Digital Capital Week

“One person was sued for $50,000 simply for using a stock photo without giving credit to the owner of the image,” started Sue. She explains that from both a liability perspective and for legitimacy, the first thing that a startup has to do is to incorporate in order to shield oneself from personal liability. LLC, LLP, C-Corp and S-Corp are the most popular choices, with LLC being the easiest to set up, and changeable to a C-Corp later with relative ease; and therefore, the most prevalent. Not going into detail about any of them, Sue and Leah simply observed that the main difference is one of tax, and they advised to sit down with an accountant and a lawyer from the very beginning to discuss projected income and to decide on the most economical way to incorporate. The message was – none of the choices are set in stone and it really depends on the type of business and on certain expectations concerning its operation.

“Always incorporate in Delaware” – right? Well, not always, say Sue and Leah. Since all businesses have to pay taxes within the state where they do their business and the state where they’ve incorporate, it makes more sense incorporating locally for most small businesses. On the other hand, if you plan to scale your business and seek investor funding in the future, then incorporating in Delaware is a good option to consider since investors are generally more comfortable with Delaware’s well-established corporate law. The message again was that there was no general rule and no cookie-cutter choices for this. One must discuss it with an attorney.

A main point in the talk was to “respect corporate formalities.” In other words, everything needs to be documented, punctually, and in written form. Things like ‘who owns the company’, who the shareholders are, the place of business, how decisions / voting is to take place, etc. Detailed information about profits and a current year end report or review should be vigilantly updated over the course of your startup’s growth. And of course, even if you think you can keep track of transactions in your head, don’t risk it! As soon as you incorporate, set up a corporate account, and be very clear with your business partners about how you intend to handle finances. “Keep your business money in a corporate account that is separate from your personal money,” advised the attorneys. “Use it constantly even if you’re a sole shareholder to show the record of money going in and coming out.” These things have to be thoroughly documented for use in mergers, acquisitions and in the case of a lawsuit.

One of the most popular topics was about the best way to fund a startup. The three possibilities are of course to bootstrap it yourself, using your own investments and through revenue generated, seek investments from friends and family, or ask investors for funds. If you have no customers yet, you don’t really have a valuation. Generally, the leaner you can be when you start and the longer you wait, the longer you can go without outside funding, and the better the valuation will be for your company when you do decide to scope out different funding opportunities later on. Sue and Leah both warned that it’s unwise to sign anything until you carefully read all the print, and after a lawyer has advised you on how to proceed. Otherwise, the risk is too big. Even if you think it’s a clear cut deal where you’ll be getting 51% of the equity – that doesn’t necessarily mean that you’ll get all the decision-making authority! There are all kinds of arrangements with all kinds of nuances.

Speaking of equity, the common-sense advice that was reiterated was to keep your ownership very closely held. “Don’t give out equity like candy – you may get stuck with a partner for life” read one of the PowerPoint slides today. You may not want members of your family to continue to control your company many years down the line, so this vigilant attitude applies when dealing with family as well. Partners are forever, unless you can buy them out. They can look at all financials, audit your company, sue you if you’re running the company in a way they dislike, and can even quit after six months and share company secrets with a direct competitor, all while continuing to own part of your company. This doesn’t mean that it’s not a good idea to give out equity as an incentive, especially in the beginning when all you have is an idea and no capital to recruit impressive talent. However, her advice was to be thoughtful about it: “you should only give equity to someone you can see yourself being partners with for the long-term and who intends to be involved with the company for the long-term. To make sure of this, a vesting schedule is often a good idea”. Leah noted that the nuances in the agreement are huge here, especially since you can specify a certain amount of time to ‘test-drive’ the partnership before fully committing.

The final four points on the slides were more bite-sized wisdom, including making sure to get everything in writing. After all, “written contracts can make the difference between $0 and $25 million!” It’s also wise to put assets in the company’s name. Take some time to register your trademark – often it’s not that time-consuming or that expensive. Patents, though laborious and require some cash upfront, can pay dividends later on. Before handing out agreements or by-laws, make sure to customize them, since they act as your very own Constitutional Convention. Finally, rather than trying to figure out on your own all the different ins and outs of starting a business, tap into your network of businesspeople, accountants, lawyers and bankers and ask for help.

Overall, this event was to-the-point and generally helpful. Leah and Sue did a great job covering the basics in such a short time and making the points accessible and memorable! Though they could not give specific legal advice unless they’re your attorneys, they did answer a number of general questions that were really helpful to the group. Thanks to both of them and Clarity Law Group for an informative event!