Naomi wrote:

I am starting a medical practice where I will be the sole owner and I will have several employees including other physicians. I am wondering if it would be better to be a c Corp with the intention of choosing s Corp status to avoid the double taxation on dividends or just do a LLC. Would the LLC mean a higher level of taxation?

For your situation, I would recommend finding good legal and accounting professionals to help you make this decision.  You will likely be wanting to have these local folks on hand anyway, as you focus on being a doctor.  There may very well be advantages one way or the other that apply specifically to medical professionals, so I'd ask some other doctors in your area for recommendations.

Both an S-Corp and an LLC should avoid double taxation, and for tax purposes are nearly identical. Generally I push people toward LLC's because they tend to be very easy to setup and maintain, but in your case again it's worth checking with someone who specializes in medical practices.  There could very well be tax advantages to a C-corp as well, so it's worth exploring all your options.

If you do get a solid answer, please come back to the site and let me know.  I'd love to have a good answer I can share with other medical professionals.

Jeff

Susie wrote:

I came across your website and found it really interesting. Am working for a start up right now and wondered whether you might be able to help...

8 months ago my boyfriend came up with an idea for a start up. For the first three months I worked on it part time with him along with another guy who was also part time. In January we both became full time and my boyfriend brought on another woman who was initially part time, then quit her job to become full time in February. My boyfriend made her CEO and Co-founder, and himself Co-founder. The other guy and myself are not co-founders but have been working on this full time since January and put a lot into the project.

We are about to close funding and time has come to split up equity. At the moment my boyfriend and the CEO as co-founders are splitting Founders Stock 50/50 and the other guy and myself will hopefully get some proportion of their stock. I have no idea what, as a non-found, but on the original team, unpaid and full time since conception, should be pushing for % wise.

I believe the official term for this is "a royal mess".  It's really imperative that you have an agreement on who is receiving what equity up-front, because it becomes awkward to have those conversations later.

There is no right answer to this question.  It depends on how many hours people are putting in, if people are putting up cash, what their work is worth on the open marketing, who is doing what, etc, etc, etc.

The one thing I can tell you is this:  However you split the equity, you need to set this up as either restricted stock or stock options.  In this way, if someone leaves, or doesn't work out and you have to part ways, they won't walk off with a huge piece of the company.

Take a look at this past article for some more information -- and there are several more here on the site (look at past articles and search for "founders" or "equity").  How to Structure Equity for the Founders

Sorry I couldnt' be of more help, but at least you can start with that article.

Jeff

Marusia wrote:

My friend and I are starting a retail business and want to go with a NY LLC. When we are up and running, developed a great product and are ready to raise money and go big, we will convert into a DE C corp.  The reason we want to go with a NY LLC are as follows...

You're all good here, I suspect.   I don't know the details of one state's LLC vs. another, so you should consult a lawyer for the good legal advice on this.  However in general, an LLC in your state is just fine.  If you are going to have investors, the I would suggest switching to a c-corp down the road.  Not necessary, but in my experience it's more flexible.  Likewise if you get into employee stock options and the like.

Either way for a startup getting off the ground, I usually recommend LLC and the state you live in should be just fine.

Jeff

Philip wrote:

Jeff, I have a business idea that I believe has great potential. Essentially it a website that I believe can attact a lot of traffic by providing a much needed service. Without getting into the details of my business idea, my question is this:  Where do I start?!?

The idea needs some software to be developed, some website design, multiple servers etc.. I have a technology background, but it has been a few years since I've done programming.

I have a full time job, a wife and a kid. My risk I can't lay everything down to chase this dream, but how do you suggest I get this off the ground?

You start with the phone.  The most important thing you can do at this point is to ask those people who are your potential customers what they think of your idea.  This is how you remove risk, identify the true pain points, figure out how appealing the service is, and determine how best to reach your customers. 

Obviously, I don't know what this specific service is, but either way, I am certain you need to start with the phone.  Even if this is some kind of mass-marketed web service, you need to have some live conversations with folks who are the would-be target audience.  Maybe you can make a posting on related websites and ask for this conversation and help.  Maybe you know who the targets are and can cold call them.  Either way, shoot to have 20 live conversations where you talk through your idea with the potential customers, and see where that leaves you. If you do that homework, I'd be happy to chime in with what you can do from there, but I suspect you'll already have that answer.

Right now, I'd say you have the cart in front of the horse.  Don't worry about how to implement the technology, or how to convince your wife that this is a good idea, or how to pay for the whole endeavor.  You need to start with the potential customers, and hear their feedback live on the phone.  (email won't cut it).

Good luck!

