After you’ve decided to incorporate your new startup, it’s time to figure out what legal documents you need to get your company incorporated and ready to do business. Incorporating your company and getting a Delaware certificate of incorporation filed with the Delaware Division of Corporations is the first step and is relatively painless.
However, things get complicated when it comes time to set up your board of directors, issue founder shares, set up a stock plan and get your newly formed Delaware corporation fully operational and ready to do business.
Startup founders should get these written agreements in place before developing intellectual property or promising a stake in the company to potential investors or employees. A startup business will need to pass due diligence, such as providing formal financial statements to prove the financial condition of the company, as part of the fundraising process, and having a founder agreement written on the back of a napkin is not going to fly. (In another post we explain why venture capital firms and angel investors typically only invested in C Corporations and not limited liability companies.)
Most incorporation services will only provide you with documents needed to get your new company incorporated, without fully setting up your board, completing your founder share purchase, setting up a stock plan, and many other post-incorporation steps required before your startup is ready to do business.
These services, such as Incfile, only provide startup founders and business owners with the Articles of Incorporation, Bylaws, and Action by Sole Incorporator. Moreover, the agreement templates and legal documents these services provide do not typically conform with the norms of venture-backed startups for setting up a new business entity.
We wrote this startup checklist to help startup founders who are navigating the incorporation process, so they know everything that they need to do before and after they incorporate to build their new company on a solid legal and financial foundation.
Startup Formation Legal Documents to Incorporate and Set Up Your Board of Directors
The Articles of Incorporation is a document filed with a state government to record a corporation’s creation. For example, if you are incorporating as a Delaware corporation, you would file your Articles of Incorporation with the Delaware Division of Corporations and pay a filing fee to create your new Delaware corporation.
Most startups incorporate as a C Corp in Delaware because Delaware law is widely understood by founders, law firms and startup investors. In addition, Delaware has a specialized corporate court, known as the Court of Chancery, which is known for speedy dispute resolution and arbitration of disputes among shareholders.
The Division of Corporations will return a stamped certificate of incorporation after your filing is accepted by the state of Delaware. You will want to retain this certified copy, as you will need it in order to register for a business bank account and setup other core financial services like payroll and insurance. (Learn more about the different types of insurance your startup may need, such as liability insurance and workers compensation insurance.)
The Articles of Incorporation will include information such as your business’ corporate name, the purpose of your corporation, the registered agent you plan to use, and the names of any incorporators. Typically, you will only have one person incorporate your company even if you have more than one founder.
Your company’s chosen business name must be unique and cannot conflict with the name of any existing companies already registered with the Delaware Department of State. You can do a business entity search prior to filing the Delaware articles of incorporation for incorporating your new business entity.
A Delaware certificate of incorporation will typically list the number of shares of capital stock authorized, as well as the par value, which is the minimum price at which shares in the new corporation can be sold for. Capbase is a licensed Delaware registered agent and entrepreneurs use our software features to incorporate in Delaware, issue shares to founders, advisors and employees, and raise funds from investors.
Bylaws is one document encompassing all the governing rules for operating the corporation. These rules are typically vague to allow maximum flexibility for officers and directors to do what is best for the company. The corporate bylaws typically include information such as the company's official name, purpose, officers' titles and responsibilities, how meetings should be conducted, and how often meetings will be held.
Action by the Sole Incorporator adopts the bylaws and appoints the board of directors who will have decision-making powers to run the new company. This document is why it doesn’t really matter to have more than one person incorporate your company when you have more than one founder because the understanding is that the incorporator will appoint founders to decision-making positions. Generally, a founder’s official, legally binding title, will be some sort of director or officer position. Since the Action by the Sole Incorporator will appoint the board of directors and the board will appoint corporate officers, having multiple incorporators does not impact the position and ownership founders will have in their company.
