How to build a tech ecosystem: The essential building blocks for your city

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Originally posted on TNW

I’m continuously excited when I hear about how many new ecosystems are evolving and growing across Europe and around the world. It truly is an exciting time in history for us to live in with many new innovations being generated by smaller companies rather than a concentrated few.

Aside from helping economies move forward through the creation of jobs and wealth, a thriving ecosystem allows startup founders to connect with other founders and share stories about how to overcome technical and commercial problems they may be facing.

Building anything new is hard, never mind alone and in a vacuum, thus sharing experiences with others should not be under-appreciated. Additionally, a growing ecosystem unlocked pools of capital be they private or public that are already existing in the local community and put them to work on improving and developing the community further.

Using London as an example, I’ve seen the local ecosystem evolve from its nascent stages, to where it is today, rivaling New York (according to Mayor Michael Bloomberg) at the global scale. This growth has been due to many factors, and I don’t want to seem to oversimplify what is arguable a very complex set of interplaying variables, but I do want to highlight some of the ones that stand out the most for me as drivers of a maturing ecosystem.

Local concentration of founders and other ecosystem players

In Steve Johnson’s book  ”Where Good Ideas Come From,” he talks about the power of a network and how proximity of nodes aids the network’s speed of development. In the case of London, the emergence of TechHub and later on Campus and Tech City has, over the past seven years, truly helped bring together many would-be founders and growing companies.

If you visit local buzzing digs such as Ozone Coffee, it is quite common to see investors and well-known founders intermingling. It is through this intermingling, across cafes, pubs, bars, and restaurants, that creates the serendipity that is required to have more ideas and decisions  ”just happen.”

The local culture’s support tone towards founders and local entrepreneurial heroes

Whilst it’s never easy to start a company, the process can easily be made twice as hard if you don’t have the support of your friends, family, and community. If your family thinks you are insane for not taking that corporate job and your friends think so as well, there is social friction in the ecosystem which prevents the unlocking of innovation.

Tolerance for failure is another aspect that is important for a culture of entrepreneurial innovation to occur. Failure both in terms of the personal failure, but also the legal failure. In a culture where failure brands and stays with you for life financially and socially, risk taking will naturally be discouraged.

While these aspects of a community are hard to change quickly, this is something that local governments and schools can help change through targeted media campaigns (as can be seen, for example, in other forms of government intervention programs and their success rates in changing popular perceptions such national health issues).

Quality of local education and engineering training

In London, we have some amazing universities, and thus, every year, a new crop of recently graduated engineers and other majors interested in starting a business enter the workforce.

For the most part, most large cities has distinguished academic bodies, so rarely is it about capability, but sometimes about offering students a place to experiment new ideas and providing them with applied internships. Universities are increasingly  developing internal incubators to allow students to exercise a more applied version of their education, which either leads to new developments, or more experienced founders.

Additionally, programs that help teach entrepreneurship to students, such the NEF, or to the public at large, such as Startup Weekend can greatly lead to an increase in the quality of the workforce and entrepreneurial mindset of a community.

Availability of HR talent and immigration reform

Aside from students, other individuals with experience are needed in a growing ecosystem. One quick way of bridging a shortage in staff in an area is to create immigration policies that allow for talented and capable individuals to enter the county and its labor force without major hurdles.

This is an area that many countries struggle with, particularly when the local population starts taking a protectionist slant towards employment opportunities. Nothing helps accelerate an ecosystem’s growth as the importing of highly skilled migrant talent.

The UK has, in many ways, led innovation in this area, originally with the creation of the Highly Skilled Migrant Programme (no longer available unfortunately) and the Startup Visa for founders in startups that have received £50K in investment. Innovations likes these have made some great strides in solving this problem for the UK, and I’m surprised how few other countries have attempted to solve this.

Access to successful mentors or serial entrepreneurs

It goes without saying that there are plenty of smart and accomplished in Europe. Companies such as Soundcloud  Skype, Transferwise and more were born out Europe and there are plenty of new companies that are creating technologies in hardware, fin-tech, and other areas.

The challenge for any emerging ecosystem is identifying these individuals and finding an efficient way for these potential mentors to meet promising new companies and founders.

A strong and growing media presence

As the old adage goes, “If a tree falls in a forest and no one’s around to hear it, does it make a sound?” Likewise, a successful startup story without an amplifier doesn’t help inspire others to do the same.

Of course, the media isn’t only about highlighting success stories, but also helps keep the ecosystem honest by bringing to light causes, political initiatives, key players, and even the occasional startup post-mortem to help founders navigate the emerging local tech industry.

Access to infrastructure

Building a tech startup is near to impossible if you don’t have access to a reliable and fast internet connection and access to key services such as hosting companies, social networks, and search engines (some countries block these services for various reasons).

This does mean some countries really struggle, but these problems tend to be ones that local governments are almost always keen on resolving quickly – not just for the tech community, but also for other communities. If censoring is an issue in your local ecosystem, that can still make things more challenging.

Access to experienced capital

Capital comes in many forms, but experienced capital can really make a difference to new companies. Experienced capital is not just about having made money before, but rather understanding what early stage startups are like and that they don’t fit the return profile, regularity, forecastability, or structure of real estate or private equity investments.

