Let’s begin by dissecting the title “Venture Capitalist”… Here’s a description from our good friend, Wikipedia:

Venture capital is a type of private equity capital typically provided by professional, outside investors to new, growth businesses. Venture capital investments are generally made as cash in exchange for shares in the invested company. A venture capitalist (VC) is a person who makes such investments.

Here are a few things every start-up should consider before seeking a VC that will let you sulk in his moolah:

Control:

The average founder of a startup who uses a VC owns 60% of his property initially, and 10% upon exit. That’s a significant amount of ‘company’ that you’re giving away, think about it. Now let’s take a look at what the other 40% of your company will be focused on. Money. Yes, that’s right, let’s stir up some controversy here. Think about what makes the average VC happy. Why would someone take risk in investing into your product? Money. It may turn out that the concern for money comes before your company, or your customers. VC’s can have the power to hire and fire people, when they own such stake in your biz (including you!).

If its not the ultimate necessity, do you really want this cash-cow second in command of your company? (Sometimes the answer is yes, but situation this comes into play later).

Do you really need it?

Hell, there’s no point in finding a Venture Capitalist if you don’t need one. The average initial investment is $3M+, and if you honestly think that you need 3 million in the bank for your startup to succeed, you’re either launching the next Paypal, or you need a reality check. Now of course, you’ll have many people bumming off of their VC cheques to pay for their apartments, their groceries, et cetera – if this is what you want to achieve raising funds for your company, why not just take out a loan?

If your reason for hiring a VC is to lower your personal risk, that means you don’t have enough faith in your startup to begin with. Entrepreneurship is all about risk taking. In fact, the actual word “entrepreneur” can be defined as “a person who organizes and manages any enterprise, especially a business, usually with considerable initiative and risk.”

Startup costs have gone way down over the past few years. The average funding needed for a startup is now 1/10th of what it was 2 years ago. Entrepreneurs can now outsource development work, which serves as a major benefit when cutting costs. Take a look at some popular success stories that have been circulating the blogosphere recently, start-ups have been launching for mere $X,XXX – low $XX,XXX! Save up, and if you must, raise some angel funding to cover promotion.

Abiding by conditions:

You couldn’t have thought VC’s would just give you money without conditions, right? Here’s a list of some of the conditions that you should expect, courtesy of Business Week:

Anti-dilution protection. If the company’s stock price goes down any time in the future, they get additional stock for free.

Dividends. In addition to stock, they get a guaranteed rate of return.

Liquidation preferences. VCs get their principal and dividends back before anyone else gets a penny.

Participating preferred. They get to double dip—they first get their investment plus dividends, then the value of their stock.

Mandatory redemption. This requires the company to buy their stock back by a certain date, establishing a deadline for an exit event.

Demand registration rights. The VCs can force the company to file a registration statement with the Securities and Exchange Commission to initiate an initial public offering—another way of forcing an exit event.

Approval rights. The VCs must approve any new financing and have the right to participate.

Reps and warranties. You’ll also have to accept personal liability for representations you’ve made about key aspects of the company. They will have the right to sue you for all you own if you forgot to give them any bad news.

Alternatives:

• Friends and family are often more than willing to invest in your startups. They know you, and what you’re capable of.
• Don’t use expensive software! Stick with freebee’s such as Basecamp (and the rest of the 37signals apps), Skype, Google Spreadsheets, and Blinksale. If you must upgrade, the monthly fees are very affordable.
• There are many budgeted designers and programmers that are just waiting to be found! Browse through logopond for some logo designers, and post some job listings on one of the many job boards. *Hint hint: Take a look at our first sponsor, who happens to be a genuine designer with shockingly low rates.
• Who needs an office? Not me! A lot of people who acquire VC funding spend it to relocate or buy office space. Working from home is perfectly fine, and saves a fair bit of costs.
• Still short? Mortgage your house, and save save save! Another option would be is to bring some developers onto the projects as partners.

Final Thoughts:

Before going to any Venture Capitalist, make sure you thoroughly weigh out all the positives, negatives, and alternative options.

I’ve been reading a few blogs lately, particularly posts entailing the costs and procedures of a new start-up. There seems to be a growing trend of minimizing start-up costs and times, and I think it is great that entrepreneurs are finally learning of the many places and ways to downsize their investments to get a start-up running. (Keep an eye out for a friskily controversial new post we’ll have coming up on this topic).

