Big companies have a daunting task. Not only do they have to feed more people but they have to grow faster than their competitors or risk declining market share and stock prices. The startup has none of these worries yet most people are afraid to join a startup because maybe Intel, Microsoft, Google or whomever will crush them. This is completely unfounded. Sure, these big companies have more people, more resources and can afford a loss for a while but they have something that no good startup has — corporate inertia.

The Achilles Heal of Big Companies

Corporate inertia takes many forms. It may be the 10 levels of approval a Purchase Order needs or the HR process that makes a candidate wait 4 weeks just for an interview or maybe it’s all those senior level managers that keep fighting for more money and people. All of these are barriers to changing the status quo and they take an enormous amount of energy, talent and desire to overcome. That’s precisely why a start-up can take advantage of corporate inertia and crush a big company. Corporate inertia is one of the most powerful barriers to big company success but it can also creep into medium or even small companies. Recognizing the build up of corporate inertia is vital to staying nimble and ready for the next big idea or competitor. Consider some of the signs of creeping corporate inertia that might even pop up at your startup:

• Too flat an organization: When an organization has too flat a structure, it not efficient since all decisions go through a small set of managers. This overburdens management and makes everything crawl to a halt.

• Too structured an organization: The more layers, the more corporate inertia takes hold. Given the reality of the first issue, it’s a challenge to find the right balance of structure and flatness.

• Burdensome capital approval process: If it takes an act of God to buy anything below $50k, then the penny pinchers have taken over and don’t really trust people to make the right decision.

• Style over substance: Anytime substance takes the back seat to style, you know that corporate inertia is taking hold. Style over substance is a classic stalling tactic that corporate inertia creates to wield power and influence.

• Second guessing every decision: Buyers remorse or decision hand wringing even small decisions just enhances the inertia. If the organization can’t make a decision without a committee or meeting, then it’s time to seriously change things.

• ”That’s not the way we do it” attitude: So this is the classic sign that corporate inertia has fully taken hold. This attitude is a complete stall tactic that no startup would ever do. Once you close yourself off to new ideas, the bureaucrats win.

• Low employee autonomy: If every decision needs to go through a boss or is seconded guessed, then that’s a situation that will just build slow decisions down to a crawl.

• Meeting after meeting after meeting: Most meetings are unproductive, wastes of time. The more meetings scheduled or attended, the more corporate inertia is present.

• Lack of focus: Too many things going on will distract decision makes away from what’s important. Usually, too many projects suggests that the confidence in the overall company direction is lacking.

• Only going after the big wins: Big wins rarely happen. Most accomplishments happen incrementally. If all management cares about is the big win, then the corporate inertia towards constant improvement will struggle to take hold. This is bad since constant improvement makes lasting improvement.

The Roots of Corporate Inertia

Like anything worth doing, the reduction of corporate inertia takes a lot of energy, time and commitment. Kinda seems counterintuitive to the whole “do more with less” or nimble company that most companies aspire too. In order to reduce all this corporate inertia, one must find the source. The prime generator of more policies, procedures, training, retreats, automated systems and yes, more management, can be boiled down to three simple things: Fear, Uncertainty and Doubt. Who you may ask has all this fear, uncertainty and doubt — management of course!

Fear of Being Blamed

As an organization grows, so does the problem of not knowing what is going on. This fear drives corporations to put in procedure after procedure to cover themselves from any and all issues. This burden slows down the corporate machine simply because getting anything done requires someone to carry this additional burden. A startup really has none of these burdens because of the type of talent they recruit, the size of the organization and the inherent risk of failure.

Uncertain Management Can Trust People

Management hates surprises. Couple this with the perceived 5x effect that bad news has over good news and you get managers that distrust others. So, it’s no surprise that the number of hoops one must jump through to get something important approved — be it a new hire or a piece of capital equipment — is so intense. The simple fact is that managers are afraid of being too trusting because the downside outweighs the upside. This type of environment actually self perpetuates the more managers and layers of bureaucracy a company puts in place. The startup does not have this problem because you have to trust that your people will get the job done — there is simply too much to do to not.

Doubt About Ones Direction

Management fears the unknown. Corporate management is terrified of it. That’s why, probably every 2-3 years, corporations “restructure” to align for maximum productivity. These restructuring are a complete and utter waste of time, money, resources and political capital. They rarely, if ever, work and only seem to shift the corporate inertia to yet another reporting structure everyone has to learn. Startups don’t have this problem. There is usually one and only one startup structure and it focuses on a single goal — ship the product. For the startup, there is no other important nor pressing problem then shipping for revenue. In a company full of inertia, it seems that the single biggest goal is to please the bureaucracy.

Reducing Corporate Inertia

We have touched a little bit on some of the main creators of corporate inertia and I’m sure you can gather some of the ways to reduce or eliminate it. One thing I should mention before we dig into reducing or even eliminating corporate inertia — it’s hard. In fact, it’s probably the single hardest thing for any company to deal with once they start to grow over a dozen people. Just image the struggle it will be with a 100 person, 1,000 person or 10,000 person company. Fear not. There are various ways of reducing corporate inertia that occur at all levels in an organization. The most successful crushers of corporate inertia take an incremental and choose their battles simply because it’s a lot to tackle for one person. With that, lets explore some of the ways to reduce corporate inertia.

• Trust people more: This one is obvious but most companies don’t do this. The reason is simple — they want to catch the few bad apples that take advantage. This attitude is a sure sign that management does not want to change nor understands that with trust must come commitment.

• Failure is always an option: Failure makes management mental. Anything that even hints that their grand strategy will fail, produces so many meetings that nothing gets done towards actually making the company successful.

• Take your ego out of it: An ego driven management team will want to micro-manage every aspect of the company to the point of paralysis simply because they want to make sure it gets done right.

• Reward substance over style: Data driven decisions are the best way to make informed, progress on projects. Doing anything else, will just waste time.

• Lead by example: If you want your organization to be nimble, then be nimble. Don’t throw up barriers and then expect others to be efficient..

• Challenge widely held assumptions: The biggest part of corporate inertia is the widely held processes that seem to never go away. Look at those processes that add no value and change them if you can.

• Help others: The best way to remove corporate inertia is to help others succeed. When you help others achieve, it sets up a more collaborative environment that naturally reduced inertia.

