Jeff:
As always on for Startup school, we're going to have two lectures a day and this is the second lecture, the second lecture of the week. It's a 10 week program with just about 20 lectures, give or take. One thing that we neglected to be clear on is that when you log into your group, if you have this up at the top, then there is a moderator assigned to your group. And if you do not, you do not. Okay. Again, if you have questions or problems you can email startupschool@ycombinator.com. Hopefully, most of you don't need to do that because we do tend to get a lot of email. There are many of you, but if you have problems, do let us know. I would like to introduce my colleague Carolyn Levy to my right here who's going to talk about startup mechanics. And then with John Levy and Jason Kwan, they'll answer some questions about getting your startup started, legal issues. I will point out that these three folks are probably the finest legal minds in the startup world. And I do not exaggerate, they may hate me saying it, but these folks have seen more, they've worked with more startups in more situations than you could believe. And some of those situations you wouldn't believe, so they know everything. And so I do hope you listen carefully and I do hope ... Look, I know you gave everyone homework to watch videos from from 2014 and 2017 on startup mechanics. I urge you all to watch those videos if you haven't already as an adjunct to what Carolyn and John and Jason are about to say because you will find them useful as you build your company. So Carolyn,
Carolyn:
Thank you. Jeff, totally exaggerated. But we have seen a lot of stuff. So like Jeff just mentioned, back in 2014, Kirstie and I did a startup school lecture on legal and accounting mechanics, and we were hoping that most of you would have time to watch that before you came here today. I'm going to blaze through a recap of that and just a touch on the key takeaways from that lecture. But I am going to skip the part about investors and fundraising because Kirstie's actually going to do an entirely separate lecture on that stuff later on in the program. Next, I'm going to go through some common mistakes and problems that we see founders make. And finally, Jason and John are going to come up here. I want to thank all of you who sent an email questions to us beforehand because we're going to go through some of those on some of your legal mechanics questions that you guys already submitted. Okay. So the first thing you have to do when you're starting a startup is actually form your separate legal entity; this is your company. And the act of incorporating is just filing a document called a certificate of incorporation, which is really short and simple for startups. And you go and you file it with the Department of corporations in whatever state you choose to incorporate in. Now, we strongly recommend choosing Delaware because the process in that state is really, really easy, and the service is really fast and efficient. And that's the primary reason we suggest, but also as a lot of you probably know most public companies are Delaware companies, so that saves you a little time if you're going to go public. Some investors actually will require that year in Delaware before they'll fund you, so that's another good reason to be in Delaware. Okay. So this has been mentioned a couple times already. We also strongly recommend that you use an online platform specifically geared to startups to incorporate. And there's a lot of these platforms, some are good, some are not so good. Clerky and Stripe Atlas have already been mentioned and those are the two that we think are great; they're YC companies. We have extensive experience with Clerky, and I was really happy to hear that Darby Wong, one of the founders of Clerky is going to do an AMA because he's great. One of the reasons why we think clerky and Stripe Atlas are so great is because they don't stop after formation, they also have post incorporation documents. And some of the not so good platforms stop after formation and they don't do post incorporation. One of the things that doesn't happen if you don't do post incorporation is founders don't buy their stock. And when we were commuting down here today, Jason reminded me of a story, a really big company and a really big law firm and they didn't ... The founders never bought their stock and this wasn't discovered until the series B financing. So if you think this sounds weird, like of course, founders need to buy socks, but this is a mistake that actually happens. Okay. Another step in the incorporation process is forming a board of directors. And for early startups, the members of the board are usually the founders. If you're a solo founder, you can have a board of one. If you are two founders, you can have a board of two. There's a misconception that board of directors have to have an odd number of directors, but that is not necessary. And then you need to appoint corporate officers. You need to have a president and or a CEO; you can have both if you want. And in Delaware you're required to have a corporate secretary. And another part of the process is adopting corporate bylaws for startups; bylaws can be extremely generic. And finally, this isn't technically part of the incorporation process, but I encourage you to open a corporate bank account as soon as possible. Most startups won't have very much cash to put in that bank account, but it's great to get into the habit of treating the corporation as a separate entity as early as possible. And it's critical to form good habits around the way you treat your company's money. Okay, so post incorporation. So now we're going to go back to what I just said about issuing founder stock. You all know that corporations are owned by stockholders and you and your co founders are going to be the first stockholders. Okay. If you are a founder team of two or more, you have to think about how you're going to allocate that stock. Our belief about the best way to allocate stock among founders is to think about the challenge of execution. And that's another way of saying the following. Do not place too much importance on the founder that had the idea for the business because all of the hard work is in front of the team and all of the value is going to be created in the future. If you are all going to be working hard going forward, which you all are, we think the equity split should be more or less equal among you. If you and your co-founders are having a really hard time coming to a consensus about stock allocation, there may be underlying trust or commitment issues with the team. So you want to pay close attention to that. Okay. Founders need to purchase their shares from the company and you buy them using a stock purchase agreement, you actually have to pay for them. But fortunately, the stock of a brand new company is very cheap. The way most founders stock purchase agreements work is that you give a very, very small amount of cash and then you contribute to the company any intellectual property that you've created. So that's the total purchase price for your founder's shares. Founder's shares should be subject to vesting. And this ties back to the point I just made about all the work being ahead of you. Vesting means that you don't get full ownership of your stock until a certain period of time has passed. During the vesting period rather, you can vote all of your shares. But if you quit your company before the full period of time has passed, the company will automatically repurchase all of your unvested shares. When shares are subject to vesting, they're called restricted stock. So your founder stock purchase agreement will be actually a restricted stock purchase agreement. And as I'm sure most of you know, the standard or typical vesting period is about four years. So I'm not going to get into cap tables in this lecture because Kirstie is going to explain them in detail in her lecture about fundraising mechanics. But the basic idea is that every company absolutely needs to keep a cap table. You need to keep a record of every single share of stock that your company issues. And we used to have to do these on these complicated excel spreadsheets, but fortunately there are now multiple online platforms that will keep track of stock ownership effortlessly, and we'll make sure that those resources are included on one of these, on the forum. Okay. Because founders tend to identify so closely with their startup, it's easy to forget that they actually need to be employees of their company. So we'll look at that. It's pretty self evident that most founders can't pay themselves in the early days of their startup because practically if there's no money, you can't have payroll. But if there is enough money, it's a really good idea for founders to pay themselves minimum wage. Strictly speaking, it's against the law not to pay yourselves, although obviously this isn't a thing that gets enforced. Okay. So employment, whether of founders or others, does not require an employment agreement. Employment Agreements are not actually appropriate for startups because employment is at will by default. And the basics of hiring and firing are governed by law anyway. In facts, employment agreements can sometimes complicate things because courts may interpret certain of the language in an employment agreement as changing that default at will status to a four cause status, which makes it a lot harder to terminate people. So an employee agreement is only necessary if you're hiring an employee who's going to have something special, like a severance package, and we really don't see those in startups. But what is really, really important is that all the founders and in the future, everyone who works for your company has signed a CIIA or a PIIA. And I'm sure a lot of you have heard of these; it's a confidential or proprietary information, invention assignment agreement. The CIIA protects the company's confidential information and trade secrets and ensures that all the intellectual property that is created is owned by the company. So you want everyone in the company signed up to one of these. Very early stage startups, usually cannot afford to have employees, but the solution is not to convince people to work for your company for free. It's one thing for founders to work for free, but it's significantly riskier for non founders creating work product and other intellectual property to work for no compensation. So unfortunately, all of you all have to do all the work until you can afford to hire. Oh, so I'm going to wrap up this summary and digress from legal mechanics to make a few common sense points. And my belief, my personal belief is that ignoring these points can cause you to waste a lot of time fixing problems later. These are really common mistakes. So ideally, you will have opened a corporate bank account as part of or right after incorporating the company and hopefully you have a little bit of money in it. So you should use that for all of your company expenses. If the company bank account has no money in it and you are paying for all the business expenses with your own personal savings, the company can reimburse you later when it eventually has money, but you absolutely need to keep all the receipts and you need to document everything carefully. Corporations have to pay taxes. If your startup is a Delaware Corporation, there is an annual tax you have to pay to that state, but if you calculate it correctly, the tax owed is really minor for startups. Corporations also have to pay ... They also have to file a corporate tax return with the IRS. Obviously when your company is just getting started, you're not going to actually owe the IRS any taxes, but you still have to file the return. And if your startup does have employees, even if it's just the founders getting minimum wage, you need to pay payroll taxes. And the best way to do this is to get set up with an online payroll service of which there are many. Well, this is a personal favorite of mine, so you need to find a good place to store the company's legal documents, like the certificate of incorporation, the bylaws, the CIIAs, the founder stock restricted agreements, founder stock purchase agreements. For example, a shared Dropbox folder is a good idea. Do not store them in a co-founders email because you do not want one person to control the access to these very important documents. Also, make sure that the legal documents that you are carefully collecting and storing are actually the signed and dated versions, and triple check to make sure that every blank signed by every party that needs to sign it. Later when your company is fundraising and investors are doing due diligence on your company, it just looks really amateur when you serve up a bunch of formation documents and there's a bunch of blanks in them. All right, so that's the summary of that. Oh, sorry, one more thing. I just wanted to mention what is acting like a real company, and my opinion is that acting, if you treat your startup like a board of directors, a governed, taxpaying founder employee, confidential information holding entity, that that's the way to act like a real company. And this is also the only way you're going to get protection from personal liability, which is the whole point of forming a separate legal entity anyway. Okay. Now we're going to move on to common mistakes and problems. Okay. I don't know when to form a corporation. This isn't actually a problem or mistake, I just wanted to talk about it here. And it turns out that a lot of you emailed us this question. So the right timing on when to pull the trigger on incorporating is going to be different for every startup. But in general, we believe in doing it sooner rather than later. And so my top four reasons about why you want to do this would be number one, because forming a corporation protects you and your co-founders from personal liability for your company's actions. Number two, the corporation is the correct repository for all