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Lecture 18 - How to Start a Startup

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General consul. >> Oops. >> Christine and Caroline. And they're going to talk about finance and legal mechanics for startups. This is certainly not the most exciting of the classes, sorry. But if you get this right this is probably the class that. So thank you very much for coming, and yeah, go ahead. >> Okay. So like Sam said, this lecture is about the mechanics of start up. And Kristi and I are going to be talking about some of the basic legal and accounting issues that your startup may face in the very beginning. I was watching Paul Graham's video, and at one point he says, founders don't need to know the mechanics of starting a startup. I thought, oh no, that's exactly what Sam titled this lecture. >> Ha. >> But what PT actually says is that founders don't need to know the mechanics in detail. Because it's very dangerous for founders to get bogged down in the details. And that's exactly right. And Kirsten, I can't give you the details in 45 minutes anyway. So our goal here today is to make sure that you do know better than to form your startup as a Florida LLC. >> So, as Sam mentioned, we are also worrying this is going to be pretty boring for you to listen to an accountant and a lawyer talking about this. You know? You've had some really amazing founders talking about really interesting things. But like, like Sam said, you know, this is the kind of stuff that if you know the basics you can get yourself set up in the right way of always paying. Stop worrying about it and then concentrate on what you actually want to do. Which is make your company a success. And so, you know, we refer to this term startup all the time. And probably in the back of your head, you kind of know that by startup we mean there has to be some legal entity. And that's, you know, kind of separate legal entity. We'll talk a little bit more about how we actually set that up and what that means to you. And you also probably know that a startup will have assets. IP, inventions, other things. And that the company needs to protect those. So we'll talk a little bit more about that. About how to raise money hiring employees, and entering into contracts. So there's a few other things that talk, that you need to talk about whilst your setting up your company, which kind of ferrets out a few issues amongst founders. Things like who's going to be in charge and how much equity is everybody going to own. So those are really good things to talk about too. You know, we can switch slides. >> Uh-oh. >> There we go. >> Okay. This is us. Kirsti has the calculator. I have like, the geriatric glasses, which is actually pretty fair. Okay, so the first thing we're going to talk about is formation. Kirsti actually just mentioned that. Your startup is going to be a separate legal entity. And the, and you guys probably already know this, but the primary purpose for forming a separate legal entity is to protect yourselves from personal liability. And what that means is, if you're company ever gets sued you know, it can't, it's not your money in your bank account that the, that the person can take. It's the corporations. So that's why you form one. So then the question is, where do you form one? And theoretically you have 50 choices but the easiest place is Delaware, and I'm sure you're all familiar with that as well. But Delaware is in the business of forming corporations. The law there is very clear and very settled, it's the standard. The other thing is that investors are very comfortable with Delaware. They already invest in companies that are Delaware corporations. Most of their investments are probably Delaware corporations. So if you are also a Delaware corporation then everything just becomes much more simple, right? There's less diligence for the investor to do. You don't have to have a conversation about whether or not to reincorporate your Washington company into Delaware. So there's a reason that so many companies do it. It's standard. It's familiar. So I'll tell you a story. We had a company at YC about two years ago, that was originally formed as an LLC in a state that I'll, that I'll say, Connecticut. The founders had some lawyer friends there who said, this is the right way to do it. And when they came to YC we said you guys need to convert to Delaware. So the lawyers in Connecticut did the conversion paperwork and unfortunately they didn't do it right. They made a very simple mistake but it was a very crucial mistake. The company was recently raising money. Like a lot a lot of money and this mistake was uncovered. That the basically the mistake was this company thought it was a Delaware corporation for a couple years, but in fact it was still a Connecticut LLC. And I'll just say this four different law firms were needed to figure that one out. Two in Delaware one in Connecticut, one here in the Silicon Valley and the bill right now is at $500,000, for a conversion mistake. So, so what's the takeaway here, pretty simple. Keep it really simple and familiar for yourself. The reason we incorporate all companies the same way at Y Combinator is because it's easy. So don't get fancy. Just save yourself some time and money. >> Okay. So once you've decided that you're going to be a Delaware corporation, how do you actually set that up? And it requires a few different steps, but the first one is actually really easy. You literally just fax two pieces of paper into Delaware saying, we're going to set up a corporation. All that does though is create a shell of a company. It doesn't actually do anything within the company. So after that, you then need to complete a set of documents that among other things approve the bylaws of the company. It creates a board of directors, it creates offices of the company. Delaware requires that somebody has the title of CEO or president, and of secretary. So also at this point, you need to complete documents that assign any inventions or any code or anything that you as an individual create, so that the company actually owns that. And remember at this point, it's, it's a really good thing to think about. You as founders have to think about things in two different ways. You always have to be thinking, am I doing this as an individual? As me? Or am I doing this on behalf of the company, which is a separate entity. So you have to maintain that split in your mind going through all of this. And we'll talk more about where that comes in a little bit later. So there are services that can help you get incorporated, of course you can use a law firm but there are also other online services that help, and the one we often use with a lot of the YC companies is call Clearkie And they are set up so that all the standard, basic documents are used and they get you set up in a very vanilla way. So that you can just move on and keep, keep focusing on what you need to do. So a note on paperwork. You're creating documents. These are really important documents that are going to be affecting what the company does, and what the company is. So it's really, really important that you actually keep these signed documents in a safe place. And it sounds so basic, but we get so many founders coming to us saying oh, I don't know. These, these, some documents. And they have no idea what they are or where they are. So really, really make sure that you keep them in a safe place. And let's be, let's be honest, this is not the glamorous part of running a startup, you know, filing documents. But actually at the times where this is crucial are going to be at really high stress times in the startup's life. It's likely to be if the company's raising a big series A round, or if the company's being acquired. The company will have to go through due diligence, and there will be lawyers asking for all this stuff. And if you don't have it and you don't know where it is, it's just making a really stressful situation even more stressful. So really, the, you know, the key thing here is, like we say, keep it simple, but keep those documents in a safe place and keep it organized. It will make your life so much easier. >> Okay. So now, we're going to talk about equity. And we're going to touch on a couple of different things in this section. The first thing that we're going to talk about is equity allocation. So what am I talking about here? I'm talking about. If your company stock is a pie, you're talking about how to divide the pie and you're talking about this with your cofounders. Why is this important? Well if you're a solo founder, this really isn't important. But if you are a team of two or more than this issue is absolutely critical. So the first thing that you need to know is that execution had greater value than the idea. What do I mean by that? A lot of founder teams give way too much credit and therefore a lot of the company's equity to the person who came up with the idea for the company. And ideas are obviously very important but they have zero value. Who's ever heard of a billion dollar payment for just an idea. So value is really created when the whole founder team works together to execute on an idea. And so you need to resist the urge to give a disproportionate amount of stock to the founder who is credited with coming up for the idea for the company. The next thing you want to think about is, okay, so how much stock, or should the stock be allocated equally among the founders? And from our perspective, the simple answer is probably yes. Our mantra at Y Combinator is that stock allocation doesn't have to be exactly equal, but if it's very disproportionate, that's a huge red flag for us. We wonder what conversation is not happening in, among the founder team when the ownership isn't equal. For example, is one founder secretly thinking that this whole startup thing is temporary? Is one founder over inflating the work that he or she has already done on the company or over inflating his or her education or prior experience? Do the founders really trust each other and have they been honest with each other about their expectations for this startup and for the future? So when ownership is disproportionate, what we worry about is that the founders are not in sync with one another. Thirdly it's really important to look forward in the startup and now backwards. Instead another way all the founders in it 100%? Are they in it for the long haul? If the expectation at your startup is that each founder is in it 100% and you're all in it for the long haul, then everything that happened before the formation of the company shouldn't matter. It doesn't matter who thought of the idea. It doesn't matter who did the coding, or who built the prototype, or which one has an MBA. It will feel better to the whole team if the allocation is equal, because the whole team is necessary for execution. So, here's the take away on this point. In the top YC companies, which we call those, you know, with the highest evaluations, there are zero instances where the founders have had significantly disproportionate equity split. >> Alright, so you've had the conversation about how to split the equity. But then what? again, we talked to many founders who were actually surprised that they have to do something in order to own this stock. They think about, they think that talking about this is, is actually enough. And this again is another situation where you have to think about you as an individual, versus you as a representative of the company. And if you, if you equate this to a large company, you know if you, if you worked at Google and you were told as part of your compensation package, that you would be receiving some shares, you would expect to sign something to get those shares. And if you didn't, you'd be thinking, oh what's going on here? Well, it's the same thing with, with a small company as well. So in this case the paper, the, the documents that you're signing is a stock purchase agreement. So you as an individual, buy the shares from the company. And in any situation, if you're buying something, there's a two-way transaction where you pay for something and you get something in return. And in this case you're getting shares in return for either a cash payment, or for contributing IP, or inventions, or code to the company, so that the company actually owns everything that you've done in the past. So, we also refer to that stock being restricted because it vests over time. And we're going to cover that next in more detail. But, as a result of the stock being restricted investing, there's one very very crucial piece of paper. That we talk about until we're blue in the face to everybody, because there's actually no way to go back and fix this. And this is actually one of the things that, because there's no, there's no way to fix this, this has blown up deals in the past. We've, we've seen companies where, because they haven't filed what's called an 83 b election deals have blown up. And I'm not going to go into detail about what that 83 b election is actually about, but just leave it as it affects your individual taxes, and it affects the company's taxes. And so, it can have a big impact. So, you know, here we have the main, the main things here are sign the paperwork. Sign the, sign the stock purchase agreement, sign the 83 b election, and make sure that you actually have proof that you sent that in. Because if you don't have the proof, it just goes into a black hole at the IRS, and investors and acquirers will walk away from a deal if you can't prove that. >> Okay. So the next thing we're going to talk about is vesting. And I imagine that many of you are familiar with what vesting is. But just in case, really simply vesting means that you get full ownership of your stock over a specific period of time. So we're talking about the stock that Chrissie just said, you bought your stock of your company, and you own it and you get to vote it. But if you leave before this vesting period is over, then the company can get some of those unvested shares back. So and I'm just going to, just so you guys know the other ways to refer to vesting, you'll hear restricted stock. That means that, that stock that's subject to vesting, the IRS speak for this is, shares that are subject to forfeiture. So, so, it's a little terminology there. okay. So, what should a typical vesting period be? In Silicon Valley, the so-called standard vesting period is four years with a one year cliff. This means that after one year, the founder vests in or fully owns, 25% of the shares. Then the remaining shares vest monthly over the next three years. So here's an example. Founder buys stock on Christmas Day, let's say, and then quits the company on the following Thanksgiving, so before the year is passed. In that case, the founder leaves with zero shares, right, cliff period hasn't been met. If the founder though, quits the day after the next Christmas, so a year and a day later, he or she's vested in exactly 25% of the shares, right? In that case, the one year cliff has been met. So, what happens to the shares when a co, when a founder stops working at the company? Company can repurchase those shares. An example I just gave, where the founder quit, a year and a day after purchasing the shares, 75% of those shares are still invested. And the company will repurchase all the, that full 75% of those shares from the founder. How? Just writes the founder a check. That's how the founder bought it, right? So, it's the same price per share that the founder paid, and it's really just giving the founder his or her money back. So then the question is, why would you have vesting? Why would founders do this to themselves, right? because it's just the founders they're, they're doing this on their own shares. Doing this to their own shares. So, and probably the number one reason why vesting is important has to do with founders leaving the company. So without, say you didn't have vesting and a founder leaves, a huge chunk of the equity ownership leaves with a him, him or her. And obviously that is not fair to the founders left behind. And we're actually going to talk about this a little bit more when we get to the founder employment slide, I'll go into that in more detail. But the other reason to have vesting is the concept of skin in the game. The idea that founders need to be incentivized, to keep working on their start up. If a founder can walk away with his or her full ownership at any point in time, then why would you stay and grind away, start ups are hard. So do single founders need vesting? They do, and the reason is because the skin in the game concept applies to solo founders as well. And investors really want to see all founders, even solo founders incentivized to stay at the company for a long time. And the other reason that single founder should put vesting on their shares is to set an example for employees. Because you can imagine it would be, you know, inappropriate for a founder to tell an employee that he or she has to have four year vesting on his or her shares. But the founder doesn't think that he or she needs any on their own shares. It's really a culture point. A founder who has vesting on his or her shares, then sets the, sets the tone for the company, saying, we're all in it for the long haul. We all have vesting on our shares, we're doing this together. So, what are the takeaways from here? I would say vesting alliance incentives among the founders, if