Advisors are great for startups. They can provide your startup with guidance on a wide range of topics and typically take a seat on your startup’s advisory board.

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

How did this “advisor” turn into a creeper?

The Genesis of the Startup Creeper

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

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

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

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

Don’t Lead Them On

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

The Decision

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

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

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

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

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

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

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

Conclusion

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

It’s been a pretty busy summer and with the football season fast approaching, becoming more productive during the week is crucial. Thus, I bought a laptop exercise bike for my office from FitDesk. I gave it a test cycle and it was pretty sturdy, and most importantly, it was quiet. I intend to use it for minor computer tasks like reading my RSS feeds and blogging.

The cool thing is that it has a small footprint, folds up, and it wasn’t that expensive (about $200). My laptop is secured to the bike with provided rubber bands as you can see in the pictures below.

Just like the preferred equity financing process, the convertible debt financing process can start with a term sheet, rather than a full set of financing documents.

A convertible note term sheet is beneficial because it postpones a lawyer from cranking out a full set of docs until consensus is reached regarding the convertible debt offering’s material terms. It also makes any potential back-and-forth negotiation on such terms easier to manage.

On the other hand, if you are dealing strictly with friends and family on a convertible note transaction, adding this extra step in the process could be somewhat cumbersome. Thus, it’s usually prudent to go straight to the convertible note deal docs with friends and family.

Here are terms that are typically found in a convertible note term sheet:

Amount of the Offering: How much capital can the startup raise via the convertible debt offering?

Closing: Is there a specific date that the convertible debt financing will close, or will there be an open round of seed investment?

Interest Rate: What is the rate of interest on the convertible debt? Is the interest payable upon maturity or monthly/quarterly/yearly?

Term: When is the maturity date of the convertible notes?

Prepayment: Can the startup prepay the convertible notes without the consent of the convertible note holders?

Convertibility: What amount of equity financing is required to trigger automatic conversion of the convertible notes to equity (i.e., the determination of qualified financing)? What is the discount received by the convertible note holders relative to the price paid by the qualified financing investors? Is there a convertible note discount price cap? Do the convertible notes convert to equity on the maturity date, and if so, at what pre-money valuation?

Liquidity Event Payment: How much (e.g., 2X/3X, etc.) do the convertible debt holders receive if the startup gets acquired before a qualified financing and the maturity date? What is the definition of “Liquidity Event”?

Warrant Coverage: Do the convertible debt holders receive warrants to purchase “Series A” shares, and if so, how much percent coverage?

Security Interest: Will the convertible notes be secured by any or all assets of the startup?

Amendment: What is the manner how the convertible notes can be amended? Majority of the principal amount of the notes?

Legal Fees: Does each party pay for its own legal fees?

The first Startup Weekend Austin is set for the weekend of September 10-12th and will take place at CoSpace. I’ll be one of the Friday night speakers.

What: Startup Weekend Austin
Where: CoSpace, 911 West Anderson Lane #203, Austin, TX 78757
When: September 10th at around 5pm (the pitches will start a bit later)

Tickets are now on sale and can be purchased here. If you have not participated in a Startup Weekend before, check out the first-timer FAQs. Hashtag: #swaustin

Startups don’t want to wait until every investor is ready before closing on a seed financing round. First, the roster of investors will not be identified and/or cutting checks on the same day. Second, what startup wants to wait on cash?

Therefore, most seed financings allow for an initial close (i.e., that first investor check) with an extension period for future investors. But in order to properly accomplish this, your startup will have to keep the round “open” via the deal documents.

Here’s what an open round mechanism might look like in a convertible note financing document:

The initial closing of the sale and purchase of the Notes (the “Initial Closing”) shall occur on [DATE], or such other date as is agreed upon by the Company and the Purchasers (the “Closing Date”). The Company may sell all or part of the remaining Notes in one or more subsequent Closings to be held on or before [X] days after the Initial Closing (each a “Subsequent Closing Date”). Each Purchaser at such Subsequent Closing Date shall become a party to this Agreement and shall have the rights of, and be subject to limitations applicable to “Purchasers” hereunder.

From the investor’s perspective, they don’t want the round to extend forever and let subsequent investors get in on the same terms several years from now. Thus, 60-90 days is a fairly common “final close date” and anything beyond that you probably need strong justification. But remember that while a lot of these deal structures are standard — each individual deal is unique. Additionally, there is a push to keep seed financing rounds open for longer than the “normal” open period.

The Dodd-Frank Wall Street Reform and Consumer Protection Act probably won’t fix or prevent anything, but it was successful at modifying a portion of the definition of an accredited investor.

Official Language in the Dodd-Frank Act:

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

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

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

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

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

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

Most, if not all, startups desire mentorship from those that have “been there before.” But have you thought of doing some mentoring yourself?

The Big Brothers/Big Sisters program is (always) in need of mentors… especially male mentors. Boys routinely wait over a year for for a big brother match. When I was a big brother, my little had been on the waiting list for 2 years.

The Dallas-Fort Worth program has over 3,000 kids waiting for a big brother or big sister match.

