Starting Up the Start-Up: Setting Up the Founders' Round


The first two installments of this blog series examined when to incorporate the start-up and how to run a start-up venture prior to incorporation. Once the founders decide to pull the trigger on incorporation (and most often startups that expect to be looking for venture capital funding will incorporate in Delaware), their next significant set of decisions will usually be with respect to the founders’ round of financing.

Common Stock for Uncommon Folks. Traditionally, founders of a startup receive Common Stock while equity investors get Preferred Stock that carries a liquidation preference, special voting rights and often other provisions such as a board seat, dividend rights and redemption rights. In recent years, alternate models have arisen with respect to a third type of founders’ only stock (with names such as Class F Common and Series FF Stock among others). These models are different from each other in important respects, but one thing they have in common is that they seek to grant to founders rights that are traditionally reserved for holders of Preferred Stock. For our purposes, the important thing to note is that insistence on these terms may send the wrong message to potential investors and could cause significant friction in discussions with potential investors and adds expense to the startup process. These “hybrid” varieties of founders’ stock should only be considered by founders who are confident that they will be in a situation in which venture capitalists will be competing to invest in the company so they will have the leverage to insist on such founder-friendly terms. Suffice it to say that the founders of the vast majority of startups that are getting funded today have received Common Stock and not a hybrid security with some Preferred Stock elements.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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