But here’s something that caught my eye, an excerpt from Guy Kawasaki’s side of ‘da net’:

$4,824.14. The total cost of the legal fees [for Truemors] was $4,824.14. I could have used my uncle the divorce lawyer and saved a few bucks, but that would have been short sighted if Truemors ever becomes worth something. Here’s a breakdown of what I got for this amount of money.

Now before I go on, do know that what Guy dropped nearly $5 grand on was more than just a “Terms of Use” agreement (see here), but for the sake of this post I’ll be focusing on what’s out there.

First of all, do you really need something like a Terms of Use, or a Non-Disclosure Agreement to protect your start-up? Let’s take a look at what can happen, and what good one can do for you.

Hypothetical, disadvantageous situation:

There’s far too great of a variety of websites and services offered on the internet to list specifics for each type of situation, but to make my point, I’ll use a content sharing / storage service. Call it StartupX. Imagine this, you have no acceptable use policy (aka, a Terms of Service, or a Terms of Use), and you’re running a successful marketing campaign. A flurry of new users sign up, and life is good. Then you notice a few illicit files being uploaded, and oh baby take my word for it – these files are viral. By the time you go and check out what these users are up to, this trend will catch on. Since the users didn’t agree to anything prior to creating their account, they go wild.

Imagine by nightfall, your server has copyright infringement written all over it, with thousands of mp3’s, ripped or unreleased movies, and more. You wake up the next morning to find your inbox flooded with hundreds of cease and desist letters, take-down notices, and legal threats from the likes of the RIAA, the MPAA, and independent producers. You’ve dropped some dollar on your site (or worse, you’ve raised a few grand from angel investors, but then again this article isn’t about those ventures), and you really hate to see it go down. You’ve seen what organizations like the RIAA have done to other sites. That’s not you.

But what can you do? StartupX didn’t require, or even give users the choice, of accepting and abiding to a Terms of Service (because it doesn’t exist). You, as whole representative of StartupX, can’t ride on the fact that the user’s are to blame… and now, not their server, but your server, houses thousands of infringed content. Now correct me if I’m wrong, but I do believe this makes you the one responsible for these files. And now, you have no choice but to shut down your service, all because you couldn’t shell out the $5,000 in legal fees to cover a Terms of Service (Admittedly, though, this could be taken to trial, which would just mean more fiscal duties). But hey, look at the bright side, chances are StartupX just made some big headlines in the blogosphere.

So what can be done to prevent this kind of situation from ever arising on your field? Plenty. Of course the statement implying one needs to spend $5,000 to obtain a viable Terms of Service (above) is a joke – a ToS, and plenty of other legal forms and agreements, can easily be found all over the internet for a one time fee of $0. (Now this doesn’t go without saying, if you’ve raised capital, or are planning to launch a large service that needs to be scalable, hiring a lawyer to consult and write your agreements for your start-up is the best way to go). I’d like to end this post by providing a few useful links to free legal templates that are out there for your use. 🙂

Terms of Service

• http://www.docstoc.com/docs/301241/Website-Standard-Terms-and-Conditions-Template
• http://partners.uslegalforms.com/partners/blumberg/index.php?a=tech-forms.htm
• http://www.businessballs.com/service_agreements_contracts_templates.htm
• http://www.lawdepot.com/contracts/service-contract/?ad=mainpag

Non-Disclosure Agreement (Good when outsourcing development, design work, or other services that you may want to keep on ‘the down lo’, or may need to reveal some figures to)

• http://fap.wharton.upenn.edu/forms/nondisclosure.htm
• http://my.execpc.com/~mhallign/form1.html
• http://www.docstoc.com/docs/14660/Web-Site-Design-Nondisclosure-Agreement
• http://ezinearticles.com/?Mutual-Non-Disclosure-Agreement-Template&id=350378
• http://www.coollawyer.com/webfront/freeconf/interactive.php

Privacy Policy (Good when requiring personal or private information from your users)

• http://www.docstoc.com/docs/14623/Web-Site-Privacy-Policy
• http://www.the-dma.org/privacy/creating.shtml
• http://www.enbs.com/privacy-policy-generator.php

And finally, if you’d like to Incorporate or set up a(n?) LLC, or trademark your name, the most recommended place around is LegalZoom.

If you enjoyed this post please feel free to comment, or share it (check out the “SHARE” button below this post).

Update: A few commenters have brought to my attention that the example situation I described may be a little too extreme, so maybe its best not to take the story too seriously, as one would still be protected under various laws or acts in the US (EG. The DMCA). The goal of this post was to remind entrepreneurs about the importance of legal work for your start-up. I loved the great discussion through the comments, by the way.