Startup Mechanics: class 2

CliffsNotes + commentary on Startup School

The 2nd class with Kirsty Nathoo is about startup mechanics including incorporation, equity, fundraising, hiring and exits.

I encourage everyone to watch the full lecture (58 mins, link at end of this post), but if you are just curious or want a 5 minute refresher, here we go:

Kirsty:

There’s a lot of complexity with setting up everything in a company, but here are the fundamentals. And while these are not the “glamorous” parts of building a startup, they are the nuts and bolts that you should do correctly. If you don’t do some of these basics, the company will face problems that will cause major time and money to solve later on.

Formation

A Delaware c-corp is the standard way to go for a startup and will work in the long term.

Don’t form anything else.

Don’t incorporate too soon or too late — incorporate if you are starting to create IP or accepting payments for your product. Use Stripe Atlas to incorporate, get a tax ID, set up a bank account, etc.

Investors in the U.S. usually don’t invest in non-U.S. companies and non-U.S. founders can incorporate in the U.S. too.

If you use a lawyer ($3–5K + filing fees), find a startup lawyer who has done this before. Or you can use Clerky to handle most of the standard items for a couple hundred dollars.

One YC company didn’t do incorporation right and it cost them $500K to fix the issue down the road.

Equity

This is a really important conversation amongst the founders to get to a fair split. All the hard work is ahead of you so trying to get to a more equal equity split is better for your long term future.

Important: do the paperwork — a stock purchase agreement — to make sure you document the share ownership.

Generally you want to vest equity over 4 years with a 1 year cliff. This means the first year all your shares are subject to repurchase by the company. Investors care that you stick around for several years and it’s standard for both founders and employees.

Important: file your 83b election within 30 days of your incorporation / stock purchase agreement!

Fundraising

You can raise on a priced round or a convertible round. Startups usually raise a little bit of money on a convertible round then raise on a priced round later on for more money.

It’s more complex than it looks here. You should use a good lawyer to help.

Li: before raising, I would suggest talking to several founders who have successful navigated the fundraising process so you avoid making a mistake early on that’s hard to fix, i.e. selling too much of the company or giving your first investors rights that make it harder for future investors to participate.

A convertible round can be done with a safe: simple agreement for future equity. It’s faster and easier to do so you save time as an early stage company. There will be a valuation cap, an upper bound for the price that the safe investors converts into the next round, which gives them a “bonus” for investing early and taking more risks.

Avoid selling too much of the company early on / raising more money than you need.

Hiring

Hiring employee is generally more complex than hiring contractors — need work authorization, tax withholding, etc.

To pay people, use a payroll service provider such as Gusto.

Li: your time and energy as a founder is too valuable so just outsource it.

Be generous with equity for early employees — as a rule of thumb the first 10 employees should get around 10% of equity. Remember to do standard vesting.

Be clear to your employees about the % of company and # of shares they own.

The equity is issued as options to buy stock in the future at a price that’s set today, which means everyone should be working to make that future stock as valuable as possible.

Doing Business

Some general business hygiene include keep your signed documents organized, know your metrics, and manage to reasonable expenses.

Kirsty’s Q&A:

The first 5 employees might be 7%-8%; first 1o employees is 10%. Be transparent which means you as the founders need to understand equity and options. Once the initial 4 year vesting period is done, usually companies give new stock grants to employees so they have new vesting period to keep the equity incentive in place.

Preferred investors get their money back first.

Watch the full video:


Li: you can never go wrong by getting the fundamentals right. It’s worth the extra time and money wisely spent setting up everything. Talk to several other founders who have done this before to make sure you cover any non-intuitive blindspots.