Haw Kuo from 500 Startups discusses the basic 101 questions lots of people have when they’re starting a new business.
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Haw Kuo: If you need to be in the stage where you’re thinking about being an LLC or an S corporation, the better question to ask yourself is, “Are you a real startup?” And it takes time to change this. What you don’t want to do is, “Sean’s going, ‘You know what, I want to invest in your company.'” And you go, “Wait crap I have to change my corporate structure from an LLC to something, to a Delaware C-Corporation.” You don’t want to get stuck in that kind of a slow-down which is yeah, if it takes too long. Sean might be in Norway swinging Viking axes or something, so you never know. There’s a lot of stuff out there. There’s a lot of lawyers you can hire, but use the standard terms. Use the standard Silicon Valley forms. Yes?
Man 1: Can you take it back to the last point? So just why the Delaware C-Corporation is superior to the rest?
Haw Kuo: Why is the Delaware C-Corporation superior? It’s not necessarily superior but it’s efficient. All the venture capital firms are very used to it and it’s just a very tried and true vehicle.
Man 1: So what makes it so different to the other, just like very, very briefly?
Haw Kuo: To which ones?
Man 1: To the S and to the LLC.
Haw Kuo: Well the point that I will make is that most venture funds will not invest in an S-Corporation or LLC because it’s a different structure that has passthrough implications. Don’t want to dive super deep into that but venture funds have their own investors. They can’t get hit with those tax pass-through issues. So that’s going to be one of the…
Man 1: So only tax.
Haw Kuo: There’s a lot of other considerations. But yeah, if you’re trying to squeak by with something that’s not a Delaware C-corporation, again, the question is, are you a real startup at that stage? Use the standard terms. I’ll talk a little about this. Rob will probably talk a little bit more about this. What you don’t want to do is you don’t want to get fancy or creative or outsmart yourselves. We actually, Clerky again as Sean mentioned, you can set up your Delaware C-Corporation. We have forms for all of your founders, shares issuances, and later on we have forms for issuing options to your employees and even doing fundraising.
So those are all things you can do online. You may wish to. Our forms and templates are used by major Silicon Valley law firms. Chris and the other founder, they were startup attorneys in their former lives, literally thousands of startups have used our forms as-is. That’s not to say that you shouldn’t have someone look through them just to make sure that they’re, as you said, suitable for your company. But if they are you can take care of it very efficiently.
The way I would think of it is, “Here’s all of these things that are available Mr. Attorney, tell me if they’re okay and I will go use them,” right? Instead of, “Hey Mr. Attorney, go spend 5 or 6 hours of your $6 or $700 dollar time and make something up for me.” As Sean said, there’s already kind of real standard forms out there. The KISS the SAFE all these kinds of things and you just don’t want to get creative and outsmart yourself. There was a point at the beginning; lawyers were basically people that code in the English language. If you don’t know how to code in the English language like a lawyer and you go start tweaking stuff well what happens?
Things could have very unintended consequences or could fall apart for you. So it’s just stay on the rails whatever rails those might be. Ruby, if that’s the case, but stay on the rails. Don’t get too fancy. Don’t outsmart yourselves. This will really cost you to fix later and is something that we see time and again. Actually it’s going to slow you down in fundraising because Sean if some company comes to you and they’ve raised on four different wacky note structures before, you’re going to ask, “What the heck are you doing, is it even okay to invest in that company?”
Man 1: Is it all on legal lease?
Haw Kuo: It is legal lease but to your point. There are about six or seven major startup law firms including Wilson that do this work. Functionally they know all the other people’s forms. I’ve been at four of these firms. Chris is from one of them. Functionally they will get you to the same point unless you want to start doing crazy stuff. They’ve looked at each other’s forms. They do this constantly. So don’t think that one law firm is going to give you the forms and they’re substantially superior then some other law firm’s. No. Especially at this stage; absolutely not. I’m sorry?
Man 2: [inaudible 00:05:17].
Haw Kuo: Sure, Chris let me know if I miss anything but Wilson of course is one of them…Gunderson Dettmer. Let’s see, there’s Fenwick & West. There’s Orrick & Herrington. There’s Cooley Godward. The Good Wind Proctor a little bit. There’s actually not a whole lot of firms that do this on that level that are really specialized. As I said, they are very familiar with each other’s forms.
Okay, little sidetrack let me blitz to the end and then I will open this up to questions. Here’s one, if you are a lawyer, unless you’re actually a startup lawyer, don’t try to be your own lawyer. Even if you’re a startup lawyer, the question is, is this the best use of my time or should I be building my company? Sean I think we’ve had this a couple of times, but people always want to do this and it’s such a specialized area of law that unless you’re actually a startup lawyer you may miss things. And kind of following on to my previous point, if you are just staying on the rails using standard documents using standard terms, you can get almost to a Series-A with some pretty minimal lawyer assistance. Just look at this form, tell me it’s okay. Okay I’m just going to use the form.
