Introduction

There’s a lot more to winding down a startup than meets the eye. From withdrawing from foreign-qualified states to selling or auctioning assets and IP, filing final federal and state tax returns, redistributing capital, negotiating vendor/lease agreements, and much more - there’s substantial know-how (not to mention the emotional toll) needed to compliantly and efficiently run a dissolution.

At Hustle Fund and Sunset, we know how hard it is to wind down – logistically, financially, mentally – because we’ve all been through it ourselves. So we put together this guide for you to help better explain what’s involved in the wind-down process and how you might start thinking about it.

As a note, nothing contained in this article is considered legal or accounting advice.

How to think about shutting down

As founders, shutting down is perhaps the greatest fear we have. It’s a thought that so many of us keep buried, to protect ourselves from the difficult reality that 9/10 vc-backed startups don’t make it.

Startups are a game of outliers - founders who give it their all and squeeze every drop of runway left. And we hear these outlier stories of folks with binders full of credit cards, debt up to their ears, only to miraculously one day find product-market-fit.

These are great stories and we believe founders should continue to stay relentless in their pursuit of success — but we’ve also seen the countless downsides of this attitude and the lack of education around what happens if you run out of time and money, without any plan for what to do next.

We believe every founder should start understanding their options at 9 months cash-out.

What are your options?

At the 9-month mark, you’re giving yourself enough time to:

• See if going out to raise an additional round of financing or a bridge round is possible
• Start exploring M&A opportunities - stock sales, asset sales, and acquihires
• Learn more about the wind-down process and the costs/time involved

Ideally you are having this conversation actively with your lead investors as well as they will be part of helping you with introductions both on the fundraising or potential M&A side. You should have a picture of your cash runway, and the various levers you might have to extend that runway if a fundraise doesn’t materialize. 

Something that’s important to note is many of these items above cost time and money. When we say 9-months cash out, that’s if you bring your bank account to zero, which generally speaking - is not a great plan.

Fundraising doesn’t necessarily cost you money, but it does cost you a significant amount of time. If you’re interested in exploring selling, you might consider hiring a banker or advisor who might need a retainer fee and there are potentially large legal bills associated with any drafting of an asset or stock sale. And lastly, there are of course legal, tax, and other fees associated with winding down.

So if you’re at “9-months” cash out, it can really be more like 6 or 7 months.

Deciding to shut down

If you’ve explored some of the options above and either decide they’re not right for you or you weren’t able to achieve the goals you set out for them, then it might be time to consider winding down. If you still have capital in the bank, you’ll have more flexibility, options, and decreased stress when going through the dissolution process. If, however, there are outstanding debt obligations, things can become more difficult, time-consuming, and expensive.

Unfortunately, winding down isn’t quite as simple as it is to incorporate a startup. There are legal, tax, and other operational aspects that you’ll need to complete to make sure you’re doing right by and protecting your employees, investors, vendors, and most importantly - yourself.

Where to start

The first place we always recommend starting is connecting with experts or other founders who have shut down in the past. So many founders feel they are the only ones who are going through this. This weight and loneliness can be extremely taxing and is completely untrue. Almost all “great” founders have experienced multiple “failed” startups in the past before hitting it big.

We also recommend potentially talking to an executive coach or therapist at this time. For many founders, this might be one of the most challenging times in their lives and it’s important to make sure you’re taking care of your mental and physical health.

You should also start chatting with your corporate counsel, accountants, and some of your trusted advisors and investors to begin crafting a plan and getting an understanding of what the next steps might look like. The team at Sunset has also helped hundreds of VC-backed tech startups wind down and is always available to chat and offer any guidance as you’re thinking through things.

What to look out for aka how much do you owe, to whom, in what order? 

As you’re talking to advisors, counsel, and your accountants, there are a few things to start preparing and thinking about in this process.

Liquidation preferences

Your liquidation preference stack plays an important role in the wind-down of a startup. The pref stack establishes a clear hierarchy for distributing any remaining assets and ensures that certain obligations are met before others (these are typically defined by their legal requirements).

Understanding this stack is essential for founders, investors, and creditors, as it directly impacts all stakeholders during the liquidation process.

We’ll talk more about the different stakeholders below when it comes to these preferences:

Debt

As mentioned above, debt obligations typically can make a dissolution more complex, time-consuming, and potentