On Digital Startup, Founders, Governance and Happy Dreams

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happyRemco kindly invited me to post, and here I am. The subjected he suggested was Startups Founders, Angel Investors & Dilution. Which is a mouthful to pronounce and even more complicated to elaborate in details, but maybe I’ll add a few items to the post.

To take a different angle on the same issues, I think most startups in Indonesia simply fails on Governance level. In fact, in the majority of ‘failures’ that I’ve witnessed, I would say that this is very often the case. Firstly tho, let’s be clear that I specifically refer to Startups as Digital/Tech/Media related Startup.

First, a Digital Startup differs by definition to traditional business in a sense that it relies on digital technology to deliver and produce the return. The underlying value will be with the people who create and make stuff happen and the Intellectual Property it produced. The Startup is a for profit business entity that will create value with Digital Technology. Not to buy a Coal Mine or Plantation Concession or a Chocolate Factory. A Digital Startup must have a clear grasp of this before they venture any further.

Next, the Startup must realize that since they are digital – and not an asset based business like a coal mine – then they also face different sorts of challenges to ‘brick and mortar’ (or coal companies). Most pronouncedly will be what sort of funding options/capital raising opportunities are available for Digital Startup (since they would have no traditional collateral to apply for a loan).

This is important to remember since the capital availability is critical to the future of your company: If your Startup is as ambitious and positive as Remco described it, then in all likelihood, the company will require an agressive capital raising plan. Raising capital and managing investors is probably the single most critical element of any Digital Startup phase, unless of course, you’re loaded (and or have a coal mine, or two).

Naturally, since most digital startups are bootstrapping among friends and started from a very small sized capitalization (in Jakarta, 100-200m IDR in paid up capital seems to be the norm for for seed round size), often with the Founders chipping to meet cash flow responsibilities. This was not a big deal for a Seed company, but Governance soon become an issue once the company requires more capital and invites new investors.

To this effect, I would take Remco’s advice one step further and suggest that the Founders do away with the individual holdings. Corporate Governance is a serious issue and more often than not, a Digital Startup needs to be nimble and be quick in making decisions. Almost always, the Founders are more interested and better versed in making their vision reality and running the business than calculating returns on shares and valuations while managing pesky investors.

If you have more than 3 founders, then the logical solution will be to keep your present setup and PT, and create a new company from scratch, specifically setup and designed to accept the investment.

In doing this, the Digital Startup accomplishes several important things at once:

- Shareholding and ownership among the first Six original Founders became a separate issue to the Digital Startup. Very often, as companies grow and the original founders reconsider their positions over the years, the ownership will consolidate to 2-3 people. The Founders will always be represented in the Digital Startup and  controlling a majority vote as a group.

- It creates a structure that is safer and better protect the investors – and ensure the success of the Digital Startup. In the event that you’re dealing with a foreign investor, the conversion to PMA will make this almost a necessity anyway and even local investors, the structure have its own advantages.

Now, as Remco pointed out, Shares are valuable resource – if not the most valuable asset – to the Digital Startup. Use it wisely. Plan on it carefully and execute on it smartly. Corporate Governance is a full time job in a Digital Startup and the CEO/Founder is ultimately responsible for it.

I met many Startups and Founders who approach Governance as a burden, trade secret and frequently, as bureaucratic headache. Well, guess, what, it’s not. If you plan to get big and deliver on the big internet dreams, Corp. Governance and Capital Structuring is a full time job.

Since the Digital Startup have no hard assets to speak of or inventory to value and minimum cashflow to speak of, any glossy dream about lofty valuation must come with reality checks. More often than not, the Founders will need to have some sort of Fund Raising Plan, eg. Are you gonna do 2 rounds or 3 rounds of investment over the next 3-5 years?

Dilution is math and to optimise for risk and returns, most digital startup will require multiple rounds. Detik.com more or less at least one capital related transaction every two years or so in all the years prior to acquisition. It’s a full time job and it requires good accounting and bookkeeping, tax oversights, audits, legal pondering and whatnot.

Granted, Detik had limited access to capital and was quite aggressive in this department, but it meets the need for the company in that it allowed Detik to fund its growth potentials and at the same time, keeping the investors happy by delivering returns on the investments – a number of very early VCs exited far before the Trans acquisition with different returns.

Unless your first Investor (or your father) is a Multinational Conglomerate, International Coal Mine, Global Hedge Fund or a Mega Bank, then the Founders need to plan and work on a fund raising plan towards an exit, 3-5 years down the road. Being acquired by a Fat Investor is an EXIT, not a growth phase scenario.

For most companies, it will take 5-6 years before the Digital Startup get to the Exit phase. Planning and managing the capital to meet the cashflow requirement is only one half of the equation as the Founders-executives of the company are also be responsible for running and managing the Digital Startup during these growing pains years. Human Resource planning and organisational structure is another practical challenge: a Digital Startup of ten friends works differently to a Digital Startup with 100 friends. Hiring senior managers and scaling up to business to deliver profitability to maximize the return on (the scarce) capital is another obvious challenge. In areas with foreign investment restriction in Indonesia, there is also a compliance requirement. On the investors side, well investing in tech startup is a risky business. Investing in tech startups in third bit country is that much riskier by nature (though investing in coal mines and partnering with generals and whatnot in coal mining ventures may not be necessarily less risky)

Your Digital Startup won’t make a magic leap from worth 100m IDR to 10m USD by clicking on a currency button. It takes hard work and important decisions. It’s mostly about governance. Any plans presented are only as good as the people aspiring for its execution, so a lot of it will be about trust and the clarity of vision from the leaders, executives and shared with all the founders, friends, employees, developers, investors, and ultimately customers – realize that the Digital Startup really is a company that is worth a lot of money and reputable to do business with.

Presumably, you could accomplish all that spectacularly by using the best know how and deploying technology. Making leaps and bounds, accomplishing better things, bigger things and doing it smarter and better every time. Occasionally, you fail, so you fix things. Down rounds are unfortunate events but it does occasionally happen. Products fail but a solid team will be able to come up with a better product. You make great, successful companies over the years, not by signing up some papers over breakfast and the happy launch parties.

Anyhow… yep… To keep my virgin ramble to the minimum, I think it’s probably a subject worth dwelling deeper – both from investors as well as startups. Indonesian bureaucracies and foreign investment restrictions are complicated enough as it is for seasoned investors and in many cases, seed stage companies simply failed to plan and structure their company to meet this future demand. If you want simple, I recommend you write a resume and apply for a job. Nobody said Digital Startup was easy.

Happy Saturday Night, all.