Category: Company Creation
Q: We are a Delaware C Corp registered as a Foreign Entity in Colorado our home state and we need to figure out the answers to the following questions with regards to stock certificates.
1. Who gets stock certificates issued and when?
My assumptions are that cash investments DO get certificates, warrants DO NOT.
Founders and Employees with vesting schedules DO NOT get certificates, until a portion of stock is vested.
2. Do the buy and print your own certificates follow the normal process?
3. Do private C Corps file capitalization stables with the SOS?
It’s a pretty simple answer, really. If you buy the stock, you get the certificates. So cash investors do get certificates. Warrants and options are securities that provide the holder to exercise them later by paying for the stock at a pre determined strike price. At the time of exercise, money is paid by the holder to the company for the stock subject to that warrant or option and then a certificate is issued. The options can not be exercised until vested, as you suggest.
i’m not sure what “buy and print” your own certificates mean, but there is no form that you have to follow. It just needs to be signed by the President and Secretary of the company. Furthermore, cap table are not filed anywhere. You may keep this information private.
Question: How many shares should I use to incorporate my company?
Keep it simple. The more shares you authorize, the more you’ll have to pay in taxes (although these are not large numbers). They key is having enough shares to have the ability to grant all sorts of equity to different people who help your company. For instance, if you only authorized 10 shares, the minimum amount of the company that you could grant would be 10%. So you want a large enough number to be able to grant small portions to folks. Whatever number you choose, don’t worry. These are all easily changeable with stock splits later down the road.
Question: I am in the process of getting my startup venture off the ground and have run into a slight road block. I have developed the business case, and fleshed out the product requirements, but need a strong developer to the product. Problem is, I have not gotten any funding yet, therefore cannot pay someone to build it. Any suggestions on places to look for developers who are willing to put in sweat equity in return for ownership in the business?
A (Brad): While finding a developer to work for sweat equity is an option, I’d assert that you’d be better served by hunting for a technical co-founder that is passionate about creating the company you envision. In my experience, it’s naive to think you can just “get developers to build the product” although it does sometimes work. Most of the great software startups that I’ve been involved in have at least one technical co-founder (and many have more than one.)
Regardless of the path you go down, you want to recruit quality. If you have no cash to offer someone, be prepared to give up a meaningful amount of equity. There’s no easy formula that translates between hourly work and equity ownership, especially in a raw startup, but be ready to have a thoughtful discussion with whomever you recruit.
If you aren’t willing to go the technical co-founder route, the best place to search is at your nearest college with a strong computer science department, especially if it is a school with a culture of entrepreneurship.
Q: We’ve developed a web-based security product whose primary application was intended for the financial industry. Since inception we’ve since began pursuing two other business lines, also based on the software, that can be considered conceptually different from the product we initially brought to market.
We’re debating whether we should pursue these product lines under the same LLC or create two separate LLCs and license the software to them, while being majority shareholders in each of the companies. Our concern is that this might be a bit too convoluted a structure for VCs to consider once we go for funding in a couple of months. Alternatively, there’s the liability perspective with regards to having three separate businesses under the same umbrella. I would appreciate your thoughts on this issue.
A: (Jason) Your instincts are correct – don’t divide your business among product lines. Any venture capitalist that invests in your company is going to want to invest in “everything,” not just a product line or two and the complexity and legal costs of setting up all of these entities and having proper licenses for property and people is prohibitive.
From a liability standpoint, one could argue that you are better off dividing up all of your lines of business (if one gets in trouble, it doesn’t hurt the others), but this is mostly a theoretical legal argument. This argument only holds water if you truly run each business separately, capitalized separately, etc. It’s not worth the bother. As a startup, you have more important things to worry about.
Finally, per our prior post, realize that that VCs don’t normally invest in LLCs.
Q: Does your company have to exist in order to get VC funding? I have an idea for a Web 2.0 company for which I have a business plan and a mockup, but I have not launched it to the public. Do VC firms even consider funding businesses that have not actually gone live?
A: (Jason) If you are an early-staged venture investor, you shouldn’t have a problem funding a company that doesn’t “exist” yet. Plenty of times we’ve invested in folks that have a small team a great idea and some PowerPoint slides. Upon investment your venture will need to be incorporated and will exist after that.
Q: I have what I think is a really basic startup question, but I’m having the toughest time getting a straight answer, so here goes.
We’re starting a website and want to form an LLC for the business, thing is, we live in Texas but will soon be returning to Nevada. Should we do all the registration (dba, llc formation and anything else required) in Nevada or form it here in Texas and then transfer once we move? In general, what are the costs of changing the state of incorporation?