• Keep it simple: Anything process that’s so complex that it can’t be explained in 30 minutes, should be redone.

• Add process sparingly: The desire to add process to “make things better” is so strong that some companies add so much burden that it makes things worst. Add or change process sparingly since the more process, the higher the corporate inertia.

• Empower your employees: Ok, I know this is totally obvious, but hey, people say it but never really follow through. You need to truly trust that your employees will do the right thing and empower them to succeed.

The Corporate Inertia Death Blow

So, all those things above are great and should be done by everyone at every level but they don’t really get at the root. To really crush corporate inertia, it takes the people in charge to make it happen. No other group creates more inertia than senior management. From the countless acquisitions, reorganizations, corporate re-identity, the latest management fad and general paranoia, senior management has to recognize that every time they do anything corporate wide, the nimbleness of their organization dwindles. So all you startups that are nervous about those big companies gunning for you, just remember one thing — corporate inertia is your friend!

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The Single Reason Why Startups Crush Big Companies originally appeared on The Daily MBA on April 4, 2011.

By Kate Manning

It doesnít take a finance degree to know that the current economy is tough. Unemployment rates are still at an all-time high, and many companies have gone bankrupt, while others are barely hanging on by a thread. In fact, in today’s ever-changing and fluxing economic climate, business loans are about the only option small business owners have for obtaining cash to further their companies. With an efficient business loan, almost any enterprise can see immediate growth as long as they use the additional capital wisely.

Reasons for a Business Loan

Business loans are taken out for several reasons. A company may want to secure financing to maintain business operations, invest in equipment, start a new branch, or any number of other motivations. Not only are these loans beneficial for burgeoning businesses, but they are normally easy to obtain as there are a multitude of lenders who willing to partner with business owners with a credit score of 720 or higher, a stable income, and a decent business plan. However the biggest advantage of taking out a business loan during tough economic times is that companies can use it to increase their working capital. While companies that are looking to expand often already have enough money to become larger, taking out a loan allows them to maintain their operating cash flow, making it easier for them to cover any unexpected expenses. Thus, they are able to make payments on their loan by using the new income gained from expanding their business.

Benefits

Another benefit of getting a business loan is that, if the loan is lent to a corporate entity, the loan will not usually have to be repaid by the business owner if the company fails. In the event of failure, the business is liquidated, which helps pay back part (sometimes all) of the funds borrowed. Many business owners keep this advantageous aspect in mind when borrowing money because it is only the corporation that will go bankrupt in the event of loan default, not the owner personally.

What is particularly advantageous about seeking a business lone in the current climate is that interest rates are unbelievably low right now. As the liquidity of banks increases in the wake of the recession’s brunt, banks are increasing the rate at which they lend and interest rates will soon rise to compensate. A large loan taken out now or in the near future will have much lower overhead than will one taken out in two year’s time, making this the opportune time to plan expansion.

Ultimately, all business owners should evaluate their wants and needs before contacting a lender. This allows the business owner to see which type of lender is the best fit for their company. Similarly, it is crucial that business owners take the time to read the all of the terms and conditions accompanying any business loan they are considering. There are often early repayment penalties associated with a loan and it is important to obtain a business loan that does not incorporate these penalties, as prepaying a loan in full can save a business a large amount of money in interest.

What to Watch Out For

There are a number of things to watch out for when you decide to take out a business loan. When your liaison at the bank presents you with your options, make sure that you understand the terms. If you don’t, ask them to explain them again until you do understand. Under no circumstances should you enter any agreement until you know it through-and-through: the frequency and flexibility of payment deadlines, how interest will be calculated (and how often), any penalties associated with missing a deadline, what kinds of customer service you can expect, and whether or not you can renegotiate the terms in the future are all key points to grasp. Remember also that your current bank is not the only one willing to lend. Examine other lenders’ ability to offer you a loan to your specifications before making up your mind. With a little caution and patience, you can avoid most unforseen, negative consequences that might otherwise arise.

Is a Loan Right for you?

Despite the drawbacks, business owners should keep in mind the many advantages a loan can present. Expanding a business in the current economic climate could mean achieving far greater success once we bounce back from the recession, and the sudden, increased liquidity can help a business suffering under sudden expenses pull through until it can stand on its own feet again. The main thing to remember when obtaining a business loan is to shop around for the best loan rates and always partnering with a lender who is trustworthy. If you can secure a reasonable interest rate, payments, and the ability to repay the full amount at once, getting a loan just might take your business to the next level.

By-line:

Kate Manning is a business major who has worked under others and as a self-employed entrepreneur. She currently owns and manages her own business in Washington State, and works as a content creator for Online Finance Degree

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The Advantages of a Business Loan originally appeared on The Daily MBA on February 14, 2011.

Time to market is everything. Most startups and even big companies live by that creed. The theory goes that the sooner you can sell your Minimum Viable Product (MVP), the better off you are. This is clearly the case if you have a product that the market wants. What complicates this approach is when a startup or any company, trades a solid product strategy for speed. Building something quick is always a good idea but what you build has to be what the market needs. Moving too fast might create products that people want to use but will never make any money. Case in point — Webvan.

Webvan was an online “credit and delivery” grocery business that delivered groceries to customers homes within a 30 minute window. People loved it. The convenience of ordering your groceries was compelling to the dot comers who were busy changing the world. Unfortunately, it went bankrupt in 2001. It’s downfall stemmed from moving way too fast on building infrastructure and market expansion without considering how the company will make a profit. This “first mover advantage” idea was a common one used during the dot com bubble. A similar company, Peapod, moved fast but based their strategy on using existing infrastructure. Peapod is still around and it’s business model has been copied by Safeway for it’s home delivery service.

Time to Market vs Time to Profit

Webvan’s time to market strategy was a good idea but what got lost by moving too fast was the fundamentals — time to profit. Time to profit should be considered just as important as time to market since that’s your real end game — deliver a product to the marketplace and start making profits. Ideally, the correlation between your arrival in the market and when you start making money will coincide. This ideal scenario rarely happens but it’s the most desirable. When you move too fast, this perspective gets lost because of the “we can make it up in volume” or “let’s seed the market first” types of arguments. This attitude is dangerous and will set your business up for failure.