Experienced capital also knows how to coach and help founders along their journey rather than just auditing founders the way a public company analyst may.

Investors that understand how the global fundraising process works and know how to scale a company are hard to come by, so for sure any local ecosystem that has a few of these are very lucky, and the ecosystem as a whole can grow greatly by increasing the knowledge share between these individuals and the rest of the investment community.

Tax relief for investors investing in risky companies

Investing in startup companies can be lucrative if you do well and manage to back the minority of companies that do well. However, you will likely lose on most investments you make in the asset class because of its inherent risk.

This has always been the fundamentally difficult thing for new investors to digest when choosing to invest in startups versus, say, a well-structured financial product from a brokerage firm.

However, tax incentive schemes for investors led by the government, such as the SEIS program in the UK which allows investors to offset income tax and capital gains tax on positive returns on an investment, can greatly increase the attractiveness of high risk investments to investors.

Ecosystems who have government support to help investors invest more, generally manage to unlock stored pools of capital that can be repurposed to help stimulate the economy.

Tax relief for successful founders

In the same spirit as the above, ecosystems that offer founders some sort of tax relief on gains when exiting a company can effectively reduce the tax impact on them. This allows founders to have more available capital to invest in new startups. In the UK, this program is called Entrepreneur’s Relief.

Although not every exit will leave founders with a disposable net worth to invest in new startups, by creating the structure that encourages this, it merely becomes a numbers game of how many founders who are successful contribute back into the economy.

Couple with investor tax incentive schemas, you effectively create a virtuous circle of wealth creation that can be repurposed for further wealth creation.

Sure, not every founder will do this, but you just need a few to take this up, for it to be greatly effective.

Access to experienced legal counsel

Experienced lawyers can save a company a lot of time and money. I’ve seen deals go sour because someone’s counsel was not well-versed in standard terms or venture dynamics.

Lawyers are there to help you make things easier and protect you from things going wrong in the future, and not the other way around, but not all ecosystems have legal counsel that is well versed in venture law.

Initiatives such as the seedsummit termsheets, the series seed termsheets, and the BVCA documents – all available online – are good starting points for startups in emerging ecosystems to learn about what is normal and what is not. Then, if in the process of evaluating counsel for your company there is a mismatch between what you’ve seen and what they are familiar with, that is potentially a red flag.

Simplified local legal systems

Part of the legal challenge is not only just finding the right kind of lawyers to hire, but also in having the ecosystem have laws that help support Entrepreneurs. For example, laws that make it difficult to hire and fire employees make it hard for a startup to control cash burn as early founders will inevitably have to expand and contract as their companies go through natural peaks and troughs.

Simplification of the legal bureaucratic burden on the founder can make a huge difference: little things like allowing e-signatures can greatly speed up how quickly deals are completed vs having to have a notary sign or other more complicated structures which can slow things down.

And lastly, and considering how many successful startups come from after a founder has had at least one failure, a government’s treatment of company bankruptcy as either a black flag for the founder for ever more or as a state that does not tarnish one’s reputation from being able to try again.

To wrap it up…

In conclusion, whilst there are many variables to consider in how to help develop a local ecosystem, the above list are some that I see as almost very crucial to kick it off.

For example, note that I didn’t include things like interest rates or a thriving local M&A market… if an M&A market is present, for example, its great, but frankly, most foreign M&A markets pale in comparison with the global M&A market led by the top international corporations.

As such, a better place to start to try and influence change is to address the variables that are easier to adapt in the short term. In the longer term, as the ecosystem blossoms, the local corporates will take notice and will want to get involved.

If you like this post, please feel free to share with your local government officials to initiate a dialog about how to spur growth of your local community’s ecosystem.

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In Which Country Should I Incorporate My Company?

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An important decision that companies often ask when starting a company outside of the USA is ‘where should I incorporate?’.

The reason why this question comes up is often because there are a series of benefits pulling founders in different directions and many times founders can receive conflicted advice from well-intending advisors. Some of the issues that founders may be balancing as part of a decision on where to incorporate include things like tax implications (tax breaks or penalties), local grants, and paperwork. This is particularly the case when they are also thinking that the USA might be where they will end up in the future.

Therefore, the purpose of this post is to identify WHAT ISSUES to think about when making the decision so that you can feel more confident about it and it is NOT about recommending a specific jurisdiction to incorporate.

Let’s start by stating that, for the most part, incorporation decisions aren’t necessarily permanent. Yes, there are cases where you make things increasingly hard for you to ‘flip’ your company (flip = taking your company from one legal jurisdiction to another), but for the most part, you can almost always find a way to move your company later if it benefits you to do so. Generally, the cost of doing this will be proportional to the complexity and legal jujitsu your lawyers will have to do in order to make this happen (more on this later). So while not permanent, worth considering all options before taking the easiest or most obvious choice.

