Why cloud solutions are a double-edged sword for startups
December 28, 2017
Gabe Zichermann gives a terrific presentation on what’s important for early stage founders
October 8, 2018

Why all co-founders need to protect their own interests

I happen to live in the UK and the tech ecosystem here in London is extremely well supported by accelerators, law firms, accountants, financial brokers, trade shows, digital agencies, co-working spaces, pitching events and other intermediary services. It wasn’t always this way of course and these developments are relatively new. While I’m originally from London, I lived and worked in New York for over a decade and returned to London in 2010. At that time, I recall that the ecosystem was just maturing and American style venture capital was just starting to be talked about. Generally, it was still a city of traditional corporate thinking. So because of the ecosystem maturity these days, it’s hard to put a foot wrong from a legal perspective if you’re starting a company in London. Umpteen law firms will offer free advice and presentations to help you get started and navigate the complex aspects of shareholder agreements and intellectual property protection. The reality is that this is not true for the rest of the world so this post is intended to highlight some of the challenges that exist with startups especially where the ecosystem is less developed or founders are just getting to grips with the reality of what’s required.

Legal, risk and compliance – Uggh

I attended a pitching event recently and was a member of the panel when someone in the audience asked how to approach starting a company in a heavily regulated industry. This was one of the only times when I’ve ever heard startup founders look strategically at the topics of legal, risk and compliance strategy. More commonly founders will have a solid idea and consider these aspects as a bit of a drag. Uggh, having to get a trademark or patent, or having to answer to tough questions from investors about risk. Compliance is often even more obscure and a hallmark of corporate legacy and banking scandals compared to startup nimbleness. Having been through the startup machine a few times I for one consider these topics to be critically important. So much so that I grouped them and included them as the key topic under the CMS360 theme of sustainability. Indeed, I believe that without paying due attention to these topics you may well be deluding yourself of the viability of your company. The lawyers and management accountants would be the best at analysing specific situations but there are a few areas I’d like to highlight in this post.

Co-founders must protect themselves

Sadly, speaking from personal extremely bitter experience, the need for co-founders to protect themselves is a hugely important topic. And to be clear, I’m not only talking about the need for shareholder agreements between the founding team but the need for each co-founder to own their own legal representation. The US is more of the ‘wild-west’ when it comes to business and typically you’ll find lawyers recommending the company engage a law firm and for each co-founder to engage their own law firm each. This may sound excessive representation but actually in my opinion it’s the right arrangement. I had numerous experiences in the US related to this but if I’d had my own legal representation back in 2000 when I started a disruptive cloud company with 3 other co-founders, I’d have been in a far better situation. As it was, my ‘buddy’ co-founder who I started the company with rode roughshod over me for 8 years, having played every dirty trick in the book to take command of all of the stock of the company. The trust I had placed in him at the start of our journey is typical of any co-founders coming together. That honeymoon period is when you trust people the most, otherwise you wouldn’t be getting into business with them. However this can rapidly turn south when the business under-performs or indeed if the business grows incredibly rapidly. That’s when legal agreements and representation are of paramount importance. It’s simple really, just make sure you have your own lawyer look over every document that the company lawyer or other co-founder lawyers have come up with and be ready to litigate if needed in relation to employment, intellectual property that you develop, and other things you bring to the party that are above and beyond the call. Imagine what Travis Kalanick went through while being ousted as CEO of Uber, or what Steve Jobs must have had to think about when being ousted from Apple in the early days. That’s it. Forewarned is forearmed.

Co-founder self-protection is clearly important but it is only one example of the legal considerations that startups must master if they are to survive and not get consumed by legal issues as the company develops. Other top areas of confusion are often related to intellectual property and what can be copyrighted, what’s automatic and what can’t be protected; the need for patents and the right timing to go through the process; and the risk you run when leveraging existing, sometimes generally available code for your application.

Risk analysis is good business practice

Let’s switch to the topic of risk. Corporate executives will know very well that risk assessments are standard business practice. They come into everything even the most unassuming projects need to have a risk register so that executive roll-up reports are complete and show all the risks across the organisation. So why don’t we pay as much attention to risk analysis when building a startup? My view is that it’s simply because of the assumed risk in building a startup that founding teams and boards tend to look at operational progress rather than worry unduly about risk registers. However, I contend that this is a fantastic practice that should be adopted by every single startup under the sun. It’s just good practice to have a strong understanding of the risks the company and projects have at any time especially if the project is customer facing and involves financial liability for things that go wrong. Ongoing risk assessments in this way would have the same result to generate the right type of dialogue so as to assess changes that may need to be made to teams, resources, budgets, timeline expectations and a realistic assessment of success or failure. So let’s start looking at risk assessment as a positive force for good rather than the corporate layers from which many want to escape. Sophisticated investors will most likely reward you with acknowledgement for this thoroughness and business management maturity.

Compliance comes into the limelight

Finally, a word about compliance. Anyone working in a regulated industry will have felt the rapid rise of compliance from a role of audit to a business function of its own. Banking for example has changed dramatically over the past decade driven by the financial crisis of 2008/9. New businesses have flourished on the back of the increased requirements to know about transactions in detail and manage the regulatory scrutiny. What used to be a staid audit based role has become a critically important function that reports up to the CEO directly. For startups this is just the beginning of two sided opportunity. On one hand there is interesting opportunity to apply new techniques to provide automation and efficiency in compliance functions using data driven approaches, AI and machine learning to manage the processes. On the other hand there is the opportunity to differentiate services by being ahead of the pack in relation to compliance competency in the markets served. Either way, compliance has come well into the limelight.

Recommendation and next steps

Clearly having strong operating leadership well-versed with legal, risk and compliance issues would greatly benefit any company especially new business startups operating with innovative business models. Within the CMS360 program we recommend a process of team self-evaluation for all key areas of our recommended framework, with legal, risk and compliance being one topic on it’s own. We recommend you establish a scorecard approach to making sure you know where you are at all times in relation to these topics.

As always, feedback is very welcome. I’m keen to learn what others have experienced and whether the ideas outlined here resonate. Also if you need help with defining any of these elements then get started with our free guide “7 rules for raising capital” available here.

Azfar Haider
Founder, CMS360.org
CMS360 is a set of management practices and solutions designed for today’s high growth companies. Our frameworks guide teams to be successful in launching and scaling businesses and the online program consists of courses, coaching and community. www.cms360.org

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