Planning at the Speed of Light

Getting stuff done is important but more important is getting the right stuff done. In order to do the right things, you have to spend some time planning and considering your time to profit. Once you have a plan, then it all comes down to execution. That’s why startups or small automatous teams have an advantage — they have laser focus on the tasks in front of them without the distractions of a big company. Laser focus is vital to a successful project but that focus has to be properly directed. That’s why it’s essential that when you are racing to get your product done that you at least step back and plan for success. You can build fast and plan for success by following the ideas listed below:

• Build Platforms: When you build a platform, you allow yourself to use it for many different things. This may seem counterintuitive to the whole focus idea but it’s not. Platforms allow for changing direction without having to scrap a lot of work.

• Leverage Others: Part of your project plan should consider how to leverage the work of others. Anything you don’t have to create is one less thing that might go wrong.

• Fail fast: Risk is always part of any project. Not properly mitigating risk can kill a project faster than anything. The key to risk mitigation is to fail fast and be able to recover quickly since you usually can’t afford parallel paths in a fast paced startup.

• Iterate with trusted end users: End user feedback is vital to a successful product. The sooner you can get users involved, the better. This also allows for critical course corrections that most of the time, you can’t plan anyway.

• Plan for the Zig: All projects have to zig and zag around obstacles to breakthrough into success. Make sure you at least have those potential zigs in mind when you launch off on your project.

• Step outside the bubble: The fog of a project will skew your reality. It’s best to step outside the daily grind and validate that what you are building still makes sense. This single method will prove to be the most valuable since you don’t always see problems that could be right in front of you.

• Plan to iterate: Ideally, you would build your MVP, launch it and become wildly successful. That rarely happens. What typically happens is that you launch something, it kinda works and then you need to tweak it. Build these tweaks into your plans so that an accurate picture of time to money can be achieved.

Speed Kills Only if You Let it

Most entrepreneurs are impatient. They know that time is money and want to get their product out as fast as possible. This single focus values getting stuff done as opposed to getting the right stuff done. That’s dangerous since the biggest failure of any rapidly moving project is that the market conditions change and the project should have zigged when it zagged. Don’t get me wrong. Moving fast is important. The faster you get something done the less likely the market requirements will change and the closer you are to profit. Do be wary of moving too fast that you get blinded by the “time to do it over but no time to do it right” or “we can make it up in volume” conundrum. This is the surest way to be the next Webvan.

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The Perils of Moving Too Fast originally appeared on The Daily MBA on January 24, 2011.

It takes a tremendous amount of discipline, luck and skill to move your great idea off the whiteboard and into a viable company. Ideas are plentiful and the discipline to weed out your bad ones will leave many a promising idea on the trash heap. This culling effort can take many forms but the best way is to systematically develop your ideas until they either take off or fall by the wayside. To achieve this, examine the following steps for getting your idea off the whiteboard and formed into a real company:

Step 1: Idea Formation and Refinement

Hardly a day goes by that someone, somewhere has the next big idea. Entrepreneurs, inventors, students and housewife’s generate lots and lots of “great” ideas. These ideas can be the nexus of the next big thing if these ideas can be take from the raw and into a cohesive, actionable plan. To achieve this, you can apply the following method:

1. Brainstorm for 15 minutes about descriptive words for your idea: Write down as many words as you can. Don’t filter or erase anything. After 15 minutes, sort the words and phases into like groups. This will form the basis of the next step.

2. Explain the idea in a paragraph: Now that you have a list of descriptive words, it’s time to formulate them into a simple paragraph that captures the essence of your idea. Try and keep this as short and descriptive as possible.

3. Write a paragraph on the pain that the idea cures: Customers buy products or services to solve some sort of issue. Capturing this issue into concrete words will help you craft a better product.

4. Describe the necessary technologies to create the idea: Creation of your idea will most likely take some sort of technology. These technologies may exist or need to be created. Knowing this will allow you to plan your product development which tells you how much money you may need.

5. Research who else might do something similar: Competitors are important to understand. Your competitors product offerings will affect how you define your product. Any investor will obviously ask you who your competitors are and how you plan on winning against them. Be cautious if you are going after a market opportunity that has no competitors. This usually means that it’s not a viable market.

Idea formation and refinement is an iterative process that will make your concept more vivid. During the process, you will start to think about how your concept works and will interact with the world. Most ideas will never make it past this stage but that’s okay. Invention and entrepreneurship will have a lot starts and stops. Just remember to stick with it because one day, one of your ideas will launch a company.

Step 2: Vet Your Idea

Every entrepreneur thinks her idea is going to change the world. This optimism fuels the drive to see her concept become reality. If this was enough, then your done. Unfortunately, raw optimism is not enough to get your idea off the ground. You need to convince others to share your passion for the concept.

It’s best to vet your idea with people who are respectful and honest. Getting honest feedback is critical to the formation of a solid idea. Diluting yourself by only seeking positive feedback will only lead to wasted time and money. You really need an honest, constructive evaluation of your concept before you waste your time and money on it.

Step 3: Write a Business Narrative

Most inventors have great ideas but they usually fail to understand the business aspects of how that idea will make money. The best way to work through this is to start with a Business Narrative. People love a good story and the business narrative is meant to clearly and simply explain your business concept so that your audience can get excited about it. This narrative also forms the basis of all your other plans.

Step 4: Prepare Your Pitch

Your pitch should flow off your lips effortlessly. The pitch needs to be short and to the point. It’s whole job is to get you the next meeting. Think of it as your mini-business plan. Your pitch will evolve (as with everything you do), so practice it as much as you can.

Step 5: Assemble Your Executive Summary

The first thing a potential investor will want to see is your Executive Summary. This one to two page document is solely meant to get you the pitch meeting. Both the pitch and executive summary need to be tightly coupled so that what the executive summary promises the pitch delivers.

Step 6: Formulate Your Financial Models

Critical to any business is to figure out how it will make money. This is done by building financial models. There are a couple of models that you business will need. One is a Cash Budget that determines how much money it will take to realize your vision. The second is a Sales Model which is used to model your sales process. The important thing to remember about a model is to document your assumptions and be open to changing it. As with everything you do, your models will change as you gain more insights into your business.

Step 7: Define Your Minimal Viable Product (MVP)

The MVP is an essential element of your overall plan. It’s the minimum product offering that you can put in a customers hands that gives you the maximum amount of learning with the least amount of effort (taken from the link above). It’s critical because the sooner you can get to market, the sooner you can learn what works and the sooner you can get revenue. MVP’s are not quick and dirty products. Rather, they are learning vehicles that need to be well thought out in order to be effective.

