Preparing for Funding Ep2: Founders’ Agreements – Recut

Office Hours is our podcast covering general issues related to small businesses and startups. Preparing For Funding is a series of Office Hours episodes hosted by VW Partners Kevin Vela and Rad Wood about getting your company’s legal house in order before taking on funding  We are recutting this series to reflect updates in law and venture trends in the last 5 years to better help you navigate through preparing for funding.

In this episode, we discuss founders’ agreements, including Restricted Stock Purchase Agreements (RSPAs), Confidential Information and Inventions Assignment Agreements (CIIAAs), and Non-Compete and Non-Solicitation Agreements.

Time Stamps

  • 1:48 – Why It’s Important to Have Founders’ Agreements
  • 4:35 – How Can Someone Walk Away with a Third of the Company?
  • 6:03 – Restricted Stock Purchase Agreement (RSPA)
  • 9:21 – Vesting Schedule
  • 11:37 – Single Trigger v Double Trigger Acceleration 
  • 14:55 – 83(b) Election
  • 17:00 – Non-Compete and Non-Solicitation Agreements
  • 18:15 – Confidential Information and Inventions Assignment Agreement (CIIAA)
  • 22:37 – Ideal Number of Founders
  • 26:47 – Founders Stock 

Related Content

Click here to view terms used in this podcast
4 Years with a 1-Year Cliff

4 Years with a 1-Year Cliff is the typical vesting schedule used by startups. A one year cliff means that nothing vests for the first year, but after a year the vesting would catch-up to 12/48, and then the remaining balance would vest over three years (typically 1/36 a month for 36 months).

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83(b) Election

An 83(b) Election is an election made under the Internal Revenue Code that allows a person receiving shares (or units) under a vesting schedule to recognize income based on the entire value of the shares as of the date of the grant – instead of as the shares vest. Basically, you accelerate the ordinary income taxes. In the context of a startup, the ordinary income liability at the time of the grant is negligible because the value of shares early on is so nominal. You want this. But if you fail to file an 83(b) election, then you will be liable for paying ordinary income taxes on the difference between fair market value and the grant price when the shares vest. If your company’s value is increasing over time, this could be a nasty consequence.

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Business-to-Business (B2B)

B2B is an abbreviation of “Business-to-Business.” B2B describes a sales strategy with businesses as the primary customer.

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A Confidential Information and Inventions Assignment Agreement (CIIAA) is a legal document used to assign all intellectual property (IP) and other proprietary rights created by an employee during the course of their employment to the employer. CIIAAs typically also contain non-disclosure, non-solicitation, and non-competition clauses. CIIAAs are also sometimes known as Proprietary Information and Inventions Assignment Agreements (or PIIAAs). 

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Class F Common Stock

Class F Common Stock is a founder-favorable class of common stock that provides founders with greater control over the company due to increased voting power in company decisions. The Class F common stock was created by the Funder Founder Institute within the past decade and is not used frequently.

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Consideration is the benefit that both parties get in a contract. In order for a contract to be binding, there must be consideration on both sides. Consideration can be something you will do, or something you will not do.

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Distribution is a payment by a company to its shareholders (or members in the context of an LLC).

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Double Trigger Acceleration

Double Trigger Acceleration is the partial or full acceleration of vesting of an employee’s options or stock based on the occurrence of two distinct events. Most typically, the two events are the sale of the company and the involuntary termination of the employee.

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Founders Stock

Founders Stock refers to equity granted to a founder when the company is formed. The equity typically has a par value that is next to nothing and a four year vesting schedule.

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Invention Assignment

An Invention Assignment is an agreement where a founder or developer assigns to the company all of the intellectual property the founder or developer has created related to the company.

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Milestones are company goals used as incentives for employees or company contracts. If a company reaches certain objectives, it may receive greater funding from an investor or an employee may receive a larger bonus.

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Non-Compete Agreement

A Non-Compete is an agreement signed by employees and management prohibiting the individual from working for or forming a competing company. Non-competes include a specified geographic region and last for a specified time period after termination.

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Non-Solicitation Agreement

Non-Solicitation Agreements are usually in employment agreements to prevent the contracting employee from soliciting the company’s other employees and the company’s customers for a competing business venture.

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Par Value

Par Value is the the initial value of a single share, and the lowest sales price a startup can receive for its shares. Typically, when a company first organizes, the shares have no or a nominal par value such as $0.0001.

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Restricted Stock

Restricted Stock is ownership shares of a corporation that are unregistered. Because these shares are unregistered, the stock is non-transferable and can only be transferred in compliance with certain SEC regulations. Restricted stock is most commonly granted to executives, directors, and founders of the company. In an LLC, restricted units are the functional equivalent of restricted stock.

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Restricted Stock Purchase Agreement (RSPA)

A Restricted Stock Purchase Agreement (RSPA) is an agreement issuing restricted stock. RSPAs are typically granted to founders to prevent the founder from leaving the company prematurely and taking a lot of the ownership with her. The RSPA establishes when the shares will fully vest and belong to the founder. Typically, the RSPA will vest over four years with a one year cliff.

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Repurchase Option

A Repurchase Option is a company’s right to buy a shareholder’s stock upon some condition. Often, founders’ shares have a repurchase option if the founder leaves the company within a certain amount of time.

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SaaS Business

A SaaS business is one whereby software is licensed to end users from a central location, usually delivered via the web. “SaaS” stands for “software as a service” and customers are generally billed monthly. Microsoft Office 365, Dropbox, Google G Suite, and Slack are all examples of SaaS businesses. Contrast those with the old days of buying software that came in a box and was installed through a peripheral drive.

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Single Trigger Acceleration

Single Trigger Acceleration is the partial or full acceleration of vesting of an employee’s options or stock based on the occurrence of a single, specified event, typically a change of control of the company.

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Stock Options

Stock Options are an option to purchase a fixed amount of shares at a fixed price that typically vest over time.

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Vesting Schedule

A Vesting Schedule is the timeline over which a stock recipient’s equity (usually stock options) vests. The typical vesting schedule is four years with a one year cliff. See Four Years with a One Year Cliff.

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Other Podcasts in this Series
1 of 10 Office Hours
Preparing for Funding Ep1: Incorporation
2 of 10 Office Hours
Preparing for Funding Ep2: Founders Agreements
3 of 10 Office Hours
Preparing for Funding Ep3: Friends & Family Funding
4 of 10 Office Hours
Preparing for Funding Ep4: Pitch Decks
5 of 10 Office Hours
Preparing for Funding Ep5: Initial Sophisticated Investors
6 of 10 Office Hours
Preparing for Funding Ep6: Accelerators / Incubators
7 of 10 Office Hours
Preparing for Funding Ep7: Seed Round
8 of 10 Office Hours
Preparing for Funding Ep1: Incorporation – Recut
9 of 10 Office Hours
Preparing for Funding Ep2: Founders’ Agreements – Recut
10 of 10 Office Hours
Preparing for Funding Ep3: Friends and Family Funding – Recut