Legal Question in Business Law in California

I'm a recent college graduate who's been contacted by a student at the Stanford business school to work on an internet startup. He just got an engineering degree and developed a website that he wants me to help with, and VC or angel investor funding seems imminent. I've negotiated with him and he's offering me 60/40 ownership, which seems fair because he did a lot of work to set up the site and he's using his newly formed connections to secure funding.

One concern, though, is that I've never met him in person. He actually found me through a Stanford mailing list, but I've moved home recently so I can't meet him in person. While he seems like a legitimate partner and definitely a bright guy, there are still many unknowns. But given that I don't have any obligations right now and this is a once-in-a-lifetime opportunity, I feel it's worth the risk. I'm going to make sure to agree to some sort of legally binding contract before we even get investor money, and we're both going to gain equity through a 4 year vesting schedule with a 1 year cliff.

Of course, I probably need to consult with a lawyer in person, but I was wondering if you had any general advice about how to proceed. What do I need to do to set up the best basis for incorporation? I've read it's best to set forth the agreement before we get funding, but I don't have much money and I'd obviously like to keep legal fees as low as possible. I hear Y Combinator provides free generic forms (http://www.ycombinator.com/seriesaa.html), but I don't know enough about the legal aspect yet to know if they're suited for us.

Also, how do we agree on our division of labor? He's in business school right now and I'll be working full time on this project, so I'm worried about how much time and energy he can devote to the project. He's not willing to take a leave of absense at the moment. What sorts of agreements do people usually make in those circumstances? Also, we'll be paying our living expenses with investor funding. How do we decide on what we'll pay ourselves, and how will we go about doing that?


Asked on 10/12/10, 12:23 pm

4 Answers from Attorneys
Edward Hoffman Law Offices of Edward A. Hoffman

How sure are you that this guy is for real? Being contacted out of the blue by a stranger for something like this should raise several red flags.

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Answered on 10/17/10, 12:40 pm
Steven Hertz Hertz Steven H.

FIrst, you should enter a written agreement as promoters saying what you will do between the two, of you, and what will be the return. I assume 60/40 means ownership. But then what do investors get for their investment? I recommend that you incorporate at some point in time because it is the best form of business entity. Your terms between you will be in the form of a shareholder agreement. The shareholder agreement explains who will own shares and how the shares are held, and whether they can be sold outside the company, whether the company will be subchapter S for tax purposes. After you incorporate, or at the same time you enter the shareholder agreement.

When a company takes on investors it must stay within the SEC and State Securities rules in order to avoid civil and criminal liability. The most important part of raising investment money is to have a full and complete disclosure of the risks involved. This is usually done by a document title "Private Placement Memorandum". After investment money is offered, but before it is paid to the company, the company must register the investment with the State. The investment might be exempt from Federal Registration, but may still have reporting requirements. If you start as a partnership, you can incorporate later and take on investors after there is a budget for it.

Another exemption from registration may exist for managing board members putting their own money into the company in exchange for ownership, similar to a partnership.

Promoters are generally remunerated for their services in promoting the company by being paid in cash as reimbursement, or under a contract, or they may be at some point employed to perform services. After the company is formed, it can agree to pay and pay salaries or dividends when they have been earned. The company can also agree to pay a promoter after the work is performed by ratification of the expense by the board of directors. The company can issue and the promoter can accept an IOU or promissory note in exchange for the services of the promoter. Alternatively the company can guarantee or offer stock in exchange for "in kind" services.

Every transaction involving securities (stock for investment or LLC shares for investment money) must be guided so as to avoid the pitfalls of SEC rules and State Securities Laws.

Anyone who works at advancing the company's interests should be paid a salary whenever this is possible. Hope this helps you.

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Answered on 10/17/10, 12:53 pm
Deborah Barron Barron Law Corporation

If you are going to get investors you should start with a business plan which will show the projected profit and loss. You should provide for salaries in the projected P & L. Depending on the number of investors, you could start as a closely held S corporation and later change to a C Corporation for a public offering. Whether or not you need a private placement offering memorandum depends on how much capital you need to raise from investors. You should have an attorney help you decide how to proceed so you are not in violation of the SEC and also to protect your interests should this company become successful, you want stock and and an agreement in writing.

Since you will have a minority share, the company decisions will always be subject to the controlling shareholders vote. Feel free to contact me should you have any further questions email me:. [email protected] or visit me at: www.lawbarron.net

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Answered on 10/17/10, 2:41 pm


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