they all have to stick it out and grow the company before any of them get any of that company. And then number two, investors don't want to put money in a company where the founders can quit whenever they feel like it and still have a big equity ownership stake in that company. >> Okay, so moving on. We've now got a beautifully formed corporation in Delaware. Everybody's got their stock. It's all the, the plain vanilla standard paperwork. So, so then what? You know, probably the next stage of a company's life is needing to raise some money. So we're going to, we're going to talk a bit more about that. And you, and, you know, we know that you've already heard a lot from investors and from founders already in, in this set of classes. And they've been talking much more around the tactics and how to raise money but, what about the paperwork? What about when somebody actually agrees to invest, then what? So, first of all in terms of logistics, in very simple terms there are two ways to raise money. So, either the price is set for what the, the money that comes in or the price isn't set. And by price, we mean the valuation of the company it's, it's the same things. So rounds can't actually be called anything people can, can name them whatever they want. But generally if you hear the term, seed round, it would mean that the price has not been set, and anything that's a Series A or a Series B, would be something where the price has been set. So not setting the price is the most straightforward, fast route to getting money. And usually the way that this is done is through convertible notes or safes. And, again this is a two way transaction. So, there's a piece of paper that says, for example, that an investor is paying $100,000 now. And in return, has the right to receive stock at a future date when the price is set by investors in a priced round. So it's important to note that at, at the time the paper work is set, that investor is not a shareholder, and therefore doesn't have any voting rights on the company. They will have some other rights which Carolynn is going to talk about separately. Of course, investors want something in return for putting in money at the earliest, ie riskiest, stage of the companies life. And this is where the concept of evaluation cap comes in, which I'm sure many of you have heard mentioned before. So usually the documents for an un, unpriced round set a cap for the conversion into shares. And that's not the current valuation of the company it's actually an upper bound on the valuation used in future to use used in future to calculate how many shares that investor is going to get. So, for an example, an investor that invests $100,000 on a safe with a $5 million cap. Then a year later the company raises a priced round with evaluation of, let's say $20 million. And then the early investor would have a much, much lower price per share, about a quarter. And therefore that $100,000 would buy them approximately. Four times more shares than an investor that was coming in and putting in 100,000 in that Series A priced round. So that's where they get their, their reward for being in early. So again, this is another situation where you need to make sure you have the signed documents and you, you know where they are, because different investors may have different rights. And so you need to know what those things are. And again services like Clerky can, can help with that. They have very standard documents that most of our YC companies use to raise money on. A couple of other things to think about when you are raising money. Hopefully you've got a really hot company that's, that's doing great and it's really easy to raise money. But you should be aware that all these people throwing money at you does have some downsides. So the first thing is to understand your future dilution. So if you raise, let's say, $2 million on safes with a valuation cap of $6 million. Then when those safes convert into equity, those early investors are going to own about 25% of the company. And that's going to be in addition to the investors that are coming in at that priced round, who may want to own 20% of the company. So you've already at that point given away 45% of the company. So is this really what you want? And, you know, the answer might be yes. Remember that some money on a low valuation cap is infinitely better than no money at all. And if those are the terms that you can get, then, then take that money. But it's just something to be aware of, and to follow through the whole process, so that you can see where this is going to lead you down the road. The other thing to bear in mind is that the invest, investors should be sophisticated. And by that we mean that they, they have enough money to be able to invest and that they, they understand that investing in startups is a risky business. You know we, we see so many companies coming into us that say, oh yeah, my, my uncle put money in, or my neighbor put money in, and they've put in $5 or $10,000 each. And often, those are the investors that cause the most problems going forward, because they don't understand how this is a long term game. And so, you know, they get to the point where they're sitting, thinking hm, I could actually do with that money back because I need a new kitchen. Or, you know this, this startup investing is not actually as exciting as all the TV shows and movies made it out to be. So, and those, those cause problems to the company, you know, if they're, they're asking for their money back. So, just be aware that, that you should really be getting money from people who are sophisticated and know what they're doing. And the term that you'll hear that, that refers to these people are that they are accredited investors. So really the main, the main points here is keep it simple, raise your money using