Gust Guide To Incorporation
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Gust’s Guide to Startup Incorporation Contents 01 Introduction 02 What Is a Company & Why Do I Even Need One? 03 04 Which Type Should a HighGrowth Startup Choose? The startup founder perspective 15 QSBS 17 Types of companies 4 The investor perspective 18 Reason 1: Limited liability 5 Why Delaware? 19 Reason 2: Collecting and owning assets & IP 6 Reason 3: Dividing and distributing ownership 7 When it’s time to form a company 8 LLCs & Common Corporation Types LLCs 10 C-Corporations 11 Benefit Corporations and Certified B-Corporations 12 S-Corporations 13 05 How Incorporation Works 06 How Company Formation Works 07 Corporate bylaws 22 Moving from incorporation to ownership 24 Issuing stock 25 Foreign Qualification Gust’s Guide to Startup Incorporation / 2 1. Introduction Welcome to Gust’s Guide to Startup Incorporation! If you’d like the easy way through this process, close this pdf and direct your browser to gust.com/ launch, where you can apply to join our Company-as-a-Service™ platform, Gust Launch, and take care of your incorporation the right way in just a few minutes. For a thorough account of the possibilities and potential concerns your startup will face as it chooses a path through the incorporation process, read on. Incorporation is a term that refers to starting a company. When it’s time to engage in business activities, it can be tough to assess which sort of company provides the most benefits to a potential business, and to find out specifically what these costs are ahead of time. 1. 2. 3. What is a company and why should I create one? What type of incorporation is right for my company? How do I go about incorporating my company? This book was written specifically for people who plan to build high-growth startups1, such as the Airbnbs, Ubers, and Facebooks of the world. It is the To answer these and other questions, we’ll present everything you need to product of research by Gust’s legal and product experts, and sets out to know and explain how each piece of information relates to your situation: a answer the following questions, which anyone starting their first (or second, founder looking to create a company that is optimized for stability, growth, or tenth) business will have about the process: and investment. 1 Not sure if you’re starting a high-growth startup? It’s likely that your company is a high-growth startup if you are expecting to do any or all of these things: hire employees, issue equity, seek professional investment, grow rapidly, and exit via either an initial public offering (IPO) or acquisition by a larger company. Gust’s Guide to Startup Incorporation / 3 2. What Is a Company? Why Do You Need One? In the simplest terms, a company is a legal designation that you can The first two are simply ways for a person or a group of people to announce create by telling your various governments (state, local, and federal) about that they will be doing business under a name other than their legal name. your intention to do business under that name. Within the category of For example, a slushy salesman named John might do business as the sole “companies,” there are several kinds of entity, which can be understood proprietor of John’s Slushies. If he had a partner, Maureen, they might do as a handful of categories (with more specific types inside each category). business as The John & Maureen Slushy Partnership. In either case, John Some of the most common categories are: (and/or Maureen) have no protection as actors in situations involving the company: they are the company and are personally responsible for any 1. Sole Proprietorship 2. Partnership • General Partnership • Limited Liability Partnership debts or obligations they enter into as the company. 2 Because companies often work on scales much larger than individual people do, the law permits the creation of companies which exist separately from the people who own and/or run the company from a legal standpoint. The rest of the types of companies above have this trait, which enables the law to consider them separately from their owners, employees, or operators 3. Limited Liability Company (LLC) 4. Corporation in some or all of the following ways. Each of these effects can separately be a compelling reason to create a company. • C-Corporation • B-Corporation • S-Corporation 2 This paragraph specifically concerns General Partnerships. In a Limited Liability Partnership, all limited partners will be protected by the same limited liability functions as partners in an LLC, while any general partners will be treated as members of a General Partnership, i.e. they will not receive protections. Gust’s Guide to Startup Incorporation / 4 REASON #1 Limited liability LLPs, LLCs, and corporations are meaningfully So, if a court judges against your startup for distinct entities from the people who own them, some reason in a suit, or if