We’re starting several companies simultaneously at Ooga Labs, and we are trying to be careful and creative about the financial and corporate structures we’re putting in place. It can end up mattering a lot in terms of how much value you can create and capture over the life of an enterprise. My last company, Tickle, founded in 1999, was a Delaware C-Corp, which is the most familiar structure to the VC community, and some of the Ooga Labs companies are also C-Corps.
The C-Corp structure served Tickle well until 2004, when we were trying to do a $20 million round of financing with new VC investors. It made no sense for the company Starters (which we define as the founders as well as early employees) who were still renting apartments, driving old Toyota Corolla’s and starting to have children, to keep going without taking some money off the table. The traditional equity structure prevented it from being easy without raising the strike price of the common shares. As is typical in most C-Corp’s, the Starters held common while the VC’s held the preferred, senior shares. The main reason a Board wants to keep the common share price down is because it’s hard to hire sophisticated new employees (including existing management’s replacements, potentially) when the strike price of the options in their equity package is high. The Board fears really good people will do the math and see they have far less upside for coming to your start up vs another start up with a lower strike price. It’s a point VC’s will often not relent on, certainly ours wouldn’t.
So we embarked on trying to figure out how to get the Starters some liquidity without killing the common share price. We spent 3 months and $350K of money with three prominent Silicon Valley law firms (one for us, one for our existing VC investors, and one for the new lead VC investor) to try to figure out how to make it work. What we found was that the ways of accomplishing our goal that had been acceptable to the IRS and SEC around 1999, had been eliminated by Sarbanes-Oxley by 2004. So we had to explore other back flips like re-capitalizing the company. In the end, we bailed on the financing for other reasons, but I had learned my lesson about the need for some sort of special stock for the Starters. I had also learned a lot more about how the SEC and IRS think about things, and we had come up with an idea for a new type of stock that would alleviate all the machinations to get Starters some liquidity along the path of growing their company. I vowed that when we started my next companies, we would fix this problem by implementing from the beginning, this separate kind of Starter Stock, which would represent some minority portion of the stock that each of the Starters received.
The basic idea of Starter Stock is that it 1) confers special voting rights to those who get the stock, and 2) it can be converted to any preferred equity stock at the time of a financing so it can be sold at that time without raising the strike price of the common stock. For instance, if the company is considering doing a $9 million Series B preferred round with a traditional venture capital firm, the Starters would first have to approve the deal due to their special voting rights, and second, Starters could sell some – say $1 million — of their Starter Stock as Series B stock bringing the total round to $10 million. $9 million goes to the company and $1 million to buy baby some new shoes. Whether this happens or not will be up to a negotiation among the investors, the board, and all the Starters, but at least you have the opportunity to legally and simply take some money off the table which then gives you the continued confidence to go for the big hit, which, in turn, aligns you more with the investors.
Every new C-Corp. at Ooga will have a Starter Stock class. We encourage everyone starting a company to look at this option if you are going to do a C-Corporation and you are planning on raising money. Two law firms that understand this new class of stock are Orrick and Perkins Coie and you should call them if you want to go this way.