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About Madhu Singh

Madhu is an attorney, MBA, founder and Chief Legal Officer at Foundry Law Group, where she works side by side with CEOs, startups and businesses crafting legal solutions that fit the needs, vision, and values of their emerging companies.

Her practice focuses on the intersections of technology, startups, and business law where she helps companies navigate these fast developing areas. Madhu helps companies in the areas of incorporation, customer engagement and acquisition. In addition to her work at Foundry, Madhu served as Adjunct Faculty Lead at the Community Development and Entrepreneurship Clinic at Seattle University School of Business for nine years and is the immediate Past President and a current board member at TiE Seattle, and past president of Women’s Business Exchange.

She holds a JD & MBA from the University of Kansas.

Episode Highlights

Why it’s important to build a strong legal foundation day one
Why entity structure matters, and what to do if you didn’t form a Delaware C Corp
The one corporate structure that’s almost impossible to remediate
How corporate structure can impact hiring your team and fundraising
How to ensure your corporate documents are up to date
Why vesting can make or break your startup
How to grant equity to your team the smart way
How options and stock differ, and how to use the right kind in your compensation structure
Why dead equity can come back to haunt you, and how to fix it
How to prepare for due diligence
Simple tips to stay on top of your entity and legal obligations

Links and resources

Incorporation solutions:Great supplements to but not substitutes for competent legal counsel

Cap table management:

Interview Transcript

Note: The contents of this conversation are meant for informational purposes only and are not intended as legal advice. Please consult a licensed legal professional to obtain tailored advice specific to your situation.

Shubha K. Chakravarthy: Hello, Madhu. We’re so happy to have you on Invisible Ink today. Thank you for being here.

Madhu Singh: Thank you for having me.

Shubha K. Chakravarthy: We have a bunch of really exciting questions. I know we’re going to talk about this broad theme of how you build a startup with exit in mind. But before we get into that, I’m just curious if you had a highlight reel of common patterns you’ve seen among founders that eventually plan to exit good, bad and different.

Madhu Singh: That’s a great question. In a startup, the experience is very exciting at the beginning. There’s a lot of excitement about the product, launching, team etc. I understand that the legal part is not as exciting and sometimes boring and seems irrelevant at the moment because it’s not tied to the actual product in the market.

I think there’s something to say about that where there’s this mixed emotions of: do we need to get everything organized or can we just hold off until the time is right. I think balancing where it makes the most sense is really why it’s helpful to just even if you decide not to do things right away or do things kind of haphazardly to begin with, to have some counsel along the way or at least a trusted advisor who can give you some tips on this.

The unfortunate thing is that if you don’t do things properly, at exit, some of the things you wish you had done are going to come back could show up and come back and bite you. In the end when it comes to taxes, diligence, you’ll find yourself responding to queries and finding yourself running all over the place trying to figure this out and fix things.

Because it’s not often like the big ticket items that hold up an exit. It’s usually the small little things that companies find when they’re trying to acquire you and then it becomes like you’re getting this big paycheck. Did you strategically plan for it from a tax perspective, and from the team perspective, et cetera.

I feel like the common theme is a lot of excitement around the startup and things like that and not very much attention paid to the actual structure processes that need to be in place from day one. Ideally, but if not from day one, shortly thereafter so that you are set up for success in the future.

Why Preparation Matters

Shubha K. Chakravarthy: Is there any egregious story either good or bad that kind of comes to mind in terms of this preparedness for exit?

Madhu Singh: Well, I can give you two examples just from the last month alone.

One founder spent so much time figuring out his cap table, what it would look like, what it looked like in a series a post Series B in so many layers. He just kept wanting pro forma after pro forma and never, and no matter how many times we reminded him, never got around to signing his stock award agreement.

I told him it cannot be backdated as easily as he thinks. He lost a year in that process. The year is important because when it comes to capital gains treatment, you need to be holding on to those shares for four or five years. He lost a year in the process and now he’s annoyed because that happened. It’s not because he wasn’t trying to do that. He just got caught up in other things.

Another one, he’s been wanting to reward his team for many years. Again, I probably checked in every three months with him, “Can we sign these agreements? Can we move forward?” He kept going back and forth on it.

They were talking, “Oh, I’ll get to it. I promise them this or that and the other.” Now we’re at a stage where the company is worth millions of dollars. You can’t just hand them over the shares without creating a big tax burden on them.

Now he’s trying to find a solution using a phantom plan and this plan and that plan. All of that is going to mean any one of those individuals that he thought of as co founders is going to take a big hit tax wise at some point.

I understand the founder wears many hats but these people are relying on you to be organized. And even people who have legal counsel, this can still happen to them as well.

It’s just when I say egregious it frustrates me. I can’t sign this for you. You have to put in some effort. In my job I’m not your admin where I can just run around after you with a piece of paper. You have to proactively take responsibility for your company.

Shubha K. Chakravarthy: I’m just curious. I feet slightly guilty because I hate paperwork as much as the next person. It hit maybe a little too close to home but I’m just curious, having seen human nature for so long, do you have any theory on why that is? Is it resistance to what feels like paperwork. Any thoughts on that?

Madhu Singh: It could be this. I don’t know. I think it’s just fear. Maybe that it’s final or that it’s just because the paperwork looks so dense, unfortunately, this fear of needing to review it and signing it although we go through it and they trust the terms and things like that.

I think some people who are really analytical, just even despite all that, have this strong desire to understand every little thing. Then that slows them down and they’ll allocate two or three hours to review something. You don’t need to do that because half of this is just boilerplate that has to be there. I think it’s just like a cycle.

Then it’s always like, I’ll get to it. Once your team is all happy. They trust you. They just believe it’s going to happen. You kind of just keep going and forget to go back and deal with it.

I get it. I get why it happened. I try to warn people with some of these stories. I’m more of a best practices type person.

I’m not trying to stress people out with this or make people nervous but sometimes this is just what happens and you have to prioritize certain things for your company.

Especially, most startups are not building lifestyle businesses. They’re building to exit and if you want to be in a good place when that happens, you have to do some of these things.

Shubha K. Chakravarthy: Which brings me to a question. When we’re first starting out, we have all kinds of visions in our heads and I’m not necessarily sure that exit is top of mind. How often are you seeing founders considering exit? If so, how does it play out in the way they build their startup or how they’re thinking about going about things?

Madhu Singh: I think there’s this underlying assumption that if they’re going to raise money then there’s going to be an exit at some point. That’s what’s in their pitch deck. That’s what they’re trying to explain why people should invest in them because it’ll grow, they’ll scale and they’ll be able to do something with it.

While actually finding an acquiring party may not be in the immediate trajectory, it does tie into raising money. These things matter even for just raising money.

Even the amount of diligence that goes into certain types of investments that you take on is very similar to the diligence that will take place in an acquisition.

That same mindset has to apply there. Even if exit is not on your immediate horizon and oftentimes startups’ more immediate desire is to raise money and then hopefully have an exit later on. I would almost say that’s a little bit interchangeable because there’s a lot of investors who want to see everything buttoned up before they’ll write you that check.

