5. Control

“Control” of a startup can manifest itself in various forms such as equal (or investor-favorable) representation on the board of directors or a requirement of obtaining seed investor approval for new hires and/or budget matters. Whatever the form of control, seed investment is way too early to be even thinking about losing any amount of control of your startup. You need to figure out why your potential angel investor wants to control your startup.

4. Dividend (that pays out)

By paying your investor a dividend (rather than having dividends accrue and be paid out at acquisition or other typical payable events), you are simply paying back the investor with his own money. What a deal — for the investor. This is something you might see in a late stage private equity financing with a company that has a history of generating revenue. It does not belong in any early stage deal. If your potential angel investor insists on getting dividends paid out quarterly, the angel investor should invest in dividend aristocrats or MLPs, rather than your startup.

3. Tranched Investment

Don’t agree to a tranched seed investment based on milestones. I don’t like tranched investments for 3 reasons. First, the benchmarks are typically difficult to come up with and negotiate and are often imperfect indicators of performance. Second, startups will tend to focus towards hitting these (imperfect) milestones and possibly ignore other projects or natural off-shoots that may pan out huge. Third, some angel investors like to make the additional investment at their option once your startup hits the milestone. Therefore, if you do agree on tranched investments, make sure they are at least automatic — if you hit, they wire. But even better for the startup would be to negotiate a tranched investment that was at the startup’s option upon hitting the milestone.

2. Non-Dilution

The investor wants non-dilution rights because they are either really greedy or they don’t trust you to issue additional equity. The angel investor’s best protection against “wasted dilution” is the fact that the founders are being diluted pro rata along with the angel investor — you have to get the angel investor to wrap their brain around this. Unfortunately, for some angel investors having the co-founders sit “side by side” with them is not enough protection.

1. Personal Guaranty

If the shit hits the fan and the company has to shut down, co-founders should only be out time…not additional cash to their investors. If your co-founders didn’t already have ulcers from taking the startup leap, they will soon after signing the personal guaranty.

Don’t avoid “big boy” expenses just because you are bootstrapping. That is, make sure you have (or at least look into obtaining) insurance against life’s big risks — serious illness, permanent disability and early death.

Most tech entrepreneurs with young families are either not insured or grossly underinsured for these life-altering events. The good part is that if you are young (and healthy), a term life insurance policy isn’t that much. Even if you don’t have a wife or husband or partner or child, it can be a good idea to obtain a term life insurance policy since you can essentially “lock in” your good early health on term life insurance policies and later change the beneficiary of the policy.

Whatever your scenario, you owe it to yourself to at least investigate these things and determine what’s right for you. But cutting out these big boy expenses if you have a family isn’t “lean” or “bootstrapping” — it’s family malpractice.

I’m not talking about price-based anti-dilution protection that is typical in an angel or VC round. What I’m referring to is a right given to a particular stockholder so that such stockholder’s equity in the company is not diluted by any future issuance of stock — regardless of the price.

Investors will say this “protects” their investment from issuances of equity that do not benefit the startup. But the fact that the startup’s founders are being diluted by such an issuance should provide enough protection.

Unfortunately, for some investors having the founding team sit “side by side” with them is not enough protection. My advice to those investors requesting non-dilution is: if you don’t trust the founding team from issuing stock in the hopes of increasing the startup’s value — don’t invest in the startup.

My advice to entrepreneurs is, if you have an investor asking for non-dilution, it likely means that the investor doesn’t think you’re good enough to run the company. The investor is likely in love with your startup’s idea, but not in love with you.

(1) Calculate Valuation and Determine Value.

Pre-money valuations startups receive from incubators are typically low…really low. If an incubator offers your startup $25,000 in exchange for 6% equity, the pre-money valuation is a whopping $391,667.

As you can see, I don’t think any startup has joined an incubator based solely on the pre-money valuation. Thus your startup needs to determine the intangible value offered by the incubator (and yes, a $150,000 convertible note with no cap and no conversion discount qualifies as an intangible).

Rather than assign a monetary value to the intangibles, a startup should instead assign an equity percentage value to intangibles like mentorship. As equity in the company tends to be the currency of early stage startups, the startup should have a good foundation for assigning value in terms of equity.

