Too many shareholders can become problematic as start-ups grow.Virginia Star

When I launched my first business venture, I sought help. I didn’t have much money so I was generous with equity to investors and supporters. Five years in, I had 80 shareholders and a capitalisation (cap) table that was difficult to manage.

Everyone told me to be careful when distributing equity. But early on, I needed support and couldn’t afford to pay contractors full rate, so I subsidised payments with equity. I had to convince incoming employees to take a pay cut, so I gave them shares. And I needed capital, so I accepted investment from wherever I could find it.

Start-up law specialist Richard Prengell of Viridian Lawyers says this problem is widespread. “Minority shareholder issues are amongst the most common legal challenges we come across. It’s easy for entrepreneurs to sell the dream early on and give away equity to people who help get the business going. But two or three years later, a messy cap table can have regretful consequences.”

Potential investors

I discovered a large shareholder group made it difficult to raise capital. Larger venture investors were nervous about our ability to manage so many stakeholders. Would anyone hold the company to ransom when we needed a critical document signed?

Prengell says a full cap table may deter potential investors. “An oversized shareholder list can become a nightmare: incoming investors may wish to make decisions about issuing new stock, bringing in more investors and incentivising employees without having to get sign-off from 30 or 40 people. This can institute delays, even if no one becomes obstructive.” He also warns about dead-weight shareholders who no longer contribute to the business.

“Investors want the company to be owned by people who are doing the work now. A contractor who helped build an early version of a product but is no longer involved in the business is a drag on a cap table.”

Five years on and we’ve put measures in place to manage our large shareholder group. Fortunately, no one ever became obstructive, but I have lost weeks chasing signatures from shareholders camping in the south of France, kite-surfing in Brazil or skiing in Switzerland. The challenge should not be underestimated.

I’m now establishing a new venture and, like last time, I’m doing whatever it takes to get my vision off the ground. This will mean issuing equity to early supporters; it’s impossible not to. But I’ll set up structures to incentivise people who make a long-term contribution; ensuring early shareholders don’t put off later-stage investors. Here’s how:

Set long-term goals

In my first business, I awarded equity to the graphic designer who made our first logo, a lawyer who drew up our early agreements and so on. This time I’ll set long-term goals. Everyone will earn their compensations over four years with a one-year cliff. So, if the design firm is still supporting the business in two years, they’ll have earned half their allocation. But if they disappear in six months, they’ll get nothing. This ensures everyone is committed for the long-term and removes the risk of dead-weight shareholders.

Prengell says the best way to incentivise contractors and employees is with an option plan. “Always give equity as options rather than shares. Put an agreement in place upfront so that options can be bought back if the contractor or employee ceases to contribute to the company.”

Have the the future in mind

Richard suggests early-stage entrepreneurs take time to consider the implications of their shareholder’s agreement. “Too many founders use an off-the-shelf shareholders agreement and company constitution and don’t look at them until there’s a problem. One of the most important things to know about a shareholder’s agreement is that it can’t be changed without everyone’s agreement.”

Entrepreneurs need to turn their mind to the future of their businesses, designing agreements that will survive several capital rounds and an exit without modification. For example, don’t name board directors. A future large investor is likely to want a board seat, and if this means amending the shareholder’s agreement then 100 per cent of shareholders need to agree. This gives small shareholders a huge amount of power and is often where businesses get stuck.

Encourage investors to form a trust

Prengell advises entrepreneurs to have small investors participate in a common trust rather than as individuals. “It’s simple to set up a trust so related investors can register on the cap table as one unit. Keeping your shareholder numbers below 50 helps contain your financial reporting obligations.”
[cws_sc_divider divi_style='long' height='1' border_style='dotted' color='#dddddd' alignment='center' margin_top='45' margin_bottom='30'] [wpforms id="10800"]  

Beware the sharks among corporate advisers, who promise a lot but go on to milk you of much-needed capital.

