Personal Finance for Startup Founders Part 1

You’re a founder. Building a business is your thing. But if you don’t want to grind forever,
managing your personal finances is the next thing you’ll need to master.

Get it wrong, and years of hard work will slip away. You’ll miss out on key tax breaks and
make critical mistakes that could cost you hundreds of thousands of dollars (if not more).

Get it right, though, and you’ll have a financial cushion that lets you take bigger business risks
without losing sleep. Heck - maybe you’ll be able to retire on your terms, building wealth that
may even outlast your business.

We’re ditching the generalities and getting into the specifics of what you should (and should
not) be doing. This is Part 1 in a three-part series:

The goal of this guide is to give you a rational, straightforward plan. You’ll have the tools and principles to turn all that hard work into the financial freedom you set out to achieve.

HOW TO USE THIS GUIDE

Think of this guide as your financial toolkit. Use it however makes sense for you. Whether it’s brushing up on your knowledge or dipping in when big money decisions come up.

• Sharpen your financial know-how: This guide is loaded with advice to help you handle founder-focused essentials like tax planning, investing basics, and managing equity.
• Choose your own adventure: No need to read cover-to-cover. Jump straight to what you need most. Already incorporated? Skip that part and dive into sections on tax-saving strategies, personal investing, or using QSBS to your advantage.
• Keep it handy for key decisions: When facing a big decision - like managing founder equity, maximizing tax benefits, or optimizing for future exits - you’ll have a resource ready to guide you.

WHY’D WE MAKE IT?

Because we see conversations and questions from Hampton members all the time around these topics. “Does my business need to be a C-Corp to take advantage of QSBS? I have a few cash-flowing LLCs, what’s the best tax strategy? How do I set the price of my shares?

It only made sense to partner with our friends at Carry. Finance for founders is literally their jam. And there may be no better resource in the world on this topic other than their founder, Ankur Nagpal. He’ll take it from here.

A Bit About Ankur Nagpal

My name is Ankur Nagpal and I’m a second-time startup founder. Everything in this guide is a result of hard-won lessons over the last decade building and investing in startups.

• I was born in India and grew up in Oman in the Middle East before moving to America for college.
• I started a business out of my dorm room that built and monetized Facebook applications. I made millions of dollars in this business (that I paid stupidly high taxes on).
• At 24, I started Teachable. Over the next 6 years, we scaled the business to $60M in ARR and eventually exited for a ~$250M acquisition. Selling the company was an inflection point for getting interested in personal finance and startups.
• At 31, I started Vibe Capital, an early-stage venture fund that raised ~$80M and invested in 80+ tech startups.
• At 32, I started Carry — a platform with the mission of helping business owners build wealth by being smart about money and taxes.

General Principles

1 - The majority of your time should not be spent on Personal Finance

Ironically enough, you should not spend too much time on personal finances.

Startups are largely a binary outcome — if your business is successful, you will be rich. Otherwise, you will likely make nothing.

Spend most of your time making something people want. Talk to customers, improve your product, and grow your revenue.

2 - Beware of premature optimization

It’s worth getting some of the basics right up front. It’s a game of optimizing when the time is right. There are a couple of really important things you don’t want to mess up:

• How you incorporate
• Accidentally messing up your QSBS eligibility (more to come later)

But, beyond that, a lot of what’s in this guide will help you optimize for your situation as a founder. However, it will unfortunately not be the difference between a successful and unsuccessful company.

3 - The goal is not just to win financially yourself, but also to enable those around you to participate in the upside

As a founder, you directly impact the lives of so many people around you — your team, their family, your investors, and more.

The goal of this collaboration is not just to teach you how to win yourself, but how to enable those around you to share in the success as well.

How Equity in a Startup Works

OVERVIEW OF EQUITY

An easy formula to remember:

Company Value = Share Price * Number of Shares

If you ever know two out of the three numbers above, you can use arithmetic to calculate the third.

It doesn’t matter if this is a tiny startup or a $1T public company, the formula always holds up.

For public companies, you may see the term “market capitalization” used interchangeably with company value or valuation.

SETTING UP A NEW BUSINESS

When you create a new startup on Stripe Atlas, it will automatically create a structure like this:

You can use the formula above to calculate a company value of $100 (10M * $0.00001 / share).

As a founder, you can pay $85 to buy 8.5M shares while leaving 1.5M shares for the option pool.