This advice holds true for even if the incubator’s program provides tangible items free and such items have an assigned monetary value. For example, if your startup get $2,000 worth of massages during the program, don’t add the $2,000 in free services to the $25,000 investment amount. Determine how much of your startup’s equity you’d actually give up for those services if they weren’t provided free — it may be worth $2,000 retail but it can also be worth 0% of your startup.

Thus, if your startup is willing to give a couple points to a few advisory board members, determine how much the incubator’s mentorship (and introductions) equates to an advisory board and assign a percentage. Now subtract that amount (and any additional equity amounts you have assigned to other intangibles at the incubator) from the total equity the incubator is requesting.

Using the previous example, if your startup believes the mentorship is worth 2%, then re-calculate the incubator’s offer of $25,000 for 6% to $25,000 for 4%. The “revised for the cash investment only” pre-money valuation is $600,000.

(2) Scrutinize the Investment Structure.

Incubators aren’t non-profits, therefore in addition to asking for a low pre-money valuation, they may structure their investment in a way that helps to ensure a higher return across their portfolio. Most incubators take common stock and sit “side-by-side” with the founders, but some may want some (weak) preferred stock and/or dilution protection.

Other incubators may want to set up an option pool. If so, the startup’s founders need to know this option pool lowers your pre-money valuation. Using the previous example, if an incubator wants your startup to set up a 15% option pool as part of the $25,000 for 6% of the company, the pre-money valuation gets effectively reduced to $329,167.

Like any issuance of stock or investment, one of the main things a startup should be concerned with is: Is this going to fuck up a future financing? (Technically, your startup should be asking this question for any contemplated transaction.)

If the terms won’t hinder a future financing, then your startup is good to go. If the terms will, then the question becomes: is the incubator going to waive these terms when a VC makes the request — without asking for anything in return for the waiver?

(3) Research the Mentors.

I wrote in a previous post, startups value mentorship over money when it comes to incubators. Research the mentors so you can accurately assign the amount of intangible value (in equity percentage terms as discussed in point 1 above) and justify the shitty pre-money valuation.

Analyze the mentors not just in what those mentors currently do or did when you were in middle school — but also how they fit with your team and your startup’s product. Do they know your space? Will you get to select your mentor or mentor group? How often will mentors drop in or otherwise be available?

(4) Inspect the Office Space.

Some incubators offer free office space. If so, check out the lay of the land to determine if your startup can be productive in the office space. Does your startup get a private office or will it share space coworking-style? How is the conference room and how hard is it to schedule time in the conference room? Can you break away for a confidential call from your girlfriend or potential VC investor? Do the chairs make your butt hurt after sitting in them for more than one hour? How is the technology?

(5) Figure Out Your Incubator’s Class End Date.

When does the mentorship and other benefits end? Can you continue to work out of the incubator’s office after your class ends? While most incubators’ class end dates fall around the respective incubator’s demo day, what type of support will you receive post-demo day from the incubator and/or the mentors? The best incubators are going to have no true “end date” and will be a forever-resource with respect to mentorship…although the incubator can likely only offer office space until the next class of companies move in.

(6) Search For the Incubator’s PR and Marketing Efforts.

If the incubator doesn’t take its class “stealth,” take a look at what the incubator does to market itself and its incubated startups. Take a look at pictures and videos from previous demo days, if any, and see if they’ll help get your startup’s name out there. It’s not really a demo day if only friends and family show up. Of course, joining some incubators give startups an instant “I’m Awesome, Fund Me Now” virtual-badge. Nonetheless, if an incubator can’t promote itself, how is it going to help promote your startup or the crucial demo day event?

(7) Reach Out To Prior Incubated Companies.

If you contact a startup that was part of an incubator’s past class know that you are accepted to and contemplating the same incubator, you should not have a difficult time getting a few minutes from one or more of that startup’s co-founders. Ask them about points 1-6 above but go further — ask them which mentors they perceived as being the most helpful or even which office to snag if you move in to the incubator’s office space. If a startup doesn’t get back to you, then that may tell you something, but don’t automatically assume that startup had a bad experience with the incubator.

(8) Determine the Opportunity Costs.

A startup that is accepted by an incubator may have an alternative funding offer from an angel investor. This can add complexity to a startup’s decision, because maybe the angel doesn’t want your startup to join the incubator. If the angel investor is offering an investment amount (greater than the incubator) that would “guarantee” your startup will reach a certain goal, it may difficult to accept the incubator’s offer. Regardless if your startup has an angel investor lined up, your startup will need to have a tangible goal in accepting the incubator’s offer that can be realized by completion of the program (or shortly thereafter). If not, the incubator is just a bridge financing to potentially nowhere for your startup.

