M. D. Anderson Cancer Center
Date: April 2008
Duration: 01:55:00
So for me today it's a pleasure to introduce Paul Pryzant.
Paul Pryzant, we know each other since quite a few years. He is
the man that everybody is asking here locally, probably nationally too
and internationally to come and talk about when you have a start up
company, how do you form the company, what is the legal aspect behind,
or the legal framework behind the company, what do you do with
governance of the company. And I was telling some of you when you
were here a little earlier today, you know, if you really think about
opening a company, you gonna have to pay attention today because that's
the nitty-gritty of your company and no matter what you have devised or
your idea or your drive will be, if you do this wrong, you're gonna pay
a lot of money, sometimes out of your own pocket for tax reasons and
you're gonna maybe not get the investors you want because you have not
set up the company in a proper way. So, you're gonna really have
to pay attention today on what's happening and, you know, it may not
always be the most fun thing to think about when you wanna do a
company, what company form you wanna have but believe me, I spent hours
and hours and hours and days agonizing over these questions and so
having somebody like Paul who is really consulting everybody on the
topic is very important. Paul has a Bachelor of Science from the
Wharton School and a AHD from UT, so he's an inbreed. What?
Very perfect, and so he was involved in many things including being the
general counsel for internet commerce company, chemical and changes on
the internet. He is involved in merger, acquisition and a lot of
startup related things, 25 years experience in the field, and he just
recently joined his new company and I'll leave it up to you to make an
advertisement for that, but clearly he's one of those guys that I send
people to or I would suggest if you have questions that one person to
go to, very clear and with that said, I mean, thank you very much and
it's all yours.
Before I get started, have you told them about the Rice Business Plan Competitions since you mentioned business plans?
I did not yet.
Ahh...
You wanna do it?
Sure. This weekend Rice in--is this--I guess it's getting a
little bit of a reverberation. Can we turn it down a littler
or--I don't know because I think most people are gonna be able to hear
me regardless.
No, we need that for the [inaudible]
Okay. Well, put it down just a little bit maybe that will help.
Absolutely.
The Rice Business School, they have a competition. They have 36
schools and literally from around the world. They have IIT.
They have just really the top universities of the business schools and
what they've done is they've sent in to of a calling process.
Each of the schools has sent business plans and it's bee selected and
this weekend is the competition and it's really, you'll be blown away
by how good this business plans are from the students because in many
cases, they're researches just like you that are then working with M.B.A.
students to put together real companies for real technology and real
plans, and so, it is really is fascinating and so it's on Friday and
then on Saturday. Saturday afternoon is when the finals are for
the top 6 teams and it's just, it's a tremendous thing to go see.
I've been a judge for the past '07 years and it's really such a
tremendous thing. So anyway, just wanna put in a plug for
that. It's at the Jones School this weekend, so to tell you about
that.
We didn't announce it here but you should have probably received
e-mails because I think we sent out and forwarded the e-mails that Rice
typically gives us and by the same token in May, we're gonna have
business plans in have this Alliance in Life Sciences specifically,
life sciences, Rice Venture forum for life sciences and so we're gonna
announce that probably in our last course that you know about that as
well.
This is a dry subject, I mean, really dry subjects. What I'm
trying to do is provide a lot of examples, a lot of stories, a lot of
situations where I can tell you about something to help bring it
alive. So, the first story is back in December of 2001, three guys
came together. You had the creative genius for software
product. He had a great idea for enterprise software. So,
he brought on board a guy with a lot of business sense. He
brought in another person that had a lot of sales experience. So,
look at this, it really sounded like a dream team and then fast forward
3 and 1/2 years, May 28th, 2005, they sold that company for millions of
dollars. Now, that sounds like the entrepreneurs' dream,
right? That's why everybody is in this room because you really
like the idea that you could start a company. You can really
build something, a great product of great science of great technology
and you can create something that ultimately will be recognized in the
market place because somebody will buy it and it's also nice, it might
put up a little jiggle in your pocket, however, it was also the
entrepreneurs' nightmare because what you had in the middle, 2 of the 3
people walked out of the company. You had a nasty, nasty
shareholder's dispute. You had the founder, the guy--the key guy
that was the creative genius that kept this company together through
thick and thin. Basically, he has, you know, he almost lost his
home, he almost lost his wife and family and then again, also almost
lost his health. He checked himself in the hospital at one point
because he though he was having a heart attack. So, I mean, all
of these things went on but somehow he still persevered to be able to
create the company and come up to a realization. And so the
problem he had was a lot of different things initially when they set up
the company just like Oli said they did it all wrong. They didn't
do some fundamental things that if they had done those things early on,
they could have avoided the problems later on. So the basic
lesson to you is that if you take the time to set up a company properly
at the beginning, you can avoid a huge amount of headache and heartache
later on. And so, I'm gonna be telling you a lot of those things
and I'll tell you the specific problem that they had for this company
in the way that they should have solved the problem. So, and then
we'll get started, but ahh...and I wanna maker sure that everybody
knows that I'm really happy to stop and answer questions. So,
anytime that you have a question, just right hand, also use the left
hand to questions too and remember it's April Fools Day, so I don't
want any April Fools jokes. Okay. [Pause] Okay.
The first thing I have to give you a tax notice, you have the IRS who
wants to make sure that I tell you that you can't use my presentation
to avoid tax penalties, isn't that great? Wonderful. Moving
on. What are we gonna talk about today? We're gonna talk
about choice identity. We'll talk about choice of name, capital
structure issues, issuing stock, preserving your IT and talk a little
bit about raising money. Again, with the end in mind, came from
Steven Coney, from his "The Seven Habits of Highly Effective People" but
what am I talking about? Money. That's what I'm talking
about because yeah when you think about the end in mind, what's your
thinking about is starting a company and then having an investor come
in and put money into your company or even better. What you'd
like is somebody to be buying your company, but before somebody is
gonna be putting money into your company Kathryn Pea [phonetic], your
gonna do due diligence on your company because you're gonna wanna make
sure that when they put the money in that they're getting what they
think that they received and then the same things to for anybody that's
buying your company, your gonna do that type of due diligence times three or four. So, that's what I mean when I say begin with the end in
mind. Think about the things that you need to be doing now to
make sure that when you go through somebody doing the due diligence on
your company then it will just--it will all be easy. Another
story, back in January of 2004, I had a, a former client of mine come
to me. I helped him sell his prior company. He came to me
and says, "Well, I got a new company. I want you to represent
me." Great. Because we have an angel investor that's
willing to put in 200,000 dollars. Now for this company, we've
already filed the patents. We've already incorporated it.
So, Paul, this ought to just be really easy, great. Great!
Wonderful! So, I said, "Well, why don't you send me the documents
for when you formed the company, I mean, you've already incorporated
it". So he sends it to me. Basically it was just a 1-page
document they'd filed. They filed the articles of incorporation
and that was it. He had not issued stock. He hadn't done
anything with the employees in terms of giving them stock or options or
anything else. He didn't even have a balance sheet. So then
when the attorney for the investor group called up and said, "Paul, I
have a list and it's probably this long, of all the things I want you
to send to me". I said, "this is really easy. I don't have
any of it. None of it, but you will have it so we could finally
get started." So, we did the packing, we ended up taking about four to six weeks putting all of these things in place. That needed to
be put in the place before. And so that's why in here, I say the
failure can cost you money. It will cost you money because it
takes more time to correct mistakes than it does to do it right up
front with the second thing. As for any entrepreneur, urgency,
time is gonna cost you money because your market opportunity, other
people are out there trying to do the same thing that you are, and so
the quicker that you get your product, your technology developed, your
patent file. All of these other things. The quicker that
you can do that, I mean, the quicker that you can get doing the things
that you wanna be doing. So that's really the moral of the story,
beginning with the end in mind.
First, choice of entity. First thing I always want to tell people
is, "Okay, why have an entity? Why not just have it in your own
individual name, just one person. Sort of getting started.
Why do I even need an entity?" The reason is because you wanna
avoid liability going beyond what you're investing in the
company. So it make sense to have this limited liability shield
for whatever it is you're doing so that the amount that you putting in
instead of you personally being on the hook, its the company, that's
why you do it. Then, now, so talking about choice of
entity. There's a lot of choices that I'm gonna talk about but I
wanna give you the answer upfront. You can write it down.
Most investors want a straight vanilla C corporation and there's some
reason for that. A C corporation is straight forward
documents. It's really easy to do, stock option agreements for
your employees. It's basically what I call the path-well-traveled
because there sort of a, if there's a rock in the road, people know
where to go. People know what the document say, people know what
the variations are. It is simple and easy. And there's also
some tax reasons why people like straight up C corporation as well and
we're gonna go through that. Now, taxes since we talked about
taxes. First of all the C corporation. For a C corporation,
the entity itself is what's taxed, the investors are not taxed.
However, if the entity makes a distribution then that distribution to
shareholders is taxed again and we call that double taxation. So,
that's the key to a C corporation is that it's taxed two times.
So, here's my example up there. The company earns one million
dollars. They're gonna pay income taxes that the entity level at
34%, 340, 000 dollars then you're gonna have 660, 000 dollars
left over. Then they're gonna distribute, let's assume that they
distribute or want to distribute that money to their investors, so that
money is going to be taxed again at 15% and when you combine
that together, the total taxes is 43.9%. Now, the
difference is if it was only taxed one time, you'll probably know that
the maximum income tax rate is 35%. So, we're basically
talking about that 9% difference that you can save and 9%
of a million dollars, you're basically talking about 90, 000 dollars,
you know, that's not cheap change for anybody. So, that's the
difference in terms of how something is taxed but that's for a C
corporation.
