Your founder stock might not be yours.
Make sure you've hit all the points in purchasing your founder stock.
TL;DR: Issuing founder stock is a delicate process. If you miss one of the key steps, chances are you didn’t properly issue yourself your stock and you don’t actually own it – so you might have to do it all over again, at a price.
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The topic for this time is making sure you actually own the stock that you think you own.
Without further ado, let’s get right into it.
“No biggie. I set up my company online”
This is usually where it starts:
A founder tells you that they used an online tool to set up their corporation. You dig a little and find out that there are a few missing pieces in the paperwork – and that usually includes the stock issuance.
Turns out, the founder whizzed through the online application without properly reading through the tool tips and instructions on the screen. As a result, pages were left unsigned, and important actions weren’t taken.
And so comes the verdict:
“I hate to say it, but you don’t actually own your stock. In fact, your company is an orphan – it doesn’t have any owners.”
Let’s rewind and take this step by step, hitting on the steps of the process for properly issuing stock.
1. Is your Board consent signed?
This should be the first step when issuing any securities, including stock to the founders. Your board (and every corporation in the U.S. has a board) has to make a formal decision to issue a certain number of shares to a given person. The decision should be in writing, dated, and signed.
Take a moment to look at your documents. Did you find this board consent? Is it dated and signed? Great, let’s go on to the next item.
2. Do you have a stock purchase agreement?
A stock purchase agreement is the document based on which the company is formally issuing the stock to the recipient. It normally goes by the name of Common Stock Purchase Agreement or Restricted Stock Purchase Agreement.
Do you have this document? Does it have the required language? Is it properly signed in all the right places?
Let’s break it down.
🔹 Does it cover the basics?
The stock purchase agreement should include the following basic and bare minimum info:
the names of the company and the stock recipient (for example, Evio, Inc. and Joanna White),
the number and type of shares being issued (for example, 3,000,000 shares of common stock, par value of $0.00001),
the purchase price per share (usually, the same as the par value for new companies),
the date the stock is deemed issued and transferred (normally, there should be an effective date at the top of the agreement or say something like “this becomes effective upon the date of the last signature”).
Founder stock agreements almost always also include a vesting schedule (for example, four year vesting with a one-year cliff).
Does your stock purchase agreement hit all of these points?
Great! On to the next item.
🔹 Is the signature page signed?
Now, scroll down to the end of the agreement (not the exhibits). It should be signed both by you and on behalf of the company (it can again be you, for example, if you’re the CEO).
All good there too? Great! On to the next point.
🔹 Is the stock power signed?
This one isn’t relevant to the proper issuance of stock, but it’s still critical (I’ll cover this in a future post). The stock power is a document that allows the company to take back any unvested stock if you part ways with the company before your stock fully vests. Commonly, it’s called the “Assignment Separate from Certificate” – or, instead, you may have a document titled “Joint Escrow Instructions”.
Find that document. Not signed? Ok, make sure all stock recipients sign this.
Don’t worry about all the other blank fields – those are meant to stay blank (yes, including the date field).
Took care of this? Great! Let’s move on.
3. Did you pay for your stock?
This is the element which a lot of founders miss: they never paid cash for their stock – as in, “wire or write a check for $30.00” type of payment. Yes, even if it’s your company, you’re buying something from it (the stock), and you should be paying for it.
Ok, I know what you’re thinking: “but I paid for the stock with IP – my board consent says so”. Fair point, to an extent. Now, imagine if there’s some kind of conflict within the company – years from now, whether it’s among the founders, with investors, etc.
Do you want your counterparty to claim that you never actually transferred the IP, or the IP didn’t actually amount to $30.00?
Yeah, probably not.
And this is why I always suggest: pay for your stock in cash.
4. Do you have a paper or electronic stock certificate?
While not necessary, having a stock certificate in place is additional proof that you, in fact, own your stock. It should be signed by two officers on behalf of the company – normally, the CEO and the Secretary. And yes, a proper electronic certificate is just as good as a paper certificate.
5. Did you update your cap table?
Update your cap table when the stock is properly issued, which provides additional proof on its issuance. If you’re using cap table management software, once you update the cap table the stock certificate mentioned in the previous point should automatically be generated, sent to the officers to sign, and then sent to the stock recipient to accept.
6. Bonus: Did you file your 83(b) election?
This isn’t relevant to your stock being issued properly, but it’s another critical issue related to issuing stock subject to vesting. I’ll cover this in detail in a future post – for now, just know that this is an important tax document and you have only 30 days to file it from the day you get your stock (no exceptions).
In case you’d like to learn more – or to file your election online – check out file83b.com.
What’s the worst that can happen?
Stock issuances cannot be backdated – and the most important dates here are the date of the board consent and that of the stock agreement. If you didn’t do this properly back in the day, you’ll have to do it again.
The problem here is that the price of stock is determined at the date of grant and should not be less than the fair market value of the stock on that date. If your company has raised a venture round, this could mean that your stock’s valuation has skyrocketed. So, if you need to redo your stock issuance, you may end up owing the fair value of your stock to the company – or your income tax on that fair value to the tax authorities, in case you don’t pay anything to the company.
Make sure you work with a competent attorney this time. If you need an intro, let me know.
Troubleshooting
Here are some common problems that arise and how to approach them:
“I never adopted the board consent.” Stop there – you shouldn’t handle this by yourself. Talk with a competent attorney. If you need an intro, let me know.
“The stock agreement isn’t fully signed.” Go ahead and sign it. However, if the effective date of the agreement refers to the “date of last signature”, you may have a problem. Stop, and talk with a competent attorney instead.
“The stock power isn’t signed.” Go ahead and sign it.
“I never paid cash for my stock.” Pay it now. Write a check and deposit it into the company’s bank account. Talk with your CPA about this. If you need an intro, let me know.
(Btw, there’s no such thing as “founder stock”)
I had to put this out there. We casually refer to stock that’s issued to the founders as “founder stock”, but legally, there’s no such concept. It’s normally common stock – the exact same stock that’s otherwise issued to early employees, etc. (unless the company has multiple classes of common stock, but we can chat about that another time).
Startup Ecosystem Member Highlight
Over the past years, I’ve had the opportunity to meet with amazing people who are just as passionate about startups as I am. I’d love to introduce them to you through this newsletter, in case they can be helpful to you as you start, grow, and scale your startup.
Meet Nareg Essaghoolian
Nareg is the co-founder of Decrypted Law, a boutique law practice focused on early-stage startups. He and his co-founder, Alexander, are both alumni of Cooley LLP and are bringing top-level legal expertise to founders for a fraction of the cost.
I particularly admire Nareg’s practice because it champions flat fees and monthly subscriptions for startups. These alternative fee models are a better fit for a lot of the legal needs of early-stage startups; it just doesn’t make sense paying hourly for them.
For these reasons, we’re also thrilled to have Nareg as an attorney ambassador of Corpora.
Nareg’s LinkedIn: https://www.linkedin.com/in/nareg-essaghoolian/
Decrypted Law’s website: https://www.decryptedlaw.com/
Nareg Essaghoolian on the Corpora Podcast:
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Until next time!
Stepan
A bit about me: I’m a former corporate lawyer with 10+ years of experience helping 100s of companies navigate the legal journey, including early-stage startups and unicorns. I quit my private practice to start Corpora and help founders raise money faster and more affordably. Let’s connect on LinkedIn.