The financial mechanics of startups. School startups from Y Combinator 2017 (part one)

6 April 2017 started a free massive online course (MOOC) from the coolest in the world of business incubator Y Combinator. In order to improve the quality of Russian-language content on the topic of startups, I decided to take the drum and to lead a column of fans of Paul Graham and his team.



Stephen: Before we begin, I want to introduce our guest today. Christie Natsu — financial Director and partner at Y Combinator (hereinafter, YC). She has worked with virtually every company that has acceleration in the YC. The creation of companies, acquisition of funding, hiring of employees, the outputs of all Christie have a great experience. Today she will talk about how startups work.

Christie Natsu: Thank you. Hi all. Thank you for coming here. As already said Steven, today's lecture focused on how startups and it we will talk about some basic challenges that startups face in the beginning of his journey. Today I will tell you the basic things; there are more complex things that today we will not speak. In this lecture, we will tell you about what you should have in mind from the beginning about the resources that can help you. We (YC) are in California, but much of what I will discuss will apply to all startups, regardless of their location. During the lecture I will talk like that only works in the US, and that working outside the United States. What we are talking about today, not the hottest part of the duties of founder of a startup; in the course from different people you will hear about how cool it is to be a founder of a startup, and how difficult it is.

We're talking about the basics; if you take care of them at the beginning of your journey, you can use simple procedures and you will not have to re-think the structure of the Board of Directors and to puzzle over the same things.

If you did not take certain actions, later you will be confronted with problems, the solution of which will have to spend considerable effort, time and money.




In the course of the case studies I will cite such examples. Here are the topics that we will touch on today.

We follow the lifecycle of a company: start with the establishment of the company, then move on to fundraising, recruitment and distribution of shares.

First step — establishment of the company, a separate legal entity. This means that it creates a legal entity that pays taxes, owns its assets, is liable for its obligations, conclude on its behalf contracts, can participate in lawsuits and as a plaintiff and as a defendant. Such an entity is not dependent on its founders, and it means you as the founder do not depend on the company (apparently, refers to the fact that the founders are not liable for the obligations of the company, and the company for obligations of the founders. — ed.). In the US, this form of legal entity called a joint stock company, Corporation (C corp, corporation; in Russia — JSC).

There are other forms of legal entities, but the Corporation is the most suitable form for start-UPS that expect success, growth, fundraising, and, in the end, the placement of shares on the stock exchange (IPO). In fact, investors can only invest in joint stock companies. If you decide to create a company in another form, there will be many other nuances. Perhaps people who are far from the startup industry, I will advise you to start with form LLC (limited liability company, limited liability company, LLC) or some other form of legal entity. This form will work in the early stages, but when you become successful and you will need to raise money, you have to change the form of legal entity joint stock company. So, if you create a startup, it makes sense to just create a company in the form of joint stock companies.
Here I must apologize for the abundance of terminology, but there's nothing you can do about it; during the lecture we will be talking about "startups", "joint stock companies", "legal entity" — this is your company.

The most difficult part in creating the company is to decide when the company should be created. It is obvious that the creation of a legal entity entails the administration and many other processes, is inextricably linked with the legal entity.

This is one of those cases where you don't want to do it too early, and at the same time don't want to be late. Too early to form a company for you if this is a side project; if you still iterate through different ideas, I doubt that you are going to do this project for a long time and seriously; if you don't know whether to work together with co-founders.

If the description fits you — then you're too young to start a company. But if you need to protect intellectual property (especially if intellectual property creates multiple people), you will need to register a company.

If you created a product and ready to sell, you also need to create a company that will receive money from buyers; you'll want to the company was your Bank account, and you have a separate account to not mix your money with company money. The company Stripe has a Stripe solution, Atlas, which helps entrepreneurs to create a company to obtain the taxpayer identification number (tin) to open a Bank account and begin accepting payments via Stripe.

Another reason in favor of the establishment of the company is to protect you as a private person. As I said, the creation of a legal entity means all of the obligations and what happens with the company will treat the company, not you as an individual. If you are faced with a situation where it will be set to create a company.

In YC, we firmly believe that the USA is the best place to create a company, regardless of the origin of the founders of the company or where they are at the time of establishment of the company.

