Legal and Accounting Basics for Startups with Kirsty Nathoo and Carolynn Levy (HtSaS 2014: 18)

Christie and Carolyn are going to talk about finance and legal mechanics for startups. This is certainly not the most exciting of the cotton sarees; right? This is probably the cosmos. Thank you very much for coming.

Okay, so like Sam said, this lecture is about the mechanics of the startup, and Kirstie and Carolyn are going to be talking about some of the basic legal and accounting issues that your startup may face in the very beginning. I was watching Paul Graham's video, and at one point he says founders don't need to know the mechanics of starting a startup. I thought, "Oh no, that's exactly what Sam titled this lecture," but what PG actually says is that founders don't need to know the mechanics in detail because it's very dangerous for founders to get bogged down in the details. And that's exactly right, and Christine, I can't give you the details in 45 minutes anyway.

So our goal here today is to make sure that you do no better than to form your startup as a Florida LLC. As Sam mentioned, we were also worrying this is going to be pretty boring for you to listen to an accountant and a lawyer talking about this. You've had some really amazing founders talking about really interesting things, but like Sam said, this is the kind of stuff that if you know the basics, you can get yourself set up in the right way, avoid pain, stop worrying about it, and then concentrate on what you actually want to do, which is make your company a success.

You know, we refer to this term startup all the time, and probably in the back of your head you kind of know that if a startup, we mean there has to be some legal entity, and that’s you know some kind of separate legal entity. We'll talk a little bit more about how we actually set that up and what that means to you. You also probably know that a startup will have assets, IP, inventions, other things, and that the company needs to protect those. So we'll talk a little bit more about that, how to raise money, hiring employees, and entering into contracts.

There's a few other things that you need to talk about whilst you're setting up your company, which kind of ferrets out a few issues amongst founders. Things like who's going to be in charge and how much equity is everybody going to own. So those are really good things to talk about to know. There we go!

Okay, this is us. Kirstie has the calculator; I have like the geriatric glasses, which is actually pretty fair.

Okay, so the first thing we're going to talk about is formation. Kirstie actually just mentioned that your startup is going to be a separate legal entity. Then, and you guys probably already know, but the primary purpose for forming a separate legal entity is to protect yourselves from personal liability. What that means is if your company ever gets sued, you know it can't, it's not your money in your bank account that the person could take; it’s the corporation. So that's why you form one.

So then the question is, where do you form one? Theoretically, you have 50 choices, but the easiest place is Delaware, and I'm sure you're all familiar with that as well. But Delaware is in the business of forming corporations; the law there is very clear and very settled. It's the standard. The other thing is that investors are very comfortable with Delaware. They already invest in companies that are Delaware corporations. Most of their investments are probably Delaware corporations, so if you are also a Delaware corporation, then everything just becomes much more simple, right? There’s less diligence for the investor to do; you don’t have to have a conversation about whether or not to reincorporate your Washington company into Delaware.

So there's a reason that so many companies do it; it's standard, it's familiar. So I'll tell you a story. We had a company at YC about two years ago that was originally formed as an LLC in a state that I’ll say Connecticut. The founders had some lawyer friends there who said this is the right way to do it, and when they came to YC, we said you guys need to convert to Delaware. So the lawyers in Connecticut did the conversion paperwork, and fortunately they didn’t do it right. They made a very simple mistake, but it was a very crucial mistake. The company was recently raising money, like a lot, a lot of money, and this mistake was uncovered. That basically, the mistake was this company thought it was a Delaware corporation for a couple of years, but in fact, it was still a Connecticut LLC.

And I'll just say this: four different law firms were needed to figure that one out too, in Delaware, one in Connecticut, one here in Silicon Valley, and the bill right now is at five hundred thousand dollars for a conversion mistake.

So what's the takeaway here? Pretty simple: keep it really simple and familiar for yourself. The reason we incorporate all companies the same way at Y Combinator is because it's easy. So don’t get fancy, just save yourself some time and money – you're going to be a Delaware corporation.

How do you actually set that up? It requires a few different steps, but the first one is actually really easy. You literally just fax two pieces of paper into Delaware saying we're gonna set up a corporation. All that does though is create a shell of a company; it doesn't actually do anything within the company.

