By Wilson Huang, business development and go-to-market strategist at ATMOSIScience, a leading provider of humidity control solutions.
Navigating the intricate maze of startup law can feel like a journey through uncharted territory. Each phase—setting up a business, drafting legal documents and managing the complexities of raising capital—presents unique challenges. You may assume that hiring a professional lawyer is the only guide you have, but what if there’s a more efficient and cost-effective path?
I’m Wilson Huang, a seasoned tech entrepreneur, part of the founding team and currently a go-to-market (GTM) strategist. Over the past eight years, I’ve ventured through these three major legal terrains of startups and emerged with valuable insights. In this article, I’ll share practical, actionable legal advice on these three areas that could potentially save you significant time and money on legal consultations. While I’ve navigated these legal waters and survived, I am not a licensed attorney. The advice I’m offering is meant to serve as a guide, not a definitive legal directive. Always consult with a professional lawyer for specific legal issues. Brace yourself to delve deep into the world of startup laws—a journey that will equip you with the legal knowledge necessary to confront any challenge your startup may encounter, no matter the industry.
Setting Up A Business
For tech startups, particularly those eyeing venture capital (VC), incorporating it as a C-corp in Delaware is often advantageous. This is due to Delaware’s comprehensive business law system – a compelling factor that outweighs any perceived sales tax benefits, which are commonly misunderstood as the primary advantage. It’s worth noting that if you don’t initially choose Delaware, investors might insist on this jurisdiction later when closing deals. VCs don’t like to, and often can’t invest in pass-through tax entities such as LLCs and S Corps. Both LLCs and C-corps provide the essential benefit of limited liability protection, ensuring a clear divide between personal and business assets. An LLC could be your best bet if you envision your startup remaining private, given its operational flexibility, relaxed regulations, and “pass-through” taxation avoiding corporate-level double taxation. However, if your roadmap includes soliciting venture capital, going public, or issuing employee stock options, a C-corp is typically the way to go. The choice ultimately hinges on your startup’s long-term goals, with both entities offering unique advantages catering to different business trajectories
Article Of Association And Considerations
In setting up a startup, equity allocation and the specifics of the Articles of Association are paramount considerations. Usually, startups are initiated by two to three founders. A recommended approach is for these founders to divide 90% of the total equity among themselves, leaving a 10% option pool for future talent or incentives for current employees. This balance of equity demonstrates a clear leadership hierarchy to external parties while respecting the co-founders’ contributions.
An equity split such as 70% versus 30% could overly skew the balance; if there are three founders, an allocation similar to 40%, 30%, 20% might be more appropriate. If you bring an advisor on board, I recommend that you offer them no more than 5% equity, contingent on their contribution to the team.
A vested equity arrangement among co-founders could be a sensible option. For instance, a student founder who owns 30% equity might gain 10% each year, provided they continue studying a major related to their startup responsibilities. This ensures a continued alignment of interests.
As for the board of directors’ structure:
1. Founding stage: One director (founder) is sufficient.
2. Seed stage: Avoid adding directors.
3. Series A: Include one Series A investor and one team member.
4. Series B: Add one Series B investor and one team member.
5. Post-Series B: The founding team should hold three seats, with A and B round investors taking two seats collectively, and so on.
Having a fair and strategic equity allocation, vested shares and a well-structured board is pivotal in ensuring a harmonious and efficient growth trajectory for your startup.
VC Dilution
Grasping dilution in the context of VC funding is an essential component of your startup journey. When developing your dilution road map, consider a scenario where each investment round dilutes ownership by around 15-20%. Generally, for a seed round, it’s advisable not to give out more than 20%, with 15% being a typical figure. At the seed stage, for instance, the founder may retain 80% ownership, with the seed investor owning the remaining 20%. In the Series A round, the founder’s stake reduces to 64%, the seed investor’s share drops to 16% and the Series A investor acquires 20%. By the Series B round, the shares adjust to 51.2% for the founder, 12.8% for the seed investor, 16% for the Series A investor and 20% for the Series B investor. This model depicts how ownership stakes evolve over funding rounds, showcasing the potential for founders to maintain a majority share while attracting valuable investment. Navigating dilution strategically can aid in safeguarding your control and financial return in the company you’ve cultivated.
The information provided here is not legal advice and does not purport to be a substitute for advice of counsel on any specific matter. For legal advice, you should consult with an attorney concerning your specific situation.
