Podcast Summary
Avoiding costly mistakes in legal, accounting, and HR: Founders must understand legal, accounting, and HR aspects to prevent significant consequences and financial burdens. Seek expert help if needed.
Founders need to be mindful of the legal, accounting, and HR aspects of their startups to avoid costly mistakes. These areas, particularly legal, can have significant consequences if not handled correctly. For instance, if a founder fails to make an 83B election when purchasing restricted stock, the IRS will tax them on the entire fair market value of the stock at the time of purchase, rather than the vesting schedule. This can result in a large tax burden upfront, which can be detrimental to a startup's cash flow. To avoid such mistakes, founders need to educate themselves or seek the help of experts in these areas. The entire series of startup basics, including accounting, legal, and HR, can be found on thisweekendstartups.com.
File 83B election within 30 days of stock purchase: Founders must promptly file 83B election to pay taxes on stock's fair market value at purchase instead of incremental vesting, avoiding unexpected tax liabilities
Founders need to understand the importance of filing an 83B election within 30 days of purchasing stock in their company. This election allows them to pay taxes on the fair market value of the stock at the time of purchase instead of being taxed incrementally as the stock vests. Founders may mistakenly believe they own the company outright after incorporation, but failing to complete necessary paperwork beyond the certificate of incorporation can lead to unexpected tax liabilities. The 83B election is a critical step in managing these potential tax burdens and should be handled promptly and accurately. It's not the attorney's job to mail it in; it's the founder's responsibility. Ignoring this requirement can result in significant financial consequences.
Appointing Directors and Officers in a Company: Boards appoint directors and grant them the power to appoint officers. Officers have the authority to sign contracts and legal documents, but only if they've been officially appointed.
Incorporating a company is just the first step in establishing it. To truly run the company, you need to appoint directors and officers, who are typically the board members and top executives, respectively. The board of directors holds the power to appoint officers and grant them the authority to sign on behalf of the company. Being an officer of the company also means being covered by Directors and Officers insurance. The title of an officer does not automatically come with the position, it's granted by the board. So, for example, a Vice President of Sales can be considered an officer if the board appoints them as such. Conversely, someone with the title of CTO who hasn't been appointed by the board is not an officer. This distinction is important because it determines who has the authority to sign legal documents and contracts on behalf of the company. Failure to understand this can result in contracts being void or disputes arising.
Relying on Apparent Authority and Incorporating Early: Vendors and third parties can enter agreements based on apparent authority, but complications can arise if the company doesn't honor them. Founders should incorporate early to avoid costly valuation issues when seeking funding.
Vendors and third parties can rely on the principle of apparent authority when entering into agreements with individuals who have signed on behalf of a company, even if they may not have the typical CEO-level authority. However, there can be complications if the company does not honor the agreement. Another important lesson is that founders should incorporate their companies as early as possible to avoid costly valuation issues when seeking funding. If a founder waits to incorporate until after securing funding, the valuation of the company's common stock will be significantly higher, resulting in a more expensive acquisition of shares. This can be a substantial financial burden for founders. Additionally, it's important to note that there are services available to help incorporate a company for a reasonable fee, but it's crucial to ensure that the proper legal steps are taken to protect the founder's interests.
Properly handling legal matters in the early stages of a business: Ensure all contracts and rights are transferred to the company, negotiate with third parties, and understand funding dynamics to set your business up for long-term success
When starting a business, it's crucial to handle legal matters properly from the beginning to avoid potential issues down the line. Using services to set up stock purchases or IP assignments can lead to mistakes if not executed carefully. Founders must ensure they transfer all contracts and rights into the company, which may require negotiation with third parties. Additionally, founders should understand that in the early stages of funding, the money goes to the company first, not the founders or employees. By prioritizing proper legal setup and understanding funding dynamics, founders can set their business up for long-term success.
Impact of secondary sales on startup financing: Secondary sales, once rare, are now common in series B financings, leading to potential shifts in how founders choose investors and the investment process, raising questions about fiduciary duties and traditional cap table concepts.
The role of secondary sales and their impact on startup financing has significantly changed over the past decade. Whereas they were once a rarity, they have now become a more common occurrence, with estimates suggesting that up to 30% of series B financings involve secondary sales. This trend has led to a potential shift in how founders choose their investors, with some investors offering large cash payments to secure deals. However, this practice raises questions about the potential perversion of the investment process and the fiduciary duties of board members. Furthermore, the current market climate is increasingly favoring founders and companies, leading to some investors offering to protect founders from dilution by issuing them additional shares. While some may view this as a positive development, others argue that it goes against the traditional cap table concept and can create confusion. Ultimately, it is important for founders and investors to carefully consider the implications of secondary sales and their potential impact on the long-term success of the company.
Considerations for Founders and Boards when Intertwining Financing Rounds and Founder Re-Ups: Founders and boards must ensure fairness and transparency when dealing with intertwined financing rounds and founder re-ups to avoid dilution and blurred transactions. Boards should exercise their fiduciary duties independently for each transaction.
Founders and boards need to carefully consider the implications of intertwining financing rounds and founder re-ups. The speaker expressed concerns about the potential for unfair dilution and the blurring of separate transactions. They suggested that these decisions should be made independently, with the board exercising its fiduciary duties for each transaction. The speaker also shared their experience of implementing a five-year, five-point compensation plan for founders to encourage longer tenure. While reasonable, they added a fifth year to make it more palatable to other investors and board members. Overall, the discussion highlights the importance of transparency, fairness, and careful consideration when navigating these complex issues.
Motivating and Retaining Founders: Founders require incentives to stay motivated and prevent them from seeking new opportunities. LLC to corporation transition involves tax implications and complexities, consult with accountants beforehand.
Founders leading their companies, even if they're fully vested and have been diluted due to multiple funding rounds, need to be motivated and retained. This can be achieved by providing them with additional incentives to prevent them from seeking new opportunities. Another key point discussed was the difference between starting a business as an LLC and transitioning to a corporation for institutional funding. While an LLC may seem like a simpler option initially, making the switch to a corporation involves tax implications and complexities, particularly regarding stock options and deductions. Founders should consult with their accountants before making this transition to ensure a smooth process.
Managing an LLC involves staying informed about legal complexities of flipping an LLC to a court: Seek professional advice and stay updated on regulations to avoid tax and accounting issues when managing an LLC
When it comes to managing an LLC, it's crucial to stay informed about all legal aspects, including the potential complexities of flipping an LLC to a court. Delaying on legal matters can lead to issues with both illegal tax and accounting. To avoid such mistakes, it's recommended to seek professional advice and stay updated on the latest regulations. Additionally, for more insights on common first-time founder mistakes, be sure to catch part two of the discussion with Becky from Wilson's and Senie, which can be found on startupslashbasics this week.