So after that, you then need to complete a set of documents that, among other things, approve the bylaws of the company. It creates a board of directors and creates officers of the company. Delaware requires that somebody has the title of CEO, president, and secretary. So also at this point, you need to complete documents, there's a sign any inventions or any code or anything that you, as an individual, create so that the company actually owns that.

And remember, at this point, it’s a really good thing to think about. You, as founders, have to think about things in two different ways. You always have to be thinking am I doing this as an individual, as me, or am I doing this on behalf of the company, which is a separate entity? So you have to maintain that split in your mind.

We’ll talk more about where that comes in a little bit later. There are services that can help you get incorporated, of course you can use a law firm, but there are also other online services that help. The one that we often use with a lot of the YC companies is called Clerke, cloaca.com, and they set up so that all the standard basic documents are used, and they get you set up in a very vanilla way so that you can just move on and keep focusing on what you need to do.

So a note on paperwork: you’re creating documents; these are really important documents that are going to be assessing what the company does and what the company is. So it’s really, really important that you actually keep these signed documents in a safe place. It sounds so basic but we get so many founders coming to us saying, “I don’t know, there’s some documents,” and they have no idea what they are or where they are.

So really, really make sure that you keep them in a safe place. And let’s be honest, this is not the glamorous part of running a startup, you know, filing documents. But actually, at the times where this is crucial are going to be at really high-stress times in the startup's life. It's likely to be if the company is raising a big Series A round or if the company’s being acquired. The company will have to go through due diligence and there will be lawyers asking for all this stuff, and if you don’t have it and you don’t know where it is, it just makes a really stressful situation even more stressful.

So really, the key thing here is, like we say, keep it simple but keep those documents in a safe place and keep it organized. It'll make your life so much easier.

Okay, so now we’re going to talk about equity, and we’re going to touch on a couple different things in this section. The first thing that we're going to talk about is equity allocation. So what am I talking about here? I'm talking about if your company's stock is a PI; you’re talking about how to divide the PI, and you're talking about this with your co-founders. Why is this important? Well, if you’re a solo founder, this really isn't important. But if you are a team of two or more, then this issue is absolutely critical.

So the first thing that you need to know is that execution has greater value than the idea. What do I mean by that? A lot of founder teams give way too much credit, and therefore a lot of the company's equity, to the person who came up with the idea for the company. Ideas are obviously very important, but they have zero value. Who's ever heard of a billion-dollar payment for just an idea? Value is really created when the whole founder team works together to execute on an idea.

So you need to resist the urge to give a disproportionate amount of stock to the founder who is credited with coming up with the idea for the company. The next thing you want to think about is, "Okay, so how much stock should the stock be allocated equally among the founders?" From our perspective, the simple answer is probably yes. Our mantra at Y Combinator is that stock allocation doesn't have to be exactly equal, but if it's very disproportionate, that's a huge red flag for us. We wonder what conversation is not happening among the founder team when the ownership isn't equal.

For example, is one founder secretly thinking that this whole startup thing is temporary? Is one founder over inflating the work that he or she has already done on the company or over inflating his or her education or prior experience? Do the founders really trust each other, and have they been honest with each other about their expectations for this startup and for the future? When ownership is disproportionate, we worry that the founders are not in sync with one another.

Thirdly, it's really important to look forward in the startup, not backwards. Said another way, are all the founders in it 100%? Are they all in it for the long haul? If the expectation at your startup is that each founder is in it 100% and you're all in it for the long haul, then everything that happened before the formation of the company shouldn't matter.

It doesn't matter who thought of the idea; it doesn't matter who did the coding or who built the prototype or which one has an MBA. It will feel better to the whole team if the allocation is equal because the whole team is necessary for execution.

So here's the takeaway on this point: in the top YC companies, which we call those you know with the highest valuations, there are zero instances where the founders have had significantly disproportionate equity splits. Alright, so you’ve had the conversation about how to split the equity, but then what?

Again, we talk to many founders who are actually surprised that they have to do something in order to own this stock. They think that talking about it is actually enough, and again, it’s another situation where you have to think about you as an individual versus you as a representative of the company.

