Key Issues to Structure & Guide a New Company
When forming a new company, founders should consider the following:
1. The right structure will prevent difficult and costly consequences.
- It generally is more expensive to correct a problem than to do something the right way from the beginning. Forming a company is no different.
- More and more and companies now are “formed” using self-help services on the Internet. However, we sometimes find that, after a few years have passed, these companies only have a copy of their filed Certificate of Incorporation and a stack of incomplete and unsigned corporate formation documents. An experienced attorney can help the Founders set up the proper ownership, governance and contractual relationships at the beginning of the new company, which can be critical building blocks especially if there are multiple Founders, key Intellectual Property rights or Assets or plans to raise capital.
- Founders should not make oral promises regarding the new company’s equity (e.g., shares or Stock Options), because these promises often are difficult to document afterward, possibly leading to disputes. It is critical that the new company resolve any Founder or equity disagreements upon formation of the company or as soon as possible thereafter. If they linger, these disagreements can become significant financial and management disruptions.
- If the initial structure and formation documents have been tailored appropriately, then the new company also may be in a better position to avoid governance issues. For example, difficult “deadlock” situations sometimes arise if future governance scenarios are not evaluated realistically (e.g., you give to your new “partner” 50% of the stock, an executive officer position and the other seat on the Board of Directors and suddenly the Founders fail to see eye to eye on important governance, control or business matters).
2. Are the founders rowing the boat together?
- As a general rule, all of the Founders of the newly formed company should enter into stock restriction arrangements where their stock is subject to Vesting. The company then will have the right to repurchase some or all of the stock of a Founder who leaves the company before the stock has vested completely.
- To avoid adverse tax consequences, the founders must make 83(b) Election filings with the IRS within 30 days following the establishment of these stock restriction arrangements. The Founders also can negotiate and execute a stockholder agreement to establish additional rights and responsibilities, such as rights of first refusal, preemption, and co-sale.
3. Does the company own its secret sauce?
- The Founders should assign all relevant intellectual property to the company upon its formation and have continuing non-disclosure and invention assignment obligations to the company. It also is important to consult with experienced patent or other IP counsel depending on the nature of the company’s Intellectual Property.
- The company should develop a trade secret policy and enter into appropriate non-disclosure and invention assignment agreements with employees, consultants and other third parties (especially if the company is in the process of seeking patent protection on its technology).
- In addition, the availability of your corporate name does not guaranty that you will be able to secure the desired Internet domain or trademark rights.
4. A bad hire can be tough to fire.
- A string of bad hires can delay or derail the plans of the newly formed company. In addition to having Proprietary Information and Inventions Assignment Agreements in place, a new company should develop appropriate employment policies and hiring practices, including an at-will termination policy and Cliff Vesting for any Equity Incentives.
- Furthermore, the Founders should evaluate the continuing contractual obligations of the Founders and new employees to their former employers, especially if they are competitors of the new company.
5. Focus your financing on Accredited Investors.
- The company will raise capital more efficiently if it raises capital only from Accredited Investors (as defined in Regulation D to the Securities Act of 1933). The company will need to comply with significantly more disclosure and other technical requirements if the new company offers or sells Securities to Unaccredited Investors.
- In addition, the company should consider raising its seed capital with convertible promissory notes as a way to defer the challenge of valuing an Early-Stage Company.
6. Stock Option Plans are complicated.
- Establishing a Stock Option Plan involves various securities, tax, corporate and employment law issues, both at the state and federal levels.
- Recycling the Stock Option Plan from your last company by inserting the new company’s name at the top of the Stock Option Plan does not work well in almost all cases (although we have seen founders attempt to use this approach).
7. Keep the Corporate House in Order
- To reduce the personal liability of the Stockholders and position the company for future success, it is important to, at a minimum: (a) hold and document regular meetings of the Board of Directors and Stockholders (at least on an annual basis); (b) maintain the company’s formation, governance and ownership records in good order; and (c) tailor, use and maintain commercial and other agreements in an orderly and consistent manner.
- By doing so, the new company will operate more efficiently and be better prepared to respond to a future due diligence request when a potential Acquirer comes knocking.