You don’t need to engage them to do your entire note round. You just don’t need to do those things. I’ll talk a little bit about that in a bit. Frankly when you’re picking a lawyer, choose wisely. There are a lot of people out there who will charge you a lot of money to do the same work as everybody else. Again, functionally speaking at the level where you’re setting up a company and you may need a little bit of advice, if you’re going with these guys who are experienced startup lawyers, aside from your liking them and them actually answering your emails, they should be doing the same level quality of work. They really should. You’re not going to go to one of these firms because that lawyer is a genius and I think this other lawyer is not a genius. No, it’s a connection game. If they’ve got the brand, you’re paying for the connections. That’s what it is.
All right moving on, that was the other button. Apparently, I can’t use the clicker. How’s heard of Just in Time Manufacturing? I’m sure everybody has. This is Just in Time Legal which is to say that you want to do things that are necessary but you don’t want to necessarily do things which are not necessary right this moment.
So the last question I’ll jump to really quick here. If your lawyer says “Oh yeah, yeah, yeah, just do this, and do this, and do this, and do this.” The real question that you want to ask them is, “Must we do this now and why?” Because there are some things that you can kick the can down the road and you don’t necessarily have to do them especially if you’re paying law firm rates for. Break the legal work into chunks. Don’t try and do everything at once, especially going through a startup. We have resources on our FAQs at support.clerky.com we’ll pass the slide deck out. There is an established order of events. Take it slow. Do it step by step. You will be okay. Don’t try to blitz through this stuff. Don’t try to just you know, “Ah, I’m just going to do it all at once.” Invariably that’s where you end up with problems. Step by step, it’s not sexy, get it done in chunks.
Who owns a car here? I know that this is a city so maybe some people don’t own a car. So there’s this thing… Yeah exactly, right? It’s really expensive. So there’s this thing called total cost of ownership. You might have looked at car buying websites like Edmond’s or something. So it’s not just buying the car, right, you have to buy the insurance. You’ve got to do the oil change. You have to do your, what is it 7.5K then your 15K and then your 30K and 60K service. What you don’t want to assume is, “Oh I’ve paid my lawyer to draft some document and okay cool that’s all I paid. I paid him $2,000 bucks and that was the end of it.” It’s not just that cost.
First of all, if you are deviating from the standard documents, that means that every attorney that you ever talk to about those documents or doing diligence needs to figure out what you’ve done in a custom fashion. That also means that your investor’s attorneys have to look at that thing and know what it is you’ve done. So that’s an increased cost over time. There’s an increased, as I said, diligence cost. There’s an increased cost when people have to go an actually calculate how these things work. There’s the very broad term called venture math which I think we may be talking about at the next session. If there’s something that doesn’t work in your custom documents or they don’t play well with other documents you might need to use, there’s always the remediation cost. I think conservatively if you really do something that’s off the rails, even just a few things, you could easily be looking at minimum 3x the amount of lawyer time on that. If you’re using standard forms, again, anybody who’s an experienced startup attorney they’ve looked at this stuff if they’re worth any grain of salt. They’re familiar with the forms. They’re familiar with the standard terms. If they look at a SAFE from YC or a KISS from 500 they know what’s in there. They don’t have to go, “Oh somebody’s edited this document. Now I have to read the whole thing to make sure that it actually works.” If you say here’s the standard KISS, haven’t edited it super simple they run a comparison look at the terms, done. If your using any of these financing documents on Clerky, same thing right? Punch in the terms, done.
Fly coach and it’ll get you to where you need to go. You don’t need all the amenities of first-class. When you got that Series-B or the series-C maybe you do some complex stuff because it’s really a situation where you need it. Especially right now in the beginning do the standard stuff. It will save you grief.
Super quick on fundraising, I know we’re going to have other people go into this. As Sean said, fundraising is a momentum game. So don’t get lost in the weeds of, “Oh my God I have to optimize for my valuation.” Or, “I have to optimize each document with each investor.” Anything that slows you down from getting that check, you want to think really really carefully before you even go down that route. Just be really, really guarded with, “Okay I got to push. I got to push through this.” Again the consistency in terms and documents helps you avoid that overrun on the total cost of ownership. You can imagine, right, if somebody comes to you and says, “You know what I have 10 investors and I want you to give me more money but each of my 10 previous investors, they invested on a different document with different terms.” That 11th investor is going to go, “What in the world am I getting into?” They’re going to ask that question. That’s their job to ask that question.
Something to consider, especially if you’re starting to custom document for this investor, or custom term for that document especially if you’re from overseas where privacy is a very different issue, this is Silicon Valley, these investors all talk to each other. They all talk to each other. Then the question is going to be “Well wait how come he got this special treatment and I didn’t?” I’m not saying that this is necessarily that you have to do the same thing for every investor, but think very carefully about it before you start doing that.
