Transcript: Protecting yourself as the founder; Ryan Howard

At Vator Splash Health 2016, Ryan Howard (Chairman & Founder, Practice Fusion)

At Vator Splash Health 2016, Ryan Howard (Chairman & Founder, Practice Fusion) talked about 'Protecting yourself as the founder'. Here's a transcript as well as the video version. 

[Introductory music]

Howard: First off, I want to talk Bambi and the Vator team for having me today and making this happen, just a tremendous effort. How many people in the room are founders? Raise your hand. Awesome. How many people are thinking and considering starting their own company? I am. Awesome. Great, so the purpose of me being here today is that I founded Practice Fusion. I started working on it in 2002, founded the company officially in 2005.

What I learned along the way is that the challenges is that you’re alone. You’re making a lot of hard decisions, you’re making a lot of those decisions with very little data and at the end of the day, you’re going to make mistakes and unfortunately, you’re accountable for all those major mistakes. Other founders have going through this. I’m not the first person, but what I found over time is that most of this knowledge that I’m hoping to share with you today is not centralized because when these mistakes are made, people usually get fired and from there, they’ll sign confidentiality agreements or get exit packages and are no longer allowed to talk about these openly.

What I’m here to do is to share some of these mistakes. Hopefully, you guys can avoid some of the pitfalls. As a side note, I’m not looking for an advisory role. I’m not looking to be on anyone’s board. I’m not looking for a paid coach job. I’m just here to simply be of service to everyone here today. I apologize, my notes are out of synch here so I’m just going to be a little bit clunky.

Starting off, being a founder is obviously an incredibly hard job. Macro concerns from day-to-day are simply building your business, hiring a great team, fundraising to make payroll day to day and with that, the last thing you want to do is worry about getting fired from the company that you started. The reality is that, this is a quote from the founder of Sequioa, “45% of their founding CEOs and their investments are fired after 18 months.” It’s something that you have to be cognizant that’s happening all the time.

In addition, if you make it past 18 months, that’s not a bad statistic. You get to keep your job. The pressure’s perpetually on throughout your tenure. Founders of Twitter, Paypal, Cisco, the original founder of Tesla, they were all exited from their companies. Again, I want to give you guys some pragmatic steps in insulating yourself when you’re starting your company.

One step that you can take and what you should really concern about when you first start the company is that you incorporate your company correctly. A few things you can do, and keep in mind, any advice I’m gonna to give up here is obviously not legal advice, but the other thing is that the more value your company has, the more valuable you can make it, the more leverage you’re going to have with each of these items I’m going to show you. These are basically negotiables.

When you actually incorporate a company, one thing you can do and that I highly recommend is putting together three to four common board seats upfront. This is critical, maintain control of your company as long as you can. At the board level is where it’s most critical. Many founders, including myself, actually lose control of their company after the Series A financing. When Practice Fusion closed its original Series A financing with Morgan Taylor, they took a seat, I had a seat, there’s a common seat as well. Sorry, an independent seat and I no longer had control of the company very early. This is a really common mistake.

Secondly, along the same vein, if you’re starting the company with co-founders, you want to have clear vesting and rules for termination. If you have other co-founders, you should have rules where if something’s not going right, if they’re not showing up for work, that you guys have as adults, put something together. If you have a co-founder that’s no longer showing up, but they own half the company, that can be hugely problematic. Also, I’ve seen many founders leave companies and leave other co-founders holding the bag when effectively, the founder that left, again owns half the company. Someone still has to stick around and run the actual business and that can be quite problematic.

Another micro-strategy, this is more about the founder having some options on liquidity. This is effectively another thing you can do when you’re incorporating the company and putting together your original restricted stock purchase agreement, is issuing a portion of your state shares as Class-FF shares. This is a class of shares that was invented by Peter Thiel and Shawn Parker and what it is is it’s effectively a preferred share. If you have some of these, you can have your entire allocation of equity being these, but if you have a portion, when you do your Series B or Series C financing, you can effectively, potentially get some money off the table which can de-risk you overall. You don’t have to wait until your company sells your IPOs five or ten years down the road. It allows you to get some liquidity and again, insulate yourself, protect yourself.