You know you can barely tell that that's 43.9% and I just
realized that. So anyway, just to let you guys know. Now,
let's talk about the taxation of pass-through entities. By
pass-through entities, I mean, partnerships, S corporations,
LLCs. How many of you have invested in one of those type of
entities and then this time of year's tax year, you receive a document
called a K1? It's a few of you? Okay, that received a K1
and what that means is that the entity itself, that partnership is not
taxed but instead the income flows through to the individual
investor. So if Ally owns 50% of S corporation, LLC or
limited partnership and he owns his 50% and it earns 10, 000
dollars, he will get a document at the end of the year that will say
Ally, you have 50% of this company that earned 10, 000 dollars
of share, so your share of the earnings is 5, 000 dollars. So
Ally is gonna take that and he's gonna add 5, 000 dollars to his tax
return and he'll pay taxes on that 5, 000 dollars. So that's how
a pass-through entity works. Now, for a professional investor and
by that I mean a venture capital firm and many other more sophisticated
investors, they don't like the idea of income passing through them and
the reason is because many of those venture capital firms are
themselves partnerships. So then the income within flow through
to the ultimate investors and they've told their investors, you're not
gonna have taxes until you get a liquidity event. The other
problem is many times that company may have earned the 10, 000 dollars
and instead of paying it to you the investor, they may say, "Ally,
sorry, I used that 10, 000 dollars to be able to pay Philippe
[phonetic] because Philippe needed to get paid and I figured Philippe
needed the money more than you did!" and Ally says, "Wait a second, I
have to pay my taxes on 5, 000 dollars but you didn't give me any cash,
that just seems unfair, seems un-American. I mean why did you do
that? Since I have to pay taxes on it, you need to give me the
money." And the person in charge of the company says, "You know,
I had my choice, I can either pay Philippe, he was doing important
research or else I could pay you and I chose Philippe". So that's
the phantom income and that's another reason why professional inventors
don't like these pass-through entities. Now, what's an advantage
of a pass-through entity? Well, at the very beginning, a
pass-through entity in most cases is gonna take the money, the money
that's being invested and they're gonna lose money because they're
developing the technology or doing other things with it. It's
gonna be sometime before they're actually gonna be making money and so
many times the early investors, they want that pass-through losses
because if Ally gets 5, 000 dollars of losses, all suddenly Ally says,
"Hey! This actually is good because it will reduce my taxes by 5,
000 dollars or whatever the number is and so that's good". Now,
but and so what you need in that situation is you need to have a small
tightly-controlled group of shareholders. That's the situation
where it sometimes it does make sense to have a pass-through entity but
if you're gonna have a professional investor that you know that your
business plans says that I need one million, two million, three million dollars
or a lot of money and so to get that money from individual angels is
gonna be very difficult and you know you're gonna need it quickly then
basically the idea is then you need to go ahead and go for a C
corporation upfront because you're gonna be getting a point where you
need that professional investor and they're gonna want a C
corporation. So, it depends on what type of investors you have
and what investors you envision that you're gonna need and how you want
the taxes to flow. And then you also have different types of
companies, let's say a real state company. Somebody that has a
shopping center and you expect it to throw up income on a regular basis
what I call a Cash Cow because it will keep throwing that income off
every year and it's expecting to pay off the income, well then you
would normally expect to have a pass-through entity because it's more
tax efficient that you only have taxes on one level. Now, the
different types of pass-through entities, you might have heard of an S
corporation. Steven, you have a question?
>> Just curious, I'm sorry, just curious as to are there times
where you start with an S corp and then you just shift over to C corp
when you feel like you need money?
>> Excellent question. Excellent question! What he's
talking about is can we for the early investors who want those losses,
can we start off as an LLC or an S corporation and then switch over to
a C corporation, yes later. Yes. The answer is you very
definitely can and that's when you have a situation of the early
investors want those loses and you know it's gonna be a year, two years
or some period of time that it make sense before you're gonna need
professional investors and so you can delay that time and go ahead and
get the loses. So that's correct. Good questions. But
there's different type of pass-through entities. You have an S
corporation. You have a Limited Liability Company or LLC and you
have limited partnerships. Each one of those has their own
advantages and disadvantages. S corporations are rarely used and
the reason is, is that they sort of an anachronism from a long time ago
and so the IRS has a bunch of rules that we call traps for the unwary
and so all of my tax partners they don't like S corporation because
there's a number of problems with them or you know some complexities
that you have to deal with. They like much better to have a
limited liability company or a limited partnership. Generally
right now in LLC if you want a pass through entity then you're gonna go
with an LLC. But then I go back to what's the reason that people
would want a corporation. If you know that your business plan
calls for a lot of money and that to be successful you have to get
money from a venture capital firm within a relatively short period of
time, let's say a year or so, then it makes sense to start with a
corporation upfront because the amount of losses you're gonna have in
that one-year period is not really gonna matter. If you have a
longer period of time and the early investors are going to want those
past through losses that's a situation where you might want to have a
pass through entity an LLC for example and then as Steven asked and
then once you have a professional investor or venture capital firm
ready to invest in your company, then you would switch over to
it. And usually with an LLC it's fairly easy to do that.
You can also deal with an S corporation but in most cases most people
go with an LLC because there are simpler rules for when you convert.
Any questions so far? Any other questions? [Inaudible
audience question] Which state to organize under? You might
have heard about a Delaware corporation and why is that. Most
public companies today are a Delaware corporation and there are some
reasons for that. One of those is that Delaware was the first
state to create this thing called a corporation in 1899. They
were the first state to do that and so they, part of their business is
to make it very hospitable for people to form corporations and they get
the franchise taxes and so as a result many people incorporated there
but the reason today why institutional investors like a Delaware
corporation or two, one is the law. Because there are so many
public companies that are Delaware corporations public companies get
into court battles. There are lots of court decisions.
There's a lot more law out there in court cases and institutional
investors like more certainty. The second reason is that they
have a special set of courts that are set up only for corporate
disputes and so if you are a professional investor, a venture capital
firm of a hedge fund or other and you have a situation that your
dispute is gonna go to court who would you rather have deciding your
law suit, the Delaware Chancery Court which has the expert's experts in
corporate law or somebody down in Harris County who might have had a
divorce case in the morning, might have had an infringement dispute in
the afternoon, might have a criminal case tomorrow and the last time
they study anything about corporations was back in law school. So
that's another reason why people like Delaware as a place for
incorporation. Now, if you do incorporate in Delaware then you're
gonna have to qualify in Texas if you're doing business in Texas and so
as a result you pay franchise taxes in two places, pay it in Delaware,
you also pay it in Texas. So when people always ask what about
Texas. I just have my little bitty company. I don't know if
I'm ever gonna be raising venture capital money. You know I'm not
going public. I'm not doing this or that. I said sure, not
a problem. You can do a Texas corporation, it's simpler.
There's only one way of franchise taxes but what you have to realize is
if you are going to be getting money from a venture capital firm later
on then they may require you to reincorporate in Delaware. I've
been in discussions with venture capital firms and that's been the
number one thing. Okay, Mr. Inventor you know you have a Texas
corporation you'll need to reincorporate in Delaware if we're gonna
invest. Just straight up front. I have one situation this
is a number of years back. I represented a company it was four
people literally in a garage and so they were able to find Austin
Ventures and convinced Austin Ventures to fund them a seed capital
round. That's pretty rare for that to happen and so Austin
Ventures represents a very well known venture capital firm that some of
you may know in Austin and we had not even incorporated the company so
I talked to council for Austin Ventures, someone in Benson & Elkins
a very well-known law firm here in town and the first thing out of this
mouth was well, the company hasn't been incorporated. Paul, I
assume that you will form a Delaware C corporation and I said of course
we're going to form a Delaware C corporation. How quickly can you
fund the money? So that's it for choice of entity.
Choice of name. What's in the name anyway? First thing
people always ask is you know there's a lot of different considerations
for choosing a name for your company and the name of your company, it's
important. This is gonna be how people are gonna know your
company and so the first thing people think about is, is it descriptive
in anyway of what your company does. You know that's the first
thing because is your company going to be known for the company name of
are you gonna have a product and that's where your branding is going to
go. Like how many people in this room have ever heard of a
company called Tyrell? Nobody has ever heard of a Tyrell.
However, does anybody in this room know about a product called the
Zeno. It's the zit zapper. It's what I've always --
Basically you can buy it at Walgreen. It's using heat treatment
to treat acne and my daughter has it. She's 17 years old and so
for Tyrell they could care less if you had ever heard of Tyrell.
What they do care about a lot is that you know what a Zeno is because
that's the product that they want you the consumer to go out and
buy. So that's one of the considerations for your company.
Now, is it descriptive of your business? And sort of with that is
it common or generic? Let's take an example. Let's say I
have a legal staffing company so I said okay, I'm gonna call it
International Legal Staffing. Can you think of a more boring, a
more generic name than International Legal Staffing? However if I
ask, Stan what does International Legal Staffing do? He'd
probably very quickly go, "it probably has to do with the legal field,
it has to do with staffing". So I have a general idea for what
your company is very quickly but if you wanna try and go out and get a
trademark for International Legal Staffing it's gonna be very difficult
to do because International Legal Staffing is very common. It's a
very generic words and so unless you could put those three words together
in a way that's distinctive and catchy it then creates a brand around
it, you can't get a trademark for International Legal Staffing.
However, has anybody in the room heard of a company that also has very
boring words in their name? International Business Machines, yet
some of you probably young of you go like International Business
Machines, what is that? But you say IBM they created the brand
around that name. International Business Machines and yes that is
trademark because people think of International Business Machines now,
they think of IBM. Actually, that's the changed name of the
company. That gives you some idea but you have to create the
brand around it. So those are some of the considerations you have
for. Does it describe your business but at the same time is it
distinctive enough that you can get a trademark for it. One of my
clients, the name of the company is Augmentix and Augmentix, it doesn't
mean anything in any language that we know of and really doesn't mean
anything. It's just a name that was created but when you hear the
business plan for the company which is to take a Dell server, just a
commodity Dell server and you want to change it or augment it so that
it can withstand extreme environments like Iraq. Think about the
Army or Marine Corps putting servers in Iraq. That's their
business plan and that's what they did and they know actually have
servers in Iraq but that's their name. When you hear about that
okay you're augmenting commodity Dell servers for extreme environments,
oh the name of your company is Augmentix. It fits together.
So you have both the distinctive and catchy but there is some
description of what your business plan is. I always liked that
name.
>> And you also wanna think about the logo. Now, is your
name available? There was a hand out that was sent to you by you
know before hand electronically and it basically gave you--Here are the
ways that you can check out your name. That used to be in the old
days and old days means like pre-1997 that to get a name you'd have to
call your attorney, you may come up with three or four different names and the
attorney would do all the checking. Well, you know today with the
internet you can do all that checking yourself upfront. You don't
have to hire an attorney to do that. So you do a lot of leg work
yourself. What are the places you're gonna check? Firstly,
you gonna check the secretary of state in Delaware and Texas and make
sure that your name is available if you choose to incorporate or form
another entity. Second thing you'll do is you'll see and make
sure that the domain name is available, it make sense. Another
thing that people don't think about but it's a good thing to do is to
do the online telephone books and generally I tell people why don't you
to look at you know the popular states like Texas, Illinois, New York,
California and just get some idea, are there companies out there that
are doing business using your particular name because that's a quick
way to find out what's out there and who's using it. Another
thing you can do is check to see if someone has a trademark for
it. You can go to the U.S. Patent and Trademark Office, uspto.gov
and you can see whether anyone has a trademark for your particular
name. Now, what happens if your particular name, it is being used
and someone has a trademark for it? Well, think about this
example. Even if somebody is using the name for one particular
purpose you may be able to use it for a completely different unrelated
purpose for example, Prudential. Anybody here would immediately
go well, Prudential that's an insurance company. They also have
financial services. That's what they do. What if I wanna
start Prudential Hamburger Stand? That's what it's gonna
be. It's completely unrelated to insurance industry or financial
services. Selling hamburgers, well that's unrelated. So
that's where you end up meeting an intellectual property attorney just
to help you distinguish to make sure that you're not you know coming
too close to what someone else is using. Now, of course you're
gonna Google the name because you wanna see what comes up. You
Google, you use the other search engines and then finally if your
choice of name is extremely important to you, you'll use a database
search that will search all of those things and a lot more and one
example is Thompson & Thompson and so you pay a fee to use those
databases to then see whether or not your name is available.
These are situations where it's really important that your name be
special and distinct and that nobody else is using it because if
somebody else is using it and one example, people know about Compaq
Computers. Compaq was started here in Houston and they did all
their searching and sure enough after they got going they found out
that someone in Iowa had a littler computer store that was using that
name so they end up having to buy the rights to be able to continue
using Compaq. Here's another story. I have one of my
clients. Basically, we're in the movie business and so he came to
me and said well you know what I was actually involved with
Compaq. I know the problems that we had with that name. I
wanna make sure that this name is available so what I want is I want
Rainy Day Entertainment. We did the Thompson & Thompson
search and actually this was before the day of the internet so we
really needed those databases to find it and so we looked at it.
We looked all. You know I had my own intellectual property
attorney and make sure there was no infringement anything else.
We went ahead and incorporated it, got the company going and my client
trotted off to Hollywood to go off and start his company and start in
the movie business. Well, if you're gonna be in the movie
business you have to join a union and that union is called the
Screenwriters Guild. So he went to register with the
Screenwriters Guild, Rainy Day Entertainment real proud of it.
They said I'm sorry that name is taken. He said it can't
be. My attorney looked at it. We did all these
things. We checked and made sure...Well, sure enough there was a
screenwriter, a lone screenwriter who had that name. He had never
incorporated it. You couldn't find it in the phonebook. You
couldn't find it anywhere but the one place he needed to be in was the
Screenwriters Guild. They would not allow him to register under
that name so he came to me and said, "Paul what do I do?" I said,
"Well, Bill you've got a checkbook and you're gonna need to write a
check and I don't know how big that check is gonna be. So he
calls up the guy, offers him with some reasonable money and the guy
said "No, I will not sell my name." So okay, Bill he wants more
money from you. He goes back to him. He gives him some you
know where he keeps raising and raising he's just getting madder and
madder so finally the screenwriter says, "Look, Bill you're a nice
guy," he says but look you don't know who I am but I have these movies
to my name. I'm a pretty wealthy guy and I've been doing business
under Rainy Day Entertainment for a long time. There is an
emotional attachment to that name. When I told you before I'm not
gonna sell it I am not gonna sell it period, end of story! I
don't care how big your checkbook is I'm not gonna sell it!" So
the client comes back and said, "Paul what do I do?" and I said "Pick
another name." [Laughs] So in this time he found the Indian
word, I think in the Cherokee language for Emerald Mountain and it had
about 15 syllables and I said do you want this one checked out.
He says no, nobody is using and it was like 15 different syllables and
that's what we incorporated his name. Unfortunately, his movie
business never went anywhere so that's why we don't know that 15-syllable name for anything. Anyway, that's the one story that I
have about picking a name.
Capital structure issues. Any questions before we move on?
Okay. We're gonna talk about debt, common stock and preferred
stock. Now first, debt versus equity. I used to think that
this was easy to distinguish between what's debt and what's equity
until I had one of my clients call because originally somebody was
gonna put in equity in his company and then he came back and says oh
no, no, no we're really gonna put in debt. He says, "Well what's
the difference." I said, "Don't you know." He says, "No, I
don't" so I explained it to him. Debt is simply a loan and so you
have to pay the money back but it conveys no ownership interest in the
underlying company. It's simply a loan. You gotta pay it
back. Now equity, equity means that you own the underlying
company and what's important to you as the entrepreneur is you don't
have to pay it back. That's the fundamental difference between
debt and equity. Now you come up with different type of
investments that are what we call hybrids. You can have a
convertible note that's convertible into equity. Now why would
somebody do that? Many times an early angel will come to you and
say well you know I really like your company. I really think
there's a lot of merit in your company but I don't know whether your
company is worth a million dollars, a million and a half dollars, two
million dollars. I really just have no idea what the worth
is. So what I'm willing to do is I will invest. I'll give
you a loan but we will stipulate that if you raise money from an
outside source of a funding then I will convert my loan, my convertible
note into equity on the same terms and the same valuation as that new
investor. So that's a tool that you use to be able to bridge the
gap between debt and equity and usually it's to deal with evaluation
issue. Now you can also have a fix conversion. A typical
situation is you could have a dollar and for each dollar it's
convertible into one share. Now then you have different types of
stock. You can have common stock. Again, just by its name
-- Alli?
>> Question on the debt. If you take loans to open your
company and you can not pay them back because your company is not doing
well. It is setup that the company is liable and therefore their
company is bankrupt and nobody gets the loan back especially if
yourself one of the guys who puts in the loan or are you liable as the
founder of the company against the other cofounders who put in the loan
too.
>> If you personally guarantee the loan then you are personally
liable but if you're careful when you set it up and you're getting the
loan in the name of the company the company is liable but you
personally are not liable. So you just have to be careful on how
you set it up. Now, I have an example that's actually on the next
slide where we were talking about the dividend rate on preferred stock
and the dividend rate was averring what the investor wanted. They
wanted 18 percent. And you know the founder was just all aghast
like 18% for a dividend and, you know, this was he
was...stuttering. Well for that I might just as well go out and
get a credit card loan. I said, "There's a fundamental difference
in the credit loan and preferred stock at 18%." It's
preferred stock and the company goes under, you don't have to pay it
back personally. But if you have a credit card loan at 18%, you do have to pay it back personally. So, that's it's a
good question Molly [phonetic]. Now, who gets the stock, common
stock is generally it's always gonna be the founders. The
founders always end up with common stock. People have asked me
from time to time, you know should the founder get preferred stock and
I said, "Well preferred over who?" There has to be somebody
underlying that you're getting a preference over. The founders in
almost all situations are gonna have just common stock. With a
common stock, I mean, one share, one vote, no special attributes and
typically to the early rounds of angels, sometimes you'll see angels
taking common stock. Nowadays with the more sophisticated angels,
you do see them taking preferred stock and then you have preferred
stock that we'll talk about on the next slide. It's gonna be your
more sophisticated angels and almost always your venture capital
firms. Now, what do we mean by preferred stock, one of the key
notes of preferred stock is that it's extremely flexible. You can
slice it or dice it every which way you can. You can--all the
different terms that are out there, you can change them in many
different ways and so it's a very flexible instrument and what are some
of the ways that it's flexible? Number 1 is the dividend.
It's like I've mentioned before. I've seen dividend rates, they
can be low, 2%, 3%, or they can be very high 18%. That's a really high number. So that's one
piece. The second, you can have, its convertible into common
stock. Typically you have like one share of preferred stocks, its
convertible into one share of common stock. And then we have what's
called the liquidation preference. Now, when you initially think
about a liquidation preference, it sounds pretty fair because you
normally think about the company being liquidated that's going out of
business. You've paid all the debts off or whatever debts and so
basically there's a pool of money left over, you would think that the
investors should get their money back first. Right. That
makes sense. However, in the documents that before the preferred
the stock what's also known as liquidation is a merger or sale of the
company. So basically, the liquidity event is going to be a
trigger of this liquidation preference. Let's go through a couple
of examples of how this works. Let's assume that you have the
founders, the founding group and they have, well they own all of the
company and they're gonna bring in a new investor and the investor is
gonna pay five million dollars for 50% of the company to make just
make it easy. So, I mean, the founders have 50%, the five
million dollar investor gets 50%. So the company sort of
rocks along for five years and then ultimately decides to sell and they
sell for five million dollars. What happens? What do the
founders get? Nothing. Because basically the five million
dollars goes back to pay the original investors. Let's change the
example. Let's assume that you have a dividend up there on the
top and let's assume that it's about a 12 or 13% dividend so at
the end of five years, your dividend amount will be roughly a 100% of the original investment or about five million dollars. So take
that example again and assume that the company gets sold end of five years
for 10 million dollars. What do the founders get?
