The Important Intricacies Of Negotiating A Job Offer With A Startup With David Siegel of Grellas Shah
Imagine knowing how to avoid blunders when negotiating equity deals with employees or founders. Our insightful guests, attorney David Siegel of Grellas Shah, equip you with the know-how to avert common missteps such as handing over excess equity, devising unnecessary intricate vesting schedules, and navigating tricky termination stipulations. They delve into the nitty-gritty of different equity forms and the tax ramifications associated with distributing stock, providing invaluable insights for both employers and employees.
Ever felt baffled by the formalities of establishing an LLC? David Siegel will shed light on why it’s paramount to treat these processes with the seriousness they deserve. Securing limited liability protection isn’t something to take lightly. We dissect the versatility of LLCs and consider the potential advantages of QSBS write-offs when swapping a membership interest in an LLC for shares in a C-Corp. Get ready as we unmask the complexities of co-founders agreements, buyouts, cliffs, and key man insurance. This episode is your guide in the intricate world of startups. Tune in!
Listening Time: 24 minutes
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The Important Intricacies Of Negotiating A Job Offer With A Startup With David Siegel of Grellas Shah
William Tincup: [00:00:00] This is William Tincup, and you’re listening to the Recruiting Daily podcast. Today we have David on from Grellas Shah, and our topic is the important intricacies of negotiating in general for everyone’s startup. David’s been a guest before, but when we go through the same thing, David, would you do us a favor and introduce yourself?
David Siegel: Sure I’m David Siegel. It’s great to be on again. I’m an attorney with Grellas Shah LLP. We’re a boutique firm in Silicon Valley. Our, we have two [00:01:00] sides to our practice. We have our litigation practice, which hopefully nobody Listening to every needs, it happens but more relevant to this discussion is our corporate practice where we represent startups and founders and startup employees and the range of things that are needed from, in the startup case, formations and financing as an M& A and whatever comes in between commercial contracts and employment issues and then we represent founders and other employees.
In various things, including negotiating offers from startups and on the company side, we do it as well. We represent companies who are trying to give or negotiating offers with employees or founders.
William Tincup: Let’s we’ll talk about it on both sides, both the candidates perspective and the employer’s perspective.
But let’s do it from the employer’s perspective to, to start with. One of the things that they. There’s probably common mistakes that from the employer the startup’s perspective what do they give away too much equity? Do they make the vesting schedule too complicated?
What are some of just the common oh, okay, I’ve seen this
David Siegel: and that.[00:02:00] You always, and this is, this’ll be true from an employee perspective and from a company perspective, is there’s, Two versions of the world when you’re talking about startups, you’re talking, you look at startups pre financing, pre, and when I say pre financing, I’m really talking about a price round, like doing a series A, series B, and then after, and it’s totally different worlds.
And so from a company perspective, the big mistakes before tend to be. Either A, negotiating too much, doing things that, giving too much power to an employee early on, whether that be giving them rights that investors won’t like single trigger acceleration, which is automatic acceleration of all equity if there’s a sale of the company, which investors won’t like, they want to
William Tincup: keep those, for the audience, they want to keep those folks on. That’s why the contract [00:03:00] isn’t as attractive, because what someone’s buying is also the, customers, technology, the employees, et cetera, and if it just has one trigger, then those people can just cash out. And then they’re gone, which isn’t as attractive, if I got, if
David Siegel: I have that right.
You have that 100% correct. And there is, there are different forms of acceleration. Some are, that are single trigger, it’s just automatic acceleration. There is something called double trigger, where the acceleration only happens if… The company is bought and then within a short period of time, the employee is fired for without cause and that particularly pre financing can be palatable to investors and acquirers, but the single trigger isn’t particularly palatable.
William Tincup: And as you’re creating a startup, you have to think about these things. You have to think about. They’re just getting the product off the market and go to market and all that other stuff. You got to think about, hey, when people come along for your ARM and they’re doing their due [00:04:00] diligence, what are they going to be looking at?
