How to start a startup: Legal Basics of Starting a Startup

Original author: Kirsty Nathoo, Carolynn Levy
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Stanford course CS183B: How to start a startup . Started in 2012 under the leadership of Peter Thiel. In the fall of 2014, a new series of lectures by leading entrepreneurs and experts of Y Combinator took place:

First part of the course

Disclaimer: in this part of the lecture course at Stanford startup school, the features of Western legal practice are set forth (which is logical). This example is interesting, because it clearly shows that Russian practice is being developed in the same direction as the efforts of IIDF experts, as the global one, borrowing and successfully adapting some solutions. We will certainly continue to acquaint you with similar legal subtleties in our blog.

Sam Altman: Kirsty and Carolyn will talk about the financial and legal aspects of working in a startup. This lecture may not be the most interesting, but if you learn this material, then you will be able to avoid trouble in the future.

Carolynne: As Sam has already said, in this lecture we will talk about some principles of a startup. Kirsty and I will talk about the main legal and financial problems that your startup may encounter in the early stages of its development.

In one of his videos, Paul Graham once said: “Founders do not need to know all the financial and legal features of creating a startup.” I thought, “Oh no! This is the name of our lecture. ”

In fact, Paul wanted to say that the founders do not need to delve into the details of these processes, because it is quite dangerous. One way or another, Kirsty and I will not consider this topic in detail. Our goal will be to at least convince you that you should not start a startup in Florida without thinking.

Kirsty: We were very worried that you would be bored listening to an accountant and a lawyer. The amazing founders spoke before us, and they touched on very interesting topics. But, as Sam said, if you know all the basics, you can make the right decisions, avoid troubles and unnecessary troubles, and most importantly, focus on what is really important for you - to lead your company to success.

We often refer to such a concept as a “startup”. Surely, you remember that any “startup” should be formalized as a separate legal entity. We will talk about the features of its formation a little more in the future.

In addition, you probably know that a startup has its own assets, intellectual property, inventions and other property that needs to be protected. We will touch on this issue, and then we will talk about how to raise funds, hire employees and conclude contracts.

Before you create your own company, you need to discuss with some of the other founders some rather important questions: in particular, who will be responsible for what in the company and what share of the company each of the founders will own.

Carolynn: First, let's talk about the startup startup process. Each startup must be registered as a separate legal entity. You probably already know that the main reason for separating the company as a separate legal entity is the protection of personal property. If your company is sued, no one will be able to withdraw money from your personal bank account - only from the company account.

I'll tell you a short story. About two years ago, we at YC worked with a company originally registered as an LLC. Connecticut limited liability company, LLC in the USA]: this was recommended to the founders by their familiar lawyers.

When these founders came to YC, we said they needed to re-register in Delaware. Connecticut lawyers began to file re-registration documents and, unfortunately, made an obvious, but very serious mistake. They found her when they attracted a very large amount of money. For two years, the founders of the company thought it was registered in Delaware, although it was still listed by shares in Connecticut.

I can only say that four law firms were brought in to clarify the circumstances of this case: two from Delaware, one from Connecticut and one from Silicon Valley. Today, the fine for improper re-registration is $ 500,000.

The conclusion is obvious - do not complicate anything. We register all companies from Y Combinator on the same principle, because it is easier. If you are not smart, then save a lot of time and money.

Kirsty: How do you create a company after you decide to register it in Delaware? A number of specific actions are required. The first is quite simple: you just fax two sheets of paper to Delaware, which says that you are going to create a company.

At this stage, the company does not yet have its assets, and nothing is happening in it yet. After that, you fill out a number of documents establishing, among other things, the company’s internal rules. They indicate the names of members of the board of directors and company management. If you register a company in Delaware, the documents must include the names of the executive director, president and chief secretary.

In addition, at this stage you should fill out documents that confirm that your company has inventions or software created by you as an individual and owned by the company. Remember that at this moment it is advisable to decide what you are doing on your behalf and what is on behalf of your company, which is a separate entity. It is very important to see a clear difference here.

There are many services that can help you register your company. Of course, you can contact one of the law firms, but besides them there are online services that provide the same services. When working with companies from YC, we often use a service called Clerky, where all standard documents are filled out for you, so you can not worry about anything and focus on what is really important to you.