Zero. Again, because you have the five million dollars originally,
then you have the dividends of fivemillion dollars investors get that and
the founders get nothing. Now, what happens if we take that
example a little bit further? Let's assume that you sell the
company for 20 million dollars. On that situation, investors get
the first 10 million dollars and the second 10 million dollars for
participating prefer that's gonna be split 50-50. Founders get five
million dollars. The investors get five million dollars, so the
total of the investor get is 15 million dollars versus the five million
dollars for the founders. Now, take that example and sell the
company for 100 million dollars. What do the investors get?
Who cares? [Laughs] Everybody is rich. Everybody is
happy. You know, so the incremental amount that the investors
get, it just doesn't matter. So where the liquidation preference
comes into play is that the company sort of you know slowly goes up and
sells for just a little bit, that's the situation where the founders
and that's you, the people sitting in this room can get wiped
out. Now, when I have people that are getting for the first time
that are just getting exposed to this and I explained to them how this
all works and I can see their eyes getting real wide because you know
this is the reality of how this works. And what are other terms
of your preferred stock? You can have what's known as redemption
right. A redemption right is basically if the company sort of
chugging along, let's say for five years or some period of time not really
doing anything and the investor wants to force you to sell the company,
they can have what's called the redemption right to force you to pay
back their money and so in essence it triggers a chain of events that
in essence can force you to sell the company. The other thing is
voting rights. Your part of the preferred stock is gonna make
sure that you, the founder of the company, can't do anything with your
company unless you get their approval. One question always, so
really the moral of the story is that when you take money from an
outside investor especially of venture capital firm, it's very
expensive money because look at all these rights that they get.
Now, of course, it also means that they're taking a big chunk of your
company. So I always ask people this time why is Bill Gates the
richest man in the world or at least he was. Now, I guess now,
he's now in number 2, why is he the second richest man in the world,
anybody know the answer?
[ Inaudible Audience Response ]
You got it. You got it. He never took money from outside
venture capital. I think he took a little bit from his dad, a few
others but very little and so he kept a large piece of a pie. We
always think of in terms of a pie that grew to be a huge, humongous pie
and so because he was able to take his company and get a self funding
where he wasn't burning cash very, very quickly, basically he got IBM
to do a sweetheart deal to finance, you know, what he was doing, so
that he was able to get money in very quickly. So the quicker
that you can get your company to cash flow break even in the least
amount of money that you can take from outside investors, the bigger
the piece of pie, you know, the pie, 100% that you'll end up
having because what your company becomes a very big and very successful
company then you have more of the wealth that's created. The same
thing with Michael Dell, very similar situation. Now, authorized
versus issued shares. This is always an interesting one to
explain to people. In your articles of incorporation, it will
authorize you to issue a certain number of shares and so to change that
authorized number of shares to increase it, you have to go out and get
shareholder approval. So a typical situation is a company could
be authorized to issue 10 million shares but initially to your initial
founders. Everybody likes this idea of like owning a million
shares, typical situations, you authorize 10 million but you give a
million shares to each of the three founders, so you've issued three million
shares, so that means that you have seven million shares left over to issue
to new investors as they come in. So that's the typical
situation. What is the par value of 001? It's an
anachronism of corporate law that goes back a lot of years before my
time and the only thing that's important about having par value is that
you can't buy the shares for less than the par value. It used to
be, you know, a while back that people would have a par value of a
penny a share. You know it seems pretty reasonable but then
people decided that they wanted like a million shares. So, with a
penny a share, a million shares then basically somebody would have to
put in what, you know, a fairly large sum of money and so then people
will say, "Oh, wait, wait, wait, you know, we don't wanna put in that
much money" so you'll say, "Okay but we can reduce your par value
either lower to a typical amount is a tenth of a penny". And so
because you have to pay at least that amount of money for your
shares. Now, stock dilution. You know, that's the
percentage that you own, that your shares are of the company. And
so if you have the investor coming in, let's take our example of the
investor comes in and puts five million dollars for 50% of the
company and it's a dollar a shares. So, they have five million
shares at a dollar a share. Let's say you have, later on that you
want to sell shares but instead of a dollar a share, you want to sell
'em for 50 cents a share. That's called dilution to the original
investors, and so their share of the company proportion the amount of
money being put in is less. Have you ever gone out at Dunn's and
basically let's say you've shop for a TV and you've found the TV that
you want and sure enough its 300 dollars. If you think you've
shopped around and that 300-dollar TV is a good price, then go ahead
and buy it. Sure enough, three weeks later, you look at them again
and you see Best Buy has it for sale for instead of 300 dollars, has it
for 150, your TV. How do you feel? Cheap! You're,
basically, you've been diluted because your TV is really worth less
than it was in just three weeks ago. And so, it's the same thing with
stock that if you're selling for one price and then later on you sell
it for a lower price. There's dilution taking place for the
original investors. Now, for preferred stock, there's gonna be
what's called anti-dilution rights to basically keep the investors, the
venture capitalist hold in terms of percentage that they have and the
people that get squeezed are the original founders because basically
their share of common is gonna be squeezed down in terms of percentage
because the professional investors if he sees they sees they have the
protection of the anti-dilution rights. So, that's something to
think about in terms of the different funding grounds that you
have. One thing we'll talk about later, one mistake that many
people have early on with their company is they have a fixed idea of
what they want the valuation to be and so in the early round,
basically, the friends and family round, one mistake they make is they
have a high value, let's say a five million dollars of the company, even
if they say, "My company is worth 5 million dollars", the friends and
family don't have any idea. They go ahead and invest in it and
then later on, they bring in a--they have to go to a professional
investor and they come in and say, "Well, your company really is only
worth wto million dollars", so your friends and family are the ones that
are being diluted, you know, by this down ground in that type of
situation. [Pause]
Issuing stock. We'll just get real quickly here. A
little bit of water. [Pause] Any questions so far?
Today, we got a topic and we'll talk about founder's stock, we'll talk
about investing and we'll talk about options. Okay. Are you
familiar with what I'm talking about when I say founder's stock?
I think I'm little bit hot, so I think I'm gonna take off my
coat. Does anybody here know what I mean by founder's
stock? Founder's stock is what the founders get at the very
beginning and typically they pay next to nothing for it.
Typically, it will be a tenth of a penny, so it's a very small amount
and that makes sense because when you're first forming the company,
these three guys, four guys, you know small group of people and typically you
would think the company is not worth a whole lot of money and that
makes sense. So that's a typical situation as to issue stock for
a tenth of a penny per share to the founders and that's called the
founder's stock, the initial stock that they get when they're forming
the company and as a typical situation is you also assign the
technology to make sure that the intellectual property is transferred
from the founders into the company. So that's generally part of
the initial stock transfer because you wanna know who owns your
intellectual property. Let's have another story. Here's
another situation where you have three people coming together to form a
company, so they issue a million shares a piece and they got started on
the company. Two weeks after they started the company and each of
the guys was gonna, you know, work real hard. They weren't gonna
take any pay and you know to really make something with this company,
had some great ideas. One of the guy says, "You know, guess what
guys? Great news! My wife is pregnant, so now I'm going to
have a baby on the way. I have another mouth to feed. I
can't work for nothing. I'm gonna have to leave the company and
get a new job!" Everybody congratulates him. The guys gets
up and he walks out the door. What just walked out the door, not
only your friend but 1/3 of the equity of your company just walked out
the door. Gone! And you might say in that situation, of
course, Bill or Sam or whatever his name is gonna be fair in that
situation. He's gonna give his stock back or change your
scenario. Maybe it's been two months, maybe it's been 10
months. Whatever period of time but the expectation was the
original founders were gonna stay with the company for an extended
period of time, no pay and that was really the deal that everybody,
implicit deal when they started this company but yet 1/3 of the company
just walked out the door. Now, what happens now that, remember
the example that we started off with at the very beginning, what I've
told you about? What happens if two people leave? So then you
have 2/3 of your equity just walked out the door, gone. What do
you call the remaining person that has 1/3? Does anybody have a
name for that person? [Laughs] Employee.
Employee. He now works for the other two guys that he no longer
gets along with, so you call him an employee. That's a really bad
situation to be in but there is--yes sir?
What about the third guy who also leaves?
What?
What about the third guy who also leaves?
At least, you don't have a company. Your company is gone. I
mean just basically you don't have anybody to take it forward, you
might have the idea, you might have intellectual property but if you
don't have somebody to take it forward, the company no matter how good
the idea, I mean, you just, your company is just kaput. You know
just basically, it's an incorporated entity, there's nothing there but
now there is a solution to this problem and its called vesting.
What do I mean by vesting? Typical situation is initially you're
gonna have to share you're issued shares and it's gonna vest over four
years. So take an easy example we'll all go through and let's
assume that 1/4 of the shares are gonna vest over four years in each
anniversary day. So that means that people start working.
