Startup Class Lecture 18 Notes – Legal and Accounting Basics

These are my notes from Lecture 18 of the Startup Class taught by Sam Altman. Kirsty Nathoo and Carolynn Levy of YC gave a talk on the mechanics of starting a startup.

My notes from the previous lectures are here.

Formation

  • Means to create a separate legal entity to protect yourself from personal liability
  • Where do you form one: have 50 choices but Delaware is the standard
    • standard and familiar: investors know about it
    • just fax two pieces of paper to Delaware which creates a shell corporation
    • then need to complete documents regarding board, CEO, etc
  • Online services to help get set up: Clerky
  • Keep the signed documents in a safe place

Equity

Allocation

  • What it is: how to divide the pie that is your company’s stock
  • Execution has greater value than idea
  • Ideas are important but have zero value
  • Resist the urge to give disproportionate amount of stock to the person that came up with idea
  • An allocation that isn’t more or less equal between founders is a red flag for YC
  • Worried that startup founders aren’t in sync if that’s the case
  • It’s also important that founders be in it in the long haul
  • In the top YC companies zero instances with disproportionate allocations

Paperwork

  • One of them is the stock purchase agreement where you buy stocks from the company
  • In this case you’re getting stock for cash or IP
  • Stock is restricted because it needs to vest
  • Takeaway: Make sure you sign the 83(b)election and Stock Purchase Agreement

Vesting

  • Vesting means you get ownership of stock over a period of time
  • Also known as restricted stock
  • 4 years with a one year cliff is the standard in the valley
    • If you leave before one year you get nothing
    • After one year you get 25%
    • Beyond that you vest monthly
    • Company can buy unvested shares back
  • Vesting ensures founders have skin in the game
  • Even single founders should have vesting to set an example for employees and show skin in the game for employees
  • Takeaway: Vesting aligns incentive among founders. Investors don’t want to put money in a company where anyone can walk away

Fundraising

Logistics

  • Two kinds of fundraising deals
  • Either price is set or price isn’t set
  • Seed round normally implies price not set
  • Series a and on normally price is set
  • Seed round normally a convertible note where the seed investors get stock at the same price as other investors when it does get set.
  • A valuation cap ensures the investors are rewarded for coming in early, getting shares at a maximum price set by the cap if the money is raised at a valuation higher than the cap
  • Dilution: need to think about how much of the company you’ll own after rounds are raised. Need to think about how much money is raised relative to the valuation cap.
  • Try to raise money from accredited investors rather than friends and family who might want the money back at a time when you can’t

Things to keep in mind other than valuation when fundraising

  • Board seat
    • Investors ask for a seat in your board of directors Be careful about this.
  • In most case you want to say no unless you think they can really add value.
  • Advisors:
    • A lot of investors ask to be advisors.
    • But you shouldn’t pay investors extra to be advisors.
    • After all, they’re investors in your company so should want to offer you advice to help you succeed any way.
  • Pro-data rights:
    • This is right for investor to buy more stock to keep the ownership percentage at the as before
    • Be careful with this since giving this could mean the founders dilute more.
  • Information rights:
    • Investors almost want contractual information rights to ensure they’re in the loop
    • Monthly updates are quite normal.
    • Don’t make promises of weekly updates or anything that will get in the way of running the company

Expenses

  • Deducted from company’s revenue on tax return statements to lower the taxes company pays
  • Company has its own bank account and should only be used for business expenses
  • The money raised by the company is the company’s money and not the founders’.
  • The way to think about it is that if the investor asked what you spent the money on and your were embarrassed about any expense that would show up on a line by line item expense report then that’s probably not a business expense.

Compensation

Founder employment

  • Founders are just like any other employee
  • Founders must be paid by law, so please do pay yourselves
  • Don’t go overboard on lavish salaries
  • Pay payroll taxes
  • Important to pay founders because in case a founder leaves and they weren’t being paid, they use it as leverage to get want they want like accelerated vesting

Hiring employees

  • Figure out if person is a contractor or an employee
  • Both sign documents that assign the IP they create to company
  • Contractor similar to a consultant: can set their own hours and the like and company doesn’t withhold any taxes from them
  • Employees need to be paid at least minimum wage, and taxes are withheld from them. Also need to ensure have workers compensation and seek proof that employee is authorized to work in the US
  • You should use a payroll service provider to handle this so you can concentrate on running startup

Firing employees

  • It always ends up being needed and is arguably the hardest part of running a company
  • Best practices:
    • Fire quickly: better for both parties involved
    • Communicate effectively: make clear direct statements
    • Pay all accrued wages immediately
    • Cut off digital services
    • Repurchase unvested shares right away

Key takeaways

  • Keep it simple
  • Do the paperwork
  • Think about equity allocation
  • Make sure you pay employees and founders
  • Know your key metrics (burn rate, number of employees)