you find yourself but can mostly do the same things (like enter into unable to fulfill contracts—whether they’re contracts or buy and sell products). But while a with employees, contractors, suppliers, or person who is doing business activities as herself customers—the courts or the other party in the is personally liable for them (and their effects), contract won’t come after you and your personal members of a corporation are not personally assets. Instead, the corporation is responsible liable for the activities and agreements made by for bearing any penalty. the corporation. This is called “limited liability” and it is one of the most compelling reasons to form a company. Gust’s Guide to Startup Incorporation / 5 REASON #2: Collecting and owning assets & IP Like liability, many of the benefits of incorporation are tied to the company’s status as an independent entity. This entity can own assets like capital, equipment, and intellectual property (IP). All of these assets increase your company’s value, especially from the perspective of future investors and existing shareholders. The last kind, intellectual property, is especially crucial for high-growth startups, which tend to focus on developing disruptive new technologies or techniques (rather than reusing established business models, as many other small businesses do). Just like with debt, you want ownership of these intellectual property assets to be the property of the startup, not the individual founders. In this arrangement, each founder’s contributions will remain with the company even if they leave, which has two big benefits: first, it means that nobody can hold the company’s future hostage purely on the basis of their past contributions, and second, it provides a sensible justification for each contributor’s equity If you do not protect your IP early then you’ll introduce downstream risks on stake. There’s also a financial benefit, which is that the value created by the future financings and/or in the market through competition. Keeping that IP intellectual property can be considered part of the value of the company, within the walls of an incorporated entity reduces risks if done properly, and which is the main mechanism investors use to decide how much money to they can benefit from corporate laws that have already been built around put into a startup. scenarios like this. Gust’s Guide to Startup Incorporation / 6 REASON #3 Dividing and distributing ownership The assets and revenue created and owned by a In all of these ways, the relevant parties Investors usually put money into companies in company as well as any investment it takes in all understand the value as being divided up exchange for some amount of equity. Employees contribute to the company’s overall value. This according to shares. A business entity, unlike a often receive equity as an incentive to work hard value manifests itself in a few forms—corpora- person doing business without forming a new on behalf of the company. Company founders tions may distribute some profits to sharehold- legal entity, can have multiple owners, whose retain large portions of equity in exchange for ers as dividends; the assets may help justify a ownership (also known as equity) is divided their hard (and usually free) work before the valuation in the minds of investors; capital con- into an arbitrary number of pieces. This concept company had any real value. The existence of tributed by investors might be added on top of is legally complicated, because equity can be a legal entity that can have many owners makes a valuation as a representation of the company’s distributed in many forms depending on the it possible to articulate all these relationships overall worth. company’s type, structure, and bylaws, but in and make sense of how they deliver value to all cases the point of the division is to explain each party. who owns the company and how much of the company each shareholder owns. Gust’s Guide to Startup Incorporation / 7 When it’s time to form a company Incorporation can be both expensive and confusing, which is why many founders delay the process. So when exactly should you incorporate your startup? The short answer is: as early as possible. Specifically, you’ll want to be incorporated as soon as (or before) you have any of the following: Any intellectual property A partner A customer An employee A grant Any potential liability An investor A need for a bank account Any assets (including trademarks or computer code) For reasons that vary case-by-case, every event on this list separately amounts to a need for an entity separate from yourself that can be held liable in case of debt or penalty, can own an asset, or can distribute shares of itself to investors. Gust’s Guide to Startup Incorporation / 8 3. LLCs and Common Corporations As we mentioned in the previous chapter, companies come in many types. The four most popular of these are an LLC or three slightly different types of For high-growth startups in the United States, there is really only one ideal corporation: C-Corporation, B-Corporation, and S-Corporation. choice (a Delaware C-Corporation3), but there are technically many options. 