Setting Aside Shares

I give a lot of presentations on incorporation and organization at universities. One time, one of the students present had a great question about shares: “how do you know how many shares to issue to the founders and how many do you set aside for future financing rounds?”

Great question. Now let’s debunk a myth about “setting aside shares”. This does not actually exist. That’s right – you read it correctly. Setting aside shares is pure fiction… At least it is 9,999 times out of 10,000. The issue of setting aside shares only really comes up if you have a limited number of shares you can issue under the articles or the company. But why would you ever, EVER, limit the number of shares you can issue?! Makes no sense to do that in a startup – at least not at the beginning…

When you incorporate, your lawyer will (rightfully) recommend a plain vanilla share capital to start with, i.e. common shares, of which an unlimited number may be issued from time to time by the board. Voilà! No need to set aside shares. You’ll issue them as you go.

Getting Organized

Incorporating your startup is not enough. You need to get it organized. Organizing a corporation involves several steps, and at a minimum includes:

  • Organizing resolutions of the directors (including adopting by-laws, a financial year-end, appointing an accountant, choosing a bank and issuing shares to shareholders).
  • Subscription letters for shareholders (i.e., each founder needs to tell the corporation how many common shares it should issue).
  • Payments for the subscribed shares (yes… you have to pay for your shares, even if they are issued for a nominal amount).
  • Issuance of share certificates or confirmations of shareholdings (the latter being available under the QBCA only).
  • Organizing resolutions of the shareholders.
  • Acceptances of office by directors.
  • Preparation of corporate registers.

Although this is a good start, your investors are going to expect a few more things when they review your minute book. Take a look at these optional, but highly recommended, steps:

  • Each founder should execute a confidentiality and intellectual property assignment agreement. Why? Because without this, the founders own the intellectual property and not the corporation.
  • Each founder should execute a (reverse) vesting agreement.
  • Planning on issuing options to employees? Might as well adopt a stock option plan while you’re at it.

Lastly, there are shareholders agreements. Not all startups opt for a full-blown shareholders agreement at the time of organization because, admittedly, they can get a bit expensive. The decision to go forward with a shareholders agreement before your first investment should be taken after speaking with your lawyer. Although there are certain clauses which are standard, shareholders agreements tend to be more customized than any other document.

And when it comes time for your first round of investment, the investor may simply require that the existing shareholders agreement be replaced by the investor’s preferred model agreement. Be careful – it doesn’t mean the investor’s model isn’t good for the founders either, but you should get this reviewed by your legal advisor before you sign it so you understand what you’re getting into. (This isn’t like an EULA where you just scroll to the bottom and click “I Accept”… But as a savvy entrepreneur, you would read it in full before clicking anyway, right?)

Contracts for Startups 101

If you can read code (any type of code), you can read a contract. Yup – that’s right, contracts and coding have a lot in common. In fact, many of the skills I learned as a web programmer have helped me with drafting contracts. Show some code to a lawyer, and they’ll probably look at you like you’re from Mars. Show a contract to a programmer, and they’ll probably think the same. But at the end of the day, coding and contract drafting are extremely similar exercises that rest on having a logical base on which to build upon. So with that in mind, I thought it would be useful to have a short post on how to read a contract if you see things through the eyes of a programmer.

Variables are an integral part of any code. You set your variables up at the beginning in order to be able to use them later on. Let’s take an example for a financing:

<?php
//variables
$var1 = 100000;
$var2 = 50000;
$total = $var1 + $var2;
//Output on page
echo “An amount equal to $”.number_format($total).” shall be invested by the Investors in the Corporation.”;
?>

(Go ahead and test it. It works!)

What did we do here? Variable 1 is $100,000. Variable 2 is $50,000. So when the script runs, the number $150,000 appears as the result after the dollar sign. Now let’s take an example using contract drafting:

“Investor 1 Amount” means $100,000.
“Investor 2 Amount” means $50,000.
“Total Investment” means the sum of the Investor 1 Amount and the Investor 2 Amount.
And then, in the body of the contract, you would have “An amount equal to the Total Investment shall be invested by the Investors in the Corporation.

In each case, we need to define variables to use them in other parts of the document. The code actually produces a number. Contracts don’t do that, so we simply restate the defined term instead.

But as you can see, the logic of programming applies to contracts in a very similar fashion. Hopefully, if you can understand programming, this post has helped make reading contracts a little less daunting.

Incorporation

So you’re ready to take the plunge and incorporate. Fantastic!!

But before you run off to some website which offers you a low-cost incorporation service (and I’m sure that same website will tell you how unnecessary lawyers are at the incorporation stage), here are some things to think about:

  • Are you going to incorporate federally or provincially? (Do you know the difference?! Or why one would be preferable over the other for your particular circumstances?)
  • Where will you be registering the business?
  • Will the founders acquire all of their shares immediately? How many shares will you issue to each? Ten? A million? What will be the subscription price?
  • Will there be any restricted stock?
  • Are you going to issue any options to key employees who are not necessarily founders? (Oh, you are? Well, what does your stock option plan look like?)
  • Do you have your employment agreements ready to be signed?
  • Ditto for your confidentiality and intellectual property assignment agreements?
  • Wait… You mean the low-cost incorporation service doesn’t offer all these? You mean they have big disclaimers saying they don’t provide legal advice and will not be held responsible for your mistakes in incorporating?! Can’t find the answers in their Q&A?!!

