Startup Checklist: 10 Legal Issues Founders Need to Know

November 24, 2015Articles PhillyMag

Startup founders make countless decisions about their businesses. Here’s a list of 10 legal issues that can make-or-break their businesses:

1. Choice of Entity. Although many factors go into determining whether to form a startup as a corporation or an LLC, two important factors are the startup’s funding and hiring plans. A startup will typically form as a corporation if founders expect to raise venture capital (generally $1 million or more), as VC firms often prefer to invest in a corporation to avoid the pass-through profits and losses of the LLC being attributable to the individual partners of the VC firm. Further, if founders intend to incentivize employees through the issuance of stock options, a startup will typically form as a corporation, as a stock option plan of a corporation is typically less expensive to put in place and easier to administer than a profits interest plan of an LLC.

2. Jurisdiction of Formation. Although forming a startup where its headquarters is located is generally fine, the most popular jurisdiction in which to form a startup is Delaware, primarily because

  • Investors are most comfortable with investing in Delaware entities.
  • Delaware has flexible business statutes.
  • There is extensive business law precedent in Delaware.

Founders should also consider the costs associated with engaging a registered agent in a state of formation where the startup is not located and qualifying to do business in other states.

3. Vesting of Equity. Founders should consider whether their equity should be subject to forfeiture over time (commonly referred to as “vesting”). For instance, if one founder leaves the business, the other founders may not want that founder to keep his or her full equity. In connection with receiving shares subject to vesting, however, the founders must be sure to make a timely election (within 30 days of issuance) under Section 83(b) of the Internal Revenue Code to avoid adverse tax consequences when such equity vests.

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