Why do I need a founders round?

No FoundationA founders round is an investment round that generates the initial cash needed to get the company started, but more importantly, it distributes equity to the founders of the company. In effect, it creates a foundation for the company’s ownership.

Do not start your company by simply giving stock to the founders. Doing this creates a taxable event for the founders because they have received something of value, a security, which is taxable. Rather, let the founders purchase a security, which establishes a basis for the purchase of the stock and which is not taxable.

What price do founders usually pay?

Since the company has just started, it isn’t worth very much. Usually, the founders pay a nominal amount, just enough so the company has enough runway to reach the first real investment round.

How many shares should founders purchase during the founders round?

No hard and fast rule exists. However, one million shares would give you good flexibility for the future. It would enable you to sell reasonable pools of shares to future investors and grant reasonable packages of options to employees, without having to do splits to create additional shares.

The only reason not to issue a million shares to the founders would be if your state of incorporation charges your company annual corporate tax based on the number of shares outstanding.

When should you conduct the founders round?

Ideally, you should conduct the founders’ round soon after you execute the paperwork that legally creates the company.

That way, the articles of incorporation and bylaws (if a corporation), the partnership agreement (if a partnership), or the operating agreement or articles of organization (if an LLC) can reflect the distribution of ownership.

Can you have a second “founders round” after the founding of the company?

Legally, founders’ shares are only available at company inception.

Founders can of course sell their shares to somebody. In this case, the new shareholder would pay the founders (not the company) for the shares.

And of course a company can always sell its treasury shares to a new shareholder. In this case, the new shareholder would pay the company. However, be careful! The investor must purchase them at a price using the current market value of the company, likely not the extremely low price the original founders paid for their shares,

When the original founder share price is paid for shares later in the company’s life, the new investor may be subject to a taxable event by the IRS.  Only in the case where nothing happened in the company between its founding and the time of the new investment would the potential exist for this to not be a taxable event.

So, the answer to the question Can you have a second “founders round” after the founding of the company? is  “Yes, sort of.” The new investor would purchase his/her shares in an “investment round”, which you can call whatever you want.

In summary

When you start a company – whether it is a corporation, a partnership, or an LLC – make sure that the founders/partners purchase their shares of the company. That establishes a basis for the security and will make tax filing a lot easier in the future. When shares are sold later on, make sure they are sold at the fair market price at that time.

 

Alan DavisAl Davis is a serial entrepreneur currently in his fifth startup. He is also an angel investor and the author of six books. He is not a CPA or an attorney, so the above is just his opinion!