When looking to incorporate and structure your company, the first thing you should do is hire a lawyer and an accountant. Your business structure should be optimized around your unique circumstances. We are offering this as general guidance, as a means to set expectations, and as a means to provide you with discussion points when you speak with your lawyer and accountant.
- Incorporate in Delaware (over 50% of all publicly traded companies use Delaware as their legal home; Delaware state law is business friendly; Delaware uses judges from their Court of Chancery instead of juries to settle disputes; it’s comparable in cost or even less expensive than most states to incorporate; they offer some privacy when filing the documentation; and most importantly, investors are comfortable with, invest in, and don’t push back on companies that have incorporated in Delaware)
- Don’t wait too long to incorporate (you should incorporate if the company has intellectual property, has more than one founder, is on the brink of hiring employees or independent contractors, or is engaging in conduct that might expose the founders to personal liability; it’s also a good idea to incorporate before seeking investment so the founders can “buy in” at a nominal stock value; founders don’t want to wait to incorporate and “buy in” at the same as investors; incorporate and “buy in” when the value of the intellectual property is still low)
- Legal entity type should be C-Corp (if you expect to raise capital from angels or venture capitalists, the only real choice is a C-Corp; S-Corps are out because they only offer a single class of stock and limit the number of investors; LLCs are out because they are pass-through entities and that goes against the provisions in many investment firm legal documents; and any form of sole proprietorship or partnership is a non-starter; your only real option, if you expect to raise outside capital, is a C-Corporation; there are limited exceptions to this advice, but you should only diverge after consulting with a lawyer and accountant specializing in venture capital)
- Make sure the newly formed entity owns 100% of the intellectual property that forms the basis of your company and its value (all the appropriate documentation exists to prove that anyone that worked on the intellectual property has assigned it to the company and received compensation; you don’t want any “lost founders” showing up on your doorstep; also beware of divided loyalties – a founder may have obligations to a current or immediately past employer which may be inconsistent with his or her obligations to the new venture; your lawyer should be able to help you with this)
- Make sure your company maintains “clean capitalization” (ensure that you have complied with applicable state and federal securities laws when granting equity to founders, employees, investors, etc.; venture capitalists and their lawyers will review every issuance of the company’s debt and equity securities and will make the company re-do anything that wasn’t done in compliance; if things are bad enough, they may even decide to pass)
- Set a low par value for your stock issuance when incorporating and allocate accordingly (really consult your lawyer and accountant on this topic, but we would recommend authorizing 10,000,000 shares of common stock at a par value of $0.0001; issue 8,000,000 for the founders – make sure you’ve had the tough dialog and know how these will be allocated prior to starting this process; set aside the 2,000,000 authorized shares remaining for employees, advisors, or other creative opportunities)
- Set up a standard vesting schedule for the founders (typically referred to as “four years with a one year cliff”; basically, 25% or 2,000,024 shares vest after 12 months; the remaining 75% vest monthly over the following 36 months – that’s 166,666 per month from months 13-48)
- A board of directors will be required by law (the structure will be unitary, meaning that it will be non-hierarchical; if you haven’t received funding, we would recommend 2 founders and an independent; expect 2 additional seats to be taken by your two largest investors; the board will function as a “committee of the whole”, meaning that you won’t have separate audit, compensation or nominating committees)
- Choose your independent director wisely (accredited investor, not a family member, not a previous employee, not a previous employer, has board experience, has strategic experience, has operational experience, is action oriented, is consensus oriented, is mentor capable, is credibility enhancing, is strong willed, has thick skin, can be the voice of reason during difficult periods, etc.)
- Negotiate for some board control mechanisms (limit number of other directorships or outside obligations, pro forma resignations for specified life events, and performance-based on-going membership and re-election)
- Don’t spend any money on having your lawyers draft up a non-disclosure agreement or NDA for you. Early stage investors don’t sign them. Save your money!
(A special thanks goes out to Josh Buhler of Buhler Duggal & Henry, LLP for providing edits and additional comments for this section!)