Deciding where and how to raise money.
Q: My partner and I have self-funded our business so far. We want to raise capital from angel and venture capital investors like my brother has for his business. What are next steps?
A: Before you decide where and how to raise money for your business, we encourage you to ask yourselves the following questions:
- What are your goals for your business?
- Do you envision selling the company or taking it public? Or, do you see yourselves passing it on to your family members?
- What role do you want to play in the future of your business? Do you want to continue to control and manage it, or are you okay with having someone else run the business?
- Can your business survive in its current situation? Or, does it need an infusion of cash to get to the next level?
- How much cash is needed?
Then look into potential sources of capital. Know what criteria the capital sources use in assessing a potential investment and make sure your company’s capabilities and objectives align with those of the capital source. By way of example, venture funds require fast track growth and high returns. This puts pressure on the business to scale quickly, and in most cases, means greater risk of failure.
Additionally, and in particular for women founders, venture capital investment is incredibly inaccessible. In 2020, the year of Covid shutdowns, the National Venture Capital Association, with Pitchbook, announced they “saw the highest ever recorded investment, exit and fundraising values.”  However, women-led startups received only 2.3% of VC investments in 2020, a decrease from 2.8% in 2019.  As such, while women work on building consensus to improve access to the $156.2 billion invested in US startups in 2020, women seriously need look into alternative sources of funding like equity crowdfunding, SBA loans, nondilutive grants and corporate investment. They also need to seek opportunities to be awarded contracts from corporations and government agencies which set aside amounts to be paid to minority and women-owned businesses.
Onboarding Employees and Consultants
Q: We plan to hire marketing consultants and tech developers who reside in different states. These are going to be short-term projects. Do we need a contract?
A: You will definitely need a confidentiality and technology assignment agreement. The reason for this is that you need and want to protect your business idea, plan and other confidential information and ensure your ownership of their work. Most corporate lawyers recommend that you sign this contract with them before you have them start work. It can be a one or two-page letter agreement that sets forth (i) the services they will provide, (ii) their compensation, (iii) their promise to keep your business idea, plan and any other proprietary information confidential, (iv) their transfer of ownership of the work product they produce from them to you, and (v) their confirmation they are a consultant with no employment rights. You will need to check with local labor or employment counsel in the state in which the consultant lives to make sure there are not any additional obligations that may apply. Or, engage a PEO, or Professional Employer Organization, to handle the local employment law compliance for you.
How many shares should I set aside for future issuances?
Q: How many shares should I set aside for future issuances to employees, consultants or advisors? And when should I put in place a stock option plan?
A: We get asked this question a lot. Typically, we form a corporation with 10 million authorized shares of common stock. The range of shares to be reserved under a stock plan for employees or other service providers is 1,000,000 to 3,000,000, with a standard of 2,000,000 shares for tech companies that plan to hire and grow quickly from the date of formation.
Any number of shares reserved within this range should be acceptable to your future angel and VC investors so long as you have a rational explanation for the number. For instance, perhaps 1,000,000 shares will be enough for your team of developers, advisory board members and other consultants for the first year or 18 months.
With regard to timing, if you plan to imminently retain consultants, advisors or other service providers and compensate them with shares at the outset, then most corporate lawyers would recommend that you adopt a stock plan at the time of formation. This plan would be included in a series of corporate actions typically approved by the initial directors in their first meeting, whether held as a meeting or approved by unanimous written consent.
Why You Should Consult a Trademark Attorney
Q: The name of my startup is really important to me. I chose it because it is modern. It reflects the online, real-time experience that I want to build – and for every generation to feel welcome on it. Given that I am about to invest in tech development of the platform, I want to file a trademark to protect the name. Can I just file the trademark myself with the USPTO?
A: It would be better if you consult with a trademark attorney before filing a trademark on your own with the United States Patent and Trademark Office (USPTO). The reason is that your name may already be used by another company in your market. But, more importantly, a good trademark lawyer may help you select a name, e.g., a “suggestive” name rather than a “descriptive” name, that will afford you more protection in the marketplace.
The rules for trademarks are different than patents (protective of innovation) or copyrights (protective of expressive works). They derive from the Commerce Clause of the U.S. Constitution, and their goal is to facilitate the buying and selling of (i) tangible products (consumer products or digital media on a CD) or (ii) intangible service (streaming service) so that the consumer knows what they are getting just based on the brand name. Also, a trademark is very fact
specific. The context in which it is used matters. For instance, if a name is generic, it cannot be a trademark because everyone needs to use it when they communicate concerning buying and selling. Instead, a trademark tells the consumer who makes the product or service, as well as representations about quality or other important attributes.
Then, with regard to a new package or design, a trademark lawyer will look at designs of competitors in the same market and analyze (i) the source identifier (e.g., the name of the maker), (ii) whether there is anything generic about it, and (iii) any functional aspects of it, among other fact-specific factors. A good trademark lawyer will point out the risks and advise on ways to change the design to lower the risks of using it in the marketplace. Then you can make an informed decision about your company name and minimize a rejection by the USPTO.
Starting Points For A New Business: Money & Finance
A client came to Los Angeles to start a new life and a new business. She was a momentrepreneur, with a mission to help others navigate through divorce and thrive. She had a prior successful business, but this was her first time starting an online business. She planned to initially self-fund, then develop it further with angel and venture capital financing. She received advice from family and friends who told her to start with a limited liability company, as the sole owner, which she did. However, she realized that she needed a business and finance partner, because while she was the creative/idea person, she lacked the financial skills to start a new business. She reached out to a good friend with an MBA and a prior career at a large technology company to assist with market research, prepare a business plan and develop the company’s online platform. How much of the company should be offered as ownership?
Answer: Before bringing anyone on board, if you intend to raise capital from angel and venture capital investors or issue SAFEs (Simple Agreement for Future Equity), the bottom line is you need to form a Delaware corporation. Your future angel and venture capital investors will require it. And you will have more flexibility to issue SAFEs to future investors and stock options to future employees, consultants or advisors if you form a Delaware corporation. Another benefit is qualified small business stock (QSBS) eligibility, where, if certain conditions are met, you pay no tax to the IRS for the profit on the sale of your ownership of the company. But this tax savings is only available to stockholders of certain active C corporations in the U.S. with assets of $50 million or less (not S corporations or holding companies) who have held their stock for more than five years. With regard to double taxation (corporate and shareholder levels), this is not as much of a concern as it used to be, because the corporate rate is much lower than it used to be, and is at 20%. However, it could rise in the future so an accountant or tax attorney should be consulted.
After converting the LLC to a Delaware corporation, the amount of ownership for a new team member depends on the extent of their involvement. Are they going to take on a leadership role as a co-founder? If so, standard practice is to issue them a block of shares, with vesting subject to the same vesting schedule as future employees, consultants or advisors, of 10% or more of the company. A typical vesting schedule for a venture-backed company is a four-year term, with one quarter (1/4) of the block of shares vesting on the date of the first anniversary of the issuance (also known as cliff-vesting) and 1/48 of the block of shares vesting on a monthly basis for the remaining three years. Regardless of the composition of ownership among your co-founders, the general rule (from the perspective of your future venture capital investors) is that the co-founders must continue to own the majority of the company after initial SAFEs, Convertible Notes, Series Seed AND Series A preferred stock financings.