Common problems and how to avoid
No two new businesses are alike, by their nature they will be contain a degree of uniqueness. However, the fundamental aspects of new and emerging businesses which may lead to success or failure, contain common patterns. Learning from these and addressing them can help a business evolve and maintain a steady path to success.
Counterproductive efforts to retain control as the company grows
Many technologists who found companies are understandably concerned about others 'stealing their baby'. Nonetheless, it is comparatively rare for a business to grow to large scale under founder control, if that founder is not, by background and disposition, a business leader. Points to reflect on as the business grows include:
- The optimum role(s) for the founders
- What size the business is expected to grow to
- At what point the business may outgrow the skills of the founders and benefit from new skills in its senior team
- Whether a succession plan should be discussed ahead of time with investors to avoid later difficulties. Succession problems, if not recognised and dealt with, can sour relationships, stunt growth and in extremis sink a company.
Confusing 51% equity with control of a business
A company is controlled by a board, and a major shareholding often brings influence at board level. However there is no totemic percentage at which control switches from one party to another. All stakeholders must decide which factors they are willing and unwilling to cede control on before the Term Sheet and agreements are signed. Some points to note include:
- Approval levels for many strategic actions, such as hiring and firing of senior staff or buying and divesting major assets, may be addressed specifically in the company's Articles of Association, Shareholders' Agreement or other documents
- Specific actions may require the approval of named stakeholders, independent of their actual shareholding
- Levels of majority in decision making may vary for different classes of decision - for example, a simple majority sufficing for some decisions but a 75% majority for more serious matters
- Loan agreements and debentures can likewise restrict shareholder control, regardless of percentage held.
The pursuit of legal perfection
Good legal agreements that reflect the intent of the parties, are essentially fair, ensure due process, and do not contain perverse incentives. They are the foundation of longer term success. Nonetheless, like technology, legal agreements can be refined for as long as there is will and funding to do so. At some point a compromise between time, cost and function is necessary. Some points to note include:
- Legal advice can often cost upwards of £200-300 per hour. It is not unusual to incur legal bills of £10,000+ on relatively straightforward deals
- Legal agreements will often be novated (i.e. renewed) at the next funding round, and the current round is not necessarily the last word. Money spent on drafting highly specific agreements now could be saved for meeting payroll in hard times
- Lawyers may draft agreements of greater or lesser 'aggressiveness'. Aggressive agreements give one party greater rights and powers. A situation can result where each side's lawyers spend time paring back overly aggressive contracts, running up substantial fees. The negotiating parties must ensure that it is they who control the terms of debate and not the lawyers. This is not always in the lawyers' interest.
Over-valuing a new technology
A great technology underpins many valuable businesses. Nonetheless, success is made up of many elements and only in the most extraordinary cases will investors credit a bare technology more than a fraction of the value it may reach when developed into an established business. Some points to note include:
- Investors see exciting new technologies every day, and though they know that among them are winners, it is not possible to identify which ones these are at the point of investment
- Investors know most of their investments will fail and will therefore assign apparently low values to early stage prospects
- Clearly existing stakeholders should seek the best deal possible, but an expectation too far from sector norms can suggest naivety and prevent a deal being closed (see Business Valuation)
The distraction of fundraising
Raising investment is vital to the survival of a business but it is not, by itself, an activity which generates value in a business. Raising funding places huge demands on the time and attention of senior management, which displaces the attention normally devoted to the affairs of the business. Some common pitfalls associated with this include:
- Raising funds can appear more glamorous than the routine management of operations, drawing still more senior attention than it requires
- Staff not engaged in fundraising can become absorbed in 'watching the drama' instead of doing their (potentially duller) everyday work
- A mitigation plan that covers the tasks being neglected by the CEO during fundraising may be required. Someone has to man the bridge
- Fundraising often absorbs the lion’s share of senior management attention for 3-6 months per round. If rounds are frequent, this can be a material share of their total time.