All posts in Startup Law

Section 1045: Let’s Fix It

by Joe Wallin on April 15, 2013 in Startup Law, Startups with 2 Comments

Amend Section 1045If Congress is on the hunt for ideas to make life better for startups and emerging growth companies, here is another:

“Amend Section 1045 of the Internal Revenue Code to extend the 60 day rollover period to 6 months.”

First Off, What Is Section 1045?

Section 1045 is a tax code section that allows non-corporate taxpayers to rollover their gain on qualified small business stock, into other nonqualified small business stock. I’ve quoted the first part of Section 1045 below.

Why is Section 1045 important? Section 1045 is to startups what Section 1031 is to real estate. It encourages investments into startups. A noble objective!

Here is the operative provision I am recommending be amended:

    (a) Nonrecognition of gain
In the case of any sale of qualified small business stock held by a taxpayer other than a corporation for more than 6 months and with respect to which such taxpayer elects the application of this section, gain from such sale shall be recognized only to the extent that the amount realized on such sale exceeds—
(1) the cost of any qualified small business stock purchased by the taxpayer during the 60-day period beginning on the date of such sale, reduced by;
(2) any portion of such cost previously taken into account under this section.
    This section shall not apply to any gain which is treated as ordinary income for purposes of this title

Why Amend It?

60 days is a very short window in which to find a replacement investment. If you have ever done angel investing, you will know. To find and close an investment in 60 days is not an easy task. Usually investors hunt for months before they find an investment that they like. Then the paperwork to effectuate the investment can sometimes take weeks as well, if there is back and forth on various business points as the deal is negotiated.

In short, the Section 1045 statute exposes a lack of understanding on the part of the drafter as to how these transactions work. You can’t just call your broker and place an order. Most angel investments are not effectuated through a broker-dealer (which is one of the flaws of the crowdfunding bill–forcing companies who want to crowdfund to work through a broker-dealer).

Conclusion

We need is a Congressional representative to introduce a bill extending the 60 day window to 6 months. Very simple. Could someone please do this?

How Dilution Works

by Joe Wallin on March 13, 2013 in Financings, Startup Law with 7 Comments

How Dilution WorksSometimes founders will ask me the following question:

    “The founders stock will be equally diluted when we bring in new investment money, right?”

And sometimes they will ask me:

    “When the company raises money, do we give some of our shares back to the company? How does it work?”

Let me show you an example of how it works:

Bill and Paul form a software company. Bill gets 60% of the shares, Paul gets 40%.

They plan to issue 1,200,000 shares to Bill, and 800,000 shares to Paul.

Their lawyer also told them at the outset to adopt a stock option plan, representing 10-15% of the issued and outstanding shares, to get the adoption of the plan out of the way, and to have it available right away so that when they started hiring employees and independent contractors and board advisors they can grant options. They did that, and put 300,000 shares in the plan.

Immediately after the founding of the company, the cap table looks like this:

Bill 1,200,000 52.17%

Paul 800,000 34.78%

Pool 300,000 13.04%

2,300,000

When they go to raise money, the company will issue new shares out of its “authorized but unissued” shares. The founders won’t give back any shares.

What are authorized but unissued shares? These are shares the company has authorized in its articles of incorporation but not issued. In the above example, the company would probably have 10 million shares authorized. In this instance the company has only issued 2 million, and reserved 300,000 for issuance under the pool. So it has plenty of shares to issue to the investor. If the company sold 200,000 to an investor, the cap table would look like this afterward.

Bill 1,200,000 48.00%

Paul 800,000 32.00%

Pool 300,000 12.00%

Investor 200,000 8.00%

2,500,000

Question & Answer: IP Assignment Agreement

by Joe Wallin on March 11, 2013 in Startup Jargon/Definitions, Startup Law with 1 Comment

Q&AQuestion:  I had some friends help me in the very early stages of my startup.  For example, one of them helped design our logo.  Another one helped me with an instructional video explaining our product (the video can now be found on YouTube).  I hate to be obnoxious, but should I have these folks sign an IP assignment agreement assigning the IP they helped me create to the company?  Do I or should I pay them anything?  I don’t want to be a jerk about this, but I also don’t want to be a fool.  Can you help me out?

Answer:  These are really good questions.  Yes, you should most definitely have these folks sign an IP assignment agreement.  It doesn’t have to be obnoxious.  It doesn’t have to be long.  Your lawyer can help you prepare a simple legal document for them to sign.  It frequently can be as short as a single page. You can explain that the company needs this for its records/due diligence files as it goes out to raise money.  Be sure to pay your friends something.  An IP assignment without any consideration could fail for lack of consideration.

Similarly, if you hire someone to consult for you, don’t have them sign a full blown consulting agreement but not pay them anything.  The  critical parts of most consulting agreements are the IP provisions.  You want to make sure whatever IP your consultants create for you belongs to your company.  This won’t happen if you don’t pay your consultant anything.  The IP assignment provisions might fail for lack of consideration.

← Older Entries