I’ll be doing a version of my 5 Guiding Values program as an Ethics CLE in March. Details to come…
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Northern Colorado Business Report – Column 2
NCBR ARTICLE
When it’s time to turn the car around
By Kevin E. Houchin, Esq.
September 26, 2008 —
Imagine this. You’re two years into owning part of a startup. You’ve invested dozens of hours with your co-founders planning. You’ve invested dozens of nights and weekends away from your family fueling growth. Now things are rolling and it’s obviously time to take things to the next level.
Unfortunately, some of your partners don’t agree. Tension is high. Tempers are flaring. As you’re driving home from another 14-hour day, you wonder what it would cost to just keep on driving.
Can you afford to say, “It’s been good, but I’m leaving to pursue success on my own terms”?
We’ve all asked the question, “What will it cost to leave?” We asked it in our very first job, and we should keep asking in every position we ever hold. Asking the question shows we are still willing and able to grow.
The key to our successful growth is being able to accurately answer the question, but many business owners fail to plan for this eventuality. There will always come a day when you really want to just keep driving and never go back. What will that cost?
Answering this question may be the most important element of business planning. It takes work to write a solid business plan with all the conventional elements of market, management and financial forecasting, but those discussions are relatively easy compared to “What will it cost to keep driving?”
Discussing what happens when someone wants out is charged with emotion, including the fear of failure that nobody wants to bring to the planning table. Avoiding the question can cost huge money when the relationship is strained, so you need to have a plan in the event someone wants out before the multi-million dollar liquidity event materializes.
So, how do you agree on that plan? I’ve helped many startup teams work through the process in three easy steps.
Step 1: Framing the discussion positively
Nobody likes discussing bad scenarios. Fortunately, many good scenarios can frame discussions about what happens if someone wants out. What if someone gets an opportunity to spend two years surfing in New Zealand? What if someone decides to retire early? What if someone gets a chance to move on to a different startup? All these are wonderfully non-threatening stories that you can use to frame your discussion.
Once you’re talking about someone leaving for a reason you all can understand (or even envy), then discussions will go more smoothly, because we can all put ourselves in the position of wanting to move on for something better. At that point we all understand how the other people feel – without anxiety, fear, or blame.
Step 2: Incentive to turn the car around
Now that the topic is framed in a non-threatening, happy story, it’s time to get down to details. Most of the time you have gone into business with other people because they add something to the mix, and losing that person would mean losing a key element of the company’s success plan.
So, you want to give people a good reason to stay. You want to give everyone incentive to turn the car around and come back to work the next day and to work out any differences. That means you’ll want to give a fair, but relatively low, valuation for ownership interest, and you’ll want the company to have the option to pay in one lump sum, or over time.
Valuation of the company is the key. As an owner, you’ll know the financial situation. As a ticked-off owner, you’ll overvalue your contribution to the success of the venture. Without a previously established valuation, or formula to establish valuation, you can’t accurately answer what it will cost to keep driving, and you will very probably underestimate the cost and overestimate the benefit of leaving.
If you decide to go, you and the other owners of the company will likely spend thousands of dollars, maybe even tens or hundreds of thousands of dollars, in legal and accounting fees trying to figure out what your share is worth. That’s incredibly wasteful and easily avoided.
There are numerous ways to value the company, and it’s important to understand that there is no “right” way. The most important thing is that all the owners agree in writing to whatever valuation approach you’ll use.
With brand new startups, I like to use the book value of the company because it’s easy to calculate, objectively measured, fair, and it undervalues each founder’s contribution to the company equally by not accounting for any “goodwill.”
In a new startup, goodwill hasn’t really been established, so the undervaluation acts as an incentive to turn the car around, because if you kept driving you would be leaving what feels like a lot of value on the table. This left-behind value acts as a great incentive to keep key partners in the company instead of taking that surfing sabbatical in New Zealand.
You’ll want to examine the valuation method every year, and after a few years consider adding some amount of goodwill into the formula, but keep it very conservative. Finally, note that if someone is pushing for higher valuation, they just might be thinking of jumping ship.