Although these documents are sufficient to get your company incorporated, you will need more documents and contracts to actually make your company operational. To have an operational and valuable corporation, you will need to figure out stock purchases, vesting schedules, and intellectual property assignments. After your corporation is created, you will need to file an annual report with the state of Delaware, in addition to paying a franchise tax to ensure that your company stays in good standing. For most early stage startups, the annual franchise tax is only a few hundred dollars, but depends on the number of shares authorized. (Learn more about how to calculate franchise tax for your Delaware corporation on our blog.)
After your company is fully incorporated, the next step is the Initial Organizational Resolutions of the Board of Directors. This document completes the organization of the company by appointing the officers and authorizing the issuance of shares to the stockholders, among other things. This means that you will have to think about how you are going to allocate your company's shares. It is common for companies to authorize 10 million shares at this stage with 8 - 9 million shares issued to founders and one 1-2 million set aside for employee stock options.
You will also need an indemnification agreement to make your company operational. Indemnification agreements mean different things in different circumstances, but in a corporate structure it means that the company will protect and defend board members, thereby indemnifying them, from shareholders of any liability as long as the board member was acting in good faith. This typically means that the corporation will cover expenses and judgment amounts incurred by officers and directors as a result of their service to the entity. An indemnification agreement protects founders from being personally liable to shareholders when they are acting on behalf of the corporation.
Purchasing Your Founder Shares And Setting Up a Stock Plan for Your New Business Entity
When founders are issued shares, they will need to purchase their issued shares. Founders will typically buy their shares of the company with cash or intellectual property (IP). Although cash is always valuable, your company’s intellectual property is what gives your company its value. Therefore a founder can purchase their shares with IP by assigning the IP to the company in return for shares to the company. Just to be clear, purchasing shares with cash does not mean you are purchasing them with green Benjamins; wire transfers are just as effective.
Founder share purchases mean that founders will have to figure out their equity split when there is more than one founder. Although there are many ways to split equity, a dynamic split is a fair way to allocate equity based on each individual's contribution to the team and studies show venture capitalists and angel investors tend prefer uneven splits in some cases.
After founders purchase their shares, you will need a vesting schedule. A vesting schedule exists to ensure that founders have incentives to stay through the early stages of the company and stay long enough to ensure the product’s success. Vesting schedules are also necessary to secure VC funding because they want to see that founders are incentivized to work on their business long term.
Next, you will need an Action by Written Consent By the Shareholders to Adopt a Stock Plan. This shareholder agreement sets aside shares for future service providers such as contractors, employees, or advisors, and the rules governing the future issuance of common shares such as vesting schedules.
As your company grows, you will need to authorize preferred shares which are awarded to investors in equity financing rounds such as a Series A. In addition, you may need to increase the size of the stock plan to make more shares available as part of employee equity compensation packages. Startups track the ownership of investor and employee shares using a cap table, which tracks all outstanding shares as well as any shares purchased by investors. (Learn more about how a startup’s cap table will evolve from company formation to many rounds of financing from investors.)
The Confidential Information and Inventions Assignment Agreement (CIIAA) is the key to making your company valuable. As mentioned before in founder share purchases, the intellectual property assigned to your company is what gives your company value. The CIIAA assigns all inventions and associated IP created by an employee during their employment at the company, to the company. This means that the company owns the invention as opposed to the employee, even if it’s something developed by the officer or director. Included in this legal document is a non-disclosure agreement (or NDA), wherein the founder or employee is obligated to protect any company trade secrets and not disclose them to competitors.
You will also need a Common Stock Purchase Agreement (CPSA) for all future share purchases, whether it’s for an employee/contractor or advisor. The CSPA is a contract between buyer and company/shareholders. It contains information such as the aggregate amount of shares of common stock purchased, purchase price, when the transaction will take place. This contract will even outline any obligations of the company. This legal agreement is used to give shares in your new legal entity to employees, advisors and consultants who are doing work for your startup.
You will have your full-time employees sign this agreement along with their employment contract if you are issuing equity as part of their compensation package. Typically, even independent contractors may receive some sweat equity for their work in lieu of pay when working with a new startup that has limited cash resources.
