Jekyll2024-03-28T12:09:04+00:00https://kruzeconsulting.com/blog/recent_feed/index.xmlUnderstanding Major Investor Rights: A Guide for VC-Backed Startups2024-03-24T00:00:00+00:002024-03-24T00:00:00+00:00https://kruzeconsulting.com/blog/understanding-major-investor-rights-a-guide-for-vc-backed-startups<p><img src="/uploads/major-investor-rights.jpg" alt="" width="2200" height="1300" /></p>
<p>For venture capital-backed startups, navigating the complex landscape of investor rights is crucial, particularly when larger investors are demanding that they get special rights - called “major investor rights.” These rights not only protect the investors’ interests but also shape the relationship between startups and their financial backers.</p>
<p>We strongly recommend that founders work with experienced law firms when they are raising VC rounds. And as CPAs serving startups, we are often called on to produce reports that major investors ask for, and we can attest that the number of investors you give these privileges to matters, as it can become a lot of work for a founder if they aren’t careful! </p>
<h2 id="what-are-major-investor-rights">What Are Major Investor Rights?</h2>
<p>Major investor rights refer to the contractual privileges and protections granted to investors, particularly those who provide significant funding to a company by hitting ownership thresholds or taking over specific percentages of particular funding rounds. These rights are typically negotiated and outlined in the terms of investment agreements. Understanding these rights is essential for both protecting investors and ensuring a healthy partnership between startups and their backers.</p>
<h2 id="key-major-investor-rights">Key Major Investor Rights</h2>
<p>Information Rights: Investors often require regular updates on the company’s financial health, operations, and strategy. This transparency helps investors monitor their investment and provide valuable guidance to startups.</p>
<p>Pro-rata Rights: <a href="https://kruzeconsulting.com/blog/pro-rata-important-to-seed-investors/"><u>Pro-Rata Rights</u></a> allow investors to maintain their ownership percentage by buying additional shares in future funding rounds. This is crucial for investors looking to avoid dilution of their stake in the company. Learn more about pro-rata rights by watching our video:</p>
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<p>Information Rights: Information rights grant investors the right to receive regular updates about the company’s status, financial health, and operational progress. The premise is straightforward: investors are entitled to periodic insights into the company’s performance, which in turn, facilitates a transparent and trusting investment relationship. Check out our post on <a href="https://kruzeconsulting.com/blog/financial-information-vcs-want-after-investment/"><u>what information VCs want after an investment</u></a>.</p>
<p>Inspection Rights: Inspection rights, on the other hand, allow investors to examine a company’s books, facilities, and engage with personnel periodically. While information rights focus on data sharing and communication, inspection rights entail a more hands-on approach to understanding the company’s operations and governance.</p>
<p>Board Representation: Major investors may seek the right to appoint one or more directors to the company’s board, allowing them to influence key decisions and strategic direction.</p>
<h2 id="navigating-investor-rights-for-startups">Navigating Investor Rights for Startups</h2>
<p>Understanding and negotiating these rights is a balancing act for startups. Again, as we’ve already mentioned, make sure you are working with a lawyer who really knows startup corporate finance. Here are some actionable strategies:</p>
<p>Understand How Much Capital Matters: Not every check should deserve major investor rights. Make sure if you are granting these rights that they are for high dollar investors. </p>
<p>Prioritize and Negotiate: Recognize which investor rights are standard and which can be negotiated. Prioritize the rights that align with your startup’s long-term vision and operational flexibility.</p>
<p>Legal Expertise: Engage with legal advisors who specialize in venture capital and startup financing. They can help navigate the complex landscape of investor rights and ensure that your agreements protect your interests.</p>
<p>Transparency and Communication: Maintain open lines of communication with your investors. Regular updates and transparency can build trust and make negotiations around investor rights more straightforward.</p>
<p>Plan for the Future: Consider how the rights granted to early investors might affect future funding rounds or exits. Striking the right balance between attracting investment and retaining control and flexibility is key.</p>
<h2 id="conclusion">Conclusion</h2>
<p>Major investor rights are a critical aspect of the venture capital ecosystem. By understanding these rights and effectively managing their implications, startups can build strong, productive relationships with their investors. Remember, the goal is to ensure both the startup’s growth and the investors’ protection, fostering a mutually beneficial partnership for the long haul. Engaging with experienced advisors and legal experts can provide startups with the guidance needed to navigate this complex area successfully.</p>4d886ec3-5690-47fc-b77c-d1f3754b1a35For venture capital-backed startups, navigating the complex landscape of investor rights is crucial, particularly when larger investors are demanding that they get special rights - called “major investor rights.” These rights not only protect the investors’ interests but also shape the relationship between startups and their financial backers. We strongly recommend that founders work with experienced law firms when they are raising VC rounds. And as CPAs serving startups, we are often called on to produce reports that major investors ask for, and we can attest that the number of investors you give these privileges to matters, as it can become a lot of work for a founder if they aren’t careful! What Are Major Investor Rights? Major investor rights refer to the contractual privileges and protections granted to investors, particularly those who provide significant funding to a company by hitting ownership thresholds or taking over specific percentages of particular funding rounds. These rights are typically negotiated and outlined in the terms of investment agreements. Understanding these rights is essential for both protecting investors and ensuring a healthy partnership between startups and their backers. Key Major Investor Rights Information Rights: Investors often require regular updates on the company’s financial health, operations, and strategy. This transparency helps investors monitor their investment and provide valuable guidance to startups. Pro-rata Rights: Pro-Rata Rights allow investors to maintain their ownership percentage by buying additional shares in future funding rounds. This is crucial for investors looking to avoid dilution of their stake in the company. Learn more about pro-rata rights by watching our video: Information Rights: Information rights grant investors the right to receive regular updates about the company’s status, financial health, and operational progress. The premise is straightforward: investors are entitled to periodic insights into the company’s performance, which in turn, facilitates a transparent and trusting investment relationship. Check out our post on what information VCs want after an investment. Inspection Rights: Inspection rights, on the other hand, allow investors to examine a company’s books, facilities, and engage with personnel periodically. While information rights focus on data sharing and communication, inspection rights entail a more hands-on approach to understanding the company’s operations and governance. Board Representation: Major investors may seek the right to appoint one or more directors to the company’s board, allowing them to influence key decisions and strategic direction. Navigating Investor Rights for Startups Understanding and negotiating these rights is a balancing act for startups. Again, as we’ve already mentioned, make sure you are working with a lawyer who really knows startup corporate finance. Here are some actionable strategies: Understand How Much Capital Matters: Not every check should deserve major investor rights. Make sure if you are granting these rights that they are for high dollar investors. Prioritize and Negotiate: Recognize which investor rights are standard and which can be negotiated. Prioritize the rights that align with your startup’s long-term vision and operational flexibility. Legal Expertise: Engage with legal advisors who specialize in venture capital and startup financing. They can help navigate the complex landscape of investor rights and ensure that your agreements protect your interests. Transparency and Communication: Maintain open lines of communication with your investors. Regular updates and transparency can build trust and make negotiations around investor rights more straightforward. Plan for the Future: Consider how the rights granted to early investors might affect future funding rounds or exits. Striking the right balance between attracting investment and retaining control and flexibility is key. Conclusion Major investor rights are a critical aspect of the venture capital ecosystem. By understanding these rights and effectively managing their implications, startups can build strong, productive relationships with their investors. Remember, the goal is to ensure both the startup’s growth and the investors’ protection, fostering a mutually beneficial partnership for the long haul. Engaging with experienced advisors and legal experts can provide startups with the guidance needed to navigate this complex area successfully.What is a Secondary Stock Transaction?2024-03-20T00:00:00+00:002024-03-20T00:00:00+00:00https://kruzeconsulting.com/blog/what-is-a-secondary-stock-transaction<p><img src="/uploads/what-is-a-secondary-stock-transaction.jpg" alt="What is a Secondary Stock Transaction?" width="1024" height="502" /></p>
<p>Today, we’re exploring the concept of secondary stock transactions. Despite a general slowdown in VC activity, we are still seeing some founders successfully sell shares in secondary transactions - particularly among AI companies experiencing rapid sequential funding rounds. Secondary transactions involve the sale of shares from existing shareholders, such as founders or early investors, to new or existing investors, without injecting new capital into the company itself.</p>
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<h2 id="definition-secondary-stock-transactions-or-secondaries">Definition: Secondary Stock Transactions (or Secondaries)</h2>
<p>A secondary stock transaction occurs when an investor buys shares directly from an existing shareholder rather than the company, contrasting with primary transactions where new shares are issued to raise capital for the company’s growth. This setup provides liquidity for shareholders while not diluting the ownership through the issuance of new shares. This contrasts with a primary transaction, where the company sells shares to the investor and the cash goes onto the company’s balance sheet for the company to use for business purposes.</p>
<p>Secondary: no money onto the company’s balance sheet, cash goes to an existing shareholder who sells their shares to an investor in exchange for the cash.</p>
<p>Primary: money goes onto the company’s balance sheet to fund operations etc., and additional shares are created and given to the investor.</p>
<h2 id="motivations-behind-secondary-transactions">Motivations behind secondary transactions</h2>
<p>Secondary transactions offer several advantages, including providing early liquidity for founders or employees and allowing VCs access to invest in companies when new share issuance isn’t possible. These sales can also rebalance the risk and reward for founders, enabling them to secure financial stability and pursue ambitious growth strategies.</p>
<h3 id="why-founders-may-want-to-do-a-secondary-transaction">Why founders may want to do a secondary transaction</h3>
<p>First, for founders or employees, it can be a nice source of liquidity. Maybe if you have a super successful company you can buy a house, put a down payment on something. Many founders don’t draw that much salary (see our <a href="https://kruzeconsulting.com/do-founders-of-startups-that-have-raised-millions-give-themselves-paychecks-if-so-how-much-money-do-they-pay-themselves/">founder salary report</a> and our <a href="https://kruzeconsulting.com/blog/startup-ceo-salary-report/">startup ceo salary report</a>). So selling secondary shares can help a founder manage their costs and lifestyle, which is a totally normal thing to want to do in a high cost area like San Francisco or NYC.</p>
<p>Second, VCs will sometimes do a small secondary of the founder shares to give the founder some money and so they are more risk-seeking. It’s not uncommon for a founder to get a startup to a certain size, and then for them to realize that 100% of their net worth is tied up in the stock of that company, which can sometimes lead to risk aversion. The founder becomes afraid of messing it up, so stops taking as much risk. And since VCs love risk since it (hopefully) drives growth, letting a founder sell some secondary stock can put that founder back into a risk taking move.</p>
<p>Third, and this is not a great thing to have to talk about, but when a founder gets divorced this can cause issues where there is a strong desire to change up the <a href="https://kruzeconsulting.com/what-is-the-best-free-cap-table-management-software-for-startups/">capitalization table</a> by letting the divorced spouse sell out of the business.</p>
<p>Fourth, a co-founder may depart a startup and the investors want to remove them from the cap table. Note that this really only comes together when a company is doing really well. If a company is doing poorly, then the business may get recapped in a <a href="https://kruzeconsulting.com/blog/downround/">downround</a>, which effectively crams down the departed founder’s shares.</p>
<p>You also see some very late stage companies (Stripe being the most famous) who allow employees to do secondaries at the point where the employees’ stock options are going to expire.</p>
<h3 id="why-vc-may-want-to-buy-stock-in-a-secondary-purchase">Why VC may want to buy stock in a secondary purchase</h3>
<p>Again, we mentioned the VCs may want to give a founder some liquidity in the hopes that it makes them more open to high risk, high reward strategies.</p>
<p>Secondly, a venture round may be over subscribed. In this case, a VC may be willing to purchase shares directly from an existing shareholder to get more ownership in the company - or even as a way to sneak into a round.</p>
<p>And, finally, there are some moments when a VC may want to sell some shares in a round - so the VC sells secondary shares to another VC! There are a few reasons for this. One is to drive DPI, which means the VC can return cash to their investors. Additionally, there are a lot of secondary sales of funds, especially for very old funds, where the fund life is winding down. There is an entire market for fund sales called secondaries where a fund just sells all their ownership positions, all their stock, and then cashes out.</p>
<h3 id="understanding-rights-of-first-refusal-rofr"><strong>Understanding rights of first refusal (ROFR)</strong></h3>
<p>It turns out there is something called a ROFR, or right of first refusal. Most VC firms get this in their stock purchase agreements and the articles of incorporation with the company; this means, the internal venture capitalists get the first bite of the apple. They have to waive their right to buy those secondary shares before an outside VC firm or individual can come in.</p>
<p>Now that’s not always the case. I believe back in the day Twitter and Facebook didn’t have that right. Or maybe, their VCs just always waived the right of first refusal; but, there were really big secondary markets in those stocks.</p>
<p>So remember, you typically have to get the internal VC’s permission to do a secondary sale.</p>
<p>This right ensures that existing investors have the chance to maintain or increase their stake in the company under the same conditions offered to outside investors.</p>
<h3 id="qsbs-and-redemptions"><strong>QSBS and redemptions</strong></h3>
<p>Transactions where companies buy back shares from founders, followed by VCs purchasing new preferred stock, need careful handling to maintain QSBS status, affecting the tax treatment of the shares. This can happen more often that you’d think in a secondary - the VC may ask the company to purchase common from the seller, then the VC buys shares from the company. Again, talk to your tax team, as redemptions can cause <a href="https://kruzeconsulting.com/qsbs/">QSBS</a> issues.</p>