of the intellectual property that you and your co-founders are creating. Otherwise, you're all just working on a project, the separate pieces of which are owned by individuals. And to me, that's a Hackathon, not a corporation. Number three, you can't raise ... You all know this, you can't raise real money for your startup without forming a corporation first because your mom might give you some money for your startup, but no professional investors is going to wire money to your personal bank account. And you need to have a corporation in order to have payroll. And you can't enter into contracts or with vendors or consultants or potential customers personally. And if you try to do these things as an individual, it's super messy. I formed an LLC instead of a corporation because I got advice that LLCs are better for taxes. So for our purposes, this is usually a mistake because even though LLCs are better for optimizing taxes, the vast majority of angels and VC firms will not invest in an LLC. So if you plan to fundraise from people other than a small group of your friends and family, your startup needs to be a corporation. The question that several of you asked in the emails is whether there are other reasons besides fundraising considerations to form a corporation instead of an LLC. So in other words, if you're not planning to fundraise for a long time after starting your company, does it make sense to start out as an LLC and then switch to a corporation later? In my opinion, the answer is no because I don't believe the tax benefits of an LLC are compelling enough to outweigh the inconvenience of converting your LLC into a corporation later. And for those of you who watched the 2014 startup school lecture, Kirstie and I told an anecdote about a company that was an LLC and they had to convert into a Delaware Corp and it was a $400,000 legal nightmare. It's obviously an outlier, but we do see this a lot at YC. We see a lot of LLC to corporate conversions and it's just kind of a headache you don't need. Okay. I'm thinking about hiring a lawyer to incorporate my company. So this is usually not a mistake if your startup is really complicated for some reason, or if you've already formed a non US entity and you now want to come to United States and raise money. In these cases, you probably do need to get a lawyer. But I'm sure all of you know, lawyers are very expensive, so save money and use one of the good online platforms that we just talked about for incorporation. Also, realize that lawyers who are free, like family members doing you a favor, may not be actually as good as the online platforms because they don't specialize in corporate transactional work. So your aunt Sally, who does personal injury, may mean well, Clerky and Stripe Atlas will do a much better job. I'm starting a startup, but I still have a full time job. This is actually already come up today. Common problem for founders because it's a big decision to ditch the security of a salary. I think some of the other speakers in this course, we'll talk about sort of the psychology of taking that plunge. But if you've decided to work on your startup in your spare time, the primary legal consideration is just keeping everything separate. So in California, for example, if you're working on your startup on your own time, with your own resources, your current employers should have no claim on your new business idea. So use a different computer, don't work on it during business hours, but keep in mind that different states and even different countries have very different rules about this particular issue. And there are things like noncompete agreements with your employer that may come into play. So if you're going to do this, you really should do a little bit of research first or get legal help. Our founding team has been working on this idea for years, so we don't need vesting on our founder shares. This is a broken record. We hear this all the time. This is a big mistake. If you don't have vesting, you are setting your company up for future problems. No investor wants to put money into a company with founders who may decide the next day that they're burned out, so they take their shares and they leave. But the more common scenario is that one member of a founding team decides that he or she is burned out, and so leaves the company with a giant ownership stake. The remaining founders have to do all the work, but someone who's not doing any work has the same ownership. It is painful to fix this problem because the price of the company stock may have increased in the interim and it becomes really expensive for the remaining founders to allocate the share ownership fairly. How many of you are single founders? I'm just curious. Quite a few of you. Okay. So, I'm a single founder and I don't need vesting. You may be thinking. I think this is also a mistake. Single founders obviously don't have the same problems that founder teams do, but no vesting is still unattractive to investors for the same reasons. Also, you will eventually hire employees and probably grant them stock options and those stock options will have vesting and it just is a lot better when you lead by example. All right. Another personal favorite. I signed a legal document but I was too busy to read it, so I have no idea what it is. This happens a lot. This is a big mistake. We see founders do this all the time and I mean we sympathize, right? The legal mechanics of your startup are the really boring parts of the process. You can get away with not reading every word of your bylaws for example, but you need to understand every provision in your founder stock purchase agreement. You actually don't want to have anything happen with your company stock that you don't know every word of. And this is actually a bigger problem. This isn't such a huge problem with formation documents, it's a big problem with fundraising documents. I can't tell you how many founders have told me they won't read a five page safe. So you want to get into the habit now of reading all of your company documents; it's daunting, it's legally, it's whatever. Read it any way, understand it. It's a great habit to get into. And then you'll know if it isn't signed. Okay. My friend offered to work for my startup for free, so I'm going to pay her with shares. Generally, this is a mistake because people who work for your company need to be paid money. Obviously compensation packages can include an equity component, but paying with only stock is not a good idea. The exception is if you're a friend can be hired by your company as a consultant or independent contractor; those are the same thing. And it's okay for consultants to be paid for services with just stock, but you have to first get comfortable that your friend is properly classified as an independent contractor. And the rules in California about this just changed and got stricter. Also, you'll want to make sure you paper this relationship with a good consulting agreement because you really want to make sure that