STARTUP BEST PRACTICES FAQ
As a startup lawyer in the Houston, Texas & Dallas, Texas area I work with a lot of entrepreneurs, angel investors, venture capital/private equity firms, and companies in the tech, oil & gas, energy startup space.
I get a LOT of the same questions time and time again. Here are my responses to these questions.
TABLE OF CONTENTS
I. General Startup Basics
III. Startup Incorporation
IV. Startup Growth and Operations
V. Startup Financing Basics
I. GENERAL STARTUP BASICS
What is the number 1 problem you see in startups?
The best investors and entrepreneurs I have worked with are ruthlessly efficient. They push the agenda hard to get better every single day. They are people of action and that don't fuck around.
People don't realize how hard AND how intelligently some of their competition is working. You'd be blown away if you knew how hard some of my clients work. While you're checking Facebook, out to the movies, or whatever, they're working harder and smarter to make a product better than yours.
I know some entrepreneurs that are still in the formation phase of their startup for years on end. They just waste time and are afraid to hit the "GO" button.
This is a terrible type of attitude to have. I don't work with individuals with this attitude. And I have literally told people to not bother with a project if I sense this attitude. This is not an attack on their character. It's just better for some people to focus on something else. And that's okay.
As an attorney, this means I lose out on some potential revenue. That's fine. I don't care. At the end of the day, some people fit the entrepreneur world better than others. But if you do want to be an entrepreneur, then stop being complacent, adopt a killer attitude, be efficient, and keep pushing.
Are startups in Texas different than elsewhere and what is the scene like in Texas?
No; however, there are some small differences depending on the industry and ease of financing. Texas is growing extremely well is very heavily focused on IT ventures, health and life sciences tech, and oil and gas/energy tech. I’ve also worked with fintech companies here in Houston, Texas and Dallas, Texas as well. So it is diverse. As I keep saying over and over again, the basics of a business are the same everywhere; and this is actually true across time. The basics concern formation, growth & operations, financing, and end game.
What is the best way to approach startups?
1. Understand the fundamentals. You're not going to understand everything. Just have a general idea and go with it. This is how the best I've seen operate.
2. Stop dealing with bits and pieces of knowledge. Information without context is a waste of time, confusing, and ultimately misleading. Understand the overarching system--doesn't matter what it is--accounting, legal, whatever. You don't have to know every detail. Just understand generally how it all works.
3. Get the right personnel to help you. You need people who are skilled, efficient, and who will take the time to actually explain matters to you in a simple, concise elegant way. The best attorneys are able to address complex ideas in a simple manner. Make sure these advisors are your advisors and not someone else's advisors.
4. Recognize the phases of a startup. Understand the game being played in each phase. Master each part.
5. Keep moving. Speed kills. Be more efficient than everyone else. I can't emphasize this enough. Be someone of action.
Can my current employer claim my startup's IP?
Yes. Pay attention to employment contracts and collateral agreements. Don't work on it on your employer's time. Don't use your employer's tools. Explanation
Can I work on my startup for my second job?
It depends on contracts with your current employer. Explanation
III. STARTUP INCORPORATION
Do I need to incorporate?
Can I not incorporate and instead operate under a DBA?
You can, but it'd be stupid. You get no limited liability protection and investors won't invest in it. Avoid being amateur.
When should I incorporate?
As soon as possible--especially if you have a partner. Explanation
But I know a guy who never incorporated and did really well...?
I know a guy who smoked like a chimney every day and lived to 98. Explanation
What kind of entity should I form for my startup?
Where should I incorporate?
Delaware if you will get professional investors. If not, then your home state. Explanation
Do I need bylaws/operating agreement?
What should I set par value to be?
Low. Try $0.001 or $0.0001 or even $0.00001.
Do I really need my shares to vest on a vesting schedule?
Yes. 4 years with a 1 year cliff. Explanation
How do I find a partner?
The same way you would find a significant other. Go out there. Find people. Meet people. Get a good fit. Figure out what roles people will play.
Can I start a company if one of my co-founders lives in a different state?
Yes. But you will need to explain how this would work when it comes financing time.
What is a registered agent and do I need one?
A registered agent receives official documentation from the state and others on behalf of the company and MUST be located in the state of corporation. The startup company MUST have a registered agent. Even if you live in Houston or Dallas, Texas and incorporate in Delaware, the registered agent needs to be in Delaware. There are companies that offer registered agent services. Prices generally vary between $99-$150 per year depending on the service provider and the state. Explanation
Why does vesting as a concept work?
a. Protection: It protects from one founder jumping ship early with a huge chunk of the company. Investors like and will demand this type of protection. Just as well--you should like and demand this type of protection.
Well drafted provisions properly address questions of change of control or other corporate transactions. Acceleration clauses protect the founder if the company does well and gets sold early on.
b. Incentive: Vesting gives founders the benefits of having those shares (e.g. voting rights) while giving them incentive to stick around.