Shubha K. Chakravarthy: It sounds like the fact that you’re going to get these funds, especially from serious or professional investors is almost like an unconscious unintentional preparation for being ready for an exit even if you’re not thinking about it as viscerally as you might be otherwise.

Madhu Singh: It’s not that in four years we’re going to sell or anything. It’s more like these investors are expecting a return at some point.

Choosing the Right Entity for Your Startup

Shubha K. Chakravarthy: . I know we have a few things to cover but first things first, right? You’ve got to start with an entity. Let’s talk about legal structure. We’ve seen so much, out there, Delaware C Corp, LLC, all of those things.

What are the common entity options for startups and what should I be thinking about if I’m a founder to choose the right one if I have an exit in mind? Or even if I don’t, to be honest.

Madhu Singh: I think it matters what your goals are for the company. If you’re trying to build a business and you plan on bootstrapping it, maybe you bring on a few contractors, maybe bring on a possible co-founder and that’s your kind of dream to build it that way. That’s totally fine.

But the advice for that type of business is very different from advice for a company that’s like, “No, I’m going to go. I’m building this. I’m going to have two co-founders. We’re going to raise money in the first 12 to 18 months. We’re planning on bringing on employees with that money. We need to be able to issue stock options.”

I often feel that the triggering difference is your financing plans.

If you do have financing plans in the first 12 to 18 months, a Delaware C Corp is highly recommended. There’s a lot of perception value that comes with the Delaware C Corp. It’s the birthplace of corporate law. People find that it’s more shareholder/ investor friendly because of that.

And there’s just a lot of common knowledge about it. So people just expect to see that. Oftentimes, if that’s what people are telling me if that’s their plan from the get go, we say Delaware C Corp. If their plan is more like a bootstrapping model, keeping the team a little bit small, maybe hiring out a little bit, we can discuss other options like LLCs or even different states as a C corp.

Like Washington, where our firm is based out of. It is just as entrepreneurial friendly, like a Washington C Corp might suffice or a Washington LLC or a Delaware LLC. So oftentimes the conversation is tied around what their initial 12 to 18 months trajectory looks like. Then we make a decision.

The thing that you have to keep in mind with all of this is that none of these things are final. So some people come and maybe, you probably have heard of this. They start as an LLC because it’s easy. You set it up. There doesn’t seem to be a lot of corporate formalities – simple, straightforward, no problem.

It’s totally fine. It’s great for that purpose. There’s nothing wrong with it. Then if you get to a place where you’re like, things are changing. We’re pivoting. We’re going to do this, that and the other. Then we’ll have a discussion about what’s the best way to evolve your LLC.

Maybe it’s to keep the LLC and start a new company. But maybe it’s to convert the LLC into a Delaware C Corp. So you have options. I’m sharing this because wherever you are, whatever you decide it’s fine. To make sure you’re in a good place for what you want to be in the future, it is worth having that conversation with counsel to help you make sure that you’re planning for that.

Some people are not ready to make the investment in the switchover unless there’s an investor standing at their door with a check and I get that. It’s totally fine. The good thing is with Delaware, you can turn things around within a few days. You can make all that happen within a week.

Knowing that there’s like this timeline, you can be strategic about how you make your decisions. I think it’s important for people. Ideally, they get advice from the front end and make the decision with counsel. But if not, there’s lots of good resources and podcasts and stuff online that you can learn about. Then you could do some of your own research.

That’s why I find that sometimes people pick different things. But really, If the goal is it be like a Series A investment or onwards, you really should be a Delaware C Corp.

Anything short of that, whatever you picked is going to be fine. It’s just more a matter of did you pick something that allows you the structure to reward the people on your team that you want to reward.

Shubha K. Chakravarthy: I just want to push on a couple of things which are many of us or many of our founders have kind of maybe started this process already. Maybe I formed an LLC because I had an idea and I just wanted to do it.

Are there any boundary conditions or irreversible decisions that you would caution a founder about that might preclude them from doing something different than they initially anticipated?

Madhu Singh: I think the one biggest thing that I caution founders on regardless of all that- I don’t know if it’s completely irreconcilable but very close to being difficult to resolve, is making an S Corp election. An S Corp election is a very specific tax designation. Depending on who the CPA is and other things, they’ll push you towards that for a variety of reasons because you can save on taxes, et cetera.

However, making that election disqualifies you from a potential better treatment in the future called QSBS (Qualified Small Business Stock). If you are able to qualify for that status when you do have an exit and a good chunk like a large amount, five or ten million plus is exempt from taxes.

The trade off is really important to assess early on. If you were an LLC, then you took an S Corp election then you converted to a Delaware C Corp, it’s not clear whether you’ve tainted your company and lost that exemption or not because S was in the middle of it. But if you were a Delaware C Corp and you took an S election because you saw the tax benefits and then tried to withdraw it, you might have lost that opportunity for that status.

People really have to make some critical decisions early on. Unfortunately, when it comes to this tax piece to see if it’s worth trying to qualify – more lately, I would say in the last two years, all the investor documents I’ve seen have a rep and warranty in there that says that you have done your diligence and that the company will qualify for that exemption in the future.

It’s become a bigger deal than it was when it first came out because it’s very friendly to companies from an exit standpoint.

I, as legal counsel, recommend people go get tax advice on this or tax counsel because it’s so specific and can really impact your business but don’t lose sight of that when you’re making these decisions.

Shubha K. Chakravarthy: Let’s say I already spoke to my CPA and he or she already said, go be an S corp. Do I have options to unwind it? Maybe start a new corporation? Are there things like IP assignments that I need to be thinking about just high level? Would you give some pointers?

Madhu Singh: In that scenario, that’s what happens. We started a new company. That’s what we always have to do. We end up starting a new company, assign the assets over and try to make it as distinctive as possible.

But beyond just this S Corp status, the QSBS is only designed for product companies and they cannot have a lot of services mixed into it. They can have a small percentage of services. There’s a lot of layers to it. I don’t want to spend too much time on the tax piece but it’s important to go get the assessment.

As an example, my law firm is a service-based business, we would never qualify for that status but if I made some of these legal tech products that exist, they could potentially qualify. It’s a product that they’ve created that qualifies as a product under the IRS code and they could potentially get that special status.

Shubha K. Chakravarthy: I do understand and appreciate that this is not a tax conversation or a law conversation but just one thing on that. These days as I work with more and more founders. I’m seeing a lot of hybrid businesses where there’s a hardware component and a software component.

I’m also seeing a lot of things which in theory could be services but that are sold as products, right? Let’s call them productized services. I give you a box and say you get the following things. Is there any clear guideline on that, that a founder should be thinking about as to what a product does it have to be?

Madhu Singh: Something that they would want to talk with a tax advisor to just see how the IRS code interprets those types of things. Because if it’s like a subscription, maintenance or that type of stuff, sometimes that qualifies. As long as it’s under a certain percentage threshold of the business.

So there’s various thresholds that come into play and things that are important in that discussion but purely services like a law firm providing services is different. That’s very obviously not excluded but to your examples, all of those could potentially be favorable in that circumstance.

Shubha K. Chakravarthy: Got it. So if I’ve come back and I’ve already created an LLC or if I have to decide between an LLC or a C Corp because I’m not sure if I’m ever going to get funding, what are the pros and cons outside of the investor treatment?

