More Related Content Similar to Tcn -structuring founder relationships and equity -oct 2012 (20) More from The Capital Network (20) Tcn -structuring founder relationships and equity -oct 20121. Structuring Founder Equity
And Relationships
The Capital Network - Expert Lunch Series
Paul G. Sweeney, Esq.
October 24, 2012
© 2012 Foley Hoag LLP. All Rights Reserved.
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© 2007 Foley Hoag LLP. All Rights Reserved.
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3. Introductions
Paul Sweeney, Esq.
– Partner in Foley Hoag’s Business Department
– Named one of “Top 20 Startup Lawyers in Boston” and “Top 10
Most Innovative Lawyers in America” by the American Bar
Association Journal
– Practice focuses on angel and venture capital financings, mergers
and acquisitions, strategic alliances and related business
transactions.
– Clients range from start-up and venture-backed portfolio
companies to well-established public companies operating in a
wide array of industries, including mobile, networking, computer
security, information technology, and high tech.
– Helped clients raise hundreds of millions of dollars in angel and
venture capital, and advised clients through several dozen
acquisitions in the aggregate amount of over $2.8 billion.
© 2007 Foley Hoag LLP. All Rights Reserved.
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4. Overview
Cutting up the pie; dividing without being divisive
“Restricted Shares”
The Founders’ Agreement; getting it down on paper
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5. Picking a Great Co-Founder
Complimentary Skills
The Three “I”s - intelligence, intensity and integrity
Ideal team is comprised of people with a history of
working together, of similar age, life state and financial
picture, where some are great at building things, some are
great at managing things and some are great at selling
things.
4 things early-stage investors care most about
= PIMM (People, Idea, Model, Market)
© 2007 Foley Hoag LLP. All Rights Reserved.
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6. Choosing Your Co-Founders
Use care in who you choose; founders are to a
startup as location is to real estate.
Ability is important, but character and commitment
are even more so.
Work hard to maintain the relationship; your co-
founder is more than just a co-worker.
You haven’t seen someone’s true colors unless
you’ve worked with them on a startup.
The success of a startup is almost always a
function of its founders.
© 2007 Foley Hoag LLP. All Rights Reserved.
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7. Critical Questions Facing Co-Founders
Definition: Who should my co-founders be?
Equity Distribution: How will we divide the equity among
ourselves?
Control: How will decisions be made, and who will make
them?
Succession: What happens when one of us leaves?
Forced Departure: Can one of us be fired? By whom, and
for what reasons?
Cash Contributions: Will any of us be investing cash in the
company? How will this be treated?
© 2007 Foley Hoag LLP. All Rights Reserved.
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8. Dividing The Pie
“Why not just split everything equally?”
X= total number of founders, and each founder gets 1/X
of equity.
It’s simple and quick
We’re all equals, so our equity stake should be too
There’s no “right” answer, so might as well divide it
equally
We want everyone to have skin in the game
Debating over equity will kill the company
If future events require, we can always adjust later
© 2007 Foley Hoag LLP. All Rights Reserved.
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9. Dividing The Pie
Consider reasonable metrics for dividing equity:
Past contributions
Future contributions
Opportunity cost
Your relationship with co-founders
–(Note: Don’t confuse equity with income)
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10. What do I pay for my Founders’ Stock?
Address this EARLY!
Everyone should pay “fair market value” for the stock.
Cash is sometimes augmented by contribution of
intellectual property, but this is tricky:
- Difficult to define scope of transfer
- Difficult to properly perfect the transfer
- Difficult to value the assets assigned
- Potential tax ramifications (Section 351 of IRC)
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11. What if I paid “more” than FMV?
Need to balance control over company (relative
percentage of company held) with company’s
need for capital.
In extreme cases, consider issuing junior
preferred stock with a liquidation preference.
© 2007 Foley Hoag LLP. All Rights Reserved.
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12. Equity - take aways
Address the “splitting the pie” issue as early as possible
Pay attention to tax issues (get appropriate advisors)
Dividing equally is often sub-optimal
Choose metrics that are appropriate for your business
Co-Founder’s equity position should reflect his/her true
value
“Skin in the game” means different things to different
people
Don’t avoid the issue; this only gets harder (and more
expensive) over time
© 2007 Foley Hoag LLP. All Rights Reserved.
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13. Should Founders’ Stock be Restricted?
“Restricted Stock” –shares subject to forfeiture
The company has the right to repurchase the shares if
the founder leaves the company for any reason.
Vesting
Acceleration
Determining repurchase price
Critical Tax Considerations – 83(b) election
Timing- When to impose restrictions
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14. What is “Vesting”
At the beginning, Company has the right to repurchaes
your shares (called “Restricted Shares”)
Vesting = Company’s right to repurchase shares
lapses over time or upon certain events
“Vested Shares” – shares that are no longer subject to
repurchase right.