Conclusion

Getting into an incubator is an exciting experience for any startup, but before signing up take a look at the incubator and how (much) it will help your startup. With the explosion of startup incubators, I hope the list above is helpful in determining whether your startup should accept such an offer. The more intangible value you can assign to the incubator, the more appealing the incubator’s offer will appear.

I understand the need to ensure you are getting value for the small amount of capital you start with — I did the same thing when I hired a large firm earlier this decade for my startup. And as a startup lawyer, I’ve fielded multiple requests for a “per page” breakdown of my legal fees.

While the per-page-basis is one way to evaluate the benefit of hiring a startup lawyer, it completely ignores the only reason to ever hire legal counsel: the advice.

I’ve drafted and/or reviewed several financing docs in 2010, but the most valuable work product I’ve dispensed to startups this year are actually sentences such as:

That option grant is fine, provided we vest his shares.

Burn the term sheet unless they delete that provision.

That’s f***ing crazy.

These sentences are worth much more than the theoretical 0.1 hours billed on the legal invoice. On a straight value basis, these 3-second sentences should be billed at $10,000 (or more) with everything else at $50. (Before I get the hate emails — I’m not trying to get paid $10,000 for these sentences, I’m just trying to demonstrate what is the true benefit of hiring a startup lawyer.)

Sometimes these “$10,000 sentences” are the difference between a client failing in month 3 and getting a Series A done a year later.

The $10,000 sentence is why no matter how many “free” legal documents are out there thanks to Google or any other “kit” you’ll see on the internet, human legal counsel will never be replaced.

Long live the $10,000 sentence.

Axl realized that what might have worked in 1983 would need to be refined for the state of music in 1991. And he was successful doing so.

Occassionally, I’ll hear from an entrepreneur that he has been working on a startup idea for 5+ years on his own and is now almost ready to launch. The longer you keep your startup in stealth mode before your public launch, the tougher it is to keep your startup relevant.

November Rain is an anomaly.

Me: Is “finder” a registered broker-dealer?

Startup: No.

Me: Well, it’s an issue because the finder offering to raise capital for your startup should likely be registered with FINRA (Financial Industry Regulatory Authority) and your state’s securities board. And the SEC is closing the window on these unregistered broker-dealers. Most importantly, using an unregistered broker-dealer can, at a minimum, jeopardize your startup’s private placement exemptions.

Startup: But how does everyone else do it?

Me: Just because they’re doing it doesn’t make it “legal.” Just because a law is not enforced does not mean the transaction is ok under the law. If I drive without my seatbelt but don’t get a ticket, does it mean it’s legal? The reality is, a tremendous amount of unregistered “brokers” (as defined by the SEC) are out there raising capital for companies.

–

Finders are one of the startup world’s dirty little secrets. And there’s a ton of these dirty little secrets trying to latch on to startups from coast to coast. If someone wants you to help your startup get seed capital only if they get a cut, you need to run far away.

You may think raising capital will take up an obscene amount of time at your startup (it does) and/or you don’t know any investors (you probably don’t), but your startup can not outsource or delegate this task. From my experience, these finders who want a cut rarely, if ever, deliver.

The finder may have a ‘rolodex’ of rich people but it’s usually chocked full of people who don’t typically invest in early-stage startups. Even if these finders deliver an investor, the investor isn’t hip to investing in startups and ends up asking for crazy investor-favorable terms that could will screw up a future financing.

Now the founders have either a really crappy financing deal (with a potentially blown private placement exemption) or have lost about 3-4 months not getting out there and networking with potential investors. You can develop your startup in a cave — but you’re going to have to leave it if you want to raise capital. No one can pitch your startup better than you.

And to any finders reading this, if your only contribution to the startup ecosystem is that you will introduce startups to investors, for compensation, then you aren’t contributing. Either genuinely help a startup, or don’t help at all.

Some have done quite well. Here in Dallas,Tech Wildcatters had a strong class and is opening up applications for the Spring 2011 class later this month.

But this morning I read a Dallas Business Journal article that I found amusing: A new accelerator is planning to invest $200,000 and provide up to 45,000 square feet of office space to about 10 mobile app startups in exchange for 15-20% equity in each startup.

