Article Contents
Just as launching and operating a startup requires a dose of courage and judgment, so too does winding one down.
While it’s tempting to look for a simple checklist of shutdown tasks, in reality two companies rarely have an identical wind-down process.
This article outlines a number of important considerations for a founder winding down a Delaware-incorporated startup.
Introduction to winding down a startup
The concepts, rules, and processes involved in winding down a startup are often unintuitive and deeply intertwined. Importantly, the wind-down process always depends on the company’s unique current and historical context.
While the filing of corporate dissolution paperwork can often be completed in less than a day, the duration of the overall wind-down process for a startup varies based on a number of factors.
Some wind-down processes are straightforward cases, while others involve many complexities; knowing where the company falls on that spectrum is challenging without experience.
A startup’s wind-down process should be a function of its unique current and historical context.
In this article, we walk through three major groups of jobs to be done when winding down your startup:
Realizing value in the company
Fulfilling legal responsibilities
Handling wind-down operations
Realizing value in the company
One of the key goals when winding down a startup is to maximize the value that is returned to company stakeholders.
Realizing value can be broken into two sets of jobs:
Realizing (selling) assets
Managing liabilities
Asset realization
The most time-consuming wind-down activity is generally the sale of the company or its assets.
While not all dissolving startups have assets of material value, those that do should budget enough time to the wind-down process to allow them to be sold.
Depending on the assets, a successful asset disposition process may take a month — or a year or more.
If the company has meaningful assets and engages a third-party broker, the process typically takes 3-9 months: the first month focuses on establishing buyer interest with the remaining months dedicated to due diligence and executing a transaction.
The value of a startup's IP is usually dependent on the know-how and presence of the founders and key employees.
The greatest value of an early-stage startup’s assets is often in the company’s intellectual property. The value of this IP in turn is usually dependent on the know-how and presence of the founders and key employees (e.g., engineers who are familiar with the company’s codebase).
As a result, the process to successfully maximize the value of company assets ideally begins when the company still has enough cash runway to retain the founders and/or key employees.
Liability management
Managing liabilities is one of the most critical activities when winding down a startup. Important liabilities include tax obligations, employee obligations, and debt obligations.
As part of founders’ fiduciary duties to the startup (discussed further in the “Fiduciary duties” section below), founders are expected to make reasonable efforts to maximize the value of any remaining company assets. Any realized value should be applied to meet outstanding liabilities.
Tax obligations include federal and state income taxes along with state franchise taxes. A startup has tax obligations federally, in its state of incorporation, and potentially in states in which it conducted business.
Startups have contractual and government-mandated obligations to their employees. Contractual obligations are set forth in company policy documents and individual employment contracts while government-mandated obligations are determined by federal and state law.
Managing debt obligations involves notifying and repaying (where possible) creditors and investors. For insolvent companies (companies unable to fully pay liabilities), the priority order of creditors becomes important. Startups must respect the notice and claims priority requirements dictated by federal and state law.
Fulfilling legal responsibilities
Fiduciary duties
The primary responsibility a founder has when winding down their startup is to act as a “fiduciary” to the company and its stakeholders.
Fiduciaries under Delaware law have a legal responsibility to act in the best interest of the company and its shareholders. In limited cases, this duty extends to certain other stakeholders, like creditors.
In their role as company directors and officers, founders owe two primary fiduciary duties to their company and its stakeholders:
The duty of care; and
The duty of loyalty.
During the company’s lifetime, the duties are owed to shareholders. Upon insolvency, the duties are also owed to creditors.
Common examples of situations that implicate fiduciary duties for early-stage companies include:
Fulfilling the duty of care by making a good-faith effort to maximize the company’s value (such as by engaging a third-party to assist in the sale of assets).
Fulfilling the duty of loyalty by ensuring any agreements a founder enters into with an acquirer are fair to the company.
Fulfilling the duties of care and loyalty to ensure distributions of assets are made appropriately to creditors and residual amounts to shareholders.
Legal structuring
In addition to upholding fiduciary duties, winding down a startup requires determining the legal structures that culminate in the dissolution of the company.
Legal structuring includes the formal set of legal agreements, company approvals, and filings to formally end a company’s legal existence.
Most early-stage startups incorporated in Delaware pursue one of three dissolution structures:
Administrative dissolution
Short form dissolution
Long form dissolution
Short form and long form dissolution are the two statutory dissolution structure options in Delaware. The Delaware Code outlines specific steps corporations should take to follow each of these structures.
Whenever possible, legal structuring is best undertaken with the company’s legal counsel.
Filings
Companies are usually required to make a number of formal legal filings as part of the wind-down process.
Common examples include a form for a certificate of dissolution (in connection with the relevant dissolution structure) and foreign qualification withdrawals.
Operating the wind-down
A smooth startup wind-down often entails executing a number of operational jobs - many of which happen in parallel with realizing company value and the fulfillment of legal duties.
While not all operational jobs listed here are strictly required legally, they usually provide a high return on time spent by limiting potential issues during the wind-down process and helping safeguard reputations and relationships.
Key sets of operational jobs include the following, discussed below:
Closing accounts
Managing stakeholder communications
Managing tax obligations
Closing accounts
As part of the wind-down process, startups should terminate vendor contracts and close bank accounts.
Accounts payable to vendors represent liabilities for the startup and associated contracts should be terminated as quickly as possible. Specific vendor contracts may vary, but common examples for startups include office leases and software subscriptions.
Once all expected and remaining cash is distributed out of the company’s bank account(s), the bank account(s) should be closed.
Managing stakeholder communications
A startup’s stakeholders may expect, and in some cases legally require, notice of the company dissolution. Key stakeholders include the company’s employees, creditors, investors, and customers.
Federal and state laws specify legal notice requirements to stakeholders for companies winding down, particularly for employees, creditors, and shareholders. The number and specifics of each of these parties may lengthen the duration of the startup’s wind-down process.
For employees in particular, their state of residence may mandate certain termination procedures that can extend a wind-down timeline.
Outside of legally-mandated notice requirements, communication to stakeholders is at founders’ discretion.
Depending on the nature of the relationships, founders should consider the type and frequency of updates to employees, creditors, investors, customers, and the general public. Communications may range from personal conversations to email or social media messages to press releases.
Updates around a company wind-down may include personal and professional reflections, messages of appreciation, and/or references to what’s next.
Managing tax obligations
In order to file the certificate of dissolution in Delaware, a startup must pay any taxes due at the state level, along with required yearly franchise taxes for each year of operation. As a result, the startup’s timeliness in meeting tax obligations may alter the duration of the wind-down process.
Final tax returns should be filed within specified time windows after the company’s dissolution and/or dissolution authorization.
Wind-down guidance with Onsen
At Onsen, we guide early-stage founders as they wind down their startups. Our team of experienced legal and finance advisors and operators provide tailored solutions to help you efficiently and compliantly wind down your company.
Contact us to discuss a strategy for your startup.