standard documents keep, make sure that you have people who understand what they're getting into, and understand what you're getting into in terms of future dilution. >> Okay. So you're raising money, you understand what you're selling, you figured out the price, you've got down the logistics that Kirstie just described. But what you may find is that you don't understand some of the terms and terminology that your investors are using. And this okay, but you have a burden to go figure that stuff out. Don't assume that just because you've agreed on the valuation of the price that all the other stuff doesn't matter, because it does matter, and you need to know how these terms are going to impact your company in the long run. At Y Combinator Chris and I hear founders say all the time, I didn't know what that was, I didn't know what I was signing, you know? I, I didn't know I agreed to that. So, really, the burden is on you to figure this, to figure this stuff out. And we're going to go over four common investor requests. So, the first one is, board seat. Some investors will ask for a seat on your company's board of directors. And the investor usually wants to be a director, either because he or she really wants to keep tabs on their money. Or because he or she really thinks they can help you run your business. And you have to be really careful about adding an investor to your board. In most cases, you want to say no. Otherwise, make sure it's a person who's really going to add value. Having money is very valuable, but someone who really helps with strategy and direction is priceless, so choose wisely. The other thing, is advisors. There are so many people who want to give advice to startups, and so few people who actually give good advice. Once an investor has given your company money, that person should be a defacto advisor. But without any official title, and more importantly without the company having to give anything extra in return for the advice. So here's an example. At Y Combinator we've noticed that whenever a startup manages to garner a celebrity investor, the celebrity almost always asks to be an advisor. We have a company that provides on demand bodyguard services, and an MBA basketball player invested. Ask to be an advisor, and then asked to be given shares of common stock in exchange for the advisor services. And the services that this person had in mind, this investor had in mind, would be to introduce his company around to all the other professional basketball players who might want to use an on demand bodyguard. But, this celebrity just made a big investment. Shouldn't he want to help the company succeed anyway? Why does he need something extra? All investors who can help, should do so. Asking for additional shares is just an investor looking for a freebie. Okay, next we're going to talk about pro-rata rights. What are pro-rata rights. Some of you may have heard of this before. But, very simply its the right to maintain your percentage ownership in a company by buying more shares in the company in the future. Pro-rata rights are a way to avoid dilution, and dilution in this context means owning less and less of the company each time the company sells more stock to other investors. So, this is a really basic example but, say an early investor buys shares of preferred stock and ends up owning 3% of the company once the financing has closed. And the company raises another round of financing, and the company will go to this investor who negotiated and got pro-rata rights and say, hey, we're raising more money. So you're welcome to buy, you know, this many shares in the new round to keep your ownership at approximately 3%, that is pro-rata rights at their very most basic. So pro-rata rights are a very common request for, from investors, and they are not necessarily a bad thing. But you absolutely as a founder need to know how pro-rata rights work. Especially because, Kirstie touched on this a little bit. The corollary to an investor having pro-rata rights to avoid dilution, is that the founders typically suffer greater dilution. The final thing is information rights. Investors almost always want contractual information rights about, to get certain information about your company. Giving periodic information and status updates is not a bad thing. In fact at YC we encourage companies to give monthly updates to their investors, because it's a great opportunity to ask for help for your, from your investors, like introductions or help with hiring, that kind of thing. But you have to be really careful about overreach. And the investor who's saying they want like a month budget, or a weekly update, that's not okay. So the take-away here is that just because the type of financing and the valuation has been negotiated, doesn't mean that everything else is unimportant. You need to know everything about your financing. >> Okay, so then moving on to after you've got that money. You know, you've raised some money the, the company bank accounts probably showing more zeros than at, than you've ever seen in your life. So, so then what? This is where you actually start incurring business expenses. And business expenses are the cost of carrying out your business. So things like paying employees paying rent for an office, hosting costs, acquiring customers, that kind of thing. And business expenses are important, because they get deducted on the company's tax return to offset any revenues that are made to lower the taxes that the company pays. And on the flip side, if it's a non-business expense that the company incurs, then that is not deductible on the tax return, so that can increase the profits that the company then have to pay tax on. So, again, this is, this is a separation issue. The company will have its own bank accounts, and that's where the company's expenses should