Reader: Why is How She Started writing this?
How She Started: When conducting some interviews for How She Started we realized that law firms can be exploitative. One founder told me her first 25k was spent largely on legal fees.
My husband is an entrepreneur and to get his business up and running cost less than 2k. I was able to speak to lawyers at the firm he uses to help future entrepreneurs understand the basics and costs.
As a disclaimer this is high level advice. Each startup is different. How She Started recommends reaching out to law firms like Decrypted Law to get advice on your personal situation.
HSS: I’m smart. Why do I need a lawyer?
The analogy we often use is not everyone speaks French, just like many people don’t speak law. It doesn't mean you're dumb because you don’t understand French, it’s just a language you for the most part don’t know or use. Although you could take the time to learn to speak law even though you're only going to need to speak it a few times (not to understate this: they are very important times) you can use that time and effort instead to build your company. You can hire attorneys like us who have dealt with your situation, speak the language of law and, perhaps most importantly, have a lot of experience seeing and applying it.
Even if you know some law because for some reason you really want to read it or learn it, you're not necessarily going to know how to apply that knowledge. We have experience knowing what venture capitalists, employees, customers, business partners, etc. are going to care about, and which laws you can or cannot mess around with.
So that's why we always recommend finding attorneys, not just to tell you what the law is, but also to tell you how that law works on a practical level. Anyone can do anything, but it’s more a question of expertise and the time you want to spend on it.
HSS: What do I need to know to start a business? What is the range that should cost and what are some common pricing structures?
Decrypted Law: The first thing to consider is cash. You need to determine:
That's going to dictate how you’re structuring the business, and how much it's going to cost to set up from a legal standpoint. If you're starting a cash flow business where you're the sole owner, it's going to be simpler and cheaper. VC backed companies have a specific structure. For example, generally VC backed companies are a C-Corp in Delaware.
Cost
We recommend setting aside around $2,000 for formation and set up of your company. That said, there are a few different pricing structures that could affect your total costs.
Flat Fee: That’s what we do. We’ll tell you the price upfront of how much it’s going to cost for you to set up your company. We take you from A-Z and get you up and running. We currently charge a flat rate of $1,750 for a corporation, $1,250 for a multi-member LLC, and $750 for a single-member LLC. State filing fees cost a few hundred dollars (e.g. $350) depending on the state of incorporation.
Hourly Billing: Many law firms charge an hourly rate. At major law firms such as Cooley where we used to work, hourly rates for associates range from about $700 to over $1,000. We were billing over $900 per hour when we decided to start our own firm. In the startup world they might defer billing until a VC backed company raises the money (e.g. maybe 6 months to 1 year, or until the company raises $100,000). One thing to caution with hourly billing is that costs can start to add up very quickly even with deferrals.
Equity: Some lawyers might take equity and discount the fee. Giving away equity might seem enticing at the beginning to save money but could end up costing the company a lot. We always recommend setting aside some money for legal spend so you don’t have to give away equity.
HSS: What legal entity is best for startups generally, and how do I decide what legal entity is best for me?
DL: This is a loaded question because it depends on so many factors. Just so you know, lawyers’ favorite response to anything is “it depends” but we’ll do our best to describe some common considerations for each entity type. It primarily depends on what your goal for the company is.
LLC or LLP: If you're going to be just a cash flowing business from day one, where
you're going to be the sole owner, or you have a couple other owners, you can look at
doing an LLC or LLP (LLPs are only for certain professions). These are pass through
entities. If you just want the cash coming into your bank account with the limited
liability protection of a company, then these forms are probably preferable.
Corporation: If you're going to be more investor led, where you’re going to have
people giving you money, or you expect that you'll have to hire a wide range of
employees or you want or need additional formality, then a corporation is pretty much
the de facto option. Most investors won't even let you use an LLC because of tax and
management governance issues.
Sole Proprietorship: We wouldn't recommend ever using sole proprietorship
because, unless you do it a certain way, you're not going to get limited liability
protection. If you want the money just to pass through to your account, then setting up
an LLC is a good way to protect your personal assets.
HSS: Why Delaware? Are there any other preferable states?
DL: If you're going the VC path: 99% of the time, you will be filing for a C Corp in Delaware. That's what investors expect. Delaware has the most sophisticated corporate law. They've heard most corporate law cases. They also have, a dedicated Chancery Court, where the judges only hear corporate law cases whereas other states do not have that. It's also more shareholder or investor friendly. Investors want that and most companies are happy to abide by that.
If you're going with the cash flowing business like in a simple LLC, I always recommend that you file in the state that you're living in so that you're only subject to franchise taxes for that state. Whereas if you file in Delaware, you also must qualify your business in the state you live in, and now you're paying franchise taxes in two different states.
We sometimes get asked about the laws in Nevada. Recently it was announced that Elon Musk moved X (formerly known as Twitter) to Nevada. Most people are not Elon Musk and it would be really hard for first time founders to pull that off.
HSS: Can you talk through founders’ agreements and vesting agreements?
DL: If you're the sole owner, then there's no truly binding agreement, since you have full control and own the entire company . The agreements, like a stock purchase agreement, are a formality. However, it is still important to get done, especially if you are looking to be venture-backed.
If you are splitting with someone, it is much more important to square away the terms and details of equity ownership and IP between the co-founders. Below are a list of essential initial agreements that governs the relationship between the company and the co-founders:
Common Stock Purchase Agreement
This agreement outlines the ownership (i.e., the number of shares) and vesting schedule for
each co-founder. Typically, half of the consideration for purchasing the shares is assigning
any previously developed IP to the company.
