Startup Law 101 Series – Mistakes Founders Make – Misunderstanding Capitalization

The Issue – What It Means to Own “X% of the Company”

What does it mean that you own x% of a company?

Founders can get confused on this issue. Why? Because there are at least three possible points of reference by which to measure percentage ownership. It can be measured with reference to: (1) issued and outstanding shares only (the narrowest corporate measure); or (2) issued and outstanding shares as adjusted to reflect the maximum dilution possible from the exercise of all stock options and other contingent equity interests outstanding in the company (the “fully diluted” measure); or (3) authorized shares used as a working model of where a company’s board of directors believes the shareholders will be at some future date (the working model measure).

In its own way, each of these measures can legitimately be used by founders in discussing percentage ownership in a corporation. Problems can and do arise, though, when founders discuss this issue and take actions on it without thinking about which reference point they are using. Below I describe the problems this creates and note what to look for to minimize potential problems on this important issue.

What the Concept of “Authorized Shares” Means

When an entity is formed it is capitalized. This means that founders contribute cash or other assets to the entity and, in return, get an ownership interest in the entity. In a corporation, this ownership is evidenced by shares of stock. In an LLC, it is evidenced by a membership interest or perhaps by units evidencing such membership interest. Whether you get shares of stock or some form of ownership units, you will own a certain percent of the company as a whole.

In various contexts, this question — “what percent of the company do I own?” — can be significant. Sometimes a key person is promised x% of the company in exchange for some specific contribution. At the time of funding, founders are told that they will give up x% of their company to VCs in exchange for the dollar investment being made. When they are considering such issues, founders need to understand how this terminology is being used in order to avoid misunderstandings and potential problems.

We can explain how this works with either a corporation or an LLC. Let us use a corporation to illustrate the points.

When a corporation is formed, the charter document (articles or certificate of incorporation) specifies the number of “authorized shares.”

The concept of “authorized shares” is an important one in corporate law. A corporation is a legal person. Being an artificial person, it acts through agents. There are shareholders, who own the corporation. There are directors, who sit as a board and manage it at the highest level. And there are officers, who conduct its day-to-day operations. Shareholders control the corporation by controlling the board, which in turn makes the most important decisions for the corporation. Having been put in place by the shareholders, the board is responsible for making all key decisions that are out of the ordinary course of the day-to-day business operations of the company. One of these decisions is whether to issue stock to various persons and on what terms and conditions to do so.

Got that.

The shareholders control the board.

The board determines what stock to issue and to whom and on what terms.

But the board must always act in the best interests of the corporation and its shareholders. Those who sit as directors on such a board have what the law calls a “fiduciary duty” to exercise the highest good faith and diligence to promote the interests of those shareholders.

To protect the shareholders, as the ultimate owners of the corporation, the corporate law sets an outer bound on what the board can do in issuing stock: the board can always vote to issue stock from the pool of shares authorized by the shareholders (or, initially, by the incorporator) for this purpose. It cannot exceed that bound. This rule protects the shareholders of a corporation from dilution of their ownership interest beyond the limits they have authorized.

So let’s recap again.

The shareholders control the board.

The board determines what stock to issue and to whom and on what terms.

In issuing shares, the board is ultimately limited in what it can issue by the number of shares previously authorized by the shareholders for this purpose — that is, the board’s authority to issue shares is ultimately capped by the number of authorized shares in the corporation.

This is important. The concept of “authorized” shares plays a vital role in corporate life by giving the shareholders an ultimate say on ownership issues in the corporation. But (and this is a big but), except when considered conceptually as the basis of a working model used for planning purposes only, the authorized-share concept has nothing whatever to do with what percentage of ownership interest any shareholder has at any given time.

Issued and Outstanding Shares as the Strict Corporate Measure

It is time for our first quiz.

You form a corporation and, as incorporator, designate 10 million as the number of authorized shares, all common stock.

You appoint yourself as the sole director and, acting as such, authorize 5 million shares to be issued to you as the sole shareholder. You pay for the shares and cause the corporation to issue them to you.

So, 10 million shares authorized and 5 million issued to you. What percent of the company do you own?

That’s right, you own 100%.

It is not, “I own 5 million of the 10 million authorized” and therefore 50% of the company. Remember, authorized shares have nothing to do with actual ownership at any given time in the corporation’s history. Only the issued shares count toward this purpose.

So, you own 5 million shares out of a total issued of 5 million and hence 100% of the company.

Let us extend the example. Say you have a co-founder who received 1 million shares at the same time as you got your 5 million.

What percent of the company do you own?

Now there are 6 million shares issued and outstanding. You own 5 million out of that total. Therefore, you own 5/6ths of the company, or approximately 83.3%. Your co-founder, in turn, owns 1 million out of the 6-million total, or 1/6th, or approximately 16.7%.

Again, none of this is calculated with reference to the 10 million shares authorized for this company. It is technically wrong, as a matter of corporate law, to say that you own 50% of the company in this example because you own 5 million out of the 10 million shares authorized, and it is equally wrong to say that your co-founder owns 10% in owning 1 million out of the 10 million authorized. Yet people will sometimes refer to the authorized shares as the basis for saying how much they or others own in a company and, when rightly considered, this has a certain logic to it. Let us consider, then, how this comes up.

A Potential Ambiguity from Using a Working Model as a Point of Reference

Let us now extend the example further and assume that you promise a key person who will be joining up with you and your co-founder that he will get 2% of your company if he does this or that.

In technical terms under corporate law, what is it that you have promised when you make such a statement? Well, there are 6 million shares issued, 5 to you and 1 to your co-founder. If you take 2% of the 10 million authorized shares, your key person would get 200,000 shares. But 200,000 in relation to the 6 million shares issued (plus 200,000 to be issued) is not a 2% ownership interest but rather about 3.2% (200,000/6,200,000). In technical terms, the 2% interest would be just over 120,000 shares (120,000/6,120,000 equals just under 2%).

While this is the technically accurate outcome, it is true that most parties, when discussing what “2% of the company” would mean in the above example, would likely think of the number 200,000. Why? Because they know that a corporation, or at least one functioning as an entity for a startup business, does not sit stagnant. It operates according to a working model.

In authorizing 10 million shares, you likely are working on the assumption that the 10 million shares will eventually be issued. You might even be thinking something like this: OK, 6 million shares to the founders, 2 million for an equity pool to be issued to key people, and 2 million for future investors. Hence, based on your working model, the correct way of interpreting “2% of the company” would be 200,000 shares, even though this would be wrong under strict rules of corporate law.

In a sense, both views are right. One measures the 2% with reference to existing shareholdings and the other with reference to anticipated shareholdings in the company.

It is precisely for this reason that founders get into trouble by making promises like “I will give you 2% of the company,” at least if they don’t clarify what they mean. Technically, under corporate law, this would mean just over 120,000 shares in our example. But if the recipient says he understood it as being measured with reference to the company’s working model, you have a problem and maybe even a lawsuit on your hands.