A few notes, we won’t go too far into them, but just know that when you’re having money coming in your board has to actually have to approve of that, so just one of those things that you don’t want to forget. And again, you don’t want to forget, again, this is somewhere where you may need attorneys to help you with, but there are securities compliance issues to think about when you sell securities including notes, convertible notes, equity, common stock. There are some compliance issues. Just keep that in the back of your mind like, “Hey, we got to deal with this. We got to deal with this.” I don’t want to jump into that because it really could be different per company. I’ll open the floor for questions at the end here.
Equity compensation I’m going to guess that many of you if you’re at that place, you will need to hire people. Just a few kind of hints on staying on the rails, you want to use a stock plan. What is a stock plan? It’s also called an option pool. It’s also called a stock option plan. To put it very simply, you take all the shares that you have authorized for your company and all you’re doing is you’re saying “Okay, I’m going to use a stock plan, a legal document, to carve out a part of that to give to employees, advisers, consultants, etc. etc. etc.” Why do you do that? And why do we say that a stock plan is your startups best friend, can be your startup’s best friend?” Because it’s elegant. It makes issuing equity or granting equity to your employees, advisers, consultants, etc. etc. scale-able and efficient. Generally you shouldn’t be just giving out stock to people who aren’t founders or really key employees. You bring on a new CTO, okay, then maybe you think about that. But if it’s just employees, advisers, consultants, anybody who’s a “service provider,” there’s a special legal definition for that, a stock plan is a very elegant way to do it.
Just something to keep in mind, might be talked about I think in the next session as well, but when you’re granting equity from a stock plan you have to do it at fair market value. It’s frankly a little bit of a blurry area as to when and how exactly this fair market value comes out. Keep in mind that you can’t just make something up. You can’t just make something up.
Okay actually, that’s about a wrap up here. So Sean we have a gift for Galvanize and Adam so…
Sean: I have that other mic here too so if anyone has questions I’ll pass this around.
Man 3: [inaudible 00:16:48]
Haw Kuo: Yeah, you know Sean’s got the beard now, I don’t know.
Sean: [inaudible 00:16:58]
Haw Kuo: So, if you set up your company through Clerky and you’re going to use 500 KISS documents, when you’re finished with your round, just let us know. We’ll refund you the charge for that.
Sean: Oh, that’s cool. I didn’t know about this. This is a surprise.
Haw Kuo: We just came up with it just for you guys.
Sean: What if they need to incorporate? Talk about what you guys do, what other people do and what is the cost associated with that.
Haw Kuo: Absolutely. So if you incorporate through Clerky, the initial cost to actually get your company set up is…You know what let me give you a more total cost. It’s…
Sean: Yeah, give it to me straight don’t give me the lawyer answer. I want to know.
Haw Kuo: It’s approximately something around $1,200 bucks.
Sean: Okay, that’s cheap.
Haw Kuo: That’s actually including all of the fees that you would generally be paying to the government and all these types of things.
Sean: So if I went out to a lawyer in market though, what am I paying? I’m paying a little bit more than 2K. That’s a little [inaudible 00:17:46] or no?
Haw Kuo: I don’t know Chris I think probably $2,500 to $5,000 for just an incorporation from a law firm.
Sean: Okay, and what is turnaround, a week, two weeks?
Haw Kuo: To set up a Delaware corporation, like two, three business days.
Sean: Two, three business days. Okay that’s pretty quick.
Haw Kuo: To get the initial corporation two to three business days and the other stuff is not government controlled, so when you’ve made your decisions you can finish your documents and you’re done. Question?
Sean: Yeah, some questions out there. Let’s use this.
Man 4: Once incorporated, probably a silly question, you’ll have to start filing taxes right?
Haw Kuo: Yeah, that is true.
Man 4: So,that’s yearly right, that you have to do that? I had a different question actually. So you’ve talked about the lawyers and what lawyers to pick. What do we expect is a good rate, like an hourly rate, that you would expect for somebody qualified to do setting up of the company?
Haw Kuo: That is a very…It’s a good question. You’re talking about the rate per hour, per person or the total cost?
Man 4: No the rate per hour. You know, you’re picking a lawyer and you ask him, “Okay, so what’s your rate?” And he’ll say something, and I just wonder, “What is the right ballpark that I would want to expect there?”
Haw Kuo: That depends on how big the firm that you’re asking for is. If you’re asking for a smaller law firm you might get a rate somewhere in between I would say, let’s just ballpark it at $400 to $500 for a partner per hour.
Man 4: You don’t need a partner to do the setup right?
Haw Kuo: No they will push that down to an associate but they’re still going to be looking at it at some level.
Man 4: Okay, but the guys who do the work what would they get then?
Haw Kuo: Again I can only speak at a smaller firm. I’ll talk about the bigger firms, too, but at a smaller firm an associate might be $300 might be upper $200’s but that’s cheap.