The main reason is that most of the money available for startups is in the US, and American investors are reluctant to invest in the company that were not created in the United States. There are exceptions and there are various options, but usually companies registered in the United States face difficulties. In the process of registering a company you don't even have to be in the US.

Most startups not only start — UPS incorporate companies in the state of Delaware. The reason is that in Delaware many lawyers; almost all of the lawyers involved in corporate law, know the laws of the state of Delaware; investors expect that they will deal with companies registered in Delaware and the laws of Delaware, the most flexible in terms of issuance of shares and similar issues, and best protects you as the founders of the company.

This is a situation in which you don't even need to think about other options — register the company in Delaware and that's it. In addition, you can register a company in Delaware without being a US citizen and not physically present in the United States. With that understood, let us proceed directly to the process of registration of the company. It consists of two stages. The first step you can send several forms in Delaware, which means that you want to register a company.

Usually within 24 hours they process paper and register your company. After registration the company needs to establish the rules under which the company will act (similar to the Charter in the Russian law — ed.) is to create a Board of Directors, to appoint members of the Board of Directors, to appoint top managers, to consolidate the company's intellectual property rights to whatever you create, belonged to the company, and to distribute the shares of the company, that is, to determine the ownership of the company.
Next, I will elaborate more on the protection of intellectual property and the distribution of the shares; the management, the creation of the Board of Directors is very complicated and I will not stop. I must say that for these issues there are two ways; the first is to hire a lawyer.

Most companies just hire a lawyer. This is a great solution, especially if what you want to do differs from the standard provisions, or if you need personal service. Usually we (in California) these services are from three to five thousand dollars plus the fee for registration of the company. In Silicon (Silicon) Valley is full of lawyers, and in the case of a startup delay payment until financing.

I must say that if you have a friend or relative who is engaged in legal matters of real estate anywhere in Alabama, you shouldn't count on their help. Because they do not understand the way start-UPS, they don't know what standard language must be present in the documents of the startup. And it can lead to tragic consequences.

In our practice there was a case; we funded the company, which was registered as OOO (LLC) to Connecticut. The reason the founders registered LLC in Connecticut, was simple: they listened to the advice of his friends, lawyers from Connecticut.

When we (YC) informed them about his decision to invest in their startup, they decided to change the form of legal entity and place of registration of the company and Delaware respectively. The process involved all the same friends, the lawyers of Connecticut. All was well until the new lawyers are from the Valley, whom they hired, found that changing the form of legal entity was a mistake, and therefore, this legal action was null and void!

By that time, the company has already raised three rounds of funding. Lawyers have made a small mistake, but it led to the invalidity of the changes in the shape of a joint stock company. They had to delay the procurement of the next round of funding until you resolve the registration problems. It took six months; they hired four law firms and have paid half a million dollars.

The moral of this story is simple — use lawyers, who have experience in working with startups, and register a joint stock company in Delaware.

Another successful, especially for young startups at the stage of creation, the option is Clerky. Clerky has been incubating in the YC; this is a platform that allows you to create all the necessary company registration documents with a simple interface where you only have to provide basic details to the automatically completed form without any errors.

On the platform you can sign all documents through electronic signature, after which they are stored in "the cloud". This is a great option if you are in the beginning of the creation of the company and you just need to create it.

Check the company using the service Clerky will cost you a few hundred dollars plus the tax for registration, and it's easier than hiring lawyers. When we are in YC approve funding for startups that do not yet have a legal entity we advise them to register a joint stock company with Clerky.

OK, let's continue. Part of the process of setting up a company is to distribute a share (shares) in the capital. This is important, because during the distribution of shares to the founders have to think about what they will do with the company, and to discuss it.

Often during distribution of the shares identified important issues that up to this point was not discussed. For example, one of the co-founders are going to devote to the project of their time, and the other all the time.

The process of distribution of shares in allows you to spot things that become serious problems during startup. Of course, if the company will come to success, the company's shares, which you, as co-founder, own will be the main source of your well-being.
It is important to distribute shares to co-founders all believed that the distribution is fair. Honesty is very important, because with these people you will need time to work together, and work in a stressful environment. In a situation when one of the founder of the 90% shares of the company, the other 10% of the shares, but they both laid struggling to get their project was successful, there may be resentment.