(a) That’s $20,000 per startup for a 15%-20% equity stake. Pretty expensive seed capital. Good luck trying to convince even the most nascent of startups to take your investment at around a $100k post-money valuation. Furthermore, the $20k is more like a living stipend than something the mobile startup deploys for development, etc.

(b) Office space is a nice kicker, but no entrepreneur is going to give up equity in their mobile app startup company for office space. Let me put this another way: No entrepreneur worth investing $20,000 in is going to take up an office space-for-equity offer. How much office space does a 2-3 person mobile app startup really need? Not much and they’ll likely office at a coffee shop, their own residence(s), or a local coworking facility. And more than likely all 3 places. The article mentions:

The accelerator’s space-for-equity approach is similar to the tactics some North Texas building owners used during the tech/telecom boom and bust of the late 1990s and early 2000s.

Partying like it’s 1999 is one thing — running a 2010 accelerator like it’s 1999 is probably not a great idea.

(c) Mentorship is key. And it is missing, at least for now, from the model. One of the 2 partners plans to provide personal mentorship. Regardless of how well the partner can provide mentorship, it falls way short of the roster of mentors provided by typical accelerators.

Whenever a client discusses with me whether they should join an accelerator, the decision always comes down to the quality of the mentorship. Startups don’t evaluate their participation in an accelerator by asking “Is the $20k worth the equity given up to the accelerator?” Rather, startups ask “Is the mentorship worth the equity given up to the accelerator?”

In the case of the planned accelerator, mobile app startups will be deciding “Is the mentorship from this one person worth 15%-20% of my startup?” That’s a tall order for the accelerator.

I wish the accelerator the best of luck — I just doubt they understand what mobile app startups desire and value from an accelerator.

But sometimes a person who gives your startup infrequent, casual advice will broadcast to the world that he or she is an advisor to your startup in an “official” capacity — which is (shocking) news to you and your co-founders. Awkward.

How did this “advisor” turn into a creeper?

The Genesis of the Startup Creeper

Most startup founders do a tremendous amount of networking. Through this networking, a founder may become acquainted with someone willing to provide some expertise, advice and/or connections. Most of the time, startups and the “advisor” have no problem with this unofficial, undocumented relationship. The startup isn’t looking for routine advice or time from the advisor, and the advisor isn’t looking for anything from the startup (e.g., cash, equity, geek cred).

But occasionally this “advisor” makes his or her role unilaterally public creating the awkward situation.

A founder will typically find out when someone he or she knows in the startup ecosystem tells the founder, “Hey, [Startup Creeper Name] told me he was an advisor to your startup.” Or maybe news of the official relationship is on their Twitter or LinkedIn page. Regardless, this “official relationship” is news to you and your co-founders. The casual advisor relationship has now turned creepy.

I got married before the Myspace/Facebook era, but I imagine this is something like going on a first date and coming home to find your date’s Facebook profile lists them as “in a relationship with” you. Creepy.

Don’t Lead Them On

You lead on a startup creeper by continuing to either solicit or accept their advice and connections. You may think they’ve been giving some decent advice, but you don’t really know why they are hanging around — or you are trying to figure out their angle. At this point, you have both failed to bring up the status of your startup-advisor relationship.

The Decision

No matter how you arrived at this point with your Startup Creeper, you have 2 choices:

(1) Make it official and offer them a position on your advisory board.

If the initial shock wears off and you are OK with it, immediately sign up the advisor to an advisory board agreement. Anyone providing more than casual advice should be signed up to an advisory board agreement — especially someone receiving confidential information regarding your startup and/or identifying themselves as an advisor.

This is an important task because the advisory board agreement will most likely contain provisions such as a nondisclosure of confidential information, inventions assignment, and a no conflicts rep & warranty. Your advisor will likely be privy to various inside info regarding your startup and it is to document that he or she cannot use it for someone else’s benefit, or more importantly, to the disadvantage of your startup.

(2) Kick the Startup Creeper to the curb, in the most tactful way possible.

If you are still feeling slimy after the initial shock wears off, then you need to wrap up the relationship in an expeditious manner. Difficult conversations are a part of business and this type of situation presents a great time to tackle your (likely) first one.

But do so without burning a bridge — no matter how creepy the advisory relationship is. Communicate in private, and opt for in-person over telephone conversations. If you cannot meet in person, choose telephone over email. Don’t forget to thank them, because they did share their expertise, time, and/or connections with your startup. And the situation would likely not have reached this level of awkwardness without leading them on in some capacity. Now, maybe they can shift their focus on another project or startup.