If you equate this to a large company, you know, if you worked at Google and you were told as part of your compensation package that you would be receiving some shares, you would expect to sign something to get those shares. If you didn't, you'd be thinking, "What’s going on here?" Well, it's the same thing with a small company as well.

So in this case, the paper, the documents that you're signing, is a stock purchase agreement. So you, as an individual, buy the shares from the company, and in any situation, if you’re buying something, there’s a two-way transaction where you pay for something and you get something in return. In this case, you're getting shares in return for either a cash payment or for contributing IP or inventions or code to the company so that the company actually owns everything that you’ve done in the past.

We also refer to that stock being restricted because it vests over time, and we're going to cover that next in more detail. But as a result of the stock being restricted and vesting, there's one very, very crucial piece of paper that we talk about until we're blue in the face to everybody because there’s actually no way to go back and fix this.

This is actually one of the things that, because there's no way to fix this, has blown up deals in the past. We've seen companies where, because they haven’t filed what's called an 83-B election, deals have blown up. I'm not going to go into detail about what that 83-B election is actually about, but just leave it as it affects your individual taxes and it affects the company's taxes, and so it can have a big impact.

So here we have the main things: sign the paperwork, sign the stock purchase agreements, sign the 83-B election, and make sure that you actually have proof that you sent that in. Because if you don't have the proof, it just goes into a black hole at the IRS, and investors and acquirers will walk away from a deal if you can't prove that.

Okay, so the next thing we're going to talk about is vesting, and I imagine that many of you are familiar with what vesting is, but just in case, really simply, vesting means that you get full ownership of your stock over a specific period of time.

So we're talking about the stock that Kirstie just said you bought your stock of your company and you own it, and you get to vote it, but if you leave before this vesting period is over, then the company can get some of those unvested shares back. So, and I'm just going to, just so you guys know, the other ways to refer to vesting and you’ll hear restricted stock; that means that that stock that's subject to vesting. The IRS speak for this is shares that are subject to forfeiture. So a little terminology there.

Okay, so what should a typical vesting period be in Silicon Valley? The so-called standard vesting period is four years with a one-year cliff. This means that after one year, the founder essentially fully owns 25% of the shares. Then the remaining shares vest monthly over the next three years.

So here’s an example: a founder buys stock on Christmas Day, let's say, and then quits the company on the following Thanksgiving. So before the year has passed in that case, the founder leaves with zero shares, right? The cliff period hasn’t been met. If the founder, though, quits the day after the next Christmas, so a year and a day later, he or she is vested in exactly 25 percent of shares, right? In that case, the one-year cliff has been met.

So what happens to the shares when a founder stops working at the company? The company can repurchase those shares. In the example I just gave where the founder quit a year in a day after purchasing the shares, 75% of those are still unvested, and the company will repurchase that full 75% of those shares from the founder. How? It just writes the founder a check. That's how the founder bought it, right? So it's the same price per share that the founder paid, and it's really just giving the founder his or her money back.

So then the question is, why would you have vesting? Why would founders do this to themselves, right? Because it's just the founders; they're doing this on their own shares, doing this to their own shares. The probably number one reason why vesting is important has to do with founders leaving the company.

So without vesting, if a founder leaves, a huge chunk of the equity ownership leaves with her or him, and obviously that is not fair to the founders left behind. We're actually going to talk about this a little bit more when we get to the founder employment slide. I'll go into that in more detail. But the other reason to have vesting is the concept of skin in the game, the idea that founders need to be incentivized to keep working on their startup.

If the founder can walk away with his or her full ownership at any point in time, then why would you stay and grind away? Startups are hard. So, do single founders need vesting? They do, and the reason is because the skin-in-the-game concept applies to solo founders as well, and investors really want to see all founders, even solo founders, incentivized to stay at the company for a long time.

The other reason that single founders should put vesting on their shares is to set an example for employees. You can imagine it would be inappropriate for a founder to tell an employee that he or she has to have four-year vesting on his or her shares, but the founder doesn’t think that he or she needs any on their own shares. It’s really a culture point. A founder who has vesting on his or her shares then sets the tone for the company saying we’re all in it for the long haul; we all have vesting on our shares; we're doing this together.