Issued and Outstanding Shares as Measured on a Fully-Diluted Basis

Let us shift to a different example to explain this further.

You have 10 million shares authorized, 4 million shares issued to founders, 2 million to investors who hold preferred stock convertible into common at a 1 to 1 ratio, and a total of 1 million stock options issued, none of which have yet been exercised. You are one of the founders and you own 1 million shares.

What percent of the company do you own?

Well, you clearly have 6 million shares issued and outstanding (4 to founders and 2 to investors). Does this mean you own 1 million out of the 6 total, or 1/6th, or just a shade under 16.7%. The answer is: yes and no.

Yes, in technical corporate terms. If your company were acquired in just that instant, and nothing in the acquisition made the options exercisable and none of the options were or could be exercised as of the closing date of the acquisition, you would share in exactly 1/6th of the total proceeds. If the company were acquired for $6 million cash, net of expenses, you would get exactly $1 million for your shares.

But no, not really. Because, while the above presents an accurate picture of what might happen in a particular instant of corporate time, the options in reality will likely become exercisable over the course of time and will or at least may be exercised in whole or in part. Indeed, the very point of issuing options is to provide incentives for key people. If they were not exercisable, that would defeat the point.

Therefore, you need to figure options (and all other contingent equity rights, such as warrants) into the equation to determine what percent of a company you really own. The technical term for taking all these into account is to say that you own “x% of a company on a fully-diluted basis.”

If we look at our example using the “fully-diluted basis” measure, then, you would own 1 million out of a total of 7 million shares either issued and outstanding or issued contingently and capable of being converted into shares in the future. Thus, you would own 1/7th of the company, or just a shade under 14.3%.

Does this mean that you might not actually get a higher percentage should an acquisition occur before all those options and other contingent interests were all exercised? Almost undeniably, you would get some higher percentage interest in most real-world situations.

Why? Because options typically require vesting and not all holders of options will vest in full. Thus, some options will simply be lost to their holders and would hence be subtracted from future computations of the “fully-diluted” capitalization of the company. Still other options will not have acceleration provisions attached to them and will not be vested (and hence not exercisable) at the time of any acquisition.

While the exact outcome is in flux, this arises from the nature of the equity interests in a dynamic startup and not from the measure itself. The fully-diluted measure is in fact the most accurate way of assessing the percent of a company that one has at any given time.

Let us again recap regarding the available measures for measuring percentage ownership in a company. In our first example above, we identified two reference points that might create ambiguity in how a shareholder might understand his percentage of company ownership: his holdings might be measured with reference to issued and outstanding shares only or it might be measured with reference to the company’s working model. To this we must now add yet a third one (the fully-diluted measure): shares can be measured with reference to the total of all shares, option rights, and other contingent rights outstanding in a company by assuming that all such contingent rights have been converted into shares.

How Capitalization Is Measured in VC Funding Deals and the Potential for Confusion by Founders

Now let go one step further to see how VCs measure capitalization at the time they make their investments.

VCs will typically take preferred stock but the nature of the stock they receive is not relevant to our illustration if we assume that their preferred stock will ultimately be convertible 1 for 1 into common stock (which we will assume here).

Let us go back to our example with 10 million authorized shares. You are a founding team holding 4 million shares total, which you issued to yourselves at trivial pricing at the time of company formation. Now you negotiate with the VCs a $6 million “pre-money” valuation for your company. They are prepared to invest $4 million in a Series A round. When added to the pre-money valuation, this gives the company a value “post-money” of $10 million. The VCs will pay $1 per share for their stock based on these valuations. They get 4 million shares for their $4 million.

In this example, the founders have 4 million shares, the VCs have 4 million shares, and the remaining 2 million shares out of the authorized total are designated as being set aside for an equity pool of shares to be issued to key people as incentives.

Now, it is the near-universal rule among startups to treat this scenario as one in which the founders “get 40% of the company,” the VCs “get 40% of the company,” and the remaining 20% is reserved for equity incentives.

This type of assessment is accurate if we assume that such percentage computations are calculated with reference to the working model negotiated between the founders and the VCs for this investment.

And there is, of course, nothing wrong with such an assessment. It is exactly what the parties have in mind when they make such a deal. Indeed, every such deal is accompanied by a sophisticated “cap table” that spells out the company capitalization in intricate detail, factoring everything possible that might contribute to the ultimate dilution of the total shares.

Yet great confusion typically results from this method of figuring and discussing capitalization.

Why? Because, in reality, under corporate law, the founding team that just did this deal has given up 50% of its company, not the 40% discussed with the VCs under the working model.

When control issues are discussed, you have in this case a classic case of shared control because each group holds an identical interest, just as in any 50-50 situation.

If, by some miracle, the company were to be acquired the day after the Series A closing in this example, the VCs would get 50% of the net proceeds of the sale, not 40%.

If part of the negotiated terms included giving the VCs the right to designate an outside CEO who would get a large grant of stock as part of his compensation, the control would shift immediately and decisively to the VC side. They would not need a full 10% shift, as might be implied from the idea that they hold a 40% interest. They would need only the slightest shift to hold just a bit more than 50% and thereby gain control.

I do not raise these issues to imply perfidy on the part of VCs. The deals so structured are legitimate ones. The parties know what they are doing and specifically negotiate them in just such a fashion, each to attempt to achieve its goals. And those goals are by no means seen as adversarial at their core. All parties see the structure as one by which they can work together to their mutual benefit. The investors have as much right to protect their investment as founders do to protect their position. In reality, each side works cooperatively with the other while taking formal steps to protect itself from potential abuse. This makes sense and is a healthy outcome for all concerned. Issues such as control are often negotiated in great detail and there are often agreed-upon terms specifying who will get what board seats and the like.

What I do mean to say here, though, is that founders need to understand the full implications of what they are doing when they do such deals. In the example just cited, they are not giving up 40% of their company but 50%. Yes, if it all plays out and the equity pool is ultimately exhausted, it will turn out to be 40%, as each of the 50-50 players will be progressively diluted to 40% as the pool shares are issued and converted into stock.

As a founder, by all means, do such deals when they meet your interests and those of your company. Just understand their implications. Should you encounter an unscrupulous VC firm under such an arrangement, you may find yourself out in the cold long before the equity pool is exhausted and your founding team’s theoretical interest diluted to 40%. Once control is lost, moreover, any shares you own that are subject to vesting would likely be forfeited if a coup occurred and your service relationship with the company arbitrarily terminated.

Do the deals, then, but understand the risks. A good VC firm will add value far beyond its money investment. A bad one can cause problems far beyond the dollar impact of its investment. When you make assumptions about who owns what percent of a company, and who can do what as a result of that ownership, you need to know which shares count and which are only part of a working model that do not count toward ownership under corporate law as measured on the day the VC round closes.

Conclusion

We have reviewed various scenarios of what it means to “own x% of the company.” As you have seen, the phrase can mean different things to different people, depending on whether it is being measured by actual shares issued, by such shares when “fully diluted,” or by a working model that makes assumptions about what shares will be issued in the future. All are legitimate modes of measurement, depending on the situation. Just make sure you understand which is being used when you assess your own interest and the interests being granted by your company to key people and to investors. If you fail to do so, you may get into trouble.