Vesting
The vesting schedule is included in the common stock purchase agreement. The company has a
right to repurchase a certain amount of the equity until you meet certain requirements.
These are usually time based, (e.g. you serve 4 years, and every month you accrue a little
bit). There's also milestone based which contain some kind of target or you produce
something by a certain deadline.
Offer Letter & CIIAA
We also recommend founders sign basic employment agreements like offer letters and CIIAs
(Confidential Information Invention Assignment). These ensure company information stays
confidential and makes sure that all intellectual property ownership gets assigned to the
company. It’s important because if that founder leaves, an investor puts money in the
company, and they want to make sure that the IP doesn't leave with a departing cofounder.
Indemnity
We also recommend founders enter into indemnity agreements. This is basically the company promising to cover the founder, the officers, the directors for any actions taken against them on a personal basis. If you started a company and someone sued you personally for some action taken on behalf of the company, the indemnity agreement obligates the company to foot the bill or cover you for the cost of defending yourself (as long as you were not committing fraud or willful misconduct and every action you took was on behalf of the company).
Transfer Restriction and Right of First Refusal
The bylaws typically include a transfer restriction and the right of first refusal. That way founders also have a little bit more control over the cap table. If someone owns common stock, (e.g. your cofounder or other employees), they can't sell to anyone they'd like to. The company must approve it. That gives the founder more control over the cap table, so long as the company remains a private company. Once you go public, the company’s shares are traded on the stock exchange.
HSS: Can you speak a little on advisors and board members?
DL: Advisors should be signing an advisory agreement in which they'll keep information confidential, assign any IP that they work on over to the company, and set out their compensation. Advisors are people you check in with from time to time to get advice on certain topics. They'll frequently only get compensated in equity not cash. How much equity they get depends on how much value they're providing. It's around 25 basis points maximum 50 basis points. Definitely not over 1%. 1% is a big threshold when it comes to startup equity. An advisor’s standard vesting schedule is usually one year or two years and just monthly vesting without a cliff because startup advisors change over time. Advisors move on and companies also need help from different types of people in different stages. They're not expected to stick around for years.
Another piece of advice is that a company should not go crazy with advisors. In the beginning, we notice many founders have mentors or professors or friends who they want to use as advisors. A company should save by only signing advisors and giving equity or any kind of cash to people who are going to advise you regularly. If someone's not giving you highly valuable advice or is not going to advise you regularly, cut them off. You don't want to have dead weight on your cap table. If you're giving equity to too many advisors, it’s likely a waste of time and equity.
Board Members
For board members typically the co-founders will be on the board. There are usually two co-founders. We get questions about deadlocks between the cofounders. We usually advise that it's not that much of a concern early on because there's not going to be much that the board needs to decide on. Once you raise a Series Seed or Series A round, almost always, the lead investor is going to ask for a board seat.
Then you'll have three members and there is no potential for a deadlock. Board members are typically reserved for lead investors in each financing round. Through Series B, usually investors will just be adding board members to your board. They are not compensated. They're fully invested because presumably they've invested a lot of money already in the company, so they want the company to succeed.
HSS: Can you talk through establishing an employee equity pool?
DL: If you plan to incentivize your employees with stock, what we always recommend is an equity incentive plan or employee stock plan. The board will approve a governing document that says, “We reserve a certain number of shares that will be governed by this equity incentive plan.” Then the board can issue shares from that plan to any employees, consultants, advisors, any service providers. There is an exemption to securities regulation that allows companies to grant stock (or options) to employees who wouldn't necessarily be accredited investors or people who could not normally own stock in a private company.
This does two really big things. First, it makes sure that all the equity is governed by the same document, so that there's uniformity. You don't want different agreements for different people. Also, we generally have these plans administered by the board. The board has a lot of discretion in how to handle these equity awards. If there's an acquisition or there's a sale you don't have to stress about negotiating with each individual stockholder. The board at a high level can just say to the employees this is what's going down. You gave us that power when you signed these documents. Logistically it’s much better.
The standard for the employee equity pool is between 10% and 20% of the company’s cap table. We usually recommend keeping it at 10% because most times founders are not giving out the full 10% before their first financing round. That pool gets refreshed every financing round unless they're able to negotiate for it not to be, but that's pretty rare.
HSS: We've all seen The Social Network, what do I do to avoid lawsuits like that? And what kind of lawsuits can get thrown in my way?
DL: It's a Pandora's box. We always advise our founders that the two things you really need to worry about are equity and IP. It all goes back to founding the company through some sort of startup lawyer who knows what they're doing. They'll make sure that everyone who is involved in the process of coming up with the idea, products, and services for your company is assigning all their IP to the company. You should address all of it on or before day one, ideally so that you do not have to worry about that later.
HSS: What’s your take on legal software?
DL: There are plenty of self-service websites out there that will help you start your company up. We feel two ways about it. It's nice that it makes it more accessible to start your venture backed company, but just know and expect that there is likely going to be some cleanup later. It's not perfect and it's not going to be totally customizable to what you're expecting.
My husband uses Decrypted Law and facilitated the introduction.
I've always been passionate about women helping other women. I created this blog to tell stories of successful female-founded businesses. Hopefully, these stories will help inspire more women to found their own businesses.