The Rick Roll. It’s classic. Some might even call it legendary. Rick Roll your friends & family. Rick Roll your co-workers. Heck, Rick Roll me. We will all belly laugh as “Never Gonna Give You Up” blares on our computer speakers. But please don’t Rick Roll venture capital firms.

By Rick Rolling a venture capital firm, I mean don’t attempt to bait and switch or otherwise mislead venture capital firms with your startup company’s pitch. They won’t find it very funny and they have seen it all before.

Here are some common venture-capital-pitch Rick Rolls:

A flock of fancy employees are on the way. Don’t talk about all the great Google execs that are coming onboard as soon as your startup gets funding without evidence to back up your claims.

Company X is our partner. “Partner” is an ambiguous term which leads to additional ambiguous language. Don’t go on and on about how you’ve “talked” with some “key executive” at Company X and how “excited” they are to become “involved” with your startup.

Company Y will want to acquire us. Don’t speculate about your exit strategy to a venture capital firm before you get funding. First, you should be more concerned with demonstrating the greatness of your startup’s idea and your startup’s ability to implement the idea, rather than hypothesizing about an event that might happen 7 years from now. And second, the venture capital firms will have access to better speculators than yourself.

My startup is the only one with this idea! Oh really? Have you checked every garage and co-working space in the world? I’d be willing to bet 25 others have your idea. Focus on the implementation of the idea rather than its extreme novelty.

While your venture capital firm might enjoy Rick Astley (it’s hard not to like a guy who sings and dances while sporting a raincoat with clear skies overhead), they won’t like being mislead by your startup company’s pitch. They’ve been Rick Rolled enough by other entrepreneurs to see yours coming. And they’ll likely feel your startup is unworthy of funding.

For another article about how to pitch venture capitalists, click here.

Have you ever tried to polish your sneakers? I have. And no matter what method or device I used to refurbish my sneakers, they remained unrefurbished sneakers. The problem wasn’t my washing machine, detergent, or shoe polish–it was that my sneakers just weren’t worth the attempt. Unlike other forms of footwear, sneakers just aren’t made to be polished.

This can be a valuable lesson for startups attempting to incentivize their employees: not all employees have the ability to be incentivized.

A startup can choose from a variety of carrot-and-the-stick incentive options to get the most out of their employees (capital-willing, of course). These options include salary, commission, bonus, stock, vacation, health insurance, retirement accounts, stock options, warrants, phantom stock, and other deferred compensation plans. But a startup must realize that some employees will not respond to any combination of incentives. Thus, your startup may have the right incentive plan but the wrong employee.

In Economics, the problem of motivating an employee to act on behalf–and in the best interest of–the startup company is known as “the principal-agent problem.” This problem arises when a principal compensates an agent for performing certain acts that are useful to the principal and costly to the agent, when it’s costly for the principal to supervise the agent. (Sound like your startup?) Basically, you solve the principal-agent problem by finding the right combination of incentives for the employee. However, the difficulty of selecting the optimal structure is reflected by the multitude of carrot-and-the-stick compensation mechanisms.

Economics assumes a lot of things, and the biggest assumption Economics makes is that people will act in a rational manner. But as we all know, people don’t always act in a rational manner.

Thus, you should not assume that your employee will respond in a rational way to your startup’s incentive offering. It may not matter what or how many carrots you dangle in front of your employee. Not all employees are made to be incentivized, just like not all footwear is made to be polished.

#5 - In your latest attempt to go viral, you call in to the Suze Orman Show and ask if you can afford to purchase your startup company, constantly letting her know how fantastic it is.

#4 - You start a blog about your blog about your startup company.

#3 - To get more street cred with VCs, you and your 2 co-founders change your names to Brad Feld, Paul Graham, and Dharmesh Shah, respectively.

#2 - Your startup company’s twitter account has less followers than I have.

#1 - You offer to pay your pizza delivery guy by issuing him common stock, and he counters with preferred stock and a 10x liquidation preference.

Choosing a startup’s legal entity can be a frustrating experience for the entrepreneur. Who has time to deal with the LLC, S-Corp, C-Corp, LP, GP, LLP & LLLP when you’re already buried with things like CSS, RoR, AJAX, PYTHON, PHP & ASP? Thankfully, if your startup is absolutely determined to raise venture capital, there’s only one viable legal entity decision your startup can make–the Corporation.