<h3 id="selling-founder-shares-in-funding-rounds"><strong>Selling founder shares in funding rounds</strong></h3>
<p>While direct sales of founder shares to VCs during funding rounds are less frequent today, they provide an essential liquidity option. This process allows founders to realize some financial gains without waiting for a company exit or public offering.</p>
<h3 id="how-to-approach-your-vc-about-selling-shares"><strong>How to approach your vc about selling shares</strong></h3>
<p>Engaging in a conversation with your VC about selling shares requires tact, transparency, and timing. Here’s a guide to navigating this discussion:</p>
<ul>
<li>Preparation: Understand the terms of your existing agreements, particularly any clauses related to share sales or ROFR.</li>
<li>Reasoning: Clearly articulate your reasons for wanting to sell shares, whether it’s for personal financial security etc..</li>
<li>Timing: Choose an opportune moment, usually best when you are pulling together a hot funding round or after a significant company milestone, to show continued commitment to the company’s success.</li>
<li>Proposal: Present a structured plan on how many shares you wish to sell, ensuring it doesn’t signal a lack of confidence in the company’s future.</li>
<li>Negotiation: Be open to feedback and ready to negotiate terms that align with both your interests and those of the VC and the company. Remember that common stock is usually worth less than preferred shares!</li>
</ul>
<p>In the current venture capital climate, understanding and leveraging secondary stock transactions is more crucial than ever for startups looking to navigate financial complexities. For personalized assistance and to ensure your startup is well-prepared for venture capital engagement, consider leveraging our <a href="https://kruzeconsulting.com/venture-capital-finance-tax-hr-due-diligence-checklist/">VC due diligence checklist</a>, crafted from extensive experience in aiding clients through their funding processes.</p>3c9a7185-6493-4274-94b4-bfd36ff4820dToday, we’re exploring the concept of secondary stock transactions. Despite a general slowdown in VC activity, we are still seeing some founders successfully sell shares in secondary transactions - particularly among AI companies experiencing rapid sequential funding rounds. Secondary transactions involve the sale of shares from existing shareholders, such as founders or early investors, to new or existing investors, without injecting new capital into the company itself. Definition: Secondary Stock Transactions (or Secondaries) A secondary stock transaction occurs when an investor buys shares directly from an existing shareholder rather than the company, contrasting with primary transactions where new shares are issued to raise capital for the company’s growth. This setup provides liquidity for shareholders while not diluting the ownership through the issuance of new shares. This contrasts with a primary transaction, where the company sells shares to the investor and the cash goes onto the company’s balance sheet for the company to use for business purposes. Secondary: no money onto the company’s balance sheet, cash goes to an existing shareholder who sells their shares to an investor in exchange for the cash. Primary: money goes onto the company’s balance sheet to fund operations etc., and additional shares are created and given to the investor. Motivations behind secondary transactions Secondary transactions offer several advantages, including providing early liquidity for founders or employees and allowing VCs access to invest in companies when new share issuance isn’t possible. These sales can also rebalance the risk and reward for founders, enabling them to secure financial stability and pursue ambitious growth strategies. Why founders may want to do a secondary transaction First, for founders or employees, it can be a nice source of liquidity. Maybe if you have a super successful company you can buy a house, put a down payment on something. Many founders don’t draw that much salary (see our founder salary report and our startup ceo salary report). So selling secondary shares can help a founder manage their costs and lifestyle, which is a totally normal thing to want to do in a high cost area like San Francisco or NYC. Second, VCs will sometimes do a small secondary of the founder shares to give the founder some money and so they are more risk-seeking. It’s not uncommon for a founder to get a startup to a certain size, and then for them to realize that 100% of their net worth is tied up in the stock of that company, which can sometimes lead to risk aversion. The founder becomes afraid of messing it up, so stops taking as much risk. And since VCs love risk since it (hopefully) drives growth, letting a founder sell some secondary stock can put that founder back into a risk taking move. Third, and this is not a great thing to have to talk about, but when a founder gets divorced this can cause issues where there is a strong desire to change up the capitalization table by letting the divorced spouse sell out of the business. Fourth, a co-founder may depart a startup and the investors want to remove them from the cap table. Note that this really only comes together when a company is doing really well. If a company is doing poorly, then the business may get recapped in a downround, which effectively crams down the departed founder’s shares. You also see some very late stage companies (Stripe being the most famous) who allow employees to do secondaries at the point where the employees’ stock options are going to expire. Why VC may want to buy stock in a secondary purchase Again, we mentioned the VCs may want to give a founder some liquidity in the hopes that it makes them more open to high risk, high reward strategies. Secondly, a venture round may be over subscribed. In this case, a VC may be willing to purchase shares directly from an existing shareholder to get more ownership in the company - or even as a way to sneak into a round. And, finally, there are some moments when a VC may want to sell some shares in a round - so the VC sells secondary shares to another VC! There are a few reasons for this. One is to drive DPI, which means the VC can return cash to their investors. Additionally, there are a lot of secondary sales of funds, especially for very old funds, where the fund life is winding down. There is an entire market for fund sales called secondaries where a fund just sells all their ownership positions, all their stock, and then cashes out. Understanding rights of first refusal (ROFR) It turns out there is something called a ROFR, or right of first refusal. Most VC firms get this in their stock purchase agreements and the articles of incorporation with the company; this means, the internal venture capitalists get the first bite of the apple. They have to waive their right to buy those secondary shares before an outside VC firm or individual can come in. Now that’s not always the case. I believe back in the day Twitter and Facebook didn’t have that right. Or maybe, their VCs just always waived the right of first refusal; but, there were really big secondary markets in those stocks. So remember, you typically have to get the internal VC’s permission to do a secondary sale. This right ensures that existing investors have the chance to maintain or increase their stake in the company under the same conditions offered to outside investors. QSBS and redemptions Transactions where companies buy back shares from founders, followed by VCs purchasing new preferred stock, need careful handling to maintain QSBS status, affecting the tax treatment of the shares. This can happen more often that you’d think in a secondary - the VC may ask the company to purchase common from the seller, then the VC buys shares from the company. Again, talk to your tax team, as redemptions can cause QSBS issues. Selling founder shares in funding rounds While direct sales of founder shares to VCs during funding rounds are less frequent today, they provide an essential liquidity option. This process allows founders to realize some financial gains without waiting for a company exit or public offering. How to approach your vc about selling shares Engaging in a conversation with your VC about selling shares requires tact, transparency, and timing. Here’s a guide to navigating this discussion: Preparation: Understand the terms of your existing agreements, particularly any clauses related to share sales or ROFR. Reasoning: Clearly articulate your reasons for wanting to sell shares, whether it’s for personal financial security etc.. Timing: Choose an opportune moment, usually best when you are pulling together a hot funding round or after a significant company milestone, to show continued commitment to the company’s success. Proposal: Present a structured plan on how many shares you wish to sell, ensuring it doesn’t signal a lack of confidence in the company’s future. Negotiation: Be open to feedback and ready to negotiate terms that align with both your interests and those of the VC and the company. Remember that common stock is usually worth less than preferred shares! In the current venture capital climate, understanding and leveraging secondary stock transactions is more crucial than ever for startups looking to navigate financial complexities. For personalized assistance and to ensure your startup is well-prepared for venture capital engagement, consider leveraging our VC due diligence checklist, crafted from extensive experience in aiding clients through their funding processes.Should you cap commissions?2024-03-17T00:00:00+00:002024-03-17T00:00:00+00:00https://kruzeconsulting.com/blog/should-you-cap-commissions<p><img src="/uploads/should-i-cap-commissions-1.jpg" alt="" width="1920" height="1080" /><!--Post Content--></p>
<p>A question we get frequently from startup founders is should they cap commissions for their sales team? The reason they ask this question is because they get the <a href="https://kruzeconsulting.com/3-financial-statements/"><u>financials</u></a> we prepare at Kruze, and they are startled that the VP of Sales or a top salesperson is <a href="https://kruzeconsulting.com/blog/highest-paid-person-startup/"><u>making more money</u></a> than anyone else in the company. And that can be a shock when the <a href="https://kruzeconsulting.com/blog/startup-ceo-salary-report/"><u>CEO</u></a> or COO finds out that another employee is making more than they are. However, capping sales commissions can seriously impact your company’s growth.</p>
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<h2 id="commission-caps-can-backfire">Commission caps can backfire</h2>
<p>While capping commissions may seem cost-effective at first glance, it could actually be less profitable in the long run. Some reasons why include:</p>
<ul>
<li><strong>Caps de-motivate your sales force.</strong> Salespeople tend to be very financially focused. Think about it – if you’re not allowing your sales team to reach their full potential, they don’t have any incentive to keep performing. Once a salesperson reaches the cap, he or she might as well stop there. You want your salespeople to have big commission checks if they’re signing deals. Compensation and sales performance are two sides of the same coin.</li>
<li><strong>Capped commissions let lower-performing salespeople “catch up” to the top performers.</strong> Professional salespeople are very competitive, and that’s exactly what you want. You don’t want someone who’s okay with losing sales to be a salesperson for your startup. Good salespeople aren’t just about the money – closing deals are a way to keep score. And you want to encourage that competitive attitude.</li>
<li><strong>Caps can cause your startup to earn less revenue.</strong> This is related to the first point, but it’s important from a business standpoint. A commission cap will lower your compensation expenses, but it means you’re probably going to earn less <a href="https://kruzeconsulting.com/blog/revenue-visibility/"><u>revenue</u></a> because you’re putting a limit on performance.</li>
<li><strong>Caps encourage salesperson turnover.</strong> For any business, competitive pay is essential for success. Commission caps simply encourage sales staff to explore other opportunities to make more money. There’s a strong relationship between performance and tenure. You risk losing experienced sales reps to competitors that pay more.</li>
</ul>
<p>You want your salespeople to make a lot of money. In fact, it’s a sign of a thriving company if the sales team is very well compensated.</p>
<h2 id="flip-the-script">Flip the script</h2>
<p>An effective alternative to commission caps is the concept of accelerators. So rather than capping, you’re doing the exact opposite. With accelerators, the more a salesperson closes, or a sales team closes in a quarter or a year, they can pick up accelerators, and actually get higher commission levels as they surpass their quotas.</p>
<p>As an example, maybe the sales team gets a 5% commission on all sales they do up to their quotas, but then after they exceed their quotas, they get 8%. That’s a 60% increase on every sale, which will be highly motivating for people on the sales team, so they hit their quotas and then keep going.</p>
<p>So we definitely don’t recommend capping sales commissions. Instead, you should probably look at <a href="https://kruzeconsulting.com/blog/highest-paid-person-startup/"><u>accelerators</u></a>. You’re building a startup. You want to be successful. Paying your salespeople well is going to help you accomplish that.</p>
<p>If you have any other questions on startup accounting or taxes, please <a href="https://kruzeconsulting.com/#contact"><u>contact us</u></a>. You can also follow our <a href="https://youtube.com/c/KruzeConsulting"><u>YouTube channel</u></a> and our <a href="https://kruzeconsulting.com/blog/"><u>blog</u></a> for information about accounting, finance, HR, and taxes for startups!</p>3c9a7185-6493-4274-94b4-bfd36ff4820dA question we get frequently from startup founders is should they cap commissions for their sales team? The reason they ask this question is because they get the financials we prepare at Kruze, and they are startled that the VP of Sales or a top salesperson is making more money than anyone else in the company. And that can be a shock when the CEO or COO finds out that another employee is making more than they are. However, capping sales commissions can seriously impact your company’s growth. Commission caps can backfire While capping commissions may seem cost-effective at first glance, it could actually be less profitable in the long run. Some reasons why include: Caps de-motivate your sales force. Salespeople tend to be very financially focused. Think about it – if you’re not allowing your sales team to reach their full potential, they don’t have any incentive to keep performing. Once a salesperson reaches the cap, he or she might as well stop there. You want your salespeople to have big commission checks if they’re signing deals. Compensation and sales performance are two sides of the same coin. Capped commissions let lower-performing salespeople “catch up” to the top performers. Professional salespeople are very competitive, and that’s exactly what you want. You don’t want someone who’s okay with losing sales to be a salesperson for your startup. Good salespeople aren’t just about the money – closing deals are a way to keep score. And you want to encourage that competitive attitude. Caps can cause your startup to earn less revenue. This is related to the first point, but it’s important from a business standpoint. A commission cap will lower your compensation expenses, but it means you’re probably going to earn less revenue because you’re putting a limit on performance. Caps encourage salesperson turnover. For any business, competitive pay is essential for success. Commission caps simply encourage sales staff to explore other opportunities to make more money. There’s a strong relationship between performance and tenure. You risk losing experienced sales reps to competitors that pay more. You want your salespeople to make a lot of money. In fact, it’s a sign of a thriving company if the sales team is very well compensated. Flip the script An effective alternative to commission caps is the concept of accelerators. So rather than capping, you’re doing the exact opposite. With accelerators, the more a salesperson closes, or a sales team closes in a quarter or a year, they can pick up accelerators, and actually get higher commission levels as they surpass their quotas. As an example, maybe the sales team gets a 5% commission on all sales they do up to their quotas, but then after they exceed their quotas, they get 8%. That’s a 60% increase on every sale, which will be highly motivating for people on the sales team, so they hit their quotas and then keep going. So we definitely don’t recommend capping sales commissions. Instead, you should probably look at accelerators. You’re building a startup. You want to be successful. Paying your salespeople well is going to help you accomplish that. If you have any other questions on startup accounting or taxes, please contact us. You can also follow our YouTube channel and our blog for information about accounting, finance, HR, and taxes for startups!Should founders accrue payroll before VC funding?2024-03-10T00:00:00+00:002024-03-10T00:00:00+00:00https://kruzeconsulting.com/blog/should-founders-accrue-payroll-before-vc-funding<p><img src="/uploads/should-founders-accrue-payroll-1.jpg" alt="" width="2200" height="1300" /><!--Post Content--></p>
