Decision Vision

Decision Vision Episode 97: Should I Work With Startups? - An Interview with Harlan Jacobs, Genesis Business Centers

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Decision Vision Episode 97:  Should I Work With Startups? – An Interview with Harlan Jacobs, Genesis Business Centers, Ltd.

Harlan Jacobs of Genesis Business Centers joins host Mike Blake of Brady Ware & Company to discuss the issues involved in doing business with startups, whether as a mentor, services provider or corporation.   “Decision Vision” is presented by Brady Ware & Company.

Harlan Jacobs, President, Genesis Business Centers, Ltd.

Genesis Business Centers, Ltd. offers specialized services to high tech inventors and entrepreneurs in respect of assistance with raising initial seed and venture capital, as well as international licensing and/or joint venture agreements. Genesis also provides Acting CFO services.

Harlan Jacobs is the founder and president of Genesis Business Centers, Ltd., a diversified high tech, for-profit incubator program established in 1993. Mr. Jacobs is a seasoned CFO with over 20 years experience as a corporate controller and treasurer prior to becoming involved in the fields of incubation and early-stage venture (seed) capital. He was the CFO for FilmTec Corporation, a successful Minnesota high tech start-up company with a unique reverse osmosis membrane technology. Formed in 1977 with only $100,000 of founders capital, the company went public in 1979.

In 1985, with sales of $10 million and net income of $1.5 million, FilmTec was sold to Dow Chemical for $75 million in cash! Mr. Jacobs was actively involved in the acquisition negotiations.

Over the years he became interested in other early-stage, high tech companies like FilmTec. Most of the companies in which he invested were having great difficulty raising the first $250,000 of capital. Paying the rent and having adequate business advisory services available early-on were common laments among the management teams he interviewed for his prospective investments.

A business opportunity seemed obvious. In 1993 he founded one of the most progressive high-tech business incubator programs in Minnesota, if not in the U.S., by offering to barter rent and “Acting CFO” services for a negotiated equity position in its incubatee companies. This bartering program has become a cornerstone of the Genesis Incubator program.

In recognition of his efforts and success in helping small businesses raise capital and get off the ground, Mr. Jacobs was appointed by Senator Rod Grams to serve as his delegate to the White House Conference on Small Business in 1995, and again as his delegate to the Congressional Small Business Conference, held in Washington, D.C., in June 2000.

Successful graduates of the Genesis Incubator program include SurVivaLink, a manufacturer of portable battery operated defibrillators that was acquired by Cardiac Sciences (stock symbol: DFIB), NT International, a specialty sensor manufacturer that was acquired by Entegris (stock symbol: ENTG), and Excorp Medical, a bioartificial liver company whose system recently received FDA “orphan drug” designation, a significant approval step.

Other promising graduates and client firms of the Genesis program (and their technologies) include CYMBET, (infinitely rechargeable lithium ion polymer battery depositions on silicon substrates), Zivix, a new electronic guitar system for use with iPads™ and the like, GEL-DEL Technologies (tissue engineering), and Electronic Materials, LLC.

Electronic Materials may very well have a “basic patent” and therefore be in a position to engage in significant licensing transactions whenever an electronics company or others utilize a computer controlled ink jet nozzle for the deposition of electronic circuitry on flexible substrates. Genesis is assisting the company to secure licensing agreements on a global basis.

Jacobs’ personal track record of investment in private placement offerings such as in Recovery Engineering, Inc. ($1.00 per share in 1986–acquired by Procter and Gamble in 1999 for $35 per share) has helped to engender the confidence of those third parties who utilize the Genesis Incubator program as a high quality screen for selecting investment candidates.

Genesis works regularly with community development organizations that wish to bring high tech jobs to their communities. Genesis helps to establish business angel networks and community-based seed capital funds that receive funding from utility companies and commercial banks (in fulfillment of the letter and spirit of the law in respect of the Community Reinvestment Act) as well as from high net worth individuals who wish to help their communities to grow and prosper.

Mike Blake, Brady Ware & Company

Michael Blake is the host of the “Decision Vision” podcast series and a Director of Brady Ware & Company. Mike specializes in the valuation of intellectual property-driven firms, such as software firms, aerospace firms, and professional services firms, most frequently in the capacity as a transaction advisor, helping clients obtain great outcomes from complex transaction opportunities. He is also a specialist in the appraisal of intellectual properties as stand-alone assets, such as software, trade secrets, and patents.

Mike has been a full-time business appraiser for 13 years with public accounting firms, boutique business appraisal firms, and an owner of his own firm. Prior to that, he spent 8 years in venture capital and investment banking, including transactions in the U.S., Israel, Russia, Ukraine, and Belarus.

Brady Ware & Company

Brady Ware & Company is a regional full-service accounting and advisory firm which helps businesses and entrepreneurs make visions a reality. Brady Ware services clients nationally from its offices in Alpharetta, GA; Columbus and Dayton, OH; and Richmond, IN. The firm is growth-minded, committed to the regions in which they operate, and most importantly, they make significant investments in their people and service offerings to meet the changing financial needs of those they are privileged to serve. The firm is dedicated to providing results that make a difference for its clients.

Decision Vision Podcast Series

“Decision Vision” is a podcast covering topics and issues facing small business owners and connecting them with solutions from leading experts. This series is presented by Brady Ware & Company. If you are a decision-maker for a small business, we’d love to hear from you. Contact us at decisionvision@bradyware.com and make sure to listen to every Thursday to the “Decision Vision” podcast.

Past episodes of “Decision Vision” can be found at decisionvisionpodcast.com. “Decision Vision” is produced and broadcast by the North Fulton studio of Business RadioX®.