The second element of this arrangement is giving the company and other owners the option to make the payout in a payment, or over time. Obviously, if someone wants out, it’s best to get them out as cleanly and quickly as possible. Sometimes there isn’t enough cash available from the company or other owners to make a quick buyout, and the buyout has to be completed over time.
I advise giving the company and owners the option to pay 20 percent of the buyout initially, then 20 percent each year over the subsequent four years with a reasonable rate of interest.
This combination of low valuation and extended payment timeline is another powerful incentive to keep essential people in the company.
Step 3: Clear documentation
Just as a good business plan needs to be documented, so does your “what’s it going to cost me” agreement, otherwise known as a “buy-sell” or shareholder agreement. Every owner needs to sign off on the same deal.
When you work with your attorney to craft this document, you will also take into consideration what happens if someone is hurt and can’t work, gets divorced, dies, or does something that requires someone to be expelled from the ownership group. Usually, these factors can be discussed quickly and any uncomfortable feelings these topics generate can be blamed on the lawyer, because you’ll all have agreed to valuation and payout options.
Business planning is a lot of fun. Building a company is a lot of fun. Working with your friends is a lot of fun. Succeed, but plan on the day (and I guarantee it will come) when one of you asks, “What will it cost me to keep driving?” Have an answer ready.
Kevin Houchin is an attorney specializing in business development, intellectual property and marketing for entrepreneurs based in Fort Collins. He will be covering the legal world for the Business Report each quarter, and can be reached at kevin.houchin@houchinlaw.com.
Northern Colorado Business Report Column #1
NCBR ARTICLE
Anatomy of a tech-transfer startup
By Kevin E. Houchin, Esq.
July 4, 2008 —
You can’t live and work in a college town without hearing the term “tech transfer” quite a bit. Yes, we understand it has something to do with making money from the technology that comes out of the labs of research universities, but what does that really mean? And how do universities and inventors share the profits?
The modern era of technology transfer started back in 1980 when Congress passed the Bayh-Dole Act, which gave ownership of technologies created as a result of government-funded research to the universities and other institutions conducting the research. The magazine The Economist evaluated the act as “the most inspired piece of legislation to be enacted in America over the past half-century. … More than anything, this single policy measure helped to reverse America’s precipitous slide into industrial irrelevance.”
According to the Association of University Technology Managers, there were about 250 patents issued to American universities each year before 1980. In contrast, fiscal year 2004 saw more than 11,000 new patent applications from universities.
Success stories include Gatorade (University of Florida), the nicotine patch (UCLA) and, yes, even Google (Stanford). We’re talking about over a billion dollars in royalties and literally thousands of startup companies, with all the new jobs and downstream economic benefits new companies – especially technology companies – create.
Think Figure 4
While “tech-transfer” sounds complex, it is easy to understand the basic structure of these deals. Just think of the number 4.
A diagram of a typical technology transfer deal looks like a “figure 4”. It starts with a university employee, a professor or other researcher, coming up with a new, probably patentable technology. As with most employee-created intellectual property, the invention’s researchers create while working within the scope of their employment is owned by the employer – in this case the university.
You might think this is unfair or that this would make it hard to recruit smart people, and you would be partially correct, given that almost everyone who pursues a serious academic career chose his or her path for something other than money. They want to help solve problems by, for example, creating a new vaccine to fight TB in Africa.
Of course, it might become difficult to recruit and retain even the most altruistic research professionals if they didn’t get a chance to benefit from profits resulting from their work. Accordingly, most universities automatically give back a standard percentage of any profits generated by patentable technology to the inventor. If there is more than one inventor listed on the patent, the group splits the pot, evenly or based on the level of contribution made by each member.
For its part of the deal, the university pays the cost of “prosecuting” (jargon for the application process) the patent. This expense can range between $5,000 and $15,000, but can be much more depending on the complexity of the technology and whether or not international coverage/protection is desired.