the company owns all of the consultants work product. You don't want to wing it. Okay. This is a big one. My co-founder and I don't want to work together anymore. So this is sometimes a small problem and this is sometimes a fatal problem. Startups die sometimes because of this, and it happens unfortunately a lot and it can be overwhelmingly acrimonious. It's kind of like watching people get a divorce. So the reason to pay careful attention to the points have already mentioned like paying yourselves, having vesting on your founder's shares, having a CIIA that clearly demonstrates that the company owns all the IP that's created. Doing these things can significantly decrease the legal drama around breakups. I don't know what decreases the emotional drama, but that decreases the legal drama. My company has some employees and I promised to issue them stock. This isn't a problem as long as you take action on it sooner rather than later. And the appropriate action to take is to adopt a stock incentive plan and to grant stock to these early employees. A stock plan is something you probably know, it's like a 15 to 20 page document. It references a specific number of shares of your company's common stock that are allocated to the plan. The company can issue restricted stock or stock options pursuant to the plan, but what you need to know about stock options is that if you grant stock options, you have to get something called a [inaudible] evaluation. And most startups don't want to do this until after they've had a fundraising event. So you can issue restricted stock to employees under this plan and they will also have vesting. And they come with a whole host of tax insecurities rules, which is why the plan needs to be 20 plus pages long. But the reason to not wait too long to do this is because the longer you wait, the more expensive your stock will get. And so you want to grant ... You want to give your employees cheap stock, or as cheap as you can because expensive stock is not very incentivizing. I got a cease and desist letter. Another company says, my company is infringing on its trademark. This is a problem an early stage startup really doesn't need, but we actually see it happen fairly often. Founders get very attached to names and once this happens, it's really tough to let go. But your company is probably too young to have created much value in the name you picked and the expense and distraction of getting into a trademark dispute with a more established, better funded company can be substantial. So your best course of action is let it go. Let the name go. Pick a new name and get back to work. Related to this, a few of you emailed the question about whether or not it's worth it to register your company's name and get the official trademark. Generally we consider a trademark registration to be something that can wait. It's a nice to have, not a need to have in the early days of your startup. All right. Finally, I picked an awesome name for my company, but I have to pay 10K to get the domains. This happens a lot. So again, don't fall in love with the name, that may cause you to make bad decisions no matter how great that name is. It is a bad decision to waste time getting into a lawsuit with a company that claims you stole his trademark, and it is usually also a bad decision to spend a ton of money on a domain. So do your research on names, like research, don't just research the PTO, research it, and then do whatever is cheapest and most efficient and move on. Okay, that's it. So now we're going to have John and Jason come up and we ... Okay, so what we did is we took ... You guys emailed us a bunch of questions and we pulled some out, we edited them a little bit for brevity, but we mostly kept them sort of unfiltered in original style. So, we're going to go through a bunch of those now.
John:
Quick announcement. There's a red mustang outside with the license plate, MEOW GIK, and a white land rover with a Nevada license plate. We have to move those. They're in the way.
Carolyn:
M-E-O-W-G-I-K, red Mustang. Anybody need to go move their car? White Land Rover? No one's getting up to move their car. I'm worried. You guys both have mics? Okay. Jason, I'm going to ask you the first question when you're ready.
Jason:
Go ahead.
Carolyn:
Okay. When does the 30 Day IRS clock for filing an 83(b) election start? And you might want to start by describing what an 83(b) election form is in case somebody here does know.
Jason:
Yeah. So an 83(b) election is a tax election. So when you buy stock, if you don't make an election, what happens is you're taxed on the stock as it vest. So each vesting period, the amount of stock that that's whatever the value of the stock is at that time, you incur an income tax for that. But in 83(b) election allows you to be taxed on the difference between the value of the stock and the price that you pay for the stock on the day that you actually buy the stock. So it's actually by default in most cases, the best thing to do when you are a startup founder is to actually make the election so that because you're going to be paying a very nominal price for your founder stock. And so there's gonna be no income tax there because you're going to be ... if you make the election because you're gonna be paying the same amount. So you'll pay like a dollar for your stock and then basically say that the stock is worth a dollar and then you make the 83(b) election and then there are no more taxes that are going to accrue on your vesting as the stock grows and value. So if you don't do that, which does happen from time to time, you can be faced with a very large tax liability if your company ends up becoming very, very valuable as your stock vests. And the time period from when the 83(b) election, about 30 day period that you have to make the filing, it starts from the day that you actually buy the stock. So, that is a hard deadline, it includes calendar days, it's not a business day period, and if you miss it, there's really not much you can do about it. There are some sort of things that you can do to mitigate the tax liability if you work with tax lawyers, but if you miss it, it can be pretty bad. So, that's one thing to definitely remember.
Carolyn:
Okay. And I will add that this is a good reason to pay really careful attention to the date on your restricted stock purchase agreement and it should be the same date that you write the check for the $1 ... Just pay attention to that. You want that all happening on the same time, so you're not really worried about like, oh my gosh, what's my actual start date. And the other thing I'll say about that is 83(b) election forms need to be saved by the company as well. So the individual founder is going to save that election form for their own tax returns in their own files, but the company needs to keep a copy too. You put that in your shared Dropbox, you make sure it's signed, you make sure it's date, and you save it in that safe place and the company has it forever. That's really important.