This is one of those things that, that we often, as entrepreneurs, we often get wrong. It’s just a lot of the, a lot of what I’ve learned about the A rounds and B rounds is it’s a lot of undoing. A lot of lawyers.
David Siegel: Yes. It’s a lot of time gets spent undoing things that are freestyled pre, say, spring day.
And that’s expensive. It’s also potentially, there are other ramifications because It’s hard to go to an employee and say, give this thing up or what if, with acceleration, it’s no big deal. But for other things, like what if the person left and there’s something you need to negotiate now and that does happen, but there are other, you pointed some other ones, giving away too much equity early on is a common one weird vesting schedules are another one.
Also. And this is not that frequent, but does happen, people agreeing, companies agreeing to things like for [00:05:00] cause termination provisions, where if the person’s terminated without cause, you have to pay them a bunch of money or accelerate their equity you don’t want anything, generally speaking, you don’t want things that are not vanilla unless there’s a really good business reason for that.
William Tincup: the different types of equity. So like we see, sometimes we talk about it in singular fashions Oh, there’s equity. It’s once you start, this, but for the audience’s edification, once you start digging into it, there’s all kinds of different ways to look at it. Yeah. From an investor’s perspective, at least.
David Siegel: Sure. And, normally at the beginning stage, we’re talking about just granting stock. And, that’s the simplest thing to do. It has the least tax implications as opposed to other forms of equity. And the reason you issue stock is because usually pre funding, the company’s not really worth very much, so a share [00:06:00] of stock is…
Almost worthless, exactly. So you can give it out for basically nothing. But you have to remember as a startup, when you’re giving out equity from a tax perspective, it makes no difference whether you’re paying somebody in cash, in equity. In a car, in fine art any form of compensation you apply, you give to an employee is taxable.
And if you give an employee equity and they don’t pay the fair market value of it that’s a taxable event that has to be reflected on that employee’s W 2. Again, at the beginning stages, that’s, so what? A company’s worth, 1, 000 and you’re giving away 0. 1% of it, that’s not that’s no big deal.
But eventually, down the road, the company’s worth something. And it becomes prohibitive for an employee to either be taxed on or to buy the equity. This most typically happens once the company gets funded in [00:07:00] a priced round. And then you switch over to options where you’re really just giving the employee the right to buy equity if they want at a future time at an agreed upon price.
William Tincup: And I was going to ask you, oh, so three questions. One is that we’ll do the monthly full buyer seller of a strike price, setting a strike price. The other is do you like when entrepreneurs use some type of technology to manage their cap table like, like Carta, but there’s several options like that.
And the other thing I’ll get to in just a second let’s just deal with strike price and Carta.
David Siegel: In terms of strike price for options, the gold standard thing to do is to get an independent valuation that’s called a 49A valuation. And this can be done either, most cap table management tools offer this as part of their package.
There are also a ton of. Consulting firms and accounting firms that will do this as well. There are pluses and minuses there. [00:08:00] Typically, the prices, the procedure through CapTable management tools are it’s pretty simple. They ask for a bunch of stuff and they give you a report. And that’s all fine and good if there’s nothing unusual going on.
But if there’s something unusual where you need your valuation firm to interact with you more and take a more bespoke ish approach, then you’ll probably want to consider a firm That’s not associated with or not through one of those solutions.
William Tincup: That’s, I’ve seen it with high growth, like people that are going through really fast growth.
It’s like they can’t grow. They can’t make, they can’t make cap table management tools. Yeah. They’re just triggered. We had to hire a thousand employees. It’s okay, and so those folks, again, if it’s just Rugger, if they study Rugger,
it’s better than Excel.
David Siegel: Yeah. Yeah. And, and in a general, from a general sense, I’m a [00:09:00] big fan of CalcTable management tools. At a, once you get a non trivial number of shareholders or investors, you don’t need it if you have five or 10 people, but you want to start, stop using Excel once there is, a non, as I said, a non trivial number of people involved.
It gets unwieldy. Yeah.