Note: St. Petersburg developers have launched a concierge service of legal assistance - " YURBYURO " - a complete platform for creating legal services. At the moment, the team is a resident of the IIDF Accelerator and participates in the reality show " Candidate for Take-Off ."

It is worth noting the importance of these documents, because they indicate what your company is and what it does. It is very important that all documents are stored in a safe place.

It sounds corny, but some founders do not pay due attention to this. They do not know what is indicated in their documents and where they are located. Nobody argues that paper work is far from the most interesting part of doing business.

Those moments when your documents are of great importance are one of the most stressful in the life of a startup. Surely they will play a role when you attract investment in Round A or during the acquisition of your company. You will have to carefully study all the documents, because professional lawyers will work with them. If you do not know where your documents are stored and what is written in them, any stressful situation will become even more tense for you.

The main thing is to keep your documents in a safe place and in strict order. So you save yourself from unnecessary work.

Carolynn:Now a few words about the financial component of a startup. First, let's talk about the distribution of shares in the company. If the value of your company's shares is high, then the question arises of the share of each founder in the company. If you are the only founder in a startup, then you can not think about it. But if there are two or more founders, the question becomes quite acute.

First, it is important to understand that the actual implementation of an idea is more important than the idea itself. In many startups, too much attention and, consequently, an overly large share of the company goes to the founder, who came up with the idea for a startup. No doubt ideas are important, but they themselves are worthless.

Have you ever seen someone pay a billion dollars for one idea? The value of the company begins to grow only when all the founders are working on the implementation of the idea. Do not succumb to the temptation and give an excessively large share of the shares to the founder, who is the author of the idea for the company.

Secondly, you need to think about whether it is worth distributing the shares of the company evenly between its founders. In our opinion, it is quite obvious what is worth. The shares of each of the founders do not have to be equal, but if they are very different, this should be alarming.

We are often interested in the opinions of the founders regarding the inequality of shares in the company. Perhaps one of the founders believes that the startup will not live long. Perhaps someone is overestimating his contribution to the work of the company, his education or his previous experience. Do the founders trust each other? Do they openly share their thoughts on the startup and its future? If the shares of the founders in the company are very different, then we begin to worry about whether they get along with each other.

Thirdly, in a startup it is very important to look to the future and not look back. In other words, each founder must give all his best. Everyone should ask themselves if they are ready for a long journey. If everyone in the startup thinks that each of the founders should put all their strength into the work throughout the journey, then everything that happened before the creation of the company does not matter.

It doesn’t matter whose idea was, who was involved in development, who worked on the prototype and who has an MBA degree. It will be better for the whole team if everyone’s share is the same, because the whole team will realize the idea. To this we can add that among the best companies of YC, that is, those whose estimated cost was the highest, there is not one where the shares of the founders varied significantly.

Kirsty:You and the founders discussed how you will distribute shares in the company. What's next? Very often, the founders are surprised that they still need to do something to take possession of their shares. It seems to them that their conversations decide something. In fact, you are considered not only an individual, but also a representative of the company.

One can imagine a similar situation in a large company: if you work for Google and you were told that you will receive part of your salary in the form of shares, then you can assume that you must sign some documents for issuing a block of shares. If this does not happen, you will think that something is wrong here. The same goes for a small company.

In this situation, you must sign a contract for the sale of securities. You, as an individual, buy shares from a company. And when you buy something, you always enter into a two-way deal. In this case, you can receive shares if you either pay in cash for them or provide the company with your intellectual property, inventions or developments. Thus, everything that you have done in the past actually belongs to the company.

Such shares are also called limited, because rights to them can be obtained only after a certain period. In the future, we will consider this issue in a little more detail.

If we talk about the process of granting rights to shares, then it is worth mentioning one very important document, which we constantly repeat to everyone and everyone, because the consequences can be irreversible. At one time, because of him, several transactions were disrupted.

We noticed that some companies do not fill out the so-called form 83 (b) Election, and often this leads to a disruption of the transaction. I will not go into details: I’ll just say that the amount of taxes that you pay as an individual and as a company representative depends on this document, and this can seriously affect your business.

Therefore, the main thing is to fill out all the documents, in particular, the agreement on the sale of shares and tax form 83 (b) Election, as well as make sure that you really submitted these securities for consideration. If you cannot prove this, you will have problems with the tax service (IRS), and investors and companies interested in acquiring your startup will not conclude any transactions with you.

