Archive for March, 2007

Applications suck

March 28, 2007

Sorry for the lack of posts, but we’ve been spending a lot of time writing our applications for Y Combinator and Tech Stars. Paul Graham is right – writing is harder than programming. Or at least less fun and more exhausting.
We’re very glad to be done so we can focus on programming again. We obviously really hope to get into a program, but, even if we don’t, writing the application was definitely valuable. We ended up talking a lot about the details of our idea, and I feel like we both have a much better picture of our goals as well as the problems we face.
A word to the wise: look for word-count limits before you write essays. We had copy/pasted the YC application questions into Google docs initially, to make it easy to collaboratively edit the answers. After we had written the app and were ready to paste it back into the web form, we noticed the instructions requesting all answers to be under 120 words. Whoops.
It definitely took us some extra time, but I’m making myself feel a little better by convincing myself we got better answer this way. It’s kind of like sketching something that’s going to be cropped – you’ll get a better drawing if you can continue drawing off the borders and then crop afterward instead of stopping your pencil right at the border. Plus, if we get an interview, we can talk about interesting stuff that didn’t make the final cut for the application.

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The formation equation

March 20, 2007

So, I was going to write a big post on things to consider when deciding to form as an LLC or an S-Corp*. Only a few issues stood in my way:
1. I don’t really know what I’m talking about**.
2. There already is a great article and discussion going on at OnStartups.com. Check it out.
Here’s a few more random tips (sorry if they are confusing, I’m going to assume you know a little bit about both entities already. If not, Google and Wikipedia are your friends). As you’re reading the following, please keep in mind point #1 above.
Random formation tips:
One big question we had was how how easy it would be to get outside investors for an LLC. As it turns out, it’s quite easy for friends, family, and angels to invest in an LLC – in fact, some angels even prefer it to S-Corps or C-Corps. However, many VCs won’t invest in an LLC. The good news is it’s relatively easy change an LLC to an S-Corp or C-Corp when the time comes.
There is less documentation and overhead (and therefore legal fees) when running an LLC than when running a S-Corp. However, remember to still keep good records – they will still be important if you want to switch to an S-Corp or secure investors. Don’t think you can be totally sloppy just because you have an LLC.
If you’re going to IPO within a year or so, it’s probably better to just go ahead and form an S-Corp over the LLC, because you’ll probably have to change before the IPO anyway.
There is a potentially big tax benefit to an S-Corp over an LLC that has to do with salaries and self-employment taxes once your startup actually has revenue. It’s a little complicated, but you can read about it here. The good news? You can easily ask the IRS and your state to tax your LLC as an S-Corp and still get this benefit.
One reason you want an LLC or S-Corp is to shield yourself from liability (so people will sue your business instead of you personally). Apparently, LLCs are pretty good for this, but there has been less case law on this, so some lawyers consider it somewhat easier to “pierce the corporate veil” of the LLC than an S-Corp (this also varies by state). If you’re doing something that might make scary people angry, you might want the “stronger” entity.
Bottom line: Out of the five lawyers I’ve interviewed, all but one suggested an LLC over an S-Corp. But this was specifically for LLCs in Colorado. Check with several lawyers in your state before you make a decision.
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* For most startups, a C-Corp doesn’t make a lot of sense, since you get taxed twice and there is a lot of overhead. On the other side, Partnerships and Sole Proprietorships don’t offer good liability protection. So, we really only seriously considered S-Corps and LLCs.
** No, really. I’m not a lawyer, an accountant, or a tax geek, so don’t take this as gospel. Consult responsible professionals before doing anything.

Y or Y not?