Of course, don’t forget to check with a good business lawyer on all such issues. The decisions will always be yours but you should make them with open eyes. A good attorney will help immeasurably on such issues. Don’t neglect this resource.

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Pros and Cons of Being an Image Consulting Expert

Image consulting experts are professionals who make clients look presentable for meetings, PR conferences, movie shoots and other big events. These experts may also help important public figures with various miscellaneous tasks such as taking care of props, selecting clothes, shoes or accessories, borrowing pros, packaging borrowed props and returning these props after the work is done. Like all jobs, it also has its pros and cons, listed below are some of the pros and cons you should be aware of if you plan to pursue a career in this field.

Pros

The main advantage of working as an image consulting expert is that, the consultant gets to work with important public figures. Another important advantage is that, the consultant gets to do what he or she loves that is make people look good for major events. Image consultants also get to work with renowned fashion experts and other important people in the field. Usually they are given handsome compensation payments for doing the work that they love.

Cons

The only disadvantages of working as an image consulting expert are that the consultant has to work under pressure and ensure that the job is done as per the client’s requirements. Although this may sound unpleasant, working under pressure is not always a bad thing especially for people who are high achievers and have the capacity to work in stressful conditions once in a while.

Remember

Although this kind of job entails making clients look their best, the consultant herself has to look good at all times. She must dress well, takes care of her nails, takes care of her hair and is presentable in all aspects. By doing these things, she portrays herself as a thorough professional who is abreast of the latest fashion trends and is capable of taking care of her client’s needs.

Conclusion

It can be concluded that these professionals have a challenging job however, there are also various benefits of being a professional who makes clients look good. Usually the perks of the jobs outweigh the disadvantages and when the job is done right, image consulting experts are rewarded handsomely for doing a good job. If you know how to express yourself, if you have knowledge about the latest fashion trends and if you are ready to go the extra mile to make clients happy then chances are that you will excel at this profession. Remember, the key to being a good consulting expert is to have a winning attitude at all times.

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The Great Gatsby – An Analysis of Love

“If love is only a will to possess, it is not love”. America in the 1920’s was a country where moral values were decaying. Every American had one objective to achieve: success.

Francis Scott Fitzgerald, the author of The Great Gatsby, presents realistic image of American life in the 1920’s. His characters, like many people of that period, only care for money; becoming rich is their main objective. As a result, their relationships, no longer based on love, fail.

All of the relationships in the novel are failures because they are not based on love, but on materialism.

One example of a failed relationship in The Great Gatsby is the adulterous affair between Tom Buchanan and Myrtle Wilson. This affair is based on mutual exploitation. Tom uses Myrtle for sex; Myrtle receives gifts and money in return. Tom Buchanan, a resident of East Egg, is “old money”, so he looks down on everyone who is not from his class. Thus, he treats Myrtle as if she is trash. Myrtle Wilson, the wife of poor George Wilson, has become disenchanted with her 12 year old marriage of her husband’s lack of success. Her desire for a better life is evident when she relates her first meeting with Tom:

“It was on the two little seats facing each other that are always the last ones left on the train. I was going up to New York to see my sister and spend the night. He had on a dress suit and patent leather shoes, and I couldn’t keep my eyes off him, but every time he looked at me I had to pretend to be looking at the advertisement over his head. When we came into the station he was next to me, and his white shirt-front pressed against my arm, and so I told him I’d have to call a policeman, but he knew I lied. I was so excited that when I got into a taxi with him I didn’t hardly know I wasn’t getting into a subway train. All I kept thinking, over and over, was ‘You can’t live forever; you can’t live forever” (Fitzgerald 42).

Myrtle even believes that Tom will leave Daisy and marry her. In reality, Tom does not even see Myrtle as a person but as a sexual object. This is made clean by his degrading treatment of Myrtle at the party, especially when he breaks her nose for having the nerve to mention his wife’s name:

” ‘Daisy! Daisy! Daisy!’ shouted Mrs. Wilson. ‘I’ll say it whenever I want to! Daisy! Dai – ‘ Making a short deft movement, Tom Buchanan broke her nose with his open hand” (Fitzgerald 43).

The pathetic nature of their relationship is reinforced when she dies. After a fight with George Wilson, Myrtle runs away towards a golden car that she thinks is Tom’s. The golden colour of the car symbolizes money , the wealth that Myrtle so desires. Apparently, the car is driven by Daisy, another symbol of materialism, and what happens has a symbol of significance:

A moment later [Myrtle] rushed out into the dusk, waving her hands and shouting … The ‘death car’ as the newspapers called it, didn’t stop … Myrtle Wilson, her life violently extinguished, knelt in the road and mingled her thick dark blood with the dust … The mouth was wide open and ripped a little at the corners, as though she had choked a little in giving up the tremendous vitality she had stored so long (Fitzgerald 143-44).

The nature of the relationship between Tom and Myrtle is best symbolized by the expensive dog leash Tom had bought for Myrtle’s puppy. It reflects the fact that Tom is the master, the one who controls his “pet” with money. As the master, Tom is free to do as he pleases. As the “dog”, Myrtle receives gifts for proper behaviour. The unequal status of Tom and Myrtle reflects the failure of their relationship, which, given its adulterous nature, was doomed to fail from the inception.

The Buchanan marriage is also a complete failure. It is the war that separated Daisy and Gatsby, and his absence is one of the reasons she married Tom. However, the most important factor was his money and status. Tom is from a rich family. He can give Daisy everything she wants. The wedding ceremony proved this:

In June [Daisy] married Tom Buchanan of Chicago, with more pomp and circumstance than Louisville ever knew before. He came down with a hundred people in four private cars, and hired a whole floor of the Muhlbach Hotel, and the day before the wedding he gave her a string of pearls valued at three hundred and fifty thousand dollars (Fitzgerald 82).

That is a marriage of convenience -not love- is apparent on several occasions in the novel. For example, while Daisy was giving birth to their only child, “Tom was God knows where” (Fitzgerald 23). Furthermore, Tom’s philandering begins only after 3 months of his marriage. A newspaper account of Tom’s accident mentions that the chambermaid he was with her broken arm. Of course, Daisy knows Tom ways too well; she even offers him her “little gold pencil” so that he gets the number of a “pretty but common” girl he is interested in at Gatsby’s party, although Tom pretends to want to switch tables for another reason. The fact is that their marriage is founded upon wealth and power; that is what keeps them together, and what reveals how barren a marriage it is.

Gatsby is the one who tries to separate Tom and Daisy. It is Gatsby’s dream to be reunited with Daisy, to go back to the past, and to marry Daisy. This is his incorruptible dream, as Gatsby tells Nick: “‘Can’t repeat the past?’ [Gatsby] cried incredulously. ‘Why of course you can!'” (Fitzgerald 117).