So what are the takeaways from here? I would say vesting aligns incentives among the founders. If they all have to stick it out and grow the company before any of them get any of that company, and the number two: investors don't want to put money in a company where the founders can quit whenever they feel like it and still have a big equity ownership stake in that company.

Okay, so moving on: we’ve now got a beautifully formed corporation in Delaware. Everybody's got their stock; it's all the plain vanilla standard paperwork, so then what? You know? Probably the next stage of a company's life is needing to raise some money.

So we're going to talk a bit more about that and you know we know that you've already heard a lot from investors and from founders already in this set of classes and they've been talking much more around the tactics and how to raise money; but what about the paperwork? What about when somebody actually agrees to invest, then what?

So first of all, in terms of logistics, in very simple terms, there are two ways to raise money. So either the price is set for what the money that comes in or the price isn't set. And by price, we mean the valuation of the company; it's the same thing. Rounds can actually be called anything; people can name them whatever they want, but generally, if you hear the term seed round, it would mean that the price has not been set, and anything that's a Series A or a Series B would be something where the price has been set.

So not setting the price is the most straightforward, fast route to getting money, and usually, the way that this is done is through convertible notes or SAFEs. And again, this is a two-way transaction, so there’s a piece of paper that says, for example, that an investor is paying $100,000 now, and in return has the right to receive stock at a future date when the price is set by investors in a priced round.

So it's important to note that at the time the paperwork is set, that investor is not a shareholder and therefore doesn’t have any voting rights on the company. They will have some other rights, which Carolyn is going to talk about separately, of course. Investors want something in return for putting in money at the earliest, i.e., riskiest stage of the company's life, and this is where the concept of a valuation cap comes in, which I'm sure many of you have heard mentioned before.

So usually, the documents for a non-priced round set a cap for the conversion into shares, and that's not the current valuation of the company; it's actually an upper bound on the valuation used in the future to calculate how many shares that investor is going to get.

So for an example: an investor invests $100,000 on a SAFE with a $5 million cap, and then a year later, the company raises a priced round with a valuation of, let’s say, $20 million. Then the early investor would have a much, much lower price per share, about a quarter, and therefore their $100,000 would buy them approximately four times more shares than an investor that was coming in and putting in $100,000 in that Series A priced round.

So that's where they get their reward for being in early. So again, this is another situation where you need to make sure you have the signed documents and you know where they are because different investors may have different rights, and so you need to know what those things are. Again, services like Clerke can help with that; they have very standard documents that most of our YC companies use to raise money.

A couple of other things to think about when you are raising money: hopefully, you've got a really hot company that's doing great and it's really easy to raise money, but you should be aware that all these people throwing money at you does have some downsides.

So the first thing is to understand your future dilution. If you raise, let’s say, two million dollars on SAFEs with a valuation cap of six million dollars, then when those SAFEs convert into equity, those early investors are going to own about 25 percent of the company, and that's going to be in addition to the investors that are coming in at that priced round who may want to own 20% of the company. So you've already at that point given away 45% of the company. So is this really what you want? And you know the answer might be yes.

Remember that some money on a low valuation cap is infinitely better than no money at all, and if those are the terms that you can get, then take that money, but it’s just something to be aware of and to follow through the whole process so that you can see where this is going to lead you down the road.

The other thing to bear in mind is that the investors should be sophisticated, and by that, we mean that they have enough money to be able to invest and that they understand that investing in startups is a risky business. Yeah, we see so many companies coming to us that say, “Oh yeah, my uncle put money in,” or “My neighbor put money in,” and they’ve put in five or ten thousand dollars each, and often those are the investors that cause the most problems going forward because they don’t understand how this is a long-term game.

So you get to the point where they're sitting thinking, "Hmm, I could actually do with that money back because I need a new kitchen," or this startup investing is not actually as exciting as all the TV shows and movies made it out to be. And those cause problems to the company; they're asking for their money back.

So just be aware that you should really be getting money from people who are sophisticated and know what they're doing, and the term that you'll hear that refers to these people is that they are accredited investors.

