Startups often ask us how a typical startup is structured. While there are plenty of free and affordable resources for various forms, they don’t provide much guidance on what forms to use and why. In fact, there is no one-size-fits-all approach to structuring a startup. Each is unique in its needs. Still, there are some default positions that apply to the typical startup structure for a technology (or other) startup seeking venture capital.
The typical startup structure for startups that will seek VC funds will include incorporation as a C-Corporation in Delaware. Read our earlier article for reasons to incorporate in Delaware.
Some startups can initially elect to be taxed as an S-Corporation until the point they are ready for professional investment. This allows the founders to receive “pass-through” taxation, which may be especially beneficial if you will be running losses that can be used to lower the personal tax liability of the founders, until there’s a strong reason for switching to the C-Corporation’s “double taxation”. See our earlier article for the benefits of electing to be taxed as an S-Corp.
The typical startup structure for startups that will seek VC funds will include the following capitalization:
- 10 million total authorized shares.
- 8-9 million shares issued to founders. These shares will typically be subject to vesting over 48 months, with 25% of the shares vesting after 12 months (the “cliff”) and the rest vesting in equal monthly installments. Sometimes there may be good reasons for deviating from this default approach, however. While founders can decide to split the shares equally among themselves, it doesn’t have to be so, especially when one of the founders contributes significant intellectual property to the company.
- 1-2 million shares authorized for a stock options pool and early hires. These shares will also typically be subject to a vesting schedule. Most venture capital firms will require an options pool upon the financing, and will not allow the pool to come from their percentage ownership of the company. So if there is no options pool built into the company from the beginning, founders can expect to be diluted more than expected.
The typical startup structure for startups that will seek VC funds will be reflected in the following documents:
- Certificate of Incorporation. This form will be filed with the Delaware Secretary of State, will set out the name of the corporation, its registered agent for service of process, the total authorized number of shares, indemnification of directors and officers, and other provisions.
- Bylaws. This document sets out the internal governance rules of the corporation, including when and how meetings are held, election and removal of board members, election and removal of officers, indemnification of directors and officers, and many other provisions.
- Consent of Sole Incorporator. This document effectuates the resignation of the sole incorporator and the nomination of the board of directors.
- Unanimous Written Consent of the Board of Directors. Through this document, the board approves corporate actions taken by the CEO to that point, approves issuances of shares, and takes other actions.
- Restricted Stock Purchase Agreement. Each shareholder will sign a Restricted Stock Purchase Agreement to purchase his or her stock. The document will include a number of restrictions, including:
- a right of first refusal in the company if the founder wants to sell the stock to someone else,
- a repurchase option for the company if the founder leaves before all shares are vested, and
- a lock-up agreement not to sell any stock within 180 days after an Initial Public Offering.
- 83(b) Election. Each shareholder will be advised to sign and submit an 83(b) election to the IRS to avoid the potentially severe tax consequences of failing to make the election.
- Stock Certificate. A certificate will be signed by the corporation’s Secretary and President for each of the shareholders. The certificate will include a legend with all of the restrictions in the Restricted Stock Purchase Agreement.
- Confidentiality and Invention Assignment Agreement. This document will require that each person involved with the company not disclose confidential information and to transfer the ownership of all inventions to the company (some prior inventions can be excluded).
- Indemnification Agreement. This agreement will set out the terms of the company’s indemnification of directors and officers for their actions on behalf of the corporation.
- Cap Table & Stock Ledger. These documents will memorialize who owns stock in the corporation and how many shares each person owns.
Of course, the incorporation, capitalization, and documents described above only reflect the default options for most startups that will seek VC funds. There may be compelling reasons to deviate from these options in specific situations. It is best to discuss your goals with trusted counsel to structure your startup and the accompanying documents to reflect those goals. Automated legal documents, while cheap in the short term, can result in even higher costs in the long term because they often fail to reflect the intent of founders who don’t take the time to read through the documents or may be confused by their complex language.
First published on Elevate Law and Strategy’s blog: “Debt vs. Equity”
DISCLAIMER: The information in this article is provided for informational purposes only and should not be construed or relied upon as legal advice. This article may constitute attorney advertising under applicable state laws.