Happy New Year!

Karthik: With the new year around the corner, Anisha and I thought it would be a good idea to put our thoughts out on why we started LexStart and what we hope to achieve in the coming year.

Over the last 4 years that Anisha and I have worked together, we have been investors, mentors and confidants to quite a few startup founders. Some of whom have given us feedback on what works and what they really need 🙂

One of the things we have noticed in most young companies, ourselves incldued, is that they make best efforts to stay on top of all their compliance matters, but, as Yoda says, “try not, do or do not, there is no try”.

We felt that most often the startup’s governance is mainly limited by the quality of advice they get and compounded by the lack of founder’s bandwidth to actively track (chase) all the actions required or done on their behalf. A lot of these compliance matters build up and get more complicated with time. All this translates into a laundry list of conditions precedent to (or, things to get done before) an investment, creating anxieties for both investors and startups alike. Questions raised on governance are always a can of worms leading to closer scrutiny.

We started LexStart to address this issue. We take on the drudgery of legal and compliance work and at the same time work to educate founders on understanding the legal ramification of all their actions and ensure that they keep their startups investment ready at all times.

Anisha: As a transactional lawyer, while assisting VCs on investments in startups, I noticed one common trend in all the deals that I worked on. While the VC would promise the startup “money in bank” in 30-45 days, this timeline invariably got stretched to 100 days or more. The reason being that when the VC’s legal counsel perform a due diligence on the startup, they find that the startup had several compliance related issues, some of which are probably easy to fix while others could take a while. This happens because founders are busy trying to prove their business model, and for obvious reasons, compliance takes a back seat.

No entrepreneur is excited about paperwork and filings! That is where we felt the need to have a platform that founders could trust and dump all their legal and compliance woes on while they get busy taking care of business. Imagine having your own “in house counsel and compliance manager” at a fraction of the cost!

At LexStart, our aim is to be every startup’s in-house counsel and compliance manager, handholding them through their legal and compliance concerns. Having represented investors on deals, we know what exactly they will ask of a startup while investing in them. We rely on a team of lawyers and company secretaries who have transactional experience to assist startups with keeping their house clean and investment ready at all times.

What we really hope to achieve is to inculcate a pro-active culture in startups when it comes to compliance. Why wait till your investor’s counsel asks you to fix things! Fix them before hand, so that you can get money in bank at the earliest and accelerate your business. So to all the founders who have read this far, we have to make it a new year resolution to #startright_rightnow!

The role of ESOP in Start ups

Takabisha roller coaster

In a roller coaster ride of a start up, employee retention through thick and thin is extremely critical – especially in today’s market where the focus is on growing fast.

As an entrepreneur or founding team if you want to add key members, who could be part of the team for the long haul, you have to pay a competitive package to attract and retain them. In order to do so, you basically have two choices:

  1. Infuse fresh cash into your start up from investors and in the process dilute your ownership in the company. Use that cash to pay salaries which should ideally include performance linked bonuses and employee benefits.
  2. Issue ESOPs to your employees and incentivise them to work towards earning those shares (through vesting) and increasing the value of those shares, which in effect increases the value of your start up.

So, instead of getting ₹X per share by selling shares in your start up to an investor to pay employees, you can, as can be understood from the full form of ESOPs, provide the same share capital of ₹X per share to your employees directly.

For companies/employers, while ESOPs may seem like a great HR benefit, a few ESOP basics to keep in mind as you decide on your first ESOP pool:

  1. If you give them an exercise price close to the ₹X per share, they will be paying for the shares when they exercise and only be earning the premium (the increase in value from today’s stock price to when they sell) that they create while employed with you. Giving ESOPs at face value (typically ₹10) implies that you are also giving them the value created by the team so far along with the above. Design the rest of your ESOP policy accordingly.
  2. ESOPs are meant to compensate for the reduced salary. They carry real value and it is important that your employee recognises it and works towards creating that value. Make sure you spend the time to explain to them how it works and the benefits that will accrue to them.
  3. Set your vesting period, schedule, criteria and performance parameters so that the employee earns his or her options relative to his or her contribution.
  4. Don’t get bent over the fact that you will have free riders on your cap table if your employee moves on. Remember that if you designed your ESOP well, by serving the ESOP vesting period they have earned it. So, if and when your employees decide to move on, wish them well on their next endeavour or better still do what inMobi does.
  5. If you want to keep your equity close to you, have the right to be first in line to buy back the employees’ vested ESOPs/shares (at the market price) if they decide to sell.

 

For Employees, a few ESOP basics to consider when having the conversation around salary package and ESOP benefits:

  1. Make sure you actually get the ESOPs. Your founders grant ESOPs with a signed ESOP grant letter stating the terms of the ESOP and make sure they or someone competent take the time to explain the agreement to you before signing on the dotted line.
  2. Make sure that you have a sufficiently long exercise period so there is an opportunity to exercise closer to a liquidity event. This is important especially if your exercise price is not a notional face value.
  3. Make sure that the options granted to you immediately vest in the case of a liquidity event or allow you similar rights as your founders – if your founders are looking for some liquidity it is OK for you to look for the same, at least partially.
  4. Make sure you understand the tax implications of exercising ESOPs granted to you.

I believe wealth created through equity earned by working in start ups is one of the biggest source of founder seed capital of serial entrepreneurs and angel investments. Would be great to have real numbers on this, anyone at @ianetwork@NASSCOMStartUps? or the @KauffmanFDN in the US? Would be useful for nations and start-up eco-systems to develop a “Velocity of Entrepreneurial Risk Capital” – Money invested in the Bansals (@_sachinbansal and @rohitkbansal) by angels to the money invested by them as angels.

But, I digress – so, back on topic. To all the founders and start up teams out there – get cracking on that most awesome solution to that big hairy problem and make sure you pick up your raffle ticket (ESOPs, in case you also lost track) before you get on the ride! Till next time…

Term Sheets: To be bound or not to be bound!

In January this year, one of my clients (a VC) came to me with a new investment mandate along with specific instructions to close the deal in 45 days. At that point it looked doable. The company being fairly young (8 months of operations), we did not expect any glitches. The term sheet stage was uneventful. In spite of our repeated requests, the entrepreneurs decided to proceed without a lawyer, assuring us that they are in the process of “shortlisting” law firms and will hire one in time for the binding investment documents. We did not want to take our chances, so we walked them through the term sheet and made sure that the entrepreneurs understood the implication of each and every term. They requested a few changes, and after some back and forth, the term sheet was signed in 10 days.

Continue reading Term Sheets: To be bound or not to be bound!

Starting Up? Then Start Right…

You have a great business idea, have discussed it with friends, family and advisors and now you are ready to start. Well, I am not going to tell you about the kind of entity you should be setting up or how you should go about it. You will find enough write ups on pros and cons of different types of entities. A lot of them will also set up the entity for you for a few thousand rupees. But then what? Just having an entity in place is not enough. Most start-ups think their legal obligations are fulfilled once their entity is set up and that they can just concentrate on getting their business off the ground and probably raise some investments. Well, they are not completely wrong. While it is important to press the accelerator on business, one should simultaneously work on putting in place the right processes and systems, from day 1. Continue reading Starting Up? Then Start Right…