Conclusion

There are tons of great startup advisors out there (although they are hard to find). People want to help your startup and that’s a good thing. But you have to manage these relationships, before they turn into awkward situations like the Startup Creeper scenario.

Official Language in the Dodd-Frank Act:

———-
SEC. 413. ADJUSTING THE ACCREDITED INVESTOR STANDARD.

(a) IN GENERAL.—The Commission shall adjust any net worth standard for an accredited investor, as set forth in the rules of the Commission under the Securities Act of 1933, so that the individual net worth of any natural person, or joint net worth with the spouse of that person, at the time of purchase, is more than $1,000,000 (as such amount is adjusted periodically by rule of the Commission), excluding the value of the primary residence of such natural person, except that during the 4-year period that begins on the date of enactment of this Act, any net worth standard shall be $1,000,000, excluding the value of the primary residence of such natural person.
———-
Translation: Now, your house (primary residence) can only hurt your status as an accredited investor under the “net worth” test:

Example 1 — if you own a $500,000 house free and clear, $0 is added to your net worth for the $1,000,000 test.

Example 2 — if you own a $500,000 house with a $300,000 mortgage, $0 is added to your net worth for the $1,000,000 test

Example 3 — if you own a $500,000 house with a $600,000 mortgage, $100,000 is subtracted from your net worth for the $1,000,000 test.

I’ve seen a few subscription docs floating around that don’t account for this recent modification to the accredited investor definition. Thus, it’s a good idea to take a look at what your subscription docs and/or accredited investor questionnaire say regarding the $1,000,000 net worth test for individuals.

When this occurs, you need to determine the reason why your potential angel investor wants control. Is it based out of fear or corporate narcissism?

That is, you have to figure out whether your angel wants control because he or she doesn’t know any other way to protect the investment in your startup or because he or she believes they can run the startup better.

If the request for control is based on fear, the investor needs to either (a) not invest in your startup, or (b) get educated on various terms of an investment that could help protect their investment. This education could come from you or your lawyer, but preferably from the angel’s lawyer.

If the request for control is based on corporate narcissism, you probably need to find a new investor. Most angels have the ability to make an angel investment in your startup because they successfully managed/owned/exited a company or ten. And they probably started this when you were busy collecting Garbage Pail Kids. Thus, they likely you view as “not ready from primetime” and their future employee.

If the corporate narcissist angel’s background involves tech (or at least something similar to what your startup is implementing), then the control aspect can be somewhat tolerable…in the short run. But you never want to end up with an angel controlling your tech startup during the day, then calling you at night because he can’t get his iPad to work on his wifi network.

Investor fear is workable, but corporate narcissism is a deal breaker. At the end of the day, don’t give up control to any angel. And from my experience, the good angels don’t want it.

“Why have we become so dependent on lawyers to control every relationship inside our companies? Why is “just in case” the default answer when asking questions about contracts? It sounds more like insurance than legal counsel. And the premiums are sky high.”

I get it. No one likes to pay for anything without receiving a quantifiable ROI.

For example, I’ve worn my seat belt, bought cars with airbags, and paid for car insurance since I was 16. But I’ve never had an accident, moving violation, or even a parking ticket. Where’s my ROI?

But should I ditch my seat belt and/or car insurance because I’ve never been in an accident?

I am lucky that I haven’t gotten into a car accident. Who knows when and if my luck will run out? Also, my lack of tickets and accidents could also mean I’m just a really cautious, alert driver. I suspect 37Signals is just a really good employer, and maybe they have been a bit lucky to avoid employment-related issues thus far.

The best way to prevent employment issues is to install good employment practices (i.e. be a good employer). But if the shit hits the fan, you’ll be much better off with a great employment contract. Much like you’d rather have insurance, an airbag, and your seat belt on if you get into a car accident.

I don’t counsel new startups to vest their founders shares so that I can increase my “insurance premium” charge (and for what it’s worth, I don’t charge any more or less for drafting a stock purchase agreement with vesting or fully-vested shares). I counsel new startups to vest their shares since I’ve seen plenty of startups fail because their shares didn’t vest.

And I’m guessing 37signal’s lawyers have seen many clients go through painful employment-related disputes.

