What do I need as proof of stock ownership in a startup?

October 12, 2005 8:51 PM

I have been offered shares in a business (a startup) in exchange for work I have done for them. I have nothing in writing yet. What do I need to get from them to prove at a later date I own this stake in their company?

First of all, I realize that as a new (and risky) startup, their chances of success may not be all that high. For that reason, I don't want to bother with the expense of involving a lawyer, so answers to that effect are no good. On the other hand, I would like some form of reasonable protection in the event the company takes off or otherwise becomes successful, to prove my ownership in the company. The stake I have been offered is 5%. Do I just need a written and signed letter that says I have this? Or do I need something more? P.S. I know nothing about stocks or stock ownership, which I know doesn't help much :).

posted by banished to work & money (10 comments total)

Do you know what kind of corporation it is (c-corp, s-corp, LLP, etc)? You'll have to be careful about tax consequences if the corporate structure acts as pass-through for tax purposes (e.g. a s-corp doesn't pay corporate level taxes, but shareholders will pay when distributions are paid).

Since you've been offered "shares," this is probably an s-corp or a c-corp. An LLC or LLP would probably be much more complicated (and they don't have "shares" in same sense as a corporation). An s-corp is more likely if it has a small number of shareholders (less than 75). Anyway, you'll need some sort of share purchase agreement and I imagine your arrangement will be registered with the state in which the company is incorporated.

You definitely need more than just a signed letter. And despite your desire to avoid legal fees, you'll end up getting a lawyer. You can probably start by calling the Corporate Commission of your state, but they'll tell you to get a lawyer too.
posted by mullacc at 9:09 PM on October 12, 2005

Usually shares are in the form of a number, not really a percentage. With shares, you basically have an agreement in writing that says on date "x" that you have been offered "x" number of shares with a strike price of "x" and you're set. The strike price is important.

So let's say they offer you 2000 shares at a strike price of $10.00 per share. When (if) they go public, they will set an initial offer price. Let's say that is $25.00 per share. The difference times the number of shares is your "profit" in that example. Of course, everything depends on what the public pays, what the stock is priced at when you cash it in, etc.

Also, there is probably a vesting schedule they will create. That means you may be 25% vested in year one, 25% in year two, 100% by year five or whatever they choose. This limits how much stock you can process, based on your loyalty to the company.

That's a real quick tutorial, but I'm sure some other folks can expand and add details.
posted by cyniczny at 9:24 PM on October 12, 2005

Also, how did they come up with 5%? If you've done $50k worth of work for them in exchange for 5% ownership, that means the company is worth $1 million. While that may sound okay for a high-tech startup with big potential, make sure you feel that your contribution is reflectled accurately in your ownership percentage. If your work has been extremely important to the existence of this company, ask for more.

Paul Graham (LISP guy who started a company and sold it to Yahoo!) wrote this article about starting a startup. It is aimed at would-be founders, but it will help give you a sense of what is going on.

On preview, cynicynz: Maybe I'm wrong, but is banished an employee of the firm? I didn't read it that way. Anyway, it sounds like your describing stock options and that is definitely NOT what banished wants. Please, please do not take stock options. Since this is a startup, banished should demand straight common shares which have NO vesting and NO strike price. This is what the founders will own and it is what banished should own.
posted by mullacc at 9:37 PM on October 12, 2005

I second mullac, watch out for the taxes and definitely get a lawyer.
posted by doctor_negative at 10:53 PM on October 12, 2005

Ok, first, everything cyniczny said applies to options, not to stock, so it's irrelevant here. You need to figure out what their corporate structure, as has been pointed out, since an s-corporation or most forms of LLCs will pass through profits and losses. Why this could be bad is that if the company goes through a period where they are making profit but not distributing all of it (or any of it) to the shareholders, which is very common in the early stages of a business, you will have to pay the tax on this reinvested profit, but you won't see the cash from it. In a C-corporation, which is the common structure for larger corporations or corporations that expect to become large, you do not have this concern. If you are investing a significant ammount of your time in this, you will probably want a lawyer. To look over the contract I would expect a fee of around $300. If changes are required to protect your interests, there could be negotiations and such, which might run a couple thousand. Thus, it's only really worth it if the shares really have significant value. One of the problems you will have is that you are a small minority of the shares, and the large majority will probably be owned by the founders. This means that without sufficient protection in the corporate structure, your share could be dilluted in ways that are unfavorable to you. You should try to get the same class of stock that the founders have, so that your interests are aligned.
posted by cameldrv at 11:46 PM on October 12, 2005