John:
It's one of the few things that can't be fixed. That's also an important-
Carolyn:
Well, yeah. I mean Jason was just saying like there are some ... There are some fixes sometimes, but they're painful and really expensive.
John:
And people look at it in diligence. This is actually one of the few things to remember if-
Carolyn:
Yeah, if you remember nothing else from this, file your 83(b) election forms. Okay. So we also got a lot of questions that touched on a variety of immigration issues. And here's a sample question we got. I'm in Canada, can you help me get a TN visa so I can work on my startup in the US. John why don't you take a crack at that.
John:
This is a difficult ... Jeff said, we know everything, but immigration is not something that we're experts on. And this is a situation where you need to speak to an expert, especially if you have situations where you're going to be ... You need to be employed, as Carolyn was saying earlier, by your company. And if you can't work in the US, you can't be employed because it's illegal, then you're better off speaking to an expert. Now, immigration is particularly tricky, it's a political issue obviously now. So the landscape's always changing, but it's also ... It's more of an art than a science. So it's always been very difficult for us jumping in, knowing the basics to talk about immigration. Were really not experts in this area, and you definitely need to speak to an expert.
Carolyn:
Okay, Jason, should I be a C Corp or an S Corp?
Jason:
S Corp. So, if you just file in Delaware, you're kind of C Corp by default. In order to actually be an S Corp, you have to make an election on a tax form. The difference between the two of the C Corp or S Corp is S Corp is pass through taxation since tax transparent. So any income earned by the corporation is then passed through to its owner, the C Corp, cuts off the income at the level of the corporation and corporation pays taxes. And so the reason why you want to be a C Corp is that's the kind of entity that investors are used to investing in. And also, when you actually take investment from outside investors, it will blow the S Corp election most of the time anyway.
Carolyn:
Okay. John, how much equity should we save for our first employees or key hires during the incorporation of the company?
John:
It depends on the size of the company and how many people you need to hire. I would say the standard is probably 10 to 20 percent people think is going to be saved for employees, but it's definitely specific to the company. So I would ... This is a situation where it's very easy for me to say, “Hey, you should be very generous with your employees, and you have alignment and make sure they are from the upside in the company.” It is something I believe very strongly and especially if you have good employees, you want to keep them, you want them aligned with your mission. So it's worth thinking about this in a longterm view, having the longterm view, and setting up everyone for success.
Carolyn:
The online platforms, Clerky and Stripe Atlas. Well, I know Clerky for sure has ... you can actually create a stock option pool at formation if you want to. So if you've already thought that far ahead and you know you want to have a plan set up, you can do that at formation. I would say though the vast majority of companies actually wait and don't adapt to stock option plan until they're a little farther along. Jason, is it illegal to have unpaid interns?
Jason:
Generally, yes. So you just went over this in the fundamentals. You want to avoid unpaid employees, and interns are going to be generally considered employees. And then there are some exceptions you can use or take advantage of for giving people sort of college credit if they're a college interns or things like that. But that's gonna take some work on your part to actually learn those rules and you're probably going to need to talk to a lawyer for those things. And if you want to get the help of people and so just pay them in the form of equity. Again, that was already covered by Carolyn's presentation, they can be contractors, but there are standards for when somebody is classified as a contractor versus an employee, and those standards got just recently ... Are harder to satisfy given some of the California Supreme Court rulings.
Carolyn:
We had a YC Company once that have 14 interns; 14 unpaid interns, that was a big mess. Okay. John, there's a ton of advice out there for how to properly structure for a for profit startup, what about nonprofits? What's the best legal practices for starting a nonprofit startup?
John:
I'm getting all the questions that I can't answer, that seems fair. The nonprofit are also completely different; it's a different animal. It's different from for profits. I mean, the government doesn't favor nonprofits because the government likes to get taxes. Nonprofits are tax free. So if you think about it, the government's going to make it difficult to become a nonprofit. You have to go through all these steps and fill out forms. It takes like nine months. I'm not an expert on it, YC is not an expert on it, we do donate to nonprofits, we accept nonprofits in our program. That said, it's always been ... You have to have a public good ... Your company has to be set up for the public good. There are certain disclosures you need to make. You have to disclose the top five salaries in the nonprofit. And I'm certainly not an expert in this area, so I don't want to touch on it any more, but it's a completely different animal.
Carolyn:
You're out there soliciting donations from foundations rather than raising from VCs, so it is a totally different beast. Jason, can I invite a stranger to be a partner?
Jason:
So, that question is probably answered itself. Generally, you want to work with people that you can trust and know. And so before you bring on somebody as a partner or co-founder, you kind of want to understand how well you're going to work together, whether you can actually build something together, whether you can actually get along. So I think the answer to that is not if you really want to make sure that you're going to be successful.
Carolyn:
And even if the person who asked this question meant partner like advisor or some other, not like a co-founder, but they meant something else, I would say don't ever work with a stranger. Right? And this goes back to what I was saying about founder breakups. I mean, that's a recipe for disaster to work with someone you've only just met because we've seen brothers break up; the founder breakup goes through all levels of relationships, so you're going to stack the deck against yourself if you have a stranger involved. John, what are key factors to consider while determining what country should one register their parent's company in?