Hang around a few start-up events and you’ll meet someone who will pitch to become your “corporate adviser”. This person will most likely be male, aged 40 to 60, dressed in a nice suit and impressive. He’ll know everyone at the conference. I encountered one when I launched my business in 2012. He seemed enamoured of my idea and suggested we meet for coffee. I assumed he was a prospective investor. A moment later, as we started talking terms, he sprang his surprise. He wanted to sell his services. For a modest fee and some equity, he could help me raise $1 million. I said, “Yes.”

Two months later, he had introduced me to a few folks, none of whom invested, and he became busy with other opportunities. I’d spent $10,000 on a fancy presentation and hadn’t raised any capital. Worse, I’d agreed to pay a commission regardless of who invested so I still received a large bill when I eventually raised funds through my own efforts. Five years on, I’ve worked with a range of corporate advisers and some have proved more helpful than the character I met back then. Here’s some of what I’ve learnt:

Steer clear early on

Daniel Petre of top-tier fund AirTree recommends start-ups avoid using corporate advisers to raise capital. He often won’t take a meeting with an entrepreneur who’s come through a middleman because they get in the way, offering unhelpful advice. “Usually, an introduction from one of these guys is a sign that something is wrong.”

Petre prefers entrepreneurs to approach his firm directly. “People think they need a corporate adviser to access good [venture capitalists]. Not true. We don’t hide in an ivory tower. We respond to every email or call and see at least 20 companies a week.” And he wouldn’t spend money preparing the presentation. “We don’t want to see a fancy, 60-page pitch deck. We want an upfront, honest discussion with the founder about the problem they’re solving and why they’re better than the competition.” He adds, “There’s no role for corporate advisers in start-up land. They’ll take $100K to $150K on a raise, which is a terrible way to spend our investment. A good entrepreneur will want to put all their resources towards building the company.”

Despite my early mishap, I’ve found more use for corporate advisers as our business has grown. Jonathan Warrand of Greenwich Capital Partners recommends entrepreneurs contact his firm once their company is generating revenue and is growing at 10 per cent to 30 per cent every month. He says, “Advisers such as ourselves can assist with the management strategy and corporate governance as well as capital raising. These disciplines are important as companies grow. “There’s a difference between introducers and full-service corporate advisers who have deep knowledge of the market and a defined capital raising approach.”

Negotiate carefully

When I have engaged a corporate adviser, I’ve been careful to avoid paying too much. Most advisers will propose an upfront fee to craft the pitch deck and perform due diligence, plus a commission of 4 per cent to 10 per cent of whatever is raised. As Petre points out, good entrepreneurs know how to tell their stories. It’s usually possible to avoid an upfront fee. And never agree to pay a commission on funds that don’t come from their introductions.

They may ask for a period of exclusivity to raise the capital and insist this is essential to motivate their team. It’s true it can look bad when multiple advisers pitch a company to the same investors. It’s also bad when the adviser you signed up with isn’t delivering and you’re stuck with an exclusivity clause.I’ve found the most important factor in a successful capital raising is momentum. The advisory team will be motivated when investors are piling in and their clients might miss out. They’ll often agree to drop the exclusivity period if they can be confident you’ll manage the process well.

Fundraising is hard, lonely and distracting. It takes a huge amount of time to source investors, plan meetings, answer questions, negotiate terms and draw up paperwork. When someone says, “Your business is great. I can raise money for you and you won’t have to do anything,” it’s a compelling proposition. I’ve learnt that different stages of business and different types of businesses need different approaches. But, with or without a corporate adviser, the founder has to sell the vision, drive the process and take responsibility for the outcome.

[cws_sc_divider divi_style='long' height='1' border_style='dotted' color='#dddddd' alignment='center' margin_top='45' margin_bottom='30'] [wpforms id="10800"]  

This is the story of a trap into which I’ve fallen twice at Posse. Investors often set the trap unknowingly – no harm is intended – while they are figuring out whether they would like to invest. Both times this happened I felt heartbroken and exhausted, with my business in turmoil. We were lucky to survive.