After reuniting with Daisy, Gatsby begins an affair that is made possible because he is extremely rich; Daisy is a materialist that can be lured by money. When they first reunite, Daisy shows little true emotion. It is only when he shows her his huge mansion and expensive possession that Daisy displays strong emotion. For example, as Gatsby shows her his expensive clothes from England; “Suddenly, with a strained sound, Daisy bent her head into the shirts and began to cry stormily” (Fitzgerald 99).

When the affair between Gatsby and Daisy is discovered, Tom and Gatsby confront each other over Daisy. In this crucial event, Daisy reveals her true view of her affair with Gatsby – that it was simply a way of filling in her empty days, an entertainment. It is also revenge for Tom’s many adulterous affairs. Deep in her heart, she is not determined:” ‘Oh, you want too much!’ [Daisy] cried to Gatsby. ‘I love you now – isn’t that enough? I can’t help what’s past.’ She began to sob helplessly. ‘I did love him once – but I loved you too'” (Fitzgerald 139).

Having betrayed Gatsby twice already, Daisy now betrays him for the final time – unwilling to face the consequence of Myrtle’s death, Daisy and Tom conspire to frame Gatsby for the accident. Gatsby is then killed by George Wilson, as Tom has led him to believe that Gatsby is both Myrtle’s lover and killer.

In the end, this relationship fails because Daisy values nothing but materialism; she does not even send a flower to Gatsby’s fueral.

Love is essential in a relationship. However, materialism is essential of the relationship presented in The Great Gatsby. Those relationships are failures because they are founded on the physical rather than the spiritual. Fitzgerald shows that any relationships based on materialism will fail in the end.

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Love is Not a Feeling

Love is Not a Feeling. What? You exclaim, of course, love is a feeling. I feel it in my chest, stomach and my body tingles sometimes. Yes, those are the physiological manifestations when one has the sensation of ‘falling in love.’

Falling in love and love are two different phenomena. Falling in love can be either a flash of emotions or a first step towards genuine love. “Love is misunderstood to be an emotion; it is a state of awareness, a way of being in the world, a way of seeing oneself and others.” -David R. Hawkins

Falling in love is a strong instinctive attraction to a person. If it is mutual and both people work at their relationship; one day that euphoric experience called, ‘falling in love,’ can grow into genuine love.

The falling in love phenomena is the call of one’s longing to belong, to cathect, but the object is instinctually chosen according to our ideals, dreams and etc., although one may not realize it. We usually fall in love with the person’s appearance, with the way she/he walks, the way he/she talks. Sometimes we impute to our object of love some mystic illusion, ideal qualities and the more we get to know the person the less we fall for him or her. That’s when the feeling of love disappears even faster than it appeared.

The more two persons get to know each other, the more comfortable they get; the less sharp, bright and exciting the falling in love experience is. Some couples continue their relationships and get married; some fall apart. It’s reasonable to say that more clothes in the closet and one more toothbrush in the bathroom is the end of the falling in love phase, but it also can be the beginning of genuine love.

The euphoric feelings we call ‘love’ is the emotion that accompanies the experience of cathecting. Cathecting is the process by which an object becomes important to a person. Once cathected, the object, often referred to as a ‘love object’ is invested with our energy as if it were a part of oneself, and this relationship between oneself and the invested object is called a cathexis. One’s cathexis may be fleeting and momentary. Genuine love implies commitment and exercise of wisdom. When one is concerned for someone’s spiritual and emotional growth, one knows that a lack of commitment is likely to be harmful and that commitment to that person is probably necessary for one to manifest one’s concern effectively. The concern and commitment to another’s spiritual and emotional growth is the purest form of love. It is for this reason that commitment is the cornerstone of any healthy relationship-friends, significant others, husband/wife.

Genuine love transcends the matter of cathexis. When love exists it does so with or without cathexis and with or without a loving feeling-those bursts of butterflies in the stomach, body tingling, etc.

It is easier-indeed, it is exhilarating-to love with cathexis and the euphoric feeling of love. However, it is possible to love without cathexis and without loving feelings, and it is in the fulfillment of this possibility that genuine and transcendent love is distinguished from simple cathexis. Genuine love is volitional rather than euphorically emotional. The person who truly loves does so because of ‘a decision to love.’ This person has made a commitment to ‘be loving,’ whether or not the loving feelings are present.

It can be difficult and painful to search for evidence of love in one’s actions, but because true love is an act of will that transcends ephemeral feelings of love or cathexis, it can be said, “Love is as love does.” Love and non-love, as good and evil, are objective and not purely subjective phenomena.

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Alternative Investment Fund Regulations

What is an Alternative Investment Fund (AIF)

AIF is an Alternative Investment Fund Regulations privately pooled investment vehicle which collects funds from investors, whether Indian or foreign, for investing it in accordance with a defined investment policy for the benefit of its investors. AIF may be in the form of a trust or a company or a limited liability partnership or a body corporate.

Why AIF

AIF Regulations endeavor to extend the perimeter of regulation to unregulated funds with a view to ensuring systemic stability, increasing market efficiency, encouraging the formation of new capital and consumer protection.

Who are not covered

Currently, the AIF Regulations do not apply to mutual funds, collective investment schemes, family trusts, ESOP and other employee welfare trusts, holding companies, special purpose vehicles, funds managed by securitisation or reconstruction companies and any such pool of funds which is directly regulated by any other regulator in India.

Categories of AIFs

An AIF needs to seek registration broadly under one of the 3 categories –

Category I AIF: The following are covered under Category I

1. Funds investing in start-up or early stage ventures or social ventures or SMEs or infrastructure

2. Other sectors or areas which the government or regulators consider as socially or economically desirable including the Venture Capital Funds

3. AIFs with positive spillover effects on the economy, for which certain incentives or concessions might be considered by SEBI or Government of India or other regulators in India

Category II AIF: The following are covered under Category II

1. AIFs for which no specific incentives or concessions are given by the government or any other Regulator

2. Which shall not undertake leverage other than to meet day-to-day operational requirements as permitted in these Regulations

3. Which shall include Private Equity Funds, Debt Funds, Fund of Funds and such other funds that are not classified as category I or III

Category III AIF: The following get covered under Category III

1. The AIFs including hedge funds which trade with a view to making short term returns;

2. Which employ diverse or complex trading strategies

3. Which may employ leverage including through investment in listed or unlisted derivatives

Applicability of AIF Regulations to Real Estate Funds

After knowing what an AIF is and its broad categories, we analyse whether AIF Regulations are applicable to the Real Estate Funds

Firstly AIF has to seek registration under AIF Regulations under one of the three categories stated above. Therefore if a Fund does not fall under any of the three categories stated above, then it will not seek the registration with SEBI.

If we look at the Category 1, registration is required by funds which invest in start-up or early stage ventures or social ventures or SMEs or infrastructure

If we look at the definition of infrastructure, Explanation to Regulation 2 (m) states that Infrastructure shall be as defined by the Government of India from time to time.

