Big Red Car here.
The Boss was up early this morning meeting with a young entrepreneur who was in the midst of a startup. They got to talking about how difficult it was to raise money and to get his idea to market. Nice young guy full of piss and vinegar. Going to be a big success.
Put Your Boots On The Old Fashioned Way
Young startup entrepreneurs often bootstrap (self finance) their initial efforts until they get that first FFF funding in place — friends, family and assorted other fools.
It is a heady time when the excitement of the opportunity is like a drug overcoming the natural reticence and inhibitions that a more seasoned entrepreneur might have as to how to organize the finances of the fledgling enterprise. Like a first love affair. Giddy and unable to imagine any irksome details rearing their ugly heads.
As the enterprise gains traction (this means the entrepreneur is eating at salad buffets in addition to devouring a lot of Ramen noodles), it is time to seek angel investors and ultimately a formal series A round of financing from real venture capitalists. More about those things some other time, I am sure.
This is what The Boss told him about organizing his personal affairs and the affairs of the new company.
Separate Your Finances
From the start, understand that your personal finances and the company’s finances have to remain separate and distinct. This is necessary from the perspective of being able to document the total investment — even if it is initially a purely personal investment — in the company and also to segregate the income (loss) between two different legal and taxpaying entities (you and the company). This will also become an important tax consideration.
I could give you some advice on this — flow through entity like a sole proprietorship or a limited liability corporation — but you really need to talk to a lawyer who is familiar with startups and their unique and precarious nature. Go talk to someone who has done this before. Get the right legal structure in place from the beginning.
Never, ever, ever haphazardly mix your personal and company finances. Ever. This does not mean you will not write checks to feed your new pet, it means keep a record of it and do it with a bit of formality. Decide whether it is going to be equity or debt.
Learn how to use QuikBooks or your favorite equivalent. Develop the discipline of producing an income statement and a balance sheet every month from the beginning. It is very easy to do. Just do it!
This degree of formality becomes very important when you bring in the first investors and you begin to discuss how to split profits. You will want to decide how you recover, if you actually can, the costs borne by you as the founder before the new investors begin to get a return of their invested capital and a return on their invested capital. The new investors will own equity in your company. Think it through.
As an aside, when you have detailed, written documentation of your investment to date, new investors will not begrudge your recovering your investment before they get their new money back. Perhaps. The quality of your documentation will have a huge impact on how they react to this concept.
This is basic packaging.
Pay Yourself First
While it is unlikely that you will be able to compensate yourself initially for your efforts, when you can you should pay yourself first. Initially — big title, little pay. Then, big title, big pay. It will happen, trust me.
Remember you own all of the equity in your new company at this junction in time, so you are going to be paying yourself initially with equity. Later on you will pay yourself with both current compensation and equity. Right now, you will own most if not all of the equity. This is ultimately how you will become wealthy and be exposed to the slings and arrows of an uncomprehending public who will simply want to redistribute your wealth and increase your tax rate. Of course, they did not help you build the company but that is a topic for another time.
Do three things when you begin to compensate yourself:
- Save at least 10% of every paycheck (gross) and put it into an asset which cannot be reached in the eventuality of a bankruptcy filing. Bankruptcy is the wolf that lurks on the other side of the door until you make an Instagram type exit or “liquidity event” as the venture capitalists like to call a bank robbery.
- Put the maximum into an Individual Retirement Account (IRA) or Roth IRA. Get a bit of advice and decide which is the best for you. Get one of each, if possible. The wonders of compound interest are a secret unto themselves. Calculate what your seemingly pathetic little IRA will be worth at an average rate of return of 10% over fifty years. Yes, Virginia, there is a Santa Claus and his real name is Compound Interest.
- Create some other retirement vehicle depending upon the legal structure of your company (401K, Simplified Employee Pension Plan). Get advice on this also.
You want to put your personal assets out of the reach of any company creditors and never suggest you will allow that veil to be breached. Do this and have a good lawyer take a look at your plan.
Give Yourself a Raise
As the company grows, your compensation should also grow with it. It is often difficult for any entrepreneur to believe — hey, I have not only developed a product and built a company around it but I have a damn good job too! A damn good job. This is really how the economy is going to recover nationally — one damn good job from small business at a time. Congratulations, you are fixing the national economy personally.
Pay yourself like you have a damn good job even if you have created it and own a big chunk of the equity.
By this time, you are likely dealing with some venture capitalists — wonderful chaps until you hit a bare patch and then you will learn a bit about human nature, I promise.
These venture capitalists, believe it or not, are the key to your getting paid. They cannot believe the privations you have visited upon yourself to build your product and company. They would never eat Ramen noodles to follow their dream. They do not have a class on Ramen noodles at Wharton or Harvard. That is why they became venture capitalists in the first place.
So what you think is a lot of money is not even their bar bill at the country club or the annual maintenance on their beach homes.
Don’t blink, set your salary high, bite your lips and rejoice afterwards.
Come to Work Early, Stay Late, Work Hard, Reap the Benefits <<< you deserve it
So now you have your personal finances completely separate from your company finances. Things are working out well. You cannot even remember what Ramen noodles taste like. [Keep a few bags around just to remind you of the journey you have made. You never want to forget what you have suffered through to become an overnight success.]
Keep working on your product, your business and your life. Keep your personal finances and your company finances separate.
But, hey, what the Hell do I know? I’m just a Big Red Car.