Who owns a brand new corporation? ... and other lessons in legal

Here’s another thing I learned last week. When you form a new corporation in the US, initially nobody owns it. There’s an incorporator who incorporates it, and that person is omnipotent, meaning he or she can do anything. In our case, this was our law firm.

Then the incorporator appoints a set of directors, and the directors can decide on the issuance or sale of stock in the company. I forget if the directors or the incorporator institutes the organizational resolutions. I’ll find that out shortly.

The company decides how many shares there are, in our case 10 million, but there’s no inherent valuation. The company can sell them to the founders at one tenth of a cent a piece, say.

It’s quite typical to have a vesting schedule. The stock is allocated to the person, possibly even purchased by that person, from the get-go. But it’s not actually his or hers until it vests. The vesting can be anyway you want it. You can start half-vested or at zero. You can vest over 2, 3, or 4 years. You can link the vesting to milestones, or calendar time, or you can skip it altogether.

Vesting can be useful if you’re more than one founder. It can be used to make sure that if one person decides to take a two-year vacation after the first year, that person won’t get to own as large a share as the other person who’s still working full-time. This can be good for both partners, because the one on vacation can do that without feeling like he’s screwing the other person. In general, it’s used by companies to give people incentives to stick around longer.

The minimum salary you can pay yourselves as executives in the company, if you want it to count as having payroll, is twice the minimum wage, which comes out to about $28K/year. I’m sure there’s ways to pay nothing, but we didn’t discuss that.

For angel investment, you can do a bridge loan, also known as a convertible note. It’s basically a loan, with an interest, and which can be paid back, and with no ownership of the company, but with a twist, which is the “convertible” part. This is the part where, if there is a financing round later, the amount of the loan can be converted into shares at the valuation of that round. I’m not sure what would typically happen in the case of an acquisition, but I’m sure it’s all negotiable.

There’s one drawback of this, which is, that the higher the valuation of the company at the first round financing, the smaller the stake the convertible note converts to. That means the angel has an incentive to attempt to keep the valuation low, or make the financing happen sooner. Not sure how that would be accomplished specifically, but the incentive is clearly there.

Finally, I was reading the November issue of Inc. on board the plane, and they recommend a couple things for co-founded companies, specifially. First, a buy-sell agreement, which means that if one partner wants to sell his or her shares, the other partner has the option of buying them instead by matching the price. Second, a shotgun clause, which lets one partner offer to buy out the other partner, with the twist that the other partner is then entitled to instead by the first partner’s shares at that price. And finally, that the company takes out life insurance on both partners, so the company can by that person’s shares back in case that person dies, so that you don’t risk ending up with that person’s 3-year old daughter as your business partner.

That’s something we haven’t discussed either internally or with our lawyer yet, so it’ll be interesting to see what learning awaits me there. I’ll let you know.