Man 4: Would you recommend to have a larger firm when you’re setting up a company?
Haw Kuo: As I said earlier if they’re experienced startup lawyers, the work will not be different but the connections might be different because the large law firms those people are more well-connected.
Man 4: So would you recommend starting a smaller firm going for a bigger firm later?
Haw Kuo: No absolutely not.
Sean: [inaudible 00:20:11].
Haw Kuo: Well don’t do that. Don’t do that for one. Like I said, choose wisely. Don’t go with, “Yeah, my co-founder says…,” and this actually has happened, we’ve seen this, “My co-founder, his father’s brother or his uncle. He’s some sort of criminal prosecution attorney somewhere but I’m sure it’ll be fine.”
Sean: It’s like if someone’s been studying startup law for two years. There’s a ton of text as opposed to any other kind of law or–
Haw Kuo: Yeah, suitable. I wouldn’t say better but suitable. They were suitable for your situation. Law firms always tell you that they will take you in and do a transfer from another law firm free. It usually doesn’t end up being free. So just understand that when you go and pick an attorney, which is why I said choose wisely, you likely are going to stick with them for a while, actually for a long time. You don’t want to be in the middle of trying to close a round then have to go, “Oh I need to switch.”
If something goes catastrophically wrong, of course, I understand. But go in there with a mindset that you are picking someone that is going to be a longer term business relationship for you. Like I said, it’s comfort, do you feel like the connections are helpful for you at a larger law firm. At a larger law firm partners can be $7, $8, $900 dollars per hour. The associates are going to be $5 to $600. A paralegal can run you $2 to $300 dollars. That’s why we’re saying if they are doing the same work… And by the way, if you ask them to set up your company they have people manually doing what our system does. Manually, like, using Word cutting and pasting.
Man 5: So we’re clear, I’m just trying to understand, are you suggesting people don’t get a lawyer?
Haw Kuo: No.
Man 5: Okay, it feels a little like an ad. But I feel like there’s probably some good advice that people can have…I’m already incorporated [inaudible 00:22:14] time.
Haw Kuo: Yeah, that’s good.
Man 5: Maybe if you can tell people how to approach lawyers. So you give them a list of all the firms that are good that sounds right. Should they get intros? How do they decide between one firm versus another. Who’s a good partner to use? Is it easier to get a more junior one or a more senior one? Maybe some of that stuff might be more useful for folks in the audience.
Haw Kuo: Wow, it’s a different talk then I intended. Hire a lawyer.
Man 5: It’s Legal 101 right?
Sean: I am not sure, but I do want to say to you guys that going and having a lawyer is good advice. [inaudible 00:22:52] As an investor the last [inaudible 00:22:55] talking to lawyers [inaudible 00:22:58] and personnel and everything you need to run a business. That’s like a big thing when you’re thinking about shortcuts I’d go there. And I think that’s a really good question. How do you get started? This is the part where people get stuck and kind of unsure. [inaudible 00:23:10] And I went in the wrong house… And I did…And I’ve got the best partner and it’s $1,300 bucks an hour, my investors are like, “Oh yeah I’ve got [inaudible 00:23:17] go spend it all. That’s a great way to spend it.” But these folks are more efficient. Let’s answer his question, “How did they get started?” How did they find that lawyer, that first lawyer?
Haw Kuo: How do you find the first lawyer? What I wouldn’t recommend doing is picking up the phone and calling the firms or just sending random emails. You’re very unlikely to get a response. Honestly, probably the easiest way to get a contact or a name at these firms, look around the room. Talk to this gentleman. Find a referral at these firms and say, “I’ve heard that that firm’s good,” or “What firm do you use?” and get a name. Get a name so at least you start with that.
Sean: Yeah, we have…I think you built the list, but I have a list and you can email me and I’ll send it to you.
Haw Kuo: So talk to this guy.
Sean: It’s the firms with an email address of the specific lawyer. Can I talk about other hacks? Can I talk about deferred payments? Because I love this because it saves people money, but I’ve seen more resistance in the market today.
Haw Kuo: You have to be careful with it.
Sean: Just for everyone, so a lot of lawyers they are looking for deal flow. They actually will sacrifice working with you early on for free with the hope that you become a big company and then they just hammer you with fees and they get all their money back. What I’ve seen in the past is 25k of free legal help and then when you raise your Series-A or your first equity round, then you have to make payment. Does this still work and is this something that these folks can leverage?
Haw Kuo: There’s still a fair amount of these offers floating around and the number is variable. It’s not set in stone and the threshold is variable. It’s not always if you hit a Series-A. It could be a time limit, you know,six months you have to pay,we’re going to start charging you. It could be by the time you raise $500,000.
