The right time to incorporate
Determining the right type of entity to create
Where to incorporate
Defining “qualified to do business” and where to be qualified
Who makes decisions for the company?
How startups compensate employees
Foreign employees and their need for a visa
Who owns your IP
Licensing IP from a university or hospital
Retaining a license to your IP
Non-competes with former employers
Reserving shares under the company’s option plan
The right time to incorporate
Once you are ready to move forward with an idea, you should formally incorporate your startup as a legal entity. It is important to do this relatively early for a variety of reasons.
Determining the right type of entity to create
Starting a company is risky, and many startups fail. Even if things go well, someone might sue the business. One of the primary reasons for operating your business through a legal entity is to shield your personal assets from claims made by the creditors of the business. If you operate the business through a corporation or a limited liability company (often called an LLC) then the owners and operators of the business will not generally be responsible for the liabilities of the business. Other legal structures like partnerships don't offer the same protection for all owners of the business. So between an LLC and a corporation, what's the best structure for you?
Where to incorporate
If you plan to raise external funding for your entity, then you should incorporate in Delaware. Delaware offers several advantages over other states. For many years, the legislature in Delaware has sought to attract companies to incorporate in Delaware by adopting a relatively company-friendly set of laws under which to operate. Delaware has a separate court whose sole job is to try cases under this set of laws, and so there are many published decisions interpreting these rules.
Defining “qualified to do business” and where to be qualified
If your company is incorporated in one state (e.g., Delaware), but you are “doing business” in one or more other states (e.g., California, Massachusetts, New York, etc.), then the laws of the states in which you do business require your company to be “qualified to do business” there. To qualify to do business in a state, you typically need to make a simple filing with the Secretary of State’s office that describes your business. You will also typically need to file reports and pay a fee (typically referred to as a “franchise tax”) in that state annually.
Who makes decisions for the company?
The shareholders of a corporation are its owners, and they vote their shares to elect the directors. The directors sit as a board, which, typically acting through a majority, oversees the corporation’s management and sets the overall corporate strategy and direction. Directors have fiduciary duties, so they generally must act in the best interests of the corporation and its shareholders. The corporation’s directors elect officers, including a CEO, who conduct the day-to-day business operations. The board must also approve certain significant corporate matters, such as stock issuances and important contracts.
How startups compensate employees
All employees (including founders) must be paid in cash in amounts at least to satisfy the minimum wage laws established by federal and state laws. Many founders opt to go without compensation in the initial stages, but technically doing so is in violation of the federal and state wages laws. Employees may receive equity in addition to cash payments, but due to tax and other complexities it is generally not feasible to grant them equity in lieu of minimum cash wages. Although the market may reflect standard salaries for different types of positions, there is no requirement that employees receive any more than minimum wage, and the wages employees receive often depend on how large and established their employer is.
Foreign employees and their need for a visa
A foreign student is permitted to own equity in a company and to serve on the board of directors of a company. A foreign student may not perform work for a company without obtaining appropriate authorization from the foreign student office at his/her university. The rules are no different for founders.
Who owns your IP
To successfully launch a new startup, the company needs to own, or have a license to use, the intellectual property that will be used in the business. This aggregation of IP does not happen automatically and requires careful planning with your legal counsel.
Licensing IP from a university or hospital
Many companies are built on intellectual property licensed from academic or research institutions, such as universities and hospitals. Companies may also license technology from those types of institutions to supplement their existing intellectual property. These licenses are typically patent licenses, but may also be licenses to software, materials or other intellectual property. Many institutions have their own licensing office dedicated to commercializing intellectual property of the institution. Some of the key points to consider when licensing intellectual property from these types of institutions include:
Retaining a license to your IP
It may seem logical and fair that the founders contributing IP they invented to launch a new startup should retain a license to that IP should the company fail or should the founders identify other uses for the IP outside those contemplated by the company. After all, the founders developed the idea and invented the IP prior to forming the company.
Non-competes with former employers
Non-competition agreements may be enforceable, depending on the state in which the employee lived and worked when the agreement was signed, the consideration (value) given in exchange for the agreement and the reasonableness of the restrictions in the agreement.
Reserving shares under the company’s option plan
The option “pool” represents the number of shares the company sets aside in reserve under its option plan to compensate its employees, consultants, advisors and directors. The size of the option pool depends on the company’s stage, circumstances and hiring needs. When the company issues shares under the plan, it dilutes the ownership percentage of the other shareholders proportionately. However, any shares reserved under the plan that are not used (i.e., that are not sold or issued by the company) do not dilute the actual ownership of the other shareholders. Therefore, the size of the option pool at the initial formation of the company doesn’t really matter all that much—if the pool is too small and you need more shares, it can always be increased; if the pool is larger than you actually need, any excess shares don’t have any negative impact on the actual ownership of the company. Most startups will initially reserve an option pool that is big enough to provide for the equity incentives needed to cover their anticipated hiring needs for the first six months to a year.
- Allocating equity among founders
- Vesting restrictions on shares held by the founders
- Vesting terms that make sense
- Accelerating vesting on a sale or termination
- Tax implications related to shares that vest
- Rules for foreign founders in the US on a student visa
- Who owns your IP
- Non-competes with former employers
- Take a good idea with you when you leave a company
- Retaining a license to your IP
- Founder compensation
- Founder employment agreements
- Accelerating vesting on a sale or termination
- Vesting terms that make sense
- Tax implications related to shares that vest
- Difference between consultants and employees
- How startups compensate employees
- Foreign employees and their need for a visa
- Unpaid interns
- Non-competes with former employers
- Reserving shares under the company’s option plan
- Agreements with employees
- Hiring a team before securing funding
- Vesting restrictions on shares held by the founders
- Accelerating vesting on a sale or termination
- Vesting terms that make sense
- Tax implications related to shares that vest
- Difference between options and restricted stock
- Tax differences between ISOs and NSOs
- Granting options vs. issuing restricted stock
- Advisory board setup and compensation
- Reserving shares under the company's option plan