<p>This particular scenario has happened in startups. You’ve started a company. You were used to getting a regular paycheck at your previous job, but right now there’s no money to pay yourself, but hopefully there will when you get funded. And at that point, you feel that you could “reimburse” yourself for all the paychecks you missed.</p>
<p>So you decide to start accruing your hypothetical salary. You basically say, “Hey, I would normally get $10,000 a month, so I’m gonna put $10,000 in the books as a payroll expense. However, that accrual just means you’re creating a liability, and there will be a liability on the balance sheet that says $10,000 per month. That will add up over time.</p>
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<h2 id="accruing-payroll-can-cause-problems">Accruing payroll can cause problems</h2>
<p>There are some problems with this plan. One problem is the amount. While you may think your salary should be $10,000 a month, you haven’t gotten that approved by a VC board <a href="https://kruzeconsulting.com/do-founders-of-startups-that-have-raised-millions-give-themselves-paychecks-if-so-how-much-money-do-they-pay-themselves/"><u>compensation committee</u></a>. It’s a number you picked, not something that was authorized. But there are also other issues.</p>
<h3 id="the-liability-can-discourage-investors">The liability can discourage investors</h3>
<p>A bigger problem is the <a href="https://kruzeconsulting.com/balance-sheet/"><u>liability</u></a> this creates. If you’ve done this, and you’re talking to investors, you have to disclose this payroll liability. If you don’t disclose it, and try to spring on them right before the funding, that’s will be a huge red flag. And your funding could very easily fall apart.</p>
<p>The size of the liability is important here – if you’ve only been doing it for a couple of months, and it’s $10,000 or $20,000, that isn’t as big an issue. But if you’ve accrued $300,000 or $500,000 of payroll, and you’re raising a $2 million <a href="https://kruzeconsulting.com/blog/tip-close-seed-round/"><u>seed round</u></a>, that’s a very big problem for an investor. They aren’t going to want to invest that much money just to see a big chunk of it go out the door right away for work that’s already done. The investors want you to build value and make progress from where you are when they invest in your startup. Essentially, they’re not paying for past performance.</p>
<p>If you disclose this payroll liability after you’ve raised the money, they will probably say no and not let you pay yourself that money. Or maybe they’ll negotiate a much smaller amount, but that will also hurt your <a href="https://kruzeconsulting.com/blog/communicate-with-vcs/"><u>credibility with the investors</u></a>. And credibility is the ultimate currency. You need these people to help you, you need them to introduce you to other investors, or do a bridge round, things like that. So don’t destroy your credibility on this.</p>
<h3 id="the-accrual-can-cause-tax-problems">The accrual can cause tax problems</h3>
<p>Another problem is that it’s “funny money.” You’re making an accounting entry, but you’re not actually paying yourself. Doing this could potentially create <a href="https://kruzeconsulting.com/blog/do-bootstrapped-startups-actually-pay-taxes/"><u>payroll tax</u></a> problems with the IRS and any state agencies. Technically you’re saying this was payroll. Particularly if you run it through your payroll system, which isn’t a good idea either. Identifying this accrual as payroll will trigger payroll taxes, which you should be paying to the IRS and any state agencies where you have <a href="https://kruzeconsulting.com/startup-state-local-taxes/"><u>tax nexus</u></a>. But since you’re not actually taking a salary, you don’t have the cash to pay these taxes. However, the taxing authorities don’t know that. They just know you’re accruing payroll.</p>
<p>So these agencies could come after you for unpaid taxes. And one of the worst things to have as you’re trying to build a startup is have the IRS or a state agency sending you <a href="https://kruzeconsulting.com/blog/payroll-tax-notice/"><u>notices that you owe them payroll taxes</u></a>. The government takes payroll taxes very seriously, because it’s one of their primary sources of revenue. So you could be subject to penalties. You will certainly end up paying your accountant a lot to fix this payroll problem.</p>
<p>It’s possible the IRS or state agencies might never know about this or may not care because actual cash didn’t change hands. But that outcome relies on their interpretation, and it’s a risk you just don’t want to take.</p>
<h2 id="what-can-founders-do-instead">What can founders do instead?</h2>
<p>One option is to request a bonus during your <a href="https://kruzeconsulting.com/blog/what-is-the-right-amount-of-venture-capital-to-raise/"><u>funding round</u></a>. When you’re talking to the investors and the rounds coming together, explain to them, “I haven’t been taking a paycheck and I’m going through my savings. Would you be open to paying me some sort of bonus or let me pay myself a bonus after I close the round? Here’s the dollar amount I’m thinking.” And make sure it’s reasonable so you don’t alienate them.</p>
<p>A lot of investors are okay with that. They know you’ve been scraping by and you built something that they’re investing in. They want you to make good decisions. They don’t want you to be so broke that you’re making poor decisions. Calling it a bonus and asking their permission is very different from accruing a large amount and presenting it as a liability. That liability will have to be paid, and your investors probably won’t want to do that.</p>
<h2 id="carefully-track-any-expenses-you-paid-personally">Carefully track any expenses you paid personally</h2>
<p>Another important thing to do is make sure you track any company expenses that you’re putting on your personal credit card during that time, and get reimbursed for your expenses. And again, you need to make sure these are reasonable. These do have to be disclosed when you’re raising money as well. But often, founders have hosting services and Google apps and other business expenses on their person credit card. As long as those expenses aren’t crazy, it’s a good thing to create an expense report. Make sure it’s documented, make sure you have all your receipts, and make sure you’re audit-ready in case you do get audited someday about these expenses.</p>
<p>Then present that to the investors in the same way you would a bonus. “Hey, here’s what happened. Would you be okay if I reimbursed myself this amount of money?” And most investors will say yes, as long as it’s not too big. And really when you’re raising money, it’s all about having a very honest relationship with your investors.</p>
<h2 id="we-dont-recommend-founders-accruing-payroll">We don’t recommend founders accruing payroll</h2>
<p>The bottom line is that you don’t want to surprise your investors, and you definitely don’t want to alienate them. You don’t want the IRS or state taxing agencies to think you may not be submitting payroll taxes. So accruing payroll isn’t a good idea.</p>
<p>If you have any other questions on startup payroll, startup fundraising, startup accounting, or taxes, please <a href="https://kruzeconsulting.com/#contact"><u>contact us</u></a>. You can also follow our <a href="https://youtube.com/c/KruzeConsulting"><u>YouTube channel</u></a> and our <a href="https://kruzeconsulting.com/blog/"><u>blog</u></a> for information about accounting, finance, HR, and taxes for startups!</p>3c9a7185-6493-4274-94b4-bfd36ff4820dThis particular scenario has happened in startups. You’ve started a company. You were used to getting a regular paycheck at your previous job, but right now there’s no money to pay yourself, but hopefully there will when you get funded. And at that point, you feel that you could “reimburse” yourself for all the paychecks you missed. So you decide to start accruing your hypothetical salary. You basically say, “Hey, I would normally get $10,000 a month, so I’m gonna put $10,000 in the books as a payroll expense. However, that accrual just means you’re creating a liability, and there will be a liability on the balance sheet that says $10,000 per month. That will add up over time. Accruing payroll can cause problems There are some problems with this plan. One problem is the amount. While you may think your salary should be $10,000 a month, you haven’t gotten that approved by a VC board compensation committee. It’s a number you picked, not something that was authorized. But there are also other issues. The liability can discourage investors A bigger problem is the liability this creates. If you’ve done this, and you’re talking to investors, you have to disclose this payroll liability. If you don’t disclose it, and try to spring on them right before the funding, that’s will be a huge red flag. And your funding could very easily fall apart. The size of the liability is important here – if you’ve only been doing it for a couple of months, and it’s $10,000 or $20,000, that isn’t as big an issue. But if you’ve accrued $300,000 or $500,000 of payroll, and you’re raising a $2 million seed round, that’s a very big problem for an investor. They aren’t going to want to invest that much money just to see a big chunk of it go out the door right away for work that’s already done. The investors want you to build value and make progress from where you are when they invest in your startup. Essentially, they’re not paying for past performance. If you disclose this payroll liability after you’ve raised the money, they will probably say no and not let you pay yourself that money. Or maybe they’ll negotiate a much smaller amount, but that will also hurt your credibility with the investors. And credibility is the ultimate currency. You need these people to help you, you need them to introduce you to other investors, or do a bridge round, things like that. So don’t destroy your credibility on this. The accrual can cause tax problems Another problem is that it’s “funny money.” You’re making an accounting entry, but you’re not actually paying yourself. Doing this could potentially create payroll tax problems with the IRS and any state agencies. Technically you’re saying this was payroll. Particularly if you run it through your payroll system, which isn’t a good idea either. Identifying this accrual as payroll will trigger payroll taxes, which you should be paying to the IRS and any state agencies where you have tax nexus. But since you’re not actually taking a salary, you don’t have the cash to pay these taxes. However, the taxing authorities don’t know that. They just know you’re accruing payroll. So these agencies could come after you for unpaid taxes. And one of the worst things to have as you’re trying to build a startup is have the IRS or a state agency sending you notices that you owe them payroll taxes. The government takes payroll taxes very seriously, because it’s one of their primary sources of revenue. So you could be subject to penalties. You will certainly end up paying your accountant a lot to fix this payroll problem. It’s possible the IRS or state agencies might never know about this or may not care because actual cash didn’t change hands. But that outcome relies on their interpretation, and it’s a risk you just don’t want to take. What can founders do instead? One option is to request a bonus during your funding round. When you’re talking to the investors and the rounds coming together, explain to them, “I haven’t been taking a paycheck and I’m going through my savings. Would you be open to paying me some sort of bonus or let me pay myself a bonus after I close the round? Here’s the dollar amount I’m thinking.” And make sure it’s reasonable so you don’t alienate them. A lot of investors are okay with that. They know you’ve been scraping by and you built something that they’re investing in. They want you to make good decisions. They don’t want you to be so broke that you’re making poor decisions. Calling it a bonus and asking their permission is very different from accruing a large amount and presenting it as a liability. That liability will have to be paid, and your investors probably won’t want to do that. Carefully track any expenses you paid personally Another important thing to do is make sure you track any company expenses that you’re putting on your personal credit card during that time, and get reimbursed for your expenses. And again, you need to make sure these are reasonable. These do have to be disclosed when you’re raising money as well. But often, founders have hosting services and Google apps and other business expenses on their person credit card. As long as those expenses aren’t crazy, it’s a good thing to create an expense report. Make sure it’s documented, make sure you have all your receipts, and make sure you’re audit-ready in case you do get audited someday about these expenses. Then present that to the investors in the same way you would a bonus. “Hey, here’s what happened. Would you be okay if I reimbursed myself this amount of money?” And most investors will say yes, as long as it’s not too big. And really when you’re raising money, it’s all about having a very honest relationship with your investors. We don’t recommend founders accruing payroll The bottom line is that you don’t want to surprise your investors, and you definitely don’t want to alienate them. You don’t want the IRS or state taxing agencies to think you may not be submitting payroll taxes. So accruing payroll isn’t a good idea. If you have any other questions on startup payroll, startup fundraising, startup accounting, or taxes, please contact us. You can also follow our YouTube channel and our blog for information about accounting, finance, HR, and taxes for startups!What are SG&A expenses?2024-03-03T00:00:00+00:002024-03-03T00:00:00+00:00https://kruzeconsulting.com/blog/what-are-sg-a-expenses<p><img src="/uploads/what-are-sga-expenses-1.jpg" alt="" width="1920" height="1080" /><!--Post Content--></p>
<p>Founders will hear the term “SG&A expenses” thrown around in board meetings a lot. SG&A stands for <a href="https://kruzeconsulting.com/income-statement/"><u>selling, general, and administrative expenses</u></a>. One way to think of SG&A expenses is that it’s the cost of running your company.</p>
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<p>Some people refer to this as “overhead,” but that term has become somewhat synonymous with “unnecessary.” Sometimes CEOs and founders will be told they need to cut “overhead” but that phrase makes it seem like overhead expenses are unimportant. And that’s not necessarily true – one example is <a href="https://kruzeconsulting.com/startup-accounting/"><u>accounting</u></a>. That gets captured in SG&A expenses, but accounting is a crucial business function. You need to understand your finances and you want to remain <a href="https://kruzeconsulting.com/do-vcs-and-angels-really-care-about-gaap-compliant-financials/"><u>compliant</u></a> with taxes and regulations. We work with companies every day who need help fixing their accounting.</p>
<h2 id="whats-included-in-sga-expenses">What’s included in SG&A expenses?</h2>
<p>Selling, general, and administrative expenses essentially refer to the non-production costs of a startup. These expenses are not directly attributable to the production of your product. The direct costs associated with producing your product are called the cost of goods sold (COGS), and don’t fall into SG&A expenses. Let’s look at each part of SG&A.</p>
<h3 id="selling-expenses">Selling expenses</h3>
<p>Your sales expenses include a lot of different elements, such as:</p>
<ul>
<li>Sales wages, salaries, and commissions along with payroll taxes and benefits</li>
<li>Packing and shipping product</li>
<li>Marketing, advertising, and promotion</li>
<li>Travel, meals, and lodging for staff to sales calls, events like trade shows, and client meetings</li>
</ul>
<h3 id="general-expenses">General expenses</h3>
