Lecture 18 - How to Start a Startup
0 (0 Likes / 0 Dislikes)
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 Clearkie.com.
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.