Jeff

Gary wrote:

I have seen your video on "How to write a Pitch Presentation" very very helpful. Thank you!  

I have heard horror stories of things going wrong with investors and the investor turning on those they have invested in. So my question to you is, "Are investors worth it in the end?"  I have been thinking about looking for an investor for a while, but I do have my doubts.

First of all, I apologize to everyone who has asked questions that have gone unanswered for so long.  Sometimes my day job gets the best of me.  LOL. 

So Gary, here's the thing:  You need to understand, with clarity, what the motivations, expectations, ideal outcomes, timeline, patience, and broader investment portfolio of your investors is, before you take their investment. 

I've seen many entrepreneurs (at least the inexperienced ones), make the assumption that the investors on "on the same side of the table" as they are.  This is made worse by investors who love to use the phrase "we're on the same side of the table as you".  LOL. 

Generally, yes, your investors want you to do well, and you want to do well.  That much is a given.  However you and the investor may have very different ideas as to what "well" means, and over what period of time you should be willing to wait before taking action. 

You need to know what the investors are looking for from the beginning.  It easy for me to say that, and it likely seems obvious.  Most entrepreneurs never ask the question though.

The other thing to consider is the type of investor.  An individual angel investor may well be more patient than a venture capitalist who may be under their own time-pressure with their limited partners.  Some angel investors may be very passive -- others will want to be in your face all the time.  You need to know if this is a small part of their investment strategy, or a big part of it -- you can imagine that this makes a big difference in how they view the investment and how prone to panic they might be.

In the end, yes, investors are usually worth it -- almost by definition, because if you are considering investment for the right reasons, it's because you *need* it to grow your business they way you want to.  Thus, if you don't get the investment, you can't grow the business the way you want to. 

Don't let yourself get spooked because of the "horror stories" you might have heard.  Seek out your investors if you need them, and take it upon yourself to do your homework on what makes the potential investor tick.  You are picking them as much as they are picking you.  It's silly but true that many entrepreneurs put 10x the thought and consideration into hiring an employee than they do into selecting an investor.  You need to know that investor like you would know your own spouse, and you should be as excited about bringing them onboard with you as they should be about making the investment.

I hope that helps.  I'm happy to go address some follow-up questions as needed.

Jeff

My answers are:  “right now” and “you won’t.”

During an interview today I was reminded of something that I say during one of my more popular entrepreneurship pitches on creating good business ideas, and that is “You don’t learn to shoot a basketball by reading books.”

Essentially what I’m talking about is simply this:  If you want to learn to play basketball, the fastest and most efficient way, BY FAR, is to pick up a basketball and start playing.  Sure, you can glean some information from books and videos and coaching – but none of that will mean much unless you are already in the mix and shooting some hoops.   I think everyone intuitively knows this.

When it comes to business though, a lot of people, maybe even most people, think you should spend all kinds of time reading books, taking classes, studying other businesses, etc.  All of these can be valuable activities, but just as with basketball, they will have SIGNIFICANTLY more meaning if you are already familiar with what it takes to play the basic game. 

You have to jump in and start learning what it takes to run a business at some point, and the best time to do that is right now, so that all the time you are going to spend reading books (and blogs like this) is more meaningful. 

You’ll ever know that you’re “ready” to do it, because you don’t even know what it takes to get there.  Just do it.  Seriously. 

There’s an old saying that goes “The longest journey begins with a single step,” or in McStartup terms, if you’re going to create the next Microsoft, you’d better get off your duff and actually start the dang company.  All those books you are reading about customer acquisition, building great culture, hiring A-players, and conquering a market will mean that much more when you actual have some experience trying to do that. 

You’ll have lots of questions, you’ll make lots of mistakes, and you’ve got a lot to learn.  If you were to spend the next 20 years reading this blog without starting a company, I’d tell you the same thing.  There are many decisions to be made along the way, and this is the first one.

So, if you’re looking for a new years resolution, take this one from McStartup:  Start that company you’ve been thinking about, and start it today.

Ok, so I'm lying.  I'm not keeping up with regular posts, so this is nothing more than a shout from the soapbox.  Nevertheless...

Here in Indiana we have a really cool program called the Orr Fellowship.  The idea is to help new college undergrads find their way into earlier stage, entrepreneurial companies who likely don't have the time to comb college campuses for new hires.  Nearly 1,000 students apply for the opportunity to land their first post-college job at one of these companies, making a 2 year commitment in doing so.  The host companies also make some promises to the fellows, like providing access to the executive team, meeting with all the fellows from the other companies during the year, and generally providing the full startup experience to the new employee.