It all starts so well. You meet venture capitalists and deliver a knockout pitch. They love it, you exchange business cards and they set out the next steps. First, you have to meet a few other people from the firm. They are busy so it can take a few weeks to secure the appointments, but they are genuinely interested and they ensure that you are seen as quickly as possible. You meet again for lunch, then dinner, then drinks. You become friends.

You discuss the wondrous opportunities for your business and the ways in which they can help you reach those opportunities. Watch out: You’ve started to fall in love. You discuss generalities about the deal terms, big stuff like the valuation and how much they’ll invest (a lot). And of course, they will want a seat on the board. You are excited; this will transform your world. In no time, you are planning how you will spend the money, looking at new office space and thinking about recruiting new team members.

One of the senior partners you needed to meet with was traveling, so you wait six weeks for the meeting. It is promising, too; he wasn’t as excited as the junior guys, but he likes them to be autonomous and allows them to pick their own deals. The senior partner suggests you meet a friend of his who runs a big company that, he says, would make a great partner for your business. It sounds helpful, but you know he really wants to know what his friend thinks of you. The company is based in Chicago; you have to travel and the meeting takes two more weeks to set up. All goes well, and after a week you hear the firm wants to move forward with your deal.

Next comes due diligence. This starts with a long list of requests and a promise that, once all the information is together, this will not drag on. They guarantee you will receive the term sheet within two weeks, so you pull in your team and work late — very late — to assemble the material. It may include questions like: Who owns all these shares on the capitalization table? Is there anyone here without an employment contract? Why did you model revenue this way? Will you really need all those engineers?

You answer all of the questions diligently, repeatedly rework your financial model, and either make changes to your contracts or write new ones. More than a month passes. You have spent money you do not have getting help with contracts, accounts and a revenue model to satisfy the investors. You have answered almost every tricky question that could be asked about your business plan, your competition and the market. Everyone seems happy and the firm assures you that due diligence is almost complete. The term sheet is only days away. Four months have past since you first met. There is one more thing — a meeting, a problem, a question, something that is going to take more time. Finally, you start talking about investment terms. And then something happens. It could be any number of things, but it is a knockout blow that kills your deal.

The first time this happened to me, I had negotiated for five months with a big name corporate brand. The company had proposed investing $3 million dollars, and the association would have catapulted Posse’s profile to the stars. I liked the executives leading the deal and could not wait to build the business with them. They assured me that they could move quickly and that they would reach a decision within a month. But the months dragged on and more people became involved, asking more questions. I was not even worried; I was so sure we would close the deal. After all, they would not invest so much of their company’s time if they were not serious, would they? But when the terms came back, they killed the deal; they were nothing like the proposal we had discussed when we first met. The company would invest, but it came up with a valuation of less than half what we expected. I might have accepted anyway, but our board refused.

Last year, I spent six months attending to the whims of a group of angel investors from New York. It took three months to complete a series of qualification presentations, after which they selected a cast of a dozen members to perform the due diligence. I answered their questions, reworked financial models and met every relevant person full time. They said they would invest more than a million dollars, and the process required only four to six weeks. Then they told me they could not invest nearly as much as they had thought. The exercise had been a gigantic waste of time, distracting me from talking to other, serious investors.

I remember venting my frustration during one of these drawn out episodes with one of my mentors. He said, “Never start due diligence until you’ve agreed on a term sheet.” With hindsight, it seems so obvious. If I had refused to do any work until a term sheet had been worked out up front, then I would not have spent months and tens of thousands of dollars pleasing investors who were not serious, did not have the money or whose deal expectations were vastly different from ours.

The problem is, refusing to do any work until a term sheet is signed sounds great but is hard to do. When you first meet, you are excited and the investor promises that the process will take only a few weeks. You can afford to invest a few weeks. Even as time drags on, everything appears to be proceeding, and you are certain the deal will close. As time drags on, costs pile up and cash reserves dwindle. You realize that, with so much time invested, you cannot afford to start the process again.

