Recorded in June 2014 (P2Binvestor Small Business Webinar Series)
P2Binvestor cofounder and Chief Operating Officer Krista Morgan is joined by Denver-based startup attorney Bryn Weaver of Weaver Law LLC. Morgan and Weaver talked about several important legal issues for new businesses to consider. The end of the webinar features a Q&A in which Bryn and Krista answer participant questions.
G. Krista Morgan is the cofounder and COO of P2Binvestor. Founded in 2012, P2Binvestor is a crowdfunding platform for commercial lending. Bryn Weaver has been supporting emerging and high-growth companies from cradle to sale or IPO for approximately a decade. Weaver was previously at Cooley LLP, a national law firm with the same focus. Currently, he practices on his own through a low-overhead model that benefits his clients. Follow him on Twitter at @brynweaver.
Krista Morgan: Hi, everyone! Welcome to our webinar – Legal Basics for Startups. It’s all about when to get your lawyer involved, when you really need to think about it. It’s part of our P2Bi Small Business Webinar Series, and I thought it was an important topic to cover as part of this because, now that our company is further along in its development, there are actually a ton of legal things that, if we had done them differently early on, it would have saved me quite a bit of hassle. And so I just think that passing on that experience to newer entrepreneurs is really valuable. I want to make a big thank you to Bryn Weaver, who is here with us. He’s our lawyer who’s actually going to tell us how things really work. Before I let him introduce himself, I’m Krista Morgan, the Co-Founder and COO of P2Binvestor. Bryn, why don’t you just tell us a little bit about yourself?
Bryn Weaver: Hello, cyberspace. It’s a pleasure to be here today. My name is Bryn Weaver. Obviously, I’m with Weaver Law. I’m a solo practitioner, and I represent startup companies. I’ve been doing that for a long time, and I’ve seen them everywhere from these very early stages that we’re going to discuss today, all the way to mergers and acquisitions, sales of the company, IPO, and so I really enjoy working with startup companies, and I’m very pleased to be able to help talk to you and hopefully help you with how you think about approaching your legal needs early on.
Krista Morgan: The topics that we’re going to cover today just broadly are we’re going to look at founder agreements, we are going to talk about incorporation structures, how to engage with service providers—which actually I think is really important because so many of us, as we’re getting started working with other development firms, or law firms, or just outside experts and what’s the best way to compensate them when you don’t have a lot of cash—and then also how to engage with advisors in your company, and lastly, of course, how to engage with a lawyer, how to find one that will be a good fit for you. The presentation should really take no more than 20 minutes, and then we’ll take questions. You can feel free to log questions throughout the presentation, and we will make sure to cover them all at the end.
I think that’s it. We’re going to jump right into it.
Bryn Weaver: Every company moves through a few stages. You start with two people and a napkin in a coffee shop, and then you move to kind of a tribal company, and then you go to a company that starts to become a little bit more formalized, and there are a lot of decision points in this stage. One of the most frequent questions I get from entrepreneurs is, “Okay, when should I form a company?” That’s obviously a critical stage because at that point, you’re going to incur a little bit of expense—not a lot if you do it right, but a little bit. You’ll have to pay some state filing fees, and you’ll have to probably be talking to a lawyer or at least somebody who knows how to do this. The key is really kind of two things that can push you into forming the company. The first one is when are you going to formalize your relationship with the co-founder. If you don’t have a co-founder, you can wait a little longer, but if you have a co-founder, what I describe as (you can see at the bottom of the screen) it’s when you’d be sad if you had to walk away because if you don’t have a co-founder agreement, you can assume that something will go wrong, or somebody will get an opportunity, or somebody will become disinterested with the project. And if you haven’t gotten your co-founder arrangement set up by then, you could be in trouble because later on, when you try to get financing or to sell your company or whatever, people are going to ask, “Did that co-founder actually contribute all the ideas or do they still have a claim?” Kind of like the social network if you’ve ever seen that. We don’t want those winkle boxes lurking in the weeds.
To have founder agreements, you actually have to issue equity and have a company. So once you start to feel like you’ve committed enough time that you’d be sad, that’s when it’s time to form a company and do founder agreements. The other trigger that you need to watch for is when you start to enter contracts. For example, if you’re going to put out a beta product, and you want people to use it, it’s good. It’s good to go ahead and probably form a company because if something were to go horribly wrong with that, you don’t want to claim that personally. You’d rather have some protection through forming your company. So those are kind of the two triggers: any time you’re going to issue equity, which is usually first the founders, and then sometimes next with investors, or if you need to enter contracts.
Krista Morgan: Yeah, and I’ll say just from my experience, it probably took us three months. There were three months of kitchen-table, business-plan writing, getting the idea together before we actually incorporated, I think. And I think probably too, I mean incorporation is I really get your point about just formalizing the agreement. Starting a company is hard, and it takes a long time, and people do see other opportunities, and I think forming that structure, giving people actual equity helps them buy into it. You probably don’t want to wait too long before you do it. All right. Well, let’s jump right into founder agreements. I’ve got a lot to say about founder agreements, so I’m going to let you start, Bryn.
