A 1623 bond from the Dutch East Company, which issued the first ever common stock in history

Startup 101 for product leaders

I’ve had the privilege to work with amazing product leaders across companies like LinkedIn, Blue Apron, and Zocdoc. Many PM’s have expressed interest in starting a company some day, agreeing their skill set could translate well into founding and leading startups. Given its job function focus on areas like user empathy, leadership, and success metrics, product management is a great background for entrepreneurship.

After reading Marc Andreessen’s blog post “It’s Time To Build,” I’ve been reflecting on how the PM community can step up to play a larger role in company formation and scale. Particularly in New York City, we have a dearth of product-focused companies and product-led teams. A deep dive on why this is the case merits its own separate post, but a few obvious contributors are inertia of status quo, fear of the unknown, and comfort with the benefits of larger and/or established tech companies.

In this article, I share fundamentals around startup formation and corporate governance to help close the knowledge gap for those considering the transition from product into startups.

Corporate governance by the board

Typically key decisions about a startup’s formation, financing, major hires, fundraising rounds, and eventual exit are made by a board of directors. This may even include replacement of the founding CEO. The board is elected by shareholders, who get one vote per share owned. This same board decides whether or not to pay out dividends to common shareholders.

Company bylaws typically set the number of board members, the manner in which the board is elected, and how often the board meets. Ideal boards are usually 7 people; most range between 3 and 31 members. Most boards are split with an equal number of internal and external board members, and see an eventual addition of an independent member to help as a swing voter on contested decisions. Lead investors usually want board seats, and founders’ seats typically decrease during each subsequent round. Some boards may also have board observers (e.g. angel investors or advisors) who simply give feedback and guidance (they don’t have voting rights).

If you’re a less experienced founder and retaining control is important to you, consider pushing for a “founder seat” that is separate from a “CEO seat” so you still have a board seat in the case of a founding CEO replacement.

Shareholder rights

Aside from determining a shareholder’s financial stake in a startup, equity affects control. Most companies grant stockholders one vote per share of common stock owned; alternatively, some companies grant 1 vote to each shareholder regardless of how many of shares of stock they own. A founder with over 50% of the shares controls the vote and does not require approval from additional stockholders. An infamous example of this is Mark Zuckerberg — he holds 57.9% of the total voting shares of Facebook, giving him tight control of the company. While it may be tempting to accept money from many willing investors, avoid this and be choosy about how you dole out equity because it may be difficult to collect signatures from many different investors. Further, think critically about how much you are willing to trade off control for further equity giveaway.

How do shareholders vote on key decisions? Proxy forms are often sent to them so they can vote by mail. Corporate bylaws require a “quorum” which means shareholders voting must represent over half of the corporation’s shares.

Preferred stock, common stock, and convertible notes

Common stocks are the type that most people invest in, and they confer a claim on profits and voting rights at a rate of one vote per share owned. Fun fact: the first ever common stock was issued by the Dutch East India Company in 1602, which started out as a spice trader.

Preferred stock does not give shareholders voting rights, but preferred shareholders have priority over a company’s income, meaning they are paid dividends before common shareholders. Typically investors with preferred shares are guaranteed a fixed dividend in perpetuity. Further, they usually have a greater claim to the company’s assets and earnings. If a company is insolvent, the company must pay out preferred shareholders before common shareholders get paid out any money. This amount also depends on what are known as liquidation preferences. If investors have a 1x liquidation preference, this means that founders agree to return 1x the amount of the investment as proceeds of an M&A or other sale event, prior to any other shareholders receiving money. Preferred stock eventually converts into common. Term sheets also specify whether or not it’s participating, meaning the shares will pay both the preferred dividends plus an additional dividend to their shareholders.

To avoid the hassle of assigning valuation to a very early stage company, many early investors provide a convertible note, wherein the investment eventually gets converted to stock a pre-agreed discount. Y Combinator has great resources on what are known as “clean terms;” in other words, examples of term sheets with founder-friendly provisions.

Information rights

Common information rights give investors basic access elements like visibility into the company’s budget and visitation rights to its physical location(s). There is usually a threshold on the number of shares that must be held in order for investors to continue enjoying these rights. Most agreements stipulate these rights will last until a major exit event such as an IPO.

Human capital

According to Noam Wasserman’s The Founder’s Dilemmas, most technology founders will have worked for 13.1 years before starting a company, while 35% will have worked over 20 years before doing so. Those in the mid-range of work experience (about 25 years) have the highest rate of success. Particularly from those who’ve worked in Silicon Valley, I’ve often heard employees complain that they are “too old” for a startup; this isn’t surprising when the tech media inundates us with romanticized stories of founders like Mark Zuckerberg and Evan Spiegel, and popularity contests like the Forbes 30 under 30. Wasserman’s data-driven analysis is inspiring and reassuring for those thinking of a starting a company later in life.

It’s further worth noting that only 18% of founders have previous management experience; individual contributors can pick up management skills along the way, but they should be conscious and proactive about how best to address their experience gaps.

Working with a co-founder

Startups with co-founders are more likely to succeed, and have been shown to have significantly higher valuations. And among those, co-founders who have worked together previously in a professional or educational setting are the most likely to succeed.

Founder drama is unfortunately frequent and hard to predict. To protect against it, consider your worst case scenarios. What happens if one of the co-founders quits, or has an unforeseen family matter that prevents him or her from working full-time? Consider including optionality to buy out the other founder’s equity, and/or a commensurate vest schedule to arm yourself with solutions for the unknown.

Founder motivations

Before you decide to found a startup, it’s critical to think about your underlying “why” for doing so, and share that with your partners. From making an impact to retiring young, one’s rationale for founding a company will likely vary. After surveying thousands of founders in his book, Wasserman found two categories of motivation emerge as the most common: “Rich” or “King,” referring to wealth-inspired founders versus control-motivated ones.

For those in the “Rich” bucket, it’s important to acknowledge that entrepreneurship is not a great way to make money. Over a 10 year period, founders made 35% less than those who worked for others. Further, 75% founders see no financial return at all for their years of hard work. And typically founders who ultimately give up control of their own companies are the ones who see significantly higher returns.

Employee equity

As the startup progresses from seed stage to Series A and beyond, remember to plan for a large enough employee option pool. This typically starts around 20% and then declines to 11 and 10% as dilution continues. During each round, you will want to project out the number of hires and shares / hire, standardizing across the seniority level. Note that C-level executives typically have the highest equity stakes: non-founding CEO’s receive around 6%; COO’s 2.9% and CTO’s 1.7% and CFO’s 1.3% and VP positions all average 1–1.3% equity.

Particularly if you are a VC or experienced founder, I invite you to share additional words of wisdom in the comments below.



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