Summary. A venture-backed company's legal history is a chain in which every link constrains the next, and the mistakes that surface at a Series B were nearly always made at formation. This toolkit walks the whole arc: forming the right entity with vested founder stock and filed 83(b) elections, raising on convertible instruments while understanding how they convert, negotiating the priced round terms that determine economics and control, closing it, and living with the covenants, valuations, and reporting the round created. It closes with later rounds, bridge and down-round mechanics, secondary liquidity, and the exit waterfall.

What this toolkit is for, and who should use it

Founders raising capital face a sequence of decisions in which the wrong answer is cheap now and expensive later: the entity type that forecloses a tax exclusion, the vesting schedule nobody imposed, the post-money SAFE stack nobody modeled, and the term sheet term that costs more at a modest exit than the entire valuation negotiation was worth.

This toolkit is for a founder, a general counsel at a growth-stage company, and the counsel advising either. It assumes a U.S. company raising from institutional investors, and it assumes nobody has time to read a treatise.

Roadmap at a glance

  1. Formation — entity, state, founder equity, and the thirty-day deadline.
  2. Housekeeping — assignments, agreements, and the records diligence will test.
  3. Convertible instruments — notes and SAFEs, and how they behave.
  4. Preparing to raise — the cap table, the model, and the process.
  5. The term sheet — economics.
  6. The term sheet — control.
  7. Documents and diligence.
  8. Closing and post-closing filings.
  9. Living with the round — covenants, valuations, and reporting.
  10. Later rounds, bridges, and down rounds.
  11. Secondary liquidity.
  12. The exit waterfall.

Stage 1 — Formation

  • Delaware C corporation if institutional equity is contemplated. Funds cannot hold pass-through interests without generating unrelated business taxable income for tax-exempt partners, option plans work cleanly only with corporate stock, and every financing document assumes it.
  • Issue founder stock early, at a nominal price, when the value is genuinely nominal.
  • Impose vesting on the founders, typically four years with a one-year cliff, implemented as a company repurchase right over unvested shares. This protects the founders from each other more than it protects any investor, and retrofitting it later requires the departing founder's consent.
  • File the § 83(b) election within thirty days of each restricted stock issuance, by a method that proves timely mailing, with the proof retained permanently. There is no extension and no cure.
  • Adopt bylaws, appoint directors and officers, authorize the issuances, and open the stock ledger.
  • Note that the § 83(b) filing date also starts the five-year holding period for qualified small business stock, which for a successful company is frequently worth more than every other tax decision combined.

Illustration. Two founders form a company, issue stock, and skip the 83(b) because the stock is worth nothing. Four years later the stock is worth $4.00 a share and each vesting tranche has been ordinary income since year one, on stock they cannot sell. No fix exists.

Resources

Stage 2 — Housekeeping that diligence will test

  • Confidentiality and invention assignment agreements from every founder, employee, contractor, and advisor — signed before or at the start of work.
  • Assignments to the company of anything a founder developed personally before formation.
  • Board consents for every issuance, every option grant, and every material agreement.
  • Signed grant notices and agreements returned for every option.
  • Equity plan adopted with stockholder approval, and every reserve increase separately approved.
  • State registrations — payroll, income tax, sales tax nexus — wherever employees or activity exist.
  • IP registrations filed and assigned to the company, with recordation.
  • Open source scan before an investor runs one.

Resources

Stage 3 — Convertible instruments

  • Convertible notes are debt with interest and a maturity; SAFEs are neither.
  • Negotiate the valuation cap, the discount, and any most-favored-nation provision — and track every MFN, because applying it years later materially changes the cap table.
  • Understand the pre-money versus post-money distinction. A post-money SAFE fixes the holder's percentage after all SAFEs convert and before the new money, so all dilution among the instruments falls on the founders.
  • Model the stack every time a new instrument is issued, not at the priced round.
  • Address pro rata rights, side letters, and information rights, and keep them in one place.
  • File Form D and the blue sky notices for each closing, not only for the priced round.

Resources

Stage 4 — Preparing to raise

  • Reconcile the cap table to the stock ledger and to every board consent, and fix the discrepancies before anyone asks.
  • Build the model: outcomes at several exit values, under each term sheet, for founders, employees, instrument holders, and the new investor.
  • Know your runway to the day. Leverage comes from a credible alternative, and a founder with three months of cash has none.
  • Run a real process — enough investors in a compressed window that partner meetings overlap.
  • Prepare the data room before the request list arrives.
  • Disclose problems early, with a plan. Discovered later they re-trade or kill the deal.

