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.