Monday, February 28, 2011

Space (and) The Final Frontier

Part 5 in a series in Startup Stages

In this post, we deal with the last two pre-institutional funding risk triggers.

Leasing Space
One mistake startups make is leasing dedicated space too soon. In some cases this is unavoidable (e.g. if you are a manufacturing company handling hazardous materials or requiring heavy equipment). But for software, Internet, or light hardware development, there may be more cost effective options.

Leasing can add considerably to the cash burn, administrative overhead, and risk of a startup. While the NNN lease rate may be low, required insurances, taxes, utilities, common area expenses, and maintenance can easily double the rate. In addition, landlords often require multi-year (3-5) agreements with security deposits, tying up or committing limited cash.

On top of this, there are upfront costs associated with tenant improvements, furnishing, and permits.

New compliance issues include:
  • Local fire department regulations/ inspections
  • Insurance policies: property and liability ($1-3 million policy coverage required by most landlords)
  • Worker health and safety including evacuation plans, notice postings
  • Special operating permits depending on the nature of the business (e.g. environmental, hazardous materials)
Additional overhead:
  • Utilities (electric, gas, water, janitorial, alarm service)
  • Facility maintenance and repair (don’t assume the landlord covers it)
  • Facility safety
Really think through whether you need to lease space. While employees create value, furniture does not.  If you must lease space, take a look at which employees really need to be physically co-located and which do not. (It’s amazing how space efficient a person with a laptop, Wi-Fi and a cell phone can be.)

As an alternative, consider hosted office space (also called executive offices). While at first glance, base lease rates are more expensive than dedicated space, total operating costs may actually be cheaper. Hosted offices usually come fully furnished with utilities, are available on one year or shorter leases, don’t require insurance, and have a range of amenities including kitchens, meeting rooms rentable by the hour, office equipment charged on a per use basis, and reception desk services.  Just watch the notice period requirements for cancellation; they can be as long as three months!

The Final Frontier:  Accepting Customer Purchase Orders
Congratulations! You're no longer pre-revenue; you’ve closed your first sale! The P.O. or contract just hit your email… and with it a new set of legal obligations.

A purchase order is a legally binding contract and by its acceptance, the startup is obligated to perform in accordance with the terms and conditions negotiated. In addition to price and delivery, terms to be negotiated should include:
  • Product or service acceptance criteria (specifications to be complied with or other conditions that allow closing of the contract and subsequent invoicing)
  • Warranty terms, indemnities, and other liabilities
  • Damage exclusions
  • Title risk transfer
  • Payment terms
In order to avoid reinventing the wheel for each contract, the startup should have its own standard sales T’s and C’s covering these. If the startup doesn’t furnish its own T’s and C’s, it could inadvertently end up agreeing to the customer’s T’s and C’s.

Assuming the startup has the associated operational infrastructure for sales order processing, development, production, quality control, and shipping, the additional administrative overhead required includes:
  • Sales terms and conditions
  • Accounts receivable, invoicing, and collections
  • Insurance policies: product liability and/or errors & omissions (services)
If the startup uses distributors or sales representatives, it will also need the appropriate agreements defining the commercial relationship.

Next and final post in the series:  Dealing With It

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