RAISING CAPITAL

What happens when you add investors? Instead of the investors buying anyone’s shares, here’s what happens instead:

Brand new shares are created (this is called “dilution”)

These shares are added to the total number of shares in the company and your investors pay the company a higher “preferred share price”

Let’s run some numbers with the example above. Let’s imagine the company raises $2M at a valuation of $12M:

Company would get $2M from the sale of 2,000,000 new shares and your equity would now be worth $8.5M from your existing 8.5M shares.

COMMON VS PREFERRED SHARES

All shares in a company are not created equal! Typically, the shares you receive as a founder are “common” shares and the shares investors buy are “preferred” shares.

The differences in how the shares are treated vary on a case-by-case basis (these are written in fundraising paperwork when you raise capital) but the most common way is preferred shares generally have a “liquidation preference”.

• Liquidation preference refers to the order in which shareholders are paid when there is an exit. Preferred shares typically receive their money back before anyone else gets paid.
• Let’s imagine you raise $5M and your investors own 50% of the company.
• If you sell the business for $7M, because of the liquidation preference your investors would get $5M (vs their 50% share of $3.5M) — leaving you with only $2M.

FUNDRAISING VIA A SAFE

• In practical terms, most early fundraising rounds are on a SAFE “Standard Agreement for Future Equity”.
• The way a SAFE works is it postpones the math of creating new shares and transferring them to investors — so the mechanic described above, does not happen till the first “priced round”.
• We’ll talk more about how SAFE notes work later.

INTERNAL VS EXTERNAL SHARE PRICE

When you started the company, the share price was $0.0001 / share.

But, when you raised money investors paid $1/share. What is the actual share price of the company?

At any given point, there are two active share prices for the company:

• The “internal” or 409a share price
• The “external” or preferred share price — what investors most recently paid for the company

Another way of thinking about this is the internal price is the price for common shares, and the external price is for preferred shares.

409a VALUATION

At least once a year (or every time you raise capital) you need to get a 409a valuation for the business. Whatever tool you use to manage your cap table (like Carta or AngelList Stack) can do this for you.

The goal with your 409a valuation process is to have the LOWEST possible 409a price since all the equity you give out will be less valuable with a higher 409a price.

In the early days, you can aim for the 409a price to be less than 10% of your preferred share price. You can also negotiate with the 409a provider before “accepting” their valuation — it’s 100% worth pushing them as low as they will go. Eventually, it settles at about 20% of your preferred price.

VALUE OF EMPLOYEE EQUITY

When you add employees, you give them shares or options that are granted at the 409a or internal price.

If you want to hire an engineer that you want to give 1% to, you would:

• Give them 120,000 shares
• Assuming a 409a price of $0.10 (10% of preferred) — their shares would be “worth” ~$108K on paper
• The formula to calculate the worth of shares: Number of Shares * (Preferred Share Price - Internal Share Price)
• Typically the shares “vest” over a period of time and are unlocked with tenure at the business
• Assuming a 4-year vest, the value of the equity becomes ~$27K / Year

EMPLOYEE EQUITY WORKSHEET

Something important to convey to team members is their initial purchase price is locked in forever. As the company grows, the preferred price keeps rising which keeps increasing the value of the equity with time.

The best way I’ve found to show future employees this is by using this spreadsheet and walking them through different scenarios

How to Incorporate Your Startup

STEP 1: SET UP A C-CORP

The most important thing here is you want to ensure you set up a C-Corporation for your company.

The most typical structure is a Delaware C-Corp and it’s what most incorporation tools will automatically set up for you.

HOW C-CORPS WORK

• C-Corps have the most flexibility and support to raise capital. Most investors will insist on only investing in a C-Corp so they aren’t responsible for unexpected taxes.
• A big benefit of C-Corps is they make every single shareholder eligible for the most generous tax break in America — QSBS, which we’ll talk about later.
• Unlike an LLC or an S-Corp, a C-Corp is NOT a pass-through entity. Pass-through entities mean profits and losses automatically pass through to shareholders — on a C-Corp, they are held at the corporate level until a distribution is made.
• A perceived downside of C-Corps is they have “double taxation” — profits are taxed on the business level, and then again when paid out as dividends. As a startup, you will likely lose money for quite a while so this isn’t a huge concern.