They have to work at least a year to get any vested shares. Now,
what happens if they leave before a year? Then basically the
company under the documents has the right to repurchase the stock at
the amount of money that they paid to purchase at it, a tenth of the
penny you share, not very much money. So, invest you repurchase
the stock. They can and basically hold back that stock into that
company. So, that's a way to keep your group together and that's
a fair way to deal with it. Now, many times you have the original
founders. They don't put the vesting in place and then you have
the venture capitalist that come in later. The investor says,
"Wait a second guys, we understand that you have, you have the stock,
we wanna make sure that you're gonna stay around for longer period of
time. They wanna impose a vesting requirement if one is not
already there. Now, let's go through some of the complexities
with vesting because there will--before I ge to that, there's other
things that you can do to keep your group together. The other
thing is you want what's known as the right of first refusal. So
that if somebody sells your shares or transfers your shares, I mean
let's say in a divorce, you know, do you wanna be dealing with, you
know, whether it's Susan, your, you know, the scientist you've been
working with or do you wanna deal with her husband Bill who has nothing
to do with the company. So, in a divorce, you wanna make sure
that the shares don't end up being owned by somebody that you don't
wanna be dealing with. So, in many times you will take care of
those situations, you know, with the shareholder agreement to deal with
like death, disability, divorce and ternary dispute. But then
let's keep on with this vesting concept. How are vested shares
taxed? Now, this is really important. It's a little bit
complex but I'll take you through it. The default for how shares
at vest are taxed is basic between on the date of that the restriction
lapses. It will be taxed at a difference between fair market
value and what you paid for it. Now that sounds okay. Let's
take an example. Let's take our 1 million shares they're gonna
vest on each anniversary date over 4 years so that's great. So
you have first anniversary 250,000 shares are going to vest so you'll
be able to basically have those shares free and clear, no restrictions
and it will be taxed on the fair market value on that anniversary
date. Let's assume that you also go to an outside investor and
you raise 10,000 dollars at a dollar a share. So what's the fair
market value of your stock? A dollar a share. What's the
fair market value of your 250,000 shares? 250,000 dollars but
that's the amount that you're gonna have to report on your income tax
return but you have no cash to pay it. It's the worst possible
result you can get. You have all of this income and you have no
cash to pay for it. That's a really bad result but there is an
alternative.
You can choose an alternative way of paying for the shares. You
file a form called Form-83B with the IRS and if you do that, but you
have to file that form within 30 days of issuance, then you can
basically pay the taxes on the difference between the fair market value
when they were initially issued and what you paid for and when the
founder, the three or four founders coming together who first formed the
company and the company is just, you know basically it's just a minute
book you know there's nothing there. It's just a little bit of
intellectual property. What's the value? It's pretty easy
to argue the value of the company at founding is really pretty close to
zero and so you can file that form early on the founder can to declare
I wanna go ahead and you know to extent there is any value I'll pay it
but declare the fair market value at pretty much a tenth of a penny a
share, you pay a tenth of a penny no taxes due. That's a good tax
result and that' something that you have control over early on.
However, there is a catch that Form-83B has to be filed within 30 days
of issuing the stock, no exceptions, no appeal, nobody to talk to at
the IRS it's just simply that's the rule and so remember my example of
somebody coming to me in January of 2004 and saying we incorporated a
year ago and we dealt with the employees and this and that, now we have
an investor coming in. Well, they had already missed their
opportunity to use this 83B as an alternative mechanism so we had to go
to a lot of hoops to be able to you know work with them to come up with
an acceptable tax answer to be able to go ahead and issue the
shares. You know basically the takeaway from this is that anytime
you issue shares you need to be thinking about the tax impact when you
do so. Yes?
Does the 30 days is issuing of the shares or it's formation of the company because very frequently it's together, right?
Usually it's together but it's from the issuance of the shares.
Okay. So I formed the company months ago and we didn't issue the shares yet then we're still cool.
Because your company isn't really formed yet. All you've done is
just you filed incorporation documents but until you organize it.
To actually issue the stock and have the organization meeting and those
formalities and you haven't organized the company. So it's from
the date the shares are actually issued. Yes?
Are you talking about the public shares of just private shares?
These are private shares because this is a private company because
you know it's just been formed. Somebody else have another
question? Yes?
In your example you used 10,000 dollars computed at dollar a share
but you've already given out 250,000 shares to a shareholder and your
argument is that the shares are not worth a dollar a share therefore
the tax burden on the 250,000 dollars. If the company valuation,
however, is no where near that amount you're arguing the market value
is actually worth now 260,000 dollars for the company in that scenario
but the company hasn't really got a public market or a trading market
or doesn't have a valuation, can they still hold them to that amount
because you can always get one person to give you a hundred dollars for
a share and you'd cause that kind of problem. So I would
argue. I'm a little concern about that example because
No it's actually right on point. If an outside investor, yes I'm
talking about a third party that has no affiliation with the company
and so they're coming in and saying well you know I wanna invest in
your company. They're gonna set the value and they actually
invest and pay money for their shares and they do it a dollar a share
then the IRS would come in and use that as an example then you may say
my company is not worth 260,000 dollars. It's really worth 10,000
dollars. So the IRS agent is gonna scratch his head and go
okay. It will help that you had investor A he put 10,000 dollars
in the company and for that percentage of the company and is based on a
dollar a share why isn't that the best evidence of what is the true
value of your company because, unrelated person there was no compulsion
for that person to put money in your company and so you can have your
argument to say well, there's no way I could sell my company for
260,000. There's nobody who would do that. [inaudible] then
why was this idiot you know putting money in at 10,000 for a dollar a
share. Why did they do that? So then you have your argument
with the IRS and frankly I think you have a losing argument so that's
difficult and of course my example's a little bit stilted you know
because of course I'm trying to make sure that really you know it comes
home to you. Alli?
Does this form only relate to vested stock or to stock just in general
when you started and when people come in later on and they invest, I
mean the value goes up but you might not have the value on your pocket
as we say even with non-invested stock?
It only relates to stock with vesting. If you issue stock without
vesting then it's a different scenario because the -- We'll get to that
actually in the next slide because we'll talk about the considerations
because then you say, "well wait a second, I'm not gonna be issuing
stock. I'm gonna be issuing options". So we need to compare
what's the tax impact of issuing stock, how's that gonna be valued and
then how's it gonna be valued if we do options. Well, let's talk
about issuance and that's what Alli is talking about. You have a
new employee. It's after a year, two years or some period of
time. Your new employee comes in and you say well I have a
choice. I can either give you 10,000 options and whether there's
an exercise price that you have to pay a certain amount of money to be
able to get those shares let's say a dollar a share, 50 cents a share
whatever you know or I could go ahead and give the stock, just give an
outright grant, no vesting just to give you 10,000 shares. So
what's the tax impact? If you issue the shares its valued at fair
market value on the date of issuance, so those 10,000 shares if you
have outside investors same examples. You have some outside
investor right about the same time that has you know put in hundred
thousand dollars at a dollar a share and you have the employee and you
give that person 10,000 shares it's valued at a dollar a share so that
person has a tax impact on the date of issuance. The fair market
value 10,000 dollars that's what they will report on their income tax
return for that year and a half would have to pay taxes on it.
Restricted shares or free trading shares? You know earlier one of us said
These are free traded shares, no vesting, no restrictions.
But some officers and directors or affiliates would be issued
restricted shares periodically in which case they wouldn't be publicly
tradable would those have the same valuation as the fair market value?
I mean if they're restricted and there's a lapsing then it goes back to
the other way that when the restriction lapses it's a fair market value
on the day it lapses but if you've just given the shares outright no
restrictions it's valued on the date of the grant at fair market
value. Alli?
And that is only for the equity you basically sold for an
investment. But it's not true for loans, right, that you
took. If you take a million dollars and you give away equity for
a million dollar that's what you have and then suddenly your company is
worth a million dollars but you own 50% and you're therefore
stuck. I mean you know when you have unequal distribution.
So one guy puts in a quarter million but after one day he owns now
basically half a million because he owns 50% of the stock so
he's tax liable for 500,000 dollars although he only put in a quarter
million, right, when you do stock issuing but if you put in loans and
you just declare the stock valued at 10,000 for example you just
basically pay taxes on 5,000.
It depends on what's the value of the company when you receive those
unrestricted shares. If you get those shares upfront on the first
day, no restrictions and base it's valued you know as the founder
shares and so there's really the company's not doing anything.
It's really, the valuation is really nothing so then your evaluated at
that date--Let's take your example and let's say somebody is going--the
original founder maybe he puts in a little bit you know equity but then
he loans the company money. So 100,000 dollars, he loans the
company money and a year later he converts that loan into equity and so
in essence he's paid for it but again, in that situation he's already
paid the money and so it's you know be valued at fair market but let's
say he converts the money a year later at a dollar a share so he gets
you know for his 100,000 dollars he get a 100,000 shares, he
converts. Well, he has in essence set the value because he was
willing to take a dollar a share and so then at the same day that he
converts then he brings in a new employee and says I'm gonna give you
10,000 shares no restrictions the same day. The value would be 1
dollar a share. Does that answer the question?
I guess the question to be asked if you take loans to start your
company that loan will not automatically convert into a stock price
unless you convert the loan into an equity. If you leave it a
loan and you pay it back as a loan I can raise 10 million as loans, I
will never have to pay taxes on these loans because it's what it is,
it's debt.
But you have no equity in the company because it's a loan so until you
convert it depending on whatever the price is then that's to be set.
And the way to do that is you declare about 10,000 dollars as equity
and 9,999 million plus something as loan and then you're only liable
for taxes on 10,000.
Well, in this example though you've actually put in cash so you're not
liable for, so if you're putting in a million dollars or you know
whatever amount that you're converting it to equity
I'm not converting. I'm paying back as a loan with interest.
