Big-law attorney turned startup advisor and advocate. I have depth of experience and knowledge in a variety of startup issues from corporate governance to financing to IP. Let's change the way business is done, one startup at a time.
I am a corporate attorney and have advised clients of protection of the intellectual property integral to their operations. In the intellectual property world, there are three types of federal registration you can pursue - patent, trademark, and copyright. Patents secure ideas, trademarks secure brands, and copyrights secure written product. If you are looking to protect your idea, you may think about filing for a patent. The first step is securing a provisional patent that sort of holds a spot for your idea while your actual patent application is pending or your idea goes into development. The patent process is complicated and lengthy, so I would recommend getting the advice of a patent attorney if that is something you want to explore. Not all ideas are able to be patented, and you may find that a patent is not an option for you. The other option is to maintain your idea as a trade secret. This essentially means that you are careful about who you share it with, and when you do share it with anyone, you have an Non-Disclosure Agreement in place that prohibits them from disclosing your idea to anyone else or misappropriating it for themselves. If you had a company built around the idea, you would establish an in-depth trade secret program designed to prevent disclosure of your idea outside of the company. (e.g. Coca Cola has a trade secret program built around the recipe for Coke.) As an individual, you would just need to be careful and, to be extra thorough, get people with whom you share your idea to sign NDAs. There is no federal registration process involved in maintaining a trade secret, just common sense and consistency with your protective practices.
I am a corporate lawyer for startups, and advise on this type of issue frequently. Even though users don't get source code, they are privy to proprietary information, so your concern is legitimate. There are good suggestions in this thread of the types of legal concerns you might have and how to address them. I would suggest that, whatever language you end up using, you can incorporate it into "terms & conditions" and use a "click-wrap" structure to implement it. This is pretty standard "check here if you agree to our terms & conditions" box. It's unibtrusive, and an important part of protecting your company's confidential information and trade secrets. Happy to chat further.
I am a startup lawyer and mediator, and my advice in situations where there is not an agreement in place that adequately resolves a conflict is to recommend mediation. If "kitchen table" negotiations have failed to resolve the issue, before you spend tens of thousands of dollars on litigation, the best route is to attempt face-to-face mediation with a neutral facilitator. It is usually less expensive than litigation and generally stays more positive and has a more mutually agreeable outcome. Feel free to contact me if you want more background on what mediation entails.
I deal extensively with corporate and securities law for startups, who face the question of what entity type and tax elections to make quite often. The answer to your question is that you may HAVE to make the switch, as S-Corp status may no longer be an option if you are taking on investors. It depends on how many investors you will have and what type of investors they will be. There are a number of requirements in order to be able to elect and maintain S-Corp status. Among them are that you must have less than 100 investors, and those investors must be individuals (or certain types of trusts). If you take on investors that bust either of those requirements (or any of the others not mentioned here), then you would no longer be allowed to elect S-Corp status. If we assume you have the option to keep S-Corp status after you take on investors, we have to look at both investor interests and your business interests. For investors, the question becomes whether they want to be taxed as an S-Corp. There are plenty of reasons that they would not (and would prefer C-Corp taxation), but everyone is different. They might be fine with it. From a business perspective, in order to maintain S-Corp status, you can only have ONE class of stock. This means that your investors would get the same shares as you have, with the same voting rights, etc. However, it is common business practice, especially in a major financing round, for investors to get a new series of preferred shares (e.g. Series A) with rights different than the common shares. In order to do this, you would have to create a new class of shares, which would also require you to switch to C-Corp status (as you would no longer be eligible for S-Corp status). All that said, this is just informational, and I am happy to talk further about your specific situation.
Founders conflicts account for a majority of startup failures, so your storyline is not uncommon. The way other founders have dealt with the same thing can vary depending on their comfort level with the team, the plan, and the risk. From your vantage point, whether you as a group sell/license your design or you "cash out" when your team gets investors to develop the product themselves, the net effect is about the same because the second option is basically you selling your % to them. (Assuming you get a fair price for your shares.) There are a few questions you want to ask yourself:
1. A provisional patent is not a patent, and should the group ever get an actual patent, do you want to own a % of it? Do you really want to be on the patent for the next 14 years? There are pros and cons here. If you leave the team, my guess is that they won't want you on the patent. With only a provisional patent filed, timing is an issue b/c they could just wait for the provisional patent to expire before filing a full patent. If you were on the patent, it might give you lingering rights to the design that would devalue their product. However, if you were on the patent, you could generate a royalty stream from an exclusive license to their ongoing company (regardless of whether you own shares in the company). This is a very basic summary - there are intricacies here that would be best explored with a patent attorney.
2. Before you go and sell your %, make sure that you and your co-founders have the organization, shares, terms, etc. of your company documented properly. Otherwise, "selling your %" could mean relatively little (especially to investors who would rather not have to pay you out when the time comes). What do your organizational documents, if any, say? This is my area of expertise, and I would be happy to chat further about your particular circumstances.
