This is a nice summary of many of the legal issues affecting early-stage startups.
Any entrepreneur or startup lawyer can take issue with any given issue but this does not detract from the overall value of this piece.
Points of difference and/or clarification:
1. LLCs often work fine for early-stage startups, offering an easy and inexpensive way for founders to get started in many cases (caution here: if there is an "always" to be said in these situations, always do an initial consultation with a knowledgeable startup lawyer to at least understand what trade-offs and compromises are involved in doing this sort of "simple" setup because it is not without risks - such a consultation is very inexpensive and well worth it for the knowledge gained - for a start on the main pluses and minuses of an LLC, see my comment here: http://news.ycombinator.com/item?id=1276805).
2. High on the list should be to make sure that IP assignments are done in connection with any equity grant made to founders for work performed before the company is formed. If you don't do this, all such IP will normally belong separately to the founders who did the work and not to the company, even if they do get a fat stock grant at the start. A formality, but a very important one.
3. I am not dogmatic about Delaware and, indeed, have pointed out that Delaware is more VC-friendly than it is founder-friendly (http://grellas.com/faq_business_startup_002.html) - therefore, think very carefully before making this decision. Delaware can be a good pick and may be the best - it just should not be automatic in my view.
4. Vesting for founders is not always required. It normally is when you have a founding team of relatively equal founders (for the reasons stated in this piece - you don't want someone casually walking away with a big piece of the company). If one founder is dominant in relation to others being brought in for more secondary roles (and for comparatively small equity pieces), there is no need necessarily for the primary founder to make his shares subject to vesting at inception. Of course, if the company gets funding, investors likely will insist that vesting apply but not all startups look to fund in this manner. At the start, (1) all founders can have their stock subject 100% to pro rata vesting; (2) none of them need do so; (3) some may be subject to vesting while others are not; (4) any given founder can have his equity grant partly vested immediately while the balance is subject to vesting; (5) such vesting as is used may vary widely, from one to four years or more, with or without cliff (usually not for founders); or (6) any of all sorts of variations on the foregoing. Hence, there is no dogmatic rule here. It all depends on what the founders needs are and how much value they have built up before starting the company (this is relevant because vesting necessarily raises the risk of forfeiture and no one wants to forfeit that which has already been made valuable prior to the start). Collateral issues: accelerated vesting on certain events, such as termination without cause and acquisition - each of these has a variety of issues associated with it and investors in particular will often object to any liberal forms of acceleration.
5. Tax is often a huge issue at the start if the company formation is mangled - that is, if founders take their "cheap" stock at or about the same time as investors pay large dollars for theirs, there may be a serious risk of service income being attributed to the founders on which they must pay tax.
6. Concerning 83(b), this is also huge but irrelevant if there is no vesting and no risk of forfeiture connected with the grants made to founders (it is virtually mandatory if stock is granted as restricted stock, with its attendant risk of forfeiture, but not otherwise). It also is not needed for stock options unless there is an early exercise provision which is exercised at the start.
I'll insert my ad in here, because this topic is so close to my heart: Before incorporating, if you have co-founders, protect yourself with http://fairsoftware.net.
I know many people who didn't use us (or a similar co-founder agreement, except we are the only game in town if you are looking for a reputable, lawyer-approved, silicon-valley, tech-friendly one).
They regretted it dearly, later. In general, first time founders are pretty clueless about IP assignment (if my co-founder dumps me, what happens to his 10,000 lines of beautiful Python), vesting (if my co-founder doesn't work out, why does he keep 50% of my company), etc...
You know better than start coding without some kind of code repository. Don't start cofounding without an agreement. You've been warned :-)
- You will find a number of angel investors happy to invest in LLC's (depending on the stage and complexity of the funding round). While it's true that some investors require a more complex structure, the blanket statement that it's "required" is just wrong. It can also be destructive. There are REAL benefits to an LLC for a pre-revenue startup.
- Place of incorporation. I've never had an investor care about the state we've incorporated in. There are obvious tax implications, but it's often easier and cheaper to just do the paperwork in your state. It really just depends.
Points of emphasis:
83b election: This is SUPREMELY important, and applies to anyone attempting to invest equity (under any legal structure). Without properly handling the 83b you run into incredibly onerous tax issues. Learn about it and do it when you incorporate.
I disagree re LLC's: not only won't VC's invest in LLC's, but conversion to a C corp can be extremely complex and expensive. Indeed, it cost one of my clients about $15K to address tax issues relative to such conversion. In addition, issuing "stock options" is a nightmare with LLC's - not to mention the extraordinary complexity of operating agreements, with their complicated layer of partnership tax provisions.
Have to disagree about place of incorporation. Investors may not care but you should. Delaware should always be your choice. Delaware is very company friendly with laws and procedures that generally make it much easier and cheaper to get things done there (document filings are a prime example). Always, always, incorporate in Delaware.
All good points--I don't completely agree on the LegalZoom issue. Our company incorporated in Illinois through LegalZoom and it worked out great. I've done LLC/partnerships on my own and the paperwork is easy. It's good to think of LegalZoom as a paralegal service and not as a lawyer. We had an actual corporate lawyer draft contracts and other important documents but I'm not paying someone $300/hour to fill out forms.
