Do your Homework: A Tale of a Startup

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November 1999

Dear A, B, C, D, E, and F, 

Hi. I'm writing because last week you all helped me negotiate my joining of a start-up. In the end I chose to walk away, relatively unscathed, thanks to all of you. I perhaps owe you more than I can repay (repeat: I didn't join the company), but I can start with a brief recounting of the events, since you asked to hear how it came out:

1. On Monday the 15th I was called by this fellow N, who was helping some undergrads I know do a start-up. (The students had come to talk to me about the idea a couple of months ago, <s>.com, and I liked it a lot.) N was gathering up the funding, putting together the company, and looking for some key people. The students starting the company (I'll call them ``the guys''; N called them ``the boys'') had identified me as the person they would most like to have aboard to advise them. Needless to say I was touched and thrilled. That night I called the guys up and talked about the details. There was about $800K in funding over a year, there were 2M shares of stock and they were to get 6% of the company each. It all sounded great.

2. On Tuesday, I spoke with N on the phone and followed up with an e-mail about how I thought I could contribute to the company and what my basic parameters were (can only work one day a week, what my typical consulting rate was, etc.).

3. On Wednesday, I spoke with N again. He was prepared to offer me 20K options on shares of the company, to vest in one year, and cover major expenses. Doing a quick calculation (1% of the company), I was appalled, given what I expected to contribute to the company and that I was to get no up-front compensation. He said that he guessed the shares would be worth $5-$25 in a year, which according to his calculations would meet my typical consulting rate or 5 times that. Even today he was estimating the company worth about $3M and he was selling shares in the company for a dollar (in 100K lots). However, I was thinking in terms of the value I was adding, not the hours I was logging. Also, if the company closed down, I'd get nothing in the end. N said, if you contribute a lot to the company, I'll give you a bigger stake later. This didn't seem right in a lot of ways. I called A, the guy I always call when I have an odd question, and he said the offer sounded low and directed me to B and C, both actively involved in the world of start-ups. I got to C quickly, he asked me a few questions, and we decided that 3% of the company (60K shares) was about right. B left me voice mail with the same basic message and some great phrases to use in the subsequent negotiations. Both B and C were emphatic that everything should be negotiated up front, especially since my most valuable contributions would come early in the company's life. My best negotiating position was now.

4. On Thursday I spoke with N again, and gave him the spiel I had worked out, and he said OK, 60,000 shares, but vesting over four years and I'd have to be on the board of advisors. I asked him what if the company was sold in less than two years and he offered 50% acceleration of the vesting. I said OK, I'll think about it and went right back to C.  C said 100% acceleration of vesting on termination without cause or change of control in the company.  C also went over a slew of numbers for me regarding pricing of shares and options and the tax consequences. At this point I thought I should tell E what was going on, so I broached the topic with him. He had one piece of advice for me: check this guy and his company out.

5. On Friday, I went back to N and said what I wanted. He wouldn't give on the acceleration on termination, but OK for sale or IPO (but not change of control). He said I would have to trust him, that he didn't work that way, etc. Grrr. I also quizzed him on some of the financial stuff.  What was the pricing of the shares, etc.? He said the shares were about a dollar, the options .10. This was about a factor of ten off of what C had been able to reconstruct from my sketchy data, that is, if preferred shares were $1, then common would be about .10, and options .01. Although I felt uncomfortable with the termination thing, I agreed anyway. He said great, send an e-mail today confirming what we agreed, we start tomorrow! I said OK, when will you get me a contract? He said 2-6 weeks. We're moving at internet speed and he didn't have time right now. You'll have to trust me, he said. Hmm. OK, I said, and hung up. As I started to write up the e-mail, something felt really awful. I had just negotiated this whole thing, I knew that my most valuable contributions would come early in the company's life, and I was going to be working for a month without a contract. And getting to this place was worse than my last root canal. I tried calling C, but I missed him and I missed his return call. As Friday wore on, D's words from the night before were ringing in my ears: you always do your homework. Uh, yeah. I realized that I had to get some more information, and I remembered that I hadn't yet checked this guy out, this guy I was supposed to trust. The students had seemed really high on him when I spoke to them on Monday, but I hadn't gotten the same feeling. He was fighting me the whole way on my terms, even though none of it required up-front compensation. I called B and got right through to him, amazingly enough. When I told him about waiting on the contract, he laughed so hard he nearly dropped the phone. He reminded me that if I'm going to move at internet speed, N should, too. Touche. He was also emphatic about the acceleration conditions that C had laid out. Now I was really worried about this guy.  Am I supposed to trust C and B, or the guy holding the purse? B deadpans: the CEO is the most important person in the company. Oh, yeah. Not able to reach E's suggested contact for vetting N, I realized that my former student F was immersed in the <local> high-tech business community. Right through to him, too. First, he knew of N's company; they had approached F about doing some kind of deal and then pulled out without explanation. Hmmm. F asked about how this new company was set up. When he heard that the folks with the money were also setting up the company, he was really worried. It's too easy to turn things in their favor without anybody knowing, he said; maybe they've left the guys no control over their own company.

Uh, oh. Now I was worried about the guys, not just myself. I call the guys and get through right away. Was everyone just sitting around waiting for my call? Apparently so. Bless you all. The tenor of this conversation was very different. Yeah, they said, it had seemed like a pretty great deal in the beginning, but the documents were so confusing and incomplete that it was quite a while before they figured out that there were 3.8M shares in the company (.8M preferred, 2M common, 1M to be optioned), not 2M, significantly diluting there apparent 6%. They felt that N had done this intentionally to get them excited and then get them far enough in that they didn't want to even think about backing out. It worked. They signed the deal. I so wished that I had called mid-week or their lawyer had shown some backbone. They say they are still excited about the company. They get paid to make their dream come true. However, they also acknowledge that they don't completely trust their CEO and they compare notes on their separate conversations with him. They're really grateful that they hold all rights to technical hiring (that is, I guess, until the board changes the rules). BTW, the guys told me that the common shares were priced at .01, not $1, making the option price of .10 seem bizarre if nothing else. Either the guy was lying to me or he couldn't do numbers. So, come 6pm on Friday, I had decided with great relief that I had to walk away, despite my respect for the guys, my desire to help them, and my desire to succeed myself. Life is too short to voluntarily work with people like this guy, especially when he has the most to gain of all involved. And I've got another job that's pretty time-consuming and rewarding as it is. I called N on Monday and told him my decision and pretty much why. He didn't really seem to get it. My feeling is that he figures out what everyone else deserves, keeps the rest for himself, and figures that's the value he adds to the whole organization. I wish the guys luck working with a CEO like that.

I learned a lot from this little adventure. I learned that my time and integrity are worth more than a million dollars. I learned that I am surrounded by really smart and generous people. I learned that the start-up world has some not so great people in it, but also lots of really generous and good people, too. And I learned that I shouldn't leave my homework to the last minute.  Thank you all so much for helping me out. Be assured that I'll be returning the favor over and over, maybe to you and probably to someone else. If I left anything out that you wanted to hear more about, please let me know and I'll send you e-mail or give you a ring.

	Computer Science & Engineering University of Washington Box 352350 Seattle, WA  98195-2350 (206) 543-1695 voice, (206) 543-2969 FAX [comments to chair]