In an interesting post on startup professionals, Marty Zwilling presents an outlook on how entrepreneurs can protect their founders’ shares in the start-up stage.
Founder’s shares are simply common stock, but issued at the time of incorporation for a very low price, and allocated to the multiple initial players commensurate with their investment (financial equity, sweat equity, IP…) or role.
These shares are allocated and committed, but not owned (vested) and sometimes not issued until a later stage. Founders can negotiate special terms (vesting and other), as part of their stocks restriction agreement upon venture investment.
Some typical considerations for founder’s stock are:
- The negligible real value, as founder’s shares are usually issued at the time the company is incorporated and therefore have no real value. Later, when the company builds value, shares allocated for employees or partners will have an appropriate estimated price.
- Vesting with no cliff, as the partners should already know and trust each other, and thus, most founders will start vesting their shares from the date they actually started providing services to the company, and not after one year, as generally considered for others.
- Right of repurchase in favor of the company, to give the founders the first right of refusal to buy shares back from a partner who decides to leave early.
- Accelerated vesting conditions, with special terms in the case of termination or demotion that accelerate vesting, especially for strategic people in the organization.
- Stock dilution control, with a special common clause in order to minimize dilution of shares.
Founders often make the mistake of waiting until they have received a strong indication of interest from an investor before they decide that it is time to incorporate; but forming a company so close in time to raising capital can create a significant tax issue, while there shouldn’t have any tax concern for a founder, because valuation has very little meaning until an outsider invests.
So, the best advice is to incorporate and allocate founder’s stock as soon as starting real work on the company, but at least six months before you anticipate any outside investors. Incorporate too early can lead investors to measure the growth and progress since the incorporation date, while too late can lead to tax issues.
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