Are there big cost differentials I should be thinking about in terms of a C Corp versus LLC and also any administrative burdens like having to file things or conduct meetings and things of that nature?

Madhu Singh: The LLC is the simplest structure. It doesn’t involve many formalities and most states have robust LLC acts. If you set it up and don’t do much else, you’ll be in pretty good shape. However, if you have a partner in an LLC, it’s crucial to have an operating agreement to outline the fundamentals of your relationship, management, buyouts, and so on.

In contrast, a single-member C Corp seems like it should be just as easy but it’s different because as a C Corp a single founder wears multiple hats. You have the role of a board member, a shareholder, and potentially an officer. Even if you’re the only person wearing all three hats, the C Corp is expected to maintain certain formalities such as holding annual meetings.

Most state laws require these meetings. Often during due diligence, we find that annual meetings never took place because people think it’s silly to meet with themselves.

This situation tends to be more practical when a group of people is involved. The C Corp has a higher administrative burden and it’s important to be mindful of which hat you’re wearing in each situation. While the legal and filing fees for both structures are usually comparable, an LLC is generally more economically efficient and provides the same liability protection.

I think it’s a great construct and understand why it may not always work for everyone but it’s beneficial for many including consultants, some IP businesses, wellness companies and law firms. However, for a more tech-forward startup it’s not always the best fit.

Shubha K. Chakravarthy: I want to clarify one last point on LLCs. You mentioned that from Series A onwards, you really need to consider having a Delaware C Corp.

Are you seeing deals where founders are getting funded on SAFEs or convertible notes pre-Series A with an LLC structure and still being okay with it, especially with professional or semi-professional investors?

Madhu Singh: Yes, it depends. This does happen more often than you might expect. But there is typically a clause in the term sheet stating that prior to the priced round, the conversion will take place. In the interim, they are fine with it being an LLC but there is an expectation that some documentation or written part of the agreement indicates that a conversion will occur in the future.

There aren’t many LLCs that exist beyond this stage. Interestingly, private equity tends to operate as LLCs and private equity investor groups often are structured as LLCs. It is entirely feasible to receive funding with an LLC using convertible notes, SAFEs, or whatever structure is used. However, the caveat is that there is an expectation of conversion down the road, should it need to be.

Shubha K. Chakravarthy: I want to round out one thing on the corporate structure which is you’ve already talked about why you’ve got to be really careful about an S Corp. I got that. So, assuming we’ll leave that out for discussion for now, I assume you just have to start over if you’re an S Corp already.

But if you’re an LLC and you’re trying to make that decision now that you’re no longer going to be just a bootstrap but you’re thinking of getting money, what is the right time that you recommend conversion?

Is it as you said, just wait until you’re sure of the money and then go through the hassle? Or are there other factors I should be thinking about?

Madhu Singh: That’s a great question. I actually just had this conversation today. It depends on a few things. The common thing that it depends on is whether or not they’re really going to raise investment and so whether they’re very close in their conversations or not. Then we pull the trigger on doing that.

The other thing is the incentive for employees. Some people want something in writing for their team that says they’re going to get it. In practice, you can set up the equivalent of an option pool in an LLC. It just functions a little bit differently and so people just need to decide if they want to make the investment in creating it, making their LLC work for that purpose or if the money is better invested in going ahead and converting.

As the plan is to do these things in the future and oftentimes because of how it can be rather complicated on the LLC and knowing that they’re likely to convert in the future, they make the decision to just convert. It becomes a balance of the timeline, the fees and legal fees involved and then the potential for investment to make those decisions happen.

Shubha K. Chakravarthy: Although it sounds like you’ve kind of made the decision by default, right? Because if you’re talking about equity being a significant part of compensation for any early employees, the expectation is that you’re not going to be a bootstrap company, right? That’s kind of a decision that’s been made by default the moment you start talking that I’ll give you equity because otherwise there’s no liquidity for these guys.

Madhu Singh: In theory there isn’t but I guess there could be because you could bootstrap it to success and sell the company. Then they would get cashed out that way. It’s not necessary. The thing is if you’re prompt because some people are fine in their offer letters.

It’ll say that when we make the conversion, we will issue these options. They kind of outline what’s going to happen but it’s going to happen at some point. Some people drag that out for however long and I don’t think it’s a good idea to drag it out because it becomes empty promises.

You create this disconnect between your team and you. You’re trying to make up the salary by giving them incentives but you’re not actually giving it to them because you’re not investing in making it happen.

I feel like you should just set it up when you’re at that stage of bringing on more people that you want to reward with equity. That’s one option or at the time of investment and they might be the same time.

They might be different times but those are two big trigger points where I think a conversation must be had as to whether or not it’s going to happen that way. When people try to get incremental like LLC units and things like that. Converting that becomes an expensive administrative and legal endeavor where you could have just set it up this way.

The last thing I’m going to say about this is that the LLC can still be useful. The LLC we’ve seen can just hold the IP. The LLC can be kept for services. It can be wound down; it could be used for something else. It’s not completely wasted or you convert it. There are many options you have.

That’s why I said realistically, none of what you’ve decided is going to necessarily be wrong. It’s more like, are you set up for what you want, where you see your company going? Then it might be worth being mindful of some trigger points during that journey where you should reconsider whether the structure you have is satisfying your goals for the company.

Other Formalities at Inception

Shubha K. Chakravarthy: Outside of the legal entity, are there other formalities relating to formation that founders should be cautious about or aware of that we haven’t talked about?

Madhu Singh: Yeah. You have to file articles of incorporation in the state that you want to incorporate in. Then, in an LLC structure, an operating agreement functions as the main agreement that outlines management, record-keeping, accounting, buyouts, etc. Everything’s in one agreement.

In a corporation structure, there’s a set of bylaws that provide governance on the roles the board members play, the roles the shareholders play, what constitutes a quorum, board meeting requirements, etc.

In addition to that, there’s going to be a separate agreement that describes the stock that you’re receiving. It can take the shape of a stock issuance, a restricted stock agreement and a subscription agreement.

They kind of have various terms but at the end of the day, it’s a document that documents the stock that’s being issued to you as a party to this company as a shareholder to this company and any restrictions that come with it.

The common restriction as most of your audience is probably aware of and yourself is vesting and some form of vesting. Vesting simply means you’re not realizing the full value of the shares you received until some period of time or some conclusion of what is associated with those vesting terms.

Those shares are yours; they’re on reserve for you but you don’t get the full value of them until some future point in time. Time-based vesting is the most common. You earn against it year over year, month over month or whatever you’ve decided.

There’s occasionally milestone vesting. People like to do that to push for a launch like your first customer or that type of thing. There are a lot of ways that vesting plays into it but vesting is incredibly important for a variety of reasons.

I would say the number one reason vesting is important when you have more than one person in a company is to show the commitment to the company and to each other. While two founders can be best friends for life, it doesn’t mean they’re the best business partners. You have a mechanism in a vesting schedule called the cliff period that allows people to make sure they’re a good fit for the company for a period of usually a year before the first trigger on the vesting schedule starts.