Step 8: Protect Your Intellectual Property

The first seven steps are meant to weed out most of your ideas. I know, it seems like a lot of work but being systematic about idea generation and vetting will produce better ideas. Once you have a vetted idea, you now need to protect it. There are various ways to protect your Intellectual Property but the most common is to File a Patent.Intellectual property is one of the items a potential investor will want to know about.

Step 9: Build A Demo Or The MVP

Investors like to touch and feel products. The best way for them to do this is to see a demo or interact with your MVP. The scale and breath of your demo or MVP will entirely depend on your business. If you have a software company, then building an MVP is a lot easier than if you have a hardware company that needs to build physical products (like a chip or system). The power of the demo is the fact that you created something. This tells potential investors that you have the ability to define a vision and execute it.

Step 10: Go Raise or Make Some Money

Once you have a demo or an MVP, it’s now time to go raise money or start to selling. The MVP route is used to gain customer traction. This means that you are attracting lots and lots of customers to your product. Most investors will want to see this traction since that is once step closer to breaking even. If you just have a demo, then you need to convince a potential investor that the demo can be turned into a real product.

Step 11: Build Your Product or Work on the Next Revision

Traction in the marketplace is a essential ingredient for a successful company. If your MVP is gaining traction, then you need get going on the next revision that incorporates the majority of the MVP learning. If you raised money, then it’s time to rapidly build your MVP so you can get into the market. The most powerful validation of any idea is when a customer actually pays you for it. This is true even if you give something away for free since your true customers are not who sign up but rather the advertise that pay you for access to your community.

Step 12: Get to Break Even

A successful company needs to make money. The sooner you start making money, the better. Any plan you come up with needs to have a Break Even Analysis done to ensure that your business model is sound and that you have raised enough money to get you there. Breaking even is one of the most exciting points in a company because it means that you are on your way to becoming an ongoing concern (i.e. A profitable company).

Step 13: Scale for Growth

Growing a business is far different than starting one. The challenges mainly revolve around systems and procedures that allow for growth while still delivering to customers. To scale for growth requires more of a focus on product refinement than product invention. This does not mean you stop inventing but it does mean that the invention steps tend to be more incremental rather than disruptive (although, you still need some disruptive ideas since those will fuel future growth).

One critical thing to remember about scaling is that the people who helped build your company may not be the people that can scale it. This can be a tremendous source of conflict with founders who have built the company from the ground up. Mitigating this requires honest dialog as to how the company will scale and who can actually do the job.

Fail Quick

Throughout this whole process, it’s best to focus on incremental learning that validates your assumptions, products, strategies or customers quickly. Failing quickly and moving on is far better than failing slowly where you cannot adjust your strategy. One other important consideration is not to be too in love with your idea. Building a company goes through so many zigs and zags that it can make you nauseous. Being tied to a particular strategy or product definition will just bog you down when tough decisions needs to be made. The path from whiteboard to company is exciting, stressful, chaotic and rewarding if you embrace this zigs and zags and learn to roll with them.

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From Whiteboard to Company originally appeared on The Daily MBA on May 17, 2010.

Attracting top talent is challenging. Motivating talent is a fine art. Retaining talent can boarder on superhuman. Throw a startup in the mix and those three tasks take on higher importance. Top talent has their pick of exciting startups so yours has to stand out.

Attraction

Startups are unique in that they attract a certain type of talent. This type of talent is driven to create, innovate and change the world. Attracting this talent requires a certain set of special conditions that will set you apart from all the others. These conditions include:

• Interesting work: Talent is attracted to startups because they work on cool stuff. Whatever the project is, it has to be interesting and stimulating.

• A competitive salary: Competitive means within industry norms. Not super low or high. You want your talent worry about building your product not about feeding their family.

• Competitive benefits: Just like the salary, the benefits have to be within industry norms. This shows that you respect your talents needs.

• Talented management: The first talent you need to attract is talented management. Good management makes everyones life easier and will make attracting top talent a lot easier.

• Other high quality talent: Top talent likes to work with other top talent. Attract as many good people as you can and watch how they attract others.

• Flexible work environment: Life sometimes gets in the way of work. Being flexible so that people can take care of their life issues ensures that top talent will want to work for you.

Notice that I did not include huge stock options or big upside potential. Those are important but not as important as creating an environment where the work is the reward and people feel like they are part of something bigger.

Motivation

People are motivated by different wants, needs and desires — startup talent is no different. While each individual may have different prime motivational factors, a startup has to provide a framework that considers all of these factors in order to maintain momentum. Consider these motivational strategies:

• Meaningful work: Most top talent will want to work on meaningful things that will change the world. This is the main reason they came to your company. Keep the work meaningful even when it might be mundane.

• Freedom to create: Top talent wants to invent and create. Allow them to do that by encouraging people to solve problems in creative ways. Don’t put a lot of process in the way. Trust that good people will build fantastic products.

• Realistic expectations: Nothing crushes talent like the never ending meat grinder of unrealistic expectations. Everyone knows they need to work hard but don’t add super-human effort to the equation — it just burns people out.

• Clear goals and objectives: Clarity of purpose allows top talent to get their job done. Strive to clearly define what is required and then don’t change it. Being indecisive and constantly changing direction will demotivate even the most motivated person. Setting these goals does not mean you don’t change them when it’s clear that something has to give.

• Flexibility: Being flexible is not just for the work environment and should be part of your culture. A culture of flexibility will allow creative solutions for problems that might pop up.

The great fallacy about motivation is that money is a good motivator. In fact, it’s the worst motivator for startup talent. If you find talent that is solely motivated by the Benjamin’s, run far away. It’s true that the attraction to a startup is the potential for huge upside but that’s a small part of it. The real motivation is to work on exciting products and services that your talent can directly affect in big ways. When the upside comes, it’s just that — an unexpected benefit.

Retention

Your attraction and motivation efforts will be for not unless you can retain your talent. The most important thing about talent retention is that management is fair, balanced and open with everyone. This can be hard when your startup is going through tough times. Any retention efforts need to be done well before the crisis or the results will be lack luster. Some retention strategies include:

• Open communication: Treat your talent like part of the team. This means that you need to be as open as practical to the situation your startup is in. Openness will always be rewarded with loyalty if it’s genuine.