Visit Brady Ware & Company on social media:

LinkedIn:  https://www.linkedin.com/company/brady-ware/

Facebook: https://www.facebook.com/bradywareCPAs/

Twitter: https://twitter.com/BradyWare

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Show Transcript

Intro: [00:00:02] Welcome to Decision Vision, a podcast series focusing on critical business decisions. Brought to you by Brady Ware & Company. Brady Ware is a regional, full-service accounting and advisory firm that helps businesses and entrepreneurs make visions a reality

Mike Blake: [00:00:22] Welcome to Decision Vision, the podcast giving you, the listener, clear vision to make great decisions. In each episode, we discuss the process of decision making on a different topic from the business owner’s or executive’s perspective. We aren’t necessarily telling you what to do, but we can put you in a position to make an informed decision on your own and understand when you might need help along the way.

Mike Blake: [00:00:40] My name is Mike Blake, and I’m your host for today’s program. I’m a Director at Brady Ware & Company, a full-service accounting firm based in Dayton, Ohio, with offices in Dayton; Columbus, Ohio; Richmond, Indiana; and Alpharetta, Georgia. Brady Ware is sponsoring this podcast, which is being recorded in Atlanta per social distancing protocols. If you like this podcast, please subscribe on your favorite podcast aggregator, and please consider leaving a review of the podcast as well.

Mike Blake: [00:01:06] So, today’s topic is share work with startups. And I think a lot of people are faced with this choice. And the choice may come in one or two forms. It could be, like myself, in the form of being a trusted adviser and a service provider. And it can also be in the context of being offered employment. Startups, like any other company, they need good talent. I mean, great talent. And I would argue that startups need great talent more than anybody because they don’t have the margin for error that other companies do.

Mike Blake: [00:01:45] But it’s not that easy of a decision. Startups, they’re are different animal. They’re a different animal in terms of the pace of how they do things. By definition, you’re operating in an environment of tremendous uncertainty. How much and whether you get paid can be a significant question. You may be asked to take stock in form of compensation, or warrants, or equity, or something. And there are other complications as well.

Mike Blake: [00:02:19] And so, the thing about startups is that working with startups is pretty sexy. Back when we have cocktail parties again, they’ll make for great cocktail party stories. But what I want to get into today with our guest is, is it more than a cocktail party story? How do you think about it? How do you make the decision whether or not you’re open to working with startups? How do you make that work for you? And how do you get the best benefit from it? And how does the startup benefit from that?

Mike Blake: [00:02:49] So, joining us today is Harlan Jacobs of Genesis Business Centers, Ltd. Genesis Business Centers offer specialized services to high-tech inventors and entrepreneurs in respect to of assistance with raising initial seed and venture capital, as well as international licensing and joint venture agreements. They also provide acting CFO services. Harlan Jacobs is the founder and president of Genesis Business Centers, and they’re established in 1993. That’s 27 years. So, they’re doing something right because if they’re doing it wrong, they’re doing it for an awfully long time.

Mike Blake: [00:03:23] Mr. Jacobs is a seasoned CFO with over 20 years of experience as a corporate comptroller and treasurer prior to becoming involved in the fields of business incubation and early stage venture seed capital. Harlan is also active internationally and is acting executive director of the American Israel Chamber of Commerce of Minnesota and is the vice chairman of the Swedish American Chamber of Commerce of Minnesota. Harlan Jacobs, welcome to the program.

Harlan Jacobs, Genesis Business Centers: [00:03:48] Thank you very much, Mike. It’s great to be here. Thanks for the invitation.

Mike Blake: [00:03:52] So, let’s start off easy here. In your mind, what constitutes a startup? I want to get that out there because I think a startup can mean different things to different people at different times from different perspectives. So, in your mind, if somebody asks you to kind of define a startup, what does that look like to you?

Harlan Jacobs, Genesis Business Centers: [00:04:15] Great question. And I wish the headline writers in the newspapers and magazines would come on a standardized definition what’s a startup. To get to your point, basically, I think that the public would be well served, your viewers and readers, to understand that it’s usually a brand=new company that’s been formed or is about to be formed, and they intend to develop and commercialize a particular product or service, usually high tech, but not necessarily high tech, and there’s a sense that this new idea or invention has great value and unique characteristics that put it in the category of a breakthrough technology that could very well be disruptive; and therefore, generate sales and profits, and ultimately capital gains for the founders and the initial investors. That’s my nutshell version of a startup.

Mike Blake: [00:05:10] So, you have a background, you’ve had some success in large companies, and you’ve had success with with small companies and startups, and you work with startups now on a daily basis. What is s that experience like? How is it working with a startup versus a more established company? And maybe in your answer, you could touch upon what is that transition like? If you’re used to working in that larger environment, what is the culture shock like going from a larger company to a startup?

Harlan Jacobs, Genesis Business Centers: [00:05:41] Again, another great question. When I try to acquaint people who have no experience with startups but are enamored from their various cocktail party conversations that they’ve been a party to, and they say, “Hey, I’d like to learn more about startups,” I start them out with a differentiation as follows. In a startup, to make the payroll, you’ve got to be able to build a product, sell a product, collect the receivable, cover all the expenses, and then have money left to pay the payroll in yourself; whereas, the big company experience that many of these people come from is the idea of making payroll, as you call the payroll department, and they issue the checks.

Harlan Jacobs, Genesis Business Centers: [00:06:21] So, it’s a whole different world and a person has to be capable of doing many things. The person that’s involved in engineering but also has a flair for sales and marketing will be very valuable as opposed to the salesperson who can only sell or the engineer who can only do engineering. And it’s just literally a different world.

Mike Blake: [00:06:44] Yes. So, interesting you mention that. So, in your mind then, somebody who’s a good fit for a startup might be somebody who’s comfortable playing many roles as opposed to being strictly a deep specialist.