Let’s say, Shubha, you were going to get a million shares on a traditional four-year, one-year cliff vesting schedule. That would mean 25 percent would vest after the first-year anniversary. On day one, you have zero but on day 365 you’re going to have 250,000 vested. Then incrementally after that over the next three years. If for some reason it doesn’t work out in that year, you’re not walking away with any part of the company because if you leave, it doesn’t work out.

We go our separate ways. You cancel the shares because they haven’t vested. Then, you can kind of hold on to the company. It gives everybody time and it’s good for both people to do that for each other even if you’re the person who had the original idea. It’s a way to show commitment from everybody’s perspective.

The other important thing is even if you’re a sole founder, the expectation is you still have a vesting schedule because investors want to see that commitment. Investors want to know that you are also equally as committed, that even though you’re the founder, you’re the ideal person, you put in the first money, etc.

If I’m going to give you my money, I want to make sure you’re committed to the company and you’re only getting your full value of the shares at some future point in time when the vesting has completed. It’s a way to measure each other.

That’s probably the biggest thing I have seen in my years of practice besides the other stuff we talked about where people get frustrated. There’s a falling out among founders, teammates and then some arbitrary person that’s no longer associated with the company somehow holds on to one, two, five, seven percent of the company. They can’t figure out how to get them off the cap table. They’re stuck because they didn’t use a vesting schedule to protect themselves.

Shubha K. Chakravarthy: To kind of round out our last discussion, it sounds like the main kinds of documents you talked about were the formation documents which are the articles of incorporation. And then kind of like a “here’s how we do business,” which is the bylaws and so forth. The third piece is about how we’ll do the day-to-day roughly speaking which is the operating agreement. Then you came into this really important topic around vesting and equity.

Equity Compensation and Vesting

Shubha K. Chakravarthy: Let’s just build on that and talk about how to use equity to grow your team because you touched on a super important topic. And then I want to go back later to due diligence. Obviously, equity is a big part of attracting high-quality employees early on and you cannot pay them a lot of cash. What from a high-level perspective, if you’re the founder or I’m a co-founder, should you be thinking about the top factors in setting up a good equity compensation plan? In addition to vesting, we already talked about vesting.

Madhu Singh: Vesting is really important. To your point about summarizing, you need governing documents for any entity. The operating agreement and bylaws, the operating agreement for an LLC, bylaws and articles for a corporation are must-haves.

Then you need some way to indicate that someone is a shareholder. The common way to do this is restricted stock agreement which we just discussed where you have these parameters around it. But outside of those parameters, the only other thing that’s in there is that here are your shares. They’re in your name and here’s the stock ledger that shows your name.

These days no one uses certificates. Most of the time there’s not this fancy certificate. If you’re using a cap table management tool, you might get an electronic certificate and that’s that.

But then that’s kind of at the founding level. When it comes to the team and hiring employees and rounding out your team, it becomes a big discussion as to what percentage of the company you want to give to them, whether or not you want to give them stock options or restricted stock and what does that ultimately look like for an incentive plan.

I think that the way to think about it is how key they are to your company. Certain types of employees like key personnel, maybe it’s like a CTO or number two to a CTO, a chief marketing person or VP sales, high-level people will probably negotiate for a little bit more if they are critical to the success of the company.

Not to say not everyone is critical but there is a difference between who would probably be key versus not key in this scenario. The folks that are maybe not key reserving some equity for them as well because people want to feel incentivized for the growth of the company.

Most people like everyday employees would probably get anywhere from a tenth of a percent to a quarter of a percent to at most a half. You do the math to figure that out.

Then for people that are more than that, they’re looking anywhere from one to two, maybe three percent depending on how great they are. In some cases, maybe more than that because they’re critical to the infrastructure.

For example, I’ve worked with a founding team. They didn’t have a technical person and so they needed a technical person. They’re not going to get investment or do anything without them. That person’s able to ask for quite a bit more; he’s going to ask for seven to probably twelve percent as well.

I told them to be prepared because their function is important to the success of the company versus just a salesperson. Because the other two people are not technical and they have to cover that role.

It becomes part of what you can offer to offset the fact that you don’t have as much cash to give them and what the open market would give them. It’s an important tool. It’s not the only tool but it is important for people to feel like they’re part of it. I think where people get hung up is what the percent actually represents.

As much as we all love math, this is probably the most math you’re going to have to do as people get confused as to the percent of the company they own versus the percent of the option pool they own. One percent of the option pool does not mean one percent of the company. It might be similar but it’s not technically the same thing.

Dilution is really important because as people are coming in and out of the company, people are going to get diluted. Being mindful of what you’re receiving from the employee side is really important. And how the employer pitches it to them is also important because they’re going to ask questions and so they need to be prepared for that.

Benchmarks for Granting Equity

Shubha K. Chakravarthy: You brought up a lot of really rich themes and I want to dive into a few of them in particular. The first thing is, you talked about what are good benchmarks in terms of how much you can expect to get and those percentages you gave, like the half percent, are they off the option pool?

Madhu Singh: Yeah, those are from the option pool.

Shubha K. Chakravarthy: What’s a good benchmark? If I’m a founder, let’s say a pre-seed, how do I look at the option pool relative to the overall ownership of the company? Is that 20 percent, 30 percent or less than that? How does that relationship work?

Madhu Singh: That’s a great question. I would say most often we try to keep it as close to 10 percent as possible. I don’t usually recommend going beyond 15 percent at a pre-seed stage. You kind of benchmark it based on what you’re seeing your staffing going to look like and how much you’re going to offer them.

It could get recast in a potential future financing round and that’s fine. Or if you have enough options that’s fine too. But 10 to 15 is usually the benchmark for that and then people’s options come out of that. The word “option” is really important here because it’s literally the right to purchase these shares in the future. It’s not a grant of those shares on day one.

The other thing that founders and companies get hung up on is they think, “Wait, I don’t want these people to have to pay for these in the future.” Technically, they’re supposed to because they have to create some basis in it. However, the value of the strike price of each share should be at an early stage rather low like a nominal amount. As the strike price gets higher, it becomes a big decision as to what that will really look like.

Some companies will bonus their employees to help pay for it. Some companies will loan the money to help pay for it. Some people wait till the liquidation event to exercise so they can offset it with the money they’re receiving.

There are ways to handle it but you have to have a strike price associated with it. At an early stage, strike prices kind of feel a little arbitrary because you’re just like, “Where did this price per share come from?”

There are some tools out there that can help you navigate what those are. Ultimately you’re likely to get a 409A valuation at some point. And that 409A valuation will look at all the different market factors where you are placed in the market, your current revenues, your potential revenue and spit out a number basically for you. Then you can rely on that. The 409A valuation is what you do so you can be audit-proof.

The IRS also agrees with you that the strike price is what you want to use. What they don’t want is a company that has, let’s say, $10 million in revenue trying to give out stock options to its employees at $0.001 per share. That’s probably not going to pass muster unless there’s some real justification. That’s not going to get flagged so you get these valuations to minimize those risks.