Lastly, this doesn’t apply to everyone, but a C-corp makes decisions on what’s best for its shareholders and in contrast, many people here are starting healthcare based companies and they have social impact and social good, so one thing you can potentially do, this is a bit of an outlier, but you should consider potentially being a benefit corp, when they make decisions, they make decisions on what’s best for the community. A lot of financial decisions – should revenue and profit go back to common shareholders, should we IPO the company – they can be affected by what’s actually best for the community around us instead of what’s just best for the common shareholders and investors.

Your employment agreement – this is where the key and this is another place where I made a major mistake. My recommendation is some time you incorporate and sometime around the time you’re closing your Series-A financing that you come up and put together a robust employment agreement. If you think about your relationship with the company, you’re likely being engaged to that company longer than most of your personal relationships. This is more of a pre-nup and in case you break up, this allows you to protect yourself.

For me, one of the things I think is really key is to always think about your downside. If this all ends today, not even if you’re fired, if the company goes out of business today, what do I have left, what do I have in my bank account? Can I get any liquidity from the equity? What’s really key here is that California is at-will so effectively, once you form your company, you start taking on investors and you no longer have control of the board. In the scenario that I just mentioned, I didn’t. You’re an at-will employee so if you don’t have the leverage on the board anymore, you can be basically let go for any reason. That’s just the reality of running a company. If the board and co-founders, they want you gone, they don’t have to give a reason to do so.

A couple of key points here along the employment agreement, another mistake I made is I recommend getting a great employment attorney. Again, while you’re closing your Series-A, it’s a great time to do this. Find outside counsel. If you’re using Wilson Sonsini or someone like that to run the company, they’re obligation is to the company. They don’t represent you as the founder. I think that’s something that’s kind of I assumed upfront that the attorney was representing me and the company and that’s not the case. You want to find a third party employment attorney and effectively have them put together some specific terms within the agreement that are reasonable that, again, protects yourself.

One of the key terms that should be in your employment contract is a cure provision. Effectively, a cure provision is that if there’s something wrong and the board wants to terminate you, you have time to actually mitigate it. They give you fair notice, you have a dialogue, you understand what the issue is and you have time to mitigate it. It’s an incredibly fair term in my opinion and something that should be in everyone’s employment contract.

Secondly, severance, I think this is probably more of a subject that would have to be up for debate and obviously you have to negotiate, but if you close your Series-A, you built some value in the company, depending on your valuation, if it’s $5 million, you should probably be at the lower end of this. If it’s a $20 million A valuation, you should definitely be able to walk with a little bit of cash. You founded the company, you put in a lot of sweat equity. The company may not have an abundance of cash. The reality is that’s not fully your problem. It’s kind of moot. You should be worried about eating, so again, this is negotiable that you should be negotiating with your direct personal counsel as well as the investor that’s leading the Series-A as well.

Pointing out the obvious, accelerate vesting, so effectively, sorry. On the accelerate vesting point, 6 to 12 months, somewhere in that range, your attorney can give you counsel there, but you shouldn’t leave the company penniless, you shouldn’t be fired with nothing. There should be something for creating the company that should be incentivizing given to you.

Lastly, just a point that a lot of people miss, if part of your equity package are options, you have to pay for those and then, they have fair market value that you’re taxed on as well. I’ve seen many people leave companies and have multi-million tax bills, so if you’re going to extend the ability to exercise those, it’ll give you time to evaluate the company, make sure it’s doing well, make sure you want to basically allocate that note of cash to pay for the shares and pay for the equity too. It can be quite expensive. I’ve seen many people leave their company, have huge pools of options and not realize they have this major tax overhead that they’re obligated to and then leave all their equity on the table, which is quite painful to work for multiple years and not get any shares whatsoever because of that.

Also on the employment front, negotiate for yourself because no one else will. When an investor comes to the table, the investor’s going to have preferences and rights in their investment agreement. They’re going to have a board seat, they’re going to have preferred shares. They have a contract with the company, they’re protected. When you have a great executive come to the company, they’re going to have terms within their employment contract because they’re savvy and mature. They’re going to have a change in control. If they get fired, the company gets bought. They’re going to get something. They’re going to get equity and cash like I mentioned, so these are things that all of the major stakeholders on the table will have. I see over and over again founders don’t look out for their best interests. I believe this is because they’re simply naïve or they just don’t have the experience or they’re overloaded as well.