The CSPA is used to buy and sell stocks, which means the document is inevitably regulated by the Securities Act and the Securities and Exchange Commission’s regulatory scheme. Since the agreement is inadvertently tied to the Securities Act, there is a lot of legalese in the document that is meant to protect both parties. Some terms of this agreement that are typically included are:
- Representations and warranties: these are assurances and assertions given by parties in the contract.
- Covenants: These are promises in the contract to do or not to do a particular act. Generally, common stock purchase agreements will include a restrictive covenant, which prohibits the resale of the shares to a third party unless the board authorizes the transfer of shares, the company shares are traded publicly through an initial public offering, or a liquidation event when the company is sold to an acquirer. Growth stage startups will sometimes permit the resale of shares through what are known as secondary sales.
- Entire agreement: is a provision that ensure clauses are not read without context to the entire meaning of the agreement.
- Governing law: the CSPA is a contract which means it is governed mostly by state law. This means that parties can choose which state’s laws govern the interpretation of the CSPA. Most parties choose Delaware and use the state’s applicable laws, however parties can choose any state to be the applicable state securities law governing the contract.
- Court of competent jurisdiction: Just like how parties can choose which state’s law apply to the agreement, parties can also choose which court(s) can settle any disputes rising from the agreement. However, regardless of the jurisdiction chosen here, the courts or tribunals in the jurisdiction would still apply the laws of the state chosen in the governing law clause.
Although the CSPA will typically have headings that clearly indicate the different clauses in the document, it is still a complicated document with the potential to have multiple governmental authorities. It may be in your best interest to consult legal counsel to ensure you are not missing any provisions of this agreement.
The Notice of Stock Issuance goes hand in hand with CSPA. It acts as a stock certificate for the shares you purchased through the CSPA. The document is delivered to the buyer to verify the investment and the amount of investment in the corporation. The Notice of Stock Issuance will also reference any governing documents and agreements that set forth the terms of the issuance of the stock.
Stock certificates are less common than they used to be because many parties prefer to have documents electronically issued. Notices of stock issuance meet expectations of verifying and confirming sale of the shares without having officers in a corporation to physically and prepare formal, hard copy stock certificates for each shareholder.
Lastly, you will need to obtain an Employer Identification Number (EIN) from the Internal Revenue Service (IRS), so that you can open a company bank account and start accepting revenue from customers or raising money from investors. The EIN is also a prerequisite for setting up payroll accounts, obtaining business insurance and getting a corporate credit card.
An EIN is fairly easy to obtain for founders who are American citizens or taxpayers, but can be time consuming for foreign founders who do not have a US taxpayer ID, such as an SSN or ITIN. (Capbase works with founders from dozens of countries and simplifies the process of starting up a startup for overseas founders.)
While these documents may not seem particularly important to complete after incorporation, the sooner you are set up with these documents the easier it will be for you down the road. The last thing you would want is to scramble for documents before an important investor meeting or when you need to assign equity to a service provider.
Building a company may start with filing those first incorporation documents, but it doesn't end there. Unlike other services which only handle incorporation, Capbase gives customers control over the full corporate setup process. You bring the business idea, and our platform will help you launch a fully-compliant company that's ready to raise money and grow fast.
Summary & Recap
- Getting your company incorporated is easy but getting your company operational takes a lot more steps. Most startups register as a Delaware C Corporation and use a registered agent service in Delaware.
- To get your startup ready to issue equity and raise funds from investors, you will need to sign multiple legal documents that set up a board of directors, founder stock purchases, vesting schedules, and stock plan, in addition to assigning intellectual property (IP) to the company.
- Without these legal documents and governance structures in place, it will be extremely difficult for your company to raise funding from venture capital firms and create a valuable company. A stock plan is used to issue equity compensation when you hire employees for your startup and you will have employees sign a common stock purchase agreement for their equity compensation alongside their standard employment agreements.
- It is important to make it official and complete all the items on the incorporation checklist as soon as possible after filing your articles of incorporation to save you from future headaches and nasty surprises down the road.
Written by Beth Zhao
Beth is a second year law student at The George Washington Law School. She is a member of the Public Contract Law Journal.
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