With access to skilled talent, and seemingly unlimited venture-funding, it is no surprise that California leads the nation in the number and successful launching of companies. Over the last several years, California healthcare and technology startups have raised almost $10 billion annually. California has Silicon Valley, Silicon Beach, incubators, accelerators, coworker spaces, and leading venture capital firms. Each week, business attorneys are busy guiding entrepreneurs from idea to implementation and from startups to emerging growth companies. They connect creative individuals with savvy consultants and corporate strategists. At Citron & Deutsch, we pride ourselves on being the go-to law firm for technology and healthcare startups for local entrepreneurs. Having provided effective, timely, and comprehensive counsel to 1,000s of companies, our startup attorneys are able to leverage that experience to guide and connect nascent companies en route to successful funding rounds and sustainable expansion. Through our decades of representation, we noticed trends and learned lessons. Now, we embark to offer some of those to our clients.
(1) Business Plans: Critical Component of a Promising Startup
As one of the first critical steps in any startup endeavor, business plans and decks should be carefully crafted. Founders should be continuously involved in the drafting and polishing of these plans and solidify their “elevator pitch.” Our firm is often used as a sounding board to review business plans, draft business plans, and provide early-stage advice.
The process of drafting the business plan is crucial because it forces the participants to look at the business in an objective, critical, and unbiased manner. Entrepreneurs must analyze all the elements, from different angles, that are necessary to make the business successful. They must then articulate the need that the product or service aims to meet or the problem that it seeks to solve – preferably in a straight-forward and concise manner. The process of preparing the business plan will showcase missing components in the organizational structure, require a deep analysis of competitors and the market, and project expenditures, such as for selling, general, and administrative (SG&A), research and development (R&D), and intellectual property protection. The process of creating and refining the plan of the owners or founders of the business leads to a realistic appraisal of the business’s chance of success before committing time and money to it.
(2) Importance of Compensation Allocation: Set Reasonable Salary and Equity Expectations
Compensation decisions may have a serious impact on a startup’s ability to attract investors and raise capital. Based on our experience, most founders of startups are paid less than $100,000 in annual salary, with many receiving $50,000 or less. Therefore, those who start companies should bear in mind the savings required to adequately sustain the early phase of a company’s evolution. To lead by example, lower salaries for founders and senior executives set similar expectations for other employees. Before any substantial fundraising may start, business owners should determine the nature and amount of compensation for founders and management executives, considering that the lower salaries and overhead will be more attractive to investors. At the same time, what attracts talent are equity grants, incentives compensation based on milestones, and other types of benefits like insurance and retirement plans. Founders should be mindful of the balance of bringing in the right talent while remaining attractive to investors.
(3) Employment Laws Consideration: Ensure Compliance with Federal and State Laws
Starting companies in the most litigious state in the nation requires companies to constantly keep both the Federal employment laws as well as California’s plethora of employment laws in mind. Please note that employees cannot work for free in California nor can employees be compensated purely based on production. This is because of the State of California (and certain cities) minimum wage requirements. For example, by July 1, 2019, Los Angeles minimum wage will rise from $13.25 to $14.25 per hour. This means that, at a minimum, employees must be offered a base of $29,640 in order to avoid running afoul of California’s labor laws. On the other hand, many early-stage startups do not have the cash flow to cover high salaries formerly earned by their founders and key executives. These individuals are often compensated with equity in lieu of a higher salary, and some agree to work for free or take an annual salary of $1 while putting in long hours beyond 40 hours a week. Startup business owners should not automatically assume this is permissible under the federal Fair Labor Standards Act (“FLSA”) or California Labor Code.
The FLSA has an executive employee exemption for business owners (29 CFR § 541.101). However, no such exception exists in California. Accordingly, employees or owners must meet the exemption requirements listed above (including the minimum salary) to be exempt from overtime and minimum wage requirements.
(4) Capitalization Table: A Component that Can Make or Break the New Company
Even sophisticated serial entrepreneurs request assistance with crafting the Capitalization Table. It is a critical component to the success of a new company. Each equity round should be clearly delineated starting from Founder Round to Seed I, Seed II and additional Options Rounds. The Capitalization Table helps the business track which shareholders own what percentage of the stock (or in an LLC, the membership interest – though LLCs are less common and not as attractive when it comes to raising capital). Attorneys often have to advise the founders about Pre-Money Valuation (the value of the company as determined prior to investment), Post-Money Valuation (the Pre-Money Valuation plus Total Investment Amount), and Investor Percent Ownership (Investor Shares divided by Post-Money Shares). We consistently advise our clients on the crafting of a solid Capitalization Table since that is an element to ensure common understanding by the Founders and early investors.
(5) Management Team: Ensure Specialized Expertise
Founders are not necessarily good Presidents/CEOs. Attorneys in the business often are relied upon to connect Founders with competent management team members (and a good accountant!). This is where years of experience and a well-polished rolodex proves critical. We often connect Founders with specialized individuals to ensure a balanced and diverse management team.
Citron & Deutsch, APC