John:
The quick answer is where's the market, where is Your Business, who are you. Most people set up in the US because they're attacking the US market, which is a big market. If you're selling something in India, you should be in India most likely. The problem with this question like the parents subsidiary question to me, I always think like when I'm talking to startups, keep it simple. This lecture seems a little dry and it's the legal mechanics, not the most exciting thing, but it's really pretty simple if you think about. It's like, hey, form your corporation, be serious, keep your documents, like don't have one person squirrel it away, buy your stock from the company, never forgets your 83(b); that's the one thing I want to drill home. After you buy your stock, file your 83(b), that's about it. There's not that much to do as long as you're serious. With parents, subsidiaries, complexity, when I hear that from companies early on, I just want to run.
Carolyn:
Yeah, you're going to make it extra hard on yourself with that kind of stuff. Jason, with the explosion of legal services tech, it's possible I may not need traditional council until a sophisticated angel or institutional round. When do you advise your companies to stop using these services and migrate to a traditional law firm? How would you distribute the work between the two?
Jason:
Yeah. There are a lot of good tools out there right now. So you could use Clerky, you can use Stripe Atlas, you can get pretty far with. I think when you get to the point where you're raising significant amounts of capital, you definitely should get a lawyer because a lot of those agreements are going to be custom and bespoke or you're just going to be some negotiation. When you're just incorporating and setting up, those services will take care of it. You could probably go without counsel or you could certainly get counsel if you want, especially if you want to do something a little bit more custom. When you get to the point where you're issuing stock to employees, you probably do want to get somebody involved just because there are some things that can go wrong if you don't do things perfectly. You also don't want to be careless about having written promises for stock with various people, so sometimes outside counsel there can be very helpful in making sure you're not out over your skis when you were talking about things like that with people.
Carolyn:
So John, this question is kind of similar to the one I just asked you, so it's probably the same answer, but you can reiterate. From a legal perspective, can I form a startup and then sell it while having a full time job? If so, what things should I consider?
John:
I also think Jeff touched on this earlier, but this is kind of asking the impossible. There's no way or I've never seen any company started part-time on weekends, holidays become like a giant company. Maybe you can do that on a small scale, but this is a ... We're asking you to start a company out of thin air and that is very difficult, to grow a giant ... This is an all consuming, full time thing. It's not like, oh, I'm going to do this as a hobby. So I don't want to sound dismissive, but I just think that's practically impossible. I wouldn't even think that way, like this isn't a part-time Gig.
Carolyn:
Jason, are patents ever worth applying for?
Jason:
So this is sort of like a ... You could talk a very long time about patents and whether it's useful or worthwhile applying for them. The short answer is, so patents are useful for protecting your technology, especially from competitions in copying your technology. Your technology matters. If you're pursuing a software startup or tech enabled internet company, patents tend to matter less; there's less protection under patent law for software patents anyway. And most of your success is going to be determined not by their protectability of your property under law, but rather your execution on the software. If you're pursuing a life sciences startup, there duplication is actually easier for competitors to execute on, so patents tend to be more important. And if you have questions about the specific things that you're doing technology wise and whether it falls into the weak patent or strong patent protection bucket, you should definitely consult with a patent expert or a lawyer on that. But the last part of this is that no company is sort of raised money purely on the strength of their patent portfolio, it's always gonna come down to how good is the founding team, can they execute on their vision; the patents are just one part of the puzzle.
Carolyn:
Okay. John, I'm thinking about setting up an advisory board and wonder if advisors should have equity?
John:
In my experience, advisory board are more a non-US thing, like non Silicon Valley thing. Maybe in Silicon Valley we see advisory boards for life sciences companies. You would see academics and professors try to legitimize the company as advisors and get a little stock. But this is not something where, it's not something where you give stock to people without thought, it's more ... I think the best quote on advisors somebody said was like, “Advisors are investors who want stock for free.” And that's Kinda how I think about it, like people should invest ideally instead of advising for free shares. I know this isn't like a one size fits all, some situations like I was saying, it's appropriate. Maybe a life sciences company and you can have consultants who gets stocked, but it's mostly a situation I try to avoid.
Carolyn:
Jason, what have you seen founders do when they had to cut off and fire a co-founder who was a personal friend?
Jason:
So has anybody here ever had a roommate who's been a friend? It's Kinda like that, right? So sometimes it's better to not do certain things with your friend so that you can stay friends. And so if you have started a company with a friend of yours and it's not working out, it's often times because you guys have different ideas about the direction the company should go in, or if somebody is working just a lot harder than the other person is. It's usually better to just solve that problem or basically resolve that problem as soon as possible rather than letting it be something that you think or hope will work out over time and letting it fester. Because not only does it hurt the company, it hurts the friendship too. So it's generally better to kind of get to a quicker resolution.
Carolyn:
Yeah, you don't want to stall on that.
John:
No. That's something I would add. The biggest mistake we see is people delaying and thinking, oh, things are going to work out and this is a friend, and things are going to change. It's usually best that you just end the relationship if it's not working.
Carolyn:
And the startup relationship.
John:
The startup relationships, thank you.