be paid out of. again, you know, thinking about this from a, from a large company, if you were working at Google, you would not use a Google credit card to buy a toothbrush and toothpaste. So the other thing to remember is that, you know, the investors gave you this money. They trusted you with all these huge amounts of, of, of money, and they want you to use that money to make the company a success. It's not your money for you to spend how you please. And believe me, we've had some horror stories of founders who take that approach. We had, we had one founder that we knew of who took investor money and went off to Vegas. And boy by his Facebook photos did he have a good time. Needless to say he's no longer with the company. But really this is, this is stealing from the investors. You know, think about it the, the concept of business expenses can get a little bit blurry especially in the early days when you're working outside, working in your apartment and your working 24 hours a day. But the way to think about it is, if an investor asked me what I'd spent their money on, and I have to give a line by line breakdown of that, would I be embarrassed about telling any of the, telling them what any of those lines were? And if you were, it's probably not a business expense. So, the other thing to bear in mind is that, you know, you're busy running your company at 90 miles an hour, just constant, constant. So you don't have to necessarily think about the bookkeeping and accounting at that point, but it's really crucial that you do keep the receipts, so that when you do engage a bookkeeper or a CPA to prepare your tax returns. They can unpick all of this and they can figure out what are business expenses and what aren't business expenses. But they're going to need your help as a founder, because they aren't going to know what all these things are. So, there is some involvement from you and the way to make the involvement the least amount possible, is to keep those documents in a safe place, so you can refer back to them. So, if nothing else that you remember do not go to Vegas on investors money and spend that money wisely. >> Okay, so in this section we're going to talk about just doing business and, we're going to hit a couple of couple of topics in this section. So the first one is founder employment. Why are we talking about founder employment? Because, as we said a couple times already, the company is a separate legal entity. It exists completely separate and apart from U.S. founders, and so no matter how prestigious we in the valley think the title founder is, you're really just a company employee and founders have to be paid. Working for free is against the law, and founders should not let their company take on this liability. You wouldn't work for free anywhere else, so why is your startup an exception? And companies have to pay payroll taxes. We had a YC company that completely blew off their payroll taxes for three years, it was a huge, expensive disaster, and in extreme cases, people can actually go to jail for that, fortunately not in this case, but it's bad. So the moral of this story is setup a payroll service. This is something that is worth spending your money on. But, and I actually I think, I'm sure some of the other lecturers have touched on this points, and actually Kirsty just mentioned too. Don't go overboard on lavish salaries, minimum wage this is still a startup and you have to run lean. So now I'm going to mention founder break ups, and first, well what is a founder break up? In this context I'm talking about one found, founder on the team being asked to leave the company. Which, because I've just said founders are employees, that means your cofounders are firing you. So why are we talking about breakups in the context of founder compensation, and it's because, at YC we have seen a ton of founder breakups and we know that the breakups get extra ugly when the founders haven't paid themselves. Why, how does it get ugly? Unpaid wages become leverage for the fired founder to get something he or she wants from the company, and typically that is vesting acceleration. So the fired founder says, hey, my lawyer says you broke the law by not paying me. But if you pay me, and you give me some shares that I'm not actually entitled to, I'll sign a release and make all this ugliness go away, and if you're the remaining cofounders, you're probably like, sounds like a good deal. And so now you have a disgruntled person who owns a piece of your company and even worse in a sense, the remaining founders are kind of working for that ex-founder, right? Because they're building all the value in the company and the ex-founder who got fired is just sitting there with their shares going, that's right, make it valuable. So, what's the takeaway here? Avoid problems by paying yourself, paying your payroll taxes, and thinking up of your co-founder's wages like a marital prenup. >> And as well as the founders, you are going to need to hire employees. And again, a lot's been spoken in previous, in previous classes here about how to find those people, what makes a good fit, how to make them really productive employees. But when you actually find somebody, how, how do you hire them? You know, what's, what's involved? And employment is governed by a huge raft of laws, and therefore it's important to get this right. It's again the kind of nitty-gritty stuff that as long as you know the basics you can probably keep yourself out of most situations, but as soon as things get complicated you need to get yourself involved with a specialist. So the first thing you need to do is figure out if the employee or if the person is really an employee or a contractor, and there are subtle differences to this classification. And this is important to get right because the IRS takes a big interest