March 14, 2007

Ever since my co-founder and I went to startup school last year, we’ve been talking about how cool it would be to get accepted into the Y Combinator program. For those of you who don’t know, YC is a company that funds very early stage software startups. I stress the “very” in “very early” – YC prefers that the companies they fund aren’t even legally formed yet. YC picks a handful of these companies, give them each roughly $15,000-$20,000 (depending on the number of founders), and has all the founders to move out to either Cambridge, MA or the Bay Area. For the next three months, YC mentors the startups, has speakers come in weekly to give talks, and helps them make connections to investors. In exchange, each company gives up roughly 6% of their stock. That’s a very summarized version of what goes on, but trust me, it’s very cool.
Sounds like a perfect fit for us, right? Well, sort of. It turns out that our timing isn’t the greatest. YC takes applications twice a year – once in the summer and once in the winter (founders to go Cambridge in the summer and the Bay Area in the winter). Last winter, we were not ready to start the company, for a bunch of reasons I won’t get into. But now, we’ve been working on the company for several months and have enough money to fund ourselves for awhile. We already have started to develop connections and could pretty much form the company next week if we wanted. So while I think YC is a great opportunity for a lot of companies, we’re really not sure if it’s the best option for us.
Before I get into the details: this post isn’t supposed to be pro-YC or anti-YC. Your decision should be context-sensitive. But I’ll outline some of the stuff we considered. And remember that not all pros/cons are worth the same. I’m not sure I can attach a number to each one, but some of them are weighing much more heavily on our mind than others. The weights you apply will also differ depending on your situation.

YC
Decision Factors (partially specific to us)
Pros Cons Questions
– Work environment
– YC Advice
– Networking
– Free press
– Money is nice
– Giving away equity
– Money isn’t crucial
– Lose valuable time
– Poorer social scene
– Girlfriends?
– Travelling?
Big question: How
much will YC help us, and is it worth it?