So really, the main points here are: keep it simple; raising money using standard documents; make sure that you have people who understand what they're getting into and understand what you're getting into in terms of future dilution.

Okay, so you’re raising money, you understand what you’re selling, you figured out the price, you’ve got down the logistics just described, but what you may find is that you don’t understand some of the terms and terminology that your investors are using, and this is okay, but you have a burden to go figure that stuff out.

Don’t assume that just because you've agreed on the valuation or the price that all the other stuff doesn’t matter because it does matter, and you need to know how these terms are gonna impact your company in the long run. But Y Combinator, Kirsten, I hear founders say all the time, “I didn’t know what that was, I didn’t know what I was signing, you know, I didn’t know I agreed to that.” So really the burden is on you to figure this stuff out, and we're going to go over four common investor requests.

So the first one is a board seat. Some investors will ask for a seat on your company's board of directors, and the investor usually wants to be a director either because he or she really wants to keep tabs on their money, or because he or she really thinks they can help you run your business. You have to be really careful about adding an investor to your board; in most cases, you want to say no. Otherwise, make sure it's a person who's really going to add value. Having money is very valuable, but someone who really helps with strategy and direction is priceless. So choose wisely.

The other thing is advisors. There are so many people who want to give advice to startups, and so few people who actually give good advice. Once an investor has given your company money, that person should be a de-facto adviser, but without any official title and, more importantly, without the company having to give anything extra in return for the advice.

So here’s an example: at Y Combinator, we’ve noticed that whenever a startup manages to garner a celebrity investor, the celebrity almost always asks to be an advisor. We have a company that provides on-demand bodyguard services, and an NBA basketball player invested, asked to be an advisor, and then asked to be given shares of common stock in exchange for the advisor services.

The services that this person had in mind, this investor had in mind, would be to introduce his company around to all the other professional basketball players who might want to use an on-demand bodyguard. But this celebrity just made a big investment; shouldn’t he want to help the company succeed anyway? Why does he need something extra? All investors who can help should do so; asking for additional shares is this an investor looking for a freebie?

Okay, next, we’re gonna talk about pro-rata rights. What are pro-rata rights? Some of you may have heard of this before, but very simply it’s the right to maintain your percentage ownership in a company by buying more shares in the company in the future. Pro-rata rights are a way to avoid dilution, and dilution in this context means owning less and less of the company each time the company sells more stock to other investors.

So this is a really basic example, but say an early investor buys shares of preferred stock and ends up owning 3 percent of the company once the financing has closed. The company raises another round of financing, and the company will go to this investor who negotiated and got pro-rata rights and say, “Hey, we're raising more money, so you’re welcome to buy this many shares in the new round to keep your ownership at approximately 3 percent.” That is pro-rata rights at their very basic.

So pro-rata rights are a very common request from investors, and they're not necessarily a bad thing, but you absolutely as a founder need to know how pro-rata rights work. Especially because, as Kirsty touched on this a little bit, the corollary to an investor having pro-rata rights to avoid dilution is that the founders typically suffer greater dilution.

So the final thing is information rights. Investors almost always want contractual information rights about to get certain information about your company. Giving periodic information and status updates is not a bad thing; in fact, at YC we encourage companies to give monthly updates to their investors because it's a great opportunity to ask for help from your investors, like introductions or help with hiring and that kind of thing.

But you have to be really careful about overreach, and the investor who's saying they want a monthly budget or a weekly update, that’s not okay. So the takeaway here is that just because the type of financing and the valuation have been negotiated doesn’t mean that everything else is unimportant. You need to know everything about your financing.

Okay, so then moving on to after you've got that money. You know, you’ve raised some money; the company bank account’s probably showing more zeros in it than you’ve ever seen in your life. So then what? This is where you actually start incurring business expenses, and business expenses are the cost of carrying out your business.

So things like paying employees, paying rent for an office, hosting costs, acquiring customers, that kind of thing. Business expenses are important because they get deducted on the company's tax return to offset any revenues that are made, to lower the taxes that the company pays. And on the flip side, if it's a non-business expense that the company incurs, then that is not deductible on the tax return, so that can increase the profits that the company then have to pay tax on.