A: (Jason). It’s not too bad – usually a couple of hours of lawyer time, so it should be sub $1000. If you want to be incorporated in your state of residence and you are fairly certain that you are going to move, I’d skip the headache and just incorporate in Nevada and be done with it. It’s not a big deal to be incorporated in a different state than where you reside.
See our prior post on states of incorporation, as well.
Every once in a while we get a question that isn’t in our specific realm of knowledge. Yesterday we got a question about a new restaurant concept. While VCs sometimes invest their personal money in restaurants, we don’t do these types of deals out of our funds. Being the “full service blog” that we are, however, we tracked down the smartest restaurant consultants in the industry to guest blog today.
Q: My partner and I are trying to open a new restaurant concept.
We both have extensive operational background in the industry and we are
approaching potential investors by showing our sweat equity into the
deal. How can we negotiate or set a monetary value of our sweat equity
into this deal, so we can have a point of reference on how much we are
bringing into the deal and how much we are willing to give in return for
their investment? Thank you.
A: (Laurie and Frank) The value in sweat equity comes from the expertise and “leg work” that done by the founders that couldn’t be accomplished by the investors.
The total value ascribed to sweat equity depends on several variables, such as the founders experience in opening restaurants, operating expertise, the other factors the founders bring to the table (such as a below market lease), the extent to which the founders will be compensated pre (pre opening management fee) and post (salary or management fee) opening, and of course, the concept itself.
There is no formula for determining sweat equity ownership but one reference point is to determine what a consultant would cost to execute the preopening aspects of the businesses and then determine what additional assets the founders bring to the table. A concept that may be solid but is not unique (for example, a pizzeria) adds little to no incremental value whereas an under market salary post opening and / or no pre opening compensation would increase the sweat equity percent ownership. An extremely unique concept that could potentially attract numerous investors is going to be more advantageous for the sweat equity side. In the end, the deal must provide an attractive potential return for the investors as well as compensate the founders for their efforts.
While ownership is an important component of the restaurant deal, it should not be considered in a vacuum; if a founder’s goal is to maximize their ownership, the other aspects of the deal should be designed accordingly and it is important to understand that ownership is not necessarily the same thing as control (see closing paragraph) nor does it always determine how profits will be shared.
Investors will likely be turned off by deals which provide a significant percentage of cash flow to the founder before the investors capital is returned. Therefore, it is helpful to separate percentage ownership from percentage share of distributions and utilize a different allocation of profits prior to vs. return of capital (“flip”). If the founder’s goal is to maximize their ownership, one way to do so may be to provide a more aggressive share of distributions for investors until return of capital, which aligns investor and founder interests by providing a shorter payback period.
Just like any other transaction it ends up being what everyone can agree on without too much haggling. The intimacy of the restaurant business mandates that “partnership” deals at least start out on a friendly basis and certainly savvy investors will have more of an understanding of what is “fair” vs. someone who is a first time investor.
Summary–expect to gain a decent but not aggressive salary, little to no pre opening fee, somewhere in the neighborhood of 25-50% equity, and ensure that the operating agreement keeps you in control as long as the bills are paid and no additional money is needed from the investors (unless that is part of the original deal). But expect to give away the lion’s share of distributable cash (usually what is left over after a reserve account is kept full), until such a time as the investors are paid back.
Q: This may seem rather fundamental and elementary, but I cannot seem to receive a solid answer from anyone. When filing the articles of incorporation (charter) papers for a C-Corporation, is there a strategic amount of shares to issue at a certain price per share upon incorporating, or is this irrelevant in the beginning? I am the only equity founder at this point, but will soon be raising seed funding, as well as setting aside 15%-20% equity for employee stock options. I have heard that 1,000,000 shares at .01 per share is typical. Is this anywhere near correct?
A: (Jason) Pre-funding, it doesn’t really matter. Make sure that you have a large enough number of shares that you can give small enough awards away. In other words, if you only had 100 shares, the minimum amount that you could grant / give away is 1% of the company – probably not a great result.
Along those same lines, consider, too, what your first hires will think if they get an option grant of “10 shares.” I realize that whether I get 10 shares or 1,000,000 is irrelevant unless I know the denominator, but there are plenty of folks that I’ve seen get awfully irrational with a grant of a small amount of shares without ever asking about the total shares in the company.
Finally, consider what state of incorporation you are thinking about and what the taxes are associated with the number of shares of stock. Many states base early corporate taxation on the amount of shares authorized.
Your numbers of 1,000,000 and .01 par (which really doesn’t matter at all) seem fine, but consider the thoughts above.