Thalasar Ventures

Legal Structures, Acquisitions and Startups.

One thing that hasn’t changed in a start-up is choosing the correct legal form for your web startup. Because of the way deals are often structured, your legal entity can either hinder or help you. Let’s go over some of the options.

When we formed Brave New Worlds in 1996 we used a Limited Liability Corporation. This is a favorite with entrepreneurs these days. They are quick to set up and have the liability protection that entrepreneurs need. I don’t need to remind anyone that most business fail, although this won’t stop most entrepreneurs.
This form of the business worked fine initially. However when it came time to sell the company, VA balked at the legal structure at first. This required us to redo the company as C corp. This added a great deal of legal fiddle faddle that might have been avoided had we chosen a C corp to begin with. On the other hand LLCs are far more common now than they were then and companies have adjusted
What’s your exit strategy?
This will dictate your legal structure. If you aren’t planning on selling the company and have started up a lifestyle company (commonly known as profitable to the rest of the world) your legal structure can be an LLC or S Corporation. If you wanna get VC, it’s a whole other kettle of fish. VC are going to want something that has a clear liquidity event
VC will want a C-Corp and a large chunk of your company
I am not a big fan of VCs. I am a big fan of bootstrapping since that’s what I did with with my last company. These days you are almost always better off bootstrapping since the IPO market has tanked. Given that most acquisitions these days are talent acquisitions, companies usually aren’t buying large market established companies (Microsoft is the real exception here – they just bought Tell-Me for between $850 Million ~ $1 Billion in stock. VCs pumped $238 Million into Tell Me over the years, so I imagine the original owners are pretty diluted at this point). Your customer acquisition costs are at all time low right now. But if you go the VC route, you need to set up a C-corp, probably with different classes of stock. Most VCs are going to be the first people compensated as some of the founders of found out.
Strong Small Teams
Two companies that regularly make acquistions are Google and Yahoo. Google acquired Google acquired 10 companies and Yahoo acquired 9 companies (Hat tip Don Dodge’s post on market returns for VC). Typically these companies are small but typically they are small strong teams (like the recent MyBlogLog acquisition) So focus on building the right team for your product and the acquisition might be easier. One thing that often gets missed by the market is the employee acquistions as typified by the Dulance acquisition by Google. All the employees quite their current job at start up A and a rehired by the “acquiring” company with nice sign on bonuses and piles o options.
These days it doesn’t matter too much
An employee acquisition is always an option. In our acquistion, the person doing the acquiring prefered a reverse triangular merger. In that merger your company is merged with a subsidairy company – here’s an over-view of the reverse triangular merger. On the other an employee acquisition merger is sometimes preferable since it is easier, requires less paperwork and SEC paperwork. Indeed employee acquisitions are almost completely stealthed acquisitions and are hard to notice at all.
So if you have built your company to flip to a larger entity, you should be open to a wide range of merger options – just make sure your initial structure covers the liabilty of starting the company and hire the best people you possibly can.If your company is a “lifestyle” company (which in VC speak is a profitable one or one that supports the founder’s lifestyle), I would go the LLC route. That way you retain the liability protection and additional tax flexibility.
On further reflection, I would expect employee acquistions to continue to grow. The advantage they have is that they are largely invisible to the competition. For example Dulance’s acquisition doesn’t appear anywhere in SEC filings, yet it occurred. Of course the key in an employee acquisition is that the acquirer needs to have their ear to the ground and find these acquisitions before they become too popular. It requires a lot more legwork.

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