3 It’s important to note that most types of companies are registered with state governments, not the federal government, so there may be slight differences in the ways these entities behave on a state-by-state basis. We’ll discuss this a little in chapter 4, under the heading “Why Delaware?” Gust’s Guide to Startup Incorporation / 9 (LLCS) Limited liability companies simple income (without being taxed at the LLC level) to arrangements in which every its owners, who then treat it as taxable personal owner is a partner. An LLC income. Whether or not any money actually basically provides the limited passes from the LLC to the individual, the liability protection for which individual owner must pay income tax on their people form companies, but does not do much share of the profits (or losses) generated by the else. Each company which chooses to incorpo- LLC. Every year at tax time, every LLC must send rate as an LLC drafts an “operating agreement” every one of its members (and the IRS) a Form among the owners, which contains all the rules K-1, showing that member’s personal share of by which the company operates. This operating the company’s profit or loss. LLCs are extremely agreement is similar in function to the bylaws of a corporation, but due to the bespoke nature The features which tend to make LLCs popular— of each LLC’s structure, there are no standard namely, their pass-through taxation structure components for this document (although there and their liability limitation without the need for a are common features). full corporate structure—make them well-suited for people who simply want a business entity LLCs are also not independently subject to through which to do business. For high-growth corporate tax: an LLC is effectively invisible (for startups, they are generally not well-suited, for tax purposes), and “passes through” any net reasons we will address in subsequent sections. Gust’s Guide to Startup Incorporation / 10 C-Corporations C-Corporations are the most popular type of American cor- its shareholders (known as “distributions”), the shareholders themselves are poration. They are different from LLCs in a few ways. The required to pay personal income taxes on the amount they receive. first is that, rather than an operating agreement, corporations abide by bylaws written into their articles of incorporation, for The third defining feature of a C-Corporation is that it comes with an out-of- which there are many regularized and standard structures. the-box mechanism for distributing equity. This is called stock. At incorpora- Due in large part to their popularity, C-Corporations enjoy the benefit of tion, corporations authorize a certain number of shares of themselves (which having both state and national courts which are familiar with their features can be increased at any time) and can subsequently issue these shares to and behaviors, so the operating a corporation as it scales is somewhat their owners (such as founders and investors). Because this instrument is easier and less lawyer-intensive than other types of companies. well-understood, this is easy to accomplish without involving lawyers. The second key difference between a C-Corporation and an LLC is the way C-Corporations are by far the best-suited corporate entity for high- in which it is taxed. C-Corporations are subject to a separate set of taxes growth startups. We’ll specifically address the reasons why this is so in than their owners or operators are. A C-Corporation pays annual corporate subsequent chapters. taxes based on its taxable net income, and then if it distributes any money to Gust’s Guide to Startup Incorporation / 11 (B CORPS) Benefit Corporations and Certified B-Corporations Most corporations are generally assumed to have the with a B-Corporation). This entity is not available to companies in all states, primary goal of maximizing their value for shareholders. In and generally differs primarily in ways that are related to its public benefit the past few decades, many companies (especially startups) goals, such as accountability to shareholders and transparency—for most have shown interest in expanding their range of aims to other structural and tax-related concerns, it is similar or identical to a include various kinds of altruistic and socially positive C-Corporation. goals—traditionally solely the concern of nonprofit organizations—to which the law refers generally as “public benefit.” These companies can also (optionally) choose to become Certified B Corporations, which is a third-party certification offered by the group responsible Corporations who seek to include some public benefit in their purpose for the creation of the Benefit Corporation