If you're simply taking back, if you're giving pay back your loan, no
there's no taxes except for the interest. You know the interest I
mean to the extent that your capital is being returned that's a
different situation. Before I continue with the example any other
questions? Well, now this is at issuance. So when you look
at this you say okay what about options. What if I issue an
option to the employee instead of I'll issue options at basing it at
10,000 shares at fair market value on that date. Let's assume
that it is a dollar a share, that's fair market value. Well, then
basically on issuance date there is no tax impact, none. So
nobody has to pay taxes because you're issuing shares of stocks at fair
market value excess. I mean you're issuing options to purchase
stock but at fair market value so there's no tax impact. So when
you talk about issuance you know options are clearly better once the
company is up and running it's much better to receive options because
there's no tax impact whereas if you get stock you are taxed on the
value of those shares. Now let's go to sale. Let's assume
that you know for the sale and let's assume that you were the employee
that received the stock, paid taxes on what are the fair market value
was on the first day and then sometime later you know the company is
sold and you get to cash out on a much higher number. What are
you taxed on? You're taxed on the value you received minus what
you paid but you pay it at 15%. Now, how are
options? So you have the same situation where somebody is
receiving for their option. They're receiving a certain amount of
money minus the exercise price but the difference is taxed at 35%. So the advantage is clearly to have the stock. You
basically have to think through the tax impact upon issuance and then
upon sale on what's the best situation depending on the fair market
value of the stock at that time and how to deal with it. So
really the take away from all of this is that if you issue stock or you
issue options you need to understand the tax impact both on issuance
and on sale. Chris?
Qualifying small business you know I've come on that there's 50%
reduction on capital gains if you're in certain areas of business which
most of the medical may apply if you've held the stock for a five-year
period or longer I think. That's probably really important to
hear in this room.
There are some special tax rules too and if you do certain things you
could get lower tax rates but as I understand those rules you basically
have to actually own the stock. It wouldn't apply if it's
option. So basically the 15% could be potentially lower if
you meet certain hurdles. You have a certain type of company and
you've met certain requirements it could be potentially a little bit
lower and so it's still the difference between owning a stock and the
options it just means that the spread instead of being 20% could
be a little bit higher. Any questions and I know this is you know
going through all the taxes. It's like of all things to be doing
on April Fools Day.
I don't know if you could talk about this but could you mention
something about phantom stocks that some companies might choose as a
vehicle to give as an option to employees because I think the
complication of a lot of the options and stocks is the tax impact and I
believe, I don't know a great deal of but I believe phantom stocks
enable you to avoid that concern maybe.
No. [Laughs] What is he talking about when we say phantom
stock? Phantom stock means instead of actually issuing the shares
or issuing an option to purchase shares we're gonna basically say that
we're gonna give you this phantom units that if certain events occur
and a typical event is if the company is sold then we will treat you as
having owned a certain number of shares of stock in company so when we
look at the aggregate proceeds we're gonna set aside a certain amount
based on the number of phantom stock units owned and we're gonna pay
those typically to employees that have been issued those shares but how
are those taxed? Taxed at ordinary income rates so you get hit up
to 35%.
But only on the sale.
Yes, yes so that's another way but it's really the same thing.
You're really taxed at a similar as options so one of the reasons why
would you use phantom stock units as opposed to using options.
Many times if somebody is using an LLC and a typical situation would be
a private equity firm buys the company. They want it to be you
know because of the different ownership structure they want it to be an
LLC but they don't want each of the employees to actually own the
shares. They don't wanna be partners you know with all these
different small employees that have small amounts and all the
complications. They wanna own 100 percent of the company.
They don't want any of the equity out to other people but they wanna
incentivize people you know so instead of them having to talk about
voting or other rights like issue, what's known as phantom stock units
if the company is sold then they give them you know basically you're
entitled to a piece of the pie. And that situation entitles no
ownership rights and if you leave the company you don't get anything.
I thought another advantage especially if, correct me if I'm wrong, if
you work here at M. D. Anderson and there are certain things you need
to report for conflict of interests per se sometimes companies would
potentially offer phantom stock in that in itself you do not own.
Am I correct by saying that and is that a reportable event or my
understanding is that that you're still not at ownership of that
company per se?
I don't know your rules but I would suspect that if you own any type of
equity or similar interest and the phantom stock would be reportable
because basically you end up the reason for the reporting is for
conflict of interest because basically I would assume any other purpose
of this for M. D Anderson, they wanna you know if you have some
interest in this company that you're working with you know whether
you're doing research or other things with they wanna know what type of
conflicts are there because what they don't want is your doing research
on this particular drug and because you own a million of this phantom
stock units you have an incentive to lean a certain way. That's
the reason for it so anything that gives you any type of equity or
equity type of interest or incentive, It's just a bonus payment you
know in essence what it would be and that if you have any interest I
would think that that would be reportable.
I think the wording we have is you have to disclose any relationship,
financial or otherwise something like that is the wording that we have
here at M. D. Anderson and I would assume that wording is across the UT
campus so at that point you would have to disclose that you own phantom
stock.
Being a securities' lawyer you always disclose everything [laughs] then
you can sleep at night and it's a whole lot better. You don't
have to worry. Okay. I know this is really just, this is
the most exciting subject that we're gonna talk about today. So,
the take away, just the take away from all this is that you're gonna
issue shares or options and depending on the stage of your company
there are different things that you can do to minimize the tax impact
that can make a big difference when you sell the company but there are
trade offs as we've seen, you know, for stock and options for what you
do. Yes?
So in a very early stage of your company, because you say from the very
beginning, you need to really know what you're doing with this.
Uhmm...hmm. I will never get this. [Laughter] So is
it important to very early on find someone who will basically who you
can trust to have your vest in and how do you find someone like that
who has your best interest in mind, knows, what they're doing and will
protect you from all the many mistakes you could make at this stage
when you started becoming, what do you do? Do you find someone
like you or how do you
You find a good attorney. [Laughter]
All right. I mean it's good to know a little bit of the undertakings but clearly I'm not gonna be savvy enough.
Oh, no.
After this seminar to do this.
That's why the key take away from this is just to understand that there's a tax impact
Sure.
And a lots of ways to screw it up.
Yes.
And just find someone that does and that someone, and not just, you
know, any attorney but it really helps to have an attorney that's
experienced in this type of startup company. There was an article
that I sent you from a Harvard Business School. It was basically
the 10 biggest mistakes that entrepreneurs make and so it's really,
it's really a good article. I was looking to writing an article
on that subject so I went out and Googled and I found that article and
said, "Man, this is exactly what I want" so why write the article
because I already have it. I can give it out at these
presentations. It's such a really good article and 2 things I
talk about is this not incorporating early enough. They talk
about--another one is not following form 83B, that's a big mistake that
people make and then another that they say is not finding an attorney
who's experienced in startup companies. So that's. Man I
hate to be self promoting but [laughs] it's, you know
[ Inaudible Audience Response ]
[ Laughter ]
>> Well, and let me tell you, I'm starting now several
companies. I have talked to tax accountants, to lawyers. My
first company done by myself and luckily I did just kind of being
stupid to the right thing. With my last company, I talked for
probably a day with my regular accountant who had to read a lot about
the issues and still couldn't come up with the right way to do this
then I met with the lawyer which I know is a very good one as well like
Paul and he clearly told me now, you need to talk to this
accountant. I went there and in five minutes we had the whole
structure set up. So, and he didn't ask me money. The 1st
one asked me to sell a 100 dollars for something I couldn't use.
So that a really good suggestion to you is find the lawyer that
understands startup companies and maybe understands some of the
accounting issues, that's rare. So Paul is one of the very few
out there or find the accountant that knows everything about startups
and will tell you which lawyer to use because they work very frequently
with the same set of lawyers and there is a very small subset of these
here in town. So, that is the reason why Paul is here today.
Somebody issues with options typically that was known as a stock option
plan that basically will set sort of the omnibus rules and regulations
for issuing them. One important issue, okay, well there's two
things, 1 the exercise price needs to be of fair market value. It
used to be before 2004, that you could issue options at lower and fair
market value and it didn't really matter. So you might have
issued stock with somebody on for a dollar of share but for the
employees, you might have issued them at 50 cents or 25 cents for the
options. Then the IRS, you know, basically they that they have
these rules called 409A and it was all, you know, basically it affects
all of the inland problems, so the inland problems will never happen
again. So you have like rules and regulations at that authorize
you, you know and so one of the things was that you could not issue
options at less than fair market value because otherwise the recipients
of the options is taxed on the value between, you know, the underlying
exercise price and the fair market value. That's a bad tax
result. That's one thing to know. The other thing and
people often ask is how big should the employee stock options will
be? Because if you have investors that are investing in the
company, and they own a certain percentage of the company, well they're
deluded by how big the pool is for the employees and since the
employee's basically aren't paying anything or many times they're not
receiving options. That dilution is important to investors.
If you have a pool that's--so the typical range would be 10 to 15% of the equity of the company would be set aside for the stock
option plan. That's a typical percentage back in the halcyon days
of the, you know, the internet boom in 1999, you saw some companies
with 25% being set aside for employees but that's got ratcheted
back in the more normal days of today. So that's typical amount
would be 10 to 15% as a typical range. [Pause] Now,
just sort of to walk through a few things about financing, yes?
At M. D. Anderson, just correct me if I'm wrong. Can you be an
owner, I mean we talked about starting up a company but can you be an
officer within a company, can you with a 15% of a company.
I know that there's some regulations about you can get off, you can get
permission from the president of the institution to do that but what is
really, I mean, if one of us wanted to really start a company, what
sorts of hoops do you have to jump through to be able to do that in a
formal way so to speak.