Ok, I’ll turn down the sarcasm. Seriously, consult a lawyer before you do anything on this front. I can’t tell you how many startups come and tell us that we don’t need to look at their minute book because “everything is done”. The second we starting asking any one of the questions above, shoulders droop, gazes are averted and frustration sets in…

Save yourself a lot of time and believe it or not, some money, and go see a lawyer first. It’s almost always more expensive for a lawyer to clean up mistakes like this than it is for the same lawyer to do the work correctly from the start.

Founding

So you saw the Social Network and started chatting with some friends. You’ve got some great ideas and you think you can turn those ideas into a viable business. You’ve finally decided to take the plunge and found a start-up. First off, congrats! Now, any idea what you’re in for? At the time that the Social Network came out, Mark Zuckerberg, in trying to play down some of the myths about founding a startup, said this about founding Facebook:

“I mean, the real story is actually probably pretty boring, right? I mean, we just sat at our computers for six years and coded.”

Mark Zuckerberg

It’s incredible, but that short sentence speaks volumes.

It’s boring?

I suppose what Mr. Z was trying to say is that real life isn’t like the movies. It’s not all glitz and glamour (in fact, there’s very little of that). Founding a startup is hard work, and if you think that it will be anything other than work, work, and more work, you’ve got another thing coming. And often times, it can be a bit tedious – anyone who has ever done any programming will tell you that (and yes, I’ve done some programming – it’s how I paid my way through law school).

It takes years

Although the actual act of founding a company isn’t too lengthy a process, the work involved in bringing an idea into fruition, while at the same time creating a business around that idea, can take years. Rome was not built in a day. And in today’s world, you have to continuously improve and reinvent yourself – lest you get invaded by barbarians who pillage your town (I’m looking at you, Odoacer…). So if commitment isn’t your thing, you may want to rethink the whole startup gig.

You’re not alone

Chances are you’re not a one-man (or woman) show. You’ve got a small group of initial founders, but the size of the team will evolve over the years. Right from the start, you need to think about who makes up that founding team and what each person brings to the table. You’ll also need to think about what happens when someone leaves (willingly, or otherwise) and what happens when you want to bring someone new on board. You’ll also need to think about selecting the right advisors (lawyers, accountants, investors, etc.).

The point is that there are tons of things to think about when you’re just starting out. And it’s OK to feel a bit overwhelmed. Just remember that founding a startup is a long term commitment which will make you sweat, laugh and cry, but also remember that you’re not doing it alone. There are people who will rely on you, and there are people you can rely on too.


Idea vs. Business

What’s the difference between an idea and a business. I can’t tell you how many times I’ve come across young entrepreneurs who, although they have no shortage of ideas, don’t understand that the idea is not enough. As Thomas Edison once said, “The value of an idea lies in the using of it.” Don’t forget this.

It seems like everybody these days has “app fever” (and the only prescription is more cowbe-… financing!). Angels and VCs do not invest in ideas… They invest in the businesses which are run by people who have ideas (and dedication, ambition, and dedication, and more dedication… and did I mention dedication?). So what makes a business, you ask? Well, Investopedia defines it as:

An organization or enterprising entity engaged in commercial, industrial or professional activities. A business can be a for-profit entity, such as a publicly-traded corporation, or a non-profit organization engaged in business activities, such as an agricultural cooperative.

Investopedia

If you’re in a startup, you can ignore the last part of the definition (non-profits don’t make good financing targets!). But if we look at the first sentence, there are a few keywords to consider: organization, engaged, activity. Boil this all down, and you get an “organization which is engaged in some sort of activity in the hope of some day making a profit” (we’ll talk about those in a later post). Apps are not organizations. It’s best to think of them as products or services. These are things a business offers.

Organizations involve people. They require leadership and teams. These teams put into action the ideas which drive the “business” by engaging in certain fundamental activities. If you’ve ever taken a marketing class before, you may have heard of the 4Ps (product, price, promotion, place) and the 4Cs (consumer, cost, communication, convenience). I won’t go into them here, but you can get a short summary on Wikipedia. So if you really want to impress some potential investors, know your business, not just your idea.

Date Your Angel!

So you’re out at an event and someone starts chatting you up around the free pizza table… You talk about yourself, but you’re careful not to talk too much about yourself. (You’re sensitive to that sort of thing and don’t want to come off too “full of it”…). You ask your new friend about themselves. What they do. What they’re into. What they’re looking for in a relationship. They smile,  you smile back. Seems like things could get interesting…

STOP.

Just because that cute girl or hunky guy at the bar is making eyes at you, doesn’t mean you should take them home without getting to know them a little better.

THE SAME RULE APPLIES TO ANGEL INVESTORS.