(Disclaimer: The author of this post gets paid to draft contracts.)

Of course, as a service provider to startups I’m in a bit of a quandary writing this post. (Your startup might need a lawyer; it might not.) But if a lawyer or any other service provider company promises your startup magical results, it’s probably a good sign that your startup needs to look elsewhere for services. And that is assuming your startup even has a need for such services.

Here’s a few examples of miracle-result pitches that have hit my email inbox from service providers wanting to gain either (1) my business and/or (2) access to my client list:

- “Hire me the SEO King/Social Media Exert and I’ll help your clients go viral…”

- “Hire me the Business Plan Guru and your clients will get awesome projections that investors will love…”

- “Hire me the investor finder and I’ll get your clients funded…”

It’s pretty easy for me to hit the DELETE key when these hit my inbox. But a startup (especially one with first-time founders) may be vulnerable to service providers and other business that promise your startup the path to glory. You’ll need to avoid the temptation to believe that any service provider is your knight in shining armor.

Those that are selling the hardest and promising the most are usually the most desperate and least likely to deliver. Knights in shining armor sell wolf tickets — not tickets to easy street.

Incorporation

(1) Entity Choice: Corporation or Corporation
(2) State of Incorporation: Delaware
(3) Authorized Shares in Charter: 10,000,000 Shares
(4) Type of Shares: Common Stock
(5) Par Value of Common: $0.0001
(6) Initial Founders Issuance: 8,000,000 Shares
(7) Founders Equity Split: Depends on the Team, But Quickly and After the Awkward & Difficult Conversations
(8) Vest Founders Shares?: Hell Yes
(9) Vesting Schedule for Founders Shares: 4 years with a One Year Cliff
(10) Consideration for Founders Shares: Cash & IP
(11) Handling of “Lost Founders”: Lock Down the IP (then Wish Them Well)

Raising Capital

(1) Length of NDA: 0 pages
(2) Fees Paid to Pitch my Startup: $0
(3) Investors: Accredited Investors
(4) Structure of First Capital Raise up to $1MM: Convertible Notes

But once you issue equity in exchange for services or investment, your startup isn’t your own anymore. You now have joint-custody.

Sure, you can (and should) still care for and nurture your startup as if it were only yours. But face it, you are slowly selling off your baby when you issue equity.

Most entrepreneurs get that, but there are still some that view any other equity holders (key employees, consultants, investors) as “The Others” and remain in a constant state of fear that all the other equity holders are going to steal their startup from them.

Being vigilant about keeping control of your startup is fine. You should always be prudent about any equity issuance. But being paranoid about it is only going to paralyze you from either (a) teaming up with people that can assist in the development of your startup, or (b) bringing in the necessary capital to take your startup to the next level.

In order to make your startup work, you are going to have to work with many different types of people, including employees, contractors, consultants, and maybe even investors. Be vigilant about issuing equity to these people, not paranoid.

I wish more startup veterans would do the same and provide mentorship to new entrepreneurs, such as taking a seat on a startup’s advisory board. A lot of the startups I work with placer a higher value on mentorship than investment capital, and would have no issue with a small equity grant to a good advisor. Do you really think startups flock to TechStars and Y Combinator for the cash?

Why does it feel like most successful startup participants have their success and fall back into the shadows of the city? Maybe it’s just Dallas. But I’m pretty sure this problem exists in most startup communities.

There are successful startup veterans in every community. They just don’t engage with the local startup scene for one reason or another. But I’m willing to bet these startup veterans received good advice along the way–or wish they did–and would be willing to return the favor.

I think it’s time to start a Startup-Advisor Dating service, in the spirit of Founder Dating. In addition to the hacker meets pixel pusher events, how about hacker & pixel pusher meet advisor events?

Maybe there’s one around that I’m missing. Anybody?

Today, Alex Muse posted on his Texas Startup Blog about a recent encounter with an investor group asking $4,500 to pitch from ShopSavvy, one of my clients.

Alex has written about why a startup should never have to pay to pitch time and time again. Thus, the investor group would have been wise to check out his blog before asking for the cash.

Jason Calacanis authored an epic post on the topic of paying to pitch as well. It’s a great read.

Just remember that no matter how hard it is to source funds, your startup should never have to cough up its own funds.

