Common First-Time Founder Mistakes with Becki DeGraw | Wilson Sonsini Startup Legal Basics

Episode Summary

Executive Summary: This edition of 'Startup Basics' on This Week in Startups, hosted by Jason Calacanis with guest Becky DeGras from Wilson Cincinnati, outlines critical legal, accounting, and HR mistakes that first-time founders often make. Topics include the missed 83B election, failure to properly issue stock, delaying incorporation until funding, and starting as an LLC. The episode emphasizes that a single oversight can create hundreds of hours of cleanup work or kill a deal. Founders are urged to act early, use legal counsel, and complete all steps—especially the 83B filing within 30 days.

Main Topics: Criticality of 83B Election (Priority: 5/5): Founders must file an 83B election within 30 days of purchasing restricted stock to avoid future taxation on appreciation. The host and guest stress it is the founder's responsibility to mail it, not the attorney's, and that the IRS offers no exceptions. Proper Stock Issuance and Corporate Governance (Priority: 5/5): Incorporating alone does not mean you own the company. Founders must appoint directors and officers, and have the board issue and approve stock, followed by the founder actually writing a check to purchase it. Risks of Delaying Incorporation Until Funding (Priority: 4/5): Waiting until a term sheet is secured forces the company to set common stock value based on the new valuation, resulting in a much higher tax bill for founders. This also creates IP assignment issues with contractors. Problems with Starting as an LLC (Priority: 3/5): LLCs, especially those with messy cap tables or tax deductions, are difficult and costly to convert to a corporation when seeking venture capital. Issues also arise around 'stock options' which don't exist in LLCs. Founder Re-up and Secondary Sales Trends (Priority: 3/5): The episode notes an increase in secondary sales at Series B (from ~5% to ~30% of deals) and the controversial practice of founder re-ups (granting extra shares to avoid dilution). The host argues this can weaken company culture and fiduciary duty. Definition and Importance of Officers vs. Employees (Priority: 2/5): Only board-appointed individuals are officers with signing authority. A title like CTO does not automatically confer officer status, though 'apparent authority' can bind the company in contracts with third parties.

Key Arguments: Mistakes in accounting, HR, and legal that could be fixed in 2 hours can create 200-2,000 hours of cleanup or break a deal later. The 83B election must be filed within 30 days of stock purchase; there are no exceptions and it's ultimately the founder's responsibility. Founders often believe incorporation equals ownership, but they must also appoint directors, officers, issue stock, and pay for it. Delaying incorporation until after a term sheet inflates common stock value and creates tax liabilities for founders. LLCs are cumbersome to convert to C-corps and often lead to hidden tax issues, especially if equity has been promised in the form of 'stock options'. Founder re-ups and secondary sales are increasingly used to win deals but can undermine culture and fiduciary duties if not handled transparently. Apparent authority means a third party can hold a company liable for contracts signed by someone who appears to have authority, even if they lack formal officer status.

Data Points: Time for 83B filing deadline: 30 days - From the date of stock purchase. No exceptions allowed by the IRS. Standard vesting schedule mentioned: 4 years with monthly vesting - Used as example for restricted stock subject to 83B election. Percentage of Series B with secondary sales 10 years ago vs. today: 5% or 1 in 20 → 30% or 3 in 10 - Reflects increased prevalence of founders taking cash off the table in later rounds. Cost of incorporation via attorney vs. DIY service: $2,000 to $3,000 - Versus ~$500 for bare-bones online incorporation; the host advises paying for professional help. Founder re-up example: dilution scenario: From 60% to 48% after 20% dilution event - Host rejected a proposal to keep founder at 60% because it was unfair to other shareholders and employees. Host's own re-up standard: time and vesting: 5 years, monthly vesting, no cliff - Jason created this structure to motivate fully vested, single-digit founders while making it palatable to other investors.

Pivotal Quotes: "This 30 days is a serious 30 days, no exceptions to it." — Becky DeGras: Explaining the absolute deadline for filing an 83B election and the IRS's inflexibility. "If you go to them in the context of, hey, we really need this to get done because we're trying to get funding, you just let the cat on the bank to where the leverage is." — Jason Calacanis: Discussing the risk of revealing urgency to contractors when cleaning up IP assignment issues after delayed incorporation. "You may have all the documents setting in front of you, but you didn't actually take the execution level. You didn't do that. Or maybe you did sign the documents, but you didn't write the check. That means you still didn't buy the stock. Or you signed the documents, wrote the check, but you didn't file the 83B election." — Becky DeGras: Highlighting common failure points even after using online incorporation services.

Implications: This episode serves as a practical checklist for first-time founders to avoid costly missteps in legal and corporate setup. The strong emphasis on early, proper incorporation and the 83B filing suggests that neglecting these basics can severely damage a startup's fundability and founder wealth. The broader trend toward founder-favorable terms in fundraising may also challenge long-standing norms of equity governance.