Shubha K. Chakravarthy: So, am I understanding correctly that you conduct a 409A valuation and let’s say the price is $10. What is typically the relationship of the strike price for those of us who are not familiar? Is the price that the employee has to pay to exercise their right to buy the share to the 409A valuation? Is it a one-for-one or is it a percentage? Like if it’s at $10, is my strike price $1? How does that work?

Madhu Singh: No, it’s a one-for-one. If the strike price comes out at $10 per share, that’s what it is. But for early-stage companies it’s never that high. I’ve seen some of the companies I’m working with that are probably at the Series B stage of things. They’re at like $1.25. We’re not talking $10 at this stage but $1.25 adds up if you have 10,000 or 20,000 options.

Most often, for pre-seed or early customers, it’s going to probably fall within the $0.02 to $0.08 range. Don’t hold me to it but generally speaking that’s usually what comes up. The 409A valuation will give you that information.

The timing of getting that valuation is important too because there are factors that surround that as well. I’m not saying you need legal counsel for everything but helping you make some of these decisions is part of it.

There are really great resources on how to think about it as well because some people don’t want to pin themselves to a valuation too early or pin themselves to a valuation when they’re in the middle of fundraising. If you have that report, it’s going to be requested by the investor and then you’ve basically given them a report of what the market valuation is, where you might be trying to push for a higher one? Timing does matter for some of these things as well.

Understanding Restricted Stock and Options

Shubha K. Chakravarthy: It sounds like if I’m a founder and I know that I’m going to prepare for an exit one day, I’m looking at using equity as a compensation and incentive tool. If I’m listening to you, I have to first make a call. Am I going to give restricted stock or am I going to give options? I know we talked about options. Did you have anything to add on when I would choose between restricted stock versus options or is it always typically options?

Madhu Singh: We push for options mostly but that’s not to say restricted stock can’t be used as well because there are some companies that prefer to use restricted stock. Restricted stock is basically making the grant of stock to the employee. The 409A evaluation, if you have one, would still apply. Then you would own those shares. You would not have to exercise them at any point in time, you will basically have done it already. They would have a normal vesting schedule, etc.

My recommendation is usually to reserve restricted stock for key employees you’re trying to attract to the company because that can be a better deal for them than options. If you’re like, “I really need you in my company, all this stuff,” but you’re like, “No, I really want to do restricted stock,” we’d probably make it work for you to get the restricted stock so that you could have that because we want you to be in the company. There are many reasons why you would push for that because of all the value you can add.

But short of that, everyone else should be coming out of the option pool. It’s not just employees but also advisors, potential consultants etc. We really are pushing for them to be out of this pool of shares. The reason being is that you’ve set aside this pool of shares for this purpose and the pool of shares can include both restricted stock and options.

But the pool of shares is set aside so that when you look at the rest of the cap table, it’s factored in. Even if you don’t use it all, at least you know it’s all factored in and you know what your percent in the company is fully diluted, taking into account the option pool that’s been set aside.

There’s not often a lot of restricted stock that comes out of the option pool but it can be there. The other reason people want to do that is it helps keep their cap table clean. You’ll have the two or three founders, maybe one investor and then an option pool. It’ll just say, “12 percent,” and nobody is looking at all the different names in there just looking at it.

As you can see, a lot of this at the end of the day beyond just the numbers and what it means for people, there’s a lot of perception value to all of this. And people like perception.

People want to give options of 10,000. They don’t want to give options of 10. The difference between 10 and 10,000 could be 0 if there are only 100 shares of the company versus 10 million shares.

It’s a little bit arbitrary math at times but perception is why people pick these bigger numbers because people always pick 10 million shares in their company or more. They want to give big round numbers to people. But it sounds like it just feels better than 25 versus 25,000.

Equity as Compensation: Best Practices

Shubha K. Chakravarthy: It sounds like you go in there and you have this ongoing hypothesis that you’re going to have a clean cap table. You set aside this option pool and use restricted stocks in extreme moderation only when you need it, right?

Then you talked about what percentages are given to whom. Do you increase it over time? How do you manage this option pool? And what else about using equity as compensation do I have to keep in mind as a founder?

Madhu Singh: These days, it’s really great that these new companies are out there helping us manage those things, like there’s Carta, Cake, and LTSC. There’s lots of them out there; you can find the one that’s right for you.

The reason it’s useful is that it creates a place to issue the options from, send out the documents for signature and track them for the employees. People can check their vesting schedules; they can do their exercises. They can do everything on these platforms now which is really useful.

But the thing to keep in mind is that any sort of incentive, even bonuses, there’s some annual review component to it. After a while, people will have gotten diluted because maybe you increased the option pool size or decreased it and things have changed. To kind of offset that, you do refresher or promotion options.

You keep using the option pool as part of your annual compensation bonus or consideration for that employee. It does come back up because people might get two or three different awards over the course of their employment with you because of these different circumstances or in a more recent negotiation.

One of our clients did. I think it was their Series B investment. As part of the term sheet, there was an expectation of refresher options for the founders because the investor was like, we need to keep all these people engaged. It continues to be used as a tool even for the founding team in the future which is really interesting because I don’t think people realize that it can come back up later on to increase the founders’ pool. You might have given up a lot of equity in financing rounds but it might be a way for you to capture some back in the future.

Shubha K. Chakravarthy: That makes a lot of sense. We had another guest on our podcast a couple of weeks ago and she mentioned that most of the value from her exit came from these additional options and not from her initial stake because she just didn’t know enough going in about all these things.

She had to make up for the work and the value that she added. That’s a point well taken. There’s one other point you talked about that I want to discuss in respect to what you just mentioned.

The first is this concept of keeping this option pool as a living thing and that you have to keep revisiting it. Is that something that the founder does on an annual basis with maybe their CFO and the lawyer? How does it happen in real life? What’s good practice around that?

Madhu Singh: In real time, it’s usually happening internally like with a CFO and their HR regarding what they want to offer people. As a lawyer, my job is if they send me the information that they’re thinking; I just provide an opinion on.

Like, this is likely what the end state will look like. Is this what you’ve had in mind? Or we recommend you make this adjustment because of market circumstances or whatever. Then, our job is to document it with a board consent and then help facilitate the issuance. All of these decisions you make at the option level require board approval.

Back to the overall topic of diligence. This is one area that people flounder the most. One area I’m always correcting is they will always check for every single option award. You could have 200 people there. Is there a corresponding board consent approving that option issuance?

If there isn’t, they will call you out on it and you will have to figure out how to fix it. It happens all the time. It’s actually rather nerve-wracking for founders because it feels like when it comes to you from an investor’s counsel which is usually a big law firm, it comes off to you as if it’s a really big deal. It’s very nerve-wracking.

Oftentimes, I’m like “Just relax. It happens to everybody; it’s not a big deal. We will fix it; everything will be fine. We can show that you guys had a meeting about this and the other”. There are different things to do. In the worst case scenario, we do a ratification correcting what happened and it’s totally fine.

But the problem is, I feel like this hypes up people because investors’ counsel is usually a big law firm which is fine. Big law firms are great for things but they have a lot of associates whose task is to find any hole possible and any “T” that’s not crossed. When you see the list, sometimes you’ll get a list like this big.

