When bringing on board a Co-founder pre-seed funding, should I use Common Stock or Stock Options?

As David and Dana indicated, you really need to sit down and talk with an attorney experienced with startups to figure out which stock option will work best. You’re dealing with stock, the possibility of revesting, wanting to know how to treat your pre-financing expenses, and whether those pre-financing expenses should be liked to equity. So, what I’m going to do to help you have more information is to talk about some of the terms that you brought up in reference to stock options.

With common stock, it is usually issued to founders and employees. Common stock generally gives people the fewest and sometimes no rights, privileges, or preferences. Since you’re talking about on-boarding a co-founder, you’re talking about someone who most likely won’t want to sit on the sidelines and have no rights. And, if for some reason, the startup was liquidated, common stock holders won’t get anything if there are preferred stock holders (presuming there is a legal provision in your charter known as a liquidation preference).

With stock options, you’re giving the co-founder the opportunity to buy stock in the startup. The co-founder would not be under any obligation to purchase stock at an agreed-upon price during a certain period of time. Stock options are written up between consenting parties in a contract and the options generally represent at least 100 shares of stock. There may be other options that may be included such as put and call options. When you talk with an attorney, make sure that if this is the route you take, your stock documents are clear regarding violations of any clause in your agreement.

Those aren’t your only options. Restricted stock helps the purchaser avoid taxes if taken on the right way (within 30 days and the shares must be bought for their fair market value when granted…and there is a special election form that must be filed with the IRS during that 30 days). The downside is that the capital gains holding period starts immediately.

There are other options available to you as well, but you really need to talk with a qualified attorney because you have a lot of special considerations for your start-up. Since you’re a startup, your budget is important. LawTrades is a marketplace of attorneys (many of which specialize in helping startups) that would be happy to answer your questions related to stock options, equity, vesting / revesting, and even fundraising at an affordable rate.