Legal and Accounting Basics for Startups with Kirsty Nathoo and Carolynn Levy (HtSaS 2014: 18) | Summary and Q&A

TL;DR

This content discusses the legal and accounting issues that startups may face in the early stages, including the formation of a separate legal entity, protecting assets, raising money, hiring employees, and entering into contracts.

Key Insights

• Founders don't need to know all the detailed mechanics of starting a startup, but understanding the basics is crucial to avoid getting bogged down in the details.
• Forming a separate legal entity, like a Florida LLC, is important for protecting personal liability.
• Startups need to protect their assets, such as IP and inventions.
• Founders should discuss key issues like leadership and equity distribution.
• Delaware is the preferred state for incorporating due to its clear and settled laws and investor familiarity.
• Convertible notes and safes are common methods for raising money in the early stages, allowing for future conversion into equity when the price is set.
• Vesting is critical to aligning founder incentives and ensuring commitment to the long-term success of the company.
• Payroll and employment procedures must be followed, including paying founders and employees, setting up payroll services, and distinguishing between contractors and employees.
• Firing employees should be done quickly, professionally, and in accordance with legal requirements.
• Startups should keep accurate records, including expenses and IP assignments, and engage with professionals like bookkeepers and CPAs as needed.

Transcript

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Questions & Answers

Q: What is the purpose of forming a separate legal entity for a startup?

Forming a separate legal entity, such as a Delaware corporation, protects founders from personal liability in case of lawsuits against the company. It ensures that only the company's assets are at risk, not the founders' personal assets. This also makes it easier for investors to invest in the company, as Delaware corporations are the standard and familiar to them.

Q: Why is it important to allocate equity in a startup fairly among founders?

Allocating equity fairly among founders is important to align incentives and promote a harmonious working relationship. It shows that all founders are equally committed to the long-term success of the company and prevents potential conflicts or issues down the line. Disproportionate equity splits can lead to mistrust and problems within the founder team.

Q: What is the purpose of vesting periods in startups?

Vesting periods ensure that founders are committed to the company and don't leave with a significant amount of equity before contributing substantial value. It aligns incentives by linking equity ownership with longevity and dedication to the success of the company. Vesting also helps protect the remaining founders and the company from potential issues or claims in case a founder is terminated or leaves early.

Q: Why should startups use a payroll service provider?

Using a payroll service provider ensures that founders and employees are paid correctly and that payroll taxes are handled properly. It helps avoid legal issues, such as non-compliance with labor laws or tax regulations. Payroll service providers can also take care of other important aspects, such as workers' compensation insurance and withholding taxes, saving founders time and effort in managing these tasks themselves.

Q: What should founders consider when firing an employee?

When firing an employee, it is important to act quickly and communicate the decision clearly and professionally. Pay all wages and accrued vacation immediately to fulfill legal requirements. Cut off access to digital systems to protect company information and assets. Repurchase any vested shares from the terminated employee to avoid potential issues or leverage in the future. Firing an employee is never easy, but it is crucial to prioritize what is best for the company's success.

Summary

This video discusses the legal and accounting mechanics that startups need to consider in their early stages. The speakers emphasize the importance of understanding the basics and setting up the startup correctly, including forming a separate legal entity and protecting assets. They also discuss topics such as equity allocation, vesting, raising money, hiring employees, and firing employees. The video provides insights into the common mistakes founders make and offers tips for avoiding them.

Questions & Answers

Q: Why is it important to form a separate legal entity for a startup?

Forming a separate legal entity, such as a Florida LLC, protects founders from personal liability in case the company gets sued. This means that if the company faces legal issues, it's the company's money in the bank account that can be taken, not the founders' personal assets.

Q: Why do many startups choose to form their companies in Delaware?

Delaware is a popular choice for forming companies because the state has clear and settled laws regarding corporations. Investors are also comfortable with Delaware corporations because they are familiar with the laws and regulations there. Choosing Delaware can simplify investor due diligence and avoid the need for potential reincorporation later.

Q: What is the importance of keeping signed legal documents in a safe place?

Keeping signed legal documents in a safe place is crucial for startups. These documents are important for assessing what the company does and what it is. They may be required during high-stress times such as raising a Series A round or during due diligence for an acquisition. Keeping the documents organized and accessible can make these situations less stressful and prevent potential legal and financial issues.