3. It comes down to what is more valuable to you - the cash you get in leaving the company, or the possibility that sticking with it and contributing in your own way (which you could discuss with your co-founders) might result in something great? You certainly don't want to be a deadweight, but everyone plays their own role - and there may be decent options for you within the company.
This is typically a longer conversation with no easy answer. Let me know if you want to chat.
The first question I ask clients who are looking to be paid in stock (whether they are founders, early employees, or contractors) is what are the terms of the stock? For instance (I am assuming here that you are a contractor rather than and employee), it is likely that (if they are setting up wisely) the startup's "founder's stock" is subject tot a vesting schedule. If you receive "founder's stock", you will be subject to the same vesting schedule. Ask yourself if that is realistic...if your work for them will be completed in six months, but the stock you receive is on a three-year vesting schedule, you might want to re-think accepting stock on the same terms as the founders. That being said, assuming you are ok with the stoic you are receiving, here are answers to your questions:
1. A "stock grant" to a contractor and receiving stock as payment for your services are pretty much the same thing. Is there a different understanding of the terminology that is troubling to you? Bottom line is that, as a contractor, you aren't receiving the stock as a "gift" or an incentive payment (like an employee would). (In some states, corporations aren't even allowed to "gift" stock - if the corporate issues stock it has to be in return for consideration (i.e. something of value).) No matter what you call it, you are receiving it as direct compensation for your work. You will need an agreement that makes clear that the stock is issued as compensation. Your basis in it for tax purposes will be the value assigned to the stock when it is granted to you or when it vests (unless you file a timely 83(b) election with the IRS - which calculates basis at the time of grant regardless of vesting).
2. If the stock is paid to your company, it will be owned by your company. So, you will not, as separate individuals, be able to make different decisions regarding "your" shares of the stock. The company will be the one to benefit directly from any appreciation in the value of the stock. And, if you want to distribute that value to you and your colleague, you'll have to pay the various levels of taxes applicable when it runs through a C-corp (i.e. corporate level tax and then personal level tax). If it is granted to you as individuals, then you each have control over when/if you dispose of it and the proceeds come straight to you and are taxed at the personal level only. Keep in mind that you or your company will also be taxed on the value of the stock granted as income (1099-MISC).
Happy to chat further.
I am going to assume you are working from home since you are asking this question...Your business address can be anywhere that your business can receive mail. So, if you have an office, use that. If you have a friend with an office, ask if you can get your mail sent there. A more legit solution may be to get a Virtual Office at one of the many shared spaces popping up around your town. Usually, these co-working spaces will have a "virtual office" option whereby you can pay a monthly fee and use their address for your business, get your mail forwarded, and get discounts on conference space.
You've received a lot of answers to this question already, but the short answer is that it is a long story! The easiest way for me to respond is to direct you to a blog entry I wrote on the topic, which spells out the most common methods of valuation and their typical applications: http://www.stantonlawfirmllc.com/2014/11/a-diamond-in-the-rough-how-should-i-value-my-business/
Let me know if you want to chat!
Most IP attorneys that I know that work regularly with startups would be happy to sit down for 30 minutes and discuss this issue with you (free of charge). They may not be able to give you a definitive answer, but they would definitely let you know what questions to ask to arrive at it. As attorneys, we generally welcome opportunities to demonstrate our knowledge and skill, so that potential clients know that we are capable and experienced. Then, when you decide to patent (or institute a different type of IP protection plan), you will (hopefully) hire that attorney to help. So, my suggestion is to tap into your network and ask around about decent IP attorneys who might be willing to chat. Keep in mind that, just because you talk with an attorney doesn't meant they can bill you for it. Usually, you will have had to enter into an Engagement Letter or other agreement (where they tell you they are charging you) for their services before they are ethically and legally able to start charging you.
You can document such an agreement in any way you like. Typically, you might see provisions regarding contingent employment & incentives in your consulting agreement. For an agreement like this to be valuable to you, you would want to set forth the terms in detail, including a good faith effort to obtain Series B, the terms on which the executive position/equity is offered (i.e. as a ROFR, automatic trigger upon financing, performance-based or other metrics, etc.), what exact position/responsibilities would be offered, what type and how much equity would be offered and on what vesting schedule (or, if preferred, you can leave these terms vague). I think it would be unlikely that a startup would want to get that specific in advance. However, it can be tough to put agreements of this sort in any sort of binding writing because the needs of a startup can change over time depending on performance, vision, investors, etc. It's a double edged sword: If you don't put these agreements in writing, then they are not binding, but if they are in writing, they may end up being out of line with actual need of the company (or you) when that time comes along.
So, don't be surprised if a startup doesn't want to be bound to anything in writing and make sure that your agreement for consulting services is fair without assuming you'll get future employment or equity.