Lecture
Legal and Accounting Basics for Startups with Kirsty Nathoo and Carolynn Levy (HtSaS 2014: 18)
- Incorporating as a Delaware corporation is the standard expectation to simplify investor diligence and avoid the need for future reincorporation, whereas forming as a Florida LLC or in other non-Delaware states may face legal hurdles and require reorganization.
- Founders are advised to form separate legal entities early to protect personal assets from liability, with the primary risk of lawsuits attaching to the corporation rather than personal bank accounts, though basic legal and accounting issues may arise immediately.
- Paperwork related to entity formation and intellectual property ownership is predicted to become crucial during high-stress events such as Series A fundraising or acquisitions, as companies without owned IP possess no value.
- Equity distribution should aim for proportional splits among founder teams, as disproportionate allocations are viewed as a red flag indicating a lack of communication, with top-performing companies showing zero instances of significantly uneven ownership.
- Founders must file an 83(b) election and provide proof of filing, as failure to do so has previously caused deals to fail with investors or acquirers walking away due to compliance risks.
- The standard vesting structure in Silicon Valley is defined as a four-year period with a one-year cliff, meaning 25% of shares are vested after the first year, while shares vest fully over the specific time period to prevent equity loss upon departure.
- Vesting mechanisms are necessary to align incentives, ensure skin in the game for solo founders, and prevent founders from retaining large equity stakes if they leave before the period ends, which investors reject.
- Early unpriced rounds may utilize convertible notes or SAFEs where investors hold no voting rights until conversion, but low valuation caps risk early investors owning a significant percentage of the company alongside priced round investors.
- Founders are expected to negotiate terms with sophisticated and accredited investors, generally declining board seats unless the investor adds specific value, and avoiding requests for free shares in exchange for advisory services.
- Investor demands for contractual information rights and periodic updates are common, though requests for monthly budgets or weekly updates are predicted to be viewed as overreach, while pro rata rights can increase founder dilution.
- Tax compliance requires strict separation of business and non-business expenses to ensure deductions are valid, and founders must avoid unpaid wages to prevent liability, as working for free violates the law and unpaid wages can become leverage for vesting acceleration.
- Classification of workers as employees or contractors is critical due to IRS scrutiny, with employees requiring minimum wage compliance (approximately $2,000/month in San Francisco), tax withholdings, and workers' compensation insurance to avoid fines and legal action.
- Payroll services are mandated to verify employee work authorization, and terminating employees requires immediate payment of all wages and accrued vacation, with a recommendation to repurchase unvested shares immediately to protect the company.
- Handling employee terminations effectively is considered a hallmark of strong leadership to prevent toxic culture, business loss, and attrition of good employees, requiring founders to prioritize company needs over ease of execution.
- Financial management requires founders to know their cash position, burn rate, and runway to effectively communicate with investors, while crypto-related businesses may face difficulties securing banking services due to institutional uncertainty.
- Operational costs for incorporation and fundraising can be minimized by using online services like Clerky and standard documents costing under $100, contrasting with traditional legal fees that reach into the thousands.