<p>General expenses are incurred by your startup regardless of the industry or the products/services you produce. General expenses can include:</p>
<ul>
<li>Rent for office space that can’t be attributed to your production process</li>
<li>Utilities, including electricity, water, or sewer expenses, which aren’t part of your manufacturing process</li>
<li>Office equipment like computers, servers, printers, or telephones that aren’t part of production</li>
<li>Office supplies that are used for administrative functions</li>
<li>Insurance</li>
</ul>
<h3 id="administrative-expenses">Administrative expenses</h3>
<p>These expenses are the costs involved in having administrative personnel, both internal or external if the company outsources any functions. These costs can include:</p>
<ul>
<li>Accounting payroll or fees for outsourcing</li>
<li>Information technology payroll or fees for outsourcing</li>
<li>Human resources personnel</li>
<li>Legal counsel</li>
<li>Any consulting fees</li>
</ul>
<h2 id="sga-costs-cover-a-lot-of-essential-functions">SG&A costs cover a lot of essential functions</h2>
<p>Managing your SG&A expenses is critical for your startup’s profitability, but you need to be careful. Cutting SG&A costs can give your profits a quick boost, but that could be at the expenses of your long-term profitability. So cutting marketing and advertising costs could improve your bottom line in the short term, but you could be losing sales further down the road. Not hiring a professional accountant could cost you later if you don’t get the right tax credits, like the <a href="https://kruzeconsulting.com/research-and-development-tax-credit-us/"><u>R&D tax credit</u></a>, or if you end up paying fines and penalties because you’re not paying the right <a href="https://kruzeconsulting.com/startup-state-local-taxes/"><u>taxes in states where you do business</u></a>. Not hiring an attorney to review legal contracts could mean you’re not getting the best deal.</p>
<p>If you’re struggling with profitability, there may be something structurally wrong with your business model. You should look at all the elements of your company, and not focus on a narrow area. It’s easy to slip into a mindset of emphasizing sales, or research and development, or product manufacturing, and short-change SG&A expenses.</p>
<p>That doesn’t mean overspend on SG&A. You should approach SG&A expenses as an investment, because it can be a competitive advantage. Without these functions, your company may never take off. So invest wisely, and get the right bang for your buck so you can actually run your business.</p>
<p>As an aside, if you’re trying to get a quick read on your startup’s profitability, you can take your sales revenue, subtract the cost of goods sold, and you’ll get gross profit. Subtract SG&A expenses from gross profit, and you’ll get your operating income. That’s a good process to know, and investors look closely at operating income.</p>
<p>If you have any other questions on SG&A expenses, startup investing, startup accounting, or taxes, please <a href="https://kruzeconsulting.com/#contact"><u>contact us</u></a>. You can also follow our <a href="https://youtube.com/c/KruzeConsulting"><u>YouTube channel</u></a> and our <a href="https://kruzeconsulting.com/blog/"><u>blog</u></a> for information about accounting, finance, HR, and taxes for startups!</p>3c9a7185-6493-4274-94b4-bfd36ff4820dFounders will hear the term “SG&A expenses” thrown around in board meetings a lot. SG&A stands for selling, general, and administrative expenses. One way to think of SG&A expenses is that it’s the cost of running your company. Some people refer to this as “overhead,” but that term has become somewhat synonymous with “unnecessary.” Sometimes CEOs and founders will be told they need to cut “overhead” but that phrase makes it seem like overhead expenses are unimportant. And that’s not necessarily true – one example is accounting. That gets captured in SG&A expenses, but accounting is a crucial business function. You need to understand your finances and you want to remain compliant with taxes and regulations. We work with companies every day who need help fixing their accounting. What’s included in SG&A expenses? Selling, general, and administrative expenses essentially refer to the non-production costs of a startup. These expenses are not directly attributable to the production of your product. The direct costs associated with producing your product are called the cost of goods sold (COGS), and don’t fall into SG&A expenses. Let’s look at each part of SG&A. Selling expenses Your sales expenses include a lot of different elements, such as: Sales wages, salaries, and commissions along with payroll taxes and benefits Packing and shipping product Marketing, advertising, and promotion Travel, meals, and lodging for staff to sales calls, events like trade shows, and client meetings General expenses General expenses are incurred by your startup regardless of the industry or the products/services you produce. General expenses can include: Rent for office space that can’t be attributed to your production process Utilities, including electricity, water, or sewer expenses, which aren’t part of your manufacturing process Office equipment like computers, servers, printers, or telephones that aren’t part of production Office supplies that are used for administrative functions Insurance Administrative expenses These expenses are the costs involved in having administrative personnel, both internal or external if the company outsources any functions. These costs can include: Accounting payroll or fees for outsourcing Information technology payroll or fees for outsourcing Human resources personnel Legal counsel Any consulting fees SG&A costs cover a lot of essential functions Managing your SG&A expenses is critical for your startup’s profitability, but you need to be careful. Cutting SG&A costs can give your profits a quick boost, but that could be at the expenses of your long-term profitability. So cutting marketing and advertising costs could improve your bottom line in the short term, but you could be losing sales further down the road. Not hiring a professional accountant could cost you later if you don’t get the right tax credits, like the R&D tax credit, or if you end up paying fines and penalties because you’re not paying the right taxes in states where you do business. Not hiring an attorney to review legal contracts could mean you’re not getting the best deal. If you’re struggling with profitability, there may be something structurally wrong with your business model. You should look at all the elements of your company, and not focus on a narrow area. It’s easy to slip into a mindset of emphasizing sales, or research and development, or product manufacturing, and short-change SG&A expenses. That doesn’t mean overspend on SG&A. You should approach SG&A expenses as an investment, because it can be a competitive advantage. Without these functions, your company may never take off. So invest wisely, and get the right bang for your buck so you can actually run your business. As an aside, if you’re trying to get a quick read on your startup’s profitability, you can take your sales revenue, subtract the cost of goods sold, and you’ll get gross profit. Subtract SG&A expenses from gross profit, and you’ll get your operating income. That’s a good process to know, and investors look closely at operating income. If you have any other questions on SG&A expenses, startup investing, startup accounting, or taxes, please contact us. You can also follow our YouTube channel and our blog for information about accounting, finance, HR, and taxes for startups!What is Founder Preferred Stock?2024-02-25T00:00:00+00:002024-02-25T00:00:00+00:00https://kruzeconsulting.com/blog/what-is-founder-preferred-stock<p><img src="/uploads/founder-preferred-stock-2.jpg" alt="" width="2200" height="1300" /><br /><!--Post Content--></p>
<p>Founder preferred stock is a pretty new thing in the startup game. Historically, founders would always get <a href="https://kruzeconsulting.com/startup-finance/"><u>common stock</u></a>, usually in the form of founder shares that they received early on. By getting their common stock so early, founders could lock in capital gains and all of the increases in value. However, a new phenomenon has developed in the form of founder preferred stock.</p>
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<p>Some founders are now getting roughly 10%, 15%, or 20% of their normal common allocation in founder preferred stock. This is a special class of stock that converts to <a href="https://kruzeconsulting.com/preferred-stock/"><u>preferred stock</u></a> when the founders sell it to investors during a future round of financing. Founder preferred stock must be fully vested when granted, and it’s not subject to repurchase or forfeiture if the founder leaves the company. </p>
<h2 id="lowering-a-founders-tax-bill">Lowering a Founder’s Tax Bill</h2>
<p>Founder preferred stock can also provide a lower tax bill in some instances. When a founder sells common stock for a price that’s higher than its fair market value, the difference between the two could be deemed compensation to the founder (who was granted the shares by the company), and therefore be taxed at ordinary income rates. Founder preferred stock automatically converts into shares of preferred stock when it’s sold to an investor in connection with a new financing round without involving the company at all. In theory,* this avoids the “compensation” argument, and may allow any profits the founder makes on the sale to be considered capital gains, which are taxed at lower rates than income.</p>
<p>Founder preferred stock was developed by the law firms who structure this kind of thing. The idea is, if you give founders, say, 20% preferred stock, when they sell some of those shares to venture capitalists down the line, both the founders and the venture capitalists are happy because the founders can sell those preferred shares at the higher preferred price, and the VCs can acquire preferred stock rather than common.</p>
<p><strong>*NOTE:</strong> We would like to make clear that this is by no means official tax advice! We are only discussing a current trend in the startup world. You need to work with your legal counsel regarding founder preferred stock.</p>
<h2 id="preferred-stock-is-more-valuable">Preferred Stock Is More Valuable</h2>
<p>Preferred stock is always more valuable than common stock. For example, common stock might be 30 cents a share and preferred stock would be $1. This is because preferred stock includes liquidation preferences and other rights. Therefore, founders are able to sell their portion of preferred stock in a <a href="https://kruzeconsulting.com/blog/what-is-a-secondary-stock-transaction/"><u>secondary sale</u></a> at a higher price. </p>
<p>It’s consistent with the rest of the preferred share class, meaning there’s less risk. As always, there’s still some risk, but there’s less of a risk that ordinary income tax rates would be applied. It’s more likely that <a href="https://www.irs.gov/taxtopics/tc409#:~:text=Capital%20Gain%20Tax%20Rates,than%2015%25%20for%20most%20individuals."><u>capital gains tax</u></a> rates will be applied instead.</p>
<h2 id="the-downsides-of-founder-preferred-stock">The Downsides of Founder Preferred Stock</h2>
<p>There are a couple of downsides to founder preferred stock:</p>
<ul>
<li><strong>Unbalances liquidation preferences.</strong> Founder preferred stock can affect the<a href="https://kruzeconsulting.com/liquidation-preference/"><u>liquidation preferences</u></a> for the company. Liquidation preferences are supposed to mirror however much the investors put in. If they put in five or ten million dollars, they get the first five or ten million dollars out. When founders are gifted or receive preferred shares, they are not really putting money in there, so it throws the liquidation preferences off balance.</li>
<li><strong>Affects board voting.</strong> Founder preferred stock could also potentially change a vote on the basis of a share class or something like that. Investors often negotiate certain voting rights or protective provisions for specific company actions or transactions. For example, there are some governance situations where VCs will say, “Hey, you can’t sell the company unless all of the <a href="https://kruzeconsulting.com/what-kind-of-financial-data-should-a-company-prepare-when-seeking-series-a-venture-capital-funding/"><u>series A</u></a> or all of the series B approve it. We as a share class want to be able to vote on this.” Founder preferred stock can affect these voting rights.</li>
</ul>
<p>So there’s a lot of mechanisms at work here, but the basic logic is that preferred stock is there to protect the founder from paying ordinary income tax rates. Instead, they pay capital gains tax rates and it’s a benefit for them. Naturally, the VCs get preferred stock.</p>
<h2 id="talk-to-your-law-firm-about-founder-preferred-stock">Talk To Your Law Firm About Founder Preferred Stock</h2>
<p>If you want to know more abouts the ins and outs of founder preferred stock, you should talk to your law firm. Your law firm will need to structure founder preferred shares, and you need to do it early when you form a company.</p>
<p>You also have to remember that founder preferred stock is not a guarantee. The <a href="https://www.irs.gov/"><u>IRS</u></a> is very much capable of looking at this kind of stuff, seeing what’s happening, and potentially questioning it when you have most of your shares in common stock. They are within their bounds to say it is “against the spirit of the deal” or the spirit of founder stock. If they do, they could make you pay ordinary income taxes.</p>
<p>We’d like to reiterate Kruze is not making any recommendations or vouching for founder preferred stock. If you’re interested in this mechanism, you need research it thoroughly and talk to your legal counsel.</p>
<p>If you have any other questions on other startup related trends, valuations, startup investing, startup accounting, or taxes, please <a href="https://kruzeconsulting.com/#contact"><u>contact us</u></a>.</p>
<p>You can also follow our <a href="https://youtube.com/c/KruzeConsulting"><u>YouTube channel</u></a> and our <a href="https://kruzeconsulting.com/blog/"><u>blog</u></a> for information about accounting, finance, HR, and taxes for startups!