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What is Founders’ Stock, Legally?

 

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The term “founder” and “founders’ stock” are not legal terms, rather, they are terms of art describing a certain class of early participants of a company and their ownership interests. You will not find the terms “founder” or “founders’ stock” defined in the corporations code.

“Founders” of companies fall into the class of initial stockholder, director (probably) and officer (probably). The founders put together the initial plan; they are the people who decide to make the leap from idea to project to forming a business, and that is when they receive “founders’ stock”. Companies that do not exist cannot issue shares of stock.

Founders’ stock means the shares of common stock that are issued in the organizational minutes or consent of the board of directors of the company when they are setting up the new business, adopting bylaws and appointing officers. This is called “organizing” the corporation. The people who get this initial stock are the “founders” as a general rule.

It’s important to look at the characteristics of “founders’ stock” as well. It will generally be a large percentage of stock to each individual founder (larger than they would ever receive joining a more mature company). The stock is normally issued at a nominal price, often times the par value of the stock, such as $0.001 per share, a very low number. The company can issue stock at a low price because it hasn’t started to do any business. The equity upside of owning the stock is likely to be the only initial compensation for the founder, and, if the company does it right, the founders’ stock is subject to vesting contingent upon the continued provision of services to the company. Stock issued subject to a vesting schedule is called “restricted stock.” The company buys back unvested stock at cost if a founder’s service to the company is terminated for any reason.

After incorporation, new team members can get stock with these characteristics and that are sometimes called “founders,” but issuing stock at a very low price after the company has done anything to build value (built a prototype, gotten some users or customers, first revenue) can lead to income taxes for the founder getting “cheap stock.” Because of this, after incorporation companies normally increase the stock price, close the “founder” class of stock and issue options instead.

This article originally appeared on Venture Docs, an online platform for automating the creation of important legal documents for startup companies, investors, crowdfunding portals and attorneys.

 

About the author: Bo Sartain

Bo is a practicing corporate attorney with the law firm of Haynes and Boone, LLP.  Bo’s legal practice focuses on the representation of investors and issuers in company formation, private equity and venture capital preferred stock and preferred LLC membership interest equity financings, and the representation of buyers and sellers in mergers and acquisitions. Formerly, Bo was a Systems Engineer and the founder and CEO of a startup software-as-a-service company.

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