Does this include S Corporations?

No. While the S Corporation structure is a popular choice for entrepreneurs and other small businesses, it comes with regulatory limitations that do not make it a feasible vehicle for raising venture capital. The three main regulatory limitations are:

• S Corporations may only have one class of stock;
• S Corporation stockholders must be natural persons (except for some extremely limited circumstances); and
• S Corporations can not have more than 100 stockholders.

The one class of stock requirement is fatal to a venture capital investment since venture capital firms will demand preferred stock in return for their investment. Also, most venture capital firms are organized as limited partnerships and less frequently as LLCs–but both legal entity types aren’t “natural persons.” And finally, as your startup grows, the 100 stockholder maximum comes into play once your startup begins issuing stock and stock options to employees.

Thus, the C Corporation will be the only type of corporation viable for a venture capital investment.

Why not an LLC?

While the LLC is also a common startup vehicle, the C Corporation wins hands down when it comes to raising venture capital. The following 4 reasons explain why:

1. Pass Through Entity

While the pass through feature (income/losses are passed down to the shareholders rather than dealt with at the entity level) of LLCs are desirable to most entrepreneurs, venture capital funds do not find pass through taxation to be a similarly desirable feature. The venture capital firm does not want the accounting and tax matters of a funded venture to be passed down to the firm, and thereby be attributed to the venture capital firm’s tax exempt and foreign limited partners. Such a scenario could create unrelated business taxable income (UBTI) issues or have their foreign investors be deemed “doing business” in the United States and thus have to file a U.S. tax return.

2. Transferability

The membership interests of an LLC are typically not freely transferable by state statute. This makes the LLC a lousy entity for one of venture capital’s exit strategies: the IPO. (Not that IPOs for venture backed companies are hot at the moment.)

3. Predictability

Started in the late 1980s and only made more popular in the last decade or so, LLCs are a relatively new type of legal entity. Thus, there just isn’t a well developed set of laws and regulations for LLCs. Corporations, on the other hand, provide a larger degree of predictability with regards to corporate governance and stockholder rights.

4. The Venture Capital Firm’s Organizational Documents

Primarily due to the reasons outlined above, many venture capital funds will have specific provisions in their own organizational documents that prohibit them from making a venture capital investment in an LLC, or any other legal structure than a C Corporation. Thus, if your startup is absolutely against being a C Corporation, you could be declined by the venture capital firm regardless of how spectacular your startup is.

The Conclusion

The C Corporation is a venture capital firm’s clear-cut choice for the type of entity in which to place their investment. When the to-be-venture-funded startup is a C Corporation, various administrative and other burdens are minimized for the venture capital firm, which allows them (and their capital) to focus on developing the startup company’s business.

Founder stock sales are becoming more prevalent as part of a venture financing. Of course, getting paid has always been a priority for the entrepreneur, but founder liquidity is becoming an increasing trend in the venture world. Enter Series FF Stock.

Series FF was created for those founders desiring to cash out a small part of their overall stake in their startup company at a funding (rather than waiting to go public or get acquired). Thus, the FF class provides founders with the opportunity for a more immediate return on their investment of cash, blood, sweat, and tears.

The mechanics of Series FF Stock work like this: At a very early stage in the startup company’s life, the founders are issued a very weak class of preferred stock. The issued FF shares typically come attached with the right to convert into a future round of preferred (such as a Series B) and then sell the converted shares to investors. This conversion and sale can only take place at a financing.

The issue of early founder liquidity can lead to tension between investors and founders. The investors want to keep the founders properly incentivized. In theory, letting founders cash out any of their stake may make the founders disinterested in growing the newly-funded company.

My belief is that a little bit of liquidity for founders at funding may actually benefit the venture backed company. The founders may have maxed out credit cards or have other bills they incurred in order to get to their startup to the point of funding. Even if the founders are debt-free, I don’t think founders will lose focus over a (relatively) small payday compared to an acquisition or IPO exit.

Keep in mind that if a founder converts and sells Series FF shares, the founder’s equity in the company is reduced. Therefore, if an IPO or M&A exit is in the startup’s future, selling shares early will likely be a costly move for the founder.

For more background about the origin of Series FF stock, click here.

Bloggers optimize. Bounce rates, feeds, heatmaps, plug-ins, keywords, and sneeze pages are just the tip of the blogger’s optimization iceburg. So why are blogs sold in such a nonoptimal way?