</p>3c9a7185-6493-4274-94b4-bfd36ff4820dFounder preferred stock is a pretty new thing in the startup game. Historically, founders would always get common stock, usually in the form of founder shares that they received early on. By getting their common stock so early, founders could lock in capital gains and all of the increases in value. However, a new phenomenon has developed in the form of founder preferred stock. Some founders are now getting roughly 10%, 15%, or 20% of their normal common allocation in founder preferred stock. This is a special class of stock that converts to preferred stock when the founders sell it to investors during a future round of financing. Founder preferred stock must be fully vested when granted, and it’s not subject to repurchase or forfeiture if the founder leaves the company. Lowering a Founder’s Tax Bill Founder preferred stock can also provide a lower tax bill in some instances. When a founder sells common stock for a price that’s higher than its fair market value, the difference between the two could be deemed compensation to the founder (who was granted the shares by the company), and therefore be taxed at ordinary income rates. Founder preferred stock automatically converts into shares of preferred stock when it’s sold to an investor in connection with a new financing round without involving the company at all. In theory,* this avoids the “compensation” argument, and may allow any profits the founder makes on the sale to be considered capital gains, which are taxed at lower rates than income. Founder preferred stock was developed by the law firms who structure this kind of thing. The idea is, if you give founders, say, 20% preferred stock, when they sell some of those shares to venture capitalists down the line, both the founders and the venture capitalists are happy because the founders can sell those preferred shares at the higher preferred price, and the VCs can acquire preferred stock rather than common. *NOTE: We would like to make clear that this is by no means official tax advice! We are only discussing a current trend in the startup world. You need to work with your legal counsel regarding founder preferred stock. Preferred Stock Is More Valuable Preferred stock is always more valuable than common stock. For example, common stock might be 30 cents a share and preferred stock would be $1. This is because preferred stock includes liquidation preferences and other rights. Therefore, founders are able to sell their portion of preferred stock in a secondary sale at a higher price. It’s consistent with the rest of the preferred share class, meaning there’s less risk. As always, there’s still some risk, but there’s less of a risk that ordinary income tax rates would be applied. It’s more likely that capital gains tax rates will be applied instead. The Downsides of Founder Preferred Stock There are a couple of downsides to founder preferred stock: Unbalances liquidation preferences. Founder preferred stock can affect theliquidation preferences for the company. Liquidation preferences are supposed to mirror however much the investors put in. If they put in five or ten million dollars, they get the first five or ten million dollars out. When founders are gifted or receive preferred shares, they are not really putting money in there, so it throws the liquidation preferences off balance. Affects board voting. Founder preferred stock could also potentially change a vote on the basis of a share class or something like that. Investors often negotiate certain voting rights or protective provisions for specific company actions or transactions. For example, there are some governance situations where VCs will say, “Hey, you can’t sell the company unless all of the series A or all of the series B approve it. We as a share class want to be able to vote on this.” Founder preferred stock can affect these voting rights. So there’s a lot of mechanisms at work here, but the basic logic is that preferred stock is there to protect the founder from paying ordinary income tax rates. Instead, they pay capital gains tax rates and it’s a benefit for them. Naturally, the VCs get preferred stock. Talk To Your Law Firm About Founder Preferred Stock If you want to know more abouts the ins and outs of founder preferred stock, you should talk to your law firm. Your law firm will need to structure founder preferred shares, and you need to do it early when you form a company. You also have to remember that founder preferred stock is not a guarantee. The IRS is very much capable of looking at this kind of stuff, seeing what’s happening, and potentially questioning it when you have most of your shares in common stock. They are within their bounds to say it is “against the spirit of the deal” or the spirit of founder stock. If they do, they could make you pay ordinary income taxes. We’d like to reiterate Kruze is not making any recommendations or vouching for founder preferred stock. If you’re interested in this mechanism, you need research it thoroughly and talk to your legal counsel. If you have any other questions on other startup related trends, valuations, startup investing, startup accounting, or taxes, please contact us. You can also follow our YouTube channel and our blog for information about accounting, finance, HR, and taxes for startups!What Are Capital Expenditures for Startups?2024-02-18T00:00:00+00:002024-02-18T00:00:00+00:00https://kruzeconsulting.com/blog/what-are-capital-expenditures-for-startups<p><img src="/uploads/what-are-capital-expenditures-capex-1.jpg" alt="" width="1920" height="1080" /><!--Post Content--></p>
<p>Capital expenditures, otherwise known as CAPEX, are mentioned in startup board meetings all the time. It’s definitely a fundamental term to understand when dealing with startup accounting.</p>
<h2 id="capital-expenditures-depend-on-your-startup-industry">Capital Expenditures Depend On Your Startup Industry</h2>
<p>The importance of your capital expenditures depends a little bit on the type of startup you are running. For example, if you’re a manufacturing or cleantech company, which involves heavy, physical equipment, CAPEX is your number one ingredient in the business. </p>
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<h2 id="capex-are-investments">CAPEX are Investments</h2>
<p>At a high level, capital expenditures are investments that a startup makes in things like:</p>
<ul>
<li>Fixed assets</li>
<li>Property</li>
<li>Equipment</li>
<li>Computers/Physical Technology</li>
<li>Furniture</li>
<li>And, often, software can be CAPEX too</li>
</ul>
<p>These are big investments. Whether your startup is building robots, or working in cleantech that’s capturing CO2 from the environment, you’re going have to have a building in which to house your machines and, obviously, you’re going to have the machines and all of the parts that go into them. These are all capital expenditures.</p>
<h2 id="capital-expenditures-on-the-balance-sheet">Capital Expenditures on the Balance Sheet</h2>
<p>Now, capital expenditures are interesting in the <a href="https://kruzeconsulting.com/startup-accounting/"><u>accounting</u></a> world because they get treated slightly differently from regular operating expenses. Operating expenses are things such as:</p>
<ul>
<li>Employee salaries</li>
<li>Food/Catering</li>
<li>Hotels</li>
<li>Travel</li>
</ul>
<p>If capital expenditures are over $2500, they are actually “capitalized” on the balance sheet. This means they are put in an asset count on your <a href="https://kruzeconsulting.com/balance-sheet/"><u>balance sheet</u></a> and you recognize the expense. You <a href="https://kruzeconsulting.com/ebitda/"><u>amortize or depreciate</u></a> those fixed assets over time. The length of time you depreciate those fixed assets depends on what they are and what the <a href="https://www.irs.gov/"><u>IRS</u></a>’s guidance is.</p>
<p>Usually that’s about two to five years. It’s the kind of thing that gets washed out on your tax return and, often, there’s some adjusted journal entries at the end of the year to make sure that the amortization/depreciation schedules match your <a href="https://kruzeconsulting.com/how-much-does-a-startup-tax-return-cost/"><u>tax returns</u></a>.</p>
<p>So when you make capital expenditures they will be reflected on your balance sheet as an asset, and that asset’s going to be reduced every year by the annual depreciation and amortization that’s applicable to that asset.</p>
<h2 id="capex-on-the-cash-flow-statement">CAPEX on the Cash Flow Statement</h2>
<p>As well as being on the balance sheet, CAPEX is also reflected on your <a href="https://kruzeconsulting.com/cash-flow-statement/"><u>cash flow statement</u></a> as it falls under investing activities. The structure of the cash flow statement will generally go as follows:</p>
<ol>
<li>The first group to appear on a cash flow statement will be operating activities. These are usually things like your net income.</li>
<li>Then there will be some add-backs, like working capital.</li>
<li>Next will be other kinds of balance sheet accounts that may fluctuate to get to your cash flow provided from operating activities.</li>
<li>Finally you’ll have investing activities, which is what capital expenditures fall under. Again, you’ll see those big cash outflows being reflected there, along with depreciation offsetting it.</li>
</ol>
<p>Your cash flow statement is a very easy way for investors to see what’s actually happening in your startup’s finances. They look at the cash flow statement quite a bit when they’re looking at capital expenditures.</p>
<h2 id="debt-financing-for-capex-heavy-companies">Debt Financing for CAPEX Heavy Companies</h2>
<p>If you are a heavy machinery/heavy asset kind of business, you have to be able to talk to your VCs accordingly. You need them to understand that these are large investments and that companies of this kind are typically going to need a lot more <a href="https://kruzeconsulting.com/blog/what-is-the-right-amount-of-venture-capital-to-raise/"><u>venture capital</u></a> than, say, a software company or a consumer packaged goods (CPG) company, for example. If your startup requires large machinery and other assets, you will most likely use <a href="https://kruzeconsulting.com/venture-debt/"><u>debt</u></a> financing to augment your venture capital equity.</p>
<p>VCs who invest in CAPEX-heavy companies are typically very close with a lot of lending firms. They know them and they can make referrals. They have them on their speed dial as it were, and that debt is actually a very important ingredient if you’re running a capital-intensive startup. You will have to finance a lot of that stuff. Debt has a lower cost of capital than equity, and if you use too much equity to finance capital purchases, you’re probably experiencing a little bit more dilution than you need to. Debt helps mitigate some of the dilution.</p>
<p>So when you’re in a board meeting, or you’re pitching your capital intensive business, please remember that you may have to finance yourself in a slightly different way. The financial combination for your startup will be different. You should also know that the accounting treatment is going to be different. A lot of those <a href="https://kruzeconsulting.com/blog/matching-assets-to-debt/"><u>assets</u></a> will be capitalized on the balance sheet and they will be reflected on the investing activities portion of the cash flow statement.</p>
<p>Finally, only annual depreciation and amortization will be shown on your <a href="https://kruzeconsulting.com/income-statement/"><u>income statement</u></a> as an expense.</p>
<h2 id="capital-expenditures-and-cash-runway">Capital Expenditures and Cash Runway</h2>
<p>With CAPEX and the cash runway of a company, we tend to look at them in two ways. We look at it on an accrual accounting basis, in which depreciation/amortization is included and the big capital expenditure is not. Then we also look at it as the pure cash flow burn rate, in which the big capital expenditure is included. When the cash leaves the bank account, the cash flow statement is going to be your friend. It adds those investing activities back into the burn rate and shows you what your true <a href="https://kruzeconsulting.com/cash-burn-rate/"><u>burn rate</u></a> is. </p>
<h2 id="vcs-for-capital-intensive-startups">VCs for Capital-Intensive Startups</h2>
<p>If you’re running a capital-intensive startup, it’s usually harder to raise money but you will often have less competition. There is a subset of VCs that focus solely on those kinds of companies. So go find them! They will speak your language and they’ll be excited about what you’re doing!</p>
<p>If you have any other questions on capital expenditures, valuations, startup investing, startup accounting, or taxes, please <a href="https://kruzeconsulting.com/#contact"><u>contact us</u></a>.</p>
<p>You can also follow our <a href="https://youtube.com/c/KruzeConsulting"><u>YouTube channel</u></a> and our <a href="https://kruzeconsulting.com/blog/"><u>blog</u></a> for information about accounting, finance, HR, and taxes for startups!</p>3c9a7185-6493-4274-94b4-bfd36ff4820dCapital expenditures, otherwise known as CAPEX, are mentioned in startup board meetings all the time. It’s definitely a fundamental term to understand when dealing with startup accounting. Capital Expenditures Depend On Your Startup Industry The importance of your capital expenditures depends a little bit on the type of startup you are running. For example, if you’re a manufacturing or cleantech company, which involves heavy, physical equipment, CAPEX is your number one ingredient in the business. CAPEX are Investments At a high level, capital expenditures are investments that a startup makes in things like: Fixed assets Property Equipment Computers/Physical Technology Furniture And, often, software can be CAPEX too These are big investments. Whether your startup is building robots, or working in cleantech that’s capturing CO2 from the environment, you’re going have to have a building in which to house your machines and, obviously, you’re going to have the machines and all of the parts that go into them. These are all capital expenditures. Capital Expenditures on the Balance Sheet Now, capital expenditures are interesting in the accounting world because they get treated slightly differently from regular operating expenses. Operating expenses are things such as: Employee salaries Food/Catering Hotels Travel If capital expenditures are over $2500, they are actually “capitalized” on the balance sheet. This means they are put in an asset count on your balance sheet and you recognize the expense. You amortize or depreciate those fixed assets over time. The length of time you depreciate those fixed assets depends on what they are and what the IRS’s guidance is. Usually that’s about two to five years. It’s the kind of thing that gets washed out on your tax return and, often, there’s some adjusted journal entries at the end of the year to make sure that the amortization/depreciation schedules match your tax returns. So when you make capital expenditures they will be reflected on your balance sheet as an asset, and that asset’s going to be reduced every year by the annual depreciation and amortization that’s applicable to that asset. CAPEX on the Cash Flow Statement As well as being on the balance sheet, CAPEX is also reflected on your cash flow statement as it falls under investing activities. The structure of the cash flow statement will generally go as follows: The first group to appear on a cash flow statement will be operating activities. These are usually things like your net income. Then there will be some add-backs, like working capital. Next will be other kinds of balance sheet accounts that may fluctuate to get to your cash flow provided from operating activities. Finally you’ll have investing activities, which is what capital expenditures fall under. Again, you’ll see those big cash outflows being reflected there, along with depreciation offsetting it. Your cash flow statement is a very easy way for investors to see what’s actually happening in your startup’s finances. They look at the cash flow statement quite a bit when they’re looking at capital expenditures. Debt Financing for CAPEX Heavy Companies If you are a heavy machinery/heavy asset kind of business, you have to be able to talk to your VCs accordingly. You need them to understand that these are large investments and that companies of this kind are typically going to need a lot more venture capital than, say, a software company or a consumer packaged goods (CPG) company, for example. If your startup requires large machinery and other assets, you will most likely use debt financing to augment your venture capital equity. VCs who invest in CAPEX-heavy companies are typically very close with a lot of lending firms. They know them and they can make referrals. They have them on their speed dial as it were, and that debt is actually a very important ingredient if you’re running a capital-intensive startup. You will have to finance a lot of that stuff. Debt has a lower cost of capital than equity, and if you use too much equity to finance capital purchases, you’re probably experiencing a little bit more dilution than you need to. Debt helps mitigate some of the dilution. So when you’re in a board meeting, or you’re pitching your capital intensive business, please remember that you may have to finance yourself in a slightly different way. The financial combination for your startup will be different. You should also know that the accounting treatment is going to be different. A lot of those assets will be capitalized on the balance sheet and they will be reflected on the investing activities portion of the cash flow statement. Finally, only annual depreciation and amortization will be shown on your income statement as an expense. Capital Expenditures and Cash Runway With CAPEX and the cash runway of a company, we tend to look at them in two ways. We look at it on an accrual accounting basis, in which depreciation/amortization is included and the big capital expenditure is not. Then we also look at it as the pure cash flow burn rate, in which the big capital expenditure is included. When the cash leaves the bank account, the cash flow statement is going to be your friend. It adds those investing activities back into the burn rate and shows you what your true burn rate is. VCs for Capital-Intensive Startups If you’re running a capital-intensive startup, it’s usually harder to raise money but you will often have less competition. There is a subset of VCs that focus solely on those kinds of companies. So go find them! They will speak your language and they’ll be excited about what you’re doing! If you have any other questions on capital expenditures, valuations, startup investing, startup accounting, or taxes, please contact us. You can also follow our YouTube channel and our blog for information about accounting, finance, HR, and taxes for startups!Brex vs Ramp - Which card is best for startups?2024-02-14T18:21:00+00:002024-02-14T18:21:00+00:00https://kruzeconsulting.com/blog/brex-vs-ramp---which-card-is-best-for-startups<p><img src="/uploads/brex-vs-ramp.jpg" alt="Brex vs Ramp - Which card is best for startups?" width="1024" height="487" /></p>