Bryn Weaver: Yeah, Krista will share with us a story, and her story is not that unique. It’s unique to her, but it’s a general structure. It happens all the time. Once you get to that sadness point if you will, go ahead and get founder equity in place. It’s really important to have mutual vesting. By vesting, if you’ve never heard of the term, what I mean is you agree, you both agree (or you three, or four, or how ever many founders you are) agree that you’re only going to get your piece of the company over time. So if you decide to go off and do your own thing and leave the company, then you don’t get to keep your piece of it.
Now, this is really important because even if you’re a co-founder – (and this is what I hear all the time, “Oh, my co-founder and I are best friends. We would never do anything to hurt one another,” or family – even better, right, or even long-time business partners) – the key is you just don’t know what’s going to happen. It may not be something malicious that happens.
I have seen over and over where you had a co-founder that got the dream job opportunity while you’re still in a very early stage, and that co-founder doesn’t feel like, here, she could turn it down. And so she goes and takes that opportunity. Well, should she continue to have the same piece of the company as if she were a full-time founder? The answer is probably not. And it’s so much easier to have that discussion upfront. Now, sometimes, people ask about how long should this vesting period be. “How long do I have to earn my equity?” and the answer is it depends. Three or four years is pretty typical because it takes about that long for a company to make meaningful progress. And as a practice note, when you go to get investors later on, they’ll want to see… if your vesting is too short, they’ll make you start over. So you kind of want to make it long enough that you can show you’ve done a meaningful commitment before you got all your equity earned. And basically as you invest, you just kind of… parts of it become permanent and will never go away over time. One of the couple of the other points you’ve shown on the slide are about whether 50/50 is always right with two co-founders. The answer is no. It really just depends on who’s making the sacrifices. If there’s one co-founder that’s going to be quitting their job and going full-time, and she’s all in, and then another co-founder, he maybe has to keep a part-time job and isn’t going to be making the same contribution, you need to think seriously about whether 50/50 is the right split.
Krista Morgan: Just to add to that, I actually had an interesting discussion with someone recently, and they actually are another founder. And they believe that 50/50 is never the right answer only because you want… at the end of the day, making decisions in a company requires a final decision maker, and you’re not always going to agree, and having 50/50 can cause problems, and you may want to decide that someone should own more so that if a tough decision needs to be made, that they end up taking the ultimate decision because it’s hard to negotiate and compromise on everything. It just is.
Bryn Weaver: Yeah, and there will be a little bit of a personal decision on co-founders. I do see 50/50 a lot, but everybody kind of knows that you’re both holding a gun to one another’s head in a way. It’s obviously not an adversarial relationship or you wouldn’t have chosen that co-founder I hope. Last point is just make sure everybody puts everything in the company. Again, there are some funny public filings I take, business or law school students with whom I work sometimes, to where there is a company and its founder – every time they got around the financing, kept having to assign a little bit more because he was holding back all the ideas that were really important to the company, and the investors didn’t like it, and they kept finding more and more that you need to do a sign-in until in fact you see it in their IPO filing that he had to do another one for the IPO filing. Don’t put yourself in that situation. Everybody should be “all in” with the ideas around the company, and a founder agreement should handle that.
Krista Morgan: Actually, that’s interesting. What about at the beginning, before you actually incorporate and you’re… Let’s say you buy a domain, and you actually buy it in your name because you don’t have a company yet. As you set up the founder agreements and the incorporation, do you want to think about those things and actually transferring them into the business? Does that need to be formalized in any way?
Bryn Weaver: Yeah, usually, when I do it. If you get a good startup lawyer, they’ll make sure you do this. That’s absolutely right. In fact, almost always, you have the domain name before you form the company because it’s one of the first things people do. They go and start picking domain names and buying them up. Yes, that would be you would actually list the domain as something, and you have to do a separate transfer with the registrar. But it’s important to put it in the founder agreement so that, again, if the founder gets hit by a bus or decides to go and do something else, the company has the right to that domain.
Krista Morgan: All right. Let me just share… I was going to share my story on founder agreements. I founded the company with my dad, and he and I are still here and still running things, but we did have two other (we called them) co-founders right at the beginning, and we brought them on and gave them sort of both sizable chunks of the company. We had no vesting, and everyone bought… The way we did it is everyone bought their shares early on, and everyone just owned them. In the end, we incorporated our company in February of 2012. I would say we closed our Series A in August of 2013, and it’s really only this year that we’re up and running and kind of making money and taking the business to the next level. And so that is over two years. It’s just a long time to stay committed to something, and you have all these ups and downs of a startup life, and in the end, the other co-founders just couldn’t… It wasn’t happening fast enough, and they didn’t believe it was going to happen, and they both wanted to leave. And so we still have this issue where they own a lot of stock. Our Series A investors, they don’t love the fact that we have these shareholders who aren’t involved in the company and still own a sizable percentage of it, and it’s just made… we tried to do some buy-backs, and we’re figuring things out, but it just adds an unnecessary level of complication to (I promise you) what is already complicated administering a company. If I were going to do it again, I would—without question—put vesting, vesting for myself, vesting for any other co-founder. It just sometimes can feel unfair. At the time, people say, “Well, I’m putting in this time now, and theoretically, I should have these shares forever because I got up and running,” but you need… Every day that you’re in the company matters, and I think the longer you stick with it, the more shares you should have, and that’s just…That’s what’s hard. What’s hard is sticking with it for a long time, and I think vesting provides the right incentive. So those are my words of wisdom.