Sean: So it could be a fixed amount? These folks should go to these firms when they get a referral or if they use our list and they should ask. How do you ask because it’s like an awkward thing? How do I get help without paying you? Do you say, “How do I get on a deferred payment structure?” How do you position this?
Haw Kuo: I might ask Chris that, but I would just ask outright.
Man 6: [inaudible 00:25:28].
Sean: That’s what I noticed it used to be 25 and I’m seeing more like 10.
Man 6: So the amount has come down a lot. I think it’s used less frequently by lawyers as a business development tool now and to be candid, I usually… Let me put it this way. It’s not free it’s deferred. You will pay the bill.
Sean: What if you go out of business? What if you go out of business…If you die, if…
Man 6: That’s the one risk they’re taking, obviously if you go out of business, don’t raise money, can’t pay the bill that’s the one scenario where you don’t pay. It’s essentially if you can’t.
Sean: Which is surprising because they’re lawyers, you figure like they would go after you but the reality is they don’t. They’re trying to get bigger deals. They’re not going to go after you for 10k it’s not worth their time.
Man 6: Anybody who’s sort of made it into this part of Silicon Valley’s magic. It’s people figuring out ways to make their business work with startups. Landlords doing all of this and lawyers have essentially…this is their version of that really for business development purposes. Again it isn’t free you’re paying it. The other thing is there is no such thing as free. One of the things you’re doing with firms that give big fee deferrals is you are subsidizing if you become successful and can pay your bill for the companies that didn’t, that ultimately go out of business and didn’t pay their bill.
I think fee-deferrals will be gone probably within the next few years…incredibly rare. I mean the trend is they’re done less frequently. The amounts are smaller and the reality is you’re not getting something for free, really. You probably shouldn’t think of it that way. From a founder’s standpoint I think the biggest risk, really, or the biggest issue surrounded by fee deferrals is to some extent the way this generally works out in practice is the law firm runs up the bill to the fee deferral amount doing, a lot of times, things that could be done later. So they dump all these standard stuff on you that may or may not be useful or appropriate for your business and they get this fee deferral and all work stops until you can pay the bill. The value that you get for whatever the fee deferral amount is whether it’s $10,000 or $25.
I think you can discount it by probably 50% is the real value that you’re ultimately getting. I personally tend to think fee deferrals are…they’re less appealing in practice then they sound. If you can find a way to get things going with a lawyer without fee deferral go for it, but at the end of the day if that’s how you have to get things up and running it’s definitely out there. In general the big firms are still doing them. Most mid and small firms are not doing fee deferrals anymore. Their rates are lower. That’s what they’ll tell you.
The one other thing is and I don’t know what you’ve seen, Sean, but it used to be that lawyers essentially asked for equity in exchange for the fee deferral and that was kind ofthe quid pro-quo. They would say “We offer a fee deferral for half a percent or a quarter percent” something like that. That’s also is much less common now. Lawyers will sometimes actually invest in the company at a Series-A or something.
Sean: Yeah, that’s more common and I’m always worried about giving equity for services. If you do well it saves you money in the short term. But what if you do really well and then if you look back on that you’re like, “Well fuck I just paid $$500,000 for something I could have paid $50 for,” because you don’t know how that equity is going to be valued in the future so that always concerns me.
Man 6: To be honest that whole model of fee deferral and equity with lawyers it started 20 years ago. It is on its way out. I think fundamentally it’s sort of a failed…
Sean: I think there’s too many C-companies too many are dying so maybe the economics don’t work. So I think what we’re going to do towards the end of everything end of day or tomorrow we’re going to send a wrap-up email. I’ll include our list of lawyers you’re welcome to reach out to them at any time. Let’s go here first and then we’ll come back over here.
Man 7: Okay so different topic…The stock plan. So when you’re starting a company now how large does the stock plan or what would you expect in stock plan. How many percent would you but in there one and the second is now you’re bringing in your first key hires, first QA guy, first sales guy, first tech guy, what would you give them in terms of equity? What is the standard?
Haw Kuo: I’ll answer the first one I’d probably turn to Chris for the second one. Companies typically will do anywhere from let’s say 5 to 15% of their total as a stock plan. It really depends on your circumstances.
Sean: This you mean option pool. You’ll reserve that for the option pool.
Haw Kuo: The stock plan aka option pool aka stock option plan. Yeah, but somewhere in that range.
Man 8: We’re also [inaudible 00:30:58].
Sean: Yeah, we are in the next one and also the option pool they’re usually worried more about that towards the first equity round. An investor will force you to carve out the 15% so it’s not as critical in the early stage just mostly because you have so much equity. Nothing’s really spoken for, but most investors will force that in an equity round 15%. Let’s talk about…
Man 9: Question are there loopholes [inaudible 00:31:25]?