At the end of the day, it’s hardly anything. It’s all something that could just be fine. This was an error. This was a typo, here’s this, here’s that and everything is fine. It’s a lot because you’re like, is this going to be a deal breaker? I don’t know. But I would say the number one thing that people do not have well organized is a corresponding board consent to go with every option.

Handling Founders’ Dead Equity Issues

Shubha K. Chakravarthy: We’ll come back to that. I know we have a bunch of questions. I just want to talk briefly about this question of dead equity. I’ve heard some cases where there are two co-founders, three co-founders, something happened, change in direction, one left and they still have their equity sitting on the cap table because they were granted those shares and nobody thought to come up with an agreement early on about what was to happen.

Have you seen this a lot? And if so, how do you recommend founders address this? Either retrospectively or prospectively is easy, you have an agreement, a founder’s agreement going in but retrospectively, how do you deal with this if you have not had that and a co-founder leaves and their equity is sitting on a cap table?

Madhu Singh: Unfortunately, it happens more often than I would like it to be even against my own, again, people not taking my advice on a vesting schedule and then getting upset that they’re in this situation and wondering what to do about it.

All you can really do is try to negotiate with them and see if they’re willing to forfeit some of their equity. Sometimes people are willing to do so because they’re like, “Yeah, I left, I’m not doing anything,” or they come to an agreement to reduce it or they come to some sort of buyout and buy them out of their shares. They try to do something.

If that doesn’t work, we’ve had a few times where companies have just decided that it was enough of a nuisance that they had to start over. So they started over completely. And there’s still a risk that those founders will come back and say, “Well, all you did was start over. That doesn’t count. I still have equity.” That risk will always be there but they’re willing to take that risk. So they just have to evaluate the exposure points and start over without those people.

Then there’s the impact of dilution. They’ll get diluted but you can’t just dilute one person in a silo. Everybody gets diluted. So, how much can you expand things to dilute them down without really diluting yourself and then trying to reissue yourself options to make up for it?

It becomes very complicated. It can be done. People have done that too where they diluted everyone and then the two founders who were still there got options issued to them or got more shares issued to them to make up for the difference. All this math is happening to make it all work.

The thing is all of that could have been avoided if there were some parameters on what vesting would look like, what the terms would look like and what a buyout might look like. Nothing is 100%. Best friend, spouse, whatever is never really 100%. You still have to be mindful of these things early on.

There are ways to manage the issue. Ultimately, we try to encourage people to go with the first one, try to negotiate something with them because it’s always better to just deal with it. You got yourself in that position and you’re just going to have to deal with it.

We’ve had at least one instance where the company was very valuable and the investor opted to buy out the founder who held the shares because they wanted those shares. That worked out great for them too. That’s a possibility as well where the investor comes in and solves the issue.

Let it linger too much. That’s the bigger problem. It’ll be a founder from five years ago. I’m like, how have you not addressed this in five years? They just put it on the back burner because nobody wants to have that difficult conversation until it’s going to come back and bite you because something big is about to happen.

Shubha K. Chakravarthy: It’s getting more and more valuable over time right? So you’re just letting it balloon.

Madhu Singh: Opportunity when it was not worth much to really settle that. And that’s the time to do it.

More Tips on Planning Equity

Shubha K. Chakravarthy: To round out, before we go to due diligence, to round out in terms of using equity, what do you think are the top three things that a founder should keep in mind as they plan on using equity to hire their team or incentivize their team?

Madhu Singh: One thing I didn’t say earlier, but I would strongly recommend don’t use only equity to incentivize the team. It should be some cash component plus equity for that particular person. If they’re a W-2 employee, it has to be cash and equity but if they’re not then you still should consider that as your marker.

Make sure you’re being mindful of how much you’re offering them because and stay within some of these recommended percentages or do some research because you don’t. Again, you do not want somebody to walk away with some change that you’re not ready for. And always use vesting schedules.

Wherever, even if they’re better than gold, it’s still even like a 3-month vesting schedule just to make sure that you’re working well together after an agreement is signed. It can be done whatever the term is. It’s worth it to you to make sure they’re a good fit. So, always use a vesting schedule for these things.

One thing I will add since just as a cover to all this because we did talk about one tax component earlier is all of these shares and we talked a lot about vesting and restricted stock and options. There is a tax form that kind of comes what they call an 83B election. Just remember those words 83B and make sure you look it up what it means and that it’s really important that gets addressed.

That’s part of the reason you can only fix so much because an 83B election is time based, that you tell the IRS when you receive the shares and when your vesting schedule started. It has to be 30 days from when you received those shares. Going back, that example I gave earlier about a founder who waited a year to sign his documents. He couldn’t do anything about it because he just now told the IRS that he had received them because if he didn’t, he would have missed out on that election and that election is incredibly important for the value of his shares.

It’s the legal piece is very important in all this but so are these tax elements. Because while it seems like you’re getting nothing as soon as those shares are worth something to the IRS, they’re worth something always like how much they’re actually worth and what taxes you owe on them is what you want to strategically manage as you grow your company.

Shubha K. Chakravarthy: Got it. Those are good points. And thanks for outlining those.

Preparing for Due Diligence

Shubha K. Chakravarthy: I want to close out with a conversation on due diligence because all of this comes to roost when you’re doing due diligence for fundraising. What is the highlight that we give on due diligence for a founder who wants to eventually exit?

Madhu Singh: Our pitch is that we’ll help you plan with diligence in mind, like kind of keeping yourself organized in a certain way. Oftentimes data rooms are requested of you. You can go online and see what the data room looks like and you can just start from the beginning, keeping your files organized in a certain way for that purpose.

And those things help quite a bit when you’re getting to this stage of raising money and things like that or going to an exit because they’re going to want to see all the customer contracts, all the stock agreements, all the capitalization, etc.

But having good corporate records, that’s the hardest one. As I mentioned earlier, because even if you have a team, even if you have a board, being mindful of getting a written record of all of that is very difficult to do if you don’t start that process early.

If it’s not a habit you have, you need to make it a habit. You need to document your board meetings. You need to have an annual meeting. You need to have these things. Investors are really great about pushing their founders to do this when they have a board and things like that.

But if it’s just you and this is your first time doing it, it’s not that easy of a habit to take on. But I will tell you that it’s often the corporate records that are the biggest glaring hole for most people as well as their customer agreements if they don’t have them or if they have them but they didn’t.

They pulled them from ChatGPT or whatever and so they’re not great agreements. The other thing that comes up often is their intellectual property because maybe they had some vendor overseas or some vendor locally or contractor help build the IP but they never got any IP assignments.

There’s a lot of things that go into due diligence because the acquiring company is going to buy this from you. I need to make sure that when I buy this from you, there aren’t these lingering issues that are going to come back and impact this to me.

And then on the selling side, you’re selling a company. There’s going to be like 30 representations and warranties that you have to stand behind when you sell your company. Everything from the capitalization to the contracts to the IP to the data security. Everything is covered.

You’re telling them that you ran the company well and there are no holes. If there are holes and here are the holes. Then like you’re selling the company and you do not want that to come back and show up a year and a half or two years later to create a problem for you.