Bryn Weaver: Very well said. That’s the exact reason. I like the way you say it. Starting a company takes a lot of time and a lot of pain and a lot of ups-and-downs. So vesting is a mutual and beneficial thing.
Krista Morgan: All right. Choosing the type of company.
Bryn Weaver: Yeah. This question comes up a lot. I think this is where you really do need to have a good startup attorney involved. We’ll talk about how to pick somebody later on. There are basically two questions you kind of ask. Your key in forming a company and setting the founder agreement and everything else is you want to minimize expense, you want to minimize emotional effort. Everything needs to be simple and smooth. And so, maybe a broader point that I’ll make through this whole presentation is just keep it simple—keep it very simple. If you try to over-optimize on vesting triggers or non-compete, all kinds of terms, you’re just going to waste energy that you really need to be putting into growing your business. When you’re thinking of a company – the type of company – the basic considerations are how are you going to finance and how are you going to hire. The reason for that is that certain investors, for example, will require a C corporation. It’s a corporation that’s taxed, and it’s taxed as an entity. They can’t have what’s known as a flow-through entity. That would be like a partnership or a limited-liability company (LLC)—part of the actual earnings of the company flow through for tax purposes to each of the owners. That’s one question. If you think you’re going to have venture capital investment in the next 12 months – so you’re raising a couple of million bucks – then you probably want to go a C corporation. If not, then you might have flexibility to do an LLC or something a little simpler. The reason C corporations are a little harder is they’re just more rigid structures, and so it takes a little bit more paper to put them together. Not impossible – a good startup attorney can still do it fairly inexpensively, but they’re not quite as flexible as an LLC.
The other question again, how are you going to hire, how are you going to incentivize employees. If you’re buying down salary with equity, which is very common, then you need to think about how many people are going to be getting that equity.
Again, if you think you’re going to get a lot of people onboard who need to have stock options, a lot of times, it’s easier to do a corporation because it is a stock option. You can do the same thing in an LLC, and you can actually do things called profit interests that are even better tax-optimized structures for incentivizing employees.The problem is, with a flow-through tax entity like an LLC, everybody’s a partner. Everybody is a part owner, and so you’re going to have to probably get K1 Forms and treat the company income as your income, and there are just some complexities around benefit plans. And so it just becomes more difficult than people in actual stock in an LLC or a partnership. Again, if lots of employees, lots of people owning stock, keep it much simpler. Do a corporation where they don’t have to think about all these complicated tax stuff.If it’s only a couple, and they’re all going to be high-level folks (and maybe they already own some businesses), then a flow-through tax entity like an LLC is not a problem because they’re already used to doing it. They probably have a tax advisor that can help them.
Krista Morgan: What about the whole Delaware versus enter other state here debate?
Bryn Weaver: Delaware is expensive. That’s the main drawback. You have to get a registered agent there. It’s the most popular place in the country for incorporation. The reason for that is, a long time ago, they decided they were going to be, and so they made really low fees, and then they developed a really great body of corporate law. The fees didn’t stay low. They still have the really good corporate law. And so, for example, venture capital investors—again, if you’re going to be doing that in six months or three months—they’re going to probably make you move to Delaware anyway if you’re not there yet. They’ll think you’ll turn your company into a Delaware company. In that case, go ahead and just incorporate in Delaware, but if you don’t know what type of investors you’re going to have (you might have angels, you might have venture capitalists, you might self-fund), I don’t usually pick Delaware just because it’s more expensive. Colorado actually has a reasonable corporate law, and it’s very simple to use. You can do online filing, and the annual fees are relatively cheap. You can do a lot of other states as well, but I tend to stay away from Delaware unless I know I’m going to have a venture capital investment in the next six to 12 months.
Krista Morgan: Yeah. And then we incorporated in Colorado, and it’s been fine. The only… I do think… As you say, if we do future rounds, it’s possible that we’ll move to Delaware. And also, there are times when our lawyers can refer off the top of their head to Delaware code but not necessarily Colorado code. So just, as you’re saying, because people are so familiar with it, it can make some things a bit easier I guess.
Bryn Weaver: Yeah, that’s right because they just got better established case law around statutes, and the statutes are really good. And they have… If you went to enforce something in the Delaware Court, they’re business lawyers that are the judges. So it’s a really good place to have to litigate something around a corporation.