All right. That's what Michael Rosenblum talked a little bit
about I think two sessions ago. So theoretically, you're not
allowed to be in the management team. You're not allowed to be a
manager director or board member. You are allowed to be a chief
medical or chief technology or chief science officer which typically
doesn't run the business of the company but more the aspects of your
science. When you go out PO, you know, as a founder, you're not
allowed to own more than 50% of the stock. So these are
kind of the ground rules and as he said, "When you wanna start your own
company, you can go to Mendelsohn and he may or may not give you a
waiver that for certain amount of time, you're allowed to be your own
CO in order to go out there and find the first real CO who takes over
your company. That's kind of the rule, so in other words, the
rules are really not very good for entrepreneurs and that's my
frustration with this course and people like you, I'm out here, I'm
paid to really help you get out there and as soon you're out there, you
hit the wall. So I'm trying to get that wall down for you guys
and were constantly working on that and Cathy is working with that at
the UT system. We are really trying to make these things friendly
for you guys but we're not there yet and with things like Enron and
ImClone and all these things. It doesn't make it easier.
Okay.
And different, you know basically [unintelligible]that's part of what,
they're trying to do is sort of help take that technology and then get
it to commercialization so I mean I am aware of other situations I
guess within the M. D. Anderson system where there was strong
incentive, by the institution, you know, to basically to try and
commercialize it and so, you know, they were willing to work within
reasonable boundaries, you know, to try and get the company sort of you
know, pass that initial stage and sort of up and running, so that it
might be something as licensable. I'll go through just quickly
just on raising money. Cause people will ask well, you've talked
about these different rounds of funding, we have friends and
family. You have angel round, you have ventured capital
round. What type of money are we really talking about? Well
for the founders of the company in a typical situation 'cause you're
gonna need some money upfront and people especially outside investors
one of the first questions they're gonna ask you is, you know, you're
out there trying to raise money, well how much money, Steven have you
put into the company? They're gonna want to know that you have
skin in the game as with the initial founders. Typical
situations, that they're putting in some amount of money depending on
their personal wealth and what they have so a typical normal would be
something like a 50 to 200, 000 dollars. You're also raising
money from your mom and dad and sister and uncle and you know people
like, we call that the friends and family, typically that's gonna be,
you know, the early money coming in. You have to try and put
things together, typically it's gonna be common stock. One of the
issues--two of the things that, problems that you get into, one, is you
have too many small investors. So, if you're trying to raise,
let's say, 50, 000 dollars.
Well, the worst thing you can possibly do is pass the hat to everybody
in this room and everybody puts in a 1000 dollars. That the worst
thing you can possibly do 'cause you have all of these people owning
shares, you have a large people number of people to try and deal with
and you've raised a relatively small amount of money, you know, that's
a bad idea having too many small investors is also a securities law
implications of it and which is also, can be bad but basically it's
more than anything, it's just unmanageable and so when a later investor
looks at your stockholders, you know, they're gonna look at, you know,
goodness we have 30 investors in this company that put a 1000
dollars. I don't wanna have anything to do with this company
because I don't wanna have to deal with all these people because out of
30 people, you probably gonna have one who's crazy, [laughs] you know,
probably gonna cause you problems and so, it's just something you don't
wanna deal with. The other common mistake that people make is the
friends and family round. They have this unrealistic expectation
of how much the company is worth. And so you'll say, "You know,
my company is worth five million dollars". If Google was worth this,
you know my company is even better, so we're ought to be at least worth
five million dollars and then the institutional round comes in later and
then does the down round and so then all of a sudden, you know, having,
you know, carving the turkey, you know all of a sudden, instead of the
knife being carved, you now being aimed at the turkey. The knife
maybe aimed at you 'cause they're upset because they invested, a
certain amount per share and they were immediately devaluated or
shortly thereafter and so that's another problem that people have you
know unrealistic expectations on value on that early round. The
founding, well, that's the other, the two high evaluation--accredited
investors. Now, this goes to the securities laws. The best
type of investor that you can have is what I call a big boy.
Somebody who can afford to lose their money and the securities laws has
a name for it, an accredited investor. It's a relatively, low
threshold. It's basically, it's a million dollars of net worth or
that the person has made 200, 000 dollars or jointly with their spouse
300, 000 dollars during the past two years and has a reasonable
expectation of making it in the current year and so if somebody meets
that threshold, then the disclosure requirements go way low because the
securities laws presumed that person can afford to lose their
money. The best way to raise money is raising money from
accredited investors and only accredit investors because if you have 1
person who is not accredited, then your disclosure requirement kick
in. Now, the securities laws, there's a lot more complexity to
this and to do that, that I'd have to spend a lot more time and you'd
all go to sleep and so, you know, suffice it to say, if you're gonna
raise money, that's another time. You need a good attorney who
can explain what the securities laws but sort of in a nut shell.
If you raise money from only accredited investors that's the best way
to raise the money and you always want people who can afford to lose
their money because, you know, let's face it being a start up, the
likelihood is that most startups do fail. So, anybody that puts
the money in, that's again, it's the worst thing you can do. You
raise 10,000 dollars from Aunt Sally, while Aunt Sally really lives in
a pretty modest house. She doesn't have that much money and the
10,000 dollars is a very meaningful number, don't take it. Don't
take it no matter how much you need that money. You know, let
Aunt Sally have her 10,000 dollars, use it for other purposes, you
wanna get money only from people who can afford it, it's like, "Okay,
Catherine, I know you really, you tried hard, everything else lost the
money, that's okay, it's not gonna affect my lifestyle" So I
could affect, you know, whoever in your investors, you always wanna
make sure if you ever have a doubt about whether or not somebody can
afford their investment, they're nervous about it, just don't take the
money. It's the best advice I can give you. The worst thing
you want is what I call a toxic shareholder and that's somebody that
can't afford to lose their money, they're mad about it, you know what
they're gonna do is make your life miserable. [Pause] Okay
angel financing. You know, there, we're talking about a typical
round would be between 200,000 and a million 'cause basically you're
talking about a small enough round where it's the bridge between
friends and family and then before you get to venture capital.
Most venture capitalist, they're not interested in this type of
money. So what typical place to find this money is, again wealthy
friends and family, wealthy acquaintances, high network families in
town. The Houston Angel Network is a very good place and to do
that, they say it's an organized group. If you look on the web
site, houstonanglenetwork.org, you'll find out information about how to
make application and then to, you make presentations to the group,
that's a good place to raise this type of money and then you'll also
have one seed capital firm in the, you know, in Houston called DFJ
Mercury and I don't know were either of them speakers. I don't
know
Yeah. Paul Campbell was here, he's with that company.
They're one of the few people that will actually, that will put in
what's know as seed capital, smaller amounts of money. We have
venture capital there. For this large venture capital firms, when
they have 100 million, 200 million, a billion dollars, you basically,
they're not gonna do, you know a hundred deals in a million dollars a
piece. I mean what they wanna do is they wanna do 20 deals if
they have let's say they have the, you know, a large fund.
They're gonna wanna do 20 deals at five million dollars, because you can
go through the same time and effort. Unless it's just an
unbelievable deal, you know, you're not gonna be, you're gonna spend
the time for smaller amounts of money. So generally the venture
capital it's gonna be a larger amount and form and is always gonna be
preferred stock. Now let's move on to preserving your
intellectual property, having the correct agreements. And I know
you had a section on, you've already talked about intellectual
property. Now, I'm not gonna talk about the nuts and bolts or
what's a pact and what a copyright is or anything like that. What
I'm gonna talk about is the type of agreements that you need to have in
place to make sure that number 1, that the ownership of an intellectual
property, whatever it is, is owned by the company and then to makes
sure that you're keeping the confidentiality of your intellectual
property. And I guess I'll go back real quickly, probably the 1
take away that I would give you in terms of intellectual property is
develop a strategy early on for how you would protect it. So,
it's basically to identify what is your intellectual property, what do
I need to do to protect it and then so then at least you have a
strategy upfront for when you have the funds to then go ahead and
protect it instead of just waiting for too long and losing potentially
some of your rights. Now, a common issue, who owns your
intellectual property? Well, let's say you have your
founders. They're doing the research on it and you know we
can--if it's a situation of you doing the work at M. D. Anderson or
you're doing work at some other institution then it's governed by the
institution, you know, since you're doing the work and as the who'll
owns it. The institution actually owns the intellectual property
but let's assume that you're not in an institution. Let's assume
that you've left M. D. Anderson, you're doing research in your garage
or wherever you come up with the great idea that's totally unrelated
and to anything that you're doing here at M. D. Anderson as you come up
with an idea, well basically whoever the inventor, whoever came up with
the idea that person owns it and so when you're forming the company,
you want to do what I call put it inside the box. You wanna put
it inside the company. So that's what we've talked about for the
founder, you know, typically when the shares are issued, they pay a
tenth of a penny per share but in addition, they assign their
technology into the company. So then you know that the company
owns it. Now, what about employees because you have an employee
who comes and they're part of your company and they're doing part of
the research, they're coming up with some of the ideas. Who owns
that intellectual property? Well, again, it's the inventor who
owns that intellectual property unless you have an agreement in place
that says otherwise and so you need an agreement in place with every
employee who touches your company and we'll talk about that in just a
minute but it's very important. Now, what about a
contractor? You say while I need a little bit of research done I
need something done. I need a website. I need whatever and
so hire an independent contractor to do some work for me who owns that
intellectual property. I'll tell you a story here. We'll
basically the answer is the contractor unless there's agreement in
place to say otherwise. You know I'm aware of one situation where
basically the company and this was back in the early days of the
internet and they come up with this new and novel idea for their
website and it was something new and different and you know selling
products and other stuff and so they hired an outside contractor to do
the development work and they did a lot of work and they were owed
5,000 dollars. Well, problem was they didn't have, the company
and the founder didn't have the money to pay the guy and they stiffed
him. They stiffed the contractor and did not pay him. So
you know then you go down another 5 years later on and actually the
company ended up making something of itself. You know they were
able to sell the company for a nice amount of money. Well, as
part of the due diligence you know basically they looked through and
they wanted to see okay, well everybody that touched your software code
or touched your website we wanna see that they have signed over all
rights to the company. Well, this you know website developer will
they have rights to the basic core idea because they helped develop it
and they were writing you know doing all the coding and everything else
for the website but you never got an agreement and what's worse, you
never paid them. So then you have this founder going back to the
person he stiffed five years earlier that he didn't pay you know and so of
course the guys like you know. You know and of course he has
5,000 dollar check ready to go. [Laughs] What do you think
the guys said? He says well you know you're selling the company
for this amount of money. 50,000 dollars sounds a whole lot
better. It really make me feel a whole lot better because what
you don't know is I couldn't take a vacation that year and so little
Suzy, my little daughter, we couldn't take a vacation that year.
