Learn about incorporating your business, non-competes, licensing your IP and decision-making processes
Explore topics related to allocating equity, vesting terms, tax implications, IP ownership, compensation and employment agreements
Dive into employee compensation, hiring foreign employees and hiring before securing funding
Find out about board membership and roles, and advisory board setup and compensation
Understand vesting restrictions and terms, options and restricted stock, and tax differences between ISOs and NSOs
Position your company for success with information on how to raise capital and secure funding from banks, VCs, friends and family
Learn about the differences between bank loans, foreign investors, crowdsourcing, crowdfunding, angels and VCs
Explore information related convertible debt, preferred stock term sheets and valuation caps on convertible notes
Expand your understanding of IP ownership, terms of service and privacy policies, open source software and more
Dig deep into information related to if and when to file, to the difference between provisional and utility patents
Explore the best way to obtain a trademark and the difference between a domain name and a trademark
Uncover little-known information related to NDAs and patent filings
Read about copyright protection and how to register a copyright
Get up to speed on how to grant exclusivity to a reseller, OEM or distributer, license agreement terms, and licensing IP from a university or hospital
Time to grow? Learn about taking funds from a strategic investor and international expansion
Explore how to prepare for due diligence, guidance on selling your business and hiring an investment banker
Time to take your company public? Prepare your company properly
You may want the vesting of your
shares to accelerate if you are fired or the company is sold. Is that a good
idea? Will your investors agree to this?
Equity is often the primary financial motivation for taking
risk in a new venture. To be a proper incentive, the reward of equity should be
tied to each person’s contribution to the success of the venture. In an ideal
world this would mean milestone-based vesting over several years. However, the
reality is that few startups can predict what milestones will be most important
beyond a few months in advance with any accuracy, and therefore most equity
award vesting is time-based. Shares held by founders typically vest over a four-
to five-year period on a monthly or quarterly basis. Most non-founder employees vest over a four-
to five-year period with a one year cliff (25% vests after the first year) and
monthly or quarterly vesting thereafter for the remaining three or four years.
The cliff period gives the company time to determine whether the employee is
working out before the person gets to keep any of his or her shares. Sometimes
founders’ shares do not have a cliff.
If your shares are subject to vesting,
how and when you are taxed on those “restricted shares” is governed by Section
83 of the Internal Revenue Code.
Specifically, the tax consequences depend upon whether you make an
election—known as a “Section 83(b) election”—under Section 83 or not.
A consultant (also called an
independent contractor) is an expert in a particular field who is in the
business of providing companies with his or her professional services.
Consultants generally set their own hours, use their own equipment (e.g., as
opposed to a company-issued laptop) and are not subject to the direction or
control of the company to which they provide services. Every state has its own
rules to determine whether a person is an employee or a consultant. In
Massachusetts, for example, a consultant must perform services that are “outside
the usual course of business” of a company. It is extremely difficult for an
individual to satisfy the stringent tests to be properly classified as a
consultant in Massachusetts (and some other states as well), and there is a
presumption that any person who provides services to another is an employee. If
these factors (and others showing a consultant’s independence) are not
satisfied, an individual will be deemed an employee.
All employees (including founders) must be paid in cash in amounts at least to satisfy the minimum wage laws established by federal and state laws. Many founders opt to go without compensation in the initial stages, but technically doing so is in violation of the federal and state wages laws. Employees may receive equity in addition to cash payments, but due to tax and other complexities it is generally not feasible to grant them equity in lieu of minimum cash wages. Although the market may reflect standard salaries for different types of positions, there is no requirement that employees receive any more than minimum wage, and the wages employees receive often depend on how large and established their employer is.
A foreign student is permitted to own
equity in a company and to serve on the board of directors of a company. A
foreign student may not perform work for a company without obtaining appropriate
authorization from the foreign student office at his/her university. The rules
are no different for “founders”.
You can’t avoid the wage and hour laws for employees by simply characterizing your workers as “interns”. The laws of each state vary, but in general, to properly classify a person as intern, the person must be a student or trainee, the focus of the internship must be on training the intern, and the company must not derive any immediate advantage from retaining the intern (must be similar to training given in an educational environment). An individual’s ability to receive school credit for the internship is helpful, although not determinative in all cases. If the person does not qualify as an unpaid intern and should instead be classified as an employee, then the person needs to be paid wages in accordance with federal and state laws, and be covered by unemployment and workers’ compensation insurance.
Non-competition agreements may be
enforceable, depending on the state in which the employee lived and worked when
the agreement was signed, the consideration (value) given in exchange
for the agreement and the reasonableness of the restrictions in the agreement.
In some states, such as California, non-competes are not generally enforceable
(other than in the context of a sale of the company). In most states, however,
they are enforceable if they are reasonable in scope.
The option “pool” represents the number
of shares the company sets aside in reserve under its option plan to compensate
its employees, consultants, advisors and directors. The size of the option pool
depends on the company’s stage, circumstances and hiring needs. When the company
issues shares under the plan, it dilutes the ownership percentage of the other
shareholders proportionately. However, any shares reserved under the plan that
are not used (i.e., that are not sold or issued by the company) do not dilute
the actual ownership of the other shareholders. Therefore, the size of the
option pool at the initial formation of the company doesn’t really matter all
that much—if the pool is too small and you need more shares, it can always be
increased; if the pool is larger than you actually need, any excess shares don’t
have any negative impact on the actual ownership of the company. Most startups
will initially reserve an option pool that is big enough to provide for the
equity incentives needed to cover their anticipated hiring needs for the first
six months to a year.
Every employee of the company should have a standard offer
letter that sets forth the general terms and conditions of their employment and
states that they are “at-will” employees. This means that they can leave the
company at any time (although their rights to retain their shares or exercise
their options will depend on the vesting terms), and also that the company can
terminate their employment at any time—with or without cause. They should also
sign an agreement with the company where they agree to keep the company’s
information confidential, assign their rights to any developed intellectual
property to the company and, in most states, agree not to compete with the
company for a period of time following their employment.
It is almost unheard of that an entire
team would be in place before securing a first round of funding. In fact, the
primary use of a first round of outside capital is often to hire additional team
members. The network and reputation that your future investors bring to the
table can also be tremendously useful when recruiting new hires. Many
entrepreneurs find that they are able to recruit more talented team members (and
without giving up as much equity) after securing funding from strong
Let our Knowledge Navigator direct you to content specific to where you are on your journey.
In the next QuickLaunch University Webinar on May 10, we will explore the fundamental concepts around founder equity and founder agreements.
Partner Mick Bain explores the idea of whether startups should take the B Corp route
Park Square and WilmerHale Release 17th Annual Technology and Life Sciences Compensation and Entrepreneurship Study
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