But early on, I think the cost militates against it because the likelihood of having to go do any kind of shareholder lawsuit or anything like that is very low [unclear 18:46].
Krista Morgan: I agree. And it is relatively simple to switch over.
Bryn Weaver: Yeah, a good startup attorney has done it dozens of times if not hundreds of times, and it’s a little bit of extra expense.
Krista Morgan: Okay.
Bryn Weaver: It’s okay to take a wait-and-see attitude on that one.
Krista Morgan: Do you ever take tax structures into account when you’re thinking about where to incorporate?
Bryn Weaver: The tax structure question really doesn’t have to do with jurisdiction. They’re kind of separate questions. Delaware, Colorado, they can all have the same kind of tax structures. Tax structure is more of a question if you have some owners that are sophisticated investors, and you’re going to be losing money. They might like an LLC because they might be able to offset gains from other companies with their losses in your company—their piece, the portion of it that gets allocated to them as an owner. But that’s pretty uncommon, and the matching is not easy. It’s very a complicated task, so I don’t usually see people worry that much about it unless it’s going to be a very small privately held company forever. In which case, with very sophisticated investor that knows that you’re doing it has tax advisors telling them to do that.
Krista Morgan: Okay. All right, well, cool. Let’s…Engaging with early service providers. This, actually, one I think is quite important especially because I meet so many founders who are not necessarily technical in their… I was just talking to someone the other day who they’re a medical professional and starting… they’re going to outsource their early MVP development to an agency. This is a pretty intense relationship, and you’re giving someone a lot of trust, and they’re critical to your business early on. What is the best way to structure that type of agreement?
Bryn Weaver: Yeah, I mean I really encourage… There are two types of a person. Let’s talk about the most common one which is just some fellow or gal who just does development. You bring this person on. The key, no matter which way you go, is all of your critical intellectual properties, so the code or the ideas, or the website, or whatever needs to be owned by your company in the end. Otherwise, they can kind of all hold you over a barrel later on. Let’s take kind of the individual that you hire. Well, I think it’s a good practice often, if you can, to bring them on as a contractor initially just because employment brings all kinds of things like unemployment claims and other complications that you don’t necessarily want to have right away. Some of the most sophisticated startup CEOs I know have a rule that they almost always bring people on as a contractor. Now, let me just talk about one other aspect to these individuals. You know you’re going to have a contract where they assign you all the things they could create for your company. That’s a given. But one question comes up. Should we use equity? And you see it on the slide – equity isn’t candy. Be careful about calling people co-founders when they’re not co-founders.
There’s no art, not a science in determining that, but a lot of it has to do with how much you’re paying them and how much sacrifice they’re making. A lot of it has to do with [unclear 22:04] they’re really going to add to the team. People will sometimes just give out titles and equity like candy and then later on [unclear 22:11] for that person’s not really a strategic part of the company, very fungible and replaceable. Be careful about calling that type of a person a co-founder. Often, they’re fine with that. They just want… maybe they want some cash, and they want probably a little bit of equity. That’s okay, but just be careful about giving large, whole percentages of equity to a contractor.
Krista Morgan: How do you structure this? Do you use like restricted stock grants, or do you do vesting, or like stock options? How would you typically structure, say, giving your developer (I don’t know) 1% of your company.
Bryn Weaver: Yeah. By the way, that’d be really high for a developer, just FYI, unless you just have no cash, and that’s the only you can pay them. I would say it’s a pretty simple structure. If they’re a contractor, it’s a contractor agreement. If they’re an employee, it’s an offer letter. Then, there is, like you say, there needs to be vesting just like with co-founders. Again, this is actually a place where you can leverage your co-founder vesting. You go to this employee or contractor and say, “Look. We’re going to give you this piece, but you’ve got to meet certain milestones, or you’ve got to stay for a certain amount of time. By the way, I, as a co-founder, I’ve got to do it too. So I’m not putting you in a different situation that I put myself.” That can be pretty powerful.
Krista Morgan: Okay. What about if you are going to engage with a whole… like let’s say an agency, like there are so many tech companies now that will offer to take some equity in exchange for building your product and then… I mean typically, if they want I would think 10% usually, what’s your kind of gut reaction on things like that?
Bryn Weaver: I guess it depends. I think I would want to get referrals from some of their customers. This is for any service provider really. I think it’s a good practice to ask for referrals. The lawyers are not exempt from that. Ask them. You can talk to a firm or client or two maybe and see how it worked out. Ten percent is pretty rich unless they’re doing something really, really key that you just couldn’t live without. But no matter who it is, again—I just want to emphasize—you should own it. The company, your company should own what they produce for you at the end of the day. There are endless iterations and considerations about how much cash and how much equity, but I guess if they’re building a whole piece of your company, a larger equity piece might make sense. But again, I think it should be tied to vesting, and you can keep it simple by talking about deliverables and what the deliverables have to be and how they have to work while still having vesting tied to those deliverables.