The point is to get the best and the brightest students, who are already in Indiana, to get engaged with the most promising companies in the state and thus keep them here.  By targeting entrepreneurial students, this also helps to foster an ecosystem where those same grads may someday create their own startups here in Indiana, and help carry the whole thing forward.  Indiana is in the throws of a changing economy, with the central Indiana area slowly but surely gaining momentum as a place where high-tech startups can thrive.  This will be news to many of you, but if you are here and plugged in to this community, you can certainly see the momentum and number of tech startups growing rapidly.

Last year, I participated in this program for the first time with Scale Computing (the best-ever company on the planet, providing unified, scale-out storage solutions, by the way), hiring Emily as our first ever Orr Fellow.  Throughout the entire process, I was impressed by the caliber of the potential hires, and I've continued to be more impressed with the Orr Fellows as I've gotten to know some of them over the past 6 months. 

Last night, Peter and I hosted several of them for dinner and a few beers (Guinness FTW), to talk a little entrepreneurship and bestow whatever scraps of wisdom we could muster.  During the course of the evening, I was astounded to learn the following:

Scale Computing is one of the only (maybe the only) host company that is providing stock options to our fellow.

This is shocking to me.  Part of my motivation for participating in the program, and for all of the speaking I do at colleges and community events on entrepreneurship, and for all the consulting I do with local companies, is to help transform this area into one that moves and thinks in a more Silicon Valley-like way.

Stock options, and a piece of ownership in the startups you work for, is a fundamental piece of the Silicon Valley ecosystem.  I have no doubts that stock options are sometimes motivating, and sometimes aren't.  However, I am a believe that, especially in the early stages of a company, everyone gets stock options. 

And likewise, I have no doubt that the participants in the Orr Fellowship, who are going out of their way to engage an early stage company, in a program that explicitly is seeking to create a more startup friendly world in this area, should be receiving stock options. 

I'm not saying that the companies should be doling out giant equity pieces here.  But what I am saying is that, for a startup culture to emerge, a piece of that culture is based around equity for the employees.  These are the future entrepreneurs in the area, and they should be learning the importance of this piece of culture building during their fellowship program. 

So, what the heck is wrong with you, fellow host companies in the Orr Fellowship?  It's time to step up with the stock options and build the foundation for a long-term entrepreneurial and startup culture.

And, for those Orr Fellows who are now or were previously at companies that didn't issue stock options:  You have learned the wrong thing.  When you start your companies and hire people, including Orr Fellows for yourself, you should issue stock options and encourage your employees to take pride in the ownership they represent. It's not just about the potential financial upside -- it's about knowing that they own a part of the dream, and that it's a dream that is shared among the entire team.

That is all.

If I start an LLC where I have 75% ownership and someone else has 25% and along the way I/we decide to change to a C-corp, how are the 75% and 25% accounted for when we begin to take on new members and investors?

Two parts to this question, and both are straightforward, the only thing you need to change is the way you are thinking about it.  Do not think about ownership in either an LLC or a C-Corp as being a percentage -- instead, think of it as being a fixed number of units (in an LLC) or shares (in a C-Corp). 

For example, let's say you had an LLC where you owned 75 units, and your partner owned 25 units.  Clearly, you own 75% of the company -- at this moment in time.  However, it's the percentage that changes over time.  If you add another partner, and issue that partner 25 units, you now have a total pool of 125 units while you still own your 75 units.  Thus your new percentage of ownership is 75/125 or 60%. 

If you were to convert the LLC to a C-Corp, you are simply going to convert each unit into some number of shares, maybe 1:1, maybe 1:1,000.  It's up to you and makes no difference in the percentage ownership.  Lets say so did this sort of conversion, so now you would own 75,000 shares out of a total number of 125,000 issued and outstanding shares.   Your percentage ownership is 75,000 / 125,000, or of course, 60%. 

It's a simple thing but it's really key to getting your head wrapped around corporate ownership:  think in absolute numbers not in percentages.  The percentage is going to be a moving target as you issue new shares.  Any time new shares are issued (assuming existing investors don't get more), you are going to experience dilution because of the math:  your shares stay the same, the total number of shares goes up. 

Radically innovation refers to that type of innovation so powerful and different that it can completely change the profession, institution, industry, business, or person in one fell swoop.  Thinking about how radical innovations come about and how they impact the world around us is a favorite subject of Tom.

I bring it up here, because I believe that radical innovation is the key to success in whatever you do – and not just radical innovation, but, as Tom puts it, “continuous radical innovation” – the constant search for those things that will turn your world on its head.