Practical Tips for Founders

Shubha K. Chakravarthy: I get the very clear picture that it’s kind of like about keeping your nose clean, keeping a house clean and you want to do that from the get go. I’m a solo founder. Maybe I’m a C Corp or maybe I’m not but I have to have all of these things done and I’m trying to run a business and launch a product at the same time?

Practically speaking, what can I do and what tools or advice or other suggestions do you have for me to actually make this happen in real life versus like in the ideal world where I’d have all of these documented?

Madhu Singh: That’s a great question. What we try to push people to do is every year you have to renew your company wherever you’re located and use that date as the time to renew. Address these things like use that day to have your annual meeting. If you’re working with us, we often try to include just a frame template for you to fill in and keep. If you’re working with other counsel, ask them to do that. Whoever your registered agent is.

You have to renew the company every year. Use that as that point of time, calendar it and just do your own little checkbox. Do I have all my contracts? Do I have all my employment agreements? Are there new members to the board? Anything changed? Just write it down.

Even if it seems silly like an agenda for that matter, a bullet point, at least you’ve written it down and it’s done. For me, the most practical time to think about it is when you’re renewing your company. Because they ask you, what is your address? Are there any new founders? Is your business still the same?

Like, different states ask different things but it’s an obvious time, I feel, to do that. The annual franchise tax for Delaware is due in February of every year and so that’s the same regardless of when you incorporated. Some people like to use that as their time to do that because the franchise tax report in Delaware requires you to list all the shareholders, the number of shares issued, the gross assets and so that’s another great option.

Like one of these two, tie it to something functional you have to do for your company and renewing it. Don’t, if you leave it out kind of in the abyss where it’s like when am I going to prioritize this? It won’t happen. But if you tie it to something that you have to do to keep your company going, it is more likely to happen.

Shubha K. Chakravarthy: And even I may or may not be guilty of this but you kind of realize that the filing dates coming up and then you just get with it and move on, right? Is there a way to make it easier?

For example, you said if they’re working with you, then you have a checklist or a template. Are there other resources that you’re aware of that would work for these founders to kind of make that a little bit easier that you might recommend?

Madhu Singh: I think some reason but again it’s like I know they sell you these packages and stuff like that. But it’s another expense. I don’t know that you need to take on that extent. I think people are just better off calendaring it for themselves. If they miss a year, fix it for the previous year.

Use the opportunity if you work with counsel or if you use a registered agent service. Some of them offer that as an add-on. If you know you’re not good about keeping those things. Know yourself and pick what makes sense. I don’t think it always makes sense to just have your attorney do that because legal fees can be much higher than some of these platforms that offer these services.

For some of those things, I think it makes sense to use tools that are available to you. But these logical points in time are probably the best way to do it. If anything else, it’s just a solo founder those kind of becomes easier.

Once you start having more people, it becomes more sensible to have a meeting or you’re keeping track of hiring decisions and board decisions and things like that. So it becomes more normal for your company to do that type of thing but short of that on your own. I think I would just tie it to these things.

Key Elements of Due Diligence

Shubha K. Chakravarthy: Then I want to talk for a little bit in terms of the substance of due diligence, right? You mentioned a bunch of things. You mentioned shares, hiring decisions, employee contracts, customer agreements and IP. Do you want to touch briefly on those and talk about what it is that investors look for and where you find founders kind of tripping up the most?

Madhu Singh: Sure. On the capitalization piece, we’ve talked about it a lot. It’s usually that board consent matching the options and the share issuance and then the annual meeting minutes type thing for them. Other pieces like customer agreements are more like, do you have them with each of your customers?

Then in your agreement, are you allowed depending on the deal structure, to engage in this transaction without it impacting the contract? So there are some contracts that are out there. Like if you have an enterprise client, they consider a change of control or a sale of all your assets as an assignment. They do not want you to do that without their consent.

Certain companies don’t consider those change of control type things as an assignment. You just give them notice or you don’t even tell them. If I am doing due diligence for a company, I’m always looking for those clauses. I’m looking for if there are any things that could create a barrier to us fully assuming the contract and those things that require consent do create that barrier.

I was also looking to make sure that all the IP pieces are cleared in those contracts and that there isn’t some funny non-compete or non-solicitation that could create a problem. Most attorneys are doing this kind of contract review looking for these two or three key items.

On the IP assignment piece, it’s mainly making sure that the company has full ownership of all the IP. If they have a patent and they got some work done from a contractor overseas but don’t have any documentation of it, that’s going to be a problem. They’ll have to go back and get that documentation or get that assignment and so we’re looking for those kinds of things for the IP assignment component of it.

Employment is a little bit more straightforward. Do you have employment records? Have you been running your payroll properly, paying all your taxes properly, doing all those things?

One of the things with the remote work world that has made that part of diligence really difficult is, the people are not using their correct addresses. For example, if we’re all in Washington but I’m actually living in another state. I still have my place in Washington but I’m doing my work in another state.

Technically, like the law requires that I update it to the address where I’m doing the work. If the address is another state and you’re not registered there, that could be a problem.

And so the remote work piece has actually made the diligence around employment a little bit more complicated because now there’s these requirements of where you need to be registered to pay unemployment taxes in whatever state your employees are working in. Whether or not you need to register to do business there is a different discussion but at an employment level you have to do this and so it becomes this whole like massive endeavor on that.

Usually tax advisors and CFOs are looking at all that kind of stuff. But that can pose a problem in some cases. And then more recently, I’m doing one where it was exposed that somewhere, Washington had a new law where the minimum salary threshold went up.

This client of mine was two months behind on updating it. There’s a two-month gap where they were violating that salary requirement. So we had to disclose that and fix that and show that we remediated it.

These wages and things can become very complicated after some period of time because we’re dealing with so many different states. We’re dealing now with a more remote workforce than we ever were before and people are not that truthful about doing this.

I remember one client of mine told me that they were using a payroll processing platform. Then I was like, are you having the employees prepare their profiles? She’s like, we just prepare them for them. I was like, do you have all their addresses? She’s like, we just put our company address for everyone.

This is a big problem because she’s going to get audited big time because that’s not their address. That’s not what the state or the IRS recognizes as where they’re receiving income. That was a big endeavor for them to fix.

People love remote work. But this part of it is not that easy to manage if you’re a small company. The penalty is on you. The requirement is on you as the employer not necessarily. The employee gets penalized too but the employer does too but you have no way of knowing unless they tell you.

So like you have to do your role in all this and then you have to collect all the proper records, all the I-9 records. I had one client in business for 20-plus years and they didn’t collect. They had hundreds of employees over the years and they never collected I-9 or completed I-9 forms from any of them.

Just for those listening, I-9 is the form you fill out. You might recall if you ever had a job where you show that you’re authorized to work in this country. Your passport, driver’s license, whatever and that’s a big immigration issue. Can you imagine? They’ve been around for so many years and it never came up.

I’m like, how is this possible? The reason I’m giving this example is no matter how small, like one founder, one employee to 25 years of business and hundreds of employees later. These same issues can impact both. Just because you’re a novice doesn’t mean someone just as experienced isn’t running into the same things.

