The Short Startup Incorporation Guide
Many startups stumble from the start; this guide will help you exit the gates cleanly.
Hey Founders et al. We’ve created a long list of legal “startup guides” to help founders navigate the stickier legal speed bumps that plague early stagers. Today, we are publishing our 2nd of this series: “The Short Startup Incorporations Guide”. We’ve packed these guides with resources and organized them into actionable steps you can take (or earmark for later).
Previous Episodes
Coming Soon
The Short Startup Insurance Guide
The Short Startup Trademark Guide
The Short Startup Contract Guide
The Short Startup Advisor Onboarding Checklist
The Short Startup Terms of Service Setup Guide
The Short Startup Fundraising Preparedness Guide
The Short Startup Data Privacy Guide
The Short Startup Data Security Guide
The Short Startup Employment Law Guide
… and more
so without further adeu…
The Short Startup Incorporation Guide
There are many online services that will do the dirty work for you. If you decide to use an online service to incorporate, you can use this guide to confirm they are providing what you’ll need to get the job done. Also, check out our Corporate Formation resources to see our list of online incorporation services.
You should also consult with a lawyer to make sure everything is being done correctly. At this early stage, basic foundational mistakes could be costly. Be conscious that shortcuts and mistakes early on can lead to expensive clean-up costs down the road.
This guide focuses on Delaware Corporations. If your company plans to issue stock to employees or raise money from outside investors, a Delaware Corporation is what they will expect. Make it easy on yourself and go with a DE Corp.
💡 Note: If you think you might want to form a different entity type (and you don’t intend to raise venture capital), check out this Entity Selection Guide from Penn Law.
Documents for setting up the corporation
Certificate of Incorporation (“Charter”). This is the initial charter of the company that will be filed with the Secretary of State of Delaware. The charter creates and authorizes shares of each class and series of stock as the company raises money, and establishes their fundamental rights, preferences, and privileges. The charter begins with some basic background info and then sets out statutory requirements including the company’s name, it’s registered office in Delaware, and it’s general business purpose (all boilerplate language). The charter also includes corporate governance matters determined by Delaware law. The company will need to hire a registered agent to receive mail from the state on your behalf (for ~$100 per year).
Action by Sole Incorporator. This is a procedural step following filing of the charter to appoint the founder(s) as the initial director(s) of the company.
Board Action by Unanimous Written Consent in Lieu of Organizational Meeting (“Action in Lieu”). This document contains the first set of actions that will be taken by the Board of Directors (“Board”) of the company to approve the charter filing, adopt the bylaws, elect the officers, establish a fiscal year, authorize the opening of bank accounts, approve the sale of stock, adopt the initial stock plan, and approve form agreements that will be used going forward.
Bylaws. Along with the charter, this establishes the framework or structure for how the company’s board, officers, and stockholders can carry out its respective functions and operations.
Other founder “Setup” Documents and Operations
Founders Common Stock Purchase Agreement (SPA). This purchase agreement covers the sale of common stock to the founder, to be issued for something like $0.0001 per share and usually paid for in cash. Sometimes these shares can be purchased “in kind” with IP that the founder is contributing to the company. The shares typically will have standard four year vesting, with a one year cliff for continued services as an employee or consultant to the company. It’s also typical for this agreement to allow for a 100% double-trigger acceleration, which means that all unvested shares will vest immediately in the case of an involuntary termination (including death or disability) following a sale of the company. Sometimes, a percentage of shares will include single-trigger acceleration, meaning that shares will automatically vest upon a sale of the company (often called a change in control).
Founders Preferred Stock Purchase Agreement. Sometimes founders are also granted FF Preferred Stock, which will typically be issued for something like $0.0002 per share (slightly more than the regular Common Stock). These shares would be fully vested at the time of issuance. The benefit of these shares is that they can be cashed out prior to an acquisition or IPO. This can be helpful for founders that want to get some liquidity down the road but prior to an exit. In most cases it makes sense for founders to have 10% of their shares as FF Preferred to avoid adverse tax consequences and because investors down the road won’t want the founders to totally cash out before the company exits.
83(b) Elections. This is a tax filing that allows founders to pay tax on their unvested shares immediately rather than waiting until they vest. It almost always leads to a much lower tax bill. This is probably the most important thing to do correctly when forming a company because it cannot be filed late. The filing needs to be made within 30 days of completing a stock purchase.
Proprietary Information and Inventions Agreement (PIIA). The PIIA assigns IP developed by the founder or employee to the company. It’s important for the company to own all the IP created by employees. Otherwise, investors and potential acquirers would be concerned that employees could walk away from the company taking their IP with them and leaving a less valuable company behind. These are signed by the founders, and should be signed by all future employees. If there was IP created prior to the forming of the company, a Technology Assignment Agreement should also be signed by the owner of the IP to assign that IP to the company.
Capitalization Table. It’s important to keep a cap table showing each person’s holdings as well as a stock plan pool. This can be done the old fashioned way in excel (not recommended), or on services like Carta, Pulley and LTSE.
Setting up equity compensation plans
When a company is incorporated, it is sometimes smart to create a stock option plan from which the company will be able to issue options to new hires as the company grows.
Stockholder Consent. In order to form a stock plan, the company will need the stockholders to approve the plan. This stockholder consent approves the initial stock option plan / pool.
Stock Plan. The Plan is typically created so that grants and sales out of the plan have standard 4-year vesting, with a one-year cliff, and no acceleration. However, these vesting details can be customized differently for individual issuances. The number of shares reserved in the plan is flexible and can be adjusted with approval of the Board of Directors.
Intellectual Property Documents Moving Forward
Proprietary Information and Assignment Agreement (PIIA). The company may not need this right at incorporation, but these agreements should be in place for any work that happens post incorporation, even work done by a founder or founding team member. As the company hires employees, it’s important to have each employee sign their own PIIA so that any IP they create while working for the company will belong to the company. This is important because if employees can walk away from a company and take their IP with them, then the company’s value decreases.
PLEASE NOTE: This is not legal advice, and thoughts and commentary are solely my own, and not those of Scale LLP.
That’s all for now. Stay Lawyerly,
Brian