• Treating talent the same: It’s important that a manager treat all her talent the same. Showing favoritism will drive a wedge between your team. This will lead some of them to have a “I can’t win” attitude and that poisons your group.

• Be flexible within reason: Rigid rules and procedures will just drive talented people mad. Be flexible yet don’t be a pushover since being too wishy-washy will also drive people away. Being flexible also means that you allow your people to solve problems the way they want to.

• Looking out for needs beyond the company: People have a life outside of work. Respect that and allow them to deal with their life issues when they arise.

• Being open to suggestions: Nothing drives away talented people more than the “my way or no way” attitude. Always be open to suggestions, acknowledge good ideas and respect dissent.

Retention is really an extenuation of attraction and motivation with a bit of forethought rolled in. The best retention strategy is to build trust and respect before things go bad. Notice that bonuses were not in the list. Any kind of written down, systematic bonus structure where people get reward for reaching certain milestones will backfire with talented people. Remember, the main attraction, motivation and retention factor is the creative environment your create. Startup talent loves the challenge of a good problem and that will motivate them more than any monetary reward.

It Starts From the Top

All of these techniques will do nothing for you unless the CEO is bought into them. It really does matter what the CEO thinks, feels and does. Once you have that, then you can create an environment where your talent can thrive, create and make a difference.

This post was inspired by the employees tag over at Answers.OnStartups

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How to Attract, Motivate and Retain Startup Talent originally appeared on The Daily MBA on April 20, 2010.

What a startup is worth comes up a lot when looking for money. The worth or evaluation of a startup is a inexact science that combines rules of thumb, some simple math, years of experience and eventually what someone will actually pay (or invest in you). In order to come up with these evaluations, you should have a systematic approach that can be vetted, modified and compared to other similar companies.

Some Terms and Definitions

Throughout this post, I will use the following terms and definitions:

• Pre-money Evaluation: This is what the startup is worth before the money goes in.

• Post-money Evaluation: What the startup is worth after the money goes in. It’s also conditional on including or excluding the employee option pool.

• Option Pool: The pool of stock options that are available for employees

• Fully Diluted: The total number of shares issued including options that could convert (which includes the employee pool)

• Round: A funding event. Common rounds are: Seed, A, B, C or D

• Internal Rate of Return (IRR): The yearly return that a series of cash flows achieves over the life of an investment.

• Net Present Value (NPV): The value of future money today, given a certain, safe return.

• Cost of Money: The return you could get if you took whatever money you want to invest and put it in a safe investment.

• Return on Investment (ROI): How many times over your money comes back to you from an investment (minus your initial investment)

• Compound Annual Growth Rate (CAGR): The year-over-year growth rate of an investment over a specified period of time.

Different Kinds Of Companies

Evaluating the worth of a startup depends a lot on the company. A traditional brick and mortar company will have a far different evaluation than a high flying Software as a Service (SaaS) company. What evaluations boil down to is the risk involved in the investment as well as the return. Risk can be hard to evaluate since there are so many risk factors that come into play. For example, a traditional brick and mortar corner store is less risky then inventing a new automobile company but the return if the new automobile company takes off far exceeds the return for the corner store. Even within an industry, the returns for specific companies can vary a lot. That’s why it’s important to consider many different factors when evaluating what your startup may be worth. This is only really a guess since the real worth is what someone will actually pay you.

Different Kinds of Evaluations

There are several different methods you can use to evaluate what your startup is worth. These methods do have some basis but in general, most are rules of thumb that seem to have worked. There are more formal ways to evaluate the worth of your startup but those are costly and for most of us, not worth it until we either exit or get large sums of money. In the case of getting a substantial investment (say from a VC), the evaluations are typically done by the VC and not that flexible. Now, lets take a look at some of the more common ways a startup company evaluation is calculated. Check out this company_evaluation_model for a way to calculate the various methods.

Method: Investment In

At a minimum, your startup should be worth the amount of money that has been invested in it. Now, sometimes reality sneaks in and this turns out to be wrong but it’s always a good place to start your analysis. The reasoning goes that the market (e.g. your investors) have decided that your company is worth at least the amount they want to put in. For most companies, this should be your minimum evaluation and in reality, it should be above that. Of course, things get complicated when your company is distressed or in a market that is decaying. In that case, your evaluation could be pennies on the dollar.

Method: 1x Yearly Revenue

This method is the simplest and usually reserved for companies that are in an established market with stable growth. The theory on this goes that the goodwill of the owner, the stability of the market and the low profit margins (these businesses are typically on the low end for profit) only amount to the company really being worth it’s yearly revenue. There are other multipliers for this, depending on the industry and the competitiveness of the marketplace.

Method: 10x Investment In

This one is the classical VC model. The thinking goes that an investment needs to return 10x in 3-5 years so that the fund can make its numbers. Now, I know this seems like cooking the books but this criteria is an important one to consider since your company will be evaluated against it.

Method: Internal Rate Of Return

Similar to the 10x method, the IIR is a way to determine the return, over time, of a series of cash flows (investments and profits) and is used as a means to compare different investments (even though it’s not necessarily a good way to do so). The typical investor wants a 5 year IIR of > 20%.

Method: 7x Profit or 3x Revenue

Another popular multiplier method is the 7x Profit or 3x Revenue model. This is usually used for fast growth companies and markets where the company has a leading position or the market growth is skyrocketing. The reasons for 7x profit or 3x revenue stems from the companies ability to scale their operations to meet the huge market demand. This ability garners a higher evaluation but is short lived once the companies growth starts to slow (mostly due to growing pains of scaling).

Method: Industry Comparables

By far the most defendable method is to compare what others have paid for similar companies. These comps are the basis for which you can compare your startup to one that has established an exit (either being bought or going public). Comps can sometimes be hard to figure out but the data is out there. The best place to start is the Money Tree Site or the websites of the companies that were bought. Most will have a press release or announcement as to what the company was sold for.

Method: Black-Scholes Employee Option Pricing

Black-Scholes is really not a method used to evaluate your company but should be used to figure out your employee option price once you have an evaluation completed. The reason being that this is the preferred method for the value of a restricted stock option (which means they cannot be sold).

