How to Start a Startup Lecture: Legal and Accounting Basics for Startups

Presenters: Kirsty Nathoo and Carolynn Levy

Setting up a separate legal entity. What kind of entity? You want to create a separate one

  • Delaware Corporation – Delaware is the easiest place to incorporate.
  • Keep it simple – incorporate as a Delaware corporation and don’t say you will just convert later.
  • How to do this?
    • fax two pieces of papers to delaware saying you will be making a company
      • do due diligence, set a CEO, officers, secretary, etc.
      • Designate your assets, IP, code, etc.
      • Ask yourself if you are doing it as yourself, or if you are doing it as a separate entity
    • You can use a law firm, or online
      • clerky.com is a great resource
    • Keep signed official documents in a safe place – don’t lose them
      • you will need them in fundraising, selling the company, etc.

Equity

  • Equity allocation
    • How much equity for each founder?
    • Execution has greater value than the idea. A mistake startups make is that they give too much value to the founder that is credited with coming up with the idea.
    • Founders should have pretty equal equity, if not, it will likely lead to issues. i.e. the founders are not in sync with eachother
    • Looking forwards, not backwards – founders that are thinking forward will focus on everything going forward, not focused on who’s idea it was or who wrote the most code, etc.
  • Purchasing
    • Paperwork – you need to document this. You need to sign a stock purchase agreement.
    • 2-sided transaction: you are getting shares in return for cash, IP, invention, etc. that you are giving.
    • Stock should be restricted- vesting schedule
      • There is no way to go back and fix this, and it has blown up deals in the past. The 83B election – it impacts your taxes and the company’s taxes. You need too sign it and prove that you sent it in to the IRS.
  • Vesting
    • “shares that are subject to forfeiture”
    • Standard vesting period is “4 years with a 1 year cliff”
      • After one year the founder owns 25% of shares
      • Then after that it vests monthly for the next three years
    • A company can repurchase shares – by righting the founder a check
    • You want to do this in case a founder leaves the company – if they leave, it is not fair to the other founders.
      • It gives them skin in the game
      • Single founders should have vesting too
        • skin in the game
        • applies to the culture of the company, requires employees to have a vesting schedule as well
      • Investors do not want to put money in a company where the founders can quit and still maintain their equity.
  • Fundraising
    • Logistics
      • Priced vs. Non-priced rounds (Price = valuation)
        • Convertible notes and safes
        • Convertible notes – you invest 100k and have the rights to purchase at a priced round in the future…
        • Non-priced rounds have a cap. How a cap works is that if an early stage investor invests 100k with a $5M cap, and in the next round the valuation is $20M. That early stage investor would get 4X the shares of the next stage investor.
      • Paperwork needs to be filed!
        • Standard documents
        • different investors might have different rights
        • Use Clerky.com for this
      • Dilution
        • If you give away 25% of the company in the first round and 20% in the second round, you end up diluting and giving away 45% of the company
      • Investors need to be savvy and understand the risk associated with their investment- look for accredited investors
        • Your uncle that let you borrow $10k might get disenchanted and want it back
  • Investor requests – the burden is on YOU to know what the investor is asking for and what you are getting yourself into
    • Board Seat – you want to say know. Make sure if you do it, that they will add value to your company
    • Advisors – everyone wants to give startups advice. Investors will be a de-facto advisor. you should not have to give them additional shares or money because the investor already does have skin in the game and should want the company to succeed because of their investment. Asking for additional shares is just them looking for a freebie.
    • Pro-Rata rights – right to maintain % of share in a company by offering them rights to buy them in order to avoid dilution. The biggest issue for founders is that it will almost always result in the dilution of their ownership as well
    • Information rights – Investors always want information. It is a good thing to give investors monthly updates, but watch out for over-reach if they want weekly updates or budget, etc.
  • Company Expenses
    • What is a business expense?
      • Paying employees, hosting costs, office expenses
        • You can write business expenses off on a tax return
        • The company will have its own bank account that you will have to keep separate from your own.
        • The investors gave you money and trust you to use it to make the company a success
    • Keeping track of expenses
      • Keep all of the receipts to understand what are and what are not business expenses
  • Doing Business
    • Founder employment
      • Founders are employees of the company and must be paid wages/salary
        • Working for free is against the law- even for founders
        • Run lean (minimum wage)
      • Set up a payroll service, you need to pay your payroll taxes
    • Hiring and firing – your co-founders can fire you
      • Unpaid wages become leverage – a fired founder
      • Avoid problems by…
        • paying your co-founders
        • Paying yourself
        • Paying your payroll taxes
    • Hiring your employees
      • Paperwork
      • Consultant vs. employee
        • There are subtle differences:
          • Both an employee and contractor will sign documents assigning any IP they create to the company they are working for
            • Contractors will sign a consulting agreement, not withhold taxes, but you need to provide a 1099
            • Employee will sign an IP assignment agreement. But the company will pay taxes, is responsible for paying those over to the founders.
            • Employees MUST also be paid a wage, they cannot make less than minimum wage and they cannot just take equity.
              • You must pay all required fees: workers compensation fees
              • You need to see proof that the employee is approved to work in the U.S.
              • Just use a Payroll service provider
      • Equity for employees
  • Firing Employees – “you are not a real founder until you have had to fire somebody.” You have to do what is right for the company vs. what is easily
    • Fire quickly – don’t let a bad employee linger. If a bad employee stays around too long, it can create toxic
    • Communicate effectively – do not elaborate. don’t rationalize, don’t apoligize. Just say “we are letting you go”. Have a 3rd party present.
    • Pay wages/salary up to the point of termination (and accrued vacation)
    • Eliminate access
    • Repurchase unvested stock
  • Legitimacy
    • Know your key metrics
    • Balance sheet and income statements
    • Tax returns

Q&A

  • How to search for an accountant, how to do this?
    • Bookkeeper vs. accountant – tax returns have to be prepared annually by an accountant – it is not worth the founders’ time
    • How to find one? Recommendations from people. It is best to deal with people that are used to dealing with startups.
  • Budget for incorporating? If you use Clerky – it is in the hudreds of dollars, not the thousands. Don’t waste a lot of money on it. Once you get moving on, it will dictate the level of legal costs. Clerky has a lot – past just the incorporation, they are a great resource.
  • Cryptocurrency – banks struggle with dealing with cryptocurrency at this time.

RG

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