In a stressful situation, the resentment only grows. The number one reason, according to which divergent co-founders is that they can't agree on the shares in the company. Usually in case of a dispute between co-founders so much effort and time is spent on conflict resolution that the company is on the Rani of survival.

The company is trying to rectify the situation after the co-founders decided contradictions, some of the co-founders left the company, and the whole process is quite painful. So in advance, say the distribution of the shares and verify that all consider fair distribution.

We believe that the shares should be more or less evenly distributed among co-founders. Please note — we are talking about "more or less equal shares"; the shares need not be equal. That's just part of the arguments that we hear from the founders: "No, equal shares are not suitable; I will have 70% of the shares, and my co-founder of 30% of the shares, because I came up with the idea." Or: "Because I made a prototype". Or: "Because I made the first sale on 20 thousand dollars." Or: "I started the project 3 months earlier than my co-founder".

But our position unchanged. Your project at the very beginning, and if you worked on it for 3 months, if the company is successful, you work another 5, 10 or 15 years! 3 months compared to horizon in 10 or 15 years — a drop in the ocean. Perhaps there is one argument with which to reckon — when you do the share of one co-founder a little more, to avoid irresolvable contradictions (dead lock is a situation where the shareholders have equal shares, but they disagree and cannot come to a compromise).

Honestly, if you begin to take action to make the decision, then you have serious problems within the company, and the calculation of stock these will not solve the problem. In the end, when you make a decision about the distribution of the shares, think not about what you have done, and that you have to do.

This question should be discussed, and everyone should assume that the final distribution is fair, all received more or less equal stake. To secure distribution from a legal point of view, necessary legal work and then you might face difficulties.

One of the companies in which we invested, at the time of joining an incubator has already created a legal entity, they had distributed shares and made everything else. For several reasons, they had to create a new company and do the merge the old with the new, and in fact they exchanged the shares of one company for shares in another. They did all that, everything was fine, they attracted investment.

Then they drew a new round of investment, but the deal worked for another law firm. When it accepts new lawyers, they carefully check all the documents; in our case, they found that when creating your first company the founders did not make a purchase of shares.

This meant that from a legal point of view, they did not own shares of "old" company and therefore not owned by shares of "new" companies (as they had exchanged the shares of the "old" company stock "new" company) because they could not make a bilateral deal.

They exchanged some shares for others. Since (obviously, since the founding of the first company — approx. ed.) their actions were illegal, and they owned shares in the company. And again — I brought in a bunch of lawyers spent a lot of time and money. But such questions should not waste your time.
The founders buy shares on the basis of the contract of purchase and sale (refers to the Founders stock purchase agreement; in Russian law there is no direct analogue of the shares established by the Protocol on the establishment of the company and to the Treaty establishing if it is created). Usually shares are sold for money. When you create a company you normally pay a few dollars (probably refers to several thousand dollars — approx. ed.).

The funds are transferred from your personal Bank account to the account of the company. Sometimes shares are exchanged for intellectual property, but is a more difficult case. Once you've bought the stock, you have ownership of the company (or its part). The right of ownership is recorded in the table of capitalization (similar to the Russian law the register of shareholders or list of members — approx. ed.).

This is a basic example of the table of capitalization, which will be complicated with the growth of the company. You will allocate new shares between the employees, you will issue new shares to investors. In simple words, the meaning of the table of capitalization that you record who owns how many shares.

When you create a company, you write the data on the founders, what share belongs to each. For example, if in the company of three of the founders, and each has the same number of shares, then they have the same share. We will return to the table of capitalization later.

One of the key parts of the contract of purchase and sale of the shares by the founders of the restrictions imposed on the shares. Founder (co-founder) owns the shares since their purchase, but if he/she decides to leave the company, the company has the right to buy back the shares.

Over time the number of shares which the company has the right to redeem is reduced. This process is called westing (delayed transfer of rights — approx. ed.). On the other hand, vesting is also the process of obtaining permanent ownership of shares over time.