STEP 2: BUY YOUR FOUNDER SHARES FROM THE COMPANY

This is another easy step that people mess up all the time.

Unlike an LLC, with a C-Corp, you need to show a record of buying your shares from the company.

Here’s how it would work with Stripe Atlas as an example:

• Stripe Atlas will create 10,000,000 shares in the new business at a par value of $0.00001 / share. This means the company is worth $100.
• You need to pay $85 to buy 85% of the company or 8.5 million shares. Document this purchase!
• The remaining 15% is in the employee option pool to hire team members down the line.

The reason it is so important to document this step is if your company is ever sold for a lot of money if you are claiming the QSBS exemption, you need to have clearly documented evidence to show the share purchase directly from the company.

STEP 3: FILE AN 83B ELECTION

This may be the most commonly messed up step at the incorporation stage and it can be very, very expensive.

An 83b is a tax election that tells the IRS you wish to be fully taxed for the total value of all shares today vs as they vest.

WHY AN 83B IS IMPORTANT

Consider a scenario — two co-founders Alex and Drew of Chainsmokers Inc., each of them are vesting their equity over 4 years.

They both bought their shares from the company at $0.00001 / share but only Alex filed his 83b. Here’s what would happen:

• After a year, Chainsmokers Inc. raise $2M at a $20M valuation. As a result, they need to get a new 409a and their internal share price jumps to $1 / share.
• Alex filed his 83b — so as Alex vests his shares, he’s good. But since Drew has not filed an 83b, every time he vests shares, he owes taxes on the “value” of the shares since he was granted them.
• What’s worse is Drew may not actually even have money to pay the taxes on these shares — yet, he has to every time he vests them. This can be extremely, extremely expensive.

HOW TO FILE AN 83B

• An 83b needs to be filed in the mail within 30 days of the stock grant — it’s an archaic process, but extremely important.
• If you use a service like Stripe Atlas or Angellist Stack, they will file it for you.

STEP 4: CREATE A BUSINESS BANK ACCOUNT

You don’t want to be comingling business and personal expenses. It’s super painful to undo later on — and gets quite messy.

I recommend using Mercury for a business bank account.

OPTIONAL: LOAN A SMALL AMOUNT OF MONEY TO THE BUSINESS

Chances are you may want to start spending money on some stuff before you have raised any capital.

One way around this is to structure a loan agreement between you and the business where you personally lend money at a market interest rate (around 4.5% right now) — after you raise money, you can pay yourself back (and it’s untaxed since it’s a loan).

Introduction to QSBS

The four magic letters of startup liquidity: QSBS

QSBS stands for Qualified Small Business Stock and it is the single most generous tax break in America today.

The people who benefit the most from QSBS? Startup founders, employees and investors.

OVERVIEW

Here’s the TL;DR for everything in this section:

• QSBS is the single most generous tax break in America for startup founders, employees and investors. You pay no taxes on $10M of gains.
• You should understand how QSBS eligiblity works as a startup founder early on so you don’t accidentally mess something up.
• It’s mostly a waiting game — you have to wait 5 years for your shares to be eligible. If you sell before then, you can do a QSBS rollover.
• When your business grows and it’s looking likely that your company will be worth a lot of money, you can look into gifting shares and setting up trusts to “stack” or multiply your QSBS exemption.

To visualize how powerful this is, consider this range of outcomes for a founder who owns 20% of her business and sells her company at different price points:

If they are in a state with no state income tax or in any of the 40+ states that respect QSBS, your take-home is the same as the numbers above.

HOW QSBS WORKS

When you buy shares from your company (as all founders do at incorporation) and hold those shares for 5 years, you pay 0 federal taxes when you sell your business on either $10M or 10 times what you paid to acquire the shares.

40+ states also follow QSBS legislation so you could end up having 0 state taxes in most parts of America. California, famously, does not respect QSBS legislation so you are still on the hook for CA state taxes.

• Full list of states that do not respect QSBS tax treatment is California, Alabama, Mississippi, Pennsylvania, New Jersey and Puerto Rico. Hawaii and Massachusetts have partial eligibility.
• The QSBS limit is per-shareholder — so every single stakeholder in your business gets their own $10M limit. With some smart tax planning, you can use this rule to multiply your own exclusion.

QSBS tends to be less about what to do vs what not to do. By default, most startups will automatically qualify unless they accidentally trip it up.

