There is this feeling among many founders and entrepreneurs that venture capital is the “dark side” and inherently evil. I have been very surprised to hear things like “we don’t want to go down the road with Vulture Capital” in the heart of venture capital in places like San Jose, Menlo Park, Mountain View, San Francisco, and Palo Alto. While I do agree that there are some bad apples, negative aspects of VCs and VC funding, and a general perception of VCs as sharks, I would argue that VCs are an invaluable part of the US economy and the use of VC funding has been extremely useful in the growth of many successful US companies.
Part of the problem is that people don’t understand exactly what VCs do and how VC works. The public only hears about a VC firm making billions off of an IPO and how VCs are like vultures that swoop in and take over the company and get rid of all existing employees. You can read my take on issues of company founders having a hard time giving up control here, but giving up some control is required in many situations to bring in the capital to make the company grow. Investors put money into a company to make money, not to make the world a better place. That is business 101.
A common question asked by start-ups or even just average average businesses is what information they can ask or use in vetting their potential employees. Some common forms used may be background checks, drug screening, and reference checks. Due to the economy creating many credit problems for average citizens (even more so with entrepreneurs who often use their own personal credit to bootstrap their company), I will take a look at the use of credit reports in making employment related decisions.
Existing federal law provides that, subject to certain exceptions, an employer may not get a credit report without prior disclosure of that the employer wants to obtain one and the employee consents. Existing federal law further requires, subject to certain exceptions, an employer, before taking any adverse action based on the report, to provide the consumer with a copy of the report and a written description of certain rights of the consumer.
California enacted AB 22 which amended California Civil Code Section 1785.20.5 to provide additional protections in this state to protect the potential employee when dealing with similar uses of credit reports. This law went into effect January 1, 2012. In addition the California Labor Code added Chapter 3.6 to include additional requirements. The law provides that the employer needs to follow the same federal requirements of disclosure that they want to obtain a credit report, but also requires the employer to state why they want it. The law goes on to further indicate that credit reports can only be requested for the following certain categories of types of positions (except by certain financial institutions): Continue reading
Many small business owners or other entrepreneurs start out with a great idea for a new product or service. They start a business and focus on doing whatever it takes to make the company successful. Many don’t take the steps necessary to properly protect the business from creditors or don’t really pay much attention to what they sign when they are making deals. The ones who do read the fine print may just have the attitude that they are so confident in the business’ success, who cares if they use their own personal credit to get some working capital. With the economic downturn over the last few years, many business owners have had to close their doors because they couldn’t get the funds they needed to even cover the simple things like payroll or rent.
Use of Personal Credit
Many entrepreneurs feel that they should put some ‘skin in the game’ by contributing some of their own money into the business. In fact, the Small Business Administration backed loans often require the founders to contribute at least a certain percent of their own assets or some other major contribution in order to qualify for a business loan. When the owner doesn’t have available cash, they look to other sources to get the money to contribute. That can lead to things like taking out a home equity line of credit or using personal credit cards to help fund the business. Obviously that is pretty risky, but often necessary to get early access to this seed money to start and grow. The banks that issued the credit did so based upon the owner’s personal credit rating. Just because the credit card may have the business’ name on it doesn’t mean the bank hasn’t covered their bases by making sure they can sue the owner personally if the business defaults in payment.
So a major issue faced by many startup founders, especially when they are bootstrapping, self-funded, or just watching their cash, is how they can get legal or other services with little to no cash. The fall back position is to give the advisor or service provider a “piece of the action.” The founder often wants to use stock in the company they formed or stock options to avoid using cash, but still obtain needed advice and guidance. Here are the main problems you will run into:
1) Valuation– You will have a difficult time agreeing on a valuation of the company’s stock (see Section on Valuation). The founder often feels that they have the next greatest invention or idea of all time and the company is already worth billions despite having no business model or revenue (just watch an episode of Shark Tank on ABC). The valuation is what you use to determine the value of the stock in comparison to what the services are worth. (e.g. 1,000 shares of stock valued at $1 per share in exchange for $1,000 worth of services) The service provider or advisor may have a different idea of what your company or idea is really worth. If you can’t come to some agreement on the value of the stock, you won’t get them to sign on.
I read a good post yesterday from Chris Dixon on his blog about why there aren’t more “Meaningful Startups.” In the article and comments, the discussion had to do with why tech companies, more specifically, internet startups get the majority of funding instead of companies that seem to solve a bigger societal problem, such as curing a disease. He argues that the other what some might call “more meaningful startups” don’t get off the ground because they have a hard time getting funded and this is due to time to exit and amount of capital required.
I tend to see that funding and society are major reasons for the tech funding boom.