For startups it makes sense to use the standard template. This is usually chetyrehrazovoe vesting with an annual threshold (cliff; four year vesting with a one year cliff — approx. ed.). Look at this slide (slide 14 in the presentation — approx. ed.); on the X-axis we show the time along the Y-axis is the percentage of your shares, the ownership of which you get. The threshold (cliff) set for one year.

In the first year all of your shares can be redeemed by the company. In a year, you will immediately receive 25% of the total number of its shares. After that, each month you will receive 1/48 of the total number of shares gradually, therefore, the number of shares that may be repurchased by the company, will be reduced. After 4 years, you will receive 100% of the shares. Thus, at any time, you can calculate how many shares the company will redeem you if you decide to leave the company.

Documents are drawn up in such a way that the company buys you shares at the original price (face value — approx. ed.) so you don't get any benefits. There are a number of reasons why we use the procedure of westing. The first reason, vesting protects the interests of the founders, remaining in the company.

As an example, consider a company in which three of the founders: you and the other two, and you have not used vesting of the shares. Assume that one of the founders of 6 months after the founding of the company decides to leave the project, you and the other co-founder for 5 or 10 years will continue to run the company and do everything in your power to become successful.

At this time your ex co-founder somewhere on the beach, drinking cocktails and enjoying life. What will you feel? You probably will not be very happy due to the fact that your former co-founder of the same proportion as you have, while you continue on it.

Just think, what happens if your company buys, for example, for $ 500 million. If you have not used vesting, your co-founder who left the company 6 months after launch will receive the same amount of money as the two founders, who worked in the company from the beginning to the time of sale. It is unlikely you will please. Therefore, vesting protects you in most situations. If one of the co-founders leaving the company after 6 months after the founding, he receives the shares, and the founders working in the company, will not share the results of their work.
Vesting is also associated with the motivation of the founders, as they have to work in the company long enough to retain their shares. It is important that investors also pay attention to it. Investors do not want to invest in some company a lot of money; in fact, they are investing in the founders, because they believe that they can make plans.

Vesting protects investors, because without westing the founders of even a month could come and say: "Guys, we no longer work in the company. Find new managers who will be all to do." The last reason in favor of the westing — that this is a good example for future employees. Soon we will make sure that you also use vesting to its employees. Tell them that for them, the vesting will be applied, but for you — no, it would be unfair; it is a way to show that you have the same conditions for all.

The following point is important when preparing documents. There is a form 83B (for USA), which is filled when registering the company. I won't go into details, but if you do not sign this form every time you get new stock (according to the procedure of westing), you will have to pay tax on the increased value of their shares a year after the establishment of the company and then every month for 3 years. So you and the company will hang the obligation to pay taxes, which is bad. To prevent this from happening, you need to file a form 83B.

If you do not do this in the beginning, to fix it you can not. You must submit this form to the tax office within 30 days after the establishment of the company, and suggest you keep proof of postage of this form so you can confirm its delivery.

It you need, when you will attract financing or to sell the company. We know cases, when the transaction is frustrated for this reason — as the rounds of funding, and the deal to buy companies because the investors (or buyers) feared the potential tax liabilities that could arise from the company.

They just don't want to deal with such cases and refuse transactions. To avoid this problem, just follow the simple instructions. Regardless of whether you use the services of lawyers or service Clerky, will tell you how to fill the form and where to send it. Just follow these instructions and all will be well.

OK, let's move on to the process of raising financing.

Thanks for the translation Dmitriy Filippov.

Continued

Clerky — Formation, Hiring, Fundraising platform
Gusto — Payroll service provider
Stripe Atlas — Formation help to accept payments through Stripe
Y Combinator SAFEs and primer



April 11 in Facebookit I threw clic:

6 APR 2017 started free massive online course (MOOC) from the coolest in the world of business incubator Y Combinator.

In order to improve the quality of Russian-language content on the topic of startups, I decided to take the drum and to lead a column of fans of Paul Graham and his team.

Here is the translation of the first lesson (part one, part two) from Dustin Moskowitz (Facebook CTO) and Sam Altman (YCombinator SEO)

PS
Here's my a compilation of all the articles Paul Graham
And "my" the translation of the book "Hackers and painters"
Article based on information from habrahabr.ru

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