Apr 27, 2017, 7:28 PM ETLecture

Legal and Accounting Basics for Startups with Kirsty Nathoo and Carolynn Levy (HtSaS 2014: 18)

Forming a separate legal entity (specifically a Delaware Corporation) is the primary mechanism for shielding founders from personal liability.
Delaware is the preferred jurisdiction due to settled case law, investor familiarity, and the avoidance of costly future reincorporation (e.g., converting a Connecticut LLC to Delaware).
A specific case study highlighted a company that mistakenly operated as a Connecticut LLC while believing it was a Delaware corporation, resulting in $500,000 in legal fees to resolve the error.
Incorporation requires faxing basic paperwork to Delaware followed by internal documents establishing bylaws, a board of directors, and officers (CEO, President, Secretary).
Founders must sign documents assigning all pre-existing intellectual property (code, inventions) to the company to ensure corporate ownership.
Founders are advised to use standard online incorporation services like Clerky rather than hiring expensive law firms for initial setup to maintain simplicity.
Signed foundational documents must be stored securely, as their absence during due diligence (fundraising or acquisition) can derail transactions.

Equity allocation should prioritize the team's future execution over past contributions; ideas themselves have zero monetary value.
Y Combinator views significantly disproportionate equity splits among founders as a "red flag" indicating misaligned expectations or trust issues.
Founders should sign Stock Purchase Agreements to formally transfer shares from the company to the individual in exchange for cash or IP.
Founders must file an IRS Form 83(b) election within 30 days of stock issuance to secure favorable tax treatment; failure to do so can invalidate deals.
Standard vesting terms in Silicon Valley involve a four-year period with a one-year cliff (25% vests after one year, then monthly).
Vesting serves two purposes: it prevents a departing founder from leaving with a large, unearned equity stake, and it incentivizes founders to remain ("skin in the game").
Solo founders should also implement vesting to demonstrate commitment to investors and set a cultural precedent for employees.
If a founder leaves before the cliff, the company repurchases unvested shares at the original purchase price.

Early-stage financing often utilizes unpriced rounds via Convertible Notes or SAFEs (Simple Agreement for Future Equity) to delay valuation negotiations.
SAFEs typically include a "valuation cap," which sets an upper limit on the valuation used to convert the investment into shares, rewarding early risk.
Founders must calculate future dilution; for example, $2 million raised on SAFEs with a $6 million cap could result in early investors owning ~25% of the company before Series A dilution.
Founders should prioritize "sophisticated" (accredited) investors over friends and family to avoid complications regarding capital needs and long-term vision.
Board Seats: Founders should generally decline investor board seats unless the investor can provide exceptional strategic value; advisors should not receive equity for advice.
Pro Rata Rights: These rights allow early investors to maintain their percentage ownership in future rounds, which inherently causes greater dilution for founders.
Information Rights: Investors should receive monthly updates, but requests for weekly budgets or excessive data are considered overreach.

Business expenses (e.g., server costs, salaries, rent) are tax-deductible, while non-business expenses are not; founders must maintain a strict separation between personal and corporate funds.
Founders must be paid a salary (at least minimum wage) to avoid legal liability; working for free is illegal and creates dangerous leverage for fired founders.
Unpaid wages by founders can be used as leverage by terminated co-founders to demand accelerated vesting in exchange for releasing legal claims.
Companies must withhold taxes for employees but not for contractors; misclassifying employees as contractors can result in IRS fines.
Workers' compensation insurance is mandatory in many jurisdictions (e.g., New York), with severe penalties for non-compliance.
Founders must verify that all employees have work authorization and use payroll services (e.g., Zen Payroll) to manage tax withholdings and reporting (W2/1099).
Hiring accountants is recommended early; while founders can track expenses, a CPA is required for annual tax filings, and bookkeepers handle expense categorization.

Founders are employees of the corporation and must be paid payroll taxes; failure to pay can lead to severe legal consequences.
Firing an underperforming employee is a necessary professional skill for founders; procrastination can drive away good employees and harm the business.
Best practices for termination include firing quickly, communicating directly without apology, paying all accrued wages immediately, and cutting all digital/physical access.
Investors should be notified of cash position and burn rate to manage expectations before funds are exhausted.
Founders should avoid spending investor capital on non-business activities (e.g., personal vacations) as this constitutes theft.

Accounting Search: The best way to find a CPA is through recommendations from other startup founders who understand the specific needs of early-stage companies.
Legal Budgets: Incorporation and standard SAFE agreements can be handled via services like Clerky for hundreds of dollars, avoiding high lawyer fees unless the business model is highly complex (e.g., HIPAA, heavy IP).
Cryptocurrency: No universal legal advice exists yet for crypto-equities or fundraising due to banking uncertainties and evolving regulations.