Now that you perhaps feel a bit more ‘relieved’ about the not-so-permanent nature of your decision, let’s look at some key factors to consider which will affect your decisions down the road:

1) Tax implications & Tax treaties – One of the key things that can really impact your personal returns and that of your investors, now and in the future, is whether there will be a tax impact to you (and your employees and co-founders). Consider things such as tax relief on returns as a founder or if you flip to a different geography in the future. Consider income tax liabilities as well as capital gains liabilities (note: links are to UK site, but there for definitions, which are universal). Additionally, for potential future investors, consider whether your local jurisdiction has a negative tax impact further down the line for them. These questions can sometimes be answered by tax specialists within your lawyer’s firm (particularly if your law firm has offices abroad) or your accountants.

2) Investor implications – As mentioned above, one reason why the jurisdiction of choice matters is because investors are optimising around what they know their tax implications are, but additionally, there are other matters in the final legal docs which they may prefer dealing with in their local jurisdiction rather than in new ones they are less familiar with. Additionally, they may have a preference where you incorporate due to tax relief they may receive as part of investing in your company. Company governance may also be affected by where you are incorporated. Certain company governance structures are enforced on your company depending on where you incorporate and investors may have an opinion on that one way or another.

3) Paperwork implications – Paperwork is clearly one of the bigger headaches of making this decision. This includes the interval in which you need to report as well as other requirements such as company filings required by Company’s Law of the country where you incorporate.

4) Residency implications – Some geographies may have a residency requirement for the founders, but others not. Keep this in mind, in particular if you don’t have the appropriate immigration status or it is hard to get it.

5) Human Resources implications – In some countries it may be harder for your employees to move to if necessary, and/or hiring may also be a problem because of lack of human capital or cost to hire and retain. Additionally, there may be restrictions on how you can hire / fire employees that might affect how you upscale / downscale your company’s employees. João Abiul Menano of CrowdProcess also suggests: “One should also considered tax over labor, in some cases a tax incentive given to an early stage start-up can largely help to keep the burn rate low (more important even for companies in which labor costs account between 70% and 90% of monthly expenses)”

6) Governance implicationsCorporate Governance requirements tends to vary from country to country. Since you’ll have to abide some of these requirements, you might as well familiarize yourself with these variables before making your decision.

7) M&A implications – When your company does eventually get sold or merged or floated, it’ll have to go through a process. In some countries this process is straight forward and simple and easy for potential acquirers to understand and do quickly. In other countries, it may be less known and thus may cause delays or complications.

8) Free Information Availability –  Although you will likely have a Lawyer helping you through many of these topics, it’s always great when you can learn on your own from others’ experiences. Some jurisdictions have more founders sharing on forums and the like, how they overcame their specific problems. This can be a very valuable way of reducing your cost to learn and thus reducing your legal costs as you know which issues to flag to your lawyers.

Having reviewed all of these issues with your current and/or future shareholders, you should at least have a better starting point to make a well thought-out decision.To further elaborate on these topics, and to be more specific about one particularly common case for UK founders, let’s look at UK vs US incorporation.

Tina Baker, of JagShaw Baker breaks down what the key pros and cons are of incorporation in each:

UK Pros –

· Simple to set up

· Form (Template) documents available (Seedsummit and BVCA)

· Good for companies with international investor base – The UK is one of the most friendly of the European jurisdictions

· SEIS/EIS tax relief for investors may be available for your company –  helps more investors take an interest in investing in early stage

· EMI (for employees) may be available – helps to attract talented staff

US Pros –

· Well-developed template documents for seed investment (lowers legal cost)

· Lighter touch, more founder friendly

· Simpler mechanisms to issue shares (except for US securities laws)

· Document execution streamlined – can be easier than the UK at times

· Privacy – company information (board, shareholders) and financial information not publicly available for private companies

· Large and seasoned US investor base

· Can sell easily to US buyer via merger mechanism

UK Cons – 

· Many US investors will not invest in foreign entities (even if the UK is probably the best 2nd option if International)

· Information about the company (board, shareholders) and financial information publicly available (in some circles, this is seen as a pro….)

· Depending on investors funding rounds can be over-complicated – not all investors are familiar with using the streamlined forms that are readily available

· If you have US investors that are funds, you may be required to give tax covenants/indemnities

· Merger mechanism may not be possible if there is a sale to a US buyer, so exits may be more complicated

· A US listing may be more complicated

US Cons –

· Can be expensive, especially if there is no business in the US

· May not be as easy or as tax efficient to operate in Europe through a branch

· Possibly inefficient tax-wise if not generating major revenue in the US

· US Securities Laws are more complicated

· Filings required with the US Department of Commerce

· SEIS/EIS and EMI may not be available

While this decision is clearly not a black and white one, hopefully, the 8 factors to consider before incorporating highlighted above + the UK vs US example help you better understand how to approach making this decision for your specific case and which questions to ask your lawyers. It may very well be that there are some similarities between the above two countries and your own, but the best way to finalise this decision is by having a conversation with your lawyers about what is best for you, your investors and the jurisdictions in question.

If you have any additional points for founders to consider as they go through this process, feel free to post them in the comments below. Additionally, if you have any feedback on the points above or have a good story to tell about your experience through this process, feel free to post as well.

 

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