Let’s start with the positives.
I mentioned that all the founders move out to the same city. While they are there, they get tons of mentoring from YC as well as weekly speakers who are generally rock stars of the startup/software world. Since all the founders are in the same city, they try to get a lot of interaction and knowledge sharing between the founders.
There’s a couple of great thing here. First of all, being in Cambridge with other founders sounds like the best work environment I can imagine. I know that personally, I do my best work when surrounded with smart people who are working hard. Ideas flow easily, and my friendly competitiveness comes out. Being around smart people just makes me smarter and it’s a lot of fun, too.
Plus, the advice from the YC guys would be invaluable. My co-founder and I are not businessmen. We’re programmers. So, although we have been, and will continue to, learn as much about the business side as we can, it would be great to have advice from people who have started companies. We could save a lot of time not making dumb mistakes if other people are there to point those mistakes out.
Then there is the networking. We’ve already spent a lot of time looking at banks and lawyers, and we’ll need to spend even more looking at graphic designers, marketing people, accountants, and investors. YC can help with a lot of that, because they already have those connections and know good people. Its a few less things to worry about (so we can focus on actually, you know, writing code).
Besides the networking to the business community, we’d also get to know the other founders, who are sure to be a great group of smarter-than-hell people. Not only is there knowledge sharing while at YC, there is the possibility of knowing someone that you can hire (or might hire you) in the future.
Finally, since YC is so well known in the startup community, we’d get a ton of exposure just by being accepted. It would be amazing to get a ton of potential users (turning them into actual returning users obviously depends on how good our code is) without spending a dime on marketing.
But it’s not all positive.
For starters, we’d be giving away 6% of our company, which is 6% that we can’t give to any other investors. If we’re intent on keeping some percentage of our company, giving away 6% at this stage just makes that harder.
And there’s the $15,000. To start with, that money isn’t worth nearly as much in Cambridge as it would be in Denver. Plus, we’re likely going to have to spend at least $1500-2000 just to move out there from Denver (and another $1500-$2000 if we want to move back).
For some companies, the money that YC gives is the majority (or even all) of their money (at least at the time they get accepted). This makes YC more attractive, because without YC, the company wouldn’t be able to exist. The YC money makes a huge difference, because it gives them time to build a prototypes and gets them to the next round of funding.
But for us, this wouldn’t be true. We’ve been working the past year to put away a lot of money to fund our startup. I’ve already quit my job and my co-founder is putting in his notice today (congrats, man!). The YC money, while nice, doesn’t really allow us to do anything we can’t do with our own savings. We’ve already started. We could build a prototype on the money we have. And we’re still going to need another round of funding in the next 6 months to a year, regardless.
We also need to think about time. I’m not so worried about wasting time on the application – the application has great questions which we need to be answering now, regardless of whether or not we’re applying to YC. But, the move to Cambridge will be a disruption – probably 2-3 weeks worth, for both of us. That’s quite a bit of time that could be used to write code.
Socially, it’s going to be hard to leave Denver. It’s pretty hard to meet friends when you’re working you ass off at a company that only has two people (you’re certainly not going to meet anyone new at the office). But since we already have a group of amazing friends here in Denver, it’s not a big worry.
In Cambridge, it’s a different story. Yeah, we know a few people, but with our insane work hours and limited social sphere, I’m guessing we’re going to be pretty hard pressed to find friends in the few hours that we take off.
When I was going off to college, I was trying to decide whether to stay in a party dorm or a quiet dorm. Someone gave me following advice: “You can always leave to study.” And they were right – it was easy to leave the dorm to get work done. And when I needed a break, it was really easy to find someone who was up for some fun. The opposite situation doesn’t work so well. I expect to be working insane hours for the startup, but I don’t want to spend my free time looking for friends. I want to be spend them actually having fun.
Finally, there are some things that are neither pros nor cons, but just questions. My co-founder has a serious girlfriend. How is the move going to affect them? I have a good friend getting married in August and a family trip around the same time. Will I need to skip those?
That’s my best attempt at capturing all the jumbled stuff we wrote on our whiteboard about this. A lot of it is just gut feeling stuff, but, being nerds, we did try to formulate some of the biggest questions mathematically.
First, the way we look at the YC deal is this: we give away 6% of the company to get $15000 + x, where x is the sum of
a) The amount of money we’d spend on a marketing campaign to draw an equivalent number of users to our site
b) The money we’d waste on dumb business mistakes that the YC guys could have pointed out
c) The additional time we’d spend finding employees, investors, advisors, board members, lawyers, accountants, etc., over and above what we would have spent if we had access to the YC network (to make the units work, we have to convert time to money using some estimate of our hourly rate)
The question is: what is the value of x? I really have no idea, since I’m so new to this whole startup thing. But in theory, the YC guys, or the companies who have been funded by YC, should have some idea about this, at least enough to give a ballpark answer. It’s something we’d like to ask if we get past the first round.
Secondly, how much will getting YC funding increase our chances of success? We’re going to make this startup thing work with or without YC, but I’m all for making it a bit easier.
Unfortunately, this one is also hard to answer. There’s probably some data (I have yet to really search for it) about the number of startups that fail or succeed. Unfortunately, there probably isn’t very good data about the number of YC companies that fail or succeed, simply because they haven’t funded companies long enough to really get an accurate idea. Yes, Reddit got acquired, and there have some other successes, but as for the rest of the companies, it’s not clear whether they are going to make it or not. We may not know for another few years still.
Really, looking at it now, the first question is just a way one way to approach answering the second question.
Of course, even if we decide that YC would be great for us, there’s still the little problem of actually, you know, being accepted. But we want to feel strongly about doing it if we’re going to submit our application. I think a pretty good metric is whether or not we’d spend a few hundred dollars to fly out for the weekend to meet with the YC guys (they have the finalists out for a weekend before deciding, but only reimburse 500 per group, which would not cover us both going. This is almost certainly by design – its enough money that pretty much any team can make it, but it’s not all expenses paid, so as to weed out those who aren’t really serious).
The application is due April 2nd. Like I said earlier, I think filling out the application is useful just to make us answer some hard questions about our business. We’ll be thinking hard about whether or not we want to submit it, and if we do, what to do between now and the YC decision in order to make sure we don’t lose momentum either way.
At this point, we’re leaning strongly towards going for YC, but we want to make sure we’re really thought it out. I’m sure that there are hundreds of other teams applying for YC funding. At least some of those must be in somewhat similar situations. How did you decide? Any angles we haven’t considered?