I wanna make it up to Suzy, my daughter. So you know the price
was a whole lot more. So how do you protect yourself? What
are the right agreements do you need in place? And this is the
type of thing that when somebody is doing due diligence on your
company, an outside investor their account is gonna come through and in
order to purchase your company you're gonna wanna know the answer to as
to exactly do you have all these documents in place. So your
proper documents with the founder and you want the technology
assignment. For every employee, you want them to sign an, it's a
long word of proprietary information assignment agreement. What
that agreement does with the employees it will do 3 things. One,
it will assign all of the technology into the company. Two, it
will say that anything they learn about the company you know that they
didn't develop but yet this intellectual property, you'll keep it
confidential and then third is you want a non competition so if
somebody doesn't take what you're doing and say okay, I'm gonna go
across the street to somebody who's developing something very similar
that said Baylor or some other institution doing similar type of
research, I'm gonna take that intellectual property. I'll just go
and I'll compete whether it violates confidentiality or not. Uhh,
a non-competition, that's what's in that agreement. And then
finally for contractors we've talked about the problem there you have
what's known as a work for hire agreement where you agree I'm gonna pay
you X amount of money you know for doing the work and in return when I
pay you basically all the work that you've done is a work for hire so
the company owns it and again it's your intellectual property keep it
inside the box, inside the company. Investors will be very
concerned about that. Yes?
So how does M. D. Anderson handle contractors because the invention is,
they can still be inventors? Eventhough, M. D. Anderson still
owns all the intellectual property but do royalties from anything from
that didn't go back to the inventors only through M. D. Anderson or
does that go back to the contractors as well?
Okay, contractors we pay them. There's a material transfer
agreement that will say the contractor does work for hire. You
own the intellectual property. He creates whatever, you pay
him. That's completely separate from the other question with
royalties. You form a company with your own invention. You
have to license your own invention into your company then it's gonna be
commercialized, money comes back to M. D. Anderson, they pay the patent
cost. If you get funded through us we take that off and then it's
split 50-50 between M. D. Anderson and you. Your part goes in
your pocket or whoever the core inventors are. The 50% of
M .D. Anderson will split in half, 25% therefore stay with M. D.
Anderson or with UT, the other 25% here in M. D. Anderson is
split, 10% for your chairman and 15% for your lab and most
chairman will pay the 10% back into your lab. So you'll
still have 25% in your lab and 50% in your pocket.
After, if they become an inventor.
Well, then they're part of this whole thing and then they part of your
15% on the royalty depending on what the agreement was.
So what if the company fails. So all of the development and the
original will come back to the founder or...Where will it go?
Well, if it's inside the box it's owned by the company.
But the company now is gone.
Well, but it's an asset of the company. So that intellectual
property, let's assume that you've gone out and you've got the patent
or you have other intellectual property rights you know that's owned by
the company and just the fact that it's failed doesn't mean that it
doesn't still own it so if you liquidate the company number one you
have to pay outside creditors but let's assume in this situation that
no other money is owed to outside creditors because that's always the
first one that gets paid then basically the shareholders if you
liquidate the company's intellectual property would then be liquidated
up into the shareholders and they would own it or more typically if the
intellectual property is worth something then you would sell that
intellectual property, the company would sell it. You know it
might be 10 dollars, it might be a hundred dollars or a thousand or
whatever it is you know because if somebody has an interest in it and
that does happen the company fails and you wanna do something with it
so they say okay you know so long as all of the investors agree.
You know there are certain whatever the percentage is that we will sell
it to somebody else or sell it to one of the original founders and divy
it up so this depends on whether or not it has value. Yes?
Say you have a patent pending and you develop this whole startup
company and what happens if some several years down the line your
claims are not upheld after it goes through the formal review, what
kind of a situation are you in then especially with investor?
You have a company with a not very good patent application.
[Laughs] It's been rejected. I mean basically you can have
other intellectual property rights that may not be patentable.
You may be able to protect some under copyright you might have as a
trade secret or other ways but it may not meet the requirements of for
patent or it may be too close to someone else's patent for you to be
able to get a patent so you know the company owns whatever intellectual
property rights there are but they may not be very worthwhile.
And a lot of the question I start feeling here is you know you wanna do
your own company and I know you guys with your own technology, the
license that you do with M. D. Anderson will have a clause for
liquidation and typically it will lead to say the intellectual property
comes back to M. D. Anderson or if you sell it or sub-license it
whatever then the same royalty is split and whatever happens will flow
through to that new entity because what they don't want is that you
form a company and later you go bankrupt and you sell off you know this
intellectual property and now you have a billion dollar company
suddenly and M. D. Anderson goes empty or UT empty. So that's all
part of that license deal. In fact I had a company like that and
we liquidated the company and everything, IP went back to M. D.
Anderson.
Uh-hmm. That's a good example. Yes?
Sir, I have an idea. I write it down and I made it to myself. Is this protected?
When you say made it all it does is it establishes the date that
you came up with the idea. Now whether somebody else comes up
with the idea in different or whatever minutes all it does is establish
that you had that idea on a certain date and what that idea was but
that's...
So there's no protection?
Very limited. Very limited.
I could comment. In the US laws if I'm not mistaken.
I'm not a lawyer.
The first person, the person to invent is the one who is the
inventor, they'll go back and establish who the inventor was.
However, outside United States, the first patent is actually the one
who has the rights. Someone may have invented it first. So
if you really care about this being used outside United States, the
patent laws and that's what property is very different. Setting a
letter to yourself may establish a date when you had an idea and could
prove it. However, it doesn't do anything outside of United States
patent laws.
That might change in the next two months, so we might go in the same way
like the rest of the world and that patent law is now in front of
congress and the senate. I don't know where it is right know and
in two to three months from now, it could be that the first who patents it owns
it. So your piece of paper is worthless at the point.
The best thing that you can do and I'm not an intellectual property
attorney. The best thing you can do is invest an hour to talk
with a good intellectual property attorney and say this is my idea and
this is what I have to be at least come up with a strategy. You
may not have any money to pay somebody actually go out and research a
patent or do anything else, you know, with it at that time but at least
you understand here's the ground rules for if I did have the money, how
will I protect the idea, or what things can I be doing now because with
one of the things you wouldn't wanna do is to start the clock running,
so that you have to file, I mean there are certain dead lines that you
have to file for, for a patent within a certain period of time and some
other things. The rules are different outside of the U.S. as
suppose to the U.S. So certain other things but those things are
really beyond, you know, what I'm talking about today, so that's why I
tell people just keep with the good intellectual property attorney,
walk through the rules to find out, you know, here's my what
intellectual property is and what could I do to protect it, you know
given the money.
And to get started here at M. D. Anderson, you knock on our door.
This is why we're here for you guys. So we consult you with all
that and without you know making severe recommendations. We'll
just tell you this is how it is. This is how we would do
it. This is what M. D. Anderson wants you to do and so on.
So knock on our doors, that's what we're here for.
And that's it. I think this is the last slide.
[ Applause ]
You know that's and three minutes to go before 5 o'clock. So we'll get you out on time.
All right. Any last questions, I mean, did we ask everything we wanted here?
And I'm happy to stay around for a couple of minutes after for anybody
wants to come up afterward for any additional questions.
Okay. There's one, one last question up there.
What determines the number of shares?
What determines the number of shares? You can have 1 share or you can have 100 million. It
Subjective? That's what
No. If you're, if you're the only shareholder and you can fund
you company and you don't plan to have any other shareholders. If
you want, you can just have 1 share and so that one share shows that
you own 100 percent of the pie and nobody else owns it or in that same
situation, you could issue yourself 10 million shares.
Exactly. So, this is my question, what is better having 10
million shares for a tenth of a penny or 100,000 shares for a dollar?
It all goes to ego. A lot of people [laughs] well there's a tax
issue to it. Franchise taxes in Delaware are actually based on
the authorized number shares and the par value, so there can be tax and
you know, franchise tax implications of having the large number of
shares out there that you can pay more than franchise taxes but
otherwise, it's really just you know, it's really, it does not matter.
Good. Well, for me again, the last comment on this one is it is
extremely important. So if you are not experienced to do a
startup and you wanna do a start up, these are extremely, extremely,
extremely important things because it's gonna determine whether your
last next year, you gonna have to pay, you know to sell your house
because suddenly you're liable for a bunch of taxes or, you know,
you're gonna give away your company as soon you make your first million
dollars because you didn't pay attention when you set this whole thing
up. So it's way worthwhile paying attention to this topic,
although as we say sometimes a little dry and it's well worth it, you
know to talk to people that have done it before, know the people in the
field that are expert in this field. It's worth it. That's
just my message to you guys. I did it a few times. I made
some mistakes, it's just worth it. All right. Thank you
very much. You know your homework and I wish you a good
evening. Thanks.
[ Applause ]
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