Harlan Jacobs, Genesis Business Centers: [00:06:55] Absolutely. The cross disciplinarian, to borrow a term, is a characteristic of many successful tech entrepreneurs. And in the company I was with back in the ’80s, Film Tech Corporation, we had an engineer who was also very good at sales and marketing. And so, he went out around the world and helped sell the reverse osmosis desalination membranes, even though he could have been back in the office helping with the engineering. And there was an example of a good successful cross disciplinarian.

Mike Blake: [00:07:29] So, you said something there initially, and you said something that I think a lot of people, they’re going to pick their ears, which is the difference in startup – and I think this is a really strong definition – a startup versus established company is how you make payroll. One is you’ve got to make sure there’s money in the account. The other is you call the payroll department. That might be enough to kind of scare a lot of people away if you don’t know how payroll is going to be made. In spite of that, why do you and others find it attractive to work with startups in spite of that uncertainty?

Harlan Jacobs, Genesis Business Centers: [00:08:06] It might sound corny to say, but there’s really a lot of excitement and energy involved in being with a startup. Whatever your relationship, whether you’re an employee, a founder, a service provider or an adviser, you’ve got a chance to bring world-class, disruptive technology to the marketplace, and you’re working with people who are extremely skilled in a particular technical discipline. And you might be part of the next Microsoft, you might be part of the next Medtronic, which is a success story here in Minnesota, or you might be part of the next film tech, which was the company I had the privilege of working with.

Harlan Jacobs, Genesis Business Centers: [00:08:48] And it’s very exciting to be part of that, but what a lot of people don’t realize is during the excitement, there’s also a lot of periods that are terrifying, frustrating, and you’re coming close to the edge of the cliff. And it’s easy to be excited and interested in the exciting aspects of it, and very few people have a comprehensive, in-depth understanding of the terror that’s involved in being part of a startup.

Harlan Jacobs, Genesis Business Centers: [00:09:17] I’ll give you an example. About 25 years ago, I was an adviser to a company, and I got a frantic call on a Sunday afternoon about 5:00 p.m. And I could tell that there was distress in the caller’s voice. And he explained to me that he didn’t know how he was going to make payroll. And I said, “Well, didn’t you plan for this?” He said, “Well, I was supposed to get a check on Wednesday from this guy, and then it didn’t come Wednesday. And then, the guy said he’ll put it in the Federal Express, and then it didn’t come on Friday. Then, he assured me it was there, and it didn’t come Saturday. But I released the payroll checks on Friday. What do I do now?” And a friend of mine who coined the phrase “the roommate factor.” What’s it like to be an adviser, or a board member, or an officer of a company that had all the other challenges? And then, all of a sudden, on a Sunday at 5:00 p.m., you hear about a new challenge that you can’t solve, and you just have to help the person through a crisis.

Mike Blake: [00:10:23] And that is sort of one, I think, of the attractions of being an adviser to a startup that there’s a clear path to making a difference, right? If I were an adviser to, say, Coca-Cola – and I’m not, but I’m just going to pick that because they’re down the street from me – I give them a piece of advice. If they take it, yay! If they don’t take it, life is going to go on, right? Coca-Cola has been around for 120 years. They will be around long after I’m anywhere near this place. With a startup though, the advice that you give them, the help that they give you through a crisis can often make the difference as to whether or not that company’s around or not.

Harlan Jacobs, Genesis Business Centers: [00:11:03] Absolutely.

Mike Blake: [00:11:04] So, do you have an ending to that story? How did they work their way through that crisis? Did they make payroll? They bounced paychecks, and the workers showed up with torches and pitchforks? What happened?

Harlan Jacobs, Genesis Business Centers: [00:11:17] Well, we we spoke to the banker and arranged for an immediate small short-term loan that required the founder to make a personal guarantee, which he promised his wife he would never do, but he had to. So, it wasn’t easy to talk him into it, but he had no choice. And it was his problem, he had to solve it.

Mike Blake: [00:11:41] Well. But the good news, and this is a topic for a different podcast, but he may not have thought of even that option if you haven’t been around him, a sort of an adviser to help him think of that. You’re in crisis. You’re hyperventilating because you think your company is about to collapse. And you might think the last thing that you’re going to be able to do is call a bank, the most risk averse of financing sources, and that’s going to be the source of your funding literally overnight, so that those checks clear.

Harlan Jacobs, Genesis Business Centers: [00:12:17] He was lucky, and it turned out well, and he learned a lesson, and eventually went on to great success. But it’s those kinds of experiences that when you sign on to be an adviser or a member of the team, whatever your status, it’s so hard to anticipate every possible thing that could go wrong. And at the end of the day, you’re dealing with people, not machines and not algorithms. And people can do odd things. They can be creative, and they can be destructive.

Mike Blake: [00:12:50] So, other than … and kind of on the payment side, and that is a risk too is that startups can’t service probably can’t pay you your full rate, and you may be in deferred … some people offer deferred payment programs. And I was, in fact, on the phone today with a law firm that has deferred payment programs for startups, and that payment may or may not materialize. But in addition to that, are there other risks of working with startups that somebody listening to this podcast should be aware of, whether they’re thinking about taking one on as a client or actually joining one as an employee or an officer?

Harlan Jacobs, Genesis Business Centers: [00:13:31] Beyond the obvious compensation issues, whether you get a paycheck, and it never happens, or whether you don’t get as much you’re supposed to get, or whether your fees are ever paid, or you get Chinese paper, and you put it on your wall 10 years later, there are other issues that anyone who’s going to join, whether as an employee, an officer, or a director, has to be mindful of. And I’m not giving legal advice but I can tell you my opinion that it’s very important for anyone who is in a role to be a helper in those capacities to be mindful of the fact that if you have check signing authority, whether you’re an employee or an officer, and if you’re a director, and the payroll withholdings aren’t remitted to the state and federal authorities in full on time, or whether the worker’s compensation insurance premiums haven’t been paid and/or if there’s back salaries and wages that haven’t been paid, you may be personally responsible and liable for that. I think the term is joint and several liability.