And in the normal parlance, the term typically refers to the technical structures that support a society, such as roads, water supply, sewers, electrical grids,

telecommunications, and so forth, and can be defined as “the physical components of interrelated systems providing commodities and services essential to enable, sustain, or enhance societal living conditions.

Therefore infrastructure does not include the real estate or construction activity since this activity deals in investing in land, developing the land by way of construction of flats, townships and other residential and commercial projects.

But if the real estate fund carries on certain projects for a social purpose like purchasing land for charity etc.; then the fund may be covered under social venture funds.

The clause further states that ‘or other sectors or areas which the government or regulators consider as socially or economically desirable and such other Alternative Investment Funds as may be specified;’

The AIF Regulations have been notified just a few days back and till date, no other AIF funds have been specified in the Category 1 by the Government. Further what the government or regulators consider as socially and economically viable is a very broad concept. However, till the Government specifically comes out with specific inclusions under Category 1; a Real Estate Fund will not be covered under Category 1 and therefore would not require Registration.

Further, the clause also states that – Alternative Investment Funds which are generally perceived to have positive spillover effects on economy and for which the Board or Government of India or other regulators in India might consider providing incentives or concessions will bee included

By adding these lines to the Category 1, SEBI has made the category 1 very vague and open to dispute and litigations since what SEBI intends with positive spillover effects on the economy is not defined or clarified. Different people or organizations may have a different opinion on this which would lead to unnecessary litigations and hardships to business owners. However, till any clarity comes on this, the business owners need to take a cautious approach to the decision of seeking Registration under AIF Regulations.

Category II AIF

Now we examine whether a Real Estate Fund falls under the Category II AIF

If we look at the funds covered by Category II above, they

1. Shall not fall in Category I and III

2. Shall not undertake leverage or borrowing other than to meet day-to- day operational requirements and as permitted by these regulations;

3. Shall be funded such as private equity funds or debt funds for which no specific incentives or concessions are given by the government or any other Regulator

For Real Estate Fund under Category I, we notice that at present it does not fall under Category I and it also does not fall under Category III since these are basically hedge funds. Further, no specific incentives or concessions are given by the Government to the Real Estate Sector. Therefore if we look at the applicability of Real Estate Fund under Category II, these funds may fall under the Category II AIFs if they do not take leverage or borrowing except for short-term requirements.

Impact of AIF on the Real Estate Funds

Under these Regulations, the minimum investment amount has to be Rs 1 crore from each investor. Therefore attracting the funds from the investors would become tough for the real estate funds, who used to raise amounts as less as INR 1 million from the investors. Now they would need to find high-value investors though this is not the only challenge that lies ahead for those raising domestic corpuses. They now also have to invest 2.5% of the corpus or Rs 5 crore, whichever is lower, to ensure that the managing company’s risk is aligned with that of the investor. Moreover, a single investment in a company or a project cannot exceed 25% of the entire corpus.

Further a Real Estate Fund registered in the form of an LLP also would be covered under the AIF Regulations. In an LLP Structure, since the investors are also partners, the risk to the rights of the investors being misused is very minimum. Therefore applying the AIF Regulations to the LLP Structure would reduce the flexibility available to such a Structure.

Conclusion

If we look at the AIF Regulations from a short term perspective, in light of the difficult fund raising environment today, the higher ticket size for investors could potentially throw up some challenges and could in a manner constrict the growth of the asset class, but clearly, in the long run, these regulations appear to have an element of maturity to play a pivotal role in the development and shaping up of the future of alternate asset class in India. It is also clear that alternative investments are more sophisticated and risky as compared to investments in equity and debt and till market matures it is advisable that only HNIs and well informed investors make an investment in this asset class and once the market matures it is made open to all. In the long run, we may see more investments in the Alternative asset class (in terms of quantum and maturity) due to the increased investor confidence in these funds.

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Home Sweet Home!

He loves to be at home, almost deliriously. Home … sweet home! Some place where you follow the same delicious routine- everyday, day after day. His mother and sisters hovering around him, giving him mouth-watering meals at the appropriate hours-so religiously maintained! Precious moments at every step of the homely existence, sometimes with his father butting in at the most inappropriate ones! And then … the compulsory evening hours before the television set with family, and a lot of nonsense yet fun. This is heaven, he justifies. Nothing can possibly ever make him think of leaving it!

Of course, he reasons, he is no longer a burden on his father's measly monthly income. Now, he too has a job-a fairly good job considering the fact that he can carry it on royally residing at home. What's more-he is contributing to the monthly budget in good measure and as a result of that he is getting even more attention from his mother and more pampering from his beloved sisters, he's almost sure about that! Yes, he had got several other job offers outside his city, but rejected all in an immaculate cost-benefit analysis that he often indulged in. He will get more salary no doubt, but most of that will go to renting flats, cooking for his own sake, transport costs for homecoming and going and other related costs. Therefore, he is ready to give up that extra income in favor of staying at his heaven.

Sometimes he gets bored too, as is natural. The delicious routine becomes a drag if he decides to think of his apparently purposeless existence. But then he reasons even more vehemently. Why-there is lot of purpose in his life, helping his ageing father, giving solid support to his mother, finding ways and means of marrying off his sisters and so on. Besides, home sweet home always has its never-ending store of pleasures. He can lounge out in the portico sofa by the window with a book or have noisy games of cards, ludo, carom, checkers and the lot with family or can join the guests who come almost every day for gossip or can go for a movie.

His heavenly existence was continuing in full bloom till one fateful day. In fact, for many others it would have been been a momentous day of great joy and promise. However, for him it was a D-day. He had to take the decision of his life-a choice between his heaven and a future that he did not put much weight on.

He got an unexpected promotion and transfer to a big city. Maybe thanks to his heavenly roots he had been very good in his office job, and just when the employers wanted to reward him for his efforts all hell broke loose for him. He shared this news with his mother and sisters in a very casual manner, not telling about the exact pay package, but only mentioning the additional unnecessary costs. However, one of his sisters got elated at the prospect of traveling to the megacity and staying in her brother's home. He looked askance at her.

He is more careful breaking the news to his father. He tries to convince him that this promotion does in no way mean a quick climb-up in the hierarchy; rather he'd wait a little longer and get the promotion at his hometown. Or he'd approach some influential person for a settlement where his dad could also help. And the unnecessary expenses that will come inevitably, his cost-benefit analysis in full flow. He is almost sure that his dad is convinced. Any doting father would want his only son near and around only. However, his father's next action was not at all expected. His father just walked out of home.

It was only half an hour later, but the suspense made it seem much longer. His father comes in with huge packets on his hands. His father calls upon his mother and places all the packets on the dining table. One by one he opens-sweets, cakes, salty delights and all. He just ushers in a big celebration. His heavenly son just looks on.

"Congratulations, my boy! I was really worried about you and your ways. But you proved to be damn good in work, and the way your company is rewarding you is just terrific. Okay … you've gorged on home food and comforts for quite long. Enough of your logic and arguments! Now you get a start on your own. And don't bother about me. Next time I'm coming to have comforts in your home! "

He tries to look pleadingly at his mother. But she is busy, and merrily setting the table. He must celebrate now.