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<ul><li><a href="#first-what-to-look-for-in-a-credit-card-for-your-startup">First, what to look for in a credit card for your startup</a><ul><li><a href="#what-is-a-brex-credit-card">What is a Brex credit card?</a></li><li><a href="#what-is-a-ramp-credit-card">What is a Ramp credit card?</a></li></ul></li><li><a href="#comparing-brex-and-ramps-cards">Comparing Brex and Ramp’s cards</a></li><li><a href="#a-quick-note-on-brex-leaving-the-smb-market">A Quick Note on Brex Leaving the SMB Market</a><ul><li><a href="#reviews-of-brex-and-ramps-cards">Reviews of Brex and Ramp’s cards</a></li></ul></li><li><a href="#brex-vs-ramp-vs-stripe">Brex vs Ramp vs Stripe</a></li><li><a href="#do-we-recommend-brex-or-ramp">Do we recommend Brex or Ramp?</a><ul><li><a href="#brex-vs-ramp-in-review">Brex vs Ramp in Review</a></li><li><a href="#biggest-perk-aws-credits-brex-vs-ramp">Biggest Perk - AWS CRedits - Brex vs Ramp</a></li><li><a href="#which-has-higher-credit-limits-brex-or-ramp">Which has higher credit limits - Brex or Ramp?</a></li><li><a href="#deep-dive-into-ramps-bill-pay-financing-interesting-for-smbs-not-so-much-startups">Deep dive into Ramp's bill pay financing - Interesting for SMBs, not so Much startups</a></li><li><a href="#a-side-note-on-travel">A side note on travel</a></li><li><a href="#does-brex-charge-a-fee">Does Brex charge a fee?</a></li><li><a href="#does-ramp-charge-a-fee">Does Ramp Charge a Fee?</a></li></ul></li></ul></div>
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<p>Our startup clients collectively spend over $60 million using these cards per quarter, and we have extensive experience training and advising our clients on how to get the most out of both Brex and Ramp. </p>
<h2 id="our-tldr-recommendation-for-brex-vs-ramp">Our tldr; recommendation for Brex vs Ramp</h2>
<p>Both <a href="https://www.brex.com/solutions/startups?partnerId=kruze">Brex</a> and <a href="https://ramp.com/partners/kruze">Ramp</a> are great card solutions for VC-backed startups. Brex is 100% focused on VC-backed startups, offers solid points for card spending, and - a key -differentiator vs Ramp - has a cash management tool that can function as a checking account. Ramp works for both startups and SMBs, offers a great 1.5% cash back and we love it’s expense management tools. </p>
<p>So, if you prefer points or are looking for an additional banking-type relationship, <a href="https://www.brex.com/solutions/startups?partnerId=kruze">Brex</a> is better. </p>
<p>If you prefer the simplicity of cash back, or are not VC-backed, choose <a href="https://ramp.com/partners/kruze">Ramp</a>.</p>
<p>*Note that we are members of both Ramp and Brex’s partner programs, which means if you sign up through our links you typically get higher sign up bonuses, and we receive modest commission. *</p>
<h3 id="a-little-bit-more-on-how-kruze-knows-so-much-about-brex-and-ramp">A little bit more on how Kruze knows so much about Brex and Ramp</h3>
<p>As a leading accounting and finance consulting firm that has worked with startups that have collectively raised over $15 billion in funding, we have some strong opinions on which card is right for you and why. Our team spends all day helping founders manage their books and finances - and we see which tools and cards they are using. Our opinions are based on the experiences of hundreds of companies that spend many millions per month.</p>
<p>We recommend pretty much every client choose one of these cards, although the biggest quality competitor we see these days is Mercury, who has a good option that is bundled with their banking-like products (not Mercury is technically not a bank, but many of our clients use it instead of a bank). </p>
<h2 id="first-what-to-look-for-in-a-credit-card-for-your-startup">First, what to look for in a credit card for your startup</h2>
<p>Traditional business owners are usually looking for a low-fee product that gives them travel points, and they expect their line of credit to be based on their personal credit score.</p>
<p>Funded startups need something different:</p>
<ul>
<li>Rewards that appeal to a tech, biotech and ecommerce companies</li>
<li>A credit or spending limit that is based on the company’s balance sheet</li>
<li>No personal guarantee on the Credit Card</li>
<li>Cheap and fast bookkeeping with accounting software integrations</li>
<li>Team spending management tools</li>
</ul>
<h3 id="what-is-a-brex-credit-card">What is a Brex credit card?</h3>
<p>Brex is a great card for a funded company - but is totally the wrong choice for a bootstrapped or traditional small business. They has an amazing points program for funded companies, with perks and rewards that a VC-backed corporation can actually use. Additionally, Brex offers a generous spending limit based on the company’s funding and performance. They also have increasingly good cash/bank-like features, including some level of FDIC insurance on cash deposits. Sign up <a href="https://www.brex.com/product/?partnerId=kruze" target="_blank" rel="noopener">here</a>.</p>
<p> </p>
<h3 id="what-is-a-ramp-credit-card">What is a Ramp credit card?</h3>
<p><a href="https://kruzeconsulting.com/ramp-card-review/">Ramp</a> combines a corporate card with expense management tools like expense report creation and analysis, personal reimbursement and expense policy creation. The company offers pretty high cash-back, at 1.5% of spend, which is a very easy way for a busy founder to get something back for the startup from the card use without having to deal with redeeming points. Ramp is strongest for Series A to Series C companies who are dealing with the rapid increase in the number of people paying for software, travel, etc.</p>
<p> </p>
<h2 id="comparing-brex-and-ramps-cards">Comparing Brex and Ramp’s cards</h2>
<p>This chart details the key differences between the Ramp card and the Brex card.</p>
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<thead>
<tr>
<th> </th>
<th><strong>Brex</strong></th>
<th><strong>Ramp</strong></th>
</tr>
</thead>
<tbody>
<tr>
<td>Built for Funded Startups</td>
<td>Yes</td>
<td>Yes</td>
</tr>
<tr>
<td>Good for SMBs</td>
<td>No</td>
<td>Yes</td>
</tr>
<tr>
<td>Spending Limit</td>
<td>Generous</td>
<td>Generous</td>
</tr>
<tr>
<td>Rewards</td>
<td>Points for spending, including higher points for key startup expense categories</td>
<td>1.5% cash back on all purchases. No exceptions or complicated “point” programs</td>
</tr>
<tr>
<td>Personal Guarantee</td>
<td>Not Required</td>
<td>Not Required</td>
</tr>
<tr>
<td>Checking Account</td>
<td>Yes</td>
<td>No</td>
</tr>
<tr>
<td>QuickBooks Online Sync</td>
<td>Yes</td>
<td>Yes</td>
</tr>
<tr>
<td>Expensify Sync</td>
<td>Yes, but Brex can replace Expensify</td>
<td>No, but Ramp replaces Expensify</td>
</tr>
<tr>
<td>ACH Payments</td>
<td>Free</td>
<td>Free</td>
</tr>
<tr>
<td>Netsuite Integration</td>
<td>Yes</td>
<td>Yes</td>
</tr>
<tr>
<td>Bill Pay Feature</td>
<td>Yes</td>
<td>Yes</td>
</tr>
<tr>
<td>Easy Bookkeeping</td>
<td>Yes</td>
<td>Yes</td>
</tr>
<tr>
<td>Instant Sign Up</td>
<td>Yes</td>
<td>Yes</td>
</tr>
<tr>
<td>Ability to Carry Balance</td>
<td>No</td>
<td>No</td>
</tr>
<tr>
<td>Robust Spending Controls</td>
<td>Yes</td>
<td>Yes</td>
</tr>
<tr>
<td>Website</td>
<td><a href="https://www.brex.com/solutions/startups?partnerId=kruze" target="_blank" rel="noopener"><strong>Visit Brex</strong></a></td>
<td><a href="https://ramp.com/partners/kruze" target="_blank" rel="noopener"><strong>Visit Ramp</strong></a></td>
</tr>
</tbody>
</table>
<p>One of the most important things for founders to realize is that both of these options, Ramp and Brex, give good spending limits based on your company’s bank account balance (among other factors). <strong>Neither requires a PERSONAL GUARANTEE</strong>, which VC-backed founders need to consider at the top of their list of requirements.</p>
<p> </p>
<h2 id="a-quick-note-on-brex-leaving-the-smb-market">A Quick Note on Brex Leaving the SMB Market</h2>
<p>In June of 2022, Brex rather awkwardly announced that they were exiting the small business market. This caused a lot of confusion, as they sent cancellation emails to a large number of their clients - even some Kruze clients got cancellation notices from Brex! However, Brex clarified that they were still servicing and adding startups <strong>that had raised professional funding</strong>. So that’s Kruze clients! We were able to get them to reinstate our clients. However, small business owners should probably not try to work with Brex, that’s not the client base they are trying to serve. Note that Ramp is still trying to service SMBs, and requires only $75k in the bank to apply for an account, so small businesses may want to consider them. Watch our video on their decision below:</p>
<div class="cms-embed"><iframe width="560" height="315" src="https://www.youtube.com/embed/bwyjSapG_I4" title="YouTube video player" frameborder="0" allow="accelerometer; autoplay; clipboard-write; encrypted-media; gyroscope; picture-in-picture" allowfullscreen=""></iframe></div>
<p> </p>
<h3 class="text-center" id="reviews-of-brex-and-ramps-cards">Reviews of Brex and Ramp’s cards</h3>
<p>Brex is a great option for early-stage companies because they are more established and have a more mature product on the market. Ramp, however, may be a better option for companies as they grow, have more employees and expenses as it offers great spend control and easy accounting. Ramp also offers a generous, no exception or complicated point 1.5% cashback and savings program.</p>
<p>We’ve collected reviews of Ramp and Brex from our team (that has run millions and millions in expenses through both systems). You can read these review on our <a href="https://kruzeconsulting.com/best-startup-credit-cards/" target="_blank" rel="noopener">best credit cards for startups</a> page - read <a href="https://kruzeconsulting.com/best-startup-credit-cards/#brex" target="_blank" rel="noopener">Brex reviews here</a> and <a href="https://kruzeconsulting.com/best-startup-credit-cards/#ramp" target="_blank" rel="noopener">Ramp reviews here</a>. Both are highly rated as of the time of us updating this review.</p>
<p> </p>
<h2 id="brex-vs-ramp-vs-stripe">Brex vs Ramp vs Stripe</h2>
<p>Another player that our startup founders occasionally ask about is Stripe’s card offering. We really haven’t seen as many companies use the Stripe offering vs Brex and Ramp. Overall, our team thinks that the Stripe card is fine for a company already using other Stripe products, but it doesn’t have the same level of integration with QuickBooks Online (so accounting is a bit harder) and Brex and Ramp are really, really pushing the expense management features in a way that Stripe just hasn’t kept up with.</p>
<h2 id="mercury-vs-ramp-and-brex">Mercury vs Ramp and Brex</h2>
<p>Mercury is taking dramatic market share in the <a href="https://kruzeconsulting.com/best-business-banks/">startup banking</a> market, including it’s corporate card tool. It’s got a lot of good features that compare favorably to Ramp and Brex, and we consider it a solid option when paired with the Mercury banking products. Of course, the folks at Mercury remind us that they aren’t technically a bank, lol.</p>
<p> </p>
<h2 id="do-we-recommend-brex-or-ramp">Do we recommend Brex or Ramp?</h2>
<p>Brex is better for early stage companies because they are more established and have a more mature product in the market. Early-stage companies (<15 people) typically don’t have the need or ability to use and/or manage many of the internal controls and process features that Ramp contains, until they have a finance-centric individual in-house. The full suite of benefits that Brex has means that it can more or less be a one-stop-shop for an early-stage company’s complete banking needs at no cost. That is a valuable for a small company early on. (Although we still recommend that a company consider a startup-focused bank like SVB or FRB).<br /><br />Ramp, on the other hand, is a better credit card option for larger, more-established companies that have greater streamlined approval, expense management, and control needs. Their bill pay is excellent, and doesn’t require you to open a ‘savings/cash’ account with them - you can just connect it to an existing bank account. This makes it even easier to switch to them, and is another reason that they are a great option to switch to as a later stage company.</p>
<p>There is another option for mid to later stage companies looking for tight expense management, accounting integrations and other finance controls/features - companies like <a href="https://www.airbase.com/" target="_blank" rel="noopener">Airbase</a> or <a href="https://www.procurify.com/" target="_blank" rel="noopener">Procurify</a>. These vendors combine cards with heavy-duty finance controls. They don’t make sense until you’ve got a full time VP of Finance or CFO in seat - provisioning and managing these tools takes time. But if you are looking for a heavy-duty, more “late-stage” (or dare I say enterprise) alternative to Ramp, they may be worth looking at.</p>
<p> </p>
<h3 id="brex-vs-ramp-in-review">Brex vs Ramp in Review</h3>
<p><strong>Brex Card</strong> - the better option for funded, early-stage companies. With a generous spending limit based on the company’s funding and performance, and no personal guarantee, it’s truly built for the Silicon Valley-style startup. Kruze Consulting clients can now get a 125,000 point sign-up bonus after depositing $500,000 into a Brex business account and an additional 25,000 point sign-up bonus after spending $10,000 on Brex card(s). <a href="https://www.brex.com/solutions/startups?partnerId=kruze" target="_blank" rel="noopener">Sign up now through Kruze</a>.</p>
<p><strong>Ramp Credit Card</strong> - likely a good option for established companies. Ramp is more focused on later-stage companies with features like expense approval, reimbursement control, and other process controls that are helpful for growth stage companies that have finance teams in place and more internal control. Also, unlike othercards that entice you to spend with complicated reward programs,Ramp is the onlycard built around keeping money in your bank. It is a corporate card that strengthens your finances. Ramp offers companies that sign up through Kruze’s links <em>**</em></p>
<p><strong>$500</strong> <strong>$750 cash back</strong> - a generous offer that you can’t get other places. <a href="https://ramp.com/partners/kruze" target="_blank" rel="noopener">Visit Ramp now to sign up</a>.</p>
<p> </p>
<p> </p>
<h3 id="biggest-perk---aws-credits---brex-vs-ramp">Biggest Perk - AWS CRedits - Brex vs Ramp</h3>
<p>A perk that our clients regularly ask about is Amazon Web Services credits. Which startup card company - Brex or Ramp - offeres the best AWS credits? Brex has a slight lead here; however, there are nuances in how Amazon runs their web services program, with our latest understanding after talking with them that there are two options to get credits, one of which is $100k - but it has to be used in 2 years. If your startup can’t use that much in AWS in 2 years, then sometimes smaller amounts that last indefinitely are better. But, getting down to brass-tacks, here are the AWS offers that the two card companies have (note that they may change these offers without telling us, so check their sites to make sure it’s the most current offer):</p>
<ul>
<li>Brex AWS Credit offer: $5k AWS Active offer + up to $100k in credits</li>
<li>Ramp AWS Credit offer: Up to $25k in AWS credits</li>
</ul>
<p> </p>
<h3 id="which-has-higher-credit-limits---brex-or-ramp">Which has higher credit limits - Brex or Ramp?</h3>
<p>In our experience, Brex offers a higher credit limit to many funded startups than Ramp. With Ramp, we have seen clients successfully (and easily) request a higher limit; the limit for both companies hasn’t really been an issue in our mind. And, more importantly, <strong>both</strong> vendors offer generally much, much higher spending limits than traditional card companies like Amex or Citi. Ramp recently launched a new form of credit to companies generating revenue, bill pay financing.</p>
<p> </p>
<h3 id="deep-dive-into-ramps-bill-pay-financing---interesting-for-smbs-not-so-much-startups">Deep dive into Ramp’s bill pay financing - Interesting for SMBs, not so Much startups</h3>
<p>Ramp’s bill pay now has a financing feature called “Ramp Flex.” This integrated into their normal bill pay workflow. With this “Flex” feature, you can have your vendors paid immediately, but actually get the money taken out of your bank account 30, 60 or 90 days later. </p>
<p>The reason this may not be great for VC-backed startups is that this will cost 1% a month, which will compound to a rather large interest rate vs. what a startup can get as yield in a money market account. And since startups often have a lot of cash (VC-backed startups that is!), why pay interest when you have the cash available? </p>