I will never get stuck in this situation again. I will never let an investor seduce me into believing that a term sheet is around the corner while I put time and money into meetings and answering thousands of questions. I will ensure that a term sheet is agreed upon up front and then start the due diligence process. If the V.C.s find something they do not like during due diligence, they can always back out of the deal, but at least I will have established that there is a deal to be done. Even though I know their firm is big and my company is small, I will do this because I know that time and energy are my biggest assets.

[cws_sc_divider divi_style='long' height='1' border_style='dotted' color='#dddddd' alignment='center' margin_top='30' margin_bottom='30'] [wpforms id="10800"]


When I started Posse in 2010, I knew I’d have to raise money, which meant pitching to investors. I attended a few start-up events and watched YouTube videos showing other people pitching ideas. I’d never used PowerPoint, and the night before my first pitch, I called up a friend to find out how it worked. I designed a simple deck and stayed up all night rehearsing. The presentation flopped. The investor laughed (politely) and declined my proposition. He must have felt sorry for me because he offered advice on how I could improve my pitch and introduced me to some friends. They all said no to the proposal but provided more introductions. And so it went. Every day for a year, I rattled off my presentation, and after every failure, I noted which items resonated and which fell flat. In the evening, I went home and worked on my deck.

After a year and more than 700 meetings, I was confident my presentation was hot, and it worked. In 2011, I closed my first $1.5 million from 23 individual investors. Most people who know me in the industry assume that I’m great at pitching; I’ve now raised more than $4 million from 80 investors. I’m happy that people consider me an effective pitcher. I’m tenacious, and I believe that if I take enough meetings, someone is bound to say yes. But know I still have much to learn. The last few weeks I’ve been out on the fund-raising trail again. We have just opened our third investing round, our biggest yet. I’m getting access to a new class of investor, and I can’t afford to maintain the same ratio of successes to failures. I must improve my strike rate.

Before going out this time, I worked with consultants who insisted that I rewrite my deck and adjust my presentation. They suggested that my tone should be more serious, that I focus more on the team’s credentials, and that I spend less time on flashy product screenshots and more on the financial model, the market opportunity and the investment proposal. At first, I felt offended, but as I implemented their changes, I realized  that in order to raise the capital we need, I would have to step up my game.

Here is some of what I have learned over the past three years:

1. Learn to Engage the Audience

Here’s my favorite definition of a leader: someone with the energy to make a dream a reality in the minds of other people. I’d never thought of myself as a leader, but when I started pitching my idea to investors I discovered that I had to make my dream a reality in their minds. So I practiced.

First, I learned how to speak in public. I attended a 10-week Toastmasters program and two drama courses. It was so painful for shy, self-conscious me, but I grew in confidence and overcame my dread of public speaking. I raised most of my first round speaking at three pitch competitions. Most of the other presenters had companies that were stronger than mine. I had no product and no team – just me and my deck. But while my competitors were focusing on their nerves, I delivered a confident, compelling story and people actually listened.

2. First Impressions Count

I’ve noticed that unless I hook investors in the first two minutes, it’s very hard to win them. They’re skeptical and they expect to hear another dud idea, so before I can get them dreaming, I have to resolve three concerns right away: Is this company solving a real customer problem? Is the problem painful enough that the customer will pay for the solution? And how big is the market for this product? For example, I say up front that the No. 1 challenge for small-business owners — whether they own a salon, a bookshop, a restaurant or a yoga studio — is that of building relationships with regular clients. These are the people who will sustain the business, but unless the owner is in the shop all day every day talking to these people, it’s impossible to know which customers are loyal, which ones are referring friends and how to make them all feel special.

Within 20 seconds, I establish that the challenge is real and important, and I name many different business types in a large market. I then describe Posse’s solution. I’ve found that unless I address these issues at the start, the investors question the rest of my presentation or, worse, tune out altogether.