in this and if they think you've got it wrong they will come after you and with fines. Both an employee and a contractor will sign documents that assign any IP that they create to the company, and that's obviously really important. But the, the form of the document is very different for each, each type of person and the method of payment's very different. So generally, a contractor will be able to set their own work hours, they'll be able to set their own location. They will be given a project where there is an end result, but how they actually get to that and the means they use will, will not be set. They'll be using their own equipment, and they'll not really have any say in the day to day running of the company or their strategy going forward. And a contractor will sign a consulting agreement, and when the company pays them, the company doesn't withhold any taxes on their behalf, and that's on the responsibility of the individual. But at the end of the year, the company will provide what's called a form 1099 to the individual and also a copy to the IRS which they'll use to prepare their personal tax returns. The opposite side of this is, is an employee, and an employee will also sign some form of IP assignment agreement. But when the company pays them, the company will withhold tax, taxes from their salary, and then the company is responsible for paying those taxes over to the relevant State and Federal authorities. And at the end of the year the employee receives what, a W-2 form, which will then get used to prepare their personal tax returns. So, as Carolina said, the founders need to be paid so do employees, it isn't enough to just say well I'm paying them in stock so that can be, that can be their, their compensation, and they need to be paid at least minimum wage. So, in San Francisco which actually has a slightly higher minimum wage than, than California as a whole that works out to about $2000 a month, so, you know, it's not a huge amount, but it, it can add up. There's also another couple of things that you need to be, you need to make sure that you have, if you have employees. So, the first thing is that you're required to have workers' compensation insurance, and especially if you're in New York where the New York authorities that look after this will send really threatening letters saying you owe $50,000 in fine because your one employee that's being paid minimum wage is not paid the $20 a month workers compensation fees. So it is really important that you do, you do set that up, and the other thing that's very important is that you do need to see proof that the employee is authorized to work in the U.S. you know, founders are not payroll experts and nobody expects you to be one either. This is all just about the basics, but what that does mean is that you absolutely must use a payroll service provider who will, who will be able to look out after this for you,. And services like Zen Payroll are again set up, they're focused on start ups and they help you get this set up in the easiest way possible, so that again you can go back and concentrate on, on what you do best. And in the example that Caroline gave just a few minutes ago, if that company had actually set themselves up with a payroll service provider, all of that heartache would have gone away because it would all of just been looked after for them. They were trying to save money by not doing it and look where it got them. So that's, that's really the key thing, use, use a payroll service provider and make sure that you understand the basics of employment. >> We're running short on time. Yeah okay, so I can breeze really fast firing employees slide and then should, or should we cut it off now for questions? What? >> Why don't we do firings real fast? >> Okay. Okay. Okay, so somebody at YC once said you're not a real founder until you've had to fire somebody. Why is that? Because firing people is really hard. It's hard for a lot of reasons including because founders tend to hire their friends. They tend to hire former coworkers, or they just get really close to their employees because working in a startup is really intense. But in every company there is going to be an employee who doesn't work out. And firing a founder, sorry, firing this employee makes a founder a real professional because he or she has to do what is right for the company instead is what is easy. So I have some best practices for how to fire someone number one, fire quickly. Don't let a bad employee linger. It's so easy to put off the difficult conversation but there is only downside to procrastination. If a toxic employee stays around too long, good employees may quit, and if the employee's actually screwing up the job, you may lose business or users. Number two, communicate effectively. Don't rationalize, don't make excuses, don't equivocate about why you're firing the employee, make clear, direct statements, don't apologize. Example, we're letting you go. Not, I'm so sorry, sales didn't take off this quarter, blah, blah, blah. Fire the employee face to face and ideally with a third party present. Number three, pay all wages and accrued vacation immediately. This is a legal requirement. We don't debate or negotiate this. Number four, cut off access to digital systems. Once an employee is out the door, cut off physical and digital access. Control information on, in the cloud, change passwords, et cetera. We, we had a situation at YC where one founder. Had access to the company's GitHub account and held the password hostage when his cofounders tried to fire him. And number five, if the terminated has any investitures, the company should repurchase them right away. So, the take-away here is that is as surprising as this may sound. One of hallmarks of a really effective start-up founder is how well he or she handles employee