1 Startups – Incorporation and Founder IssuesHBS Rock Center November 2, 2016 Paul Sweeney, Esq. Partner (617) © Foley Hoag LLP. All Rights Reserved.
2 These materials have been prepared solely for educational purposesThese materials have been prepared solely for educational purposes. The presentation of these materials does not constitute legal advice, nor does it establish any form of attorney-client relationship with the author or Foley Hoag LLP. Specific legal issues should be addressed through consultation with your own counsel, not by reliance on this presentation or these materials. Attorney Advertising. Prior results do not guarantee a similar outcome. © Foley Hoag LLP 2016. United States Treasury Regulations require us to disclose the following: Any tax advice included in this document and its attachments was not intended or written to be used, and it cannot be used by the taxpayer, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.
3 Introductions Co-Chair of Technology PracticePaul Sweeney, Esq. Partner (617) Co-Chair of Technology Practice Named one of the “Top 20 Startup Lawyers in Boston,” and one of “Ten Most Innovative Lawyers in America” by the ABA Journal Has worked on over 135 angel and venture capital financings (debt and equity) over 18 years of practice.
4 Incorporation What is it? Why do it? Deciding when to incorporateChoosing a form of legal entity What is involved Questions
5 What does it mean to “incorporate?”From a legal perspective: Creates a legal entity, separate and distinct from its owners Can own assets / and incur liabilities Can enter into contracts (with rights and obligations) Can sue and be sued in court Corporate existence is on the state level Created by filing Certificate of Incorporation with state In most cases, duration of the entity is perpetual From a practical perspective: State laws require fees and formalities. Capital is provided to the corporation in return for equity (stock, membership interests, etc.) or debt.
6 Why and when to incorporate?“I’d rather wait to incorporate until I’m confident that my concept is viable or fundable, and until I’m 100% sure who is going to be on my team.” “I heard incorporating triggers out of pocket costs and ongoing tax (franchise fees) and other filing obligations, so why not wait till the last minute?”
7 Why and when to incorporate?There’s more than one founder Starting restricted stock vesting period Starting capital gains holding period IP is being created Conducting business / launching product Hiring employees or contractors Issuing stock or stock options Raising capital
8 Ongoing administrative overheadDownsides Initial filing fees Initial legal fees Ongoing administrative overhead Tip: Why January is often better than December
9 Which form of entity? Majority of startups are formed as:C Corporations / S Corporations / LLCs Key Considerations: Liability protection Raising capital Ownership issues (stockholders vs. members) Employee equity incentives Tax treatment (“double taxation” vs. “pass-through”) Appetite for complexity / legal expenses Look at the end game: Intend to raise capital, grow business, grant options and sell? – Corp Intend to generate profits, distribute cash flow to owners? – LLC
10 Where should I incorporate?Delaware (full stop)
11 Why Delaware? Investors insist on itPredictable and well developed corporate law High degree of protection for directors Well known, efficient filing process and procedural formalities But….. franchise taxes and annual fees
12 What is involved? Reserve the name early in DE and resident state (but beware of trademark issues!) Certificate of Incorporation By-laws Initial consent of sole incorporator Initial consent of director(s) Stock certificates, receipts and ledger Qualification to do business in resident state Registered Agents for each state S corporation election, if applicable Application to obtain a tax ID (EIN) Opening bank account Annual tax returns
13 What is the name of the company? How many shares to authorize? What is involved? Key questions: What is the name of the company? How many shares to authorize? Who receives shares, and how many?
14 Picking a Great Co-FounderComplimentary Skills The Three “I”s - intelligence, intensity and integrity Ideal team is comprised of people with a history of working together, where some are great at building things, some are great at managing things and some are great at selling things. 4 things early-stage investors care most about = PIMM (People, Idea, Model, Market)
15 Critical Questions Facing Co-FoundersDefinition: Who should my co-founders be? Equity Distribution: How will we divide the equity among ourselves? Control: How will decisions be made, and who will make them? Succession: What happens when one of us leaves? Forced Departure: Can one of us be fired? By whom, and for what reasons? Cash Contributions: Will any of us be investing cash in the company? How will this be treated?
16 Should Founders’ Stock be Restricted?“Restricted Stock” – shares subject to forfeiture The company has the right to repurchase the shares if the founder leaves the company for any reason. Vesting Acceleration of vesting Determining repurchase price Critical Tax Considerations – 83(b) election Timing- When to impose restrictions
17 When do I involve the Lawyers?As early as possible! Organization of company (charter, bylaws, stock incentive plans) Restricted Stock Agreements, or any other agreement containing equity feature or right of first refusal Financing transactions (both debt and equity)
18 Questions? Paul G. Sweeney Partner (617) 832-1296 © Foley Hoag LLP. All Rights Reserved.