What is founders' stock?
Founders' stock is not any special type of stock. It's just a different term for the stock that founders receive at incorporation. It's regular ol' common stock. Investors receive preferred stock.
Does stock that founders receive at incorporation carry dividends?
Are there any other types of "founders' stock"?
Series FF stock: a type of stock that founders can receive that are designed to allow founders to cash out a little bit.
Series FF stock is just like common stock that is issued to founders except the Series FF shares can convert to preferred shares when preferred shares of the company are being sold to investors. Basically, if an investor is going to buy preferred shares in the company in a financing round, they can buy some of these shares from the founder for the same price (the series FF converts into the preferred shares to be bought.) The conversion from Series FF stock to preferred stock would have to be approved by the board.
Example: You as a founder have some common stock and some Series FF stock. The are both functionally the same for now. There's a big financing taking place where an investor wants to buy preferred shares of the company. You've been working hard and want to have some cash, so you want to sell some of the Series FF stock that previously behaved just like common. The board approves a conversion of Series FF stock into preferred stock. The investor purchases both for the same price per share: preferred shares from the company as well as preferred shares (previously Series FF) from you.
Downside of Series FF stock: they are complex and add to legal fees; might dissuade investors who won't be pleased that a founder is cashing out a bit
Upside of Series FF stock: allows for founders to get some cash; addresses the issue of allowing founders to sell some stock without raising the fair market value of common stock (recall that we want to keep this low.)
Class F Common stock: A type of super common stock that has 10x the voting power of regular common stock as well as special veto rights. Downsides are that they might dissuade investors from investing.
Who should own what percent?
Founders do not need to split 50-50. Decide who is going to do exactly what and what each founder will contribute and go from there. It's a hard discussion but worth figuring out.
Is single trigger or double trigger acceleration better?
Double trigger makes the most sense.
What are the most important things to make sure to do when it comes to incorporation?
1. Structure: Creating a C-Corp
2. Stock: Authorizing the right amount and kind of stock
3. Vesting: Having a vesting schedule
4. IP: Assigning IP to the company
IV. STARTUP GROWTH AND OPERATIONS
How do I do my taxes?
You hire someone. Don't waste your time trying to figure it out.
Specialize and polish the hell out of this project.
How do I protect myself and my startup interests?
Have your advisors and lawyers. Not your investors' lawyers.
You pay attention to: ownership control, voting control, board control, and financial control. Click here for more information.
Are officers the same as board members?
No. But they can be.
How is a company governed?
Officers (e.g. CEO, CTO) manage the day to day affairs of the company. Board members (i.e. directors of the board) make high level decisions of the company.
V. STARTUP FINANCING BASICS
What is an accredited investor?
Some securities (stock) are registered with the SEC. Some aren't.
Registering is a super expensive process where lots of disclosures about the company are made to the SEC. Almost no small company does this because it's just not worth it.
People can invest in these companies that don't register their stock and stock offerings and such. But the government wants to make sure these people are heads up enough to not get swindled by shady folks peddling stock. The way the government assures that these people have reasonable financial knowledge is to put the burden on the company to make sure that the investors are accredited. Usually this means that the individual makes a certain amount of money or has a certain number of assets that signifies that they are financially savvy enough to make these types of decisions. This means that they are "accredited." See here for more information.
Investors investing in startup companies need to be accredited. I have seen people fuck up on this many times. Don't make this mistake.
Does an investor really have to be accredited?
What if the person is a close family friend?
Doesn't matter. They have to be accredited.
What if my uncle wants to put in some money and support my company?
Either structure the deal as a loan or as a convertible note. If convertible note make sure your uncle is an accredited investor.
Should I try to take money from this guy i met who wants 50% of my company for 5k?
No. Have some respect for yourself. Focus on building your company. Always, always know what terms are reasonable.
My friends and family are willing to finance my startup. How do I do this?
As loans with a very long maturity with the risks spelled out well. Make sure they understand that they may never be repaid--and that they have to be okay with that. If it's for a lot of money, then as convertible security or equity (series seed) but only if they are accredited investors.
How much common stock should I give investors?
Don't give common stock. They need to get a different class of stock (preferred.)
What is dilution?
Dilution is your ownership percentage of the company going down as a result of others' ownership percentage of the company increasing (less pie for you, more pie for others.) It happens when the company issues more stock to others or brings on new investors into the company. Explanation
What is a term sheet?
A document that sums up the main points of a negotiated deal between investor and startup company. Explanation
What is better for my startup? Convertible debt or Series A priced round?
Convertible debt unless there's a cap. If there's a cap, then it's more circumstantial.
How do I find an investor?
You become so good that they can't ignore you.
If not that, then by going to events--meeting and talking to people.
HELP! My startup is going to do a financing deal. What do I do?
Same thing as always. Learn the fundamentals. Hire the right attorney/legal personnel to help you. Crush it and KEEP MOVING.