legal entity and is not a type of have a legal entity option called a Benefit Corporation (sometimes confused corporate legal structure in its own right. Gust’s Guide to Startup Incorporation / 12 S-Corporations Some C-Corporations can optionally file Form 2553 with the The rules that determine which businesses can elect to be treated as S-Cor- IRS, which changes the C-Corporation into a “Small Business porations are somewhat restrictive and a little confusing, but in practice end Corporation,” popularly known as an S-Corporation. S-Cor- up working for most high-growth startups. To be eligible, a company can’t porations are essentially just an election for pass-through operate within certain industries, and must have fewer than 100 sharehold- taxation status, and are perhaps best considered a subcat- ers (although a married couple or an estate can count as a single sharehold- egory of C-Corporation designed to compromise between the corporate er), all of whom are individuals (or “certain trusts” and estates) rather than rigidity and standardization of a C-Corporation and the tax-invisible nature corporations or partnerships, and all of whom are residents of the United of an LLC. States. In addition, an S-Corporation can only have one class of stock. Gust’s Guide to Startup Incorporation / 13 Business structure comparison SOLE PROP. GEN. PRTNRSHP ✓ ✓ Moderate Difficult Difficult Moderate Extensive Moderate Few Few Few ✓ ✓ C-CORP B-CORP LLC Offers liability protection ✓ ✓ ✓ Can own assets & IP ✓ ✓ ✓ Can grant stock ✓ ✓ Owners can split profits/losses w/ business ✓ ✓ Owners can report profits/losses on personal tax returns ✓ ✓ ✓ Created by state-level registration ✓ ✓ ✓ Easy Moderate Extensive ✓ Ease of raising funds Ongoing record keeping reqs. May have an unlimited number of owners LTD. PRTNRSHP ✓ Gust’s Guide to Startup Incorporation / 14 4. Which Type of Company Should a High-Growth Startup Choose? Now that we’ve looked at the myriad types of basis of their benefits and drawbacks. There are There’s a right answer—spoilers: it’s a Delaware companies available to an entrepreneur seeking two main categories of stakeholder a startup C-Corporation—but to understand exactly why, to become the founder of a high-growth startup, founder should consider: themselves (and their we’ll walk through all the potential ramifications we can compare them to each other on the cofounders) and the investment community. of each choice. The startup founder’s perspective As Daniel DeWolf at Mintz Levin puts it, “Incorpo- While it’s possible to develop workarounds for rating as a C-Corporation in Delaware is the gold an LLC to divide its ownership structure, notably standard for high growth startups. It provides profits interest (which signals an intent to divide limited liability, ease of use, ease of setup, the profits at a later date, counting from when the ability to issue stock options, and tax benefits interest was granted) and capital interest (which upon sale for many qualified small businesses.” represent portions of the value of the company if it were to be liquidated), these don’t exactly The two key differences between an LLC and a translate to stock or ownership in the obvious, C-Corporation are the ability to divide ownership comparatively intuitive ways that shares of a and the way in which their income is taxed. C-Corp do. Gust’s Guide to Startup Incorporation / 15 On top of these differences, LLCs entirely lack a way to grant options, which However, LLCs operating at a loss do offer their owners the ability to pass are a common equity incentive format that startups give to employees and through some of that loss directly to their personal tax returns, thus reducing advisors that more or less represent the ability to purchase shares of the their net taxable income. This is genuinely attractive to many startup entre- company at a discount when it’s advantageous to do so. Since almost any preneurs, who are likely to be bootstrapping their businesses and forgoing successful high-growth startup will seek professional investment, these a salary, and are therefore very grateful to reduce their tax burden. structures will need to be converted into analogous C-Corp ownership units (i.e. shares). In short, that’s a lot of expensive lawyer time. Startup founders who are interested in taking advantage of pass-through taxation while still choosing the standard and well-suited C-Corporation Despite the comparative difficulty an LLC introduces as a result of its inability structure for their startup can choose to elect S-Corporation status. There to directly issue stock, many startup founders are still hesitant to choose a are two distinct disadvantages to this approach, one of which can be C-Corp structure. The number-one reason is because they’ve heard about handled easily and one of which cannot be mitigated at all. the “tax advantages” of LLCs: many first-time founders hear that a