Legal and Accounting Basics for Startups

Kirsty Nathoo and Carolynn Levy discuss the important legal and accounting basics for startups. They cover topics such as keeping the legal structure simple and standard, staying organized with paperwork, being fair and forward-looking about equity, vesting, stock, financing terms, hiring, firing, and to overall following the rules and taking things seriously.

Notes

• 38s – Founders don’t need to know the mechanics of starting a startup… in detail. There are basics that are important to know, though
• 1m16s – Knowing basics can help you avoid a lot of pain
• startup as a legal entity, protecting assets, hiring employees, etc.
• 2m50s – What kind of entity?
• Delaware corporation; keep it simple
• fax docs to become corp in Delaware or at least shell of company
• 5m41s – Be organized: future due diligence requirements; humdrum reality of running a startup
• titles of CEO, president, and secretary required
• documents to assign inventions, IP
• think: am I doing this as an individual or as agent of co.
• YC often uses clerky.com to set up Delaware corp
• Keep your paperwork organized
• 8m16s – Equity: Allocation, Purchasing, Vesting
• 8m25s – Allocation: Execution > Idea (ideas = 0); how much for each founder?; look forward not back
• Ideas are important but they have zero value; no one has ever paid $1 Billion for an idea
• YC prefers founders be equal or nearly equal. Large variance among founders is red flag- lots of unanswered questions
• Look forward: are all founders in it 100% and for the long haul; whole team is necesarry for execution
• Among YC ultra successful companies, 0 of them had 1 founder with disproportionatly high share allocation
• 11m18s – Purchasing: paperwork alert; 2-sided transaction
• You as an individual buy shares from the company; shares in exchange for cash, ip, code to the company
• Restricted stock: vests over time; 83B election crucial – no way to undo mistakes with this
• 13m48s – Vesting: vesting is earning the right to permanent ownership of the shares over time
• Vesting = restricted stock = shares that are subject to forfeiture
• In Silicon Valley, standard vesting period is 4 years with 1 year cliff
• 1 year cliff means founder owns 25% after 1 year (0% before 1 year); then stock vests monthly up to 100% to 4 years
• If founder leaves early they get their vested shares and company buys back unvested shares at same price founder purchased
• Vesting: why have vesting?
• Reason for vesting: protect other founders if a founder leaves; skin in the game, startups are hard
• Single founder should have vesting too; because of skin in the game, investors like seeing it; and set example for employees
• Vesting aligns incentives among founders; investors don’t want to put money into company where founders can walk away at any time and still have a big ownership stake in company
• 18m00s – Fundraising: Logistics, Investor Requests; Company Expenses
• 18m40s – Logistics: priced v. non-priced rounds; paperwork alert!; potential dilution
• priced means valuation has been set
• seed round – price not set; any other round (series A, B, etc) means price has been set
• not setting price most straight forward, fast way to get money
• convertible notes or safes: note says investor is paying $X now and in return has right to receive stock at a future date when price is set by investor in a priced round; at the time that paper work is set, that investor is not a shareholder
• seed stage investors typically will have valuation cap on company, which will mean their investment will be able to buy more shares in a future priced round than someone investing at that stage
• 21m40s – downsides of taking investor cash:
• if you raise $2 million on safes with a valuation cap of $6 million, then those investors will own about 25% of company; add to that 20% that incoming investors will want and that leaves founders with 55% – maybe good or bad deal depending on what you need and can get
• investors should be sophisticated (i.e. accredited); have money to invest and they understand risks
• keep it simple; raise money using standard documents (clearky); sophisticated investors; understand future dilution
• 24m25s – Investor Requests: board seat; pro rata rights; advisors; information rights
• board seat: most cases want to say no
• advisors: (lots of people want to give advice; very few actually give good advice); investors should want to help company without requiring additional shares (handouts); advisor is not “paid” title
• 27m01s – Pro rata rights: right to maintain percentage ownership in a company by buying more shares in the future; way to avoid dilution
• as founder, you need to know how pro rata rights work because pro rata rights might mean they face greater dilution
• 28m17s – information rights: monthly status reports good and encourages; monthly budget or weekly updates not ok
• in addition to type and amount of financing, there are additional details that need to be negotiated and agreed upon
• 29m08s – Company Expenses: what is a business expense?; keeping track of expenses
• spending invesor money: should be able to justify every expense to investors as legitimate business related expense
• keep receipts in safe place for accountants
• don’t go to Vegas on investor’s money
• 32m34s – Doing Business: founder employment; hiring and firing; legitimacy
• Founder Employment: founders are employees of the company and must be paid wages/ salary; founder breakups
• setup payroll service; minimum wage
• avoid problems: pay payroll taxes; pay yourself; pay your co-founders
• 35m24s – Hiring Employees: paperwork alert!; consultant vs. employee; equity for employee
• Contractor v. employees: in both cases they will assign IP to company; but form is different and method of payment; distinction is important for IRS.
• Contractor: sets own hours; determins how to accomplish goals; employer does not withhold taxes but will provide form 1099 at end of tax year
• Employee: company pays salary and will withhold taxes; end of year they get W2 for taxes
• Even when paying employee with stock, must still at least pay minimum wage
• When have employees need to have workers compensation insurance
• need to see proof that employee is allowed to work in USA
• must use payroll service provider (like zenpayroll) and understand basics of employment
• 40m22s – Firing Employees: fire quickly, communicate effectively; pay wages/salary/accrued vacation up to point of termination
• do what is best for company, quickly; make clear statements, face-to-face with 3rd party present
• Eliminate physical and digital access; repurchase unvested stock
• 42m33s – Legitimacy: know your key metrics; balance sheet & income statements; tax returns
• 43m00s – Biggest Take-Aways: keep it simple, use standard, stay organized; be fair and forward-looking about equity, have vesting; stock doesn’t buy itself, do the paperwork; be savvy about financing instruments, terms, investor requests; founders need to get paid; employees must sign documents to assign IP to the company
• key metrics: cash position, burn rate, when cash will run out, be able to talk to investors
• be legitimate corporation: follow rules and taking it seriously
• 44m30s – Q&A
• How do you find an accountant and when do you need one?
• Bookkeepers categorize and record income / expenses; CPAs will prepare taxes; do need CPA withing 1st year to handle taxes. Finding one is tough–recommendations for professionals used to dealing with startups
• 46m10s – How to incorporate and when need to hire a lawyer?
• Can incorporate for few hundred online (clerky); when to hire lawyer depends on type of business: HIPAA, privacy, investers, etc. Clerky can help with standard documents
• 47m30s – What are your comments about raising funds with crypto-currency?
• very product specific no general advice; banks will struggle with newness

Additional Reading

• How to Work with Lawyers at a Startup by Mark Suster
• Startup Company Lawyer by Yorim Taku
• Useful resources – clerky.com, zenpayroll.com, zenefits.com
• Transcript

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