Krista Morgan: I like it. All right. Let’s move on. Advisors. Let’s talk about engaging with advisors because every startup I talk to, myself included, has about 1 billion. Lots of advisors and not enough investors.
Bryn Weaver: Right. I think it’s great if you can find an investor that is also a good advisor. I mean money and advice is always better than just money, which is always better than no money. But I think the questions I hear entrepreneurs raise about advisors is… there are probably a couple. One is, “How do I find them?” Second is, “Okay. I found an advisor. How do I make that initial contact or set realistic expectations or what their participation is going to be?” Let me give you what I see, and it’s going to depend on the advisor. I know some very experienced, serial entrepreneurs in this area. We’re in the Front Range area, but there are other places as well, that they will not even really start talking with a company without a formal advisor agreement and equities stake in place. It’s partly just because they’re so busy. Some people do that because they are really trying to be unfair. So even with advisors, you need to ask around about “how are they in bed” so to speak. Are they really a good advisor? Are they really going to help you, or are they going to be supportive? Do they just take their equity and run away and not help? Advisors with equity should vest also by the way. You kind of have a spectrum. You’ve got maybe a person who… I don’t know, Krista. You may have examples of this. Somebody you meet with every quarter or something that’s just a friend and you bounce ideas, and they don’t really have a piece of the company or a formal role. That’s really normal in an entrepreneurial ecosystem, and I don’t think you have to… you wouldn’t expect them to demand equity for that nor would you expect them to spend major efforts for you other than just a sounding board. It’s when you start getting somebody that you need involved on a monthly or bi-monthly basis, and you’re actually asking them to undertake certain projects and maybe to even handle certain aspects of the business or make really key introductions. At that point, maybe it makes sense to me to have an actual advisor agreement with some restricted vesting equity. If you really want them to be involved, you can create an advisory board that has regular meetings just like a board or directors would.
And that’s kind of a spectrum you see. On the low end, you probably don’t need to use any equity or have any agreement in place. On the high end, you probably do.
Krista Morgan: The only thing that I would argue on that is I find that in the early stages of a company, before you have investors, the people… like you see on a ton of startup websites, they like list out their advisors because they can get…let’s say I find…For example, one of our advisors is a big blogger in our space, and it’s not that… what I like is to—and certainly in all our early investment materials, we’re going out raising money—we would say, “Well, we have this expert in the field who loves what we’re doing and is on our advisory board,” and it wasn’t so much that I needed them to do things as I needed their name to give me credibility. It was like I was buying credibility with stock options. I feel like that is…So if you’re starting a natural foods company and you get some buyer from Whole Foods on your advisory board, then that helps you get credibility.
Bryn Weaver: Yeah, I think that’s right. And like I said, some people will require it upfront to even be involved with a company. You just need to vet them carefully, and maybe talk to a few companies they work with. But I don’t have any problems… I think that just letting you use their name is a sacrifice and is something of value, and it really can be… you just have to… What I found is, with advisors, they usually are very comfortable with vesting, the really sophisticated ones. And they realize that in most cases, you are the one that’s going to be able to end your relationship quickly if you need to, and they won’t ask. They’re comfortable with that because they’re confident that they had enough that you won’t want to terminate the relationship.
Krista Morgan: Yes. I mean just on the subject of advisors, we did put together an advisory board early on, and I certainly don’t use it as often as maybe I should or would like to. I find that as your company gets up and running between board of directors’ meeting, between just running your company, managing an active advisory board and actually keeping them involved in your company is quite time-consuming and difficult. Okay. Anything else on advisors?
Bryn Weaver: No. All right.
Krista Morgan: How to choose your lawyer.
Bryn Weaver: This is kind of a subset of choosing any service provider. And just like with the others, you want a relationship of trust, you want somebody that does what you do. I mean there are many different types of lawyers out there, many of them are very smart, capable people who I would never choose to represent a startup company. For one reason, they may be a specialist in a field and unable to do anything outside the billable hour where they’re just going to run giant bills for you and create a relationship issue. Also, representing a startup takes a certain amount of really good business judgment about what’s critical and what’s just nice to have or low-risk. If you don’t have somebody that’s done that, that’s done startups a lot, you’ve kind of run into a situation where, sometimes, they’re having you do legal overkill, and it takes too much of your time, and money, and effort.
I think definitely try to get a sense of trust. Talk to people about who they’ve used. Ask the lawyer, “What do you want me to do? What should I be doing these first few months?” and, “How often have you done that for another company like me in the last six months?” The other really key thing—and I think a lot of good lawyers do this anyway—as you may or may not know, most lawyers bill you by the hour. It’s X hundred dollars per hour. And many good startup lawyers are willing to invest in you by not billing you anything for just initial conversations. They probably shouldn’t bill you for just initial conversations. I meet with a lot of entrepreneurs that I don’t end up representing and just talk with them about how to think about engaging a lawyer and how to think about their initial startup experience. But if I do engage, I always try to approach it very much like a software development project. Meaning, we all define what the scope of my work is going to be, and I tell them basically the budget for that. And I don’t go over it, and if I do go over it, I write it all. It’s okay to ask your lawyer to write off the time if you feel like you didn’t or at least to talk to them about it. Now, it’s a two-way street. You’ve got to communicate. You’ve got to make sure the scope of work you’ve identified is the right scope of work, and you can’t kind of keep adding things back on that and expect it to be the same price. Just like any software developer, if I gave you a scope of development and then I started adding features and modules and everything, you’d expect the price to go up. Same thing goes with a lawyer. Pick someone you trust. Pick someone that does a lot of what you do so they can grow and use their experience to do it more quickly and more efficiently and cover all the key stuff. And make sure you have a defined budget for each project early on.