C-Corporation’s profits are “taxed twice,” compared to an LLC’s profits, which are The first disadvantage is that S-Corporations are effectively investor-proof. only taxed once, and should therefore be avoided. S-corporations, as noted above, are limited to one class of stock and 100 individual shareholders (who cannot be businesses or partnerships). Still, This belief is based on a misunderstanding of the pass-through taxation an S-Corp is perfect for an initially founder-funded startup, and then when structure. Since few high-growth startups turn profits in their first few years, the startup’s first investors arrive, the company can simply drop its S-Corpo- there is effectively nothing to “double-tax.” Startups tend to reinvest any ration election and turn into an investor-friendly C-Corp with the ability to revenue they generate in growth, and no profits to tax means no tax on issue the Preferred stock that they will insist on purchasing. profits. No profits also means no dividends paid to shareholders, so there will be no personal tax on those nonexistent profits either. In other words, The second disadvantage is that an S-Corporation (as well as an LLC or any “double taxation” in a high-growth startup usually amounts to 2 x $0 = $0, or other non-C-Corporation entity type) is not eligible to take advantage of the double taxation on nothing. Qualified Small Business Stock tax write-off, which can amount to millions and millions of dollars in savings. Gust’s Guide to Startup Incorporation / 16 QUALIFIED SMALL BUSINESS STOCK (QSBS): A key consideration for everyone Under certain circumstances, stock issued by C-Corporations counts as Qualified Small Business Stock (QSBS). After five years of ownership, the gains made on the value of this stock can be written off the personal taxes of the stockholder up to $10,000,000 or 10x the stockholder’s adjusted basis in the stock, whichever is greater. In other words, the $10M in non-taxable gains is the minimum, provided you have $10M in gains in the first place. The requirements for equity to qualify for the QSBS exemption are relatively straightforward: stock issued by an active, domestic, C-Corporation that has less than $50,000,000 in assets right after issuing the stock. Virtually all newly-incorporated, high-growth, US C-Corp startups would meet these requirements. For both startup founders, who are expecting (or hoping for) a massively successful exit, as well as investors in such a startup, this $10M+ in tax exemptions should be an extremely compelling reason to choose C-Corporation status. After all, is the possibility of saving a small amount in taxes deducted from your personal income this year worth potentially paying taxes on up to ten million dollars in personal gains when you make it big? Gust’s Guide to Startup Incorporation / 17 The investor’s perspective Like founders, investors’ primary cause of It’s also important to note that the efficiency aversion to LLCs is the difficulty created by their isn’t just a one-time benefit at the moment of non-standard equity mechanisms. Remember investment. It remains a concern for the duration that since LLCs are technically always partner- of the relationship as it impacts everything from ships, any equity-like features need to be cus- additional equity issuances to investor protective tom-written into the operating agreement each provisions. The crux of this issue is the LLC’s time they are issued in order to approximate the mandatory IRS form filing, known as a K-1. equity functions of corporations. Recall that the LLC is invisible for tax purposes. Sophisticated professional investors often have In tax season, the partners (i.e. all equity-hold- cidentally expose their investors to tax penalties portfolios with dozens—or even hundreds—of ers, including each of the investors) have to for late filing, which is unlikely to have a positive companies. If an LLC is among them, investors file a document with the IRS that explains the effect on what should be a mutually beneficial, are required to deal with these ad-hoc equity attributed income they received (whether or not satisfying relationship. agreements on an individual basis. Even though they actually received any of it in cash) from the these may look and behave similarly to stock partnership. These forms are called K-1s, and Between the sheer annoyance of K-1s, the in a C-Corporation, the reality is that each one they are not popular with investors. legal and accounting difficulties created by must be treated separately because there are LLCs’ ad-hoc approaches to equity, S-Corpora- no standards. Compare this to the known and If an investor held a stake in an LLC (i.e. was a tions’ inability to issue preferred stock or take understood C-Corporation partner) in any given year, the IRS requires that investment from business or partnerships, and shares, and it’s easy to understand why investors the file a K-1 in order to