3. Establish Your Credentials

I’m naturally modest, and when I started out, I didn’t talk about my achievements. Yet at every meeting, investors would ask, So what have you done before, and what makes you qualified to build this business? As it happens, I had built two successful companies so I had a good answer to give. One day, someone suggested I put my background and myself on the second slide. At first, this felt uncomfortable. I was concerned that I would come across as arrogant. But I noticed that establishing my own credibility changed the way people listened to the rest of my presentation. Ever since, I have continued to list my accomplishments — along with those of critical team members, directors and investors — on my second slide. And I’ve learned that there’s nothing wrong with a little bragging.

4. Know the Facts

I’m embarrassed when investors ask questions I can’t answer. There have been times when I have been unable to answer questions, and I know it has blown my credibility. So I study before I pitch.

5. Answer Every Question

When I started pitching, I used to focus on the fun, entertaining stuff like how I came up with the idea or how I bought the domain name. This got a great reaction and helped me build rapport, but I don’t think it helped me raise money. It may even have reduced my chances. If I came across as fluffy, Posse might not seem a serious business. Meanwhile, investors always asked awkward questions that I was hoping to avoid: How much have you spent so far? What have you spent that money on? Who owns shares in the company? When will you break even? I had prepared responses that skirted the questions I didn’t want to answer, and I suggested that investors who wanted to know more could obtain that information in a due diligence pack.

Recently, I changed tack. My pitch deck now includes slides that address all of the tricky questions, and I go through each of them in detail. It’s made the overall presentation far more transparent and credible.

6. Build Momentum

In my experience, investment rounds only close when there’s momentum. I spent a year presenting to investors for my first round, and I had about 15 people who offered conditional commitments. But it wasn’t until a large group put money into an escrow account that the rest of the soft commitments came in. That gave us momentum, and we attracted more money than we expected.

Early on, I used to inflate my numbers slightly or talk about deals that weren’t done because I knew that by the time due diligence started we’d have reached those numbers. Now I tend to undersell our progress in the first meeting and then send out regular updates when we hit milestones or sign major deals. This creates a sense of momentum, which is preferable to delivering a more impressive first meeting In just the last week, I have met with more than 20 investors and pitched the same presentation each time. There are no shortcuts, and learning to pitch well requires time and attention. So far, the meetings have been positive, and my sense is that we will close the round quickly. I’ll let you know how it goes.

[cws_sc_divider divi_style='long' height='1' border_style='dotted' color='#dddddd' alignment='center' margin_top='30' margin_bottom='30'] [wpforms id="10800"]  

Starting a tech company is expensive. That’s why those who start one — unless they can do everything themselves, including designing, coding and selling — must accept fund-raising as an early goal.

Every day we read about budding entrepreneurs who raise millions of dollars to start something. Often, we never hear of them again. A handful resurface when the company sells for a fortune, but most trip and fall into the start-up vortex of doom, spinning to an almost certain and painful death. Companies don’t send out press releases when they die, so the vortex isn’t well known. But as someone who has spent the last eight months trapped in it, I know I’m lucky to have escaped to tell the tale.

Three years ago, at home in Sydney, I hatched an idea for a tech company called Posse, a “social search engine” that helps users get recommendations for products, places and services from their friends. I drew up a plan for the product and showed it to a web development agency for a cost estimate. The agency’s answer was that it would cost plenty. So I created a PowerPoint deck and started pitching investors. With an idea but no track record, I thought angel investors might be the way to go. I pitched more than 700 times, and one full year after I started, I finished my first round with $1.5 million from 23 individual investors.

Next came the team, a product, and in no time we were parting with $100,000 a month in expenses — engineers don’t come cheap! And after 10 months, we were still finding our feet. I made a couple of hiring mistakes, the product didn’t work right, and we needed to raise more money. We were now entering the vortex. The second round was tougher to raise than the first. We had made progress but didn’t have exploding user numbers. I discovered that it’s much easier to raise money for a vision than for a product. With a big vision, investors dream of what might be. When the product appears, no longer a vision, investors see what it doesn’t do more than what it does do — or what it might do.