In some cases the university can directly license the technology to an existing company, which then develops the technology into marketable products. If this kind of direct license happens, the revenue stream flows from the consumer to the industry partner or licensee. The licensee typically pays a predetermined set of fees, percentage of sales ( “royalty”), or some combination of the two back to the university. In some cases, ownership equity is also provided in exchange for the rights to the technology. Simple.
However, many new technologies that develop from university research do not fit into existing markets or products. They may require some form of validation or proof of principle, and often require more extensive business development and technology maturation.
Some of these technologies may be suitable for a “university startup” and we get to form the “figure 4” of the transaction. In this case the university might ask the inventors, or the inventors might approach the university, to discuss formation of a new company specifically to commercialize the technology.
Commercialization happens
Let’s say this happens and let’s call the new company “NewCo.”
After NewCo is formed, the university licenses the technology to NewCo and works closely with NewCo to help make the business a success. NewCo further refines the technology, develops a market assessment and potential customer database for products and services derived from the technology, and sells these products and services in the marketplace.
Sometimes the founders of NewCo will quit their university jobs and devote their full-time energy to the new venture, especially if the inventor was a graduate student or untenured faculty. Other times, the inventors will keep their day jobs and bring in outside management professionals to run the company.
The inventors take an equity interest in NewCo, and many times the university receives an equity stake in the new company as part of the exclusive license of the patent. Many times other outside investors may add some cash or expertise to the project in return for stock in NewCo.
When NewCo has commercialized the product and taken it to market, the university shares royalties with the inventors, which is a required part of the Bayh-Dole legislation, and practiced by U.S. and most international universities as well. Not bad.
Of course there are as many different details and nuances to these agreements as there are people and patents, but most technology transfer will follow the basic anatomy of my “figure 4” diagram.
Kevin Houchin is an attorney specializing in intellectual property law and marketing for entrepreneurs based in Fort Collins. He will be covering the legal world for the Business Report each quarter, and can be reached at kevin.houchin@houchinlaw.com.
Lawyers & Not Lawyers in Political Campaigns
My friend Don back in Iowa sent me these images from an email that’s going around. Of course he knows I’m a lawyer, and he also knows I’m a former Republican (now registered “unaffiliated”), and he was trying to pull my chain. I guess this post is proof he succeeded.
Granted, this can be interpreted either way – as a supporting vote for either Obama or McCain. However, the email itself was definitely meant to communicate that McCain/Palin is a better choice because they are NOT Lawyers.
Of course I’m biased by being a lawyer myself. You can’t get through law school without having a pretty thick skin relative to lawyer jokes, but this one is more important. I wouldn’t hire a doctor that had not been to medical school. It seems only logical that qualifications for being “hired” to support and maintain the Constitution and the other laws that are the foundation of our society MIGHT include some actual education relative to the subject… law school comes to mind.
The problem evidenced here is bigger than just the political debate. It goes to the heart of the failing reputation of the legal profession. This one is squarely on the lawyers. It’s squarely on the law schools. And it’s going to be on the law student.
I wrote my book Fuel The Spark: 5 Guiding Values for Success in Law School and Beyond as a tool and a catalyst to start making this change. I’m not the only one that wants to EARN the respect of the general public again. We do that one lawyer or law professor or law student at a time.
Turn the Car Around (Latest NCBR Column)
My latest column for the Northern Colorado Business Report is now online.
When it’s time to turn the car around
By Kevin E. Houchin, Esq.
September 26, 2008 — Imagine this. You’re two years into owning part of a startup. You’ve invested dozens of hours with your co-founders planning. You’ve invested dozens of nights and weekends away from your family fueling growth. Now things are rolling and it’s obviously time to take things to the next level.
Unfortunately, some of your partners don’t agree. Tension is high. Tempers are flaring. As you’re driving home from another 14-hour day, you wonder what it would cost to just keep on driving.
Can you afford to say, “It’s been good, but I’m leaving to pursue success on my own terms”?