
If I Launched a Startup - Cheat Sheet - feydr
http://startuplawyer.com/startup-issues/if-i-launched-a-startup
======
grellas
A sharp, concise checklist put together by a talented startup lawyer - to
which I would add a few observations:

1\. A Delaware C-corp is often a fine choice for startups but be careful not
to make it a fixed rule. Whatever you do must fit your circumstances and not
be something you do simply because it is declared from on-high. You don't want
to find yourself in the position of the young founder who ultimately said "why
incorporating my startup [in Delaware] was my worst mistake" (see
<http://news.ycombinator.com/item?id=2399139>). And, as tptacek points out
variously on this thread, sometimes an LLC or an S-corp might be a better fit
for you or your team - this choice is often tax-driven, though it can also tie
to the less formal management structure and the often lower cost of an LLC
(see my comments here on some pluses and minuses of LLCs in a startup context:
<http://news.ycombinator.com/item?id=1276724>). My point: think it through
before making this choice (on domicile, here are some thoughts on how local
domicile might in some cases be better than Delaware:
<http://grellas.com/faq_business_startup_002.html>).

2\. C-corp is a particularly good choice for 2011 if you plan to hold the
stock in your venture for more than 5 years with the hope that you can sell it
free of any federal capital gains tax and also free of AMT. Not all stock
grants will qualify, even in a C-corp, and so you should check with a good CPA
(for some of the relevant factors, see my comments on so-called QSB stock:
<http://news.ycombinator.com/item?id=2018041>).

3\. Vesting for founders is a mix-and-match process and does not have to be
uniform for all founders. Those who have not yet make significant
contributions to a venture at the time of entity formation normally should
take their interest subject to vesting - otherwise, they might walk away with
a large piece of equity before having earned it. This wouldn't necessarily
apply to all founders, however, and it is at times appropriate that one or
more founders on a team get their stock (or at least a significant part of it)
free and clear of vesting requirements. Otherwise, there is an unfair risk of
forfeiture placed upon them. Also, the one-year cliff idea often doesn't fit
with founders, in my experience; more typically, there is some sort of
immediate pro-rata vesting (monthly, quarterly, etc.).

4\. The "lock down the IP" point is often overlooked, especially by founders
trying a DIY approach: make sure you have not only technology assignment
agreements to capture all IP generated in the pre-formation stage but also
invention assignment / work-for-hire agreements to make sure the company owns
all IP generated by founders after they have their initial stock (the company
does not automatically own it just because they are owners doing work on the
venture). The idea of IP has its detractors today but your company will suffer
in fund-raising and on exit if holes exist in these areas. All it takes is one
bad episode - anything from a founder bolting to form a directly competitive
venture using the same IP to an ex-founder filing suit to block further
company development on IP that he claims he owns - to convince most founders
that IP protection is in fact vital in the early-company stage for most
ventures.

5\. One other very important item: make sure to separate your founder grants
from any large cash investments that are done for equity. If you don't, it
will create tax risks because, if cash and services are contributed for stock
at the same time and for the same type of equity, the service providers (i.e.,
those contributing the "sweat equity") can potentially be taxed on the value
of the equity received as measured by what might be a high company valuation
(e.g., you get 50% and an investor gets 50%, you contribute your talents and
services and the investor puts in $200,000, all for common stock - result: you
are at risk for having received up to $200,000 income item on which you must
pay tax). Not a particular tax risk if investors use convertible notes
(because the stock is not priced in that case) but a potentially serious one
if investors get stock. The relevant planning tip: while you don't need to
unduly front-load expenses, don't wait too long before setting up the entity
either - you should generally do this _before_ you have your investors lined
up and about to sign.

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tptacek
Note that while these are probably the best practices for a company that
_knows it is immediately going to take funding_ , LLCs and S-Corps are valid
choices for companies that aren't sure or that are going to be making money
before they take funding.

The S-Corp in particular has some attractive features: it simplifies equity
grants to employees compared to an LLC, and taxes are easier to deal with in a
C-Corp (there's also a sort of notorious salary-vs.-distribution trick people
place with S-Corps to reduce their taxable income).

The LLC is incredibly easy to set up; you can probably get one via 1-click on
Amazon now.