So again, this is a separation issue. The company will have its own bank account, and that’s where the company’s expenses should be paid out of. Again, you know, thinking about this from a large company, if you were working at Google, you would not use a Google credit card to buy a toothbrush and toothpaste.

So the other thing to remember is that, you know, the investors gave you this money; they trusted you with all this huge amount of money, and they want you to use that money to make the company a success. It's not your money for you to spend how you please, and believe me, we've had some horror stories of founders who take that approach.

We had one founder that we knew of who took investor money and went off to Vegas, and boy, by his Facebook photos did he have a good time. Needless to say, he’s no longer with the company. But really, this is stealing from the investors.

You know, the concept of business expenses can get a little bit blurry, especially in the early days when you're working in your apartment, and you're working 24 hours a day. But the way to think about it is if an investor asked me what I’d spent their money on, and I have to give a line-by-line breakdown of that, would I be embarrassed about telling any of that? Telling them what any of those lines were? And if you were, it’s probably not a business expense.

So the other thing to bear in mind is that, you know, you're busy running your company at 90 miles an hour, just constant, constant, so you don’t have to necessarily think about the bookkeeping and accounting at that point, but it's really crucial that you do keep the receipts.

So that when you do engage a bookkeeper or CPA to prepare your tax returns, they can unpick all of this, and they can figure out what are business expenses and what aren’t business expenses, but they’re going to need your help as a founder because they aren’t going to know what all of these things are.

So there is some involvement from you, and the way to make the involvement the least amount possible is to keep those documents in a safe place so that you can refer back to them. So if nothing else that you remember, do not go to Vegas on investors' money and spend that money wisely.

Okay, so in this section we're going to talk about just doing business, and we're going to hit a couple of topics in this section. So the first one is founder employment. Why are we talking about founder employment? Because as we said a couple of times already, the company is a separate legal entity; it exists completely separate apart from you as founders.

And so no matter how prestigious we in the valley think the title founder is, you're really just a company employee, and founders have to be paid. Working for free is against the law, and founders should not let their company take on this liability. You wouldn't work for free anywhere else, so why is your startup an exception? Companies have to pay payroll taxes.

We had a YC company that completely blew off their payroll taxes for three years; it was a huge expensive disaster. And in extreme cases, people can actually go to jail for that, not in this case, but it's bad.

So the moral of this story is set up a payroll service. This is something that is worth spending your money on, but I actually think I'm sure some of the other lectures have touched on this point, and actually Kirstie just mentioned it too: don't go overboard on lavish salaries – minimum wage. This is still a startup and you have to run lean.

Now I'm going to mention founder breakups, and first, what is a founder breakup? In this context, I'm talking about one founder on the team being asked to leave the company, which because I’ve just said founders are employees that means your co-founders are firing you.

So why are we talking about breakups in the context of founder compensation? And it's because we have seen a ton of founder breakups, and we know that the breakups get extra ugly when the founders haven't paid themselves. Why? How does it get ugly? Unpaid wages become leverage for the fired founder to get something he or she wants from the company, and typically that is vesting acceleration.

So the fired founder says, “Hey, my lawyer says you broke the law by not paying me, but if you pay me and you give me some shares that I’m actually not really entitled to, I'll sign a release and make all this ugliness go away.” And if you're the remaining co-founders, you're probably like, “Sounds like a good deal.”

So now you have a disgruntled person who owns a piece of your company, and even worse in a sense, the remaining founders are kind of working for that ex-founder, right? Because they're building all the value in the company, and the ex-founder who got fired is just sitting there with their shares going, “That’s right, make it valuable.”

So what's the takeaway here? Avoid problems by paying yourself, paying your payroll taxes, and thinking of your co-founders’ wages like a marital prenup. And as well as the founders, you are going to need to hire employees.

Again, a lot's been spoken in previous classes here about how to find those people, what makes a good fit, how to make them really productive employees, but when you actually find somebody, how do you hire them? You know what's involved?