With a start-up, everything must fit together for the product to fly. We needed the right team and the right strategy, and we needed to execute. Some companies require several iterations to get it right, and that can take years. I moved from Sydney to New York and spent 70 percent of my time raising money, a process that compromised our priorities. Investors wanted to see growth when we needed to focus on engagement — getting people to return to use Posse again. I’ve caught myself pushing growth to impress investors, when both the team and I knew it was inappropriate.

The team became disheartened, and since I was on the road raising money, I wasn’t around to motivate them. They became less productive, and everything slowed down just when investors were demanding progress. As this dragged on, team members left, which made things even more depressing. I was exhausted and started to lose faith. Many companies fail at this stage. It’s the death spiral that almost killed my business and at times seemed like it might kill me as well. The things I have learned about avoiding and surviving that spiral, as I’ve built my company, will be the topics of my posts on this blog.

To get started, here are a few discoveries I have made along the way.

1. Avoid the Vortex

Entrepreneurs are optimists. I started with a plan, budgeted costs and believed my idea would fly. I would raise enough money for the first year, and I thought that by then I’d have enough traction to raise my next investment round at a higher valuation. This is how entrepreneurs think when starting out, but the number of companies who actually do this in the first year is tiny. Even successes like AirBNB, Twitter and Pinterest needed several years and many pivots to get it right. If I had it to do over, I would raise more money right upfront, when everyone is still excited about the vision. And I would give myself at least two years runway, giving us time to make mistakes and focus on the right things without distraction.

2. Raise Money Before You Need It

When we were spending $100,000 a month, I knew just how much time we had left, and four months before it ran out, I started trying to raise money again. As we compromised priorities and team members left, my energy collapsed. It’s almost impossible to raise money in this situation. I remember one day in particular. On a hot New York summer afternoon, I was sitting in my co-working space at the Alley in Midtown. Paralyzed by stress, I couldn’t do a thing. I summoned my last fragment of energy, walked to Central Park, sat on the grass and cried. I knew I was approaching the very bottom of the vortex. I was spinning fast; one slip and it would all be over.

3. Focus on Breaking Even

It’s sexy to focus on growth; we often hear of sky-high offers for companies with no revenue but lots of users. Yet thousands of companies have both users and growth — just not steep enough growth to raise money or be bought by Facebook. Next time I start a tech company, I’ll pick an idea capable of generating revenue from Day 1, then I’ll expand that revenue so we break even as quickly as possible. I might seek investment to accelerate growth — but I won’t fall into the trap of needing it.

4. Learn to Live With Discomfort

Early on my founder journey, I recognized I would need to figure out how to handle stress. I started reading about Buddhism and found comfort in its teachings: that everything is temporary, that suffering is a part of life. Uncertainty and suffering are part of running any business. I took up yoga and learned to meditate, yet I survived the year by recognizing that my path was of my own choosing. That day in Central Park, I got a glimpse of failure. To my surprise, it wasn’t that bad. I wasn’t about to die, after all. Since then, I’ve been more willing to accept the uncertainty.

At 4.58 a.m. on a recent Saturday morning, I got the email I needed: confirmation that the funding round I’d been working on all year had closed. The last investor had said yes. That day, I slept, watched TV and went for a walk in the park, enjoying my first adrenaline-free day for months! What got me through the year was tenacity. Half an hour after my breakdown in Central Park, I dusted the twigs and dirt off my skirt and marched down Lexington Avenue to another pitch. Like 99 percent of my meetings with investors, it ended with their saying no — but it didn’t matter. The only way out of that vortex is to keep going.

[cws_sc_divider divi_style='long' height='1' border_style='dotted' color='#dddddd' alignment='center' margin_top='30' margin_bottom='30'] [wpforms id="10800"]