Carolyn:
And hopefully preserve the friendship.
John:
Preserve the friend, exactly.
Carolyn:
Okay. John, what is the best methodology for reviewing potential loopholes in your privacy policies in terms of service?
John:
This is an area where if you're going to spend money early on and a lawyer and you have something that's tricky, that's a sensitive startup topic; it's worth spending money on a lawyer. But there are excellent services for privacy policies and terms of service on the internet right now [inaudible] is one, and all the major law firms also have privacy policy generators. But if there's something specific or [inaudible] I'll send out on the resources tab. It's definitely important, it's required. If you're taking somebody's information, you have to have a privacy policy up on your website or your app in California. So this is something you need to do, there are good services. In certain circumstances you're gonna need to hire a lawyer in this situation.
Carolyn:
So as many of you probably know, if you are collecting personally identifiable information from anyone in the EU, you're governed by the GDPR and that's a huge quagmire. And so if you fall into that bucket, even though some of these privacy policy generators are fantastic, they're not going to get ... They're probably ... I mean, unless someone's really done a great one, they're probably not going to cover all the stuff you need to know for GDPR. So you would probably want to get a lawyer for that. Let's see, Jason, should we work 18 hours a day as a co-founder and founder of our startup? How can we measure and manage our commitment status for our product?
Jason:
So the advice we give all of our startups is to still exercise, sleep, and have some semblance of a life in terms of like maintaining some of your relationships and friendships. So 18 hours a day is not something that we would recommend really, except for maybe like short sprints where you need to get something out. And just remember that this is just gonna be a multiyear journey while you're building a company, so to use a tired cliche, it's a marathon, not a sprint.
Carolyn:
You don't want to get sick. Okay. John, should we have a shareholder agreement and what should be included in a good shareholder agreement?
John:
Shareholder agreements are really a non US type of document. It's a document that describes in detail what happens when there are departures, severance, founder breakups, or all different types of situations. And often they can be very detailed. The ones that I've seen, Canadian companies have come in with them. It's really a foreign thing, not so much to US. It goes back to what we were saying or what I was saying earlier, you want to keep things simple. There's no reason to have this giant prenup in a situation for a startup. I mean, chances are if things go wrong with a startup, there are no assets to divide anyway. It's not like a marriage, using the prenup analogy-
Carolyn:
Except when you break up.
John:
Except when you break in a marriage, there are assets hopefully. There's a house, couch, television, whatever; you need a prenup. Sometimes for startups, these detailed documents that I get from the Netherlands about what happens when a company breaks up with no assets, seem just like a waste of time to me.
Carolyn:
Overkill. To clarify for some people. I think that the person who asked this question was talking about the shareholder agreements that John was talking about, which is among founders. When you sell preferred stock to investors in like a series A financing, there are shareholder agreements and they do govern a lot of the things that he just talked about. But that's between the company and the investors. So that is different, and that is of course a very US thing. So just to make sure people weren't confused about that. Okay. Our last question for Jason. Many companies have information about their rounds, like price per share or amount raised displayed on Pitchbook, Crunchbase, and other sites. Given that this seems to be due to company charters and filings being publicly available, is there any way to prevent outsiders from seeing this detail about your company?
Jason:
The technical answer is yeah, there are methods you could use to actually conceal some of the information to the charters. The charter are publicly filed documents, and people can pay $100 or whatever to pull down the charter from Delaware and look at some of the details of your company. So that's sort of like the literal answer, but I think the larger answer is just ... It's not something that I would worry about really because it's sort of way down on the list of priorities in terms of what you need to sort of think about and plan for. And look, there are plenty of companies that have this information listed on Pitchbook, they're doing fine and plenty of others that are not doing fine because it's not because they're on Pitchbook or not on Pitchbook, it's because of other things. So it's just I wouldn't spend a whole lot of time thinking about this.
Carolyn:
So Jeff and [Adora] , I don't know how we're doing on time and whether or not you want to do any ... Is there a Q&A?
Jeff:
Are there any questions? [inaudible] why don't we take just a few questions and then we'll call it a day.
Carolyn:
Okay. Alright. Yes.
John:
I'm not an expert on nonprofits [inaudible] oh, thank you. She's asking about B Corp, which is a quasi nonprofit and for profit corporate-
Carolyn:
It's a social good.
John:
... Social enterprise where part of your mission is for the public good. That's not something I'm an expert in, unfortunately. Many companies have been doing it recently, it's much more prevalent, I just I'm not really qualified to speak of it.
Carolyn:
It changes the fiduciary duties, right. So the whole goal of the ... I mean, the goal of your average corporation is you make money for the stockholders, right? B Corp is more like there's a social good, so the fiduciary duties on the part of the management and the directors are different. And like John said, they're gaining in popularity, so I think we're gonna see a lot more of them. It's not really YC's things, so I would hesitate to give you any advice about them. But I know there's actually a couple of good books about them, I have one of them [inaudible] . But there's a lot of information out there about them.
Audience:
[inaudible] .
Carolyn:
You know, if not for YC's, maybe, but-
John:
It could be fine.
Carolyn:
Yeah, it could be fine. It's just we haven't done a lot of them so we don't really have any data about what that looks like longterm.