Five percent should definitely be decided now, and not later. Since that five percent should theoretically be worth much more as the company grows, it’s more important to set the value of the shares today – not when they give them to you. Don’t wait and be a nice guy figuring that they’ll remember to take care of you, because that’s how lawsuits get started. The best way to handle this is to have the company issue stock certificates to all current shareholders. This is not as complicated as it sounds - when you incorporate (or form an LLC) you should get book with stock certificates and a corporate record. Let’s say the company has 1000 shares (or units) – the founder(s) owns 95% or 950 shares and gives you 50 shares for your 5%. As the company grows and issues more stock out your total percentage of the company shrinks, but the value of your shares should increase. If the company authorizes more shares – say they forward split the 1000 to 1,000,000 you’ll still have the same percentage, but you’ll then have 50,000 shares. The amount of shares is really meaningless, since the value of the shares is what counts. I have safe full of certificates in start ups that are worthless now, but at the time had value based on the business. On the flip side of that, a lot of stock that I have in some companies that I though wouldn’t go anywhere are now looking pretty good.
posted by marc1919 at 8:01 AM on October 13, 2005

My apologies - I did write about options. Mis-read your question.
posted by cyniczny at 8:30 AM on October 13, 2005

Unless you're the type to view buying a lotto ticket as an "investment" I wouldn't go near a deal like this. Unless they go public or are bought by a public company you're not ever going to get paid for your work and all you'll get is headaches for your trouble. Furthermore, even if they did go public, there's nothing stopping them from issuing more shares between now and then so your 5% turns into .00005% when the IPO happens.

Depending on how they are incorporated you also might be responsible for 5% of the taxes the company is supposed to pay each year. If you decide to go forward with this you'll want to talk to a lawyer and a CPA about it first.

I'd also suggest checking out my comment in this other thread about pretty much the same thing.
posted by pwb503 at 9:12 AM on October 13, 2005

Usually shares are in the form of a number, not really a percentage

The company should have an authorized (by the Board of Directors) number of shares that can be issued, and the company should be able to tell you how many shares are outstanding (already issued). So one question is - 5 percent of which one?

But whatever you get, in writing, should state the number of shares, not a percentage (even though the percentage was used for calculation purposes).

Also, the Board can authorize additional shares at any time. So, for example, say, that you get 5,000 shares out of a total of 100,000 shares (let's say that 100,000 shares are both authorized and issued, for simplicity). Then the Board authorizes another 100,000 shares, and issues 50,000 of them to a venture capital company in exchange for $500,000. Now you don't own 5% anymore. And the Board could then authorize issuing the other 50,000 of new shares to company management in exchange for "services given", further diluting your percentage ownership.

With only 5% of the shares, you're not in a position to seriously contest whether the company got enough cash for the 50,000 shares it sold (in this example) to the venture capitalist, or, even more importantly, whether the company truly got adequate value for the 50,000 shares that went to company management.

Bottom line: when you get shares, you're not only betting on whether the company will be successful, but also on whether company management (which normally controls the Board of Directors, since they typically have a majority of stock) is going to be fair to those with small amounts of stock, like you.
posted by WestCoaster at 9:31 AM on October 13, 2005

(These comments are less financially-oriented, more business sociologically-oriented.)

My guess is that a "new (and risky) startup" that issues a vendor "5%" of their stocks, and doesn't do it in writing is really "some college kids sitting around a dorm room with an idea and a friend who can code."

(If that's the case ...)

If the company is going to want to be taken seriously as a startup, they're going to need to get their act together. It'll probably be hard for you to force the question, since it sounds like you're not in a power position there. But you should meet with the founder(s) and explain all of your questions and concerns. Get documentation on all of it. If they're not organized enough to have these things worked out already (that is, if they just said, "um, we need some code made for this site. Let's give banished ... uh ... 5%? Banished? Sound good?"), then I doubt they'll have the stick-to-it-iveness to keep the startup going through an IPO (heavens!) or an acquisition.

I recognize, of course, that I could have misread all of that. But if that's the case, and you're just doing this coding for fun, then yay. But they need to get their ducks in a row, and they need to get your documentation in line. You're now an owner of the company. That mean's you're (partly) the boss.
posted by Alt F4 at 4:05 AM on October 23, 2005