<p>However, for traditional, bootstrapped SMBs this could be an interesting option. This bill pay feature shows how Ramp is trying to continue to service the SMB market, where as Brex has chosen to only focus on VC-backed companies. </p>
<p> </p>
<h3 id="a-side-note-on-travel">A side note on travel</h3>
<p>One item that we’ve become increasingly pleased with from both Brex and Ramp are their development of travel features for startups with teams. Both providers are rapidly developing features to make it easier for companies at scale to manage their spend. For companies with teams who travel, Ramp in particular has excellent features that help keep travel spend in policy, visualize the company’s travel budget and more. Both have solid mobile apps. For example, the Brex mobile app is pretty amazing for travel. After you use it, say at a restaurant, you’ll get a notification on your phone. Simply click into the Brex app, take a snapshot, add some data like who you were with (depending on your startup’s expense policy) and viola, you are almost done with your reimbursements! It’s pretty great, and does push us slightly to preferring <a href="https://www.brex.com/solutions/startups?partnerId=kruze" target="_blank" rel="noopener">Brex</a> if you have a high-travel company.</p>
<p>Want a detailed review of the <a href="https://kruzeconsulting.com/best-startup-credit-cards/">best credit cards for startups</a>? Click here to read our breakdown of the top players we see our clients using. We list out the pros and cons of each of the cards we see with major market share.</p>
<p> </p>
<h3 id="does-brex-charge-a-fee">Does Brex charge a fee?</h3>
<p>No, Brex doesn’t charge fees to have the basic corporate card. They make their money from the interchange, and do not charge monthly fees, transaction fees, etc.</p>
<p> </p>
<h3 id="does-ramp-charge-a-fee">Does Ramp Charge a Fee?</h3>
<p>No, Ramp also doesn’t charge fees for the basic corporate card. That means there are no transaction fees, monthly fees, etc. It’s a low-cost option for startups.</p>
<p>In summary - <strong>don’t go with a standard card if you are a VC backed company</strong>! Get a solution like Brex or Ramp! They are built for you, especially because they don’t have a personal guarantee, have great tools for founders, good rewards, and more.</p>4d886ec3-5690-47fc-b77c-d1f3754b1a35Table of contents First, what to look for in a credit card for your startupWhat is a Brex credit card?What is a Ramp credit card?Comparing Brex and Ramp’s cardsA Quick Note on Brex Leaving the SMB MarketReviews of Brex and Ramp’s cardsBrex vs Ramp vs StripeDo we recommend Brex or Ramp?Brex vs Ramp in ReviewBiggest Perk - AWS CRedits - Brex vs RampWhich has higher credit limits - Brex or Ramp?Deep dive into Ramp's bill pay financing - Interesting for SMBs, not so Much startupsA side note on travelDoes Brex charge a fee?Does Ramp Charge a Fee? Our startup clients collectively spend over $60 million using these cards per quarter, and we have extensive experience training and advising our clients on how to get the most out of both Brex and Ramp. Our tldr; recommendation for Brex vs Ramp Both Brex and Ramp are great card solutions for VC-backed startups. Brex is 100% focused on VC-backed startups, offers solid points for card spending, and - a key -differentiator vs Ramp - has a cash management tool that can function as a checking account. Ramp works for both startups and SMBs, offers a great 1.5% cash back and we love it’s expense management tools. So, if you prefer points or are looking for an additional banking-type relationship, Brex is better. If you prefer the simplicity of cash back, or are not VC-backed, choose Ramp. *Note that we are members of both Ramp and Brex’s partner programs, which means if you sign up through our links you typically get higher sign up bonuses, and we receive modest commission. * A little bit more on how Kruze knows so much about Brex and Ramp As a leading accounting and finance consulting firm that has worked with startups that have collectively raised over $15 billion in funding, we have some strong opinions on which card is right for you and why. Our team spends all day helping founders manage their books and finances - and we see which tools and cards they are using. Our opinions are based on the experiences of hundreds of companies that spend many millions per month. We recommend pretty much every client choose one of these cards, although the biggest quality competitor we see these days is Mercury, who has a good option that is bundled with their banking-like products (not Mercury is technically not a bank, but many of our clients use it instead of a bank). First, what to look for in a credit card for your startup Traditional business owners are usually looking for a low-fee product that gives them travel points, and they expect their line of credit to be based on their personal credit score. Funded startups need something different: Rewards that appeal to a tech, biotech and ecommerce companies A credit or spending limit that is based on the company’s balance sheet No personal guarantee on the Credit Card Cheap and fast bookkeeping with accounting software integrations Team spending management tools What is a Brex credit card? Brex is a great card for a funded company - but is totally the wrong choice for a bootstrapped or traditional small business. They has an amazing points program for funded companies, with perks and rewards that a VC-backed corporation can actually use. Additionally, Brex offers a generous spending limit based on the company’s funding and performance. They also have increasingly good cash/bank-like features, including some level of FDIC insurance on cash deposits. Sign up here. What is a Ramp credit card? Ramp combines a corporate card with expense management tools like expense report creation and analysis, personal reimbursement and expense policy creation. The company offers pretty high cash-back, at 1.5% of spend, which is a very easy way for a busy founder to get something back for the startup from the card use without having to deal with redeeming points. Ramp is strongest for Series A to Series C companies who are dealing with the rapid increase in the number of people paying for software, travel, etc. Comparing Brex and Ramp’s cards This chart details the key differences between the Ramp card and the Brex card. Brex Ramp Built for Funded Startups Yes Yes Good for SMBs No Yes Spending Limit Generous Generous Rewards Points for spending, including higher points for key startup expense categories 1.5% cash back on all purchases. No exceptions or complicated “point” programs Personal Guarantee Not Required Not Required Checking Account Yes No QuickBooks Online Sync Yes Yes Expensify Sync Yes, but Brex can replace Expensify No, but Ramp replaces Expensify ACH Payments Free Free Netsuite Integration Yes Yes Bill Pay Feature Yes Yes Easy Bookkeeping Yes Yes Instant Sign Up Yes Yes Ability to Carry Balance No No Robust Spending Controls Yes Yes Website Visit Brex Visit Ramp One of the most important things for founders to realize is that both of these options, Ramp and Brex, give good spending limits based on your company’s bank account balance (among other factors). Neither requires a PERSONAL GUARANTEE, which VC-backed founders need to consider at the top of their list of requirements. A Quick Note on Brex Leaving the SMB Market In June of 2022, Brex rather awkwardly announced that they were exiting the small business market. This caused a lot of confusion, as they sent cancellation emails to a large number of their clients - even some Kruze clients got cancellation notices from Brex! However, Brex clarified that they were still servicing and adding startups that had raised professional funding. So that’s Kruze clients! We were able to get them to reinstate our clients. However, small business owners should probably not try to work with Brex, that’s not the client base they are trying to serve. Note that Ramp is still trying to service SMBs, and requires only $75k in the bank to apply for an account, so small businesses may want to consider them. Watch our video on their decision below: Reviews of Brex and Ramp’s cards Brex is a great option for early-stage companies because they are more established and have a more mature product on the market. Ramp, however, may be a better option for companies as they grow, have more employees and expenses as it offers great spend control and easy accounting. Ramp also offers a generous, no exception or complicated point 1.5% cashback and savings program. We’ve collected reviews of Ramp and Brex from our team (that has run millions and millions in expenses through both systems). You can read these review on our best credit cards for startups page - read Brex reviews here and Ramp reviews here. Both are highly rated as of the time of us updating this review. Brex vs Ramp vs Stripe Another player that our startup founders occasionally ask about is Stripe’s card offering. We really haven’t seen as many companies use the Stripe offering vs Brex and Ramp. Overall, our team thinks that the Stripe card is fine for a company already using other Stripe products, but it doesn’t have the same level of integration with QuickBooks Online (so accounting is a bit harder) and Brex and Ramp are really, really pushing the expense management features in a way that Stripe just hasn’t kept up with. Mercury vs Ramp and Brex Mercury is taking dramatic market share in the startup banking market, including it’s corporate card tool. It’s got a lot of good features that compare favorably to Ramp and Brex, and we consider it a solid option when paired with the Mercury banking products. Of course, the folks at Mercury remind us that they aren’t technically a bank, lol. Do we recommend Brex or Ramp? Brex is better for early stage companies because they are more established and have a more mature product in the market. Early-stage companies (<15 people) typically don’t have the need or ability to use and/or manage many of the internal controls and process features that Ramp contains, until they have a finance-centric individual in-house. The full suite of benefits that Brex has means that it can more or less be a one-stop-shop for an early-stage company’s complete banking needs at no cost. That is a valuable for a small company early on. (Although we still recommend that a company consider a startup-focused bank like SVB or FRB).Ramp, on the other hand, is a better credit card option for larger, more-established companies that have greater streamlined approval, expense management, and control needs. Their bill pay is excellent, and doesn’t require you to open a ‘savings/cash’ account with them - you can just connect it to an existing bank account. This makes it even easier to switch to them, and is another reason that they are a great option to switch to as a later stage company. There is another option for mid to later stage companies looking for tight expense management, accounting integrations and other finance controls/features - companies like Airbase or Procurify. These vendors combine cards with heavy-duty finance controls. They don’t make sense until you’ve got a full time VP of Finance or CFO in seat - provisioning and managing these tools takes time. But if you are looking for a heavy-duty, more “late-stage” (or dare I say enterprise) alternative to Ramp, they may be worth looking at. Brex vs Ramp in Review Brex Card - the better option for funded, early-stage companies. With a generous spending limit based on the company’s funding and performance, and no personal guarantee, it’s truly built for the Silicon Valley-style startup. Kruze Consulting clients can now get a 125,000 point sign-up bonus after depositing $500,000 into a Brex business account and an additional 25,000 point sign-up bonus after spending $10,000 on Brex card(s). Sign up now through Kruze. Ramp Credit Card - likely a good option for established companies. Ramp is more focused on later-stage companies with features like expense approval, reimbursement control, and other process controls that are helpful for growth stage companies that have finance teams in place and more internal control. Also, unlike othercards that entice you to spend with complicated reward programs,Ramp is the onlycard built around keeping money in your bank. It is a corporate card that strengthens your finances. Ramp offers companies that sign up through Kruze’s links ** $500 $750 cash back - a generous offer that you can’t get other places. Visit Ramp now to sign up. Biggest Perk - AWS CRedits - Brex vs Ramp A perk that our clients regularly ask about is Amazon Web Services credits. Which startup card company - Brex or Ramp - offeres the best AWS credits? Brex has a slight lead here; however, there are nuances in how Amazon runs their web services program, with our latest understanding after talking with them that there are two options to get credits, one of which is $100k - but it has to be used in 2 years. If your startup can’t use that much in AWS in 2 years, then sometimes smaller amounts that last indefinitely are better. But, getting down to brass-tacks, here are the AWS offers that the two card companies have (note that they may change these offers without telling us, so check their sites to make sure it’s the most current offer): Brex AWS Credit offer: $5k AWS Active offer + up to $100k in credits Ramp AWS Credit offer: Up to $25k in AWS credits Which has higher credit limits - Brex or Ramp? In our experience, Brex offers a higher credit limit to many funded startups than Ramp. With Ramp, we have seen clients successfully (and easily) request a higher limit; the limit for both companies hasn’t really been an issue in our mind. And, more importantly, both vendors offer generally much, much higher spending limits than traditional card companies like Amex or Citi. Ramp recently launched a new form of credit to companies generating revenue, bill pay financing. Deep dive into Ramp’s bill pay financing - Interesting for SMBs, not so Much startups Ramp’s bill pay now has a financing feature called “Ramp Flex.” This integrated into their normal bill pay workflow. With this “Flex” feature, you can have your vendors paid immediately, but actually get the money taken out of your bank account 30, 60 or 90 days later. The reason this may not be great for VC-backed startups is that this will cost 1% a month, which will compound to a rather large interest rate vs. what a startup can get as yield in a money market account. And since startups often have a lot of cash (VC-backed startups that is!), why pay interest when you have the cash available? However, for traditional, bootstrapped SMBs this could be an interesting option. This bill pay feature shows how Ramp is trying to continue to service the SMB market, where as Brex has chosen to only focus on VC-backed companies. A side note on travel One item that we’ve become increasingly pleased with from both Brex and Ramp are their development of travel features for startups with teams. Both providers are rapidly developing features to make it easier for companies at scale to manage their spend. For companies with teams who travel, Ramp in particular has excellent features that help keep travel spend in policy, visualize the company’s travel budget and more. Both have solid mobile apps. For example, the Brex mobile app is pretty amazing for travel. After you use it, say at a restaurant, you’ll get a notification on your phone. Simply click into the Brex app, take a snapshot, add some data like who you were with (depending on your startup’s expense policy) and viola, you are almost done with your reimbursements! It’s pretty great, and does push us slightly to preferring Brex if you have a high-travel company. Want a detailed review of the best credit cards for startups? Click here to read our breakdown of the top players we see our clients using. We list out the pros and cons of each of the cards we see with major market share. Does Brex charge a fee? No, Brex doesn’t charge fees to have the basic corporate card. They make their money from the interchange, and do not charge monthly fees, transaction fees, etc. Does Ramp Charge a Fee? No, Ramp also doesn’t charge fees for the basic corporate card. That means there are no transaction fees, monthly fees, etc. It’s a low-cost option for startups. In summary - don’t go with a standard card if you are a VC backed company! Get a solution like Brex or Ramp! They are built for you, especially because they don’t have a personal guarantee, have great tools for founders, good rewards, and more.When Fundraising Should You Practice With Less Desirable VCs?2024-02-11T00:00:00+00:002024-02-11T00:00:00+00:00https://kruzeconsulting.com/blog/when-fundraising-should-you-practice-with-less-desirable-vcs<p><img src="/uploads/when-fundraising-should-you-start-with-less-desirable-vcs-first-1.jpg" alt="" width="1920" height="1080" /><br /><!--Post Content--></p>
