Structuring Founder Relationships


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Once you move from a single person to adding a co-founder, hiring your first employee, or setting up a partnership that takes your company beyond just you, it’s important to make sure you have your stockholder agreements set up correctly. There is more than one kind of stock option to share. Do you know them all and when to use them? Don’t worry, we’ll help you.
This Google Hangout will cover invaluable information on structuring founder equity to avoid the pitfalls that can harm a company’s ability to attract investment capital.
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Bob Bishop, Goodwin Proctor

Published in: Business, Economy & Finance
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Structuring Founder Relationships

  1. 1. ©2014 Goodwin Procter LLP Structuring Founder Relationships Founder Equity / Relationships; Shareholder Agreements and Choice of Entity Robert E. Bishop
  2. 2. Goodwin Procter LLP 2 Innovation Goodwin Procter’s Founders Workbench   Founders Workbench: a free, online resource to help entrepreneurs navigate many of the legal and organizational challenges   Site includes self-service tools for generating basic company legal documents   Resources include significant content, links and library of resources, Capital Calculator, Deal Dictionary, Document Driver, and Founders Workbench blog 2 1st Place “Your Honor” Awards Web Site Winner CIO 100 Award Winner for Information Technology Department Legal Standard of Excellence Award Winner from the Web Marketing Association’s WebAward 2013 Awards Top 5 U.S. Law Firm for marketing and business development. Ranking based on the use of technology, social media and other communications tools; Founders Workbench featured case study
  3. 3. Goodwin Procter LLP 3 Overview   Founder Equity / Relationships   Shareholder Agreements   Choice of Entity
  4. 4. Goodwin Procter LLP 4 Founder Equity / Relationships Choosing the Right Co-Founders:   One of the most critical decisions a team has to make   Skill set is critical but so is personality / compatibility   Character and work ethic are essential
  5. 5. Goodwin Procter LLP 5 Founder Equity / Relationships How to divide the pie?   More of an art than a science   Pro rata is not (necessarily) right   Considerations: ›  Relative contributions (IP, commitment, intangibles, etc.) ›  Opportunity costs to the Founders (what other options do the Founders have?)   Cash investments should (typically) be addressed separately   Resolve this issue at the outset – do NOT “kick the can”
  6. 6. Goodwin Procter LLP 6 Shareholder Agreements Key terms:   Vesting   Composition of the Board of Directors   RoFR / Co-sale rights
  7. 7. Goodwin Procter LLP 7 Vesting Importance of vesting:   Without it, a Founding team member can leave and keep all of his or her stock   Most investors (particularly VCs) will insist on it ›  Tactical advantage of putting something in place upfront that could survive ›  BUT the investors can always make you re-write terms
  8. 8. Goodwin Procter LLP 8 Vesting (Cont.) Vesting terms, etc.:   Typically 4 years   Monthly or quarterly vesting   No “cliff” – different than employees   Some vesting upfront? Maybe   Types of acceleration ›  Termination without “cause” quit for “good reason” ›  “Single trigger” on a “sale event” ›  “Double trigger” and “modified double trigger” ›  Death / disability   83(b)s – 30 days is no joke
  9. 9. Goodwin Procter LLP 9 Board of Directors   Need to determine who is going to “run the show”   Generally tracks ownership, but not necessarily   Use an odd number of directors to avoid deadlock (can be difficult with 2 equal co-Founders)   Keep it simple   This will get revisited in connection with a financing
  10. 10. Goodwin Procter LLP 10 RoFR / Co-Sale Rights Rights of First Refusal   Gives the Company / the other Founders the right to purchase shares that a co-founder proposes to sell Co-Sale Rights:   Gives the other Founders the right to sell along side a co-Founder that proposes to sell shares
  11. 11. Goodwin Procter LLP 11 Other terms   Post-IPO lock ups – good to get these in place at the outset   Restrictions on transfer   Put / Calls – sometimes in unique situations   Amendment terms – be careful here!
  12. 12. Goodwin Procter LLP 12 Choice of Entity Typically 3 Choices:   C corporation   S corporation   Limited liability company Each generally provide a “liability shield” which is the primary reason for incorporating, but there are differences…..
  13. 13. Goodwin Procter LLP 13 C corporations   Most common approach for high growth companies ›  Simplicity / familiarity ›  Most VCs have restrictions on their ability to invest in LLCs because of certain tax implications to their limited partners ›  VCs (and other entities) cannot invest in S corps   Downside: Double taxation and other less favorable tax implications
  14. 14. Goodwin Procter LLP 14 S corporations   Benefits: ›  Looks like a C corporation ›  No double taxation ›  Other tax benefits   Disadvantages: ›  Limit on number of shareholders ›  Only one class of stock permitted (precludes preferred stock financings) ›  Only U.S. individuals (and certain trusts) can be shareholders
  15. 15. Goodwin Procter LLP 15 Limited liability companies   Benefits: ›  No double taxation ›  Other tax benefits ›  Ability to grant “profits interests” ›  Maximum flexibility / “blank slate”   Disadvantages ›  Less familiar ›  More complex / expensive ›  Requires more sophisticated advisors