Tag Archives: Delaware corporation

Investors don’t care where your Startup is Incorporated

Many founders I speak with are concerned about where their startup is incorporated and how this could impact fundraising opportunities in the United States.  In reality, this concern is unfounded.

Any sophisticated investor considers the product/service, team, market potential and other commercialization factors before, if at all, considering where a startup is incorporated.  In some circumstances, an investor may request that the startup alter its jurisdiction of incorporation but whether or not they proceed with the investment is determined 90% by quality of the company over jurisdiction of incorporation.  As relayed to me by Canadian founders, “if an investor passes because you’re a Canadian company, that’s not the real reason for passing“.

Where an investor requires your startup to be incorporated in the U.S. there is a simple process for creating this structure that I discussed in a previous blog post – The Canadian-U.S. Swap: Moving an Early-Stage Startup to the U.S.

Canadian founders should focus on building a compelling product/service and not waste energy worrying about minutia of incorporation.  Sell investors on your company and any issues concerning where your company is incorporated can be worked out between your legal counsel and investors.

Revisiting “Should I Incorporate my Canadian Startup in Delaware?”

It seems Canadians are still wrestling with whether to incorporate their startup in Delaware.  I wrote about this question back in September 2014  and since then the post has racked up over 1,000 views.  Back then, I concluded with this piece of advice, which I still stand by:

Don’t lock yourself into Delaware before you know where your investment comes from.  Based upon the cost and complexity of operating a Delaware startup from Canada, I recommend that you incorporate in Canada at the start.  Where a future U.S. investor requires you to incorporate in Delaware (or another state) your legal advisors can assist with this transition.  Conversely, Canadian investors may prefer to invest in a Canadian company!

Tip:  your product/service is important, not the place of incorporation.

Delaware vs Canada Startup Structure

Canadian startups are frequently influenced by U.S.-centric blog posts concerning startup company structure.  Relying on these posts ignores some fundamental differences in how Federal and British Columbia corporations can be incorporated compared to a Delaware corporation.  Indeed, Canadian startups should not ignore such differences as they permit a more lenient corporate structure from which to grow a company.

To start, here is an overview of the Delaware corporate structure typically recommended to startups:

  1.  Authorize 10,000,000 shares.  Delaware corporations must authorize a fixed number of shares at the time of incorporation.  This number can be altered in the future but will require shareholder approval.  The large number is used as: (a) it avoids fractional shares; and (b) looks expensive.
  2. Issue around 5,000,000 shares.  Shares are issued to founders but at least a 1/3 of authorized shares remain unissued for option pool grants and investment rounds.
  3. Allocated shares to option pool.  A certain number of shares are allocated to the option pool.  The art of structuring the option pool, especially in regard to finance rounds, will be discussed in a future post.

Once complete, assuming a 10% pool, 6,000,000 shares (5m founder shares and 1m pool) have been issued or allocated.  The remaining 4 million shares, or 40% of the company, will be reserved for future investment rounds and expansion of the option pool (if needed).

Conversely, Federal and British Columbia corporations are NOT required to authorize, and thereby set a cap on the number of, shares.  Instead, shares can be unlimited, thereby granting the Canadian startup great leeway in granting shares in the future without having to worry about running into the authorized share limit that Delaware corporations face.

Here is what the same startup, incorporated Federally or in British Columbia, would look like structurally:

  1. Authorize an unlimited number of shares.
  2. Issue about 5,000,000 shares.
  3. Allocate the option pool, fixed or rolling.  Given that shares are unlimited, you are not forced to set a fixed number of shares to constitute the option pool, although you could.  Instead, you can set the option pool size as a rolling % of issued shares creating an automatically adjusting pool size regardless of the number of shares issued in the future.

Ultimately, the Federal/BC startup is not faced by the same rigid share structure, governed by the authorized share requirement, that a Delaware startup is, thereby taking away a few of the corporate structure challenges that U.S. startups often face.  With unlimited shares, the Canadian startup’s future share grants are only restricted by the corporation’s constituting documents, agreements with shareholders or third parties and BC corporate law.  Conversely, the Delaware corporation needs to review how a share grant will reconcile with the number of authorized shares and, if needed, increase that number and seek shareholder approval to do so.

Of course, if you want to structure the company exactly like a U.S. startup, you certainly can authorize a fixed number of shares in your Canadian startup!

Share Structure: do you need so many classes?

I frequently encounter early-stage startups with too many share classes.  If you have read previous posts, you know that I advocate for a simple share structure for early-stage companies (usually common and, if needed, non-voting common).  If more complex structures are required in the future, they can be created then.

When you are considering your startup’s share structure, consider creating only those share classes that you know you need now or will need.  To that end, ask the following questions before creating any share class:

1.  What is the share class to be used for?  You need to understand the purpose served by each share class.  Don’t create share classes because a third party tells you to or because you see other companies with similar structures.  Each share class should have a reason for existing.

2.  When is the share class to be used?  If the share class is to be used at some point in the future, consider whether that class will 100% be suited to that hypothetical future event or will it need to be modified to suit that future event?  Further, what is the likelihood of the future event occurring?  If it seems unlikely the shares will be used in the future, consider not creating that class.  For example, I question the value in creating preferred shares to be used for future investors as you currently do not know what terms those hypothetical investors will want on the preferred share class.

3.  Will your share structure agitate investors?  Perhaps you do have a future use for 4 share classes but what is the impact of this share structure on your capital raising activities?  Will startup investors, used to seeing common share structures (and maybe a non-voting common), take issue with your complex share structure?  This especially could be the case where you can’t explain the reason for the structure.  Always consider how outsiders will view your share structure.

In sum: don’t create share classes without a reason – even if your lawyer says so!  A founder should know their company structure and why it was created that way.