Harlan Jacobs, Genesis Business Centers: [00:14:39] Again, I’m not an attorney. I’m not giving legal advice, but as a person who is going to be in the trenches, one still needs to have a basic understanding of the law as it pertains to his or her personal liability. So, that’s a factor. And I’ve seen this before where, for example, in my field, someone says, “Oh, would you be our treasurer? We need someone to be the treasurer.” And I have to explain to them, “I will provide you the functions and benefits of the comptroller, or treasurer, or CFO, but I can’t accept check-signing authority because of the personal liability that’s associated with it.” And sometimes, they just don’t want to put the energy into understanding the nuance of what I’ve explained to them, but I have no choice. I can’t wake up some morning, and open my mail, and find out that the IRS wants me to pay $25,000 because I’m the only person they can find who was somehow associated in that check-signing capacity. So, that’s one of the issues.

Harlan Jacobs, Genesis Business Centers: [00:15:37] The other issue, if you’re a director, you may be liable for other damages, and the cost of defending yourself, whether the lawsuit is successful or unsuccessful. So, compensation is a whole different animal, but the downside of helping in a certain capacity is something that I think is not as well understood as it should be by someone who’s knowingly wanting to get involved. You can be an adviser or an ordinary employee and not have those perils, but if you’re a nice guy or gal, and you decide to accept the appointment as the acting CFO, and they want you to sign on the check form at the bank, beware.

Mike Blake: [00:16:22] And I think that’s really important that I want to kind of highlight this a little bit because one of the potential attractions of working for a startup is you may get a title that you might not have had the opportunity to get otherwise. You may just not have the seniority, haven’t put in your dues, or whatever it is. And all of a sudden, you become a chief something officer. And that sounds great, but being an officer of a company means something. And if you’ve got that O part at the end of your title, that does mean that, most likely … I’m not giving legal advice for sure, but there is a substantial risk that you’re being put effectively in a fiduciary position to shareholders and/or employees.

Mike Blake: [00:17:17] And this is under appreciated, as much as anything, that’s why people have that title to get paid as much as they do. It’s not just because of their skill set, and their seniority, and whatever education they have but, also, simply, the willingness to take on that responsibility because you can’t just walk away from it. And  that’s meaningful. And I can’t agree with you more that once you light the stars out of your eyes, sit down with your own legal counsel and work through what being an officer really means and put you on the hook for. And that will likely also differ state to state. So, that’s one of those things, I think, is going to be more local in terms of how the law works than is national in scope.

Harlan Jacobs, Genesis Business Centers: [00:18:07] I would add that there’s, also, the potential damage to one’s reputation and standing in the community. One might be enamored of a new pump or a new contrivance of device and not have a good grounding in the laws of thermodynamics and inertia, and doesn’t know how to perform, and wouldn’t know what the results were from a test that did a mass energy balance. But at the end of the day, if that company raised money, and it took two and a half years to find out that the basic principles of physics or the operation of it wasn’t either possible or cost effective, then everybody turns to anybody who can be pointed at and blames them for failure to provide proper oversight.

Harlan Jacobs, Genesis Business Centers: [00:18:56] And it’s a classic unknown unknowns, and it’s a danger to one’s reputation. And look at the people – and I won’t cite the exact name of the company that starts with the letter T, but there was a company in California that raised a lot of money and had some cabinet members on its board of directors, and it ended up being a well publicized failure. And I have to watch my words judiciously here, but think of all the people who get invited to a board, and they’re enamored like a moth to the flame, and then two years later, they find out it was either a hoax or it should have been understood that it could never possibly work, the thermodynamics weren’t there, the chemistry wasn’t there, the cost effectiveness wasn’t there. So, another point of risk.

Mike Blake: [00:19:49] Yeah. That actually gives me a … I’m going to write down a note here. We really should have a podcast, should I serve on a board, because that enters into that discussion, right? And there’s a lot of attractiveness to serving on a board. It’s prestigious. It can be very well compensated. It can be a very rewarding work. But there is a downside that if things don’t work out, you can very easily be left holding the bag.

Mike Blake: [00:20:15] So, Harlan, you’ve been working with startups a good chunk of your career. And I’m curious, in your in your experience, what are the most frequent needs? What does startups most frequently need help with?

Harlan Jacobs, Genesis Business Centers: [00:20:33] Well, another friend of mine coached the phrase, came up with a phrase, coaching and cash, capital and coaching. They clearly need capital, but they also need to understand how to start a business, how to grow a business, how to utilize the capital, so that they can go back for another round of capital when they’re, in all likelihood, going to need several rounds of capital. So, they have to be educable. They have to be able to process advice.

Harlan Jacobs, Genesis Business Centers: [00:21:06] Not every piece of advice that I or anybody is going to give to a client is going to be the absolute best advice to take, but they have to be able to listen to advice, and to know how to separate the wheat from the chaff, and follow the good advice more often than not. And if they listen to experienced people, they’re going to be better off, they’ll have higher prospects for success in growing their business and raising capital, utilizing the capital successfully, and going back, and getting another round at a valuation that doesn’t result in what we sometimes call a down round or a cramdown.

Mike Blake: [00:21:47] So, the capital on the coaching side, what do you find yourself coaching people most frequently about?

Harlan Jacobs, Genesis Business Centers: [00:21:56] I’m so glad you asked that question. If there’s one thing that I’d really like to do with the entrepreneurial world to help them would be to help them get away from percentages. I wish I had a $20 bill, a crisp $20 for every time an entrepreneur has come to me, and it must be in the DNA, they start telling me about how they want to do this percentage to this person, that percentage, that percentage. Stop. Again, I’m not giving legal advice, but I say the person is going to remember five years from now that they had 2% of the company. Now, what you should have said at that was at that point in time, you’ll have 2% of the company, and we’re going to have successive rounds of capital, and eventually, you’re going to have a much smaller slice of the pie, but the pie is going to be much larger.

Harlan Jacobs, Genesis Business Centers: [00:22:50] I wish I could get most entrepreneurs, especially the people who come from a scientific technical domain, to understand that shares are issued in exchange for services and capital. And at some point in time, those shares have a percentage relationship to the total number of shares issued in outstanding. But get away from the concept of an absolute percentages. You don’t take percentages out of the corporate treasury and bestow them at sword point on someone’s shoulder. You issue shares of stock, and then you can calculate the percentages of ownership in a table.

Harlan Jacobs, Genesis Business Centers: [00:23:27] And that can get them in so much trouble because they didn’t intend to mislead anybody, but five years from now, when somebody has a big success, their attorney calls him up and says, “Well, John Jones or Susan Smith said, you promised them 2%,” and you have to make a settlement to make the problem go away.

Mike Blake: [00:23:48] That’s interesting. So, I imagine a lot of those cases is there’s that promise. That’s not even a written promise, is it?

Harlan Jacobs, Genesis Business Centers: [00:23:56] Right.

Mike Blake: [00:23:56] It’s just a verbal promise. And I think a lot of people don’t understand this. And again, I’m not an attorney either but I have seen it where that implied promise is, at least, enough to get you to court. You may not win, but winning a court case is distracting and expensive, right? And there’s just enough leverage. As long as you get a judge to take the case, then that person that claims that have received the promise, they all of a sudden have a lot of leverage.

Harlan Jacobs, Genesis Business Centers: [00:24:30] I think there was a movie made about a famous case in the last 10 years, but I’ll leave that to your listeners’ imagination to figure out which one I’m talking about.

Mike Blake: [00:24:40] So. I think a common misperception or just a common perception of startups is, I mean, they just can’t pay. And you’ve been working with startups for 27 years. I can’t imagine that they’ve done that all for free. So, I’m just going to put the question to you. Can startups pay?

Harlan Jacobs, Genesis Business Centers: [00:25:02] Some can pay a small amount initially, and some can offer you a generous amount of founder’s stock, and some can offer a generous stock option or warrant depending on whether you’re an employee or whether you’re an independent contractor. I caution everybody who’s inclined to take less than market rate compensation in cash that they should be mindful that the percentages are very low. The percentage of companies that have a liquidity event of meaningful return on capital could be as little as one out of a hundred.

Harlan Jacobs, Genesis Business Centers: [00:25:37] And so, I try to put it in perspective, I explain to them, you might have to work with a hundred startups over the next 20 years for which you take warrants, or founder stock, or options. And maybe one out of a hundred, maybe two or three out of a hundred will give you a return on investment. So, it’s not for the fainthearted, and it’s not for people who have to put braces on the kids’ teeth, and send high school students on to college, unless they’re independently wealthy to begin with.

Mike Blake: [00:26:07] So, you mentioned something I want to touch upon, and I hope we’ll spend some time here because I do think it’s important and it’s complicated. And that is you may very well be offered stock, or warrants, or options in lieu of cash payment. And in your mind, how do you think through that, whether or not you’re willing to accept them at all, whether you’re being offered enough, or if there are terms that are being sufficiently flexible that you can actually do something with them? Can you walk through how you think about that in terms of being offered equity, or what you think best practices would look like?

Harlan Jacobs, Genesis Business Centers: [00:26:47] Sure. Well, for acting CFO services and for helping a scruffy little startup to raise its first quarter million to a million dollars’ worth of capital, in the past, sometimes I’ve accepted 10 percent of the founders stock. I’ll give you a case in point, without embarrassing the company. I had a company that I once owned 5% of the company for a remittance of $50, and I now own 0.0005% of the company. The company had eight venture capital rounds, preference rounds, where the B investors had their way with the A investors all the way up to the only guys that had a decent percentage of the company with a final in the eighth round. Sad story.

Harlan Jacobs, Genesis Business Centers: [00:27:40] So, having said that, it didn’t turn out well, but I made the calculus up front that if I own 5% of the company, maybe by the time there was a liquidity event, I might have 0.5% of a very large pie. And if they sell the company for a couple hundred million dollars, you take 0.05% of that proceeds of the liquidity event, that might be a meaningful amount of return on investment and capital gains rates versus maybe the $25,000 that you could have received if they would have had cash and paid you at market rates at that point in time.

Harlan Jacobs, Genesis Business Centers: [00:28:22] So, it’s your classic trade-off. You can’t do it every day. And sometimes, what you have to do is a combined cash and warrants approach. And sometimes, you just have to insist on cash. And I’ve had cases where people have come back to me, literally, this year from 2012. They weren’t quite ready in 2012. And this year, they were finally ready. And I was grateful that they kept me in line and got back to me.

Mike Blake: [00:28:53] I think that’s important is just because you no to stock now, that doesn’t mean that that opportunity will come back around later, right? So, I think what’s also kind of interesting about the dynamic of that equation is you are giving sort of a signaling effect. If somebody comes to me for advice, or they want me to provide a service, they offer stock, and I say yes versus no. I’m, in effect, blessing that stock or not blessing that stock by being willing to exchange my time for it. And that can sort of lead to its own challenges in that conversation.

Mike Blake: [00:29:41] And maybe someone’s listening to this, and they’re offered stock, they really just don’t want stock, but they like to work with the company, can you offer some advice and kind of what you say or how you handle that conversation? They say, “Look, just because I’m not taking stock doesn’t mean I hate your company. It just means I’m not taking stock right now.” How do you handle that conversation?

