STARTUP

Peter Thiel's 3 Rules for Starting a Business

The PayPal co-founder and VC has landed a new gig: college professor. Here's some of the wisdom he's sharing with his students at Stanford.
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Peter Thiel is an accomplished guy who's known not only for being one of the founders of PayPal and a successful VC, but also as someone's who not afraid to articulate bold ideas and put them into action. But now he's adding one more item to his resume: college professor. The outspoken start-up veteran is teaching a class this semester at Stanford (despite encouraging would-be entrepreneurs to drop out of college) and lucky for those who can't get a seat in the full-up course, one helpful student is posting his lengthy lecture notes online.

Stanford Law student Blake Masters' notes are detailed and well worth a read in full if you're interested in the deep dive, but to give you a flavor of what they hold, here are some of the essential points of Thiel's sixth lecture, just posted this week, which covers the rules for founding a business, particularly a tech startup.

"A startup messed up at its foundation cannot be fixed," Masters has Thiel saying (all quotes are from Masters' notes so there is no guarantee they reflect Thiel's words 100 percent accurately—they're likely to be paraphrases). Not unexpectedly for someone who sees foundings as so critical, Thiel has a number of firm rules for the early stages of starting a business. What are they?

Nail the culture right from the start. 

The early days of a company is a golden opportunity to set ground rules and establish the structure (or lack of one) in which things get done. "There is, of course, a limit to how much you can do with rules. Things can and will break down even with perfect rules. There is no real chance of setting things up correctly such that the rest unfold easily," concedes Thiels, but he adds, "you should still get the early stuff as right as possible."

What is the right culture? Thiel suggests thinking this through with a 2 x 2 matrix. "On one axis you have good, high trust people and then you have low trust people. On the other axis you have low alignment structure with poorly set rules, and then a high alignment structure where the rules are well set." Young Google was high trust, low alignment. Foxconn is low trust with lots of rules. "This is basically totalitarianism," says Thiel, but argues different cultures work for different companies. His preferred combination is, "high trust people with a structure that provides a high degree of alignment… People are rowing in the same direction, and not by accident."

How do you achieve the right culture? "One factor dominates all others," according to Masters' notes. "Whether the founders are aligned with each other... is key both in terms of structure and company culture. If the founders are in sync, you can move on to the rest of the equation. But if they aren’t, it will blow up the company. Nothing will work."

Be a Delaware C-corp.

No if, ands or buts about it. "A very important preliminary question is how you should set up your company. This isn’t a hard question. You should set up as a Delaware C corporation. That is the right answer," insists Thiel. This separates your business and personal affairs, offers flexibility when it comes to issuing stock, and makes it possible to exit the business by going public. "The big disadvantage for C corps is double taxation," but the advantages outweigh this problem.

Make sure ownership, possession and control are aligned.

First, some definitions. "Ownership is who actually owns the company. This means who has equity and in what amounts. Possession is who operates the company. That is, who, on a day-to-day basis, is making decisions and doing stuff in company offices. Finally, control is who exercises control over the company in a formal sense. Control lies with the various people you put on your board, most of whom really don’t know your business that well," according to Thiel. Have these groups working at cross-purposes and you're going to struggle. "Employees tend to have lots of day-to-day possession, small ownership stakes, and very minimal control. But issues arise if they’re not happy with their ownership or control pieces. Things are even trickier when you add investors to mix," Thiel says.

It's your job to sort out these different groups so they're working in concert. Start with compensation. "In tech startups, equity is the classic alignment tool… Since everyone benefits from an increased share price, everyone tries to increase the share price." But beware where it can go wrong. "The flipside of that is that bonuses and cash salaries produce opportunities for misalignment. Salary caps are very important. A categorical rule of thumb that Founders Fund has developed is that no CEO should be paid more than $150,000 per year."

Of course, as businesses advance, angel investors, VCs and board members are added to the mix, creating many more complexities. Good thing Thiel has a ton more to say on the subject. Just check out Masters post for the rest of his thoughts.

IMAGE: Courtesy company
Last updated: May 1, 2012

JESSICA STILLMAN | Columnist

Jessica Stillman is a freelance writer based in London with interests in unconventional career paths, generational differences, and the future of work. She has blogged for CBS MoneyWatch, GigaOM, and Brazen Careerist.

The opinions expressed here by Inc.com columnists are their own, not those of Inc.com.



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