $200,000 based on .1% of the difference between $21M and $1M.
- What’s the risk profile for accepting the difference between current salary and potential upside? Example: assume salary is $5,000 per year less than market, so $20,000 in less total compensation over four years, but the upside of marking $200,000 from the stock for a 10x risk profile between one dollar in less current comp to 10 dollars of potential comp.
- What personal benefit is good/bad working in a chaos-rich startup environment vs a more established company?
Many startups have an equity component in their compensation and potential employees would do well to understand the salary and equity trade trade-off.
What else? What are your thoughts on the salary and equity trade-off in a startup?