Mix and Match

The method you use depends a lot on your business. In general, you should run all of them and compare the results to see how close each one comes to the other (be sure to check out the company_evaluation_model, which has the above models in it). Mixing and matching the different models will give you the ability to check your assumptions as well as cross check your math. When doing an evaluation, it’s important to come at it from various directions so that the overall evaluation is more creditable. Of course, these methods are only quick and dirty models that get you in the ball park of your true evaluation but for most of us, it’s a good starting point.

What The Market Will Bear

In reality, your startup is worth what someone will actually pay for it. Until someone puts money down, most of your evaluation calculations will be based on guesses and gut feels. There are certified individuals that are trained to evaluate a business and set a price. These professionals are costly but do provide a certified value that is backed up by a complex analysis, based on industry best practices. If you ever get to that point, consider yourself lucky since that usually means someone is serious about buying or investing in your startup.

References

• Venture Line Article on techniques to evaluate a company.

• Neat tool on how to distribute equity.

• Investopedia article Black-Scholes for Employee Stock Options

• The Money Tree Report site

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How to Evaluate a Startup Company originally appeared on The Daily MBA on April 3, 2010.

See if this sounds familiar: A couple buddies come up with this super cool idea to completely dominate the SaaS market for tools that help companies save billions by monetizing their social media reach . These buddies know the technology, have the contacts and VC’s want to pour money into this “change the world” company. Sounds like a pretty good deal. Something that anyone would want to jump at and they probably will. The problems you will face getting this great new venture off the ground will be many and the first one will be the distribution of founders equity. What I mean by founders equity is the founders stock in a C-corp. The same techniques can apply to LLC’s but for simplicity, let’s focus on a C-corp

This will probably be the first uncomfortable meeting you and your co-founders will have. To help reduce your anxiety, let’s take a look at a some scenarios that you might find yourself in so that when this topic comes up, at least you have a starting point.

Scenario #1: The Golden Three

In this scenario, you ideally have three co-founders. One is the CEO that has experience starting and raising money. Number two is the technology guy who has a track record for building really cool stuff. The third is the marketing guy who knows anyone and everyone in your target market. These are the golden three that will start and build your new company into what will become the next “insert your favorite successful company here.” In this scenario, the distribution of founders equity is pretty easy — each person gets a third. The reasoning is that each will play a critical role in the success of the venture and without them, the venture would fall flat. Now, I am sure there is some debate about whether two or three founders is the ideal number. There are plenty of successful examples for both. Just keep in mind that you need those skills and your foundering team needs to have them.

Tip: When the golden three are present and contributing, equity should be distributed equally.

Scenario #2: Money Bags

Unfortunately, we live in a world where it takes a certain amount of money to get stuff done. Startups are no different. The first permeation on our ideal scenario is the founder with a ton of money. To be honest, this is a mixed blessing. On the one had, you need the money. Actually, you really need the money. On the other hand, a founder with a lot of money will want more control and will tend to dominate the decision making process. This is why it’s best to not have a founder with a huge dollar stake in the business. I know, the temptation is huge to take the money but the cost of this money is more than the equity you give up. You see, gentle reader, this money will control the business more than it should. The co-founder that has a huge financial stake will make bad decisions for the business since what might be good for the company may not be good for an investor. Case in point, when an exit strategy presents itself, the co-founder with the huge equity stake will probably revert to investor getting a return mode than executive that wants to build a company. Granted you might have a founder that puts in a little more than the rest but that’s unavoidable and manageable.

Tip: Beware the co-founder with a potential huge financial stake in the business.

Scenario #3: Connected

Have you ever seen a Rolodex? Back in the day, your “manhood” as a mover and shaker was directly proportional to the size of your Rolodex. Today, it would be the number of connections you have on LinkedIn. Someone that’s well connected will have tons and tons of contacts. These contacts are a potential source of customer leads and/or money. Read that last line again. These contacts are a potential source of customer leads and/or money. It’s great that a potential founder might have a huge list of people they can call to get business. Does this mean they should get more equity? Maybe but that’s a big maybe. Contacts are only good if you can convert them to something tangible. If they can do that, then it’s worth it. In terms of the split, it would be fair and related to the contribution.

Tip: Setup some realistic goals that can prove the power of their connections.

Scenario #4: Wunderkin

Some hotshot techie dude , who either invented the Internet, C++ or Python or all three, has this great idea for his next new invention. The only problem, he has no clue about business or the market or how to raise money but the idea is uber cool and can “sell itself”, he tells you. Sure. Are you also interested in a bridge? It turns out that it’s actually hard to sell stuff and raise money. The idea or technology is only the beginning of a long and painful assent to a real company. Now, the idea is important and if your Wunderkin actually built the silly thing or has a bunch of patents on it, then he deserves a little more equity. If it’s just an idea, then that’s just like a contact that’s not converted. Ideas do change over time and once you get a bunch of smart people working on a problem, that great idea will have morphed into something completely different.

Tip: Sweat equity requires some sweat. Ideas are great but something tangle is far better and should be rewarded.

Scenario #5: Delivered The Goods

Sometimes you get a founder that actually built something, got some sales and now needs to take it to the next level. These founders will have a huge vested interest in retaining more control then the “new guys.” This is just human nature, so don’t take it personal. The best way to handle this is to clearly state what everyone brings to the table. If the IP or product is really going to be part of the venture, then it makes a lot of sense to give that founder more. The problem will be in how much the IP or product is really worth. Those discussions can be contentious since human nature being what it is will mix some ego into the negotiations. Resist going down that path.

Tip: Take a hard look at contributed IP or products. Do a detailed evaluation on what it’s worth and agree with your fellow founders on how much equity you will give up for it.

Scenario #6: Hangers On

It’s also inevitable that your new whiz bang idea will attract people who think they can help you and really can’t. Or even worst, the people who could help but are either too distracted, too busy or just too lazy to step up. These hangers on will make splitting equity a challenge since they will expect far more than they actually contributed. The best way to deal with this is to gather up your real contributing founders and chat about how to handle your hangers on. A unified front will make the arguments on why they want more equity end quickly. You do need to be cautious since the “forgotten” founder problem can give you a major headache in the future. So, unless they really did nothing, you should give them a little something just to hedge your bets on future claims.

Tip: Get your real contributors together and discuss how to fairly deal with hangers on.

