Episode Summary
Executive Summary: In this episode of 'This Week in Startups,' host Jason Calacanis and Wilson Sonsini partner Becky DeGrasse discuss foundational legal basics for startups, focusing on entity choice (LLC vs. C-Corp), the importance of proper documentation, and IP assignment. They emphasize that getting these basics wrong leads to costly cleanup, and that VCs disfavor LLCs due to pass-through taxation. The conversation covers when to start as an LLC, when to convert to a C-Corp, and the risks of informal agreements among co-founders.
Main Topics: Entity Choice: LLC vs. C-Corp (Priority: 5/5): Explains the key differences between LLCs (pass-through taxation, limited liability) and C-Corps (double taxation, preferred by VCs). Discusses why VCs avoid LLCs due to fund structure complexities. Cost of Legal Cleanup (Priority: 5/5): Highlights that fixing legal mistakes costs 3-5 times more than doing it right initially, and often requires going back to stakeholders with 'egg on your face.' When to Convert from LLC to C-Corp (Priority: 4/5): Advises starting as an LLC for simple, bootstrapped ventures, but converting to a C-Corp before taking VC money or adding complexity (employees, multiple investors). Co-founder Agreements and IP Assignment (Priority: 4/5): Stresses the need for written agreements (even simple emails) to document ownership and IP contributions, preventing disputes when founders leave or companies succeed. Risks of Informal Projects (Priority: 3/5): Warns against working on projects without legal documentation, as ideas can be misappropriated and co-founders can later claim ownership without proper IP assignment. Wilson Sonsini's Role with Early-Stage Startups (Priority: 2/5): Becky encourages early-stage founders to engage with the firm despite its size, noting they work with companies from idea stage through IPO (e.g., Google).
Key Arguments: Getting legal basics wrong (entity structure, IP assignment) leads to costly, painful cleanup that costs 3-5 times more than doing it right initially. VCs disfavor LLCs because pass-through taxation creates untenable accounting and legal burdens for their fund structures with multiple LPs and portfolio companies. Startups should start as LLCs if bootstrapping and simple, but convert to C-Corps before taking VC money or adding complexity to avoid expensive conversions. Co-founders should document agreements in writing (even simple emails) to establish ownership and IP rights, preventing disputes when the company succeeds. Without signed IP assignment, anyone contributing ideas or code may have a claim to ownership, leading to costly settlements (e.g., Snapchat co-founder dispute).
Data Points: Cost multiplier for fixing legal mistakes: 3-5 times - Fixing messed-up legal documents costs 3-5 times more than doing it correctly from the start. Number of investors in average startup round: 10 - Average round has 10 investors, and with four rounds, cap tables can have 40-50 investors. Number of LPs in average fund: 100 - Average fund has about 100 LPs, complicating pass-through taxation for LLCs. Number of investments per fund: 50-75 - Funds typically have 50-75 investments, further complicating tax distributions for LLCs. Potential settlement value for early contributor: $100 million - A 2-3% settlement in a company like Snapchat could be worth $100 million for minimal contribution.
Pivotal Quotes: "When startups come to us, they will often say, 'Oh, these are really simple things. I'm just going to pull a form off the internet and I'm going to use that.' And without fail, they mess something up. And when they mess something up, it causes cost three, four, five times the amount to actually fix it." — Becky DeGrasse: Explaining the high cost of using generic legal forms instead of proper legal advice. "If you are an LLC and you have a VC that's interested, they're going to ask you to convert to a corporation." — Becky DeGrasse: Stating the non-negotiable requirement for VC investment. "The default rule is: nobody's bound by confidentiality. Nobody is bound by IP assignment. So if I'm in the room and I'm throwing out ideas and I'm helping you build this... I've got a claim unless I sign something." — Becky DeGrasse: Emphasizing the need for written IP assignment to avoid ownership disputes.
Implications: Founders must prioritize legal basics early to avoid costly cleanup. Choosing the right entity (LLC vs. C-Corp) and documenting co-founder agreements and IP are critical for attracting VC funding and preventing disputes. Engaging experienced legal counsel from the start is a strategic investment.
About This Week in Startups
Jason Calacanis covers startups, tech, markets, media, and all the hottest topics in business and technology. He also interviews the world’s greatest founders, operators, investors, and innovators.