Running businesses is not easy. There’s so many different things you have to do to keep it in this place, especially if you really want to get to that exit. The time that it really shows up what you did and didn’t do is due diligence. You don’t want to show a red face in that process.

Shubha K. Chakravarthy: To that point, I want to be prepared, especially when things are hard. I’m about to get the check. You know, it can get really intense. How do I keep track of, for example, that I didn’t pick up an I-9 from somebody? How do I protect myself from day one? What are those safeguards that alert me to these things?

Madhu Singh: I don’t know. People do so many safeguards but you know to the extent you have checklists or to the extent you can do audits for yourself. Some people want to use their funds to get audited, do them. Prepare in advance for this. But if you’re going to have an exit, it’s not usually just arbitrary, it’s usually planned.

In advance of that planning, we might do some pre-planning just to do a review of everything to make sure that you’re ready to go and due diligence will take some time. You want to have good counsel working with you to kind of help you prepare for this along with the tax piece and all that kind of stuff.

So, I’m not trying to say that you have to do everything correctly from the beginning. There is some laxity to it. But the thing is, if you do have these things in mind, don’t be too lax about it. And to the extent that you can stay prepared, do what you can but within reason.

I don’t want this to be the reason you’re not focused on your business because we get caught up over here. It’s all just part of it. Hope at some point maybe you get some administrative help and you task delegate this to them. We work with lots of people’s operations people to help them keep it.

Their job is literally to keep all that stuff organized. Delegate wherever you can. Because the founder is doing too much as it is. And you need a trusted person that’s advising you on this place on the way. Then you also need to be able to delegate some of these things and don’t be too scared.

If your company’s value is there, the buyer will buy the company and we’ll do this. It’s not going to be a board consent missing that keeps them from doing that. It’s just going to be their lawyer racking up the bill to make that happen. To be honest with you, sometimes it gets to be too much from the legal side. I see it and I tell my client to go talk to your business counterpart. Tell them it’s getting to be too much and if they are in this deal or not?

Be frank with them because once the business people get involved, they’re totally fine. It’s often the lawyers can get bogged down on all these things where some of these things are like this is what’s bothering you? Let’s move on from this. The business people, 99 percent of the time, want to move on and get the deal done.

Focus where it is and then they’ll go talk to their lawyers. Everything will settle down a bit. I have to do that. I told them. I was like, I can’t get this lawyer to let this issue go. I believe it’s a non-issue. Here’s the reasons why. Please go discuss on your end. You need an advisor who can tell you that and be frank with you, not just keep battling it out.

Final Thoughts on Exits and Due Diligence

Shubha K. Chakravarthy: We’ve talked a lot about a lot of things to prepare for an exit. As we wrap up, what would you say are the top three things founders should keep in mind when they’re building their startup, preparing for an exit?

Madhu Singh: The number one thing is or actually I guess a couple of different things.

Don’t ignore the paperwork. The paperwork can be really valuable to you. If it’s not today, it will be valuable to you in the future. So if you do want to have that exit and be as successful as the product you have in mind, don’t ignore the paperwork.

Make sure that you’re taking care of your team because if they do not feel taken care of even when it comes to the paperwork and things like that. It’s not going to end well. That’s a big exposure point for you if it doesn’t end well in the plans and pick good advisors who are helping you, who know the industry, who know the way that tech companies work.

Do not pick an accountant who’s never worked with a startup before. Pick someone who’s aware of these issues that come up, that are common or like someone who could advise you along the way and surround yourself with good advisors like putting away the legal CPA and everybody else.

Like good advisors, mentors, take the time to learn the stuff that you need to be doing because it’s not right for you to just share all this stuff and then not know anything that you’re doing either. You need to have some level of knowledge for it and I think this podcast is a great way to do that because even just buzzwords like 83B, QSBS, vesting, even if you don’t know what that means. These are things to go look up and learn about because you want to be thoughtful in what you’re doing.

The journey should not be alone. There are so many great entrepreneurial organizations, so many great places you can get this support from. And those people should know. They should be able to tell you the good, the bad, the ugly. Like what worked, what didn’t work and learn from their failures.

Cause they’ll tell you. They’re like, I met this guy recently. He had an LLC throughout and he sold the company and his big plan was to just write all of his employees a check. And so he might’ve been writing million dollar checks but those people only saw what five, six hundred thousand of it. And he didn’t realize that by not getting them set up with equity in the beginning, he screwed.

Ordinary income is a killer. And like he thought he was doing the right thing and I was like, how did no one tell you about this? Like throughout this process, how did this never come up? And it’s just a little shocking when you see that because you’re just like, how did this never come up?

But then I’m always like, I feel like it did come up and maybe just got ignored. I don’t know, who knows the real story but I feel like if you have the idea, you want to bring people into your idea. You’re setting the vision. You’re the founder.

You’ll also have to do these things, while, it’s not your favorite thing. You still have to do these things. And if you don’t want to make it your favorite thing, you have to delegate it. Don’t let it linger. Don’t end up where people are like, Oh, how do I give stock to people? Five years ago?

It doesn’t work that way. There’s always so much you can fix in the past and you can only kind of be proactive for the future.

Hopefully you get to the exit. If you don’t, hopefully you’ll get some investment and some opportunities. And if you don’t, if it doesn’t all work out, you still need all this stuff to close it down. You don’t want things like, after you’ve shut everything down to show up for you five years later because you didn’t pay this or take care of that. It still matters if it doesn’t work out either too.

Shubha K. Chakravarthy: Right thing to do in short, right? This has been amazing. So, anything that I should have asked on the topic that we didn’t cover that you think is worth bringing up?

Madhu Singh: No, I feel like you covered quite a bit. This is probably more because everything we talked about is usually like a separate session. When I’m doing, these on panels. Consolidating everything is nice because there’s a way to weave it all together.

People want to know where AI fits into all this and how much it can do to help you. It can be a good resource. It could create that checklist for you, perhaps. Or diligence checklist and things like that. But I tell people, like, I remember when, not way back when, but like a year or so ago when they were like, oh, AI is going to take everybody’s job.

And the first one I used to say is lawyers, AI is going to take all the lawyers’ jobs. And now it says, what jobs will AI not take? It’s lawyers because they tried it and it’s not as great as people think it is when it comes to proper legal work. And so, like, it’s useful for checklists and lists like that, but it’s not a way to build your agreements.

I can always tell when somebody used ChatGPT, it’s very obvious. And it’s because it’s learned like online forms and the online forms are not great. Pulling from certain places that have posted all this stuff. They’re not good. They’re not the best of forms. They’re definitely not the best of forms when it comes to startups.

There are some really good resources that are online and affordable and I’m happy to share that with your audience and I can send you some links that I would like if you use these. Then come to me after that. I’d be like, great, at least you use something good. But if you don’t, if you use some generic stuff out there for your startup, it’s not going to end well.

So use it as part of your learning, but don’t rely on it for your paperwork. Piece of it.

Shubha K. Chakravarthy: Awesome. So we’d love to have that list whenever you can send it over and thank you very much for a great conversation. I’m sure this was very informative to me on many levels and I’m sure it will be to many more people. So, Madhu, it was a pleasure having you and thank you so much.

Madhu Singh: Thank you.