Harlan Jacobs, Genesis Business Centers: [00:30:06] Well, in terms of the interpersonal dynamics, the diplomacy, the desire to maintain goodwill and cordial relations with the person, obviously, one has to be tactful. Sometimes, it’s just a matter of explaining the truth. My spouse won’t let me work for stock anymore. We’ve had a couple of wallpaper items we put on the wall, they’re decorative, and the stock wasn’t worth anything. And again, as you point out, you never know when the people might come back after they do have some funding. I’m not sure if that responds to your question. Would you mind going over it again?

Mike Blake: [00:30:48] Yeah. Well, I think we’re headed in the right direction. So, that the question simply is or the question is, there’s a risk of offending somebody to some extent when you decline to take stock in their company, right? I mean, they think their company is great. And of course, even if you’re going to work for the company, if you’re going to be an adviser, they have an idea in their mind, they would like you to believe in the company as much as they do, right? But I think that that’s not appropriate. I mean, it’s great if you do happen to share the founder’s zeal, and that’s great. But it’s not appropriate that an adviser or an employee necessarily have the same fervor and devotion to the company and to the idea of the company as the founder because nobody can act like a founder unless they’re a founder, right?

Harlan Jacobs, Genesis Business Centers: [00:31:41] Well, your points are well taken. Here’s one of the ways I helped put it in a framework that depersonalizes it and helps to make sure that the person’s feelings aren’t hurt or their self-image crushed. I explain to them, this is a rank startup. I said, “You’re going to need $250,000.” A person sometimes says to me, especially a scientific technical person, “What do you mean $250,000? I’ll work for free for a couple of months.”

Harlan Jacobs, Genesis Business Centers: [00:32:07] I said, “You’re going to need $50,000 of cash for the retainer with the patent attorney. You’re going to need $50,000 retainer with the securities counsel and general counsel who are not going to work for you until you pay them a cash retainer. You’re going to need to go to some trade shows and do some travel. And that’s going to be $50,000. And you’re going to need some walking around money, and money for deposits, and a few other things. These people are not going to take stock from you. You have to have cash.” And then, that puts it in a framework where I can become part of that professional or third-party milieu where we have to be paid.

Mike Blake: [00:32:45] Now, I’m fortunate. I have built it out because I’m a business appraiser, I cannot. I’m ethically prohibited from taking stock in a company because they create a conflict of interest. So, I’m fortunate. I have an automatic jail free card. So, there’s a school of thought that suggests that it may be worthwhile going to work for a startup just because of the experience that it will give you. Do you think there’s something to that? Is there something that putting some time in with a startup, even if the pay isn’t there, just because it would give you a chance to learn new skills that you wouldn’t ordinarily have the the opportunity to do?

Harlan Jacobs, Genesis Business Centers: [00:33:27] In an absolute sense, if a person can afford the risk or can literally afford not to have any meaningful compensation for a period of time, and they have a well-defined need to learn certain skill sets, and to firsthand experience the problem, stresses and frustrations of a startup company, then by all means, they should do that. I haven’t met too many people who wanted it as a merit badge or something to add to the resume that they’ve had firsthand experience of the frustrations and problems associated with the startup. They, more likely, are inclined to get involved because they’re excited about the project.

Harlan Jacobs, Genesis Business Centers: [00:34:10] That might be a golfer and it’s a new golf club. It might be a heart surgeon and a new heart valve. It might be a person who has an airplane and a guy or gal who’s taken an iPad and substituting that for the $50,000 instrument control panel that they’d otherwise have to buy. In those kinds of situations, it makes sense for them to maybe jump in and join. But just to add to your resume, I guess I would have trouble selling that to anybody.

Mike Blake: [00:34:41] What about using work with a startup in order to help build a network and a personal brand? And I can see two scenarios in which this might be plausible. One is you’re out of school, you’re just starting out, and you’ve got sort of a blank slate professionally. Or second, you’re sort of transitioning out of a more conventional role, and you want an opportunity just to start to meet the people in the startup realm, wherever you are. And that could be a local geography. It could be national. Is there something to a thesis of saying, “This is a way to jump start building a network in the space where I would kind of like to be in”?

Harlan Jacobs, Genesis Business Centers: [00:35:24] Well, it’s a great question. If someone were coming right out of college, and the employment market wasn’t very good, and he or she wasn’t burdened by immediate payback of a substantial amount of student loans, then they could very well say to themselves in good conscience, “Hey, why don’t I go to work for this local startup? Maybe they’ll pay me. Maybe they won’t. Maybe they’ll pay me minimum wage. And maybe I’ll get some stock. It’d be great experience. And a lot of people my age, people I have common interest in are there, and who knows where it could lead.” So, that might make sense.

Harlan Jacobs, Genesis Business Centers: [00:35:59] For the person who’s 45 to 55 years old, and has family obligations, and probably hasn’t fully set aside resources for retirement, I don’t think that would be well advised. So, it’s clearly tailored to a person’s personal resources, and risk level, and ability to handle frustration. It’s. tough.

Mike Blake: [00:36:25] Yeah. And when I hear people that do that, to me, it just says it’s a dressed up way of saying, “I’m doing an internship.” And if you can do an internship, that’s fine. There’s nothing wrong with it. But like you said, I think a lot of this, just like we talked about in our podcast, not about whether or not you should do it, but part of that thought process is, can you afford to do it, right? What is the opportunity cost of taking on that kind of responsibility versus pursuing something else?

Harlan Jacobs, Genesis Business Centers: [00:36:59] Sure. Can I go back?

Mike Blake: [00:37:01] Please.

Harlan Jacobs, Genesis Business Centers: [00:37:01] Could I go back to one of your other questions? I just wanted to add something to cases where I’m looking at an opportunity. Is it timely? May I do that?