William Tincup: Sometimes when people are going through angel investing, they’ll go to an angel network and it’s okay, everybody’s going to put in 20, 000. It’s okay, you don’t need a cap table. It’s oh, you have 40 people, 20, 000 investment. It’s okay these are the things that they often are.
Listen, these are the things that when you do your around, these are the things that get cleaned
David Siegel: up. Yes, they do. And the earlier you think about them, the less it costs to clean them up. That’s right.
William Tincup: That’s right. Are you a fan of the Delaware C Corp? I’ve seen. People kind of start with LLCs just because they’re, pretty simple to start [00:10:00] with and then move from that to a Delaware C Corp or do you if left to your own new startup and, your new client comes in and they really haven’t done much, it’s, they’ve been in stealth mode, do you, would you rather just fast track them to again, it doesn’t have to be a Delaware C Corp, but what’s your favorite mechanism
David Siegel: there?
So I, it depends on first of all, how long, if the if it’s a VC track company, if there’s someone, if company that wants to go the VC track, then my first question is how long do you expect to be waiting before doing a priced round? Because the, there is some cost in transitioning from an LLC to a C corp, which is what is likely to have to happen.
So is it worth it from a, for example, from a tax perspective, if you’re an LLC, you’re getting passed through and maybe you think you’ll have a long period of time and a bunch of losses that you can take on your tax return. Great. If you’re like we want to do an [00:11:00] early seed equity round in six months, then I’m going to be like what are you doing an LLC for?
LLC have, there’s a danger with LLCs not and I don’t mean this. As being inherent to LLCs, but more in practice is that they’re very flexible and less formal in some senses than a corporation. And if you don’t take the formalities of it being a separate entity seriously, then you can lose the limited liability protection of the LLC.
It’s. With a corporation, things are more set in stone, how they’re supposed to be done and everyone knows, there’s a board and there has to be board approval of things and stockholders approval of other things and It is. With I think it’s something that’s still coming up, yeah.
With an LLC, it’s the rules are whatever the, your operating agreement states and you make that up and then people forget to do the things they’re supposed to do and that can create risk. And I will say
William Tincup: it does have, it’s membership, right? It’s a hundred percent [00:12:00] membership.
David Siegel: And so yeah, you can call it, you can, you get to call it whatever you want.
And units, you can do percentages, different types of units. You don’t have to register any of these things with. The Secretary of State of any state, you just write whatever you write. And that’s
William Tincup: again, tremendous amount of flexibility. All things are probably going to have to be redone when you take a price round.
David Siegel: Yeah. Now, mind you, I will say there are, there can be a benefit to LLCs, which a lot of people don’t think about which is, so with a C Corp and only a C Corp, you can get potential qualified small business. Stock the, with that, and so that’s up to a 10 million write off on capital gains when you sell your stock.
You cannot get that from an S corp ever, you can only get it from a C corp and you have to hold the stock for five years and there’s some other requirements. The thing is that LLCs are special in that [00:13:00] If you get a membership interest in LLC and later in exchange for that LLC interest, you get a shares in a C Corp, you can get you can enjoy QSBS on the gain above the value of the LLC interest that you had.
And and that gain, so the it’s. Either 10 million or 10 times the value of the LLC interest you gave up. Let’s say you start your company as an LLC and you build a bunch of value in it. And let’s say you own 100% of it. Let’s just keep things simple. It’s worth five million dollars by the time you convert to a C Corp.
Then later on, if you hold that, those C Corp shares for five years, then you can get a write [00:14:00] off of up to ten times that five million dollars. Oh my goodness. But it’s only, but it, you don’t, you get no write off on. The price from 0 to 5 million. So essentially, to get the 50 million write off, you have to sell, your shares as sold have to be at least worth 55 million.
Got it. But that’s enormous. Yeah.
William Tincup: I was going to ask you, do you in house, do you all have tax? Do you have folks that kind of help because a lot of this comes down to tax
David Siegel: implications, right? This is a hundred percent. Yeah, this is, it’s largely tax. And yes, yeah, we have in house tax attorney to help with this kind of stuff.
