The Basics of Technology Company Capitalization - 16 Apr 2009

The Basics of Technology Company Capitalization

Posted on 16 April 2009
Tags: capitalization, technology

In my role as an attorney representing emerging growth technology
companies, I spend a lot of time talking to and working with
entrepreneurs as they prepare to start new companies.  This is the
fourth in a series of five posts
that I will write exploring some of the legal and practical business
issues that aspiring entrepreneurs need to understand as they begin
this process.

Picking up where we left off last time,
you now understand who the participants in your new corporation will be
and it is time to allocate the ownership of the company among the
founders.  You are also already starting to field calls from venture
capitalists and angel investors who think your idea is so brilliant,
they are all dying to write you a check for a piece of your company.
First, I will provide you with a general overview of the typical
capital structure of a technology startup and then go into a little
more depth with respect to each.

Founders

Founders generally receive shares of Common Stock as their ownership
interest in the company.  Founders do not typically write a check to
receive their shares, instead they contribute the initial intellectual
property to the company as consideration for their Common Stock.  I
won’t get into how you should allocate the shares amongst the founding
team, but I will point you to a great blog post by Aaron Houghton,
co-founder of Preation and iContact on this subject: http://www.techinnoventure.com/?p=357.

Most Common Stock issued to founders will be subject to the
company’s right to repurchase the shares in the event the founder
leaves the company - hence the term “sweat equity” (you have to work
for it to earn it).  The company’s ability to repurchase the shares has
several advantages which are may not be immediately obvious on their
face.

• First, it protects your investors who have invested in the
  management team just as much as the technology by locking in key
  members of management and aligning interests. 


• Second, it is a good mechanism to deal with the free rider problem
  when you have multiple founders.  It would be undesirable to have one
  of the team of three leave the company after one month, but have the
  same ownership interests in the company as the remaining founders. 


• Third, similar to the second point, it can give a team some period
  of time to attempt to work together and see who is and is not a solid
  performer, without giving away a significant portion of the company

The schedule by which the company’s right to repurchase the shares
lapses will vary from company to company, however, a standard vesting
schedule is 25% of the shares are released from the repurchase option
after one year, and the remaining shares are released in equal
installments over the course of the next 36 months, such that all
shares have been released after 4 years.

The agreements setting forth these vesting schedules can also
provide for the acceleration of vesting upon the occurrence of certain
events.  “Single trigger” acceleration means that one event must occur
before the vesting schedule is accelerated.  These events can be
termination without cause or the sale of the company.  “Double trigger”
acceleration means that two events must occur before vesting is
accelerated.  A common example of double trigger acceleration is: if
the company is sold (1^st trigger) and your employment is terminated without cause within the first 12 months following the sale (2^nd
trigger) then the shares are released from the repurchase option. 
Acquirors like this language since it ensures that the employees at the
acquired company still have economic incentive to come to work
following the sale, but protects employees in the event their new
employer decides to fire them.

Employees

Employees generally receive stock options as their equity incentive
to work for a company.  A stock option is the contractual right to
purchase a certain number of shares of stock (almost always Common
Stock) at a predetermined price (the exercise or strike price) at some
point in the future (generally, within 10 years of the date of grant). 
Options are almost always subject to vesting (see the standard vesting
schedule discussed

more...<a ref="http://www.youngtechstars.com/entrepreneurship/the-basics-of-technology-company-capitalization" target="blank" title="equity compensation for start-ups">

Glen Caplan