Resources

Stage 5 — Term sheet economics

  • Liquidation preference. Insist on 1× non-participating. At a modest exit — the most likely outcome — participation costs the common far more than any plausible valuation concession is worth.
  • Dividends. Non-cumulative, when and if declared. Cumulative dividends are a hidden increase in the preference, compounding.
  • Anti-dilution. Broad-based weighted average, with the customary carve-outs. Resist full ratchet.
  • The option pool. Size it from a written hiring plan, not from convention, and understand that a pool created pre-money dilutes the founders alone. Trade pool size against valuation explicitly.
  • Pay-to-play, which disciplines investors to support the company in hard times. Founders should ask for it.
  • Seniority of later rounds — pari passu versus senior — because a stacked preference exceeding the exit value delivers zero to the common.

Illustration. Two term sheets: $30 million pre-money with a 1× non-participating preference, or $36 million pre-money with participating preferred and a full ratchet. At a $60 million exit the founders do materially better under the lower valuation.

Resources

Stage 6 — Term sheet control

  • Board composition. Do not give up board control at the Series A. A 2-2-1 structure with a genuinely mutual independent director is market.
  • Protective provisions limited to the customary list — charter amendments adverse to the preferred, senior or pari passu issuances, redemptions, dividends, a sale, changes to the authorized preferred or board size, significant indebtedness, and a change in the principal business — by a class vote of a majority of preferred, with a deemed-consent mechanic.
  • Resist budget approval, hiring vetoes, low expenditure thresholds, and individual investor vetoes.
  • Drag-along with protections: same price and consideration, fundamental representations only, liability capped at proceeds and several rather than joint, and no imposed non-compete.
  • Founder vesting with credit for time served and double-trigger acceleration, and objective definitions of cause and good reason.
  • No-shop kept short, with termination if the investor withdraws or changes terms.
  • Expense cap negotiated; it is genuinely negotiable.

Resources

Stage 7 — Documents and diligence

  • Use the NVCA model documents: the amended and restated certificate, the stock purchase agreement, the investors' rights agreement, the right of first refusal and co-sale agreement, and the voting agreement. Departures are visible and must be justified.
  • Start the disclosure schedules early. They take longer than the agreements.
  • Expect diligence covering corporate records, the cap table and all equity documentation, IP assignments, material contracts, employment and classification, litigation, insurance, tax, privacy, and open source.
  • The recurring findings are always the same: a contractor with no invention assignment, an option approved but never papered, an unfiled 83(b), and a state registration nobody made.

Resources

Stage 8 — Closing and filings

  • Board and stockholder approvals, including class votes and any convertible instrument holder consents, with the appraisal notice where required.
  • Charter filed, file-stamped copy received, good standing obtained.
  • Verify wire instructions by voice on a number obtained independently.
  • Form D within fifteen days of first sale; blue sky notices in each investor's state.
  • 409A valuation completed before the next option grants.
  • Board reconstituted, indemnification agreements executed, D&O bound.
  • Cap table updated and reconciled; closing binder delivered.

Resources

Stage 9 — Living with the round

  • Board governance changes immediately: regular cadence, materials in advance, minutes that reflect deliberation, and a compensation process that can withstand review.
  • The covenants are real. Financial reporting deadlines, key person insurance, invention assignments from every new hire, and D&O maintenance. Calendar each with a named owner.
  • Refresh the 409A annually and after any material event, and never grant at a stale price.
  • Maintain the cap table monthly, reconciling software to ledger to consents.
  • Explain the equity to employees — the preference stack, the 409A price, and what outcomes at various exit values look like. Silence on this is how equity becomes resentment.

Resources

Stage 10 — Later rounds, bridges, and down rounds

  • Later priced rounds repeat the Series A architecture with a new series, and the negotiation shifts to seniority among the preferred and to whether existing protective provisions are amended.
  • Bridge financings between rounds use convertible notes or SAFEs, frequently with a discount to the next round and sometimes with a most-favored-nation provision. Insider bridges from existing investors raise fiduciary questions and should be run through a disinterested approval process.
  • Down rounds trigger anti-dilution adjustment, and the mechanics matter: a broad-based weighted average adjustment is modest, a full ratchet is punitive. Where the company needs the money and the existing investors will not fund it, expect a pay-to-play structure converting non-participating holders to common or to a shadow series.
  • Recapitalizations — collapsing the preference stack, reverse splits, new money at a low price — are conflicted transactions where the existing investors are also the new money. Use an independent committee with its own advisors, document the alternatives considered, and obtain the disinterested stockholder vote where possible. This is where fiduciary litigation in venture-backed companies actually happens.
  • Bridge to nowhere. A company raising a bridge with no plan and no lead should model what happens if the next round does not close, because the noteholders' maturity or change-of-control rights will govern the outcome.

