Incorporation Issues for Growth Companies

The Founder Institute Seattle, Winter 2012

Andy Aley

GSBlaw.com

About this Presentation

This presentation is provided for general informational purposes only, is not made available for the purpose of providing legal advice and is not delivered in the course of an attorney-client relationship. While this presentation is intended to provided general information relevant to the intended audience, no warranty is made as to the informations accuracy. This presentation is not a substitute for competent legal advice from an attorney licensed to practice in your jurisdiction.

Circular 230 Disclosure: The income tax principles, rules, and outcomes discussed in this presentation are intended to be used solely for general informational purposes. The information contained in this alert is not intended to be used, and cannot be used, for the purpose of avoiding federal tax penalties.

GSBlaw.com

Whats this all about?

Building a solid foundation for growth. Avoiding time loss at a more critical moment.

GSBlaw.com

Why Incorporate?
Liability issues Multiple founders Intellectual property development Seeking investment Stock sales and tax issues Hiring employees / contractors Visa requirements

GSBlaw.com

Entity Choice
C Corp Basics
Common choice for growth companies. No limitations on foreign or entity shareholders. Ability to issue multiple classes and series of stock. Earnings are subject to taxation once at the corporate level, and once at the stockholder level.

GSBlaw.com

Entity Choice
S Corp basics
Potentially beneficial to pre-funding companies or bootstrapped companies. Profits and losses pass through to shareholders. Ownership limitations prohibit non-U.S. shareholders and most entity shareholders. Multiple classes of stock are prohibited.

GSBlaw.com

Entity Choice LLCs

Profits and losses pass through to equity owners. No restriction on foreign or entity ownership. Costly to implement multiple classes of equity. Costly to implement equity incentive plans. Most professional investors avoid LLCs. Generally not recommended for growth companies.

GSBlaw.com

Jurisdiction
Delaware
Familiar to investors nationwide. Well defined corporate law. Efficient secretary of states office. Greater formation and maintenance expense ~$500 to form / potentially large annual franchise tax.

GSBlaw.com

Jurisdiction
Washington
Limited corporate case law, courts tend to follow Delaware. Less expensive to form and maintain ~$250 to form / $60 annually. Investor unfamiliarity could be a disadvantage, some investors may require re-incorporation in Delaware.

GSBlaw.com

Corporate Governance
Directors: Elected By Shareholders Broadly responsible for corporate oversight Owe fiduciary duties to company and shareholders

Fiduciary Duties
Officers: Appointed by and generally report to board of directors Responsible for carrying on the companys business Owe fiduciary duties to company and shareholders

Corporation and Shareholders

all you (for now)

GSBlaw.com 10

Equity
Issued = stock that a stockholder actually owns. Authorized = total number of shares that the corporation may issue. Reserved = authorized but unissued shares that have been reserved for a specific purpose (e.g. option plan, convertible security). Fully Diluted = all issued and reserved shares
Approach carefully: mix ups can cost ownership %

GSBlaw.com

11

Classes of Stock
Common Stock Basic economic and voting rights. Economic rights are equivalent to other common holders, subordinate to preferred. Possible to provide for varied control rights by creating classes of common stock. Preferred Stock Superior rights compared to common holders (e.g. liquidation preference, anti-dilution). Founders and employees typically hold common stock, VCs and institutional investors typically hold preferred stock.

GSBlaw.com

12

Class F Stock
Specific to Founder Institute 10 Votes per Class F Share Right to appoint a Class F Director with two votes Protective provisions requiring specific approval of Class F Corporation would authorize Class A Common Stock and Class F Common Stock A sufficient number of shares must be reserved for conversion of Class F to Class A Class F is easily convertible to Class A Not a requirement, and not one-size-fits-all

GSBlaw.com

13

Restricted Stock Agreement

Designed to ensure that equity stake is aligned with input to the Company over time. Founder stock subject to repurchase right/risk of forfeiture that lapses over time. Repurchase/forfeiture is triggered by defined events (e.g., termination for cause, voluntary resignation) Vesting may be fully or partially accelerated on change of control Potentially beneficial tax treatment

GSBlaw.com

14

FI Warrant Terms
Entitles the Institute to purchase 3.5% of the fully-diluted shares of the company, measured after a Qualified Equity Financing. Exercise Price = QEF price Security = QEF securities (e.g. Series A) Term = 5 years from QEF, or 10 years if no QEF or IPO. Redeemable for $100,000 Founder Termination Payment Payable by company to FI in the event of involuntary termination

GSBlaw.com

15

Whats the process?

GSBlaw.com

16

GSB and FI Companies

Engagement Terms $1,750 flat fee for incorporation. Covers out of pocket costs of filing. Deferral of up to $5,000 for other legal needs (excludes immigration). First Steps Complete incorporation questionnaire. Meet with one of us to discuss questions and particular needs. Be sure to let us know about immigration issues, third-party IP contributions, obligations to current employer, etc. Return engagement letter, complete any open items, deposit flat fee.

GSBlaw.com

17

Incorporation: Whats included

GSB prepares a set of incorporation documents based on questionnaire and consultation Certificate of Incorporation Bylaws Restricted Stock Agreements Invention Assignment / BPA

Restricted Stock Purchase Agreement Director Indemnification Agreements IP Assignment Option Plan / Agreement Founder Institute Warrant Board and Shareholder Consents State Filings and Notices We also provide a few useful documents for future use Three forms of NDA selectable for different circumstances Form of Independent Contractor Agreement Trial access to GSB AdviceOnline HR Product
GSBlaw.com 18

Questions?
Peter Cancelmo 206-816-1332 pcancelmo@gsblaw.com Scott Warner 206-816-1319 sgwarner@gsblaw.com Andy Aley 206-816-1361 aaley@gsblaw.com Stephen McKay 206-816-1524 smckay@gsblaw.com

GSBlaw.com

19