complete their taxes, so the $10M+ in potential tax exemptions available prefer the known commodity: it’s less work for the investor’s tax filing can easily be blocked by only to C-Corporations, professional startup the investors and their lawyers, making these a single company’s tardiness in distributing the investors almost exclusively choose to invest in types of investments significantly more efficient. forms. In other words, a startup founder can ac- C-Corporations.. mechanisms of Gust’s Guide to Startup Incorporation / 18 Why Delaware? Benefits of incorporating in Delaware: Delaware’s filing offices and court systems are prompt and offer good customer service. The state has predictable, welldeveloped corporate laws that experienced businesspeople and lawyers worldwide understand. Corporations (and most types of companies) are chartered by state governments rather than the federal government. Because Delaware is a small state, it developed a series of tax and regulatory laws (notably the Delaware General Corporation Law) and court systems that are more advantageous to the corpora- The laws are the most businessfriendly and protective of a company and its management and board of directors. tion than almost anywhere else in the country, leading it to be the most favorable place to incorporate for both companies and investors. It’s a revenue win for them; a tax and regulatory win for companies. As it grows with more board members and investors, a Delaware The net result is that most investors will prefer to invest in startups incorporated in Delaware, since its laws and regulations are both familiar and preferable to professional investment groups and startup corporation offers flexibility for Board actions and shareholder rights. lawyers. In some circumstances, there are compelling reasons to incorporate elsewhere, but most startups stick with Delaware as “The First State” and file a foreign qualification form to operate in their own home state. Gust’s Guide to Startup Incorporation / 19 5. How Incorporation Works Incorporation refers to a charter granted by a governmental jurisdiction, in this case the State of Delaware, for a group of people to do business as a legal entity rather than as individuals. This involves filing a Certificate of Incorporation, which means picking a name, signing a document, and sending it to the office of Delaware’s Secretary of State. To actually draft and file the Certificate, a founder will need to engage a lawyer or legal filing service. Gust Launch’s incorporation process is the latter—it is a quick and easy software experience that fills out and files the Certificate of Incorporation, using a set of documents which have been custom-tailored for use by high-growth startup companies by experienced startup lawyers. As part of the incorporation process, companies authorize themselves to use vesting, which (in extremely simplified language) makes the shares issue shares of stock. Most high-growth startup companies, including all available incrementally over time4. Startup grants often vest over 48 months, those who use Gust Launch, authorize themselves to issue 10,000,000 meaning that 1/48 of the shares vest every month. If a startup has 10,000,000 shares, each at a par value of at least $0.00001. authorized shares and grants 0.1% to a new advisor, the grantee would have 10,000 shares, which is easily and meaningfully divisible by 48 (to ~208 Setting a company up with millions of shares lets the company give relatively shares per month). By contrast, if you authorized only 5,000 shares, an 0.1% small grants to advisors and employees. To understand why millions of grant would be 5 shares. This math doesn’t work nearly as well, because a shares are necessary, it’s important to mention that most shareholder grants grantee cannot easily vest 5 shares over 48 months. 4 To learn more about vesting, read “How Vesting Protects Companies and Founders” on the Gust Launch Blog. Gust’s Guide to Startup Incorporation /20 The per-share price (or par value) of $0.00001 is possible because the startup has no assets, so the taxes each grantee must pay on their stock grants can be kept extremely minimal by declaring an overall value of the company at $100. Gust Launch’s incorporation process also includes an SS-4, which is the application for an Employer Identification Number (EIN). This IRS-assigned ID number is used when paying taxes and otherwise identifying the company to the US government. It’s necessary for opening a company bank account, as well as for paying employees when the company is ready to hire. The Gust Launch incorporation process is quick and easy—to get started, visit gust.com/launch or watch a video demo at http://gust.ly/incdemo. Watch a video demo of the Gust Launch incorporation process Gust’s Guide to Startup Incorporation / 21 6. How Company Formation Works The term “company formation” refers to a series of decisions to make