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Culinary Arts and Nutrition

Imagine yourself in a room full of tempting food, jellies, chocolates, pastries, cakes, pizzas and much more mouth watering dishes. Slurp… I know by now you are too tempted to get to the market and buy yourself a nice, juicy burger, coke and an ice cream tub or are ready to order a pizza, rather than reading.

Just for a moment think of the chefs who stay in the kitchen all day long that is loaded with scrumptious cuisines giving out such enticing and alluring aromas. It must be really tough for them to resist the delicacies they prepare for their customers. One the other hand, if they start tasting every dish they prepare it will be extremely tough for them to sustain good health.

It is said, ‘People judge a book by its cover’, and the same applies to a cook too. A healthy and fit chef ascertains us that he is health conscious and knows all about good and rich cooking. This might not prove true in all cases; some guys do not have such luck. There are many professional chefs are surrounded by buttery carbohydrates, rich sauces, creamy puddings and fine succulent meat but are thin like a Cornish wafer.

The roly-poly chefs that we were accustomed to once, are replaced by much more disciplined, controlled and healthy chefs. There was a time when a thin chef was not trusted but today the scenario has totally changed. The more lean and fit a chef is the more energetic he will be. A chef should be prepared to bounce around the kitchen in order to do everything just right.

Being a chef, it is important to taste every dish and every dessert prepared to ensure it is delicious. In doing so the fats keep on settling on the stomach, in turn making you fat. To avoid this, it is better to take small mouthfuls in intervals. Small meals ensure better metabolism. Some chefs believe in drip free food and indulge in raw fresh fruits, raw vegetables and much water. They also avoid any sort of meal in between lunch and dinner. Lastly, a good 20 minutes walk each day. In case you do feel hungry at night, eat a bowl of cereal.

A chef is however known for his skills in cooking and preparing meal yet his physical appearance and nutritional habits also play an important role. Not only does it attract more customers for him but is also important for his own good.

Nutrition is also an important aspect of cooking delicious foods. And chefs are not an exception to this rule. While pursuing their education in the culinary arts, one of the subjects that these aspiring chefs study is Nutrition. Here, they learn about the amount of nutritive elements present in each ingredient – and how to analyze and determine which foods have how much nutritive value.

No doubt, this knowledge goes a long way in helping these chefs create delicacies that are not only tasty but also healthy for their customers.

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What is Hospitality Interior Design and Who Uses It?

In the hospitality industry, interior design performs a similar function. The layout of a lobby or guest room in addition to the color scheme, lighting, and furniture choices, greatly affects how a guest feels and how they view their surroundings.

Hospitality interior design covers a variety of different venues. It is used in restaurants, hotels, even retail stores. Every design aspect from the floor plan to the color of the walls and the style of furniture makes a difference in affecting a certain tone or atmosphere. Depending on the tone a business wishes to set, an interior designer might choose a bright, vibrant color pattern paired with modern furniture and innovative decorative accents or he might select a subtle, more muted color palette paired with plush furniture and simple wall decorations to inspire feelings of calm and comfort.

Lighting and color palette go hand in hand when it comes to hospitality interior design. Most interior designers have been educated to know what types of lighting to pair with bright color schemes versus those which are more subtle. The lighting of a venue may also be affected by furniture choices and the actual architecture of a building. Rooms with vaulted ceilings might require wall fixtures which direct the light upwards while smaller rooms might utilize overhead lighting or corner lamps. Not only does the type and placement of lighting affect the atmosphere of a room or building, but the degree of illumination is also important. A soft glow is more relaxing while bright or colored lighting inspires feelings of excitement and energy.

In addition to lighting and color palette, several more factors come into play within the realm of hospitality interior design. The type of furniture selected dictates whether a room is meant to be more decorative or functional and the arrangement of said furniture plays a role in establishing atmosphere as well. An open floor plan into which the furniture is sparsely placed induces an airy, free atmosphere while small groupings of furniture might incite feelings of intimacy. When considering different styles of hospitality interior design there are myriad factors to think about but the most important decision to make is what kind of atmosphere should be affected. A good interior designer will be able to make all aspects of hospitality interior design work together in order to create a cohesive feel the subscribes to a certain tone or atmosphere.

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How Can Probiotics Help in Weightloss?

One of the leading health issues in society today is the growing number of obese people and obesity. I remember when I had my pre-employment medical examination, the doctor was so prejudiced and biased that simply because I weighed 115 kgs, he did not provide me any clearance and wanted me to seek and consult a second opinion from an endocrinologist as he said that I might be overweight due to a problem with my thyroid glands or something.

What he did not know, which I did not anymore tell him since I did not have a face-to-face with him when he released my medical results was, I already lost weight with my current weight during the medical examination. How? I had to simply took in Provita Probiotics.

Why Probiotics?

If we look into our digestive system, it is composed of several microorganisms which can be simply classified into good and bad bacteria.

To understand the affects of probiotics on weight loss you need to start with an understanding of the key players. There are two first families of bacteria in the gut: The good Bacteroidetes and the not-so-good Firmicutes. “Lean individuals have a higher proportion of bacteria from the Bacteriodetes family, while obese individuals have more from the Firmicutes family,” Dr. Bulsiewicz explains. “This means that obese individuals carry gut microbes that are designed to efficiently extract the bad parts of our food, namely from fat and sugar, and the implication is that by modulating our gut flora to maximize Bacteroidetes and minimize Firmicutes, we can optimize healthy energy harvesting from our food and kick our obesity problem to the curb.” Put another way: “If we choose the right blend of bacteria, the scale can tip in our favor,” he says.

Provita, as a probiotic supplement is composed of several components that all aid in improving our digestive system and reduce fat in our body, especially belly fat. These components include:

