I must say right away that in this article you will not find practical tips on building and managing startups for the purpose of subsequent sale, as it was with Adobe for $ 20 billion. And there certainly won't be anything useful here to take care of your pet unicorn. Any entrepreneur who is at the stage of attracting his first investments knows better than me how to go from 0 to the first billion. In this article (or series of articles) I will try to reveal the legal, and sometimes not quite legal nuances for growing your own "unicorn". I will share my knowledge on building a startup based on the experience gained from lectures by Michael Esquel and Gordon Davidson, working with a law firm serving startups from Central and Eastern Europe, as well as my own experience with the project Datatruck.io and as a co-founder of the Silkroad Innovation Hub.

My area of study at Stanford Law School was corporate governance (the relationship between owners and managers of a company), and I was very interested in the ancient problem of the principal-agent. Having many years of experience working with private and state-owned companies in Uzbekistan, I have often noticed inefficiency, inability to make quick decisions, and sometimes even deliberate harm on the part of company managers, which is especially evident in state-owned enterprises. Managers appointed by the state vertical are often not interested in the profitability of companies. At Stanford Law School, I became interested in startups and venture capital investments, especially from the point of view of the principal-agent conflict. In this article, I will talk about one of the tools widely used in startups to minimize this conflict.

Let's analyze the path of the "unicorn" using the example of a well–known food delivery company - Doordash. There is a famous Startup Garage course at Stanford Business School, which, unfortunately, I learned about too late and could not enroll. As part of this course, students join teams of 3-4 people and present their startups by the end of the course. Doordash founders Tony Zu, Ivan Moore, Stanley Tang and Andy Fung started working on the idea of PaloAltoDeliveries.

In the first week of the course, Tony Zu and his team interviewed more than 60 restaurant owners. One of the interviews with the owner of the macaroons store stood out: the owner complained about the volume of phone orders, which she could not cope with. It was a moment of inspiration for Zu and his team. They created a landing page for the site PaloAltoDeliveries.com , posted the menus of several local restaurants in PDF format and provided a phone number. The first order arrived within half an hour.

Most startups do not think about distributing shares or registering a legal entity before attracting the first financing. So it was with Doordash. In March 2013, PaloAltoDeliveries startup received its first seed stage funding in the amount of 120 thousand dollars from YCombinator, and a legal entity – DoorDash, Inc. – was registered on May 21, 2013 in Delaware.

Seed (sowing) An investment is an investment in a company that is at a recent stage of its development. Usually, she already has an established team of performers around the initiator of the idea, work has begun on creating a product or service, and issues with legal status are being resolved.

Delaware as a company registration address is an obvious choice for almost all startups. The reason lies not only in the favorable tax regime, as is commonly thought, but also in a convenient and understandable judicial system specializing in corporate disputes. For 67% of Fortune 500 companies, a favorable tax regime and a convenient judicial system are the main factors in choosing Delaware. For startups, this is often a requirement of venture investors. I will describe the additional benefits of the laws of the state of Delaware in the following articles.

The first problem that every startup faces is the distribution of shares between the founders. It is good when the founder is alone and gradually distributes shares to new participants from his 100%. When there are more founders, it is necessary to ask uncomfortable questions and solve the distribution at the very beginning. It is necessary to take into account such factors as: whose idea, who will perform important functions, who will devote all their time to the startup. The most common and easiest way is to divide everything equally, but these questions will still arise when attracting investors. Venture investors will want to hear that the issues of share allocation have been carefully considered and all the founders are happy with their shares. After all, a startup is not only an idea, but also its execution. A satisfied founder is more likely to grow a unicorn.

Naturally, the founders may be wary of distributing shares if someone invests one hundred percent, and someone is looking for a main job and does not show the same commitment. This was the case with the founders of Doordash. A startup started by four founders was left without one co-founder by its second anniversary. For undisclosed reasons, about 17 months after the company was founded, Ivan Moore left the company. It would be unfair if the other three co-founders worked until the company's IPO, while Ivan Moore remained the owner of a quarter of the stake in Doordash.

To avoid such situations, the practice of vesting is generally accepted in startups. On paper, a co-owner may own, say, 25% of a startup, but his rights to shares take effect within a predetermined time. The most common westing practice in Silicon Valley is 4 years with a 1–year cliff. This means that every month the co-owner is credited 1/48 of his share package, but shares begin to accrue only after the first year. If the co-owner leaves the company before the end of the first year, he will receive nothing. This tool ensures that all co-owners will be motivated to work for at least the first 4 years.

Vesting means that you will not receive shares in the company until you have worked in it for a period specified by the contract. The standard vesting period is four years, every month you "earn" a share of the shares from the "put".

A cliff is the minimum period that an employee must work in the company in order to receive any share. The standard cliff period is one year. If the partner is to receive a 10% share, the annual share will be 2.5%.