Mike Blake: [00:37:10] Yeah, go right ahead.

Harlan Jacobs, Genesis Business Centers: [00:37:11] Okay. So, I have a rule of fives as to how I size up opportunities, especially as it relates to taking all the compensation as founder stock. And in a nutshell, it’s, does the company have world-class disruptive technology that has robust intellectual property, can be protected by a combination of patents and trade secrets? That’s one. Two, does the company have market prospects for being able to achieve a hundred million dollars of revenue at 60% or higher gross margin within five years of funding? It’s the second one.

Harlan Jacobs, Genesis Business Centers: [00:37:45] Does the company’s management team have a demonstrated track record of achievement in its scientific or technical realm? That’s the third. Does the founder’s team enjoy a good reputation and for integrity and the ability to listen and process advice? That’s the fourth. And the fifth one is, does the founder’s team have a commitment to a liquidity event in a reasonable time event horizon. Those are the five things that I apply when I’m doing my mental version of the Black-Scholes formula.

Mike Blake: [00:38:15] Okay. That’s a pretty good checklist. So, let me switch gears here. If you get involved in a startup, we talked about this a little bit, and I want to expand upon that, as we talked about, there are some risks. There’s a financial risk to some extent. There may be other risks. When you work with startups, how do you protect yourself to make sure that your risk is managed appropriately?

Harlan Jacobs, Genesis Business Centers: [00:38:53] Beside the earlier point about not taking check-signing authority and to protect my reputation, I try to do as much due diligence as I can on the science and technology, not as an expert, but I will go to people who know something about metallurgy, or somebody who knows something about biochemistry, or somebody that knows something about a particular global marketing opportunity. I may not always get sufficient information but, at least, I’ve avoided the possibility of overlooking something that, somewhere down the road, people will point to and say, “Why didn’t you know? Why didn’t you find out this or that kind of a thing?”

Harlan Jacobs, Genesis Business Centers: [00:39:36] One of the real tough things with entrepreneurs is you never know. You’ve just met somebody, and start doing a criminal history on them, and a bankruptcy search, and a few other things that are sometimes difficult or less unpleasant to do, you just never know what the person’s really like or really capable of. One of the risks to the entrepreneurial team is that, oftentimes, there’s a high incidence of family stress that can lead to divorce. I’ve met a number of entrepreneurs who are ultimately very successful. They’ve been through several marriages, and they’ve had problems with some of their children. And it’s that old saw, if they can mistreat their spouse this way or that way, maybe they’re going to eventually mistreat you as a professional. And when people are cornered, and they have real serious problems, you just never know what’s going to develop.

Harlan Jacobs, Genesis Business Centers: [00:40:45] Nothing’s perfect. You can never be fully protected. You just try to do your best with reference checking and checking on the technology. And I guess the bottom line, it makes it easier for me to accept a client after I’ve introduced him to three attorneys, and three CPAs, and three patent attorneys, and three bankers, and three insurance agents, and three of this, that, and the other, and I see that they’ve taken on a prominent attorney whom I respect and a prominent CPA whom I’ve respected, et cetera, et cetera, and they are they’re associated now with good professional people to give them good, strong professional advice. That helps me to get a better comfort level, and it also increases the chances that there will be guardrails that will keep these people from going over the cliff.

Mike Blake: [00:41:37] And what about documentation and contracts? Do you think that’s a big part of that too to make sure that your scope is limited and there’s some sort of indemnification where possible?

Harlan Jacobs, Genesis Business Centers: [00:41:47] Absolutely. I find good fences, make good neighbors, and I explain to them, “Here’s what I’m going to put down on a piece of paper. Here’s what I’m prepared to do. And this is the compensation I’ll accept. And these are the contingencies, and the terms and conditions under which we’re going to operate.” And in my case, I have to explain to them that I may have two, three, four, five, or six parties for whom I’m providing similar services at the same time, but they’re not directly competitive, and there’s no conflict of interest. And on any given time, you might call me with an immediate problem, and I might be unable to give you immediate attention, and you just have to understand that it’s kind of like being a cardiologist in a small town, not everybody’s going to have a heart attack at the same time, but if they do, how do you spread yourself around?

Harlan Jacobs, Genesis Business Centers: [00:42:39] So, you do your best, you have a written agreement. And to extricate yourself from what could be a difficult situation, I always try to make an initial term that has limited duration, so that if I can see things aren’t working out very well, then we just don’t renew because a renewal requires bilateral mutual agreement to renew. And if I declined to renew, then it’s easier that way than just to pick up the phone all of a sudden say, “Hey, I’m just not comfortable. I don’t want to keep working with you. Goodbye.”

Mike Blake: [00:43:14] Yeah. And the contract part, I want to to pause on that for just a second because I think one can be lured into not having documentation when you really should. One, because the startups don’t want to deal with it, right? The startups sort of take as a badge of honor this, “We operate loosey-goosey. We operate out of the lines of of of normalcy. And we don’t care about rules and everything else.” They may also be run by 24-year-olds that don’t know anything, and haven’t had the bruises, and broken bones, and scars that come from not signing agreements.

Mike Blake: [00:43:50] And I think if you don’t come from that world, you can be lulled, you can be seduced, really, into thinking, “Well, that’s just the way startups are. We’re not going to sign agreements. And we’re all just going to do handshakes, and exchange Twitter accounts, and everything’s going to be great.” But for most people, some sort of documentation of the nature of your relationship, and where your liability and responsibility begins and ends. Don’t give in to the temptation to sort of throw that out the window. That’s worth keeping.