Employment is governed by a huge raft of laws, and therefore it's important to get this right. It's again the kind of nitty-gritty stuff that as long as you know the basics, you can probably keep yourself out of most situations, but as soon as things get complicated, you need to get yourself involved with a specialist.

So the first thing you need to do is figure out if the employee or if the person is really an employee or a contractor. And there are subtle differences to this classification, and this is important to get right because the IRS takes a big interest in this, and if they think you've got it wrong, they will come after you with fines.

Both an employee and a contractor will sign documents; there's a sign any IP that they create to the company, and that's obviously really important. But the form of the documents is very different for each type of person, and the method of payment is very different.

Generally, a contractor will be able to set their own work hours, they'll be able to set their own location; they will be given a project where there is an end result, but how they actually get to that and the means they use will not be set. They'll be using their own equipment, and they’ll not really have any say in the day-to-day running of the company or their strategy going forward, and a contractor will sign a consulting agreement.

When the company pays them, the company doesn’t withhold any taxes on their behalf; that's on the responsibility of the individual. But at the end of the year, the company will provide what's called form 1099 to the individual and also a copy to the IRS, which they are used to prepare their personal tax returns.

The opposite side of this is an employee, and an employee will also sign some form of IP assignment agreement, but when the company pays them, the company will withhold tax from their salary, and then the company is responsible for paying those taxes over to the relevant state and federal authorities.

At the end of the year, the employee receives a W-2 form, which will then get used to prepare their personal tax returns. So as Carolyn has said, the founders need to be paid, so no employees; it isn't enough to just say, “Well, I'm paying them in stock.”

So that can be their compensation, and they need to be paid at least minimum wage. So in San Francisco, which actually has a slightly higher minimum wage than California as a whole, that works out about $2,000 a month. So you know it's not a huge amount, but it can add up.

There's also a couple of other things that you need to be, you need to make sure that you have if you have employees. So the first thing is that you're required to have worker’s compensation insurance, especially if you're in New York where the New York authorities that look after this will send really threatening letters saying you owe $50,000 in fine because you're one employee that's being paid minimum wage has not paid the $20 a month of worker’s compensation fees.

So it is really important that you do set that up, and the other thing that's very important is that you do need to see proof that the employee is authorized to work in the U.S. You know founders are not payroll experts, and nobody expects you to be one either. This is all just about the basics, but what that does mean is that you absolutely must use a payroll service provider who will be able to look after this for you. Services like ZenPayroll again set up their focus on startups, and they help you get this set up in the easiest way possible so this again you can go back and concentrate on what you do best.

In the example that Carolyn gave just a few minutes ago, if that company had actually set themselves up with a payroll service provider, all of that heartache would have gone away because it would have all just been looked after for them. They were trying to save money by not doing it, and look where it got them.

So that's really the key thing: use a payroll service provider and make sure that you understand the basics of employment.

We’re running short on time, yeah? Okay, so I can breeze through really fast firing employees slide, and then should we cut it off now for questions? What?

Okay, okay, okay, so somebody at YC once said you're not a real founder until you've had to fire somebody. Why is that? Because firing people is really hard. It's hard for a lot of reasons, including because founders tend to hire their friends; they tend to hire former co-workers, or they just get really close to their employees because working at a startup is really intense.

But in every company, there's going to be an employee who doesn't work out, and firing a founder ... Sorry, firing this employee makes a founder a real professional because he or she has to do what is right for the company instead of what is easy. So I have some best practices for how to fire someone.

Number one: fire quickly. Don’t let a bad employee linger. It’s so easy to put off a difficult conversation, but there is only downside to procrastination. If the toxic employee stays around too long, good employees may quit, and if the employee is actually screwing up the job, you may lose business or users.

Number two: communicate effectively. Don't rationalize, don't make excuses, don’t equivocate about why you're firing the employee. Make clear direct statements. Don't apologize. Example: "We're letting you go," not “I'm so sorry, sales and take off this corridor, blah blah.” Fire the employee face-to-face, ideally with a third party present.

Number three: pay all wages and accrued vacation immediately. This is a legal requirement that we don’t debate or negotiate.