In the only company I founded that took serious VC, I didn't handle any of the
legal, but the sense I got was that legal for a real VC round is so innately
expensive that the S-to-C conversion isn't a big deal by comparison. It's most
convenient for everyone if you're not even incorporated, but that's their
problem (it is dumb to do business without incorporating); if you're worth
funding, nobody is not going to fund you because of the cost of converting to
their preferred structure.

~~~
rprasad
Agreed. The primary issue with an S-to-C conversion is that any assets with
built-in-gain (i.e., worth more now than when they were acquired) may result
in "immediate" income to the corporation. This is not an issue for most
startups, unless they start off spending lots of money (i.e., Color). (Also,
"immediate" in tax world really just means they'll be part of that year's
income.) The conversion itself is otherwise tax-free at the federal level, and
in most (but not all) states.

LLCs, however, are a frigging nightmare. They're the most difficult form of
business entity to set up (except for non-profit 501(c)(3)'s). Accounting for
LLCs will require an experienced (expensive) accountant. Plus, state laws on
LLCs aren't uniform in the states that matter.

~~~
tptacek
That hasn't been my experience with LLCs. If you're making money and you're a
founder, you need an accountant full stop. But having said that: you make
distributions, and the principals pay self employment tax. Where's the big
deal?

Here's where I get jumpy on this stuff:

S- and C- corporations are complex enough to put people off until they get a
lawyer. Most startup founders probably don't have a lawyer when they start.

When you say "LLCs are a nightmare", besides the fact that they're aren't for
most people (they aren't even notably complicated for most people; that's the
point), and that it's not that hard to switch out of an LLC when things get
complicated (by that point, you have a lawyer)...

... besides those things, you're also probably effectively talking people out
of incorporating at all. That's more than suboptimal; it's dangerous. It
creates situations where you can be personally liable for all sorts of company
expenses. We've had HN posts from people who were told by cofounders and
business partners that they were personally liable for huge expenses, and had
those same people discovered they owed zero because they were incorporated.

Don't do business as a sole proprietor. Get a structure with limited liability
as soon as you can. If it's between an LLC now and an S-Corp "maybe 6 months
from now, maybe earlier if we can find a good lawyer and we're making money"
--- do the LLC.

You're the expert here. Where am I wrong in this analysis?

------
idlewords
Can't resist giving a shout-out to the sole proprietorship without outside
funding. It's pretty amazing how much cheaper it has gotten to start a whole
range of software businesses in the last three years.

~~~
phil
Are you personally liable for the services you provide? That seems scary, to
say the least.

~~~
sdizdar
Please talk to the layer to understand liability for your particular business.
As a officer of a company you are still personally liable for some things and
D&O will not cover it. In other words, don't think incorporation will make
your private assets 100% safe.

~~~
tptacek
You are particularly exposed when it comes to torts you personally have a hand
in, and possibly for contracts where it can be entered in bad faith.

That said: I'd be very surprised to hear a lawyer say that incorporation makes
you _more_ exposed. You make a good point, but I'm still pretty sure the
default should be "incorporate somehow".

------
Eduard
"If I Launched a Startup - in the US" this should be named.

~~~
cmer
Maybe. But maybe not. I started my startup in Canada and still incorporated in
Delaware. Very glad I did.

~~~
gawker
I would love to hear more about your experience! I'm interesting in doing a
startup in Canada but I'm not sure about the whole legal issues.

~~~
cmer
I gave a talk a couple of years ago where I discussed what we did. See slide
77+ here: [http://www.slideshare.net/cmercier/how-i-founded-
bootstrappe...](http://www.slideshare.net/cmercier/how-i-founded-bootstrapped-
grew-and-sold-my-web-startups-meshu-2009)

Let me know if you have more questions!

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neeleshs
These are great points for someone like me who knows only programming. I would
say this is a good list to look at 'when the time comes'. EDIT: More clarity
in line 1

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alphadogg
The one non-negligible issue I had with the tips was the "vesting over time"
approach recommended in the article. I prefer to setup vesting to milestones,
such as "x contracted clients", or "delivered first MVP (minimum valuable
product, as defined by a list of mutually-accepted user stories)", etc. IOW, I
prefer vesting to some sort of deliverable, not just time.

------
doctoroakin
great resource here!

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TheOtherDamian
I am tired of the word hacker.

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arkitaip
These are the things he would do in the beginning?! What about the part where
you create something of value? I guess this is the explanation why lawyers
don't launch startups.

~~~
wmeredith
I think when discussing startup infrastructure you have to assume the creation
of something of value or the conversation stops before it starts.

