Positioning Your Start-Up For Success: Advice to Entrepreneurs Forming a Company

Positioning Your Start-Up For Success: Advice to Entrepreneurs Forming a Company Joshua D. Fox, Esq.

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Corporate Formation

Possibilities:

– Partnership – Limited Liability Company – Subchapter S Corporation – Subchapter C Corporation

Considerations:

– Tax – Liability – Number and Types of Owners – Funding Plans

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Under which jurisdiction’s law should we organize?

Which type of entity should we choose?

© 2014 Wilmer Cutler Pickering Hale and Dorr LLP

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Corporate Formation

What Type of Entity Should We Choose? Partnership

– “Pass through” tax treatment

– No limit on number or types of owners

– All owners do not necessarily have limited liability

– Not an investor-favored form

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Corporate Formation

What Type of Entity Should We Choose? Limited Liability Company


– No limit on number or types of owners

– All owners have limited liability


– Cost and time to administer

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Corporate Formation

What Type of Entity Should We Choose? Subchapter S Corporation



– Limit on number and types of owners

– Limit on classes of equity


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Corporate Formation

What Type of Entity Should We Choose? Subchapter C Corporation


– No limit on number and types of owners

– No “Pass through” tax treatment

– Investor-favored form

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Corporate Formation

What Type of Entity Should We Choose? Become a C-Corp if you want to:

– Obtain VC funding

– Go public

– Use equity to compensate employees

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Corporate Formation Where Should We Incorporate?

Delaware

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Protecting Your Intellectual Property Who owns IP created prior to incorporation?

– You?

– People who collaborated with you?

– Former employers?

– University?

Answer: It could be some or all of the above.

Answer: The Company does not own it (yet).

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Protecting Intellectual Property

How do we make sure that the company owns all of its intellectual property after incorporation?

Answer: – Assignment of inventions agreements

– Non-disclosure agreements

– Licenses from third parties (e.g., universities)

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All Founders By: All Collaborators All Future Employees


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Establishing Relationships with Employees and Independent Contractors

Protect the company when establishing relationships with founders and early-stage employees and independent contractors, not any single individual

Standardized terms covering – At-will employment (offer letters)

– Vesting of equity

– Assignment of inventions

– Non-disclosure

– Non-competition and non-solicitation

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Issuing Equity Prior to Fundraising

Allocation of Equity: Beware of splitting stock ownership 50/50 among two

founders

Eliminate discussion of percentages; Translate into share numbers

Consider contributions to date and expected roles for the future

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Issuing Equity Prior to Fundraising

Dilution: Plan in advance for equity grants to be made to new hires

Dilution can be a good thing: – Dilution typically necessary to bring in cash or human capital to

grow the business

– Smaller piece of bigger pie

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Issued and Reserved Shares

Issued shares recommended = 2 million per founder

Purchase price per share = $0.001 per share

Total amount paid by each founder = $2,000

Purposes of initial cash contributions: – Adequate capitalization (limit liability)

– Pay initial filing fees (Delaware incorporation and foreign qualification in other state(s))

Reserve: 20% for stock option pool (1 million shares if two founders with 2 million shares each)

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Vesting of Equity

Company’s right to repurchase unvested shares of founder stock at original purchase price – Compare repurchase of vested shares at fair market value

(reduces incentives)

Protection for co-founders in the event one or more co-founders leaves

Helps ensure that co-founders’ equity better reflects actual contributions

Expectation of VCs and sophisticated investors that founders will stay on to build the company

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Vesting of Equity

Typical Schedule: Vesting over 4 years – 1 year cliff of 25% and monthly thereafter

Possible up-front vesting as “credit” for service provided to date

Acceleration of Vesting – Option #1: Upon change in control (single trigger) – Generally

disfavored by buyers and VCs; Consider precedent; Possible 25-50%, then reduction in number of years vs. retain original schedule)

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Vesting of Equity

Acceleration of Vesting – Option #2: Upon termination without cause (single trigger) –

Generally disfavored by company/co-founders and investors (difficulty establishing cause)

– Option #3: Following sale of the company, if termination without cause or for good reason (double trigger) – Generally acceptable (even 100% acceleration – often within 12-18 months of sale)

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Section 83(b) Elections

Founder typically files 83(b) election when issued restricted stock and paying fair market value for stock

Without making election, stockholder has taxable income as stock vests - difference between fair market value of shares that vested and the price paid for such shares

With election, taxed on difference between fair market value of all unvested shares at time of grant and the price paid for such shares – No tax payment when price equals fair market value

Within 30 days of Board approval of issuance

Consult a tax advisor (personal tax matter)

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Lock-Up and Restrictions on Transfer

Lock-up – Founder agrees not to sell shares during a specified period

following an IPO

– Typically 180 days

Company Right of First Refusal – If founder wishes to sell stock to a third party, company has the

right to purchase the stock on the same terms as those offered by third party

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Voting Agreements / Rights of First Refusal Agreements / Co-Sale Agreements Typically put in place in connection with a financing; Do not

recommend such agreements among founders before financing - Voting Agreements

• Election of Directors • “Drag Along” provisions

- Rights of Refusal in favor of stockholders (investors) after company

- Co-Sale Rights in favor of stockholders (investors)

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Conclusions

Do the right (simple) things now - you’ll save time, effort and expenses later. Form the Appropriate Entity

Protect the Company’s IP

Establish Relationships with Employees and Independent Contractors that Benefit the Company

Issue Equity in a Manner that Plans for the Future

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Contact

Josh Fox

[email protected]

781-966-2007

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Wilmer Cutler Pickering Hale and Dorr LLP is a Delaware limited liability partnership. WilmerHale principal law offices: 60 State Street, Boston, Massachusetts 02109, +1 617 526 6000; 1875 Pennsylvania Avenue, NW, Washington, DC 20006, +1 202 663 6000. Our United Kingdom offices are operated under a separate Delaware limited liability partnership of solicitors and registered foreign lawyers authorized and regulated by the Solicitors Regulation Authority (SRA No. 287488). Our professional rules can be found at www.sra.org.uk/solicitors/code-of-conduct.page. A list of partners and their professional qualifications is available for inspection at our UK offices. In Beijing, we are registered to operate as a Foreign Law Firm Representative Office. This material is for general informational purposes only and does not represent our advice as to any particular set of facts; nor does it represent any undertaking to keep recipients advised of all legal developments. Prior results do not guarantee a similar outcome. © 2014 Wilmer Cutler Pickering Hale and Dorr LLP

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Date post:	13-Jan-2015
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Positioning Your Start-Up For Success: Advice to Entrepreneurs Forming a Company

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