Carolynn:Next, we will talk about the process of granting rights to shares, or vesting. As you know, vesting is understood as the process of acquiring rights to shares after a certain period of time. Here we talk about the stocks that you purchase from your company, and which give you the right to vote. However, if you leave the company before the expiration of the vesting period, your company may regain these shares. This type of shares is also called limited, bearing in mind that the shares are in the process of vesting. The tax service usually says that such shares are “refundable”.

What is usually the term of the vesting? In Silicon Valley, the so-called standard vesting period is four years with a cliff [eng. cliff - the period after which the employee receives the accumulated amount of shares] in one year. This means that in a year the founder becomes the full owner of 25% of his shares, and he receives the rights to the remaining 75% every month for the next three years.

Imagine that at Christmas the founder buys a stake, and leaves the company on the next Thanksgiving, that is, before the expiration of one year. In this case, the founder does not have rights to these shares, since he left the company before the expiration of the cliff period. If the founder leaves the company a day after the next Christmas, that is, after one year and one day, he or she receives the right to 25% of the shares, since the cliff has expired.

What happens to stocks after the founder leaves the company? The company may repurchase these shares. In our example with the founder, who left a year and one day after the acquisition of shares, the company must buy back the remaining 75% of the shares from him.

How? The company will simply write a check to the founder: just like the founder got these shares. The check shall indicate the same price at which the founder acquired these shares. Thus, it turns out that the founder simply returns his own money.

The question arises: why do you need a vesting? The importance of this procedure is associated with the departure of the founders from the company. If there was no vesting, then the founder, after his departure, would take with him a rather large share of the company's shares. Of course, this would not be fair to his colleagues. We will talk about this in more detail when we touch on the salaries of the founders.

In addition, vesting stimulates the work of founders in a startup. If the founder at any time can leave the company with his share, then why stay in it and invest your own time and energy? After all, work on a startup requires titanic efforts.

Is vesting the sole founder in the company? Needed because he also has an additional incentive to work. Investors want all of the founders, including sole founders, to be interested in long-term work.

The presence of hosting in companies with one founder is also an example for other employees. You can imagine how stupid it would look if the founder begins to tell his employees that within four years he should get the rights to his shares, when in fact he really needs these shares.

Vesting affects the corporate culture of the company: the founder, who needs to get the rights to the shares, sets the pace for the whole startup, when he says: “We are set for long-term work, we are all going to get the rights to our shares, and we will do it together” .

Kirsty: Moving on. We have correctly registered the company. Each has its own share of shares. All standard paper work is completed. Now what? The next stage in the development of a startup will be raising funds.

In previous lectures, several investors and founders have already shared their experience of raising funds. If they talked about strategies for obtaining investments, then we will talk about the preparation of the necessary documents and what to do when someone is ready to invest in your company.

As for attracting financing, two cases are possible here: either the value that investors are guided by is set, or it is not set. By value is meant a valuation of a company. In principle, investment rounds can be called anything you like, but, as a rule, when it comes to the sowing round, then the cost has not yet been established. In the so-called rounds A, B and so on, the cost has already been determined.

If there is no information about this value yet, then getting money is easier. This operation is carried out on the basis of an agreement on a special form of convertible loans, which in the English literature is called Safe.

And again, two parties take part in the transaction. The document states that, for example, now the investor pays $ 100,000, and in return receives the right to receive shares in the next round, when the value of the company will already be known. It is worth noting that after paperwork this investor is not a shareholder and therefore does not have voting rights in the company. He will have other rights, which Carolynn will discuss separately.

It is only natural that investors want to get something in return when they invest their money at the earliest and most risky stage of the company’s development. And here it is necessary to mention such a concept as an assessment of the company's capitalization, which, I am sure, many have heard.

During a round with an unknown price, a document must be signed stating the amount of capitalization in the conversion of shares. Moreover, it differs from the current assessment of the company.

Capitalization assessment is the upper limit of the company's value, which is then used to calculate the number of shares owned by the investor. Suppose an investor provides a company with a convertible loan of $ 100,000 with a capitalization of 5 million.

If in a year the company manages to attract investments by evaluating its value at $ 20 million, then the cost of one share for the first investor will decrease by about four times. Thus, the investor will be able to buy about four times more shares for the $ 100,000 invested by him than if he invested the same amount in Round A. Thus, the investor can benefit from the fact that he invested earlier than others.

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