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business:company-formation [Jan 20, 2015 03:11 AM] dordal [Basics of Founding a Company - 2014] |
business:company-formation [Jan 6, 2024 08:01 PM] 34.217.21.167 old revision restored (Dec 8, 2023 04:42 PM) |
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+ | = Basics of Founding a Company - 2014 = | ||
+ | If you're starting a new startup, there are several things that you want to do right from the beginning, especially if you're looking for investment. This doc outlines the process I went through in February 2014. Depending on when you're reading this, things may have changed. | ||
+ | |||
+ | |||
+ | Broadly, things break down into four categories: | ||
+ | |||
+ | * Forming the Business Entity | ||
+ | * Issuing Stock (to founders and others) | ||
+ | * Handling IP | ||
+ | * Raising Money | ||
+ | |||
+ | == The Business Entity == | ||
+ | |||
+ | The first order of business is to actually form a business. There are any number of ways you can do this, but if you're starting a new company, you'll want a corporation, | ||
+ | |||
+ | * There are quite a few types of entities, such as corporations, | ||
+ | * C-Corps can have more than one class of stock (S-Corps can't, and LLC's don't even have stock), which is useful for investors, who typically want preferred stock. | ||
+ | * C-Corps have been around forever, and have a predictable set of case-law behind them. Other entity structures, like the LLC, are newer and have less developed law. | ||
+ | * Although corporations are tax-inefficient, | ||
+ | * A C-Corp is not a pass-through entity, which means investors don't have to deal with your tax issues personally (or as a firm). | ||
+ | * A C-Corp can have more than 100 owners, which will be critical down the line. Furthermore, | ||
+ | * You'll want to incorporate in Delaware, not whatever state you live in, because Delaware has some of the most business-friendly corporate laws, and the court system there is efficient and business-friendly. You'll still have to qualify as a ' | ||
+ | |||
+ | === Officers & The Board of Directors === | ||
+ | |||
+ | When you form your entity and issue stock, you'll need to choose officers for the company. These are the people who are responsible for the overall operation of the company, and have the power to sign documents, etc. There are three roles that you need to fill initially; these can be held by one person or different people: | ||
+ | * President: Overall responsibility for the company | ||
+ | * Treasurer: Handles the money | ||
+ | * Secretary: Records things for the company, e.g. meeting notes from a Board of Director' | ||
+ | |||
+ | You'll also need to form a board of directors. For now, it will mostly likely be the officers of the company. When you take investment, you will likely give up one or more board seats to the investors. | ||
+ | |||
+ | == Issuing Stock == | ||
+ | |||
+ | When you form a corporation, | ||
+ | |||
+ | You probably // | ||
+ | |||
+ | === Vesting === | ||
+ | |||
+ | Equity should vest, meaning that you don't get it all the day the company is formed. Instead, you get a portion of it over a period of time. The typical vesting schedule these days is a four year ( 48 month ) vesting with a one year cliff. That means that nobody gets anything for a year, and then at the end of the 12th month they get the first full year's worth of equity. After that, people get more equity monthly. That way, if a founder bails out after six months, they don't get anything. | ||
+ | |||
+ | You may want to put in specific provisions which allow you to accelerate vesting on certain events, such as a change of control (e.g. the company is sold). The most common provision here is ' | ||
+ | |||
+ | === Number of Shares === | ||
+ | |||
+ | The number of shares you authorize & issue can be somewhat arbitrary. First, the difference between authorized shares and issued shares: shares are authorized per the company charter, and it means the board //can// issue them. Issued shares are those that have actually been issued to an individual or an entity by the board. Authorizing more shares is a pain-in-the-ass; | ||
+ | |||
+ | A good rule of thumb is authorizing ~15,000,000 shares, but issuing ~10,000,000 shares to the initial founders. | ||
+ | |||
+ | === Founder' | ||
+ | |||
+ | You may want to consider setting up Founder Preferred stock ( a separate class of shares; typically Series FF ). This allows the founders to sell shares at the preferred share price, but doesn' | ||
+ | |||
+ | === Investor' | ||
+ | |||
+ | Unless you have investors the day that you form the company ( very unlikely ), you won't issue any preferred stock for investors. However, when you eventually raise a round, your investors will most likely want preferred stock. Preferred stock comes with superior rights to common stock, including: | ||
+ | |||
+ | * A [[http:// | ||
+ | * Veto rights for certain things, such as a sale of company; issuance of new stock, etc. | ||
+ | * [[http:// | ||
+ | * The right to designate a certain number of board seats. Having an odd number of people on the board is a good idea, and frequently, you'll see ' | ||
+ | |||
+ | === Pricing Shares === | ||
+ | |||
+ | There' | ||
+ | |||
+ | As an example, if your share price was $0.00001 and you were issued 1MM shares, you'd have $10 ' | ||