Startups often start without taking into account details such as westing or cliff. Many founders either don't think that someone might leave the project prematurely, or they don't know about such tools. This is especially common for startups from countries that are not startup hubs or where such tools do not exist. This does not make such startups unacceptable for the American or other VC markets. Venture investors often require the founders to sign a number of documents, including the stock restriction agreement, with the terms of the vesting. The founders can agree with the investor on a shorter vesting period, taking into account the time already spent working on the startup.

Stock restriction agreement is the signing of a document limiting the ability to dispose of shares, sales, etc. with 100% ownership of them. For example, you cannot sell your shares before the expiration of 4 years.

Besides the founders, the success of startups depends on the employees. The problems that the founders want to solve may go beyond their abilities or lack the hands to complete tasks in a timely manner. Qualified specialists are often expensive and may not agree to work in a startup because of the high risks. Incentive stock options exist for such cases. At some point in the startup's life, the founders think about allocating shares to attract or retain important employees. Stock options for a startup align the motivations of employees and founders: the better an employee performs his functions, the better for the company and the founders. Options provide significant financial motivation for employees.

Let's take the example of Michael Block, one of the first 50 employees of Doordash. Imagine that Michael received an option to buy 100,000 shares at a price of $0.10 per share. If Michael completed the documents on time and used the option after 4 years, he will spend 10 thousand dollars to buy shares. If he sells shares after the IPO at $190 per share, he will earn $18.9 million before taxes.

An option agreement is an agreement where party No. 1 – the consumer makes an advance payment of the option and secures the opportunity, the right to purchase, rent, installments, a more favorable price, and so on. Party No. 2 – the executor must exercise this right at the request of party No. 1.

Employee options are also subject to vesting. The most common practice is 4 years of westing with a 12-month cliff. This guarantees that the employee will work hard for 4 years. After this period, the company may issue additional options. To do this, companies (not only startups) adopt employee stock option plan programs, which specify the conditions for issuing and distributing options to employees, advisers and founders.

The vesting tool described above ensures well-coordinated work within the startup team to achieve its goals and reduces the conflict between the principal and the agent. However, vesting is just one of many tools that can help startups on their way to success.

To minimize the conflict of the principal-agent in startups, in addition to vesting shares, there are other important tools. One of them is a pre—foreclosure agreement (Right of First Refusal, ROFR). This tool allows the company and its existing shareholders to maintain control over the sale of shares to third parties. In the presence of ROFR, if one of the shareholders decides to sell their shares, the company or other shareholders have the right to be the first to buy back these shares at the offered price before they are sold to the side. This protects the company from the unexpected appearance of new shareholders who may turn out to be unfriendly or not interested in the long-term success of the company.

Another important tool is the agreement on the joint sale of shares (Co-Sale Agreement). This document allows the company's shareholders to sell their shares only if the buyer agrees to also buy a certain number of shares from other shareholders on the same terms. This ensures that shareholders will have equal opportunities to sell their shares and avoid a situation where one of the shareholders sells his shares on favorable terms, leaving other shareholders in a less favorable position.

One of the most widely used tools in startups is a convertible loan agreement (Convertible Note) and a simple agreement for Future Equity (Simple Agreement for Future Equity, SAFE). These contracts allow startups to attract investments without having to immediately assess the value of the company. Investors provide a loan to a startup, which is then converted into shares of the company at a later stage, usually at the next round of financing. This reduces risks for investors and allows startups to attract the necessary financing faster.

Among other tools widely used in startups, it is worth noting the Investor Rights Agreement. This document regulates the rights of investors to information about the company's activities, participation in management and decision-making. For example, investors may have the right to appoint their representative to the company's board of directors or the right to veto certain decisions concerning the company's activities. This allows investors to control their investments and participate in the management of the company.

In addition, the Voting Agreement helps to establish the procedure for shareholders to vote on key issues. This agreement may contain rules according to which shareholders are required to vote for or against certain decisions agreed in advance. This helps to avoid conflicts between shareholders and ensures consistency of actions when making important decisions.

In conclusion, it should be noted that the success of a startup depends not only on the availability of ideas and financing, but also on the correct legal registration of all aspects of its activities. The use of instruments such as share vesting, a pre-purchase agreement, an agreement on the joint sale of shares, convertible loans, agreements on investor rights and voting agreements helps to minimize risks and conflicts, as well as ensures the coordinated work of the team and stakeholders.

I hope that the legal and organizational aspects outlined in this article and subsequent materials will help startup founders better understand the process of creating and managing a successful company. In the following articles, I will continue to cover other important topics related to the legal aspects of startups, such as intellectual property, confidentiality and data protection agreements, as well as the legal nuances of working with venture funds and investors.

This material was prepared within the framework of the Project "Stimulating productive Innovations" with the support of the International Bank for Reconstruction and Development and the Ministry of Digital Development, Innovation and Aerospace Industry of the Republic of Kazakhstan.