Q: How should founders allocate equity among themselves?

When allocating equity among founders, it's important to consider that execution has greater value than the idea itself. Instead of giving disproportionate amounts of stock to the founder who came up with the idea, it's better to distribute equity equally among the founders. This ensures that everyone has a fair share and avoids potential conflicts and imbalances among the team. In successful startups, there are no instances where founders had significantly disproportionate equity splits.

Q: What is vesting and why is it important?

Vesting refers to the process of gaining full ownership of stock over a specific period of time. It ensures that founders are incentivized to stay with the company and work towards its success. Vesting also protects the company in the event of a founder leaving. It's crucial to set a vesting period, typically four years with a one-year cliff, and have founders sign agreements to prevent ownership disputes and potential issues down the road.

Q: What are some common terms and requests made by investors in fundraising rounds?

Investors often ask for a seat on the company's board of directors, additional shares to maintain their percentage ownership (pro-rata rights), and information rights to receive updates and company information. Founders need to understand these terms and requests and how they can impact the company. It's important to carefully consider and negotiate these requests to ensure the best outcome for the company and its founders.

Q: What are some best practices for hiring and employing employees in a startup?

Startups need to distinguish between employees and contractors and adhere to laws governing each category. Hiring employees requires setting up payroll services to handle taxes and other legal obligations. It's essential to pay employees at least minimum wage, have workers compensation insurance, and verify their eligibility to work in the US. Using a payroll service provider can help simplify and manage these responsibilities.

Q: What steps should be taken when firing an employee?

When firing an employee, it's important to act quickly and communicate the decision clearly and directly. Pay all wages and accrued vacation immediately, cut off access to digital systems to protect company information, and consider having a third party present during the termination conversation. If the terminated employee has any vested shares, the company should repurchase them promptly to avoid potential complications.

Q: Why is it important to pay employees and payroll taxes correctly in a startup?

Paying employees and payroll taxes correctly is crucial to comply with the law and avoid legal and financial issues. Startups should treat founders as employees and pay them at least minimum wage. Not paying payroll taxes can result in fines and legal consequences. Payroll services can help ensure compliance and simplify the process of paying employees and managing taxes.

Q: What is the significance of handling employee terminations effectively?

Handling employee terminations effectively is a hallmark of a professional and effective founder. Firing quickly and communicating clearly can minimize negative impacts on the company and remaining employees. Paying all wages and accrued vacation immediately and cutting off digital access help protect the company's interests. How founders handle employee terminations reflects their ability to make tough decisions and prioritize the company's success.

Q: Why is it important to consider business expenses and separate personal finances from the company's finances in a startup?

Startups need to separate personal finances from the company's finances to maintain legitimacy and comply with financial and tax regulations. Business expenses are deductible on the company's tax return, reducing the overall tax burden. Keeping clear records of business expenses and liabilities ensures accurate accounting and prevents potential legal and financial issues. Personal expenses should be kept separate to avoid future complications and concerns about mishandling investors' money.

Takeaways

This video highlights the importance of understanding the legal and accounting mechanics of startups. Founders should aim to set up their startup as a separate legal entity, such as an LLC, to protect themselves from personal liability. Delaware is a popular choice for incorporating due to its clear laws and familiarity among investors. Founders should allocate equity among themselves fairly, using execution as a measure of value rather than the idea alone. Vesting is crucial for aligning incentives and should be considered when distributing shares. When raising money, founders should use standard legal documents and be wary of the dilution caused by excessively disproportionate equity splits. Hiring employees requires compliance with employment laws, such as distinguishing between employees and contractors, paying minimum wages, and setting up payroll services. Firing employees should be managed swiftly and effectively, ensuring clear communication, prompt payment, and protection of company assets. Separating business and personal expenses is vital to maintain legitimacy, comply with tax regulations, and prevent potential legal and financial issues. Overall, founders should focus on the basics and seek professional assistance when necessary to ensure the success and legality of their startup.

Summary & Key Takeaways

• Formation: Setting up a separate legal entity, preferably a Delaware corporation, to protect founders from personal liability.

• Equity: Allocating equity among founders, focusing on execution rather than just the idea, and maintaining equal ownership to align incentives.

• Vesting: Implementing vesting periods to ensure founders stay dedicated to the company and to avoid disproportionate ownership splits.