William Tincup: The two things I want to ask you about is one is co founders, the steps that you guys see with co founders. The startup that I advise, they had three co founders. And this is pre COVID we were really getting into the first couple of months of COVID and he was in India with one of the partners and he died.
So the other two partners are like, the [00:15:00] other two co founders are like, what do we do? What do we do with his share? What do we do? It was, I knew they just started, like they were like in a wireframe, like they were paying in, they have a product, they have a revenue, they have that stuff.
And so I think they, they’re all Indian guys. And so they figured out let’s do something nice for the family and then go build the business. And hopefully that’ll work. That’ll be something that will be remembered, but he was a key part of the team, and so it was a huge hit, but I’ve got a bunch of co founder stories, but what, from your perspective, where do we see, not just some of the mistakes, but just, the intricacies part of the title, like, where do you see it where people get this right, or, eh,
David Siegel: don’t?
So a couple things. One is a lot of startups don’t pay salary to co founders at the beginning. It might be a necessity, but it might be a necessity not to, a practical necessity, but legally speaking, in most states, it’s actually required. And so you’re creating [00:16:00] risk by not paying salary. Again, it might be what you have to do, but go into it with open eyes.
That if you’re not paying salary, then at a minimum, any co founder that leaves on bad terms is going to have leverage against the company. It can’t be all sweat equity. It can’t be. Yeah, exactly. Not… Not doing a cliff is, can be problematic. It doesn’t necessarily have to be a full year.
And I think co founders should discuss what kind of cliff to have and have a real conversation because the reality is someone leaving, who being, somebody being terminated at 11 months is going to have a lot of ill will. Unless there’s a really good, if they leave voluntarily, it’s usually okay.
But so it should be thought about intentionally, but having no cliff. Can be a real problem because
William Tincup: for the audience, co founders, they have agreements with the company. So just an employment agreement with employees that we’ll talk about next is they have an agreement. There’s an [00:17:00] official co founder agreement that they have.
And usually they’re the same, they’re very similar, if not the same. And again, you get into kind of some of the things that you talk about, like buyouts, like what does a buyout look like if we decide to part ways? Cliffs, you already nailed that. That’s great. Keyman insurance, maybe not at the beginning, but at one point, you’re going to want to get to a place where you do something like that.
But where else do you see co founders get.
David Siegel: A huge one is there’s a concept in the VC world, which unfortunately I hate, but it is what it is of the notion of there being deadweight on the cap table, which from an investor perspective is the notion that for someone who was a founder or a service provider or the company who received equity, if they’re no longer with the company, but they have a lot of equity.
Investors get upset with that because they think it’s nonproductive equity. [00:18:00] So
William Tincup: just like an investor doesn’t want to pay like a new round, they don’t want to pay debt. Exactly. They want to pay backwards. They want to, they want their money to go towards growth.
David Siegel: The reality is the, and investors differ, I would say from a founder perspective, usually.
Investors are okay with, allow them 5% or less for a departed co founder, some will go up to maybe 10, but the reality, particularly in a two co founder company, a co founder leaving voluntarily or otherwise, In a year or so might have vested in 15% of the company or something like that. Yep.
And that might make the company unattractive to investors. Yet here we are with a contractual obligation to that this person owns that much. And so I think it’s something that a lot of founders don’t discuss at the outset. That the reality is [00:19:00] they’re committing to one thing. And then they can’t really commit to it.
They’re stuck with it unless they negotiate something otherwise. But the founders should discuss from the outset how that should be handled. 100%.
William Tincup: Couldn’t agree more. It’s tantamount to… Talking about a prenup, whether or not you sign or don’t sign a prenup. The idea is, hey, what if things don’t go the way we think they do go?
Or we want them to go. Okay. Let’s talk about that. Like I remember having a conversation with a business partner where it’s like, Hey, what if you die? What do I need to do with your wife? What if your wife dies? You’re going to be, you’re going to need to be off the grid for a while.
What do we need to do there? So I think all that stuff, it’s so easy to just jump into product, jump into this, this entrepreneurial mindset of, Hey, there’s a better way to do this widget. And it’s you’ve got to actually think and talk to people, just, really it’s not painful discussions.
It’s just okay let’s just, let’s just talk about all the things that could go sideways and how [00:20:00] we can correct. Some things in place. I did wanna ask you about, I, I, this is newer to me in the last probably five years, but with startups, especially ent with engineering talent like founding, maybe not they’re not foundings, they founders, but they’re key employees, especially on the technology like the the founding engineer. Yeah. You know what I mean? Like what do you do, what do employment agreements look like with. Let’s say you’re at 20 employees and in, and you need to, there’s a CTO that you really need to bring in, what is, what does that agreement look like that’s either similar or different to the other employee agreements that you have?
David Siegel: Typically when that, Typically, when you’re hiring a CTO, it’s either one of the founders of the CTO or you’re bringing something, somebody in post series A who’s now really taking on that role. So when it’s a founder, it’s no different than any other. So put that one aside, it’s the post series A.
I, and I would say it’s [00:21:00] pretty similar when we’re talking about CTO. Sometimes they’ll call it VP of engineering instead but I would put, there are some other key hires that’s pretty similar, VP of sales. would be another one where there is a much more bespoke negotiation over terms. I will say, in, in, in usually equity terms, to some extent, Dollar compensation as well.
But most post series A companies are pretty rigid on equity terms for most employees because they don’t have, they’re not given much of a choice, except for these key positions where, for example, you can, if you’re in one of those positions, you can ask for acceleration. You can really negotiate, significantly negotiate the amount of equity.
Or shorter cliffs, like every, everything is really on the table. If you’re demonstrated in one of those areas I would say in the VP of sales [00:22:00] perspective, you also, you’re going to be having a lot of haggling over commission as well. I would say from a company perspective be careful, particularly I’m less concerned about sales.
I’m more concerned about engineering hires at that level. They often have side projects. You want to be very careful about carving out IP that gets assigned to the company. That’s something to talk about with an attorney. Your investors can’t really help much with that. They can help a lot with equity.
And and it’s good to lean on them to some extent for that. It’s also
William Tincup: good to have the conversation around work product. Defining what is and isn’t a work product, and again, that’s a lot of that’s going to be in the employee agreement as well, but it’s okay, do you have side projects?
Okay, great. Let’s talk a little bit about these things, keeping a separation between church and state or whatever you want to call it. Exactly. Yeah. But then, okay, the work that you’re doing here. needs to stay here. Like all that stuff, [00:23:00] again, I like the way you sub framed it.
Everything’s, especially with that type of talent, everything’s negotiable. Yeah. You’re going to get into conversations with people. I need to have you on again, and I need to do, I need to have you on with, there’s a guy in Indian Valley you might know him, Kevin Kinkor. K I N K O R. And he does staffing for startups.
David Siegel: Oh, that’s why I’ve heard of him. Yeah. I deal with a lot of those kinds of people. Super great guy.
William Tincup: Super great guy. But to actually have the three of us
David Siegel: on. Yeah. We probably have different perspectives on some aspects of it.
William Tincup: Right out the gate, we would. Absolutely. It’d be more of a, it’d be more of an argument but David, thank you again.
Thank you for carving out time for us.
David Siegel: Absolutely. Happy to do it.
William Tincup: And thanks for everyone listening until next time.
William is the President & Editor-at-Large of RecruitingDaily. At the intersection of HR and technology, he’s a writer, speaker, advisor, consultant, investor, storyteller & teacher. He's been writing about HR and Recruiting related issues for longer than he cares to disclose. William serves on the Board of Advisors / Board of Directors for 20+ HR technology startups. William is a graduate of the University of Alabama at Birmingham with a BA in Art History. He also earned an MA in American Indian Studies from the University of Arizona and an MBA from Case Western Reserve University.