Sean: Yeah, they’ll talk about that with Cal Table 101 and what they see. It is a hard question to answer because there’s a lot of stuff going on in terms of when did he or she join the business? Who else has invested? What is their role, but they’ll go into a little more detail. Those I would sort of caution. Those are things you want to figure out as soon as possible. You do not want those dragging on and then your co-founder coming to you three months later when things are working being like, “Yeah I don’t think I have enough.” These are very tough conversations that happen all the time.
Haw Kuo: Have those types of things up front because it’s awkward.
Woman 1: So with the option pool getting back into that would the early employees that do have stocks are there tax implications for them? Like do they have to pay taxes?
Haw Kuo: Are there tax implications for options? That depends on how you do them.
Sean: Maybe we should talk about the 83-B? You can talk about that?
Haw Kuo: Essentially there are two very simple ways you can think about this. There’s the regular kind of option and then the restricted kind of option. The regular option is you say, “I give you the option to purchase whatever.” Let’s say it’s 100,000 shares and it vests. So you get to purchase on some schedule and there’s very standard Silicon Valley schedules for this. You get to purchase a chunk of it every month or very standard is you wait a year and then you can purchase a quarter of it, but the very standard way to do it for your employees…and I’ll get to your question about the early people…is they can’t do anything with it until it vests which is called a release from a repurchase.
For founders and also for early employees, what typically happens is the founders go, “I need to own my business.” I got to actually own the shares so those are restricted shares and sometimes depending on who the person is and what the situation is, some key employees you may also decide to grant those types of shares to. So again, very high level. Those are exactly the same only that you own them already. I would instead of giving Sean the right to buy the 100,000, I would give Sean the 100,000. He would buy them now at this point in time…all of them but I have the right to buy them back on a very similar schedule which decreases over time.
A very typical four years, one year cliff which means that he owns all the shares. I have the right to buy all of them back until a year has passed. Once that year hits, he owns a quarter of it and then I can’t buy that back anymore. If you go that route, you will need to file something called an 83-B-Election. If you do go that route and you need to file an 83-B-Election do not be late with it. You have 30 days to file it. Do not be late. You do not want to fix that.
Sean: You have 30 days from when you exercise the options. Let’s try and keep this high level because it’s too easy to get in the weeds and I’m already a little confused and this is my job.
Haw Kuo: It’s 30 days from when you either acquire the shares or you exercise for those.
Sean: The 83-B sort of shields me from some tax liability in the sense where I’m only taxed at the value of them today not the value of what the shares will be when they go liquid.
Haw Kuo: Yeah.
Sean: Because there have been lawsuits about this but what I think the short answer is there’s not really tax liability until there’s liquidity until there’s cash out, but the 83-B allows you to shield yourself from the massive upside there hopefully will be because when you exercise you’re exercising at a very low amount. The shares are worth very little and you’re not paying the premium that investors are paying. You can save yourself a lot of tax money. You have to also…83-B yeah. You…get counsel to help you, a lawyer to help you with this. You have to do certified mail.
Haw Kuo: Actually you can do it through our system…express. You still have to mail it yourself, but you get it all prepared for you. We’ll give you instructions.
Sean: But when the options are exercised you have to file that within 30 days. It will save you a ton on taxes if there is liquidity.
Haw Kuo: There’s a certain way you need to send these things in. The IRS is not always good about actually saying, “Hey, we got it.” So you got to prove you did it.
Sean: Yeah, because I have a bunch of those in a drawer…the certification so we’ll see how that works.
Haw Kuo: I’ve wondered what happened with your previous startup.
Sean: Other stuff. all right, let’s go back here.
Man 10: Alright sorry to keep digging into the options pool issue. So you talked about the options pool versus the rest of the company. I’m a little confused. Is the rest of the company just standard equities versus the options pool which is reserved for options for the employees and what do the investors get?
Haw Kuo: Let’s step back for a second. Right when you start your company, you typically only have one type of stock. An option is a right to buy that stock. It’s not something else entirely, it’s a right to do that. What we talk about with an option pool is we are simply saying…let’s say we have 10 million which is very typical for Silicon Valley startups and we’re going to make one million of them kind of set aside for issuance to employees, advisers, your service providers. Investors especially early-stage investors are probably going to go in with convertible instruments, which means that they’re essentially loaning you money. It’s a convertible note or it’s a convertible security…which they’re kind of loaning you money without it ever getting repaid…but when they hit an event which is they usually do a Series-A it turns into stock at that point. That’s typically how early investors do it. Later stage investors if you hear about a Series-A or a Series-B they’ll get Series-A or Series-B stock with preference.
Sean: I was going to bring that up, too. I think Capture, you guys were talking about preferred versus common? Does everyone else understand that there are sort of two classes? Investors are getting preferred. Employees and founders are getting common. So we’ll talk about why. Probably have a little more time for some more questions?
Man 11: This is a bit about fundraising. If you were raising a convertible note and then some point later you’re going to do a following round and it’s still a non-equity round. Is there any reason to look into a SAFE or a KISS or is it preferable just to stick with the convertible note?
