Myths About Startup Equity

“Mr. Fuji as everyone knows, is a fountain of misinformation.” Quote from the late great Gorilla Monsoon a star from the World Wrestling Federation.

Here in the New York Metro area, we get the chance to hold sessions with loads of startup companies.  From incubators to accelerators to coworking spaces, we get the opportunity to meet with some of the best and brightest minds especially in the tech space. Their ability to question everything and absorb a multitude of ideas and observations is second to none and a unique skillset that many of us admire.

We are accountants and consultants and so topics we present tend to center around accounting and taxes. While I would love to think those attending are mesmerized by our subject matter, I have come to believe it is the free pizza and soft drinks which attract them. However, there is a subject we cover that seems to draw a bit more of a response than the equivalent of sitting through a root canal – – and that subject is equity. How to split up the pie; techniques to use to share ownership and pitfalls to avoid seem to get attendees to perk up. Like most things in life, when deciding on equity sharing, a bit of advanced planning helps; but who has the time when one is creating their MVP, trying to drive the community to their product or preparing for a Demo Day.

Unfortunately, we have heard a few myths over the last couple of months and I thought it best to take some time to clear the air a bit.

  1. “You can wait to issue equity” – actually when you issue equity is completely up to you; the value you have the use in the transaction is the issue. Just keep in mind assuming the value of your entity increases over time (or else why would you give up your life for it) the higher the value, the more difficult this task becomes.
  2. “Founders can always get shares at discounted rates” – one of the better tales we have heard. Founders’ shares only have minimal value before you raise financing and there is no near term proof of value (usually by some outside party.) However, once funds are raised, you may get more shares as a founder but the new (and usually higher) value has to be taken into account.
  3. “We don’t need no stinkin’ valuations” – unless you are in a clear founders’ shares startup situation or use the value of a recent transaction, yes you do need a valuation (referred to as a 409a as this is the IRS regulation that governs.) Without it, your tax exposure can make you the next Leona Helmsley.
  4. “I can always file an 83b” – as long as it is filed within 30 days of receiving the equity, it uses an appropriate value and you pay any related tax, yes you can. After that, you can’t put that genie back in the bottle and you are on your own.
  5. “Who cares if my company is an LLC or C Corporation?” Almost every investor does; and most prefer C Corporations.

Equity issues are complex and costly so please consult with your attorney and accountant before completing any equity transactions. Relying on a myth can cost you dearly.

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