Nothing New

The importance and value of a mobile app’s users isn’t novel. I’m pretty sure Alamofire, maker of Gowalla (ex-Southlake represent), recognizes this importance and values each user they acquire. And I’m also pretty confident Alamofire owns its Gowalla users. But Gowalla isn’t a white-label app. Different issues and incentives apply.

The White-Label User Ownership Wrinkle

At first glance, large company ownership of the white-label app’s users seems like common sense: the white-label app is branded as the large company’s app, so ownership of its users should flow to the large company. But depending on the terms of the white-label deal, the mobile app startup should consider staking at least a joint-ownership claim of the white-label app’s users.

In most white-label deals, the large company doesn’t want to bet their white-label app’s success on an unproven startup. Additionally, the large company has their own brand reputation at stake and most likely just isn’t used to working with small startups. Thus, the large company will push for various provisions in the white-label agreement that will allow them to terminate the agreement early (of course, the large company will not want to extend these same early-termination provisions to the startup). Furthermore, the large company is typically not willing to throw a bunch of immediate cash the startup’s way.

Early-Termination Issues

The large company will likely push for a short initial term and attempt to include various events that would each trigger an early-termination right for the large company. The startup will be held to various performance obligations and representations & warranties. Additionally, other early-termination provisions may exist in a service level agreement.

A trigger of any such early-termination provision and the startup could be given the boot…regardless of how successful the white-label deal is for the large company. Based on the white-label agreement, the large company could find it in their best interests to exercise early-termination and replace the startup with another company or in-house developers.

If a startup gets paid via a revenue share arrangement, the potential exists for the large company to exercise their early-termination rights and get their white-label app’s users free-of-charge (or worse, the IP). But even if the white-label agreement vests the startup with all IP ownership, including both the startup’s mobile app and the white-label app, the large company could still receive the free benefit of the jointly-grown user base.

The Distribution Channel

A requirement that the large company remove the white-label app from the various mobile app distribution channels will not prevent the large company from getting a free mobile-app user base. The large company could simply replace the white-label mobile app with a new mobile app via an “update” to all the existing white-label app users. Therefore, a large company should not be able to replace the white-label app, unless the startup commits some pretty serious performance-related offenses or rep & warranty breaches under the white-label agreement.

Conclusion

Heard of the term “starter wife?” Well, a startup could be the “starter developer” for a large company if too many large company-favorable provisions exist in the white-label mobile app agreement.

As a general practice, white-label mobile application agreements should include provisions concerning ownership of the white-label mobile application’s users. Additionally, ownership (sole or joint) of the white-label mobile app’s users can be a hedge against the large company terminating your white-label agreement in good times and bad.

30 lives on Contra was virtual invincibility. Enter the secret code, you will beat the game. (Presuming of course, you have an ounce of video game skills.)

Unfortunately, there is no 30 lives cheat code that can be woven into your startup legal documents. Whether you got your documents on the cheap from LegalZoom or you paid top dollar for a large law firm to draft them, your legal docs are not a shield of invincibility. Your startup can have the prettiest set of legal documents ever drafted and your startup still may not beat the game.

Instead, startup legal documents are a safety net.

What if a co-founder decides to bolt? Good startup legal documents make sure your startup doesn’t free fall to the ground (i.e., vesting schedule and company repurchase option). What if your startup’s rockstar developer claims ownership of the startup’s IP? Good startup legal documents make sure your startup doesn’t go down in flames (i.e., inventions assignment agreement).

Legal documents assist your startup along its path, but they don’t guarantee your startup will be successful. I’m a startup lawyer and earn my living drafting documents for startups. But I never have–and never will–draft a legal document containing anything equivalent to the Contra 30 lives secret code.

I realize these various governments need to raise tax revenue. But they end up with asinine and short-sighted “solutions” to do so, since no politician has the balls to propose an income tax increase. They know doing so would be political suicide. (Of course, governments could reduce expenditures, but I’m not holding my breath.)

So rather than making (almost) everybody pitch-in via an increased income tax, politicians are going to tax various segments of American society. The segments that will be targeted for taxation are those that carry the least pull or don’t speak out against the tax. Thus, it’s imperative people speak out against Colorado HB 1192.

I have no connection to Colorado other than this blog has received 160 visits from the state in the last 30 days. But I am afraid other tax-revenue desperate state lawmakers will catch wind of this tax. Only about 12 states in the country have this type of tax–it should be zero.

Learn how you can speak out against Colorado HB 1192 here.