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Ask HN: How should we structure this company?

6 points by person_b ↗ HN
Ask HN: How should we structure this startup?

Cast of characters: Person A has a significant consulting practice in an industry and wants to start building tools for clients that A thinks are resellable (a la 37signals). A's got a prototype that is functional but doesn't scale both technically and as a product (only integrates with one client) etc.

Person B: Not interested in contract work but interested in working for equity stake in the company. Smart technical guy who has worked with A in the past.

Backdrop:

Person A and B get along well, have worked together successfully in the past and during the development of the project. B has now completed a rewrite of the software to support multi-tenants, scale to some reasonable estimate and the product is ready to go. A is now working with his consulting client base to begin generating revenue for the product. It looks like the product will make revenue, but relatively meager in the first few years (maybe enough to pay these guys a mid-5 figure salary if all the clients sign up).

Questions:

How should this company be structured so that it can function as a lifestyle business for both A and B? What should A and B do to protect themselves from the other no longer participating in the business? What if A and B want to take investment in the future? If the percentage ownership is different for A and B, what's to protect the lesser owner?

Possible endings:

- Give A and B profit rights in an LLC

- A and B get equity that vests over time

- A and B get full equity immediately with some buyout provision

Thanks for reading this far and of course, we are also consulting a lawyer but would like to get founders' opinions as well.

6 comments

[ 0.26 ms ] story [ 21.4 ms ] thread
paulsingh
LLC: easy to setup, vesting/equity can be tricky, pass through taxes. C-Corp: harder (more expensive) to setup, vesting/equity relatively easy, double-taxation.

If you can swing it, I think the "right" way would be to setup a C-Corp so you've got all your ducks in a row from the get-go -- you won't need to worry about restructuring if you ever add staff/funding in the future, one of you decides to leave, etc.

If nothing else, I strongly recommend that you setup this new product outside the existing company that the consulting is done under. (I have direct experience with this as one of the companies I'm advising had to deal with this mess recently when they wanted to give out equity to employees, deal with investors, etc.)

person_b
Hi paulsingh - thanks for the input. Agreed on setting it up outside the existing company that the consulting is done.

If we did it in the C-Corp, do you have any advice for how to handle the equity? Do both founders vest into it over time?

Not implying this would happen as both parties are relatively reasonable in this situation, but in situations where the companies aren't split equally, what's to prevent the majority stakeholder from diluting the minority stakeholder to nothing or to change the terms of the agreements themselves?

paulsingh
Vesting: Absolutely, no questions about it. Everyone should vest -- this keeps someone from getting equity and immediately quitting (for example).

You'll want to talk to a lawyer about anti-dilution provisions but I suspect that you'll want to make sure that the minority shareholder has voting rights to prevent situations like the one you describe.

FWIW, this is a relatively "vanilla" type of situation. (You'll setup a new company, each of you will sign over the IP to the new product and then have equity stakes in this new entity.) Have a lawyer review all the docs before you sign them and this will be pretty straightforward -- please do yourself a favor and don't cut corners just to save a buck. :)

Scott_MacGregor
Since you may want to raise money, a Delaware Corp, with shares vesting over time for both A and B seems like a good fit. As far as profit splits go, that can be set forth in the bylaws however you want. A buyout option provision seems like a good idea too.
person_b
Curious how buyout provisions are usually priced - seem like several options to me but none seem optimal:

1. Based on some predefined amount 2. Based on some metric like revenue of the company, number of customers 3. FROR from an outside offer

Any other suggestions for methods?

Scott_MacGregor
You can base it on anything you want that seems fair to both of you. Sometimes in a company that is a good size but is not public, you might want to require a third party to evaluate the value of the company, and set forth a timeframe for the buyer to come up with the cash or note to buy the shares with. In a smaller company your CPA can probably come up with a value for you.

One thing to think about is what serves you now may not serve you in 2 years. If that is the case you can change the wording to suit the circumstances better when you need to. Talk to your attorney and ask what seems best based on your situation now.

One reason a buyout clause is smart, is that corporate shares are considered the same as money by a divorce court and can be assigned by the judge to the person's ex spouse. Meaning you could have a hostile, non-contributing person on your board. So be sure to talk to your attorney about that.