terminations. okay. So then, we had this section that we called legitimacy, which actually going to, goes into a little bit more about,. You know, how to be, how to be a real company. How to be sort of a grown up company. And we can totally jettison- >> Is this the last slide? >> >> No. >> We have our take-aways- >> Take away the last slide. >> Take-aways. >> Okay. So, Chris, you want to read the take-aways? >> Okay, so, we've, we've pretty much covered all of these anyway. But, you know, the basic, the basic tenet to all of this is, keep it simple. Do all the standard stuff. And keep it organized to make sure you know what you're doing. Equity ownership is really important. So make sure that you're thinking about the future rather the three months of the history of the company. A stock doesn't buy itself, so again, make sure you do the paperwork for that. Make sure that you actually know about the financing documents that you're signing up to. It's not enough to just say, yeah, I'll take your 100k. Make sure you actually know those rights. And you need to get paid. You and the employees need to be paid. And then, everybody needs to assign IP to the company. Because if the company does not own this IP, there is no value in the company. If an employee must be fired, then as Carolyn, as Carolyn was saying, do it quickly and professionally. The couple of things, that we didn't mention, was knowing your key metrics. At any time, you should know the cash position, you should know your burn rate, you should know when that cash is going to run out. So that you can talk to your investors, about that, and, you know. A lot of running a company is following the rules and taking it seriously. It's not all the glamorous bits that we see in all the movies and TV shows, so you do have to take that seriously. >> Okay. So, it was shorter when we did it the first time. >> That's right. >> Sorry about that! >> >> Sorry. >> If you could get like, two questions in there? >> Sure. >> Yep. How do you advise searching for an accountant? And when in the process do you need them? >> So there's two. So, the question was how do you advise searching for a, an accountant? And when do you. When, at what point do you do this? So, there's two different things. There's a bookkeeper and there's a CPA, an accountant. And generally, bookkeepers will be the ones who can categorize all your expenses. And CPAs are the ones that will prepare you tax returns. In the very, very early days, it's probably fine for the founders to just be able to see the bank statements and to be able to see those expenses coming out. But tax returns have to be prepared annually. And so, at some point in that first year of the company's life, some service is going to need to be. Engaged to do that, because it's just not worth the founder's time to do it. There are services available, like inDinero, which kind of try to, to make things as effortless as possible from the founder's point of view. So that kind of thing is quite useful, but you do need to get a CPA at some point. Because you need to file your annual tax returns for the company. >> And how do you find one? >> Finding one is kind of tough. Probably the best thing is recommendations from people. With, with any kind of specialist, a CPA or an account a lawyer, or anything like that, it's always best to use people who are used to dealing with startups. Again, not your, sort of, you know, your aunt who lives in Minnesota and doesn't actually know how startups work. So, probably recommendations are the best way. Sure. >> Considering what's in a budget for you know incorporating the lawyer for getting legal advice for my first seed round and then for hiring the first employee. Money for that >> So, in terms of incorporation, don't spend a dime on that. You can do that online. >> Well, I, actually, I'm sorry. It does cost a little bit. >> It just costs, yes. >> Incorporating online using a, a, a service like Clerky, which Kirsti mentioned, is inexpensive, like in the hundreds, not in the thousands. So you don't need a lawyer for that part. When you actually need to hire a lawyer is, it kind of depends on what business you are starting, and how complicated it is in terms of, you know, do you have a lot of privacy policies, do you, is HIPA involved, I mean you can imagine, there's like a ton. And so, and also when then you mention when you're raising your seed around. Well, how much money are you raising and who are the investors and what kind of terms are in the term sheet? Sometimes that dictates whether or not you need to get legal council. >> And again, a service like can help if you're just using very standard documents for the fundraising. There are very basic, vanilla fundraising documents so, you can use those. And again, they, they cost you know, less, less than $100, I think, which can save you some legal fees. One more question. >> Do you want to take? Should we go back over this side? I'm going to ignore good luck. Let's go over here. >> Do you guys have any advice or comment on the complexity that comes with working with cryptocurrencies or cryptoequities in particular? Like your fundraising, since that's becoming more and more popular. Oh, wow. That's a tough question to end with. yes. There are, there are some issues. Often banks will struggle to deal with, with companies that are working cryptocurrencies. Because they haven't quite figured out how to, to deal with it, and, and that sort of thing yet. generally, a lot of it, it, it's, it's very product-specific. It, it's not something that kind of has real general advice unfortunately. >> Okay. Thank you very much. >> You're welcome.

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Posted by: pulak on Nov 21, 2014

Lecture 18 - How to Start a Startup

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