Krista Morgan: What about… obviously, we’re in Front Range area, and for tech companies, Cooley comes up all the time, and Cooley is known around in the area for taking early equity in companies and then giving them time and taking care of everything, but obviously, they’re a huge firm, and not every company needs them. What’s your… say, I’m starting tech company, do I want to go and have that conversation? Do I want to wait and just find a smaller startup lawyer initially? What’s your opinion on that?
Bryn Weaver: Yeah. There’s not a perfect answer. For you guys, I think, because your company has a really peculiar regulatory aspect to it, sometimes having a big firm lawyer that has two or three associates that can throw out research on a really key critical issue is important. I used to full disclosure, I used to work at Cooley. I worked there for a long time. And so it’s a great firm, and there are a lot of other big firms in the Front Range that do the work they do. But they are expensive. And so no matter if you’re working with a big lawyer or a small lawyer, I think you follow the same process, but just realize that, with a big firm, they’re going to be getting pressure to bill you. And so, if you’re going to be just doing a startup that’s not going to have investment for awhile or whatever, a lot of times, unless you already know a lawyer that you can trust, it doesn’t make sense to use a big firm because they’re really kind of gunning for the venture-backed companies. And a smaller lawyer that does a lot of what they do can do the venture work for you too. So if you have a really peculiar regulatory need or very unique space, it might make sense because they might have an expert in the field. If it’s just kind of general technology and startup work, I think you’re fine using a smaller firm.
Krista Morgan: But what about IP? Let’s say I think I know my company is needing to start a patent. Do you think that factors in to your decision early on?
Bryn Weaver: Not really because I… For example, in my practice, I don’t do patents. I do licensing. I do startups, but I don’t do patents. But I have a friend who’s a former big firm attorney, like myself, that has his own firm and does patents at a much lower rate than the big firms. You need somebody for patents, for example, that’s a strategic thinker, has done a lot of it, is not just going to try to file as many patents as possible. That’s not the right answer for most companies. In fact, patents are often not the right answer for most software companies I would say.
Krista Morgan: Maybe let’s do whole other webinar on patents.
Bryn Weaver: Yeah, yeah. But I think the answer is no. You don’t need a big firm for all the sophisticated work. It really is this hyper, really hyper-specialized, and I don’t count general patent work as that. I mean there are good people out there doing a lot of that small one, solo practice firms. But again, you want to talk to them about what they do, what their approach is. Interview. Date your lawyer before you marry your lawyer. And maybe never marry your lawyer. Always be willing to move if the relationship isn’t working. It’s a trusted advisor, but they’re also billing you at a higher rate a lot of the times. Somebody once told me never name your lawyer, like if your kids come home with a pet, don’t let them name it or it’s going to stay. And so they give the same advice on lawyers. I wasn’t quite sure how to take that, but it wasn’t directed at me so I didn’t feel that bad about it.
Krista Morgan: Okay! I think that’s everything. We are happy to take lots of question. I will really thank Bryn for coming to join us and just giving us all this great, free advice—no charge to you, like a free consultation through the internet. That’s what this is all about.
Bryn Weaver: There you go. Well, you know I’m glad to help. I obviously don’t represent anybody on the phone, but do reach out to me. You have Krista. Thank you for the opportunity. I love helping startups. Like I said, I talk to a lot o entrepreneurs that I don’t even represent, just to kind of help them get kick-started in the right direction.
Krista Morgan: Okay. We’ve got some questions coming in.
Should I hire an attorney who practices in the state in which I incorporated my business?
Bryn Weaver: The answer to that is not necessarily. Most corporate lawyers can handle most corporate law. Especially Delaware. Delaware, everybody knows Delaware Law. The answer is not necessarily. Most lawyers can work their way through. Now, if you have a local lawyer and you have a lawyer from another state, let’s say you’re incorporated in Utah, and you have a great lawyer there who does startups, and then there’s another great lawyer who’s a Colorado lawyer and hasn’t done a lot of work with Utah companies, I’d choose the Utah lawyer for that one but not necessarily.
Krista Morgan: This is a good one.
Should I require angel or venture capital investors—and I think this would apply to early advisors and service providers—should everyone be signing NDAs?
Because I know when we started, we NDA-ed everybody, and now, I NDA-ed nobody. We don’t bother.