Lastly, you might get along with your board and co-founders now and you might trust that they’ll do the right thing, but the reality is is that when things go sideways, people always tend to show their ugly sides, especially when money is involved. Again, just always protect your best interests here.

Next up, a great way that can kind of insulate yourself and protect the company as well, get a great corporate counsel. Some of you might know this, some of you might not. It’s pretty standard stuff, but the majority of firms will, in the valley, work on, contingency upfront so think about DLA Piper, Wilson Sonsini, Fenwick, you can go to them. If they believe your idea has merit, you don’t have to pay them upfront. You can defer fees, usually $25 to $50,000 until your seed or Series A. You shouldn’t be paying your attorney upfront. You should be spending all your money on R&D to develop your product. You don’t want to pay legal fees and you shouldn’t have to.

You don’t pay until you’re funded, as I mentioned. The reality is is that they do this to make money. If you’re successful, you’re going to drive them hundreds of thousands, if not millions of dollars in revenue from their services over time. Also, a lot will ask for equity upfront. Just say no, if your idea has merit, they’ll still do the deal. They’re not going to do any less work if they’re not getting equity. I might actually flip this over on them, most of the firms actually have funds so you can actually ask them for money.

Things I’ve learned along the way – sorry, a little bit behind here. A great lawyer can assist you in managing your board. When you think about your attorney, a great attorney, one I’ve used in the past and I’m using again right now, his name is Eldon Satusky, he’s at Wilson Sonsini, he spends half of his life in board meetings. He’s an expert on this. Leverage that expertise. A great attorney should be a strategic asset in managing your board. They should be able to give you a pulse on how the board’s feeling, what strategies work for communication, and also, if the board is unhappy, that attorney should be working with you as a partner to give you a heads up on what is going on and how you can mitigate those issues.

Secondly, many larger firms represent investors. One of my attorneys actually represented one of my investors. The reality is that that investor drove dramatically more bookable revenue for that attorney than Practice Fusion ever would. Whether there was a direct conflict or indirect, it was real and you effectively want some of that that’s quite neutral and not beholden to the investor. This is really really critical, make sure they have no conflicts. You always want to work with someone that’s explicitly on your side.

Lastly, if you don’t like your attorney, this is just some sad advice, simply cut them loose. Attorneys are commoditized services and in the Valley, there’s lots of them. They’ll all take your business and effectively, it’s really easy to ship your files over. Sometimes I see this that people feel that they’re entrenched and they don’t like their attorney. It’s really easy to do a transition.

Also, just some context on protecting yourself from your teams, from my perspective, there’s three to four teams you want to focus on. First and foremost, there’s your management team. Think about the obvious, your CFO, your head of marketing, head of product and operations. Secondly, your board team, so this includes board members you’re going to recruit for common seats as well as board members that will come on with investor seats as well. And then thirdly, this is the one I see most neglected, is your personal support team, so think about coaches, therapists, things like this. I see this neglected the most by founders.

On the management team, when you  hire the right senior leader, you’re going to see a tectonic shift in your organization. Jason Portno is here from Subtraction Capital today and when he actually joined Practice Fusion as our CFO, he used to use this word 'force-multiplier'. I didn’t really comprehend what it was until Jason came on and brought some people with him. Most founders, including myself, especially when I was quite junior when I was 30 years old, I was intimidated by older, more seasoned executives, which ultimately slowed me down and slowed the other founders down because they’re not willing to put someone more senior on the team. Once you get over that, you have these 'force-multipliers' and they’re 'force-multipliers' for multiple reasons.

First and foremost, if you’re managing a function, if I’m managing marketing for example, last year we didn’t have CMO at Practice Fusion so I was managing it, I had five additional direct reports, so the obvious thing is that when a leader comes in, they free up time. But with that, the leader should be able to recruit significantly. They should have a tremendous amount of bandwidth in their network to being on better marketers than you have today. It will expedite the team’s productivity as well as building the team. A great leader will be able to recruit from their past life for other jobs as well.

Also, pointing out the obvious again, the leader is going to be able to drive much better results for that function than you can. I’m not a marketing expert, I’m more of a generalist, I’m pretty good at it. A great CMO, we brought one on board and he was fantastic. What’s really invigorating is watching the organization literally become more valuable because you made that hire finally.

