Founders & Startup 101: Part V) Capitalization, Cap Tables, & Initial Accounting

Many founders are asked during the funding process for a “cap table.”  So what exactly is a cap table and where do you get one?

In this article, I will explain what cap tables are, how to prepare one, review capitalization, and the initial accounting associated with startups.  This article is meant to be educational only and should not be used as legal advice.  Laws and regulations can vary by state and particular circumstance, so if you have specific questions, you should consult a local licensed attorney.

I)  Capitalization

People need to have a basic understanding of what capitalization of a company means before they can really understand what a cap table is.  Capitalization is a term that deals with the capital structure of the company.  It is made up of the amounts and types of financing used by a company. Types of financing include common stock (which can include founder’s stock), preferred stock, retained earnings, and debt.  It provides a general overview of the company’s debt and equity (See Part I to understand equity).  You add the long term debt, equity, and retained earnings together for the normal total number.  Most people are familiar with a version of this called market capitalization or market cap.  That is essentially taking the number of issued shares of common stock times the company’s current price per share for a total number of market cap.  It is one number used to determine an estimated value of the company as a whole.  It can also change due to accounting changes due to various transactions.

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Founders & Startup 101: Part IV) Private Placements, PPMs, & Fund Raising

So what exactly is a private placement memorandum (PPM) and why do I need one?

This article goes over the basic information about what a PPM is, when and why you may need one.  This information is being provided as a general overview and a basic education of the common terms and federal securities laws involved with a PPM.  Each state has their own securities laws and the discussion in this article is not to be used as legal advice, as each circumstance is different and you should consult with a licensed attorney in your state to be sure that any PPM or offering you do complies with all current laws and regulations.

What is a PPM?

A private placement memorandum is an offering document, sometimes called a prospectus, offering circular, or PPM.  The majority of early startups and emerging growth companies commonly raise money through what are know as private placements.  It is simply a sale of stock (or debt) in the company to private investors that become shareholders in the company.  The reason they are classified as private, is not because they are private investors, but because the offer and sale of stock (a security) does not involve any public advertising or general solicitation of investors.  For example, when a stock goes public, they are offering stock publicly by filing a registration statement, press releases, etc.  This process of registering the securities with the SEC allows the company to utilize the media and other methods to offer its stock for sale.  Since most companies don’t have the money or resources to file a registration statement with the SEC, they rely upon selling the stock through exemptions from registration.

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Founders & Startup 101: Part II) Forms & Sources of Funding

So you developed the next big app or social media website idea, formed an entity, and developed a business plan, now how do you get funding?

This is the second part of a series of blog articles that will explain in layman’s terms some of the things that every founder should know about the types of equity and how common forms of funding relate to your company’s equity.  All answers and discussion are meant to be educational only and should not be relied upon as legal advice for your specific situation.  I will discuss things generally and as applied in California, so this is not meant to be all inclusive, but a general basic education.

Here is part II:

There are many forms of funding and sources.  This gives a basic description of the most common forms of funding a startup company and where the funding comes from.  This is only a basic brief discussion to give beginners an understanding so they understand some basic terms.

A)  Debt Finance

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Founders & Startup 101: I) Forms of Equity

So you developed the next big app or social media website idea, formed an entity, and developed a business plan, now how do you get funding?

This is the first in a series of blog articles that will explain in layman’s terms some of the things that every founder should know about the types of equity and how common forms of funding relate to your company’s equity.  All answers and discussion are meant to be educational only and should not be relied upon as legal advice for your specific situation.  I will discuss things generally and as applied in California, so this is not meant to be all inclusive, but a general basic education.  I am also using a C corporation for the discussion relative to equity structures, so this doesn’t necessarily apply if you formed an LLC (limited liability company) or other type of entity.

Here is part I:

I)  Forms of equity (ownership interest in the company)

Founder’s Stock– This is a generic term often used when dealing with start up companies.  This is the stock issued by the company to the founder’s of the company.  The most common way this occurs is that the corporation is formed and then there is a corporate resolution to issue a portion of the corporation’s authorized stock to the people who started the company.  They are usually issued in exchange for the founder’s initial services to start the company, for technology assigned to or developed for the company, or for some other thing of value, such as cash provided to the company.  It is pretty typical that a company issues common stock as founder’s stock versus preferred stock.  It is usually no different than any other type of common stock issued by the company, other than it was issued to those who founded the company.

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Founders & Startup 101: Part III) Finder’s Fees

Part III)  Finder’s Fees

So you have a great idea, founded a company, and you are telling your friends and family about it.  It is difficult to succeed without some working capital, i.e. cash in the bank.  If you are new to startups or haven’t had to worry about raising money before, you suddenly are introduced to a new world of people who claim they have very rich friends or “know people.”  They would love to help you raise some money, but they want a piece of the action.  They may ask you for a percentage of the cash their “people” bring in, a percentage of equity in your company, a job with your company, or maybe some combination of these.  So what can you do to compensate someone who claims to be able to bring you in anywhere from a few thousand to many millions of dollars in funding?

This is a very common problem that founders and early startup companies face. Here are some common questions:

  •  What the “norm” is for these types of deals?  None, if done, they vary widely on circumstance.
  •  What percentage of equity should I give them?  Probably not a big deal what you give as long as you still retain control of the company and are allowed to dilute them down in the future
  •  Should I use options instead?  Possibly.
  •  Should I just give them cash?  Probably not.
  •  Am I wasting my time with this person or can they really can bring in the dough?  Probably.
  •  Should they sign some kind of non-disclosure agreement (NDA) or other legal document?  Probably, yes.
  •  Are there any risks to me or the company if I go with this person?  Yes, even if they are licensed or registered to be a broker/dealer.
  •  Can I pay my employees or bring the finder on as a VP to pay them a finder’s fee?  No, that doesn’t really change the analysis of whether it is legal if it is a percentage of the raise.

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Open Source Licensing & IP Legal Issues

I found this pretty good brief review by the American Bar Association’s Software Licensing Committee that discusses the potential legal issues involved with open source.

Legal and Other Risks Associated with Open Source

Along with the many benefits of open source, however, come a number of risks. Perhaps the most obvious risk is potential liability for intellectual property infringement. The typical open source project is a grass-roots effort that contains contributions from many people. This method of development can be worrisome from an intellectual property standpoint because it creates multiple opportunities for contributors to introduce infringing code and makes it almost impossible to audit the entire code base. The risks of this development process are largely borne by the licensees. Contributors do not vouch for the cleanliness of the code they contribute to the project; in fact, the opposite is true — the standard open source license is designed to be very protective of the contributor. The typical license form does not include any intellectual property representations, warranties or indemnities in favor of the licensee; it contains a broad disclaimer of all warranties that benefits the licensor/contributors.

Even if such representations and warranties or indemnity obligations existed in open source license agreements, it would be difficult if not impossible to recover against the licensor for having licensed infringing code. Many of the most prominent open source projects appear to be owned by thinly-capitalized non-profit entities that do not have the financial wherewithal in most cases to answer for a massive intellectual property infringement suit.

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