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Founding a company is a high-risk, high-reward investment for entrepreneurs. Excitement aside, whether you are a first-time founder or a seasoned veteran, there are a handful of “legal” items that you should consider as you ramp up. This post summarizes a few of these key items.
Initial founder(s) & equity allocation
Each company will have one or more founders. A baseline question that every founder or founding team must answer is whether the equity allocation amongst founders is split evenly (e.g., 50/50) or allocated unproportionally (e.g., 70/30). All factors should be considered here, but a key metric to think through is the amount of “time” that each founder will dedicate to a company.
It is no secret that founders are often not able to dedicate 100% of their time to a new startup, so attention should be given to that. By way of example, if a company has two founders, with one founder dedicating 100% of their time to the startup, and a second founder dedicating 50% of their time to the startup, perhaps an initial equity split is 70/30, rather than a traditional 50/50 between two founders. Each startup is unique, so careful thought should be given to the initial equity split.
Vesting
It is common for founders’ shares to be subject to a vesting schedule. What this really means is that if a founder does not continue to provide services to the company for a specified period of time (more on this below), then that founder will “forfeit” (or return) all or a portion of the shares of stock initially issued to the founder. For any founder, this is perhaps the most critical item to consider and negotiate when founding a company as it relates directly to a founder’s ownership percentage in the company; thus, vesting should be discussed with a trusted legal advisor to ensure a founder understands the implications of vesting and whether it is appropriate for the founder and the company.
The “market” approach for west coast technology companies is a four-year vesting schedule, with 25% vesting one year from the date of formation, and thereafter vesting monthly during years two, three and four, resulting in each founder being “fully vested” four years from formation. This is just the tip of the iceberg though, so when in doubt, consult with your trusted advisors and or fellow entrepreneurs.
As an interesting discussion point, a good number of my founder clients prefer to start off with no vesting at formation, knowing that when they raise venture money the investor(s) will then require that founders subject their shares to vesting. This is not a “bad” sign, and honestly, it is quite the opposite.
To put it simply, investors are not only investing in the company, but they are also investing in the founders. The rationale for requiring vesting to be placed on the founders at the time of the investment is that investors want to ensure the founders are incentivized to “stick around” and continue to build the company for at least a number of years from and after the investment date.
Pro tip: If you have multiple founders, go with vesting for everyone and avoid serious issues and headaches later.
Management & control
If you are a solo founder this is simple, you run and control everything from day one. If there are multiple founding members, it is necessary to give thought to who will serve on the board of directors and who will hold certain officer positions.
The board manages the company and will need to approve all major decisions on behalf of the company and its shareholders. This generally includes, among other items, a financing round, annual budgets, the hiring and or firing of senior executives, and essentially ensuring the company’s vision or big-picture strategies are being fulfilled.
It is always best to have an odd number of directors to avoid deadlocks. Generally, if there are multiple founders then each will serve on the board of directors at the outset, but note that if you have an even number of founders, you should give some thought as to how deadlocks would be broken. This means deciding what happens if there are two members on the board and one member votes “yes” and the other member votes “no” on a matter.
Each company will then also have “executive officers” – officers need not be employees or founders, and any one person can hold multiple officer titles at once. Generally, each company will have a CEO, president, secretary and treasurer. Similar to the discussion above about determining equity allocation, each founder should consider the role that each founding member on the team will play in the early days of the company to decide the title(s) to allocate to each member.
Intellectual property (IP)
IP matters. It is vital that you have documents and procedures in place to ensure that the company’s IP is sufficiently protected. This means ensuring that all parties that are working with, for, or around the company have executed appropriate documents that guarantee that all “company IP” is actually and effectively owned by the company.
Missing the mark on protecting the company’s IP is unfortunately one of the few issues that can later turn out to be a dealbreaker or gamechanger for a company and its ultimate success – in a bad way.
To make matters worse, this is often done “by accident” and without intention of any party. It occurs from a lack of proper documentation and processes from the founding days. Working with experienced legal counsel will ensure that your IP is protected and actually owned by the company.
Tim Poydenis is a partner in Goodwin’s Technology Companies group and based in the firm’s Santa Monica office. His practice focuses on representing startups, emerging growth companies and venture capital investors. He advises companies throughout all stages of their corporate lifecycle, from formation to exit, as well as the venture capital firms and strategic investors in connection with their investments in these companies. In addition, his practice encompasses equity and debt financings, mergers and acquisitions, strategic transactions, partnerships, joint ventures and general corporate matters.