Number four: cut off access to digital systems. Once an employee's out the door, cut off physical and digital access; control information on in the cloud, change passwords, etc. We had a situation at YC where one founder had access to the company's GitHub account and held the password hostage when his co-founders tried to fire him.

Number five: if the terminated employee has any invested shares, the company should repurchase them right away. So the takeaway here is that as surprising as this may sound, one of the hallmarks of a really effective startup founder is how well he or she handles employee terminations.

Okay, so then we had this section that we called legitimacy, which actually goes into a little bit more about how to be a real company, how to be sort of a grown-up company, and we can totally jettison.

Okay, so first, you want to read the takeaways. We’ve pretty much covered all of these anyway, but you know the basic tenets to all of this are keep it simple, do all the standard stuff, and keep it organized to make sure you know what you're doing. Equity ownership is really important, so make sure that you're thinking about the future rather than the three months of the history of the company, and stock doesn’t by itself.

So again, make sure you do the paperwork for that, make sure that you actually know about the financing documents that you're signing up to. It's not enough to just say, “Yeah, I’ll take your $100k,” make sure you actually know those rights, and you need to get paid. You and the employees need to be paid, and then everybody needs to assign IP to the company because if the company does not own that IP, there is no value in the company.

If an employee must be fired, then as Carolyn was saying, do it quickly and professionally. The couple of things that we didn’t mention was knowing your key metrics. At any time, you should know the cash position, you should know your burn rate, you should know when that cash is going to run out, and so that you can talk to your investors about that.

A lot of running a company is following the rules and taking it seriously. It's not all the glamorous bits that we see in all the movies and TV shows, so you do have to take that seriously.

Okay, so it was shorter when we did it the first time. Sorry.

Sure, yeah, searching for an accountant and when in the process do you need them? So there are two. So the question was how do you advise searching for an accountant, and when do you, at what point do you do this?

So there are two different things: there's a bookkeeper and there's a CPA and accountants. Generally, bookkeepers will be the ones who can categorize all your expenses, and CPAs are the ones that will prepare your tax returns.

In the very, very early days, it's probably fine for the founders to just be able to see the bank statements and to be able to see those expenses coming out, but tax returns have to be prepared annually, and so at some point in that first year of the company's life, some service is going to need to be engaged to do that because it's just not worth the founders' time to do it.

There are services available like in DeNiro which try to make things as effortless as possible from the founders' point of view, so that kind of thing is quite useful, but you do need to get a CPA at some point because you need to file your annual tax returns for the company.

Finding one is kind of tough; probably the best thing is recommendations from people with any kind of specialist CPA or an accountant, a lawyer or anything like that. It's always best to use people who are used to dealing with startups; again, not your sort of, you know, your aunt who lives in Minnesota and doesn’t actually know how startups work.

So probably recommendations are the best way. In terms of big corporation, don’t spend a dime on that; you can do that online. Well, I actually, I'm sorry, a little bit incorporating online using a service like Clerke, which Kirsty mentioned is inexpensive, like in the hundreds not in the thousands. So you don’t need a lawyer for that part.

When you actually need to hire a lawyer is it kind of depends on what business you are starting and how complicated it is in terms of, you know, do you have a lot of privacy policies, its HIPAA? But I mean, you can imagine there’s like a ton.

And also, then you mentioned when you're raising your seed round, well how much money are you raising and who are the investors and what kind of terms are in the term sheet? Sometimes that dictates whether or not you need to get legal counsel.

Again, a service like Clerke can help; if you are just using very standard documents for the fundraising, there are just very basic vanilla fundraising documents. So you can use those, and again, they cost less than a hundred dollars, I think, which can save you some legal fees.

Do you want to pick? Should we go back over this side?
I'm going to ignore public. Let's go out.

Do you guys have any advice or comment on the complexity that comes with working with cryptocurrencies or evidence in particular, like your fundraising, since that's becoming more and more popular?

Oh wow, that's a tough question to end with. Yes, there are some issues. Often banks will struggle to deal with companies that are working cryptocurrencies because they haven't quite figured out how to deal with it and and that sort of thing yet. Generally, a lot of it, it's very product-specific. It's not something that kind of has real general advice, unfortunately.