Here’s a typical story:

VIEW VIDEO

Read more about the impact you can impart here and FAQs. You can donate or even better, volunteer now.

I’ve noticed a lot of recent articles promoting that a startup can “skip the lawyer” and incorporate via an online service. These sites typically list about 20 incorporation tasks they’ll do for your startup for around $250 plus the applicable state filing fees.

Sounds like a great deal, but there is more to a proper startup incorporation than simply filing the articles of incorporation with the Secretary of State. The 19 other “tasks” they list? Little or no value.

Want to vest your founders’ shares? Can’t do that through an incorporation service. In fact, typical incorporation services do not even offer a stock purchase agreement. And you can definitely forget about a technology transfer agreement or anything else IP-related. Documents like these are the critical components of a proper startup incorporation.

When you use an online incorporation service to incorporate your startup, you aren’t getting a deal on incorporation. Instead, you are overpaying for 1/10th of a proper startup incorporation.

If all you want to do is file a charter, you can “skip the lawyer.” And you can skip the incorporation service as well.

Occassionally, a startup will get a term sheet from an angel with a pre-money valuation less than the investment amount (i.e., the angel wants control of the startup). And “control” isn’t just defined as a majority of the shares of the company — if the angel asks for approval of all budgets & hires or for a board seat (and they would represent 1/2 of the board) they are still asking for control.

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

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

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

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

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

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

Tech Wildcatters will be showcasing their first graduating class of startups July 29th @ 1pm.

Location: The Magnolia – 3699 McKinney Avenue, Dallas TX
Program:
1:00pm — Welcome and Introduction to Tech Wildcatters
1:30pm — Keynote by Charlie Feld
2:15pm — Break
2:30 pm — Presentations by the TechWildcatters Class:

CollegeJobConnect – better undergraduate recruitment
Image Vision Labs – cleaning up the cloud
Concepta Systems – virtual document management
Mobestream Media – mobile loyalty program management
Brand Protection Agency – retail price transparency for brands

4:30 pm — Networking Happy Hour at Lemon Bar (next door to the Magnolia)

You can attend by registering here.

If you follow this blog, you know that I think convertible debt is a good structure for a startup’s angel round. The main feature of the convertible note is that the debt investment made by the angel investor will typically later convert into equity. For this article, let’s assume this equity is the Series A Preferred Stock purchased by a venture capital fund.

Convertible Note Discount

As a sweetener to the angel investor (i.e., compensate the angel for the early risk), the convertible promissory note will have an automatic conversion discount feature by which the angel investor will exchange the convertible debt for shares of the Series A Preferred Stock at a discount to the price per share paid by the venture capital fund at a Qualified Financing.

For example, if a venture capital fund purchases Series A Preferred Stock at $1.00 per share, the discount may allow the angel investor to purchase the same Series A Preferred Stock at $0.75 per share. (For more background, check out this post for an example of how convertible debt and the conversion discount works.)

Incentive Misalignment

Convertible notes have drawbacks — they aren’t perfect. The main drawback is the quirk that the lower your pre-money at Series A, the more equity your angel investor gets.

EXAMPLE 1: If a VC invests $2,000,000 at a $5,000,000 pre-money valuation ($7,000,000 post money) and an angel investor has a $100,000 convertible note with a 25% discount, the angel investor will own 1.9% of the startup immediately after the Series A round.

EXAMPLE 2: But if the VC invested at a $15,000,000 pre-money, the same angel investor would own 0.78% of the startup right after the Series A.

Because of this quirk, an angel investor may not have much incentive to help increase your pre-money valuation before a Series A…regardless of the conversion discount. Meanwhile, you and your co-founders are doing everything possible to increase the startup’s valuation.

Convertible Note Price Cap

To provide upside protection, angel investors like to put a “price cap” on the convertible note discount. This price cap is expressed in terms of a pre-money valuation and effectively acts as a share price ceiling. Thus, an automatic conversion discount with a price cap might read something like this:

“The conversion discount shall be the lower of (i) a 25% discount to the Series A Preferred Stock share price, or (ii) the price per share if the Series A premoney valuation was set at $[10,000,000].”

Using the hypothetical in Example 2 above, an angel investor using this $10,000,000 pre money price cap would receive 0.88% instead of 0.78%.

Price Caps as a Weapon

The original idea was that price caps would provide upside protection for an angel investor. But occassionally I’ll see an angel throw in a really low price cap (<$400k) in the automatic conversion section. How many Qualified Financings are going to take place lower than $400k (and make the conversion discount percentage even a legit term)? Lowball price caps are essentially a “#$!@ you” to the startup — although I suspect a VC would ‘just say no’ to such a low price cap.

For the past 2 years, Dallas Startup Happy Hour has hosted thousands of entrepreneurs who have made connections and even formed startups out of the event. Now it is time to mix it up and provide even more value to the Dallas startup community:

New Venue: Architel’s new facility in the North Tower of the Campbell Center (I’ve seen the plans for the new Architel facility and they are certified “sweet”.)

New Date: Last Wednesday of the Month, starting October 27.

New Format: Cocktails, Hors d’oeuvres, and a Speaker.