retail store would have very different formation documents than a ven- and documents and actions to adopt reflecting those decisions that ture-funded startup. Often, a startup will bring in an experienced lawyer at ensure that the brand-new C-Corporation has the structure and traits that this point if they are using one of the more general-purpose online legal investors expect. filing services. Some online incorporation services either skip the formation step or simply We’ll describe the Gust Launch approach, which takes the process step by send the founder general-purpose documents that aren’t appropriately step, using online documents specifically intended for startups. customized for specific types of companies—for example, a family-run STEP ONE: Establish corporate bylaws Immediately after filing for incorporation, a company needs to draft and adopt its bylaws. These are operating rules to specify the organization, structure, and governance functions of the corporation. Gust’s Guide to Startup Incorporation /22 BASIC CATEGORIES OF BYLAWS There are a few other pieces to the bylaws. Stockholders: Many will be different for startups than for other people who own shares of the company have meetings and vote to elect Board kinds of companies. For example, startups can members, among other things. save countless time and money by including provisions in their bylaws to take advantage of Board of Directors: this section specifies the number of people on the Board, what their powers are, and the rules that apply to them. new Delaware laws that allow for paperless stock records and online votes and notices. This is one of many reasons to hire a startup lawyer or use startup-oriented legal automation software, such Officers: the organization’s top management, what they do for the organization, and how as Gust Launch, that use documents appropriate to startups. they will be appointed. In the beginning, this might mean co-founders as well as any advisors or investors the company has. Indemnification: the corporation accepts the responsibility to cover legal actions brought against certain people who act on its behalf. In other words, if a founder or officer is sued, the corporation will pay the attorney fees and any damages assessed, rather than leaving the founder on their own. Stock: how the company’s stock ownership is tracked, including how the company records ownership, rights to receive dividends from the stock, and other specifications. Gust’s Guide to Startup Incorporation / 23 STEP TWO: Move from incorporation to ownership There are several ways to go about the next formation steps. Gust’s process The new Board is empowered by the bylaws to appoint officers of the is optimized for simplicity and speed of execution. company. The next step is for the Board’s newly appointed initial member to appoint the company’s first CEO (usually themselves), secretary, and In the incorporation process, the person signing and filing the Certificate treasurer (the three “statutory” officer positions required by Delaware with the state of Delaware is known as the “Incorporator,” and has certain and the bylaws), as well as any other initial officer positions they wish to initial duties specified by the Certificate and by Delaware law. For conve- set up initially. The co-founding team are now the officers and Board of the nience, Gust asks the primary founder to sign as Incorporator, and in that company, but they do not yet actually own the company. In fact, nobody does. role to adopt the initial bylaws by signing an “Action of the Incorporator.” By That’s what shares of stock are for. The next step is to solve this problem. that document, the Incorporator also appoints the first Board members—in this case, appointing themself to be the first member of the Board, and then resigns as Incorporator (because the position has no further duties). Gust’s Guide to Startup Incorporation / 24 STEP THREE: Issue stock Per Delaware law, the Board directs the issuance of shares of company ownership. The Gust Launch Certificate of Incorporation provides for 10,000,000 Incorporation & company formation, step by step: authorized shares of the new company, which just means that the company can theoretically be divided in up to 10,000,000 equal pieces. To create actual ownership, stock will have to be “issued,” meaning that the company pushes out shares from being merely authorized to being actually outstanding, and then 1. Obtain a charter by filing its Certificate 2. Apply for and receive an EIN from the grants will likely make up a significant but not complete portion of the 10,000,000 authorized shares, 3. split among the co-founding team and any other initial participants . of stock to each recipient, who will need to sign a package of stock grant documents and purchase the stock (at the nominal “par value” of $0.00001 per share specified in the Certificate of Incorporation) for the grant to be complete. Most companies with multiple founders and team members opt to make stock ownership subject to vesting. There is also a stockholder agreement to handle a myriad of terms that apply to stock ownership, like transferability of shares. This is the point at which the co-founders would Adopt bylaws containing the rules and structure that investors expect, and set out its operations and powers 5 Once the Board approves the initial stock grants, the CEO oversees and signs the issuance and grant IRS so that it can open a bank account, hire employees, and pay taxes “granted,” meaning that the shares are sold to one or more people or business entities. The initial stock with Delaware 4. 