Scenario #7: The Mashup

Take all of the above scenarios, stick them in a blender and then hit liquify. The resulting mush will probably resemble your situation more than anything else. Every situation is different and having a formula or method that works for everyone will be hard to achieve. In general, you need analyze the situation from both a business and fairness perspective. Doing this will make the process a little less crazy and a lot more productive. In addition, there are a couple more guidelines that seem to work well. These include:

1. Founders agreement: Writing down the deal between founders is a great way to avoid the challenges of equity distribution. If you have triggers or vesting rules, put those in as well. Everyone should know what they are getting into.

2. Don’t incorporate right away: One problem with starting a company is that you really don’t know if it will work out. You also don’t know if these new founders will actually do what they say. That’s why it’s important to get your team to put in a little work up front to achieve some sort of milestone together. This way, you can vet the founders while getting something done.

3. Be fair and transparent: Treating everyone fairly is important. Part of being fair is to be as transparent as you can about how performance will be evaluated and equity distributed. If the goals are clear and the decisions are transparent, then things should go fine.

4. Sweat Equity to Founders Stock Conversion: Most founders choose to convert all that sweat equity into stock via some conversation factor. Whatever that factor is, make sure that it’s consistent and that the hour tracking is agreed upon. It usually better to do it based on some tangible work product rather than total hours spent since some people are slower than others. A good rule of thumb is to have everyones rate (dollars per hour) be the same and then have some sort of percent conversion after all the hours are added up. Better yet, setup milestones that earn certain equity percentages. Either way, make sure you write it down.

Founding a company is fun. Splitting the equity can be a nightmare. Take the time to think about each founders contributions and take a step back to really deal with what is fair and equitable. In the end, dealing with dividing your founders equity up front and transparently will set up your new venture up for success.

Additional Resources

• Neat tool on how to distribute equity.

• Venture Hacks Article on How to Fire a Founder

This post was inspired by the questions under the equity tag over at Answers OnStartUps

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How to Divide up Founders Equity originally appeared on The Daily MBA on February 13, 2010.

This post is a must read for any techie that needs to hire a marketing person. I do recommend looking at the original post that inspired Jason to write this one. The Answers.OnStartUps forum is an excellent resource for entrepreneurs. I frequent it often and am a regular contributor (it’s kind of addictive).

The real take away from this is when hiring anyone, make sure you understand what you need from them and what they can offer you. Setting expectations is critical to a successful hire.

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OnStartups: A Geek’s Guide to Hiring Marketing People originally appeared on The Daily MBA on January 26, 2010.

Focus is a critical component to success and Neil nails it with this post. Without focus, you get easily distracted on things that don’t matter. Starting a business is no different. You really need to pick one and dive in. Distracting yourself with multiple ventures will increase your odds of failure. It’s just that simple. Do the math like Neil did and you will come to the same conclusion.

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Quicksprout: The Biggest Mistake Your’re Going to Make originally appeared on The Daily MBA on January 26, 2010.

Disclaimer: I am not a lawyer nor an accountant. I don’t even play them on TV. What I have done is some research. I have also been at a couple of startups where I had to figure out the paperwork. It obvious, but please do consult a qualified financial or legal adviser before making any stock option related decisions. If any of you out there are professionals, feel free to drop me a line with any corrections.

Why Give Out Stock Options?

Because they are free. Well, not exactly free but close to it. Startups give out stock options to align their employees to the goals of the investors. Typically, a company will have a stock pool, after each round of funding, to give out to employees. This pool is roughly between 10-20% of the total shares outstanding and dolled out depending on service, rank and the whim of the board. So, stock options are a perk that tries to make employee a little more like owners.

Types of Stock

Before we dig into stock options, we should discuss the types of stock that a company can issue. It’s important to understand this because this will determine the fully diluted amount of stock outstanding, which affects your overall company ownership. The various types are:

1. Founders Stock: Is a special class of stock that is only issued once, upon founding of the company. You usually buy this type of stock since the price is low (on the order of cents) and there are tax advantages (long term capital gains) for buying and holding it.

2. Preferred Stock: As the name implies, preferred stock is special. It’s usually reserved solely for investors and has special perks. These perks include: being paid first, preferences before conversion to common (e.g. Multiples) and voting rights. The price and terms for preferred stock is set per round (e.g. A-round, B-round).

3. Common Stock: If it’s not preferred, then it’s common. Eventually, all stock may convert to common, depending on the preferences listed at each round. This is important to know since it sets the total shares issued as well as the amount of participation the common shareholders will have in a liquidity event (e.g. Being bought or going public). In some cases, the preferred will take all the money and leave the common stockholders with nothing. Common stock is what your options are for.

Types of Options

There are only two types of options that you will get at a startup — an Incentive Stock Options (ISO) or a Nonqualified Stock Options (NSO). In IRS speak, an ISO is called a Statutory option while an NSO is called a Nonstatutory option.

Incentive Stock Options

These type of options can only be issued to employees. They have certain tax advantages, the biggest being that ISOs are taxed on the sale of the stock not the exercise of the option. This means that you can exercise your options and not have to worry about taxes until you actually sell the stock. Well, not exactly. You do need to look into Alternative Minimum Tax (AMT) triggers since that plays by a different set of rules (see below). Some of the other rules that ISO’s follow are:

• Must be granted at Fair Market Value (FMV)

• Non-transferable

• Must be granted 10-years after board approval

• Must be exercised 10-years after the grant date.

Nonqualified Stock Options

All other options, at a startup, are typically NSOs. There are something called warrant’s, but those are usually reserved for outside investors, so we won’t deal with that here. NSOs are more flexible than ISOs but they don’t have the same tax advantages. The main thing about NSOs is that they are taxed when you exercise the option. This means they are taxed at ordinary income tax levels and you don’t get the benefit of long term capital gains. NSOs have the flexibility in terms of:

• Can be given to anyone

• Can be priced at, above or below the current market price, so no issues with FMV

It is critical that you understand which type of options you have. The tax implications are real and severe if you do the wrong thing. It’s best to consult a professional tax advisor as to your best course of action.

Option Pricing

ISO options are priced via a complicated process known in the trade as a 409A. We won’t get into the details since it’s complicated and for a startup, hard to calculate. The thing to keep in mind about option pricing is that it will be less than the present preferred round price. As the company gets closer to a liquidity event, the option price will converge to the round price. The rational for this is simple. Early in a startups life, the risks are high. The options can’t be exercised, so the value has to be based on a future value of a company that might not be around when the option can be exercised. All this means is that early options are worth less since they are more risky. As the probability of a liquidity event gets greater and greater, the options become less risky — thus worth more.

