Launch Magazine - Fall 2007 - (Page 20) keep your Cap Table and your capitalization simple. Document it carefully. Do it right the first time — it is hard to undo or change. Getting Started — Some Key Issues and Considerations So how should you model a Cap Table? Start with a Microsoft Excel spreadsheet. The math functions in a spreadsheet will serve you well — by providing a mathematical cross check to your share numbers and facilitating updates to your Cap Table numbers as you add shares and shareholders. Then, with this foundation, ask yourself some basic questions about your capitalization plans and needs. Among them: CEOs of their companies have at least a 10 percent stake on a post-financing basis so that the CEO is properly incentivized to make the company succeed. Founders in CTO or CFO roles are typically targeted at lesser percentages. But, there are more exceptions than rules here. Some founder groups like the egalitarianism of equal percentages and some founders may have more cash or intellectual property to contribute to the company than others, so should receive stock accordingly. In each case, while it is fine to think about ownership between founders (or any shareholders) on a percentage basis, make sure you document equity on a share basis to avoid confusion about the dilution that will come with later issuances and financings. Should there be some vesting among your founder group? You may be starting a company with a group of previously high-income, hard-charging young guns. That’s good. But young guns accustomed to significant income may give up on your business plan if you do not find success quickly (and new companies rarely do). You may want to model your capitalization to allow for repurchase at an agreed price if a young gun leaves, as sort of “golden handcuffs” to keep them with the company. At the same time, note that vesting can sometimes trigger some unintended tax consequences that can be avoided in large part by making what is called an 83(b) election with the Internal Revenue Service. To see more about 83(b) elections, as they are beyond the scope of this article, visit http://www.pmstax.com/sec83/sec83bElection.shtml. How should you structure vesting? Your choices are time and performance. Time is much simpler because it is totally objective and easily understood. Time vesting is usually handled over four years, with “cliff vesting” of 25 percent at the end of the first year — because employment problems, disputes and fallouts are likely to arise in the first year — and monthly pro rata over the remaining three years. If an employee subject to vesting isn’t working out, terminating employment cuts off vesting. Performance vesting also works, but usually carries dangerous and subjective elements that can lead to uncertainties and higher legal costs. For example, using revenue as a performance vesting metric seems easy, right? Wrong. For example, are revenues gross or net? Net of what? Do they include receipts for services not yet performed? Are they based on billings or collections? Note that if you elect not to have your founder group subject to vesting, a venture capitalist may impose it on you anyway. And the venture capitalist’s terms will probably be less friendly than terms you may be able to set in your founder group on vesting issues, such as length of vesting term and acceleration upon certain Do you expect to be raising money from your first investors soon? Try to model your capitalization structure so that your share price will be roughly $1. Why $1? That’s what investors in our market expect. Is it a problem to have a share price different than that? Not at all, but why not lead with what investors expect? How, then, do you get to a price of $1 per share? Understand an investor’s price formula: Price equals valuation divided by your fully diluted shares. So first, take your best guess at valuation. Angel and venture capital investors in our market usually expect initial valuations for pre- or emerging-revenue companies to be in the neighborhood of $1.5 million to $3 million, unless you have a more compelling valuation story. Then, understand what fully diluted shares means: the sum of your outstanding stock plus your option plan (more on that later) plus any convertible securities (such as options and warrants) outside of your option plan. Next, set your fully diluted share number so that the pricing math works out to roughly $1 per share. One counterintuitive aside before we leave this topic: Avoid the temptation of taking money at the highest price possible from unsophisticated investors because, if your valuation comes crashing down in a later round, those investors will feel ripped off and very unhappy with you. How should you treat ownership between the founders? Typically the founder in a CEO role receives more stock than the others. Most investors like to see the 20 launch fall http://www.pmstax.com/sec83/sec83bElection.shtml
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