+ | |||
+ | Now say your share price was $10 and you were issued 1MM shares. You'd have a whopping tax bill on $10,000,000 of ordinary income! If your company sold for $15 per share, you'd only make $5 per share, and have to pay capital gains on that. So instead of paying the lower capital gains rate on ~$15/share, you'd get to pay it on only $5/share, and have to pay the much higher ordinary income tax rate on the first $10/share. | ||
+ | |||
+ | Preferred stock is generally issued at a ~5X valuation of the common stock. So if your common stock was $1/share at the time of funding, preferred stock would be $5/share. There' | ||
+ | |||
+ | ==== The 83(b) Election ==== | ||
+ | |||
+ | When you form a company, it is VERY important to file an 83(b) election if you have vesting ( which you should ). Normally, if shares vest, the IRS considers the shares to be taxable the day that they vest, not when they are issued. If you recall that shares are taxed at the ordinary income rate when they vest, you may realize the problem: as your company goes up in value, your share price is growing. As it grows, you start accumulating huge tax bills... for example, in the fourth year of vesting, if your share price was $10 and you had 250,000 shares vest that year, you'd owe taxes on $2.5MM. At the 39% marginal tax rate, that's $975, | ||
+ | |||
+ | The 83(b) election allows you to recognize the entire cost of all the shares as ordinary income today ( when you found the company ) and not as they vest. Thus your entire ownership vests as capital gains if/when you sell the company. | ||
+ | |||
+ | === Handling Money === | ||
+ | |||
+ | I'd recommend that you //DO NOT// contribute money to the company in exchange for stock. This creates a problem because it means you're pricing your shares in exchange for specific cash consideration. You want to keep your shares at the lowest cost basis that you can; if you pay for your shares in cash to get money into the company, you'll be having to pay more for them than you want to. | ||
+ | |||
+ | Instead of buying shares, you should make a loan to the company. This is much cleaner; you can expect to be repaid ( or more likely, have your loan converted to equity ) at the first funding round. ( Apparently, in some cases, investors may demand that the loan be forgiven. I'm less enamored with this approach, but I've been told it happens. ) | ||
+ | |||
+ | == Handling IP == | ||
+ | |||
+ | If you're starting a new company, there is undoubtedly some IP ( intellectual property ) which needs to be incorporated into the company. Most likely, you and your cofounders developed this before you started the new business. There are a few considerations here: | ||
+ | |||
+ | First, can anybody else reasonably claim title to the IP? A previous (or current) employer is a big worry; if you work on the search team for Google, and then decide to leave and start your own search engine, you could be in trouble. Google most likely has an agreement with you which says that anything you develop belongs to them, and they won't be too happy with you taking that and going to start a competing company. | ||
+ | |||
+ | Second, you somehow have to get the IP into the company. This is typically done initially in exchange for stock (e.g. you get your shares in the company in exchange for giving up the IP ). When you form the company, you'll sign a Technology Assignment Agreement, which says all IP you've created to date belongs to the company, as well as an IP Inventions and Assignment Agreement, which will detail that all future IP you develop will become property of the company. | ||
+ | |||
+ | == Raising Money == | ||
+ | |||
+ | And now, the all important part: raising money. You'll likely have two rounds in the first few years; a seed round and (hopefully) a Series A. | ||
+ | |||
+ | === Seed Round === | ||
+ | |||
+ | The most common thing for the seed round is a ' | ||
+ | |||
+ | * A maturity date of 12-18 months, which means you'll need to raise money before that date. | ||
+ | * If you do a ' | ||
+ | * Typically, there might be a discount on the conversion, e.g. the loan will convert with 20% off the per-share price. This compensates the initial investors for the early risk. | ||
+ | * These loans frequently have a cap; e.g. a $6MM pre cap. This means that if your pre-money valuation is more than $6MM, the seed investors get to covert their debt as though the cap was $6M. | ||
+ | * If you don't raise money by the maturity date, the terms typically say ' | ||
+ | * If you do pay them back, it will be at some interest rate; typically 6% to 8%. | ||
+ | |||
+ | The biggest advantage of a convertible note is that they' | ||
+ | |||
+ | === Series A Round === | ||
+ | |||
+ | At some point, you (hopefully) will have enough traction to raise a Series A round. This will be a priced round, meaning that you will negotiate a pre-money valuation for your company ( say $5M ) and then the amount the investors will invest ( say another $5M ). You then issue new shares in exchange for the cash invested; in this case you would double your shares outstanding. After the dilution, you'd have 50% of your company, and your investors would have 50%. Well, ' | ||
+ | |||
+ | == Getting Started == | ||
+ | |||
+ | That's it. Those four things should help you get started on a new venture! |