The wrong leader – choosing the wrong leader can set your company back by more than a year. I’ve seen this first hand multiple times. Let’s take sales for example. It might take three to six months to hire someone, another three months to get them on board and that’s actually being quite friendly. On the life sciences front, I’ve had searches using professional search firms that take more than a year. It can be quite painful to find the right person to fit your culture. I think there’s a juxtaposition of a life science or health care individual trying to work in Silicon Valley and that can be quite painful to hire for.

But the net is that, let’s take a sales person, if they’re off track, they’re entire team will be generally off track. Let’s say your revenue goal is $15 million, they’re tracking at $10 million so you’re $5 million behind your goal, this causes problems for next year when your goal is $25 million. You’ve compounded your deficit over time, likely forever. You’re never going to make up on those sales. If you’re going and you’re working effectively, if the sales that are coming in, you’re using those to make payroll, you’re going to shorten your runway, so you’re going to have to raise more money so it causes all kinds of problems within the organization.  It can be life and death for the organization, it can cause you to get fired as well, if you miss your sales goals too.

Enough wrong leaders can cause major dysfunction in the organization. People are the reason companies fail. They can also ruin the culture. The wrong leader can cause dysfunction, they can cause fighting, they can cause people to quit as well. Always have a very low tolerance for under-performers. One thing you learn over time if you’re going to be successful is you need to have to courage to have the hard conversation to let someone go. We had a mantra, “Hire slowly, fire fast.” It serves us quite well.

As a side note, the wrong leaders are also expensive. I just mentioned the sales leader which is pretty pragmatic. They can cause you millions in revenue. To exit someone, the actual pragmatic direct cause can be expensive as well. You’re paying an executive $300,000 a year which is not egregious. You might have lost traction with them, that’s okay. The severance package might be another $100-$150,000. The equity vested and then the equity is part of the severance as well. I’ve had people cost us over a million dollars. It can be quite painful and then they weren’t productive at all so it’s doubly painful.

On the interviewing front, your ability to assess a candidate within a limited time during interviews is critical. It eliminates the risks I just mentioned, pointing out the obvious. One thing I learned over time – this is just something that some people hate it, but group interviews result in more data, more consensus definitively, in  my opinion. If I meet someone and five other people in the organization meet them, we spend 10 or 15 minutes on salutations, tell me about your background, so that’s all redundant content that happened in each one of those interactions and you don’t really get that deep in an hour conversation. The group interview make it longer, have everyone sit there. You build consensus and people can get much deeper and intimate with the candidate.

A great candidate should be able to explain and deconstruct how they solve a specific issue at an excruciatingly low level. This is actually Elon Musk’s Litmus Test for hiring and this is something we found of service to us quite well. The other thing we learned over time is we tested everyone and it worked really well. Practice Fusion always had a top-25 rank culture in the Valley. When a developer would come in, we would effectively let them write code and we evaluate the code.  When a marketer would come in, we’d have them look at our marketing program and have them basically come up with a presentation.

Where we didn’t do this as much in the earlier days was the executives. Someone would come in with Google and Microsoft in their resume and we just for some reason assume that they were really good at their job and we got really good at evaluating these people over time. We would have them in for what we call “A day in the life.” When you meet an executive, if you really want to hire them, you should have them for one to two full days and don’t have them show you their current work. Have them spend a day learning the problem space, have them take some time to themselves and then come back and work with the team for a day on how they'd can fix it. At the end of that meeting, I guarantee you that the entire team would be yes or no. You have worked with them, you have de-risked their working style, you de-risk their ability to execute, you de-risk their aptitude, so it’s something that’s served us really well.

If someone won’t do it, they don’t want the job and simply don’t hire them. Also, if this scene’s pretty obvious but it’s amazing how often people don’t do it and how often we didn’t do it. Check references. I never check any references a candidate gives me, board or executive candidate. Go on Linkedin, do the due diligence, get the real data because if you don’t, you’re going to find out the hard way.

Lastly, this is something that’s key too. In the early days of Practice Fusion, we’d hire people that we may not have liked per se, but they were really smart and they were good at executing. What I found over time is that definitively, they should be able to do the job, but in addition, they would have to be a culture fit. The reality is you’re going to spend more time with these individuals likely than your partner or spouse so you have to get along. It’s the only way that you’re going to build long term value together. Total assholes, again, will just ruin your culture. Whether other people admit it or not, people will quit because a terrorist is in your organization.