Haw Kuo: So their all really similar frankly and actually there’s a convertible note version of the KISS. That’s really a judgment call. Do you feel that having a different instrument would help you get money? I don’t know the answer, but I kind of go to my consistency point, right. Maybe you update your note that you’ve already used for new terms if you’ve gotten to a new point in the business where that might be necessary. You say, “Well that’s kind of the same document. We can keep using it.” Yeah, but that’s a judgment call.
Sean: Can we clarify, though, that notes are done in batches per se where everyone comes in on the same terms and then you’re like six months later…I have to do more notes. You would do a different note probably with different terms.
Haw Kuo: You can use the same document, but you might have different terms on it.
Sean: Can I do where one person I give them 10 million cap the next person I give 7 million cap same day? Can I do that? Do I go to founder prison or what happens?
Haw Kuo: Technically you could, but–
Sean: But what would happen? That might make somebody mad and they will find out. If we do have different valuations at some point this all comes together and there’s a waterfall. People look through how the conversion takes place and that’s where they may see that, “Oh wow, Bob got a much better deal than I did and now I’m going to go run him over with my car.”That’s where these situations might come but you’re the founder actually so not a problem. They’ll all be playing golf together and they want care.
Haw Kuo: Yeah so you have stuff to consider.
Sean: So you can do that, but you run risk of pissing someone off.
Haw Kuo: Usually you’re looking at a time lapse, right. “Okay well the notes I raised or the convertible securities or the safes I raised at the first quarter of the year. Okay, I need a bridge round or I’m going to do the same thing but it’s Q4.” If your business has grown, hopefully you’re probably going to want to raise on some better terms. You want to make sure to account for that
Man 12: If you’re on a standard vesting schedule like the one you mentioned, would you have to file the 83-B within 30 days of signing your contract or within 30 days of the one year cliff?
Haw Kuo: I’m sorry.
Man 12: For the 83-B form, when would you have to send that out if you’re on a standard vesting schedule like the one you mentioned?
Haw Kuo: When you get the stock. When you actually get the stock. So if they made an offer letter to you but they haven’t actually given you the stock, not yet.
Man 12: It’s when you get the actual stock certificate right?
Haw Kuo: No.
Man 12: Okay sorry.
Sean: Yeah, actually they don’t really…you don’t get a shiny thing you frame anymore. Those days are gone. I’d be nice, they look cool.
Man 13: To make sure you haven’t answered this question getting the stock…so he’s asking about vesting how that relates to the 83-B Election. So you file an 83-B Election on shares not on option, first of all. It’s when you get…either the founders when they buy their shares at the beginning and have vesting. So it’s shares that are subject to vesting that’s what an 83-B election is for. Founders when they buy their shares would file an 83-B election. You file the 83-B election at the beginning right when you acquire the shares even though the company has the right to repurchase your shares if you leave. They’re subject to vesting. You file the 83-B election within 30 days of acquiring the shares. So the vesting schedule has no baring on when your 83-B election would be filed.
Haw Kuo: Thanks for clarifying that. I think I missed part of that.
Man 14: Can you just maybe verify for shares that are for advisers and also for accelerators. Should that, for example for accelerators, should it come out of that pool that’s set aside? Should it not come out of that, purely out of separate investor shares, so kind of that?
Haw Kuo: Generally speaking, if you have advisers, you’re going to want to issue them equity of the type of your choosing, but out of a stock plan. They’re a service provider, you generally have a pool set aside for service providers. For accelerators the two top ones I know of they go for convertible so you won’t set aside things for them because they won’t actually own shares until an event happens…until an equity financing typically happens. At that point their convertible note, or SAFE or whatever it is, is going to turn into shares, on whatever terms are written on that document.
Sean: Those would also be preferred shares so that the advisers are getting common…an accelerator would convert to preferred.
Woman 2: Rather than doing a series of convertible notes, can you not just do one and then keep extending it?
Haw Kuo: And you do just one note…?
Woman 2: And extend it?
Haw Kuo: I guess you could. Let me just take a quick step back. There used to be this way of issuing notes where you would say, “Okay, I have this master agreement. This is my bible of notes and then you would use that to issue notes to people and when you got to the end of that document because it usually had some sort of limit on it. You might have to actually extend it. Nowadays what a lot of people will do are on standalone notes like what 500 uses, so you don’t actually have to do an extension to the notes because there’s not a master agreement. But each note that you’re giving someone contains the entirety of the agreement. You don’t have to go and extend it at all and this is very common nowadays. Does that answer your question?
Sean: All right, we’ll talk about in fundraising, too. There’s momentum in your business there’s also momentum in your fundraising. And so, it’s kind of like if this thing is dragging on forever is does send some weird signals. It’s more like we put together that money and you can also use that as a forcing function where it’s like if it’s like you’re trying to close that off. It’s like, “Yeah we’re closing this in two weeks you got to jump in now.” Investors are always incentive to wait and all I’m doing is waiting I’m pushing people off. I’m like come back in a month I want to see does the business change or do you die. If there’s no incentive to move quick, they will wait. They have every reason to.
Man 13: Is there anything to watch out for, for foreign companies setting up a Delaware, just in general?
Haw Kuo: Absolutely.
Sean: I get this question all the time and I don’t know how to answer it. Really basic high level what is the structure they should use? Is it the Delaware owns the international company? Is it through the Caymans? How do you do this?
Haw Kuo: I will get to that. Let me take a quick step back and answer his question. What does he have to worry about? You want to figure out taxes. You want to figure out if there’s any immigration issues should you be coming for a program such as 500 Startups. You want to figure out and this is tied to the next question. You want to figure that if you choose a structure. Let’s say you chose a Delaware C-corporation. Are there any additional documents that you’re going to need because of your country of origin? And if you have international subsidiaries and you want to fold those into a Delaware C-corporation, it’s common but this is something it may be really, really custom. But a lot of companies do this, they set-up a C-corporation and they basically have that C-Corporation own all the entities overseas. That’s something that you definitely want to talk to an attorney about because it depends on the country. Absolutely no idea how that could–
Sean: That’s where it gets hard to answer because every country is different. But are you saying there’s two options? I can dissolve the international company and just flip purely into Delaware or the Delaware could own the international entity.
Haw Kuo: It depends on the country.
Sean: Okay it depends on the country. And then what does the investor care about? Let’s talk about that. I think I only care about is the IP assigned to the Delaware corp. that’s all I would care about I’m not sure.
Haw Kuo: I think most investors…I think yes and the other thing does the company that I’m investing in…Let’s just take the top level Delaware C-corporation, does it actually own 100% of everything including the IP? Otherwise let’s say it doesn’t actually own the subsidiaries, well what have I just invested in? Something to consider. Some companies do go Cayman, but again that one’s really a question for a lawyer. Is that the right situation for you?
Man 13: Sure and in your guys experience in private startups where you got private funds coming in for three months and potentially stay or potentially go back. What’s the Visa status normally? What time normally do you see them working on that kind of stuff?
Haw Kuo: You’re going to have to talk to an immigration attorney.
Sean: I mean we have referrals we don’t have one on staff. I can tell you our founders bend and break every rule they can to be here and I encourage that. Can we turn the camera off? But yeah you should. This is where I don’t like to give advice because I really don’t know that world. There are different ways to do it and I know some actually get the Investor Visa if they have capital at home they can establish themselves with.
Man 13: I know there are a couple of options. I was just wondering.
Sean: Ours is a three month program or three and a half. A lot of people…countries allow you to come here for three months and so they go home for a day and then they come back, like, they reset the clock. Longer term though, you need to have an immigration lawyer that helps you get set up right.
Haw Kuo: Sean has access to one I believe.
Sean: Yeah, we have someone we refer, but that’s the thing. It’s just too specialized and our batches are 50% international so for us to do that on…cost will be too much for us to sort of handle.
Man 14: Just to mention we have an Australian company and then we set up a Delaware C Corp and the Australian company owns the Delaware C Corp and in American there’s anti-inversion laws so we can invert that so that the Delaware owns the Australian entity, but American law is you can’t reverse that. If you come to America and set up shop here and you don’t get the funding and you want to go back, you can’t reverse it. So make sure you know what you’re doing before you do it. So we’re holding off until we get the investment.
Haw Kuo: That is a good point. I think I’ve heard that about Australia. Be sure that’s what you want.
Sean: Does the toilet spin the other way? Is that true or is that a myth? I can’t remember. That is true. Okay.
Haw Kuo: Any final questions we probably have time for one more.
Sean: Yeah, let’s do one more and then let’s make sure we’re staying on time.
Woman 3: I know you mentioned earlier about the Delaware D-C Corp. That’s real prevalent among investors and all. I was wondering have you any insights about the Delaware B Corp? That’s kind of building up a little momentum. How is that like?
Haw Kuo: I’ve seen it, but honestly I don’t think investors are all that crazy about it.
Sean: I’ve never seen one. Can you tell us really quick what the difference is?
Haw Kuo: The B Corp is a for-benefit company.
Sean: A social Corp, sure.
Haw Kuo: I’ve never actually really done one personally–
Sean: We’ve done one, I think.
Haw Kuo: I don’t know how investors would react. That might be a question–
Sean: I think that some especially ones that have a social mission, they’re getting more comfortable with it. I can only think of one maybe two companies that we brought in that were a B Corp and they were socially-minded. It was recycling of hardware, computer hardware.
Haw Kuo: I want to say I know this company but the name skips me. This is 13, right?
Sean: No I think it was 12 but let’s move on everyone, round of applause. Thank you.