5pm – Cocktails, Food, and Networking
6pm – Program (Speaker)
630pm – Cocktails and Networking

(Read all the details here.)

Because of all the changes and improvements (and to get all future announcements regarding the speakers), we will all have to register on the newly created Meetup Site: Dallas Startup Happy Hour 2.0 Meetup

So take one minute and Register Now.

A startup’s Series A financing shouldn’t be a large liquidity event or salary payday for the startup’s founders. While a startup typically receives millions of dollars in a Series A, if too much of that $$$ flows guaranteed to the founders, various incentives get out of whack.

Not all startup founders understand this tenet.

Case Study

Earlier this year, this issue presented itself when a client was the lead investor in a Series A round of about $2MM at a $4MM pre-money. The term sheet was pretty much a done deal, when the startup’s CEO demanded a salary of $25,000. Per month.

My client countered with a reasonable startup CEO salary, but the startup’s CEO didn’t back down from his $300,000/year figure. You can guess what happened to the deal.

In addition, here’s an example of how a startup CEO’s huge salary didn’t help his startup: CEO’s $500,000 Salary Burns Startup Into Fire Sale.

The Importance of Startup CEO Salary

The startup community focuses most of the term sheet discussion on liquidation preferences and anti-dilution, but startup CEO salary is nonetheless an important issue. According to Peter Theil, Startup CEO salary is a predictor of a startup’s success:

“The lower the CEO salary, the more likely it is to succeed.

In practice we have found that if you only ask one question, ask that.”

If a startup CEO’s post-Series A salary is too high, he or she may not have a true sense of urgency to implement and/or create shareholder wealth.

This doesn’t mean a startup CEO must continue to make Costco runs for ramen noodles. But if the startup’s CEO gets a huge salary, the startup CEO could likely view his or her equity stake as “house money” (i.e., even if the startup fails, the CEO won’t feel too bad because he still received got a hefty salary).

Furthermore, a demand for a high startup salary can signal that you don’t believe all those things in your investor pitch.

Startup Happy Hour is held the first Monday of every month and is open to all Dallas – Fort Worth area startup founders, startup employees, investors, and people thinking about doing a startup. The event was started by Alex Muse and has been connecting entrepreneurs with employees, co-founders and angel investors since 2008. The free drinks are an added perk.

As a courtesy to everyone in attendance, we ask service providers to not just show up to pitch their services.

Startup Happy Hour is sponsored by Architel and CoHabitat.

Street parking is free and available on Thomas Avenue and Routh Street. View Map

Date: June 7, 2010
Time: 5:30pm – 8:00pm
Location: CoHabitat, 2517 Thomas Ave, Dallas TX

RSVP on Facebook or Plancast (or both).

Brad Feld will be in Dallas this Friday and will put on a “Beers with Brad” event at Lotus.

I’m pretty sure Brad is the hottest celebrity to hit Lotus since Britney did in 2009. So Dallas, let’s put on a good event and make Brad believe Dallas (his hometown) should be the Winter TechStars location.

What: Beers with Brad Feld
Where: Lotus (2900 McKinney Ave)
When: Friday, May 28th; 6pm to 8pm
Cost: Free! (Open bar until the ShopSavvy – StartupLawyer.com sponsorship runs out)

Big thanks to Tech Wildcatters for arranging this event!

Several weeks back, 37signals asked “Employment Contracts: What are they good for?” on Signal vs. Noise. Basically, they questioned the value of their employment contracts since they have never had an employment dispute:

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

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

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

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

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

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

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

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

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

Since I moved from thestartuplawyer.com to startuplawyer.com, my organic visits have been down 80%. I usually get about 400 visits per day from search and now I’m floating around 100.

I’ve done a 301 re-direct and a change of address via google’s webmaster tools. I know it might take some time for Google to get me back in the game. But I also read that if my incoming links are updated the process is quicker.

Thus, if you have previously linked to my site, could you please update the link from thestartuplawyer.com –> startuplawyer.com ?

Thank you all for reading! I really appreciate it.

Here’s the presentation slides from Startup Weekend Los Angeles:

CoHabitat will be the host of the May 2010 Dallas Startup Happy Hour.

The Dallas Startup Happy Hour is the talk of the startup community in Dallas. Check out the coverage in the Dallas Morning News here: http://bit.ly/aKTJDq As a result of the events, several startups have found a) employees, b) co-founders, c) angel investors and d) had a few free drinks.

What: Dallas Startup Happy Hour

When: Monday, May 3rd 2010 6pm-8pm

Where: CoHabitat, 2517 Thomas Avenue, Dallas

Who: This event is open to all DFW area startup founders, startup employees, investors, people thinking about doing a startup, etc. As a courtesy to everyone in attendance, we ask service providers to not just show up to pitch their services.

RSVP via Plancast: http://plancast.com/a/2xn4

A quick note about parking… street parking is usually readily available after 5:30pm on Thomas Ave or Routh St.

(Thanks to LaunchDFW for the heads up!)

Why does it seem like those who claim to be the “miracle solution” for your startup end up letting your startup down?

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

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

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

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

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

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

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