Vesting

Stock options vest over time. Usually, options vest over a four year period with a one year cliff. The one year cliff means that you don’t get any of the vested options till a year after the grant date. At that point, you 25% of the options vest. After that, the vesting schedule is 1/48 per month for a four year vesting schedule.

There can be vesting triggers for certain events. These are all up to the company and board of directors. A typical vesting trigger might be a change of control or loss of title. In these cases, all of the options could vest right away. It really depends on the board. It is not unheard of to have fully vested options (i.e. 100% vested at the grant date) as a bonus.

IRS Section 83B

The IRS Section 83B is an election that allows employees to change how restricted stock options are taxed. Restricted stock usually comes in two categories:

1. Founders Stock: When a company is founded, the Fair Market Value (FMV) is really hard to determine and fairly low. The Founders stock is restricted and “granted” or given right away (e.g. No vesting schedule). This means without an 83B election, you would be paying AMT as the stock price appreciated at each round. So, all founders should buy their shares and file an 83B election. This ensures the most favorable tax treatment (since it starts the long term capital gains clock) and eliminates any AMT issues. The downside is that you can be out the cost of the stock (which is most likely low) if the company fails.

2. Early Option Exercise: Some option plans allow you to exercise your options before they vest. This type of exercise has to happen within 30 days. The tax advantage is that it starts the long term capital clock while the stock vests.

See, this is kinda tricky. You really do have to read that grant paperwork carefully to understand how taxes will be calculated. It is perfectly acceptable to ask your CFO to explain this to you or have them recommend a professional.

Tax Calculations

Taxes are complicated. To make it even more complicated, the IRS actually has two tax systems. Yup. Two different tax systems that have completely different rules. Exercising stock options will have tax implications for each system.

Standard Income Tax

Most people are used to this system because we all pay taxes. Options can be taxed two ways in this system: as short term capital gains (like ordinary income) or long term capital gains (at a reduced rate). These rates vary all the time, so it’s best to look up the long term capital gains rate and how it relates to options. As of this writing, the criteria for long term capital gains is 2 years from the grant date and one year after the exercise date. The long term capital gains rate is between 5% or 15%, depending on your tax bracket.

Alternative Minimum Tax (AMT)

AMT becomes a problem with ISO options because of the ability to hold without a taxable event. Remember, that an ISO is taxed when you sell the shares not when you exercise the options. NSO’s are taxed when you exercise the options, so they are taxed at your regular income tax rate. Keep in mind that if you exercise and sell an ISO in the same year, AMT is not an issue because it’s consider short term capital gains and taxed at your normal income tax rate.

ISO’s have a major disadvantage to the employee in that the spread between the purchase and grant price is subject to AMT. For taxable incomes up to $175,000 or less, the AMT rate is 26%. Above $175,000, it’s 28%. If the AMT rate is more than your normal tax rate, then you pay AMT and not the regular tax rate. There is also something called a Minimum Tax Credit (MTC), which is the difference between the AMT amount and your normal tax amount (if AMT is higher). This MTC can then be deduced in subsequent years.

I’m sure by now your brain hurts from all this. Mine too. The thing to take away from the whole AMT thing is to know that it exists and talk to your accountant.

Some Examples

Lets take a look at some examples to see how this stuff works.

Example 1: NSO Options

Jane received 5,000 NSO options at $1.00 from Wonderful Company. The vesting schedule is 4 years with a one year cliff. It’s been two years since the grant date and Jane now wants to exercise some options. The present stock price is $2.50. So, the math looks like this:

Total Options: 5,000

Option Price: $1.00

Options Value: $1,000 (at Grant)

Vested options after two years: 2,500 (24/48 or 1/2)

Vested option worth: 2,500 * 2.50 = $6,250

As soon as Jane exercises her NSO options, she will owe regular income taxes (short term capital gains) on the spread, which would be $2.50 – $1.00 = $1.50 per share or

$6,250 (Exercise Value) – $2,500 (Option Price) = $3,750 taxable income.

Now, if she held the stock, even for the long term capital gains timeframe, she would still owe taxes on the $3,750. So, it’s important to sell some options to cover the taxes that you owe even if you think the stock will go up later.

Example 2: ISO Options

Jim received 10,000 ISO options at $0.25 from Uber Cool Company. The vesting schedule is 4 years with a one year cliff. It’s been 1.5 years since the grant date and now Jim wants to exercise some options. The present stock price is $9.50. Jim’s math looks like this:

Total Options: 10,000

Option Price: $0.25

Options Value: $2,500 (at Grant)

Vested options after 1.5 years: 3,750 (18/48 or 3/8)

Vested option worth: $35,625

Jim exercises his vested ISO options. At that point, he owes no regular income taxes but the spread ($9.50 – $0.25 = $9.25 * 3,750 = $34,687.50) between the grant and exercise price is subject to AMT. So, Jim needs to talk to his accountant to see if he will trigger owing AMT. If Jim holds his stock for more than a year after he exercises it, then he will owe long term capital gains when he sells it.

Summary

The complexity of the tax system makes it challenging to understand what you might owe when exercises options. Couple that with the changing nature of our tax system and you can see why 1) I am not an accountant and 2) why they get paid so much. It’s always best to seek out professional help when trying to sort this out. What you should do is become familiar with the terms so you can ask the questions. Listed below is a summary of things you should be aware or:

• Option type: ISO (Employees Only) or NSO (Everyone else)

• ISOs are not taxed at exercise but at selling. It does have that nasty AMT trigger

• NSOs are taxed at the time they are exercised.

• Vesting schedules are typically 4 years with a 1 year cliff.

• Grant date

• Option price

• Your particular AMT triggers for ISOs (talk to an accountant)

• Exercise price

• Exercised option hold period

• Does your options qualify for a IRS Section 83B election?

References

• Investors Guide Article

• Stock Option Plan Article

• A detailed article about ISO/NSO stock options from David Naffziger’s blog

• IRS Publication 525 related to taxable and non-taxable income.

• A good explanation on 83b elections

• Excellent article on AMT and stock options

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Startup Stock Options Explained originally appeared on The Daily MBA on December 20, 2009.