  1. Bifidobacterium Lactis – helps takes the nutrients we ingest in food into our body. It also helps in preventing the increase of bad bacteria. In a study conducted in 2015 showed that a fermented milk containing B. lactis may improve gastrointestinal symptoms and well-being, and it was suspected that this was true because of changes it created in gut motility, hypersensitivity, and even leaky gut. Another study demonstrated that when people took a particular strain of B. lactis, called BB-12, in conjunction with Lactobacillus rhamnosus GG, they had decreased amounts of dental plaque and reduced inflammation in the mouth, which has led us to an increased understanding of how oral health is tied to gut health and why having a healthy oral microbiome is important. One recent article suggested that disruption of the gut microbiome in autism spectrum disorder (ASD) extends to the oral cavity and that looking at the oral microbiome could be helpful in evaluating ASD status. This is just one example of how oral health is tied to gut health and overall health, as well. Another fascinating study demonstrated that B. lactis reduced fat mass and glucose intolerance in mice with diabetes and obesity. It was felt that reduced levels of the pro-inflammatory substance called lipopolysaccharides (LPS) from bacteria that is associated with leaky gut was one of the mechanisms by which this occurred. We already know that an imbalance of bacteria in the gut can be associated with a variety of different conditions and diseases, so this is a great example of how a good guy can be added to the ecosystem and help tip the balance in favor of health, rather than disease. In this case, this probiotic helped improve blood sugar balance and weight. A particular strain of B. lactis, known as HN019, has been shown to have a significant impact on those with metabolic syndrome. This probiotic had beneficial effects on inflammation, nitric oxide metabolites, and antioxidant measurements, and the authors of the study stated that if their results are confirmed, supplementation with this probiotic should be considered further. It’s fascinating how adding a particular probiotic strain to your lifestyle routine can create such improvement in one’s health. It goes to show you how even a slight imbalance between the good bugs and bad bugs in your gut can cause and contribute to so many different medical conditions and symptoms.
  2. Bifidobacterium Bifidum -lowers cholesterol levels of the body. Although there are not as much research done on such strain of probiotics, certain researches revealed that B. bifidum shows promise in treating the following conditions: infection by Helicobacter pylori (H. pylori), irritable bowel syndrome (IBS), restoration of intestinal bacteria after chemotherapy, constipation, lung infections, ulcerative colitis, certain kinds of diarrhea, necrotizing enterocolitis, a type of infection in the intestinal lining caused by harmful bacteria, and pouchitis, a complication of surgery for ulcerative colitis

These are just the first two components found in Provita Probiotics. We have not further gone into the other components as this may come up to be a very long note. We would just like to educate people on the powerful effects of Provita Probiotics, being a probiotic supplement that has 16 strains or types of probiotics in the market that all provide us with the needed benefit of improving our GUT or digestive system and promoting weightloss. Further studies by health and medical practitioners reveal that Probiotics have the following effects:

Increased Fat Elimination

For some dieters, removing consumed fat from the body before it has a chance to do damage would be a great help. Probiotics may increase the amount of dietary fat that is released by the body through feces, according to the results of a study published in Lipds in Health and Disease by Japanese researchers. Fat consumed by the subjects was not as easily digested for use or for storage by the body in those who were given certain probiotics, resulting in the excess consumed fat being eliminated by the body through the digestive tract. As the fat was being emulsified through normal bodily processes, fat droplets were found to be larger in those who were given the specific probiotics. While the mechanism of action is unknown at this time, perhaps the larger droplets of fat are not able to be used as easily by the body, allowing them to be released as waste.

Diminished Appetite

Those who have a hard time losing those extra pounds because they feel hungry all of the time might want to think about using probiotics for weight loss. It seems that certain probiotics may actually influence how satisfied you feel by regulating the way your body reacts to a hormone called leptin. Leptin is produced by fat cells to let the brain know that there is enough stored away for energy. The brain can then signal the body to reduce the appetite. However, those who are obese may develop what is known as leptin resistance, where the brain can no longer properly identify those signals when leptin levels get way too high. Research in the British Journal of Nutrition showed that probiotic supplementation helped leptin signals to reach the brain, allowing subjects to feel more satisfied after eating. In turn, this can help individuals to eat fewer calories to better help with weight loss.

Decreased Fat Storage

While certain probiotics have been shown to move some of the extra fat that is consumed out of the body before it can cause problems, it appears that probiotics may help to reduce the amount of additional fat that is stored in the body. The reduction of increased fat stored occurred even with excess food intake. Research by Osterberg, et al, published in the journal Obesity showed that those who were given a certain probiotic gained less weight while eating too many calories compared to those who were given a placebo. Another study shows how the good bacteria of the gut may affect this. Aronsson, et al, in a study published in PloS One, found that a certain protein can help to prevent the accumulation of fat within adipose tissue. This protein is increased with a proper balance of the microbiome in the gut, effectively reducing how much consumed fat gets stored for later use. While these studies did not necessarily show the benefits of probiotics for weight loss, it showed that the use of probiotics can help with weight management by reducing the amount of extra calories that are stored as fat.

Reduced Body Fat

Another way that probiotics have been shown as useful in regards to body weight is in their ability to reduce the amount of fat that is currently being stored by the body. This process actually begins in the gut, according to research by Omar, et al, that is published in the Journal of Functional Foods. By increasing the number of specific good bacteria in the intestines through the use of supplementation of probiotics, researchers were able to induce a change in body composition in the subjects. The probiotics changed the way the body utilized food for energy, allowing for an increase in the use of existing fat stores for fuel. Individuals noted a decrease in body fat, specifically around the organs. The probiotics given in the study helped subjects to enjoy more weight loss, a healthier BMI, and loss of belly fat.

Enhanced Metabolism

By equalizing the levels of beneficial bacteria that are found in the digestive tract, probiotics can help the body to function more effectively. The same study that showed probiotics may reduce the amount of fat that is already stored in the body draws interest in the ability of these same probiotics to increase metabolism. A health metabolism continues to use calories, even when you are not exercising. Fat is a little more difficult for the body to digest, so many dieters find that they lose muscle over fat stores when eating a calorie-restricted diet. Because probiotics may change how the body utilizes macronutrients for fuel, these beneficial bacteria can help the body to burn fat for fuel rather than the protein stored in muscle. Those who take probiotics with their healthy diet and exercise program may enjoy a higher calorie burn even during inactive periods.

So how does probiotics help? Well, personally, my first month of use has allowed me to lose 15 kgs coming from a weight of 125 kgs to now 110 kgs and it does not stop there. I noticed that I don’t get constipated, my bowel movement became regular and I get the feeling of being content with my food intake faster compared to before.

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Startup Law 101 Series – Ten Essential Legal Tips For Startups at Formation

Here are ten essential legal tips for startup founders.

1.  Set up your legal structure early and use cheap stock to avoid tax problems.

No small venture wants to invest too heavily in legal infrastructure at an early stage. If you are a solo founder working out of the garage, save your dollars and focus on development.

If you are a team of founders, though, setting up a legal structure early is important.

First, if members of your team are developing IP, the lack of a structure means that every participant will have individual rights to the IP he develops. A key founder can guard against this by getting everyone to sign “work-for-hire” agreements assigning such rights to that founder, who in turn will assign them over to the corporation once formed. How many founding teams do this. Almost none. Get the entity in place to capture the IP for the company as it is being developed.

Second, how do you get a founding team together without a structure? You can, of course, but it is awkward and you wind up with having to make promises that must be taken on faith about what will or will not be given to members of the team. On the flip side, many a startup has been sued by a founder who claimed that he was promised much more than was granted to him when the company was finally formed. As a team, don’t set yourselves up for this kind of lawsuit. Set the structure early and get things in writing.

If you wait too long to set your structure up, you run into tax traps. Founders normally work for sweat equity and sweat equity is a taxable commodity. If you wait until your first funding event before setting up the structure, you give the IRS a measure by which to put a comparatively large number on the value of your sweat equity and you subject the founders to needless tax risks. Avoid this by setting up early and using cheap stock to position things for the founding team.

Finally, get a competent startup business lawyer to help with or at least review your proposed setup. Do this early on to help flush out problems before they become serious. For example, many founders will moonlight while holding on to full-time jobs through the early startup phase. This often poses no special problems. Sometimes it does, however, and especially if the IP being developed overlaps with IP held by an employer of the moonlighting founder. Use a lawyer to identify and address such problems early on. It is much more costly to sort them out later.

2.  Normally, go with a corporation instead of an LLC.

The LLC is a magnificent modern legal invention with a wild popularity that stems from its having become, for sole-member entities (including husband-wife), the modern equivalent of the sole proprietorship with a limited liability cap on it.

When you move beyond sole member LLCs, however, you essentially have a partnership-style structure with a limited liability cap on it.

The partnership-style structure does not lend itself well to common features of a startup. It is a clumsy vehicle for restricted stock and for preferred stock. It does not support the use of incentive stock options. It cannot be used as an investment vehicle for VCs. There are special cases where an LLC makes sense for a startup but these are comparatively few in number (e.g., where special tax allocations make sense, where a profits-only interest is important, where tax pass-through adds value). Work with a lawyer to see if special case applies. If not, go with a corporation.

3.  Be cautious about Delaware.

Delaware offers few, if any advantages, for an early-stage startup. The many praises sung for Delaware by business lawyers are justified for large, public companies. For startups, Delaware offers mostly administrative inconvenience.

Some Delaware advantages from the standpoint of an insider group: (1) you can have a sole director constitute the entire board of directors no matter how large and complex the corporate setup, giving a dominant founder a vehicle for keeping everything close the vest (if this is deemed desirable); (2) you can dispense with cumulative voting, giving leverage to insiders who want to keep minority shareholders from having board representation; (3) you can stagger the election of directors if desired.

Delaware also is an efficient state for doing corporate filings, as anyone who has been frustrated by the delays and screw-ups of certain other state agencies can attest.

On the down side — and this is major — Delaware permits preferred shareholders who control the majority of the company’s voting stock to sell or merge the company without requiring the consent of the common stock holders. This can easily lead to downstream founder “wipe outs” via liquidation preferences held by such controlling shareholders.

Also on the down side, early-stage startups incur administrative hassles and extra costs with a Delaware setup. They still have to pay taxes on income derived from their home states. They have to qualify their Delaware corporation as a “foreign corporation” in their home states and pay the extra franchise fees associated with that process. They get franchise tax bills in the tens of thousands of dollars and have to apply for relief under Delaware’s alternative valuation method. None of these items constitutes a crushing problem. Every one is an administrative hassle.

My advice from years of experience working with founders: keep it simple and skip Delaware unless there is some compelling reason to choose it; if there is a good reason, go with Delaware but don’t fool yourself into believing  that you have gotten yourself special prize for your early-stage startup.

4.  Use restricted stock for founders in most cases.

If a founder gets stock without strings on it, and then walks away from the company, that founder will get a windfall equity grant. There are special exceptions, but the rule for most founders should be to grant them restricted stock, i.e., stock that can be repurchased by the company at cost in the event the founder leaves the company. Restricted stock lies at the heart of the concept of sweat equity for founders. Use it to make sure founders earn their keep.

5.  Make timely 83(b) elections.

When restricted stock grants are made, they should almost always be accompanied by 83(b) elections to prevent potentially horrific tax problems from arising downstream for the founders. This special tax election applies to cases where stock is owned but can be forfeited. It must be made within 30 days of the date of grant, signed by the stock recipient and spouse, and filed with the recipient’s tax return for that year.

6.  Get technology assignments from everyone who helped develop IP.

When the startup is formed, stock grants should not be made just for cash contributions from founders but also for technology assignments, as applicable to any founder who worked on IP-related matters prior to formation. Don’t leave these hangning loose or allow stock to be issued to founders without capturing all IP rights for the company.

Founders sometimes think they can keep IP in their own hands and license it to the startup. This does not work. At least the company will not normally be fundable in such cases. Exceptions to this are rare.

The IP roundup should include not only founders but all consultants who worked on IP-related matters prior to company formation. Modern startups will sometimes use development companies in places like India to help speed product development prior to company formation. If such companies were paid for this work, and if they did it under work-for-hire contracts, then whoever had the contract with them can assign to the startup the rights already captured under the work-for-hire contracts. If no work-for-hire arrangements were in place, a stock, stock option, or warrant grant should be made, or other legal consideration paid, to the outside company in exchange for the IP rights it holds.

The same is true for every contractor or friend who helped with development locally. Small option grants will ensure that IP rights are rounded up from all relevant parties. These grants should be vested in whole or in part to ensure that proper consideration exists for the IP assignment made by the consultants.

7.  Protect the IP going forward.

When the startup is formed, all employees and contractors who continue to work for it should sign confidentiality and invention assignment agreements or work-for-hire contracts as appropriate to ensure that all IP remains with the company.

Such persons should also be paid valid consideration for their efforts. If this is in the form of equity compensation, it should be accompanied by some form of cash compensation as well to avoid tax problems arising from the IRS placing a high value on the stock by using the reasonable value of services as a measure of its value. If cash is a problem, salaries may be deferred as appropriate until first funding.

8.  Consider provisional patent filings.

Many startups have IP whose value will largely be lost or compromised once it is disclosed to the others. In such cases, see a good patent lawyer to determine a patent strategy for protecting such IP. If appropriate, file provisional patents. Do this before making key disclosures to investors, etc.

If early disclosures must be made, do this incrementally and only under the terms of non-disclosure agreements. In cases where investors refuse to sign an nda (e.g., with VC firms), don’t reveal your core confidential items until you have the provisional patents on file.

9.  Set up equity incentives.

With any true startup, equity incentives are the fuel that keeps a team going. At formation, adopt an equity incentive plan. These plans will give the board of directors a range of incentives, unsually including restricted stock, incentive stock options (ISOs), and non-qualified options (NQOs).

Restricted stock is usually used for founders and very key people. ISOs are used for employees only. NQOs can be used with any employee, consultant, board member, advisory director, or other key person. Each of these tools has differing tax treatment. Use a good professional to advise you on this.

Of course, with all forms of stock and options, federal and state securities laws must be satisfied. Use a good lawyer to do this.

10. Fund the company incrementally.

Resourceful startups will use funding strategies by which they don’t necessarily go for large VC funding right out the gate. Of course, some of the very best startups have needed major VC funding at inception and have achieved tremendous success. Most, however, will get into trouble if they need massive capital infusions right up front and thereby find themselves with few options if such funding is not available or if it is available only on oppressive terms.

The best results for founders come when they have built significant value in the startup before needing to seek major funding. The dilutive hit is much less and they often get much better general terms for their funding.

Conclusion

These tips suggest important legal elements that founders should factor into their broader strategic planning.

As a founder, you should work closely with a good startup business lawyer to implement the steps correctly. Self-help has its place in small companies, but it almost invariably falls short when it comes to the complex setup issues associated with a startup. In this area, get a good startup business lawyer and do it right.

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