“Unvested Shares” - shares that are still subject to
repurchase right.
Note: Time based vesting vs. Performance based
vesting
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15. Vesting Schedule
Standard Vesting Schedule: Four year total, with 25%
vesting after one year (“cliff vesting”), remaining 75%
vesting monthly over next three years.
Vesting commencement date – credit for past service?
“Re-vesting” at a financing event
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16. Timing: Restrictions on Day 1?
Primary reasons for imposing vesting even before
VC financing:
1. If multiple co-founders, each is benefited if company
is able to repurchase unvested shares of a departing
co-founder.
2. If the terms are reasonable, they might survive the
venture financing.
© 2007 Foley Hoag LLP. All Rights Reserved.
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17. Acceleration Upon Change of Control
Standard Approach - allow some amount of accelerated
vesting (6-12 mos.) upon Change of Control
“Double Trigger” - acceleration tied to the termination of
the founder (usually without “cause”) within a certain
period of time (12 mos.) after the Change of Control.
- Difficult to implement if cash only consideration.
Note: Founders and Investors have adverse interests
© 2007 Foley Hoag LLP. All Rights Reserved.
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18. Acceleration Upon Termination
Accelerate upon termination without “cause” or
“constructive termination”?
- Difficult to define “cause” and “constructive
termination”
- Difficult to implement
- Usually results in regret (except for the departing
founder).
Consider treating acceleration like severance (3-6-12
mos.)
© 2007 Foley Hoag LLP. All Rights Reserved.
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19. Repurchase Price
Two Approaches:
- 1) Company repurchases unvested shares at the nominal price
paid by the founder. (Most common approach)
- 2) Company repurchases unvested shares at a price equal to the
fair market value (FMV) at the time of the repurchase.
•Board usually determines FMV
•Problem #1- Investors often view the founders as having not
yet “earned” the stock, and so they resist allowing founder to
benefit from an increase in equity value.
•Problem #2- the Company might not have the $.
•Possible Compromise: Differentiate the purchase price based
upon the reason for the departure.
© 2007 Foley Hoag LLP. All Rights Reserved.
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20. 83(b) Election
General Rule: If service-based vesting is imposed up
on founder’s stock, founder recognizes income (the
difference between fair market value and the price paid)
as the stock vests.
83(b) Election: If founder elects within 30 days of the
issuance of the stock to be taxed on the value of the
stock at the time of issuance (less anything paid for the
stock, which can include the value of IP contributed to
the business), then no income recognized upon
vesting.
30 Day Limit – Strictly Enforced. (Being close doesn’t
count.)
Election is voluntary - Can’t unwind if shares are
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forfeited.
21. 83(b) Election
Example: Founder purchases stock for $0.01 per share
(fair market value is $0.01). Stock is subject to four year
vesting with a one year cliff.
–If founder does not make 83(b) election, then at each
vesting date founder recognizes income based on
difference between $0.01 and FMV. In addition, the
company is required to pay the employer’s share of
FICA tax on the income and to withhold federal, state
and local income tax.
–If the founder had made 83(b) election, the founder
would not recognize any income as the stock vests.
© 2007 Foley Hoag LLP. All Rights Reserved.
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22. The Founders’ Agreement
Some Do’s and Don’ts:
–Don’t confuse equity issues with management issues
–Don’t assume everyone will always be agreeable
–Don’t get bogged down in legalese – decide what
you want, then have your attorney put it into proper
legal form
–Do make sure everyone’s objectives/visions/risk
profiles are compatible
–Do talk to others who have had experience in these
matters
–Do understand what is in the agreement
© 2007 Foley Hoag LLP. All Rights Reserved.
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23. When do I involve the Lawyers?
As early as possible!
Organization of company (charter, bylaws, stock
incentive plans)
Founders’ Agreement, or any other agreement
containing equity feature or right of first refusal
Financing transactions (both debt and equity)
© 2007 Foley Hoag LLP. All Rights Reserved.
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24. Take Aways
Choose your co-founders wisely.
Choose your attorney wisely, and early!
Always involve an attorney before issuing equity or
entering into agreements among co-founders.
© 2007 Foley Hoag LLP. All Rights Reserved.
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25. Sources and References
www.onstartups.com
www.founderresearch.blogspot.com
“Founders at Work” by Jessica Livingston
“Startups that Work” by Joel Kurtzman
“Business Basics for Engineers” by Michael Volker
© 2007 Foley Hoag LLP. All Rights Reserved.
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26. Questions?
Paul Sweeney
(617) 832-1296
psweeney@foleyhoag.com
© 2007 Foley Hoag LLP. All Rights Reserved.
2012 Proposal or event name (optional)
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