Lecture 18 — Legal and Accounting Basics for Startups
Kirsty Nathoo, Carolynn Levy — Partners of Y Combinator
The best place to form a company is Delaware because everything becomes much simpler.
There are services that can help you get incorporated. You can use a law firm, but there are also other online services that help. The one that we often use with YC companies is called Clerky. They are set up so that all that standard basic documents are used and they get you set up in a very vanilla way so that you can move on and keep focusing on what you need to do.
A note on paperwork. You’re creating documents. These are really important documents that are going to be setting what the company does and what the company is. It’s really important that you actually keep these signed documents in a safe place. It sounds so basic but we get so many founders saying, “Oh, these are just some documents.” They have no idea what they are or where there are. So really, really make sure that you keep them in a safe place. Keep them organized. It will make your life so much easier.
Equity allocation. The first thing that you need to know is that execution has greater value than the idea. What does she mean by that? A lot of Founder Teams give way too much credit and therefore a lot of the company’s equity to the person who came up with the idea for the company. Ideas are obviously very important but they have zero value. I disagree with her, her words are too radical.I think it is really to sell only idea without execution.
The stock should be allocated equally among the founders or at least it’s should be proportionate. Because usually when ownership is disproportionate, the founders are not in sync with one another. A startup needs a complete team to execute, equal distribution of equity helps keep a team together.
Look forward,not backwards.
Vesting means that you get full ownership of your stock over a specific period of time. You bought your stock of your company and you own it and you get to vote, but if you leave before this vesting period is over, then the company can get those unvested shares back. When your hear restricted stock, it means that the stock is subject to vesting.
The number one reason why vesting is important has to do with founders leaving the company. If you didn’t have vesting and a founder leaves, a huge chunk of the equity ownership leaves with or her. Obviously that is not fair to the founders left behind. Single founders should have vesting too.
So what i understand that paperwork is very very important and responsible. If the attitude is wrong, the problems are unavoidable.
What about when somebody actually agrees to invest?
In terms of logistics, in very simple terms there are two ways to raise money. Either the price is set for the money that comes in or the price isn’t set. By price we mean the valuation of the company. Rounds can actually be called anything. People can name them whatever they want, but generally when you hear the term seed round, it mean that the price has not been set. Anything that’s a Series A or Series B is something where the price has been set.
Sometimes an investor pays $100K now and in return has the right to receive stock at a future date when the price is set by investors in a priced round. It’s important to note that at the time that paperwork is set, that investor is not a shareholder and therefore doesn’t have any voting rights in the company.
Four common investor requests:
- Board seat. Some investors will ask for seat on your company’s board of directors. The investor usually wants to be a director either because he or she wants to keep tabs on their money or because he or she really thinks they can help you run your business.
- Advisers. They are so many people who want to give advice to startups. Few people actually give good advice.
- Pro-rata rights. Very simply, pro-rata rights are the right to maintain your percentage ownership in a company by buying more shares in the company in the future.
- Information rights. Investors almost always want contractual information rights to get certain information about your company. Giving periodic information and status updates is not a bad thing.
Founder Employment. As prestigious as we think the title founder is, you’re really just a company employee and founders have to be paid. Working for free is against the law and founders should not let their company take on this liability.
The first thing you need to do is figure out if the person is an employee or a contractor.
Best practices for how to fire someone: number one, fire quickly. Don’t let a bad employee linger.