Second up, your board term. The single biggest mistake that I believe founders make is assembling their board. This happens a lot. I mentioned the three to four common seats upfront to protect your interests. It will balance out bad board members as well. If you get a bad board member, and you have some common seats filled, it will turn the noise down on that. Again, I lost control of the board on Practice Fusion. I didn’t have any leverage after the Series A which is a profoundly large mistake on my behalf.

The board’s primary function is governance and hiring and firing the CEO. I think that most people don’t recognize that. Therefore, spend more time on this than all the other things you do. If you’re spending a day with an executive candidate, you should be spending many meetings with potential board members because they literally are your boss. Once a board member is on, it’s nearly impossible to get them off. It’s quite painful, it’s like going to Vegas, getting married without a pre-nup and never being able to get divorced.

I highly recommend avoiding bloated boards that can run your company. The larger the board, the more overhead you’re going to have and you’re going to feel that directly because you’re the only person in that organization that actually reports to them. This can be quite painful especially with junior board members. They’ll ask a lot of questions. If they don’t have a lot of companies in their portfolios, they can actually churn up a lot of your bandwidth. Also, I see this all the time, I lightly helped a person in a health care company in the city, she has a seed stage company with five people on her board. It makes absolutely no sense to me why she would want four other bosses, why she’d want this overhead.

If someone’s’ that valuable to help you or wants to be in the board that bad, put an advisory board together. Give them the same equity, give them a great title, but why make them your boss? Totally unnecessary. I recommend don’t adding board members unless you absolutely have to. Again, the board’s role is hiring and firing you so why create additional overhead, and again, to maintain control of the board as long as you can as a founder.

Investor board members, deconstructing this really quickly, over time, the majority of your board members will likely be investors so if you’re doing an A though D series of financings, you’re going to take on likely four investors as board members. Upfront, what I notice is that we would pitch big funds so we’d go to Sequioa and it would just be in and out. They’d ask us a hundred questions and we’d have three meetings. If we’re lucky, we’ll get a term sheet. Upfront, during the second meeting, you want to go, “Who in this room is actually likely going to come on our board?” to get that context so you can start building a relationship with them early on.

You want to interview them until you’re comfortable. Like I said, at least three meetings, the more the better. You want to ask hard questions. You want to ask when the last time they fired a CEO and why. You want to basically get that context. You want to tell them upfront what your expectations of a board member are. If you don’t, they will tell you what their expectations are. Most of the board members are veteran investors and have dramatically more experience than you do, so that can be quite problematic.

Upfront, set expectations, explain how you run your board meeting and then, the reality is that this isn’t just all about the founder, founder, founder. This is a partnership. They’re putting their livelihood on the line to but you a check. They’re putting their reputations on the line so you want to make sure you understand their expectations and how you’re going to work together. It is a long term partnership and the goal is to build value together.

Secondly, dial in your EQ, watch for dysfunctional behaviors. Everyone here is a cognizant human being that’s alive. You’re picking up lots of data all the time. Fast talkers, anxiety, twitches, things like that, germ-phobes, one of my favorite board members wouldn’t shake anyone’s hands. How do you think that person reacted when we told her we were off our finance plan? Head spun around backwards like the Exorcist. Those things can be quite challenging.

Also, one thing I constantly did, part of it was my fault, part of it was my ego, part of it was keeping up with the Joneses. Don’t get so excited about the valuation that you’re throwing the baby at the bath water. I did this multiple times at Practice Fusion. I had advisors that wanted a huge valuation because as investors, it might make them look really good. Again, my ego got the best of me, but be willing, if you get a $20 million valuation, be willing to go back to that investor or someone else and go, “What if we do 10% off this and I can maintain a little more control of the board,” or whatnot.

Again, if you’re going to build long term value, you need to be there long term. On that, that’s what I have today. Thank you so much.

Audience: [claps]

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Editor's Note: Our annual Vator Splash Spring 2016 conference is around the corner on May 12, 2016 at the historic Scottish Rite Center in Oakland. Speakers include Nigel Eccles (CEO & Co-founder, FanDuel, Andy Dunn (CEO,Bonobos), Libby Schaaf (Mayor, City of Oakland), Mitch Kapor (Founder, Kapor Center for Social Impact), Oisin Hanrahan (Co-Founder & CEO, Handy), and more. Join us! REGISTER HERE.