Anticipating the Dreaded Three D’s that Derail Startup Founders and Business Owners
Everything was going great, we were crushing it. After three years of hard work and sacrifice, our product took off like a rocket ship. Orders were pouring in. Retailers lined up to stock the product. OEM’s wanted to bundle it. And VC’s were knocking. A publicly-traded software company invited us to their headquarters in Silicon Valley to discuss their interest in acquiring our growing startup.
And then in an instant….everything fell apart.
My partner, the company’s CTO and product genius, was murdered. If that wasn’t tragic enough, I was the chief suspect and found myself undergoing police interrogation as the entire community wondered if I had killed my partner for the insurance money. (NO, but more on that sad tale in a minute. First, we have a company to save.)
Word spread quickly. Orders slowed to a trickle. The potential acquirer and the VC’s stopped calling. The conventional wisdom was, “founder dead, company dead.” In less than three months we found ourselves with twenty employees and only 30 days of runway left. It looked like it was going to be a total loss…another failed startup…a victim of bad luck.
Fortunately, we defied conventional wisdom and miraculously saved the company. We sold it three years later to a different publicly-traded company. The turn-around required us to relocate and completely reinvent the company – another story for another time.
The police caught the two low-lifes who murdered my partner. He was gay…they apparently found that offensive, so they killed him and robbed him. The police quickly eliminated me as a suspect after confirming the key man life insurance policies on both my partner and myself had expired. We had mistakenly neglected to renew them during our rapid expansion phase. A bitter-sweet mistake, to be sure.
1. DEATH (OR DISABILITY)
The first (and most serious) of the Dreaded Three D’s is DEATH (or Disability). Sh*t happens. Life happens. Bad things happen to good people. The best you can do is to anticipate the worst and take steps to mitigate the fallout. What happens to your company if YOU die suddenly? What happens if you lose one or more key team members? What actions can you take now to protect your family, partners, employees, and shareholders…and ensure your legacy?
I divorced after 25-years of marriage. The decision was mutual and mostly amicable. The kids were grown and gone, nothing to fight about there. The biggest issue that was contested on both sides was the value of our respective businesses. Her lawyer said her business was not worth much, but the stock in my businesses was worth millions (not true). Plus, he convinced her, I was probably hiding money in offshore accounts and ventures I had not disclosed (not true).
How each business was valued would determine the ultimate settlement and could have significant ramifications for the bankers, shareholders and employees of both businesses. A witch hunt for phantom assets would be costly and protracted. When a couple divorces, they are also divorcing their long-term friends and business partners. It’s a no-win life event, except for the lawyers. They always win. And the more hotly contested the divorce, the bigger the win for them.
In the end, cooler heads prevailed. An independent valuation of both businesses convinced the mediator to push both of us towards a fair, final settlement. Good financials and accurate books won the day, not emotion or unsubstantiated accusations. She got 100% of her business and became a minority stock holder in my business. Both businesses were able to move forward with the least amount of disruption.
The second most disruptive of the Dreaded Three D’s is DIVORCE. Most divorces happen between the ages of 40 and 60. Those are the peak earning years for most people – the absolute worst time, economically, to get a divorce. The emotional and financial impact on business owners going through a divorce can have dire consequences on the business itself, and its employees and stockholders. Many startups and growing companies end up being torn apart during a bitter divorce, if the business owners have not taken the appropriate steps to shield the business.
Source: Census Data
My first startup venture ended in personal bankruptcy. I had maxed-out all of my credit cards to help fund the startup and pay for rent, food and other essentials during the period when there was no salary or income of any kind. My partner and I had a falling out after we merged the company with another startup company, and effectively lost control. I was forced out, broke, saddled with debt and no income. It was a great first lesson in the “take no prisoners” world of high tech startups.
I took a job in the “real word” and filed for Chapter 13 bankruptcy. I was ordered by the judge to pay $0.30 on the dollar to my creditors over a three-year period. After three years my lawyer and I went back to court to ask for permission to extend the bankruptcy another two years so that I could repay 100% of the debt I owed my creditors.
The judge said, “Son, you met your obligation under the bankruptcy agreement. I am ready to dismiss this and let you get on with your life.” I told him my life would never be the same if I left even one creditor hanging for less than what they were fully owed. He smiled, shook his head, and granted the extension. Two years later the bankruptcy was officially dismissed with 100% repayment to the creditors.
Several years later I was raising venture money for my third startup. The VC’s conducted a background check during their due diligence. They called me in and explained they would not be able to invest because of the bankruptcy in my past. I was too high of a risk. I produced the final judgment from my briefcase, slid it across the table and said, “Did your due diligence show that all the creditors were paid back 100%?” They looked puzzled and surprised, because that fact does not show up in a credit report. “I will never leave anyone hanging if I can help it,” I said. “That includes you!” I got the money and my new venture was launched.
The third of the Dreaded Three D’s is Debt (or bankruptcy). Startup founders and business owners can rack up tons of debt during the process of building a company – and many pledge their personal assets and/or the assets of their businesses against those debts. This situation can make it increasingly more difficult to continue to finance a business. Banks stop lending. Suppliers stop extending credit. Even VC’s shy away from promising businesses where the founders or the company have taken on too much debt, or have a past bankruptcy. A manageable amount of debt is common and expected. Excessive debt can derail a business and send the owners back to square one.
Steps to Take to Anticipate the Dreaded Three D’s:
1. Get some professional advice. Ask your advisors these “what if” scenarios and what you can do about them now to mitigate the fallout if they happen.
2. Have a Buy-Sell Agreement with your founders and all key shareholders. That includes your spouse!
3. Have a succession plan. Don’t think about it as an exercise you undertake to plan for your death. Think about it as an exercise to allow yourself to go on a long sabbatical, ensuring your business will be in good hands until you return.
4. Clearly separate your personal assets and accounts from your business assets and accounts. Founders and business owners get into the most trouble when they mix their assets or accounts.
5. Structure stock agreements with your spouse, significant other, and children, to protect the long-term interests of the business and its other stockholders in the event of divorce or death. Be very careful about unintentionally creating a defacto controlling interest by your spouse or heirs should one of the dreaded three D’s befall you.
6. Try to avoid personal guarantees when borrowing money for your business. If you must give a personal guarantee, make sure it’s repayment has first priority over every other obligation in the event of a sale or dissolution.
7. Get a good Key Man Life Insurance Policy (and don’t forget to pay the premium when it is due!)
Fate often has a jarring and sometimes downright maddening way of reminding us that life is unpredictable at best and devastatingly tragic at worse. We can’t control everything, but we can anticipate and mitigate some of the bad things that can derail us and our businesses. The fact is, most of us will be in debt at different points in our lives. Most of us will divorce at least once. And death, of course, eventually comes for all of us. Best to figure out in advance what to do about each.
May you live long, be happily married (or single), and debt free!