Angels will be among the first people you meet who are looking at your startup as an attractive investment opportunity. Take the time to get to know them before you start signing on the dotted line of the term sheet. (Actually, the lines aren’t dotted any more… somehow the expression still sticks though…). Just because someone is ready to throw some money at your startup, it doesn’t mean you need/should take it.

Your investors are with you for the medium to long term. They’re going to ask for certain rights in their term sheet. They’re going to ask you and your startup to perform certain obligations. And in exchange, you should be asking for more than just money. Good mentorship in the early stages is paramount. And in the era of crowdfunding and alternative financing opportunities, mentorship is probably more important than the money itself. So make sure that your angel is the right “fit” for you.

How do you know what makes a good fit? It’s the same as any other relationship. Do you communicate well together? Do you have similar interests? Do you dedicate enough time to one another? And by the way, just like any other relationship, it takes lots of hard work to make it a success over the long term. If the plan is to take the money, issue the shares, and have a few meetings and then never speak to one another again, you’re wasting your time and theirs… Not to mention giving up valuable equity which could be put to better use with a more appropriate investor.

So, word of advice: Date your Angel. Put your best foot forward, and demand that they do the same. You each owe it to yourselves before going any further down the rabbit hole.

Boards: Directors’ Obligations

What does it mean to have a seat on the board? It means responsibility. It means long term strategic planning. It means keeping an eye on the bottom line. But above all else – at least, in Canada that is – it means acting in the best interests of the corporation.

And that, my dear friends, is a very loaded expression. But instead of telling you what it does mean, it’s perhaps more helpful if I tell you what it does not mean. Under Canadian corporate law, acting in the best interests of the corporation does not (well, at least not necessarily) mean acting only in the best interests of shareholders. This is a key distinction between Canadian and US corporate law.

In the Canadian context, shareholders are certainly important, but there other considerations. In fact, here it is straight from the Supreme Court of Canada:

In considering what is in the best interests of the corporation, directors may look to the interests of,inter alia, shareholders, employees, creditors, consumers, governments and the environment to inform their decisions. (see the BCE Decision at paragraph 40)

To some of my American readers this may seem preposterous, but it is the law in Canada. Let me reiterate the point with another quote from the Supreme Court of Canada:

The fiduciary duty of the directors to the corporation is a broad, contextual concept.  It is not confined to short-term profit or share value. (See the BCE Decision at paragraph 38)

So whether you are a founder or an investor, before you take a seat on the board, make sure you understand that the decisions you make as a director have to be in the best interest of the company, and not in the best interests of your pocketbook. This does not mean that the two are mutually exclusive. But there may be times where both founders and investors alike have to make decisions which are not in their personal interests, but are in the interests of the corporation. Failure to do so exposes the director to claims of oppression and breach of statutory duty.

So take a seat, but take it with your eyes open.

Corporate Names: Choosing a Name

Choosing a name for your company usually involves a pen, a note pad and a lot of head scratching.  You want to pick a name that people will remember – something catchy – which is easy to write or type. But what don’t you want?

Easy. You don’t want a name for your company which violates someone’s trademark. And you don’t want to pick a name which is illegal.

Trademarks and company names

We’re lucky that in Canada and the United States, there are federal databases for trademark registrations. Other jurisdictions around the world have them too, but let’s keep the focus on Canada for a moment. Trademarks are a form of intellectual property which entitle the owner of the trademark to exclude others from using their trademark for unauthorized purposes. Who decides what’s an authorized purpose? The owner of the trademark.

In Canada, CIPO is where you’ll want to run a first check of the name for your company through the trademarks database in order to see if it is actually part of someone else’s trademark.

Sometimes, a company doesn’t go as far as registering a trademark, but will use a trade name (or “nom d’emprunt” in French). Think of it as a form of unregistered trademark. This unregistered form of intellectual property also entitles the owner to some rights (although not as clear cut as the registered form). For this reason, Industry Canada requires incorporators to submit a NUANS report prior to incorporation which shows that no other CBCA corporation uses the proposed name for your company. In Québec, you’ll want to run a search on the website of the REQ to see if anything pops up as well, whether you’re incorporating under the QBCA or simple registering to do business in Québec.

One of the trickiest issues comes up when a corporation has incorporated without a specific name – meaning Industry Canada or the REQ has simply assigned a number (ex. 1234567 Canada Inc. or 1234-5678 Québec Inc.). These corporations may also have trade names which they have indicated to the REQ, but it won’t be readily apparent because of the numbered legal name. So keep an eye out for those when picking a name for your company.

Language laws and naming regulations

You also need to think about applicable language laws and naming regulations. For example, you can’t pick a corporate name which is prohibited by law, misleading or otherwise restricted by regulation. Little known fact: you can’t call your CBCA incorporated company “Parliament Hill Inc.

And you also need to make sure that if you are doing business in Québec, you have a French language version of your name – even if your name is a made up word with no obvious French language equivalent.

So before you settle on a name for your company, before you begin investing money in logo design and brand image, run the name by your lawyer. A couple of bucks spent early on can save you thousands later, and a whole lot of headaches.