Bryn Weaver: There are a few answers to that. Venture capitalists will not sign an NDA. They will almost never because they review too many business plans, and it’s just begging for litigation. They rely on their reputation, and before you approach a VC, I think it’s good to find out what they’re like. Try to ask around.
Krista Morgan: Yeah, our angel investors didn’t either. I mean we didn’t have anyone sign.
Bryn Weaver: Yeah. It’s very uncommon, and even for early advisors, I don’t usually get them to sign an NDA unless I make them a formal advisor with an X piece of equity and maybe an advisory board seat. It’s just there are two kinds of schools of thought on this. One is that you should always have everybody sign NDAs, but I don’t really subscribe to that. What you really need as a startup company—I’m sure, Krista, you could speak to this—you need feedback. And anything that prevents feedback, like them having to even think about a contract, is friction you don’t need in your startup process. Do you have a risk? Absolutely. You have a risk, but it’s not that common that somebody completely poaches your idea because, frankly, your idea now is probably not what your idea is going to be when you actually take it to market.
Krista Morgan: It’s funny. We actually have a question here about…
How do I treat divulging trade secrets?
Let’s say I do. I mean we’re obviously a crowdfunding company, so this comes up a lot, and if I’m crowdfunding and I tell everyone my secret sauce, then I’m going to have all this competition. And one thing that I have learned is that, as I’ve said many times, starting business is hard—not for everyone—but I hear so many great ideas, and the chances of me hearing about a cool idea and actually going to start a business that would leverage that idea is so… It’s just the chances of that are so low, I think. And now I tell… Obviously now, everyone knows about our idea, but even early on, I started telling people what we were doing, and I was really transparent, and I think, as you say, it just got me a lot of good feedback, and I didn’t really see it as a risk. I saw it more as a benefit. I did have, actually, a friend of mine. It’s hard to believe it. She has a startup, and early on in our friendship, she said, “I’d like you to sign an NDA so I could talk to you about my business,” and I said, “Absolutely not.” Like, I cannot be bothered. If that’s really what you feel is going to be necessary, it’s almost… not insulting, but it can be a little bit over the top.
Bryn Weaver: Yeah. And just remember your first idea is almost never your final idea. So you may steer them in the wrong direction if you’re really worried about that. Now, let me just put one point out there. If you’re going to engage with a big company that’s directly in the exact space you’re in, you may think about an NDA at that point, and they would expect it. But for individual advisors, or friends, or potential investors, don’t even bother I would say.
Krista Morgan: Right.
What kind of books and records do I need to keep for my business?
I actually love this question because I am a huge proponent of diligence materials, and I talked about this in our last webinar, the bootstrapping one: being organized about all of my corporate documents has made raising money (seed money, angel money) so much easier. It takes a long time to do, so if you are organized about it right from the beginning, keeping all your incorporation docs and… I mean I keep mine in DropBox diligence folder, and everything is saved there. NDAs are saved, stock option grants, advisory board agreements, kind of any legal thing I’ve ever signed gets held in that folder.
Bryn Weaver: I think that’s a great way to do it. You do want anything to do with your formation of your company and your equity, and your lawyer can help you do that, but normally, for a startup, I wouldn’t encourage having to pay a lawyer to do that. Do it yourself. Just be organized. DropBox is fine. As you grow a little bigger, you have to think about other… your company will grow as well, and you’ll have staff to do that. But yeah, definitely. It’s easier to start right on that and keep going right than it is to go back and try to dig stuff out of emails and everything else. So having it in one place initially is really, really good, Krista.
Krista Morgan: All right.
How much dilution and share ownership should I give up to investors in my business?
Oh, dear, there’s no good answer to that.
Bryn Weaver: It’s negotiated every time. You should put a value on your business, but a lot of investors will be turned off if it’s a really ridiculous value. So there’s no science about that. It’s a bit of an art. That’s where you want to talk to advisors in your space or people that know. I mean you can pick a ballpark number. Angel investors, Krista can speak to. Venture capitalist, they’ll tell you what they think your value is.
Krista Morgan: Yes, that’s true, and I’ve heard… I mean just sort of my… like based on word on the street, in college terms, if you’re doing some kind of angel round, which is seven, anything from $500,000 to maybe $1.5 million, then you’re probably going to give up 25-45% of your company. The angel money you give up, I think you give up more because it is very high-risk money, but you’re not giving up control typically, I think for that. Venture guys, I mean I’ve heard all kinds, but I’ve heard… because venture doesn’t really come in until Series B, Series C, and I’ve heard they really don’t ever… They don’t tend to take less than 10%. They don’t tend to take much more than 30%. But I think that that varies widely. And then seed round (I think we have a question about seed round), I would say always convertible note on your seed round. I mean it’s just not worth thinking about anything else because your company is too early to value. So what you want to do is just give people a discount on your first actual round.