I don't know Illinois law well, but there are good reasons why most corporations are Delaware (with a few in Nevada and a couple other states), including tax and governance issues. Did you ask an attorney if Illinois was the right state for you?
> I don't know Illinois law well, but there are good reasons why most corporations are Delaware (with a few in Nevada and a couple other states), including tax and governance issues.
CA works really hard to ensure that there are no tax advantages to incorporating elsewhere. If you do biz in CA, you pay CA taxes on that biz (and possibly some other biz - CA wants money).
In fact, CA even has a minimum fee ($5-800 IIRC) for doing biz here even if you don't make money.
By most corporations, I think you mean most large, public corporations incorporate in Deleware. I just didn't want to hassle with being a foreign entity in my own state and the taxes and fees in Illinois are reasonable.
You don't need a lawyer of LegalZoom to incorporate. Do it yourself, it's even cheaper. Just make sure to do due diligence in your operating agreement. DocStoc has a lot of template that you can reference. However, you should find a lawyer for legal matters when doing agreements for other companies.
If you don't plan on seeking investment, it the short-term you should go with an LLC for simplicity and tax reasons.
That post read like a job security pitch for his field. I think as a general rule you want to avoid and delay using lawyers as much as possible: too much complexity, paperwork and cost, too early. Get to a sellable (and selling) product/service first, otherwise you're wasting your money and time.
On the flip side of that, a few hours of lawyer time in the first year of Facebook might have saved the IP ownership dispute that has now cost about $100 million dollars in settlements, and might still go higher.
There are a lot of stories of startups that went under because the 50/50 owners couldn't decide on a plan of action, or turned out to not own any of the IP that they thought they owned.
If you think paperwork by lawyers is expensive, try funding a lawsuit.
Getting to a sellable and selling product/service requires creating IP, and probably half of his points were related to the creation and ownership of IP. It's also where the biggest and nastiest problems can arise down the track.
At the very minimum, before sitting down and designing your sellable product, draw up an agreement on the future of it. Spend a hundred buck on a lawyer to read through your agreement and advise you of any problems.
Any entrepreneur or startup lawyer can take issue with any given issue but this does not detract from the overall value of this piece.
Points of difference and/or clarification:
1. LLCs often work fine for early-stage startups, offering an easy and inexpensive way for founders to get started in many cases (caution here: if there is an "always" to be said in these situations, always do an initial consultation with a knowledgeable startup lawyer to at least understand what trade-offs and compromises are involved in doing this sort of "simple" setup because it is not without risks - such a consultation is very inexpensive and well worth it for the knowledge gained - for a start on the main pluses and minuses of an LLC, see my comment here: http://news.ycombinator.com/item?id=1276805).
2. High on the list should be to make sure that IP assignments are done in connection with any equity grant made to founders for work performed before the company is formed. If you don't do this, all such IP will normally belong separately to the founders who did the work and not to the company, even if they do get a fat stock grant at the start. A formality, but a very important one.
3. I am not dogmatic about Delaware and, indeed, have pointed out that Delaware is more VC-friendly than it is founder-friendly (http://grellas.com/faq_business_startup_002.html) - therefore, think very carefully before making this decision. Delaware can be a good pick and may be the best - it just should not be automatic in my view.
4. Vesting for founders is not always required. It normally is when you have a founding team of relatively equal founders (for the reasons stated in this piece - you don't want someone casually walking away with a big piece of the company). If one founder is dominant in relation to others being brought in for more secondary roles (and for comparatively small equity pieces), there is no need necessarily for the primary founder to make his shares subject to vesting at inception. Of course, if the company gets funding, investors likely will insist that vesting apply but not all startups look to fund in this manner. At the start, (1) all founders can have their stock subject 100% to pro rata vesting; (2) none of them need do so; (3) some may be subject to vesting while others are not; (4) any given founder can have his equity grant partly vested immediately while the balance is subject to vesting; (5) such vesting as is used may vary widely, from one to four years or more, with or without cliff (usually not for founders); or (6) any of all sorts of variations on the foregoing. Hence, there is no dogmatic rule here. It all depends on what the founders needs are and how much value they have built up before starting the company (this is relevant because vesting necessarily raises the risk of forfeiture and no one wants to forfeit that which has already been made valuable prior to the start). Collateral issues: accelerated vesting on certain events, such as termination without cause and acquisition - each of these has a variety of issues associated with it and investors in particular will often object to any liberal forms of acceleration.
5. Tax is often a huge issue at the start if the company formation is mangled - that is, if founders take their "cheap" stock at or about the same time as investors pay large dollars for theirs, there may be a serious risk of service income being attributed to the founders on which they must pay tax.
6. Concerning 83(b), this is also huge but irrelevant if there is no vesting and no risk of forfeiture connected with the grants made to founders (it is virtually mandatory if stock is granted as restricted stock, with its attendant risk of forfeiture, but not otherwise). It also is not needed for stock options unless there is an early exercise provision which is exercised at the start.
A nice checklist for going through legal issues at the start, with related HN commentary, may be found here: http://news.ycombinator.com/item?id=1198968.