It is true that most businesses are looking to innovate, but to think about radical innovation really changes the way you view things.  It’s very different from thinking about “constant innovation” or “continuous improvement” which is the mantra of many businesses today.  As Tom quipped during his speech, “General Motors followed the mantra of continuous improvement all the way into bankruptcy.”

 Put another way, and to borrow from the world of academia, continuous improvement gets college campuses wired, installs the latest lab environments in the buildings, and creates a campus environment more rewarding for the students.  Radical innovation moves the entire university experience online and does away with the campus altogether.

Continuous improvement puts shocks on your carriage.  Radical innovation replaces the horse with an engine.  Continuous improvement accelerates the reload speed and accuracy of your rifle.  Radical innovation gives you a machine gun.   You get the idea.

The challenge is to continuously seek the radical innovations in your business – to look for and to go after the very technologies that, if developed elsewhere, would bring a swift and painful end to your business.  In the mean time, of course you need to look for ways to improve your business, your products, and your practices.  However, time and resources need to be spent going after the radical, not just the better.

This probably sounds a lot easier than it is.  Radically innovation is an unpredictable, expensive, and messy business.  With limited resources, the temptation will always be to direct those resources toward the projects that will have the most immediate and predictable impact.  Just as you would imagine the mad scientist to find himself surrounded by doubters (right up until the invention actually works), you’ll find that investors, employees, partners, and competitors will view resources directed to these “rogue projects” as wasteful, silly, and distracting. 

Thus is the challenge of going after radical innovation within an ongoing enterprise.  The near term benefit sits squarely on the opposite, and in a world of business that’s often driven by quarterly numbers, high rates of employee turnover and movement, and a desire for immediate satisfaction, it can be extremely difficult to manage the balance of resources between what is today’s reality, and what might change that reality. 

The pressure will be on improving today’s reality.  But if you’re not careful, you’ll have the world’s greatest carriage company – right up until Henry Ford hands you your lunch – just ask GM. 

You see, Rose-Hulman is widely known (in the very small circle that follows such things) as the #1 undergraduate-focused school for Science, Engineering, and Mathematics in the US, and has been for quite a while now.  Rose prides itself on this feat, as well they should.  However, I’ve been trying to push them in a direction to trumpet more of their business successes as well.

Holding a whole variety of administrative positions during his time at Rose, Tom was also first and foremost, a teacher.  He taught in the economics department, the only non-technical major available at the school.  While I was there I was signed up as a double-major in computer science and economics, but my interactions with Tom was primarily in his specialty area of entrepreneurship.

I took a 300-level class called “The Entrepreneur” which is about the only business-ish class you can take at the school.  I wrote my first business plan as part of an independent study course Tom mentored for me that we called “The Entrepreneur II”.  Basically, I launched my first business with a mountain of technical training, a vision, the business mentorship of Tom Mason behind me. 

Now, you can declare a minor in Technical Entrepreneurship, thanks to Tom.  Likewise, they’ve launched a graduate program called Engineering Management, which is everything that a tech-minded engineer wishes his or her MBA program actually had been. 

As far as technology focused universities go, Rose is light-years ahead in thinking about the intersection of entrepreneurship and technology and what it means for students.  This achievement rests squarely on the shoulders of Tom Mason.

Now, what’s important to note is that Rose-Hulman is not a big school.  The total student enrollment is 1,800, hardly larger than my own high school.  The student-to-faculty ration is 12:1.  It’s a small place where your interaction with professors is high, and the professors themselves teach all the courses, most of which meet 4 or 5 days a week.   Classes are packed together, bells ring to mark the ends of periods.  The classroom buildings are all connected together to form one large structure.  The whole thing operates with a pace that is lot more like a high school than a traditional university.

Despite the small size, Rose alumni have gone on to do some great things.  Bernard Vonderschmitt was the founder of Xilinx.   Dennis Carter is the VP of Marketing at Intel that came up with the “Intel Inside” campaign.  Andrew Conru founded Friend Finder, Mike Hatfield founded Calix, Cerent, and Cyan.  In 2009, Forbes magazine picked the top 20 most promising companies in America – two of them were founded by Rose-Hulman grads (one of which is my own Scale Computing).

If you think about that last point for a bit, it’s pretty shocking.  Forbes reviewed over 4500 companies during their selection process.  2 of 20 winners hail from a school of 1800 students, tucked away in an obscure midwestern town most famous for being the home of Larry Bird’s college days at Indiana State. 

Something special goes on at Rose, and when it comes to connecting innovation, education, and entrepreneurship, they owe a great deal to the work of Dr. Mason.  One of his greatest insights is something I’ll share in my next blog post, and it relates to how innovation impacts all aspects of business.