Lawyers, lawyers, everywhere!

March 12, 2007

Last week’s adventure was tracking down a lawyer. Why do we need a lawyer already, you ask? Well, in the short term, we need help forming the company, drafting articles of organization, drafting NDAs, etc. Couldn’t we do this ourselves? Sure, but I’d really hate to find out I screwed up some crucial detail in 6-12 months when we’re, say, trying to get investors.
On a more general level, it’s probably good to get a lawyer earlier rather than later. Right now, I can take my time to meet with a bunch of different lawyers and figure out which one will be a really good fit. With any luck, I’ll find someone who not only gives us sound legal advice (e.g. “Stay clear of the RIAA/MPAA, they’re out of their freaking minds”), but can also be a general adviser for our business and help us network with other advisers and potential investors. If I waited until I really needed a lawyer (either in a good situation, like we have an investor who wants to give us a bajillion bucks, or in a bad situation, like we’re getting sued), I’d probably ending up picking someone more or less at random, which rarely works out well.
I’ve never really talked to lawyers before, so this week was quite an experience. The firms I met ran the entire range from a very small firm with only a virtual office to a huge firm with a 24th floor office overlooking the city.
I’m certainly no expert, but here’s how I approached the meetings. First, I explained our general situation: my job experience, my co-founders experience, and how this is our first startup. I explain that I’m working full-time, but my co-founder is moonlighting (bonus points for the lawyers who dig deeper into the moonlighting issue to see if we’re at risk. I’m 99% certain we’re fine, but it’s nice to see they are listening and looking for issues). Then I explain what type of software we want to build. We usually talk about that for a bit. I know all talks between a lawyer and I are privileged and confidential, but, rightly or wrongly, I tend to just give them the vague outlines of what we want to do.
After that, I generally explain what we’re looking for in a lawyer, which boils down to three things:
1. Someone who has worked with small businesses, in particular small tech businesses (and has helped them grow and get funding)
2. Someone who understands we’re on a budget. This doesn’t mean “we want the cheapest hourly rate.” First of all, a cheap hourly rate doesn’t necessarily mean you’re getting cheaper service, since someone charging less may be less qualified and take longer. But more importantly, we’re willing to pay for quality work. What it does mean is that we want a lawyer who looks for other ways for us to save some money. For instance, can we fill out certain forms ourselves and have the lawyer just look over them? Are there flat fees for certain tasks? Will they suggest ways to use our time together more effectively, so we can save time and money?
3. Someone who who gives our business the attention it needs. I don’t expect that we’re going to have legal issues that require incredibly quick turnaround, but we do want a lawyer who can get back to us promptly. Even more importantly, we want someone who isn’t too busy just to sit down and chat about our business on a monthly basis, even if we don’t have specific legal questions.
I generally lay all that out and then we talk for awhile about how and why they would be a good fit for our company. Towards the end, I always ask for references, specifically technology companies that either are very small, or were very small and have grown larger.
Starting today, I’m going to start contacting those references. Here’s my tentative list of questions
1. How long have you worked with Lawyer X?
2. What kinds of legal services has Lawyer X provided you?
3. What’s the best part about working with Lawyer X?
4. What’s the most frustrating experience you have had with Lawyer X?
5. Overall, how happy have you been with the legal services you’ve gotten from Lawyer X?
6. Isn’t “Lawyer X” the most badass name for a lawyer ever?
Hopefully, this will give me a pretty fair picture of the overall experience of working with each lawyer. Anything else I should be asking? Any warning signs to look for when considering lawyers? And given how sue-happy this country is, does anyone want to put bets on how soon we’ll be getting sued for something?