Blog selling is once again a hot topic. Most articles deal with what multiple of revenue or subscribers a blog will sell for on the open market. This article, however, will show you how to get the high end of any valuation formula or method. All you have to do is use a dash of corporate M&A strategy.

To fetch a high price for your blog (other than taking an unsophisticated blog purchaser to the cleaners), you must copy how the corporate world would handle a similar acquisition. The corporate world would:

(1) Stay around to blog after the sale; and

(2) Use an earnout provision in the blog sale agreement.

STAYING AROUND

In the corporate world, business buyers are concerned revenue will suffer after the purchase. If a buyer cannot reduce the risk of a post-purchase revenue dip, the seller will not get the company’s full valuation. The buyer will simply discount the valuation and pay the seller less.

Key personnel loss is the main reason why companies suffer post-purchase revenue dips. Obviously, a blog’s loss of its blogger fits right in with this scenario. A blogger is the de facto key personnel of its blog.

Corporate buyers typically require key personnel to stay around and work for a specific duration as if the purchase did not take place. This helps reduce the buyer’s risk of a post-purchase revenue dip, as the company can hopefully achieve a seamless ownership transition by the time the key personel leaves.

The blogosphere has generally realized that staying around is a good idea for the blog seller. And I’m seeing that some bloggers do stay around after the sale. For example, Blogging Fingers just sold and the selling blogger will stay on for at least one week. But one week is not long enough to achieve a smooth transition of ownership and adequately reduce the risk for potential losses. I recommend that a selling blogger stay around for at least 3 months, and if possible, 6 months. 6 months may seem like forever in blog time, but keep in mind that corporate earnouts (see below) can last for several years.

So if a selling blogger agrees to stay around after the purchase, what will ensure that he or she will put forth the same effort into the blog post-sale? And why would the selling blogger want to stick around for up to 6 months?

THE EARNOUT

An earnout is a type of business installment sale under which the final purchase price is not fixed—it is contingent on the company’s future performance. Earnout agreements are often used to resolve disputes between a seller’s asking price and a purchaser’s valuation.

Earnouts are particularly useful when the seller has a limited history or unproven, but promising prospects for revenue generation. (Sound like your blog?)

This is how a basic earnout transaction works:

Step 1: The buyer makes an up-front payment to the seller. This payment is accompanied by the buyer’s promise to pay an additional amount if the company reaches certain goals.

Step 2: The seller continues to work as if the company purchase never occurred for a specific time frame.

Step 3: At the end of the term (or at various intervals), the company’s performance is evaluated against the goal provisions of the earnout clause.

Step 4: The seller stops working for the company and receives additional amounts if the earnout’s goals were met.

WHY THE EARNOUT IS PERFECT FOR BLOG SALES

The use of an earnout when selling a blog has advantages in addition to providing the monetary incentive for the blog seller, including:

(1) The buyer’s initial guaranteed investment in the blog is reduced, as is the risk it assumes (buyer only pays more if the blog makes more);

(2) The buyer may find the purchase will pay for itself out of future profits;

(3) The buyer and seller will reconcile their differences over the blog’s valuation and purchase price (e.g., if future revenue is low, the final purchase price will be low; if future revenue is high, the purchase price will be high); and

(4) The seller may be able to obtain a much higher purchase price than he or she would have obtained if an earnout was not used.

One scenario where the earnout provision can be put to good use is when the blog to be purchased is generating some serious traffic or has many subscribers, but has not fully monetized for whatever reason.

Keep in mind that the goals of an earnout provision can be tied to other factors than revenue. There’s no reason why subscribers or unique visitors could not be substituted for or used in addition to revenue.

While the earnout is a perfect way to handle a blog sale, I’m not aware of any blog selling sites that allow blog sales to be structured with an earnout. Sitepoint doesn’t even mention anything about staying on board in their FAQs about selling a website. It’s somewhat understandable, however, because earnouts can sometimes be difficult to set up. Yet they are well worth the hassle for both seller and buyer.

CONCLUSION

If you are selling your blog, you must realize that you have just entered the corporate world. Thus, you have two choices: (1) stay around after the sale, use an earn-out provision, and get paid for all your blog is worth; or (2) allow someone to purchase your blog at a discount, thereby wasting a large chunk of your blog optimization efforts.

