START-UPS & EARLY RAISES

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START UPS OFTEN DEFAULT TO USING AN LLC OR S CORP AS ITS INITIAL CORPORATE FORM, BUT THERE ARE LIMITATIONS IN USING AN LLC OR AN S CORP CORPORATE STRUCTURE WHEN SEEKING INVESTORS

HERE ARE SOME CONSIDERATIONS TO EVALUATE BEFORE MAKING  YOUR DECISION ON THE RIGHT CORPORATE STRUCTURE WHEN FORMING YOUR COMPANY & WHICH STATE IN WHICH YOU WILL REGISTER YOUR COMPANY 

FIRST: WHAT STATE WILL YOU INCORPORATE IN?

There are several points to consider, but three. of the most defining considerations is whether you will seek investments from private, venture or institutional investors, which state has the most developed corporate law and income tax considerations.

SECOND: WHICH CORPORATE STRUCTURE SUPPORTS YOUR ABILITY TO SEEK INVESTORS?

Investors, certainly sophisticated and institutional investors, rely on the C Corp structure when deciding to make an investment.  The reason: it is the most formalized corporate form and allows for different classes of ownership.  This is key for investors who will seek preferred shares issuance whether in investment rounds or issuance of a SAFE or Convertible Note.

Example: When you start with an LLC and later seek sophisticated investors, you will need to convert your LLC into a C Corporation to create the formal structure they are seeking. This is an expensive process and can be a time consuming process if you have multiple investors who hold SAFEs with different valuation caps, convertible notes and equity through Crowdfunding Agreements.  Why? You will need to obtain their approval of the LLC to C Corporation conversion and address the type of equity interest they will be converted to, which may be different (and less advantageous) than what they would have received through their original investment terms.

S Corporations can not issue more than one class of shares, so this corporate form is not a viable option for issuance of a SAFE (which provides for preferred shares upon certain triggering events) or any other investment vehicle that will result in preferred shares issued.

START UPS OFTEN CONSIDER USING A SAFE OR CONVERTIBLE NOTE

HERE ARE SOME INITIAL CONSIDERATIONS TO EVALUATE BEFORE MAKING THAT CHOICE TO OFFER AN INVESTOR A SAFE OR A CONVERTIBLE NOTE;

FIRST: Before considering how much to seek in investment using a SAFE and the terms of that investment the company must invest in creating a CAP Table to identify shareholders, types of shares (common, preferred, options) and the ownership percentage of each as well as the investment dates, prices per share and investment amounts.  A company may reserve shares in an  Option Pool for employee stock options, that will be included as well as vesting schedules for when issued options or restricted stock vest.  The CAP Table information is used to create a 409A Valuation to determine the Fair Market Value of shares.  Organizing this critical information will enable a a company, and its potential investors, to negotiate terms that will be mutually beneficial.

SECOND: A SAFE does not have a fixed maturity date but includes trigger events that will convert it to preferred shares in a company.  The terms of the SAFE will vary even among SAFEs issued to different investors at the same time or as funds are raised on an ongoing basis.  A SAFE may include a Valuation Cap or Discount Rate or other options depending on the issuing company's and the investors' negotiation of the terms, keeping in mind future financial raises.

THIRD: A Convertible Note is a debt instrument with a defined maturity date.  Terms of the Convertible Note will identify, among other things, the interest rate and a variety of conversion triggers that result from actions taken by the issuing company that provide the Holder of the Convertible Note either an option to convert upon certain events or an automatic conversion upon certain events that occur during the term of the Convertible Note.