Bryn Weaver: Maybe just a couple of points there, Krista, because that is actually a really important point. I just was talking with a friend of mine in starting a company, and I talked to him about just that. As I said, you want to keep everything super simple at the beginning, and a convertible note round is basically your investors buy promissory notes from you. It’s a real debt. If you were not able to raise a subsequent round, you’d have to negotiate with them about what would happen with that, but it’s very simple. They get a promissory note. It has a very modest interest rate on it, and like Krista mentioned, it will convert into equity at the first real investment round you do.
The benefit is you put off the valuation. You just know they’re going to get some kind of a discount. Twenty percent is a ballpark number that gets tossed around a lot, anywhere from 25 to 15 is PC. And when the investment round happens, then they will just buy equity at that price with that discount. That’s a great mechanism for keeping it simple early.
Krista Morgan: Yeah.
I’m thinking about applying to be on Shark Tank—I think Shark Tank just came, and I heard all kinds of people are going to apply—so if you’re my lawyer, Bryn, and I’m going on Shark Tank, what are you advising me on as I do this?
Bryn Weaver: I love Shark Tank. Can you get any autographs for me? I think when you go into a formalized program like that—Shark Tank is one, but there are others, like the seed accelerators, TechStars (I used to represent TechStars)—you’re really going to live with their documentation in most cases. There’s very little negotiation you can do.
You should read it. You should understand what you’re getting into. But you’re probably not going to… It’s like trying to go to your mortgage company and negotiate the mortgage. People ask me all the time, “You’re a lawyer. Don’t you read your mortgage really carefully?” and I say, “No. I don’t. I look at the interest rate and a few other key things, but I can’t negotiate it.” And neither can you probably negotiate Shark Tanks all that much. Now, if they were to invest in you eventually with the investors, I don’t know. Maybe there’s a little more room there. But I actually have not (I’ll be honest)… I haven’t represented anybody with Shark Tanks although I got a little hope because a friend of mine just was on, got a call back from Shark Tank, so we’ll see.
Krista Morgan: All right. That’s exciting. We’re coming to the end of time. I don’t want to keep everyone forever. Let’s see.
What do I need to worry about in hiring my first employee?
I think we covered most of that. I think employee offer letters. I understand that offer letters are actually not that straightforward, and then it’s probably good to have a standardized offer letter that you use, like employee NDAs. We have employee NDAs that we put out in front of our package and stock option grants. You have to have your stock option grants set up.
Bryn Weaver: The wrong answer is we’ll just do it by verbal agreement, especially if there’s equity involved. The right answer is, yes, you should have a package, and it’s usually either a contractor agreement or an offer letter. If it’s a contractor agreement, it will have its own inventions assignment and non-disclosure terms, but if it’s an offer letter to an employee, you have a separate agreement like Krista mentioned that controls that. And then you have something around the equity. Usually, you’ll get a plan in place if you’re going to be doing a lot of it. It’s just something that sets forth the terms of the equity. Those are the key pieces. They are really key. It’s always easier to negotiate when you’re hiring somebody than when they’re leaving.
Krista Morgan: All right. And then I think this will be our last question.
What kind of fees? What’s my legal budget? I’m getting my company started. I’m going to set up. I’m going to incorporate. I’m going to have a stock option plan. I’m going to have some contractor agreements. Just ballpark, what do I put in my budget for legal startup fees?
Bryn Weaver: For the initial founder agreements and… It depends on your lawyer. There’s another question we got, but I’m going combine it with this.
How much does a lawyer cost?
The answer is that depends how much they bill. Large firms can charge you $500 to $700 an hour. I know it’s astronomical, but that’s just their model, and it just depends on how experienced the attorney is at the firm. If you get a really junior person, they’re probably more in the $400 range, but they also don’t know as much. So they’re going to take longer. For smaller firms, you’ll get down much lower than that. I wouldn’t expect you’d be paying $100 an hour for any attorney that does startups, but two, three, you can do that. But the key is really the budget. The hourly rate is only one part of the equation. It’s how many hours is it going to take them, and what are you going to get out of it when you get there? That’s why I always set a budget with my customers. I think, ballpark, for $1,000, you can get your company set up, and your founder agreements, and a couple of other small agreements, an option plan and some other… an hour or two of work. But the big thing is just talk with your lawyer ahead of time, make a budget that you can all live with, make them live with the budget, make yourself live with the scope of work.The big thing people don’t want is a surprise. You’ll probably going to spend $500 to $2,000 to incorporate and get things set up for the founders.
Krista Morgan: Okay! All right! Well, good. So we are going to wrap it up. We’ve told you how… and anyone who listens to this webinar is free to reach out to us. You can reach out to us at Hello@P2Bi.com. Bryn, how do they reach you if they want to get you to look at their startup?
Bryn Weaver: You can always reach out to Krista, and if you just can’t remember, my email address is my name, BrynPWeaver@gmail.com. It’s really easy, but Krista has it too.
Krista Morgan: There you go. I’ll pass along referrals for Bryn if need be. Okay. Thanks, everyone. Thanks for joining, and we will see you at our next P2Bi Small Business Webinar.