QSBS REQUIREMENTS

1. ACTIVE C-CORPORATION

The business must be an active C-Corporation in the United States.

• Active means you can’t get the QSBS clock ticking on a holding C-Corporation that does nothing at the time.
• This only applies to domestic C-corporations.

2. THE ASSET TEST

The company must have gross assets of $50M or less at all times before and during the time the equity was issued:

• Assets refer to the cash, property and other assets held by the business. This does NOT refer to the valuation at which you raise money.
• Most businesses have quite a while during which they still qualify. But if you have $10M in the bank and raise a $40M Series B, the stock issued at or after the Series B would NOT qualify.
• As long as your stock is QSBS eligible at the time, it does not matter if eventually the company exceeds $50M in assets. Your stock is still qualified — but stock issued after that point would not be.

3. QUALIFIED TRADE OR BUSINESS

At least 80% of the company’s assets must be in a qualified trade or business.

Most services businesses are excluded from QSBS qualification. This includes but is not limited to:

• Perform services related to health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, finance, banking, insurance, leasing, investing, or brokerage
• Rely on an employee or owner’s reputation (i.e. if it endorses products or services, uses an individual’s image, or has an employee make appearances at events or on media outlets.)
• Produce products, such as fossil fuels, for which percentage depletion (a type of tax deduction) can be claimed
• Operate a hotel, motel, restaurant, or similar business

Are a farming business At the end of the day, QSBS is a “stance” your accountant needs to take. I’ve seen lots of businesses that perform services claim they are a technology company vs. a services business.

4. HOW TO NOT ACCIDENTALLY FUCK UP QSBS STATUS

The most common way is repurchasing shares from departing employees or other stakeholders.

If you are buying back shares from employees that are a significant amount, always have an attorney double check that the transaction is ok. Most people don’t realize that this can adversely affect QSBS status for shares before and after!

Other less common ways of messing up QSBS:

• Putting a big part of your balance sheet in non-cash and cash equivalent instruments — if you invest more than 10% of company assets in mutual funds or corporate bonds that pay out more than 2 years in the future. We’ll cover this in the cash management section, but be careful here!
• No longer being a qualified trade or business.
• Exceeding over $50M in assets.

QSBS FOR OTHER SHAREHOLDERS

If your company does well, part of your job as a founder is to ensure you make the people that believed in you wealthy as well. While QSBS affects you more than anyone else, your investors and employees can also benefit substantially from it — so let them know about their eligibility as well.

QSBS FOR INVESTORS

You likely do not need to educate your investors about QSBS — most of them already know but it doesn’t hurt to share.

The biggest way to unlock your investors unlocking QSBS is to allow them to own shares in the company directly as soon as possible. If they have only invested via a SAFE, their clock doesn’t start ticking till the first priced round.

Some investors take the stance that a SAFE starts the QSBS clock ticking — it’s a very aggressive stance (I don’t believe it will stand if challenged) — but it’s such a big benefit that a lot of investors see it being worth the punt.

If you know you may be near a liquidity event — and the investors have not hit the 5 year mark, you could see if they would like to prepare for a QSBS rollover.

QSBS FOR EMPLOYEES

Your team probably doesn’t know about QSBS - educate them!

Think about ways you can get your employees the ability to earn shares as soon as possible (vs options) — in the early days when your company strike price is low enough, it’s quite affordable for them to buy shares directly.

What I did at Carry is gave out restricted shares to all early team members — they had to pay a nominal amount to buy the shares (it’s still subject to vesting) but the QSBS clock has started ticking for all of them already.

Let's Recap

Want to See Part 2? 

If you see a $20 bill on the sidewalk, you pick it up, right? So why leave potentially hundreds of thousands (or more) on the table by skipping over the basics of startup finance? 

In Part 2 of our Hampton's collaboration with Carry, we talk about how to grab some of that low-hanging fruit:

• Big tax breaks you might be missing.
• Save more for retirement with a tax-free growth strategy (there's a deadline on December 31st for this).
• What tasks you should be doing on a monthly basis.
• Talk numbers with confidence when schmoozing investors.
  

Part 1 was all about getting your business off the ground and setting yourself up for success. Part 2? It’s about running the show. Truly understanding your finances, making smarter moves with your money, and ensuring every dollar works as hard as you do.

Go check out the guide now... it's free, you lucky thing!