Corporate Start-up Fundamentals

Craig ShermanWilson Sonsini Goodrich & Rosati

April 29, 2008

Startpad

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CORPORATE START-UP FUNDAMENTALS

• Topics:o Entity Selectiono Corporate Formationo Founder Ownershipo Equity for Employeeso Securities Law Basicso Pre and Post-Money Calculations o Bridge Notes

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ENTITIES

• Using an Entityo What is an entity? – legal “person”o Why use an entity? – limited liabilityo What types of entities are there?

corporation partnership limited partnership limited liability company S corporation

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ENTITIES

• Using an Entityo Corporation

Most common VCs and other investors understand Negatives

Two levels of tax Cannot realize losses Limited flexibility

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ENTITIES

• Using an Entityo Other entities (other than S corporation)

Partnership – not limited liability Limited partnership – need a general partner VCs – most cannot fund pass through entity Difficult to implement option plan

o S corporation Pass through Limitations (# and type of shareholders) Easy transition to regular (“C”) corporation

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CORPORATION

• The Corporation – structureo Where to incorporate? Delaware? Washington?o Structure

Owners = stockholders Overall management = board of directors Day to day management = officers

o Governing documents Certificate of incorporation

capital structure fundamental rights

Bylaws operating manual

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CORPORATION

• The Corporation – issuing stocko What is stock

Types of stocko Where does it come from

authorized stock issued stock

o How to issue stock

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SECURITIES LAWS

• Securities Lawso Federal and state lawso Every offer or issuance of a securityo Registration requiremento Register OR find an exemptiono Disclosure, NOT merit review

authorized stock issued stock

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FOUNDER OWNERSHIP

• Founder Ownershipo How do founders get stock?o What consideration is paid?o Vesting or not vesting?

investors often require avoid free-loading need the equity to replace departing founder

o Tax issues for vesting stock 83(b) election

o Options for founders?

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FOUNDER OWNERSHIP

• Founder Ownershipo Do it earlyo Value is low

tax issues accounting issues

o Avoid disputes as to ownership

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FOUNDER OWNERSHIP

• Founder Issueso Avoid informal promises of equityo Avoid promising percentageso Advanced expenseso Paying back wageso Avoid 50/50 partnerships

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EMPLOYEE EQUITY

• Why give employees a stake?o Motivation – the potential big payoffo Team spirit – “skin in the game”o Compensation – tie compensation to collective

successo Conserve cash – cash is king for startups

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EMPLOYEE EQUITY

• What is a stock option?o Most prevalent employee equityo Contracto Right to purchase stocko # shareso Purchase priceo Term

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EMPLOYEE EQUITY

• Why options?o Lock in low priceo Upside with no downsideo No current out of pocket expenseo Delay income tax

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TYPES OF STOCK

• Types of Stocko Preferred stock vs. Common stock

Preferred = special rights/preferences Common = plain vanilla

o Why the distinction? Outside investors demand special rights Justifies lower price for common – avoid…

Tax problems Accounting problems

Size of the gap

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BRIDGE FINANCING

• Bridge Financingso Convertible promissory noteso “Bridge” the company to an event

(i.e. next equity financing)o Convertible

Convert into what? When convert? What terms to convert under?

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BRIDGE FINANCING

• Bridge Financingso Kicker for added risk

Early = risky Less money = risky Warrants Warrant “coverage”

o Secured vs. unsecuredo Advantages

Quick No valuation established

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STARTUP HORROR STORIES

• Unaccredited investors in the angel round• Founder who's gone but owns a large chunk of the company• Promised payment of back salaries to executive

team/employees• Paying employees equity only versus minimum wage (WA

state gotcha)• Founder deadlock• Poor corporate records that kill the deal

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STARTUP ISSUES

• Questions?