Jeff:
One point about a B Corp is you can imagine it might not be as attractive to your typical venture investor. So it depends on what the goals for the company. If you're looking to create a startup, which is high growth, fast growth, you won't generally see a B Corp, and most investors probably look at that somewhat askance.
Carolyn:
Also, we do have one recently that converted into a B Corp that had been around for like five or six years. So that's something you could think about too.
Audience:
[inaudible] .
Carolyn:
Yeah. I mean it can be done, I just don't know the wisdom of it. Way back there?
Audience:
[inaudible] .
John:
Yes, it is similar. The question is, I believe you have a SaaS company in Australia and you're attacking the US market, but you're also in Australia, you're not sure where to incorporate again. Again, the key is where are your customers. It sounds like you're thinking about the US, you not 100 percent sure, and I would just figure out really where you want to be most from a practical standpoint. Again, like setting up complex structures is really what the question that we were talking about earlier, and I have like a little aversion to that. It could be a situation where it makes sense to have a parent subsidiary structure for you, but it's a little more complicated than [inaudible] .
Carolyn:
You can incorporate in the US and then have your Australian company be a sub, but again, you could just incorporate in the US and just sell into Australia. Like you could just not ... I mean, if that's your market and that's where you want to raise money, just incorporate and be a US company.
John:
We always suggest US companies as it's much easier to fundraise in the US and much more favorable terms in my opinion. So I always tend to push people to be in the US. It's just better for the business long term.
Audience:
Just two more questions.
Carolyn:
Okay [inaudible] got this? I have a question about [inaudible] Okay. So his question was when you add new co-founders later on, maybe a year or so later, do you have to restart all the original founders vesting schedule to match the new? And the answer is no, you do not. So you put ... you and your original team of co-founders, let's say you put four year vesting on your founder stock and then a year later you find a fourth co-founder who you think is great ... And by the way, be a little bit circumspect about throwing the word co-founder around. Like sometimes that person who comes a year later is just a key hire and not a founder. There's a lot of emotional attachment to the word founder in Silicon Valley, we all know why. But not everyone's a co-founder. But to answer your question, no, you guys will stay on the same vesting schedule. The new person who came a year later, we'll start four years on the day that he or she started at your company. Now, the thing that some of you probably already know is that when your investors come in, they may decide they want to restart you all. I mean, unless you had absolutely zero leverage, so not going to start you back on square one. But sometimes investors look at your schedule and they say, “Ah, you guys only have about a year left? That's not really enough for us. Can we put on another year.” So that happens every now and then, and again, it depends a lot on leverage, but don't be surprised if that happens. Did that answer your question? Okay.
Audience:
One more. One last question. So you talk about having [inaudible] applied outside US, and part of [inaudible]
John:
So the question was how do you hire outside of the US when you have a US entity?
Audience:
[inaudible]
John:
Yeah. So, the short but unsatisfying answer is going to be that it depends on which country because each country has different sort of rules for who counts as an employee and who counts as a contractor and what you have to do in order to actually satisfy those roles. And then also, when you actually open up a significant presence in any sort of foreign country, what you often times have to do is create a local entity and sometimes that can be a subsidiary and sometimes it can actually be something more simple like a local branch. Again, your menu of options sort of depends on which country you're going into. I don't know, do you have like a country specifically? Yeah, India. So India, typically what happens is there's a subsidiary that's created, it's usually owned 99 percent by the American parent, Delaware parent and one percent, or some other small percentage by one or two local Indian sort of representatives. And then that subsidiary is the one that hires employees in India.
Audience:
[inaudible]
John:
I think if you want to try and avoid that kind of structure ... Again, I'm not an expert on India law, you probably need to talk to somebody who actually has a license in India to actually advise on the employment issue because just like in the United States, various countries have stronger or weaker protections for when you can classify somebody as an employee or not.
Audience:
Okay.
Jeff:
Thank you guys very much. So sorry to have to cut off, I know there's a lot more questions live here. Remember Darby Wong from Clerky is having an AMA now, tomorrow, but it's open now, you can post questions. So if you have questions, that is an outlet, and you can always work with your group to ask more questions. Just one more word on the part-time question, which has come up a few times and we discussed a little bit at the break. The way I look at that, it is certainly true that some companies are kicked off while people are working in a full-time job. But those aren't really companies yet, they're just projects, they're just ideas. Once you really start your company, and all of the great companies have this feature, you'll be on a full time; you'll be on a more than full-time, you'll be on at 120 percent. So, thank you all for coming in person and thank you for watching online. Just a couple reminders. There will be a conversation with the founder of Y Combinator, Paul Graham on Friday, as well as the AMA tomorrow with Darby. Next week we're going to dive into product with the CEO of YC, Michael Seibel, and David Rusenko from Weebly on building product and product market fit. There are also several great videos in the startup library on product that I very much encourage you guys to take a look at. And lastly, log in to the site, many of you already have. Post on the forum, post in your group, and figure out how it works. Hopefully, it'll be good home for all of you, and if you have any issues, send an email to ycombinator@startupschool.org, and everyone have a great day. Thanks.
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