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UNCW BLA 361 - Startup Company Lawyer

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Startup Company LawyerWritten by YokumShould founders pay for their stock in cash or contribute intellectual property?When do I need to incorporate a company?What type of entity should I form?What state should I incorporate in?What do you need to do before you quit your job to form a startup company?What is par value?How many shares should be authorized in the certificate of incorporation?MESSAGE FROM ASSOC. PROF. PAMELA S. EVERS, ATTORNEY AT LAWThis article has been offered by web posting to UNCW students for educational purposes only. Articles posted may have been edited for clarity and format by Pamela S. Evers. Startup Company LawyerWritten by YokumShould founders pay for their stock in cash or contribute intellectual property?January 14, 2009If a founder owns intellectual property that he or she plans on contributing to a company, the founder may want to payfor founder stock by assigning the intellectual property rather than paying cash. Even though founders typically purchase stock for $0.01 or $0.001 per share, the aggregate purchase price can often be in the thousands of dollars. (Or course, the par value can be set extremely low, such as $0.00001 per share in order to allow founder stock purchases at extremely low prices.) Sometimes, a founder will choose to assign a business plan to the company for this purpose. Nevertheless, there are number of risks associated with purchasing founder stock by means of assigning intellectual property, including: difficulty in adequately defining the scope of what is being assigned or what the company needs in this regard now or in the future;  difficulty in making sure the assignment is properly perfected;  difficulty in accurately valuing the assets assigned, which could affect the company’s stock option pricing if the company’s auditors determine that the value of the intellectual property (and, by correlation, the fair market value of the common stock purchased) was significantly higher than stated; and  potential tax ramifications (the contribution must to reviewed to make sure that the transaction complies with Section 351 of the Internal Revenue Code in order to be tax free). In order for an exchange of property for stock to be tax free under Section 351, there are two requirements. First, theproperty generally must to transferred solely in exchange for stock of the company. This is easily met because the founder typically does not receive any cash in the exchange. Second, immediately after the transfer, the founder(s), including those transferring cash, must own (i) stock possessing at least 80% of the combined voting power of all classes of stock entitled to vote, and (ii) at least 80% of the total number of shares of each other class of stock. If there is more than one founder, the contributions do not need to be simultaneous, but need to be at or around the same time as the other founders so that it is part of the same transaction in order for the transfers to be aggregated tomeet the 80% test.If a founder chooses to purchase stock by means of assigning intellectual property, the founder needs to execute a proper assignment so that title to the intellectual property is clearly transferred to the company. In addition, the founder should generally always include at least some cash consideration in order to ensure that the par value per share is paid in cash.When do I need to incorporate a company?July 20, 2009[It's been awhile since I wrote anything. I am giving a presentation to some of the founders in TheFunded Founder Institute on incorporating their companies, so I thought I would recycle some thoughts.]Founders of startup companies often wait to incorporate a company until they are confident that their concept is viable or fundable. At some point, however, an entrepreneur will need to formally incorporate a company. Several reasons exist for taking the step to incorporate. More than one founder. If there is more than one founder, the likelihood of an argument about how the equity should be split in the new company increases dramatically. Incorporating a company and issuing stock tothe founders will help prevent misunderstandings among the founders about equity splits. Trying to clean up pre-incorporation promises to grant equity in a startup company is a painful task, especially if founders part ways before there are formal documents in place to deal with the situation. Please keep in mind that even if a companyis incorporated, founder stock purchase agreements with repurchase rights over unvested stock if founders leave are not included with the documents from typical online incorporation services.  Creating intellectual property. If there is any IP created and there is more than one founder, then incorporating an entity and assigning IP to the entity is important. Otherwise, if a founder leaves before incorporation and IP has not been assigned to the other founder or an entity, then use of IP created by the former founder may be problematic. Once again, please keep in mind that the documents from typical online incorporation services do not contain IP assignment provisions in connection with the purchase of founders stock or separate IP assignment documents.  Hiring employees or third party contractors. Although I’ve run into a situation where the former CEO of a Fortune 500 company personally paid an “employee” out of his own pocket for a year prior to incorporation while incubating an idea, most founders will need to incorporate a company if they intend to hire employees. In addition, if an entrepreneur needs to engage third party contractors, it generally makes sense to incorporate a company so that the third party enters into an agreement with a company instead of an individual. In addition, any IP created by the contractor can be assigned to the company instead of an individual founder.  Issuing stock options. Many entrepreneurs do not have the cash to pay third parties and may partially compensate third parties by granting stock options or giving them the opportunity to purchase equity at nominal prices. Although it is possible to have pre-incorporation agreements to grant equity upon incorporation, it is simply easier to incorporate a company and grant stock options or equity to satisfy these promises.  Launching a service/product and general liability issues. One important reason for incorporating a company is to protect the stockholders against


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UNCW BLA 361 - Startup Company Lawyer

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