5. 6. Elect a Board of Directors Appoint the founder and others to be officers Issue and sell stock to founders, giving them ownership of the company file their 83(b) elections, which relate to taxation of future gains in value of vested stock. 5 For more background on how this all works, check out Gust’s guide to startup equity terms and principles. Gust’s Guide to Startup Incorporation /25 7. Foreign Qualification The last step of incorporating and setting up a company is only relevant to companies which incorporate in states other than the state in which they are physically located or active. In this case, a company will need to file for foreign qualification, which means submitting a document to the state in which they are actually based asking for permission to do business in that state. In other words, if a company is based in Delaware but has its headquarters in Alabama, it will need to file a foreign qualification with Alabama in order to operate. This will inform Alabama of the company’s existence, and gives that state the power to regulate and tax the company. The actual document that must be filed varies from state to state (as does 10,000,000 shares. Nevada, on the other hand, calculates its fee according the fee which the company must pay to file it), but most states refer to this to the value of the startup’s equity using a minimum par value of $0.001 document as a “Certificate of Authority.” The requirements of the applica- per share, which ends up putting the fee for new startups with 10,000,000 tion may differ but usually include a mix of information about your business shares at around $75. (such as how many shares you’ve authorized) and sometimes a certification from your state of incorporation called a “Certificate of Good Standing” that Actually filing for foreign qualification is as simple as looking up the forms attests that your business conforms to local laws. for the state in which you wish to qualify, filling them out, and sending them in. However, due to the variant nature of the fees (and forms), consulting The fee is generally a flat rate, and for the most part, this fee is not especially a lawyer about this process is often advised. A Gust Launch subscription substantial: it’s on the order of a few hundred dollars. However, in a few includes the process of foreign qualification and files the appropriate states, the burden can vary greatly, especially for high-growth startups. For documents on its startup’s behalf, leaving founders responsible only for the example, in Virginia, the fee is calculated on the basis of the number of fees charged by the state as well as a small filing fee charged by our filing authorized shares, which results in a fee of over $2,500 for startups with partner, which depends on the state in which you wish to qualify. Gust’s Guide to Startup Incorporation /26 Credits CONTRIBUTORS: EDITOR: Alan McGee Ryan Kutter, Esq. Gil Silberman David S. Rose Andrew Crimer Head of Product Relationship Manager Startup Lawyer Founder & CEO Marketing Manager ABOUT GUST Gust is the global SaaS platform for founding, operating, and investing in is the official platform of the world’s leading angel investor federations and scalable, high growth companies. Gust’s online tools support corporate legal venture accelerators. More than 500,000 startups have already used Gust to and financial formation and operation for entrepreneurs, as well as deal flow connect with over 70,000 investment professionals. Gust powers the official and relationship management for investors, from startup through exit. As the online hubs of the world’s largest innovation ecosystems including New world’s largest community of entrepreneurs and early-stage investors from York City (Digital.NYC), Boston (StartHub.org) and London (Tech. London). 191 countries, Gust pioneered the equity funding collaboration industry and For more information about Gust, please visit gust.com. Gust’s Guide to Startup Incorporation / 27 Is your startup growing to include customers, partners, employees, intellectual property or investors? Gust Launch is the quick and easy way to incorporation, created by experienced startup lawyers. Learn more at gust.com/launch.
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