Legal lingo can be overwhelming for first time founders. This is quick guide of the incorporation and fundraising documents a founder should be familiar with in order to:
- Feel empowered in conversations with investors and lawyers
- Avoid costly mistakes
These are the primary legal documents involved in incorporating a company in the rough order you will need to complete them.
Certificate of Incorporation – make it real
- How a corporation becomes a legally distinct entity. It is filed with the secretary of state's office in the state of incorporation (usually in Delaware).
Bylaws – how it runs
- The internal manual of the corporation, establishing things like the number of directors, frequency of board meetings, rules for approval of contracts and procedures for amending the bylaws and articles of incorporation,
Action of the Sole Proprietor – who is in charge
- Appoints the first directors to the board.
Initial Action by Directors (Unanimous Written Consent) – all the details
- The first actions of the board, importantly it does the following: elects officers (CXOs), authorizes the issuance of stock to the founders, establishes a bank account and establishes standard forms stock purchase agreements, proprietary information & inventions agreements and more (outlined below).
Indemnification Agreement – boards hate lawsuits
- Protects the company's directors/officers from potential personal liability for actions taken as director/officers
Arbitration Agreement – where to fight
- Determines how disputes will be settled outside of court.
Employee Identification Number (EIN) – say hi to the IRS
- Identifies a company to the IRS and is required for you to open a bank account, hire employees and file tax returns.
Proprietary Information and Inventions Agreement – the company owns everything
- Protects the company's IP by ensuring that any confidential information received by an employee and any inventions produced an employee while working for the company related to the company's business belongs to the company and not the employee.
Non-Competition – employees can't compete
- Prevents employees from joining a competitor.
Non-Solicitation Agreements – employees can't steal people
- Protects the company from ex-employees trying to poach current employees.
Founder's Stock Purchase Agreement – founders become owners
- Establishes the number of shares purchased, their price (usually $0.001) and sets the vesting schedule among other terms (repurchase rights, transfer rights, acceleration).
83(b) Election – how to avoid taxes
- A letter that is filed with the IRS that allows you to be taxed on the value of your equity (which is close to zero at founding) on the date it was granted instead of when it vests.
Voting Agreement – guarantee founder control
- Can establish a dual-class voting structure where the founders have Class B shares with 10 votes per share (supervoting).
State Business Registration – operate legally
- Ensures that your company is qualified to do business in a given state (which is important if you registered your business in Delaware but are headquartered in New York or California for example).
Stock Incentive Plan – convince people to work for you
- Establishes the option (usually ~15% of outstanding shares in the company) as well as stock option and restricted stock award agreements for compensating employees, directors, officers, and advisors,
These are the primary legal documents involved in completing a fundraise in the rough order you will need to complete them.
Term Sheet – TL;DR of investing
- Set by the company and the lead investor, this determines how much is invested, at what price, by whom and with what rights and restriction.
Amended and Restated Charter – making room for the investors
- Allocates Series X Preferred shares to be issued to the investors and establishes the rights of Preferred vs Common stock.
Board Consent – board says yes to money
- Approval by the board to issue Series X Preferred shares according to the Series X Preferred Stock Purchase Agreement.
Stockholders Consent — shareholders say yes to money
- Approval by the shareholders to issue Series X Preferred shares according to the Series X Preferred Stock Purchase Agreement.
Series X Preferred Stock Purchase Agreement – long version of the term sheet
- Issues the shares allocated in the Amended and Restated Charter to the investors with the terms established in the term sheet.
Pro Forma Capitalization Table – who owns what
- A complete list of the shareholders, their total number of shares, share type, and investment amounts.
409(a) Valuation – how much is it worth to employees
- Determines the fair market value of the common equity in a company. For an early-stage company, this can be as low as 20-30% of the share price of the Series X round. This price needs to be established so that options or stock grants can be issued to employees.