##UPDATE: This post was chosen to be published in the February 2008 issue of the Texas Bar Journal. Check out how it looked here (PDF format).

Non-disclosure agreements (NDAs) can be important legal documents for the startup entrepreneur. If drafted carefully, the NDA can protect your confidential idea from being highjacked by employees and other parties. (Well, the NDA won’t actually stop the disclosure of confidential information, but it will make for a nice “EXHIBIT A” in your lawsuit against the leak.) Just don’t make the rookie mistake of asking a VC to sign your NDA.

Asking a VC to sign a NDA is tantamount to splitting 10’s at the blackjack table. You just don’t do it. In the least, it will show that you do not understand the mechanics of how VCs operate. At worst, the VC will burn your NDA and dump your submission in the trash.

If VCs maintained the practice of signing NDAs for each submission they received, only two groups would benefit: lawyers and paper companies. Lawyers would benefit because they would get to draft, edit, and negotiate each NDA. Additionally, the VCs would have to retain a team of lawyers to keep track of all the NDAs they’ve signed with the fund-seeking entrepreneurs that have come before you. Therefore, NDAs would increase a VC’s transaction costs and potentially prevent a VC from even hearing your pitch. Both reduce the already slim chances you will get funding.

So what do you do if you have “the next greatest thing” that no one else can know about? Don’t tell anybody about it. Or at least be careful and selective of what you reveal. You may not have to disclose the entire schematic to pique the interest of a VC. And if you do get some interest, a VC may be a little more willing to sign your NDA at that point. Finally, remember that “first to market” doesn’t always make you the winner.

When you incorporate your startup company, two main decisions arise. First, what type of entity should your startup company be? Second, where should you incorporate?

Of the two, entrepreneurs focus primarily on choice of entity–LLC, Corporation, etc.–and usually just incorporate in their home state. And home state incorporation will make sense for most. But for a few startup companies, incorporating in a foreign state like Delaware, will be a better decision.

Delaware’s division of corporations lists 4 reasons to incorporate in Delaware on its website:

Why Choose Delaware as Your Corporate Home?

More than half a million business entities have their legal home in Delaware including more than 50% of all U.S. publicly-traded companies and 60% of the Fortune 500. Businesses choose Delaware because we provide a complete package of incorporation services including modern and flexible corporate laws, our highly-respected Court of Chancery, a business-friendly State Government, and the customer service oriented Staff of the Delaware Division of Corporations.

Talk about selling your state short. I’ll see their four reasons and raise them one. Thus, the following are my top five reasons to incorporate in Delaware:

1. Flexible Laws. Delaware’s General Corporation Law is the most advanced and flexible business formation statute in the United States. It is designed to provide maximum flexibility in the structuring of business entities and the allocation of rights and duties among founders and shareholders.

2. No Wildcard Juries. If you do end up going to court to settle a dispute, Delaware’s Court of Chancery uses judges instead of juries. I don’t know about you, but I’d rather place my startup company’s legal fate in the hands of a well-trained expert than people whose legal experience consists of The People’s Court and Law and Order re-runs.

3. Precedence = Less Litigation. Since judges are used, decisions are issued as written opinions that your startup company can rely on. Thus, most Delaware corporations do not end up litigating disputes because their professional advisers examine these published opinions and construct deals to avoid lawsuits.

4. It’s Free! (Well, almost). Delaware charges $89 to incorporate. A little bit cheaper than California ($100..but they nail you for $800 every year in franchise fees), New York ($125), and a lot cheaper than Texas ($300). [note: Even if you incorporate in a foreign state like Delaware, your startup company may still be subject to registration as a "foreign entity" and compliance with the laws of states you transact business in.]

5. Privacy. In a world where personal privacy is constantly eroding (the Google 3D Mapping truck should be driving by my house anyday now), Delaware does not require director or officer names to be listed in the formation documents. Thus, Delaware provides a level of anonymity from snoopers.

Even though this post makes a big push for incorporating in Delaware, you shouldn’t assume Delaware is the default choice for your startup company. The fact so many large, public companies choose Delaware should demonstrate that large, public companies tend to benefit the most from incorporating in Delaware.

So think about it and discuss incorporating in Delaware with your co-founders and professional advisers. But note that if you are planning to work with an investment bank or venture capital fund, you will likely have no choice but to become a Delaware entity. And for the five reasons above, that may not be such a bad thing.