How many shares should be authorized in the certificate of incorporation?
January 25, 2008
I usually advise companies to authorize around 10 to 15 million shares of common stock. Around 8 or 9 million shares are issued to founders with a 1 million to 2 million share option pool, for a fully-diluted base of around 10 million shares. The remaining authorized but unissued shares are a reserve in the event more shares need to be issued.
From a purely mathematical perspective, it doesn’t matter whether there are 1 million or 10 million fully-diluted shares. However, when companies are granting options to new employees, even the smartest engineers feel better receiving options to purchase 100,000 shares as opposed to 10,000 shares, even if it represents the same percentage ownership of the company.
Assuming a $15/share IPO price and dilution due to financings, 20 million shares outstanding will result in a $300M market cap, which is about the minimum size necessary to complete a successful IPO. This avoids having to do a reverse or forward stock split at the time of an IPO.
What is Section 409A?
January 19, 2008
Background
On April 10, 2007, the Internal Revenue Service (IRS) issued final regulations under Section 409A of the Internal Revenue Code. Section 409A was added to the Internal Revenue Code in October 2004 by the American Jobs Creation Act.
Under Section 409A, unless certain requirements are satisfied, amounts deferred under a nonqualified deferred compensation plan (as defined in the regulations) currently are includible in gross income unless such amounts are subject to a substantial risk of forfeiture. In addition, such deferred amounts are subject to an additional 20 percent federal income tax, interest, and penalties. Certain states also have adopted similar tax provisions. (For example, California imposes an additional 20 percent state tax, interest, and penalties.)
Implications for discount stock options
Under Section 409A, a stock option having an exercise price less than the fair market value of the common stock determined as of the option grant date constitutes a deferred compensation arrangement. This typically will result in adverse tax consequences for the option recipient and a tax withholding responsibility for the company. The tax consequences include taxation at the time of option vesting rather than the date of exercise or sale of the common stock, a 20% additional federal tax on the optionee in addition to regular income and employment taxes, potential state taxes (such as the California 20% tax) and a potential interest charge. The company is required to withhold applicable income and employment taxes at the time of option vesting, and possibly additional amounts as the underlying stock value increases over time.
Please also see the post on “How do you set the exercise price of stock options to avoid Section 409A issues?“
Additional information
Below are links to all of WSGR’s client alerts on 409A.
You can assess the applicability of Section 409A by reviewing WSGR’s client alerts covering various aspects of Section 409A and the final Section 409A regulations in detail, including:
Highlights of the Final Section 409A Regulations (published April 16, 2007)
Stock Rights Under Final Section 409A Regulations (April 19, 2007)
Separation Pay Arrangements under the Final Section 409A Regulations (April 27, 2007)
A Road Map for Traditional Nonqualified Deferred Compensation Plans under the Final Section 409A Regulations (May 17, 2007)
Action Items for Compliance with Section 409A Final Regulations (June 12, 2007)
IRS Provides Transition Relief until December 31, 2008, for Section 409A Compliance (October 24, 2007)
Compliance Required with Section 409A before December 31, 2008 (June 12, 2008)
What does the legal opinion cover?
January 12, 2008
Company counsel typically delivers a legal opinion to the investors at the closing of a venture financing. The legal opinion in a venture financing generally covers the following:
- Due incorporation, valid existence, good standing, corporate power to carry on its business, and qualification to do business as a foreign corporation;
- Corporate power to execute, deliver and perform the transaction documents and issue and sell the shares;
- Capitalization of the company;
- Shares issued in the financing are validly issued;
- All corporate action has been taken;
- The transaction documents have been duly executed and are enforceable against the company;
- The transaction documents and issuance of shares do not conflict with the company’s charter documents, material contracts and laws applicable to the company;
- No governmental approvals are necessary;
- Exemption from the registration requirements under Federal securities laws; and
- Absence of litigation
Receiving a legal opinion comprises part of an investors’ due diligence, but is not a substitute for it. Delivering a legal opinion requires a certain level of work by company counsel, which increases legal fees. Although legal opinions are typically offered and delivered in financings involving a venture capital fund, they might not be volunteered or requested in a financing involving angel investors, or a typical bridge financing.
Most arguments among attorneys about legal opinions generally relate to the scope of the legal opinion and seem to revolve around what is customary and the amount of time required to deliver the opinion.
The American Bar Association has a collection of articles for attorneys regarding legal opinions. The Business Law Section of the State Bar of California has also published various Opinion Reports.
TheFunded Founder Institute
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