Harlan Jacobs, Genesis Business Centers: [00:44:24] That’s good advice. One of the other things I do oftentimes before I’ve accepted a consulting assignment is I will meet with people for coffee and give them some advice over the phone. And I’m always careful to explain to them, “I’m going to help you at this point in time up to a certain point. And for these services that are gratis, I’m happy to help you. At some point in the future, I’m going to come back to you and say, ‘Okay, the introductory period is over. If you’d like to have ongoing services, then, now, we need to have an agreement for services.'” And by telling them that in advance, and then by actually doing some things that are hopefully useful for them, and they appreciate it, it’s more likely that they’re going to take me up on the consulting assignment at the future point.

Harlan Jacobs, Genesis Business Centers: [00:45:15] So many of them are afraid that they signed a contract with you, and you take the retainer, and you do nothing. And I can understand that anxiety on their part. So, I always like to help people with a little bit. And then, if I’ve actually done something pretty good for them, and I say to them, “Okay, now it’s time for the contract,” and they say, “No, thanks,” then, I look up and I go, “Thank you,” because I’ve just found out that this is one of those persons who’s a taker and believes in a sense of entitlement, and I’d rather know that now than a year and a half from now. So, “Thank you. Good luck to you,” and that’s fine.

Mike Blake: [00:45:53] So, that touches on another point. We’re talking with Harlan Jacobs, and we’re talking about working with startups. And I can’t speak for the Minnesota environment but down here in Atlanta, we do have, I think, a very strong pay-it-forward environment here. Many of us who have experience will make ourselves available to give advice and support to startups. I’ve had monthly office hours for a long time. And I’m curious what you think about that model. Is that something you’ve ever done yourself? Have you seen others do it? Do you think it makes sense? Do you think it’s crazy? What does that sort of thing kind of sound like to you?

Harlan Jacobs, Genesis Business Centers: [00:46:37] Well, first off, I compliment you for being part of a community here that does that and for you yourself doing it. That’s a common ethos here in Minnesota. In fact, we’re the home of what’s called The 5% Club, where major corporations, starting with Pillsbury and General Mills, gave 5% of their pre-tax profits to charity.

Harlan Jacobs, Genesis Business Centers: [00:46:58] Now, as to in-person service, paying it forward, paying it back, yeah, that’s part of our ethic, our social ethic here in Minnesota. And I think it’s great. And it helps us to make up for the fact that we’re not a bastion of venture capital. I’ve seen great ideas here fail to get local funding, and these things would have got funding in Silicon Valley; and therefore, they need a lot of extra coaching and talent.

Harlan Jacobs, Genesis Business Centers: [00:47:26] Another problem that we have, which we try to overcome in the mentorship thing, is in Silicon Valley, you fail, and that entitles you to a hearing with the venture capitalists to do another deal. In Minnesota – I don’t know what it’s like in your community – you still get this … remember the book, The Scarlet Letter? Here, you get a scarlet F on your jersey for failure, and you hardly ever get a second round of capital from anybody for your next company if you’ve had a failure in your first company. And that’s a problem that we have here, and it requires extra care and attention on the part of those of us who can help these people.

Harlan Jacobs, Genesis Business Centers: [00:48:05] I was going to be an actuary, and in college we had to study statistics. And I remember a type two error is the rejection of a valid hypothesis. And I’ve seen so many valid hypotheses go unfunded here. In fact, I have companies in the medical device realm, helped them get started in 1996, and they’re still looking for more funding, and the technology is still viable. There’s been no shelf life for it. So, you just have to keep helping these people, whether it’s their first time or whether they’ve been at it for a period of time. It might sound arrogant to say, but it’s sort of a modern-day version of noblesse oblige. If you’ve benefited from other people’s help, it’s time for you to help other people.

Mike Blake: [00:48:51] Yeah, we have a similar concept. We try to push the buttons of the elevator that goes down to pick the next guy up. But we do have that scarlet F here as well, which is unfortunate because I don’t know if there’s any better education than a business failure. And in fact, one of our early podcasts, Miles King came on, I want to say it’s podcast number 12, or 13, or 14, something like that. And he was on a program whose title was “Should I Close My Business?” And he’s had to close a couple of businesses, and he was a courageous guy to come on, and was willing to sort of lay it out there and talk about the failures.

Mike Blake: [00:49:32] And one thing he made very clear, and I’ve learned about him as I’ve gotten to know him, is that the success that he enjoys now is a direct result of what he learned from the previous failures. He didn’t raise external capital. He just simply worked his ass off and bootstrapped it. But I remember when I asked, his first venture was a pizza restaurant and it failed. And I said, “What was your thought process about starting another?” He said, “I had to start another one. Otherwise, everything I invest in the education in the first one would have gone to waste.” And, unfortunately, that’s something only time is going to figure out. There are very few places, unfortunately, that celebrate failure, that see that as the education that it is. And unfortunately, this got to sort of take time.

Mike Blake: [00:50:26] Harlan, we’re running out of time here, and I want to be respectful of your time and, of course, that of the audience. This has been a neat conversation with a lot of good nuggets in it. If people like to contact you for more information to carry on this discussion, can they do so? And if so, what’s the best way to do that?

Harlan Jacobs, Genesis Business Centers: [00:50:45] Sure, I’d be very pleased to hear from any of your colleagues and viewers. Telephone number is 612-701-8153. And the email address is harlangenesis@mac.com. And I’m on LinkedIn. And I guess that’s probably the best way to try.

Mike Blake: [00:51:11] Well, thank you. That’s going to wrap it up for today’s program. I’d like to thank Harlan Jacobs so much for joining us and sharing his expertise with us. We’ll be exploring a new topic each week. So, please tune in, so that when you’re faced with your next business decision, you have clear vision when making it. If you enjoy this podcast, please consider leaving a review with your favorite podcast aggregator. It helps people find us, so that we can help them. Once again, this is Mike Blake. Our sponsor is Brady Ware & Company. And this has been the Decision Vision Podcast.