If the company has the cash (and would not be insolvent as a result of the repurchase), the company could repurchase the shares. However, venture funded companies may have protective provisions that prevent stock repurchases without preferred stockholder consent. In addition, if a founder’s shares are repurchased and the company later goes bankrupt, the other stockholders may have claims against the company, the board and the founder as the opportunity to sell wasn’t provided to all stockholders. Of course, mathematically, if shares are repurchased, the number of outstanding shares decreases and the percentage ownership of existing stockholders increases. This is a different result from a sale of shares from one stockholder to another. Finally, a purchase by the company of shares at presumably FMV will directly affect FMV for option pricing purposes. A sale between two non-director/insider shareholders might not affect FMV for option pricing purposes if the company has no knowledge of the price.

If your lawyers aren’t able to articulate the differences, you probably need an upgrade.

We (founders) got common stock upon incorporation and I’m wondering if we should have done this instead. Too late now.

We are doing a financing in the next few months and some VCs have offered to buy some of our common stock at 85% of the value of the preferred. We are cash flow positive and generally doing quite well. They have made this offer because we don’t want to raise that much money, and they are putting in less than they’d like. This way they get more.

Is there a reason why the company can’t simply buy back the shares of some employees (or founders), using either our operating cash flow or proceeds from the preferred stock sale? Seems like it’s a better deal than having the VCs buy common stock directly, especially if it’s at a discount to the preferred price. It’s also a cheaper way of increasing the options pool. Our law firm is not very familiar with the practice. Just wondering how these things normally work or what options are out there…

Anyone seriously thinking about Series FF should have a long talk with competent attorneys (corporate, tax and employee benefits) about the benefits and potential risks (tax and other). This post does not attempt to explain some of the technical tax risks. I can’t currently say that I am comfortable recommending Series FF to companies. No one should assume that I recommend the practice simply because I’ve written about it.

To be honest, I would be surprised if there is no capital gain on the sale because the tax basis for the founder has not changed. In other words, at least this is how I understand the tax rules, if I buy Series FF shares at 0.01 each and sell them at 1.00 each, then my gain is 0.99 each, even if the market value of the shares are 1.00 each.

Having said that, given that I am a founder with a start-up that only has founder capital right now, it may make sense to convert all of our capital into Series FF type shares by changing the terms of our current shares, in case there indeed are positive tax benefits. Thanks!

Regards,
Ty

1. I will defer to tax experts, but I believe that there is an open question as to whether the sale of Series FF is capital gain.

2. Once again, deferring to tax experts, I suppose if you did a “do over” on capitalization and treated all common/option holders equally, then the company could recapitalize to create common and Series FF.

The certificates of incorporation for Delaware companies can be ordered from the Secretary of State. I suspect that anyone could review the Founders Fund portfolio companies and order the COIs.

The Series FF concept is interesting, but untried.

I have a couple of questions based on your exchange wih Jeff above.

First, it is still unclear to me what is the tax differences between common stock held by founders vs. non-founders using the Series FF. Jeff seems to imply that using the Series FF addresses some tax issue, “depending on the bells and whistles.” But isn’t the basis of the stock (either common or Series FF) the same? In other words, when these shares are sold, the tax consequences are still the same, right? Maybe I’m missing something here.

Second, you note that “in a perfect world, Founders Fund would probably want the Series FF issued upon incorporation.” But let’s say the founders set up their startup with simple common stock. Several months later, when the company is still probably at the same founders’ valuation (because money has been burned but there is still no visibility about the business and prospects of success, and perhaps the founders inject more capital at the same original price), the founders decide to amend their articles to convert all of their common stock into Series FF. Then aren’t we still in the same boat?

Can you by chance point us to where we can review the terms of the Series FF that has been used. Any of these articles accessible via the web?

Thanks,
Ty

Generally, founders want common stock issued at a very low price per share. Preferred stock is issued at a higher price per share. If you issue Preferred Stock at a high price on the same day that you issue common stock, there is a risk that the IRS might deem the issuance to the founder at a low price to be “income” to the extent that the price paid by the founder is less than fair market value.

To alleviate this risk, we sometimes suggest waiting some time period before dramatically increase the price of common or preferred stock — so that there is some argument that the value of the company increased during that intervening time period.

Also I noticed that on your posting you mention: “Generally, stock should be issued at fair market value (otherwise, there may be deemed income from the company to the founder). ” ……. “…founders stock is typically issued at a very nominal price per share, such as $0.001…”

This is very confusing… A prompt response would be really appreciated.