<p>A piece of advice that we hear being given out a lot in the startup world is that, when your startup is fundraising, you should fine-tune your pitch by approaching less desirable or non-target venture capitalists first.</p>
<p>People have different opinions on this strategy and, here at <a href="https://kruzeconsulting.com/"><u>Kruze</u></a>, we personally don’t subscribe to it as a technique. However, we do understand some of the rationale behind it, so let’s look at the reasons that people recommend this tactic.</p>
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<h2 id="practicing-your-pitch">Practicing Your Pitch</h2>
<p>When you first start fundraising for your startup you might have, say, five target VCs that you really want to invest in your company. Usually that’s because they have particular characteristics that work well for your business, such as:</p>
<ul>
<li>They really fit the brand</li>
<li>They’ve previously raised significant amounts of money</li>
<li>They have experience in your industry</li>
<li>They have a <a href="https://kruzeconsulting.com/blog/vc-general-partner-investments/"><u>partner</u></a> who is well-known and experienced</li>
</ul>
<p>Given the high stakes on securing one of these target VCs, people often recommend you start by pitching to less desirable VCs so you can practice. They suggest that by taking a couple of “test” meetings first you can:</p>
<ul>
<li>Work the kinks out of your <a href="https://kruzeconsulting.com/startup-pitch-deck/"><u>startup’s fundraising pitch deck</u></a></li>
<li>Get some feedback from professional VCs (even if they’re not your first choice)</li>
<li>Build your confidence in delivering your <a href="https://kruzeconsulting.com/blog/top-5-venture-capital-pitch-decks/"><u>VC pitch</u></a></li>
</ul>
<p>The idea is that this will potentially increase your chances of securing your dream VC, since you have polished your pitch with those you’re less interested in impressing.</p>
<h2 id="practicing-on-secondary-vcs-could-backfire">Practicing on Secondary VCs Could Backfire</h2>
<p>Like we mentioned, practicing on less desirable VCs first is recommended by some, but here at Kruze we think there are a number of reasons why this is a bad approach:</p>
<ol>
<li>You’re wasting people’s time. If you aren’t serious about taking money from them, it’s unfair to even take meetings with them as that <a href="https://kruzeconsulting.com/blog/how-do-venture-capitalists-spend-their-time/"><u>time is precious</u></a>.</li>
<li>We think you should treat all investors you are going to meet with equally and with respect. This means you should bring your A game to any pitch meeting. Using a VC as a “rough draft” seems disrespectful.</li>
<li>Probably the biggest reason is pitching to VCs is unpredictable. It’s incredibly hard to predict which VCs will resonate with what you’re pitching. Who you actually end up working with may be very different than who you thought you’d end up with at the beginning of the process. It’s a bit like finding a needle in a haystack, and you’re most likely going to have to pitch to 25 or more VCs before you find one to invest in your startup, unless you’re a very successful founder already.</li>
</ol>
<h2 id="pitch-to-your-friends-and-pre-existing-investors">Pitch To Your Friends and Pre-Existing Investors</h2>
<p>We recommend that you practice your pitch on your friends and your pre-existing investors and associates. Many startups have raised money from a <a href="https://kruzeconsulting.com/preseed-funding/"><u>pre-seed</u></a> or <a href="https://kruzeconsulting.com/blog/seed-round-number-of-investors/"><u>seed fund</u></a> before you start pitching for <a href="https://kruzeconsulting.com/blog/does-your-startup-have-what-it-takes-to-raise-a-series-a/"><u>Series A</u></a>. These investors will make time for you since they want to see you succeed!</p>
<p>By practicing your pitch with your associates and your friends, you won’t waste the time of professionals or risk your own reputation by doing so. If you’re not seen as serious when you’re taking these meetings, or people know you’re simply using them for practice, then you could stigmatize yourself. That could affect the opinions of VCs you actually really want on board.</p>
<p>Practice on other people, then bring your A game to pitch to the professionals.</p>
<h2 id="dont-waste-opportunities-when-fundraising">Don’t Waste Opportunities When Fundraising</h2>
<p>Finally, we want to remind you to try not to separate and segment your potential VCs too much. At the end of the day, all you need is one to invest, and even that is really hard in the current climate. So don’t sacrifice any opportunities by not taking investor meetings seriously.</p>
<p>If you have any other questions on fundraising, valuations, startup investing, startup accounting or taxes, or taxes, please <a href="https://kruzeconsulting.com/#contact"><u>contact us</u></a>.</p>
<p>You can also follow <a href="https://youtube.com/c/KruzeConsulting"><u>Kruze’s YouTube channel</u></a> and our <a href="https://kruzeconsulting.com/blog/"><u>blog</u></a> for information about accounting, finance, HR, and taxes for startups!</p>3c9a7185-6493-4274-94b4-bfd36ff4820dA piece of advice that we hear being given out a lot in the startup world is that, when your startup is fundraising, you should fine-tune your pitch by approaching less desirable or non-target venture capitalists first. People have different opinions on this strategy and, here at Kruze, we personally don’t subscribe to it as a technique. However, we do understand some of the rationale behind it, so let’s look at the reasons that people recommend this tactic. Practicing Your Pitch When you first start fundraising for your startup you might have, say, five target VCs that you really want to invest in your company. Usually that’s because they have particular characteristics that work well for your business, such as: They really fit the brand They’ve previously raised significant amounts of money They have experience in your industry They have a partner who is well-known and experienced Given the high stakes on securing one of these target VCs, people often recommend you start by pitching to less desirable VCs so you can practice. They suggest that by taking a couple of “test” meetings first you can: Work the kinks out of your startup’s fundraising pitch deck Get some feedback from professional VCs (even if they’re not your first choice) Build your confidence in delivering your VC pitch The idea is that this will potentially increase your chances of securing your dream VC, since you have polished your pitch with those you’re less interested in impressing. Practicing on Secondary VCs Could Backfire Like we mentioned, practicing on less desirable VCs first is recommended by some, but here at Kruze we think there are a number of reasons why this is a bad approach: You’re wasting people’s time. If you aren’t serious about taking money from them, it’s unfair to even take meetings with them as that time is precious. We think you should treat all investors you are going to meet with equally and with respect. This means you should bring your A game to any pitch meeting. Using a VC as a “rough draft” seems disrespectful. Probably the biggest reason is pitching to VCs is unpredictable. It’s incredibly hard to predict which VCs will resonate with what you’re pitching. Who you actually end up working with may be very different than who you thought you’d end up with at the beginning of the process. It’s a bit like finding a needle in a haystack, and you’re most likely going to have to pitch to 25 or more VCs before you find one to invest in your startup, unless you’re a very successful founder already. Pitch To Your Friends and Pre-Existing Investors We recommend that you practice your pitch on your friends and your pre-existing investors and associates. Many startups have raised money from a pre-seed or seed fund before you start pitching for Series A. These investors will make time for you since they want to see you succeed! By practicing your pitch with your associates and your friends, you won’t waste the time of professionals or risk your own reputation by doing so. If you’re not seen as serious when you’re taking these meetings, or people know you’re simply using them for practice, then you could stigmatize yourself. That could affect the opinions of VCs you actually really want on board. Practice on other people, then bring your A game to pitch to the professionals. Don’t Waste Opportunities When Fundraising Finally, we want to remind you to try not to separate and segment your potential VCs too much. At the end of the day, all you need is one to invest, and even that is really hard in the current climate. So don’t sacrifice any opportunities by not taking investor meetings seriously. If you have any other questions on fundraising, valuations, startup investing, startup accounting or taxes, or taxes, please contact us. You can also follow Kruze’s YouTube channel and our blog for information about accounting, finance, HR, and taxes for startups!Are Term Sheets Legally Binding?2024-02-04T00:00:00+00:002024-02-04T00:00:00+00:00https://kruzeconsulting.com/blog/are-term-sheets-legally-binding<p><img src="/uploads/are-term-sheets-legally-binding-3.jpg" alt="" width="1920" height="1080" /><br /><!--Post Content--></p>
<p>Term sheets can be a little bit of a gray area in the venture capital/startup world since certain elements, such as the confidentiality agreement, <em>are</em> legally binding. However, despite this, you may still hear of people “spilling the beans” and sharing details of the term sheet. Let’s look at these uncertainties.</p>
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<h2 id="term-sheets-and-founder-reputation">Term Sheets and Founder Reputation</h2>
<p>As we just mentioned, there is a lack of clarity regarding whether or not a <a href="https://kruzeconsulting.com/blog/exploding-term-sheet/"><u>term sheet</u></a> is strictly legally binding. The way we tend to think about it is, instead of them being legally binding, term sheets are more “reputationally binding.” If you sign a term sheet with a venture capitalist, or a venture capitalist signs a term sheet with you, <strong><em>you should have every intention of going forward with that deal.</em></strong></p>
<p>This is true from both sides, both for the VCs and for founders. If you’re a founder or a VC who pulls out of deals, contracts, or term sheets with investors/startups, word is going to get around. Understandably, neither venture capitalists nor founders like flakiness.</p>
<p>The spirit of the term sheet is that, at this point, those making the deal (the founders and investors) have officially agreed on the <a href="https://kruzeconsulting.com/blog/choose-VCs-carefully/"><u>terms of that agreement</u></a>. And now that everything is spelled out, all you need is the final documentation to be signed. That includes things such as:</p>
<ul>
<li>Stock purchase agreement</li>
<li>Investor rights agreement</li>
<li>Updated articles for the corporation</li>
</ul>
<h2 id="avoid-re-trades-and-renegotiation">Avoid Re-Trades and Renegotiation</h2>
<p>What you don’t really want to have to deal with are re-trades or last-minute renegotiations. In our experience, people who impose re-trades or try to renegotiate near the end of the deal process often get a bad reputation.</p>
<p>As a VC or a founder, you may be tempted to make last minute changes or requests. However, here at Kruze, we recommend only doing so if you uncover something, during <a href="https://kruzeconsulting.com/venture-capital-finance-tax-hr-due-diligence-checklist/"><u>due diligence</u></a> for example, that’s bad enough to justify the disruption.</p>
<p>Ultimately, and we cannot stress this enough, at this point it really is about your reputation as a startup founder or a venture capitalist. If you’re the kind of person that’s going around re-trading or trying to change things up at the very last minute, especially when you are in the stronger position, that will always look bad on you.</p>
<h2 id="dont-sign-a-term-sheet-youre-not-serious-about">Don’t Sign a Term Sheet You’re Not Serious About</h2>
<p>Because reneging on a term sheet is a pretty serious blow to your reputation, make sure you don’t sign a term sheet that you don’t want to close on. Remember, when you do sign a term sheet you’re on the clock. The other party will be putting effort and good intentions behind it. If they find out that you are bailing on them or have an ulterior motive there is big potential for a lot of feelings to be hurt. And that leads to ramifications to your business down the road.</p>
<p><strong><em>Be judicious and only sign something if you fully intend to go forward with it.</em></strong></p>
<p>And - always work with an experienced lawyer. We’ve found that the best startup law firms have worked with pretty much all of the top VCs, so they know which investors have reputations that are good… or bad. Plus, you don’t want to get bad legal advice on something as important as selling part of your company! </p>
<p>If you have any other questions on term sheets, valuations, startup investing, startup accounting, or taxes, please <a href="https://kruzeconsulting.com/#contact"><u>contact us</u></a>.</p>
<p>You can also follow our <a href="https://youtube.com/c/KruzeConsulting"><u>YouTube channel</u></a> and our <a href="https://kruzeconsulting.com/blog/"><u>blog</u></a> for information about accounting, finance, HR, and taxes for startups!</p>3c9a7185-6493-4274-94b4-bfd36ff4820dTerm sheets can be a little bit of a gray area in the venture capital/startup world since certain elements, such as the confidentiality agreement, are legally binding. However, despite this, you may still hear of people “spilling the beans” and sharing details of the term sheet. Let’s look at these uncertainties. Term Sheets and Founder Reputation As we just mentioned, there is a lack of clarity regarding whether or not a term sheet is strictly legally binding. The way we tend to think about it is, instead of them being legally binding, term sheets are more “reputationally binding.” If you sign a term sheet with a venture capitalist, or a venture capitalist signs a term sheet with you, you should have every intention of going forward with that deal. This is true from both sides, both for the VCs and for founders. If you’re a founder or a VC who pulls out of deals, contracts, or term sheets with investors/startups, word is going to get around. Understandably, neither venture capitalists nor founders like flakiness. The spirit of the term sheet is that, at this point, those making the deal (the founders and investors) have officially agreed on the terms of that agreement. And now that everything is spelled out, all you need is the final documentation to be signed. That includes things such as: Stock purchase agreement Investor rights agreement Updated articles for the corporation Avoid Re-Trades and Renegotiation What you don’t really want to have to deal with are re-trades or last-minute renegotiations. In our experience, people who impose re-trades or try to renegotiate near the end of the deal process often get a bad reputation. As a VC or a founder, you may be tempted to make last minute changes or requests. However, here at Kruze, we recommend only doing so if you uncover something, during due diligence for example, that’s bad enough to justify the disruption. Ultimately, and we cannot stress this enough, at this point it really is about your reputation as a startup founder or a venture capitalist. If you’re the kind of person that’s going around re-trading or trying to change things up at the very last minute, especially when you are in the stronger position, that will always look bad on you. Don’t Sign a Term Sheet You’re Not Serious About Because reneging on a term sheet is a pretty serious blow to your reputation, make sure you don’t sign a term sheet that you don’t want to close on. Remember, when you do sign a term sheet you’re on the clock. The other party will be putting effort and good intentions behind it. If they find out that you are bailing on them or have an ulterior motive there is big potential for a lot of feelings to be hurt. And that leads to ramifications to your business down the road. Be judicious and only sign something if you fully intend to go forward with it. And - always work with an experienced lawyer. We’ve found that the best startup law firms have worked with pretty much all of the top VCs, so they know which investors have reputations that are good… or bad. Plus, you don’t want to get bad legal advice on something as important as selling part of your company! If you have any other questions on term sheets, valuations, startup investing, startup accounting, or taxes, please contact us. You can also follow our YouTube channel and our blog for information about accounting, finance, HR, and taxes for startups!