In December 2014, I was in my mid-20s, and we were having regular meetings with the team for the early stages of starting TranQool. We used to meet at our houses or at the Chapters in Bayview Village Mall, effectively our office. One of the first things we realized we needed to do was to incorporate. I remember reaching out to an accountant and receiving some generic guidance. I was puzzled by terms like “president” and “secretary.” I ended up consulting with a few accountants and lawyers, but they all viewed us as a small business, and I found their advice somewhat irrelevant. It became clear that I needed to educate myself.
After our incorporation, we signed up for a major law firm’s startup program. We also properly dealt with shareholder agreements, share transfers, investment documents, and so on with them all the way until the acquisition. A small piece of advice: while it may incur some costs, it’s crucial to get your house in order. VCs don’t appreciate unforeseen challenges due to poor company setup.
During that time, I read a couple of corporate finance books and researched what is taught in schools. Being passionate about finance and numbers, I genuinely enjoyed it. I believe that my knowledge of finance was very helpful as an entrepreneur. I wasn’t planning to become a CFA (Chartered Financial Analyst), and corporate finance, in particular, is quite challenging. However, having a general understanding of some financial terms can be beneficial for early founders. I mixed my book knowledge with what I learned on an as-you-go basis and I think this has given me a practical point-of-view about startup corporate finance. This practical knowledge I gained really helped me later on — our lawyer once told me that I could make a good corporate lawyer — and I believe every startup founder has to know a little bit of corporate finance.
In this article, I will delve into some terms, jargon, and technicalities you need to know. Feel free to reach out if you have any questions.
- Types of Company: Without knowing much about your startup, more often than not, you’ll want to incorporate a corporation. Just accept this advice, and don’t worry about other types: Partnership, Sole, etc.
- Types of Incorporation: There are multiple ways to incorporate. You can do it as a federal company or a provincial company. There are some differences, but in essence, provincial incorporation means conducting business only in that province, while federal incorporation allows you to do business across the country. We were incorporated in the province of Ontario and created extra-provincial businesses as needed. For federal incorporation, you need at least one Canadian resident on the board of directors, whereas some provinces like BC and ON allow incorporations for fully foreign-owned companies. I’ve always used Founded (now Ownr) for my clients. Full disclosure: I know and admire the founders of Founded, Derek, and Shane. We met in 2015 at an event when they were running a startup called MyLawScout, which was similar to TranQool but for lawyers. Small world. Check them out; the platform is amazing and offers professional company management options.
- Board of Directors: A startup board is a group of directors that govern the company, oversee operations, provide strategic guidance, and protect all stakeholders. A board of directors typically has a diverse set of skills, expertise, and industry knowledge relevant to the startup. Every private company must have at least one director. Consider having an odd number of seats and think about resolutions and how you want to make internal decisions.
- Share Creation: Instead of creating 100 shares, consider creating 1 million shares at a nominal price. This makes it easier for you down the road to attract investment, as you can avoid giving a fraction of a share to an investor, especially if their check size is relatively small compared to the pre-money valuation of the company.
- Shareholder Agreement: A shareholder agreement regulates the management of the corporation, procedural matters, covenants of the corporation, dealing with shares, and provisions for the resolution of any future disputes between shareholders. While I won’t go into depth about it here, you need one, and you should discuss questions with your partners, such as how much decision-making power you want shareholders to have versus the board of directors. This is particularly important as you raise rounds and typically give away board seats as well.
- Types of Investing in Your Own Business: You can put money into the company as a shareholder loan or buy shares of the company at the issuance at a set price. Generally, in my view, a shareholder loan is the preferred method from a tax perspective and for seniority reasons once you involve investors.
- Investment Vehicles: Once you are ready for funding, and once you have found investors, you can choose from share sales, notes, SAFEs, and KISSs. I prefer SAFEs (Simple Agreement for Future Equity) for early-stage startups. It’s simple and not legally burdensome. Read about it online and let me know if you have any questions. You’ll have to think about your Cap (Valuation Cap), your discount, and pro-rata rights.
- Termsheet: “A startup secures $X million at a valuation of $Y million.” This headline could potentially announce your company’s Series A funding in the future. However, beneath these prominent figures, lies a set of crucial provisions that will shape your startup’s trajectory and influence the payouts for you and your employees in the event of an exit. These provisions are meticulously outlined in a term sheet.
- Cap (Capitalization) Table: A Cap table, short for capitalization table, is a spreadsheet that breaks down who owns what in a startup. The Cap table is a critical due diligence item because it reveals how every stakeholder is affected by a fundraiser. Keep in mind that you’ll get diluted as you raise funding, so create a cap table that projects your rounds of fundraising and analyze how much ownership you’ll retain after each series. Remember, 1% of something is better than 100% of nothing, but you need to understand what you’re giving away and why.