Resources

Stage 11 — Secondary liquidity

  • Company right of first refusal and co-sale apply to any founder or employee sale; enforce them consistently.
  • A sale above the 409A price is evidence of value and will affect the next valuation. Anticipate it before approving a tender.
  • Information asymmetry is a securities problem: a company facilitating employee sales must provide adequate disclosure to sellers.
  • Company-sponsored tender offers at a fixed price are the cleanest structure, and may be subject to tender offer rules depending on size and breadth.
  • Tax — holding period and, for option holders, whether a disqualifying disposition occurs.
  • Track the QSBS consequences: a secondary purchaser does not acquire qualified small business stock, because the exclusion requires original issuance.

Resources

Stage 12 — The exit waterfall

Build it, refresh it annually, and run it before accepting any term sheet.

  1. List every security with its preference, participation and any cap, accrued dividends, and as-converted share count.
  2. Order the preferences by seniority — senior, pari passu, or junior.
  3. Deduct from the top: transaction expenses, escrow, management carve-outs, and change-of-control payments. These are routinely omitted from founder models.
  4. Pay preferences in order, comparing each series' preference amount to its as-converted amount and taking the greater for non-participating, or applying participation subject to any cap.
  5. Distribute the remainder to the common and to converting preferred pro rata.
  6. Run it at several values, including values below the total preference stack.

The output tells founders and employees what their equity is actually worth in the likely cases, and it is the most clarifying document in a venture-backed company's finance file. Share the substance of it with the team.

Master resource index

Articles

Checklists

Related toolkits

External and primary sources

  • 17 C.F.R. § 230.506 (Regulation D); § 230.701 (compensatory issuances); Form D filing requirements
  • 26 U.S.C. § 83 (restricted property and the 83(b) election); § 409A; § 422 (incentive stock options); § 1202 (qualified small business stock)
  • Delaware General Corporation Law § 151 (classes and series); § 242 (charter amendments); § 228 (written consent); § 262 (appraisal)
  • National Venture Capital Association model legal documents
  • Securities exemptions: 15 U.S.C. § 77d(a)(2), § 77d(a)(6) (crowdfunding), § 77e; 17 C.F.R. § 230.147 and § 230.147A (intrastate), § 230.152 (integration), § 230.251–263 (Regulation A), § 230.501–508 (Regulation D), § 230.701 (compensatory equity), § 230.144 and § 230.144A (resales); 15 U.S.C. § 77r (state preemption of covered securities).
  • Entity and charter mechanics: 8 Del. C. § 102, § 141(a) and (d), § 151, § 152, § 157, § 161, § 202 (transfer restrictions), § 203, § 211, § 228, § 242, § 251, § 262, § 271.
  • Convertible instruments: 8 Del. C. § 157 (rights and options) and § 161 (issuance of additional stock); UCC § 8-204 (restrictions effective against purchasers) and § 8-401 (duty to register transfer).
  • Tax: 26 U.S.C. § 83 and § 83(b); § 409A and Treas. Reg. § 1.409A-1(b)(5); § 422 (ISOs); § 1202 and § 1045 (QSBS); § 382 (loss limits); Rev. Proc. 93-27 (profits interests).
  • Disclosure and antifraud: 15 U.S.C. § 77l(a)(2), § 77q(a); 15 U.S.C. § 78j(b) and 17 C.F.R. § 240.10b-5.
  • Fund-side: 15 U.S.C. § 80a-3(c)(1) and § 80a-3(c)(7); 15 U.S.C. § 80b-3(m) and 17 C.F.R. § 275.203(m)-1.

This toolkit is educational and not legal advice. Venture terms vary with market conditions, geography, and leverage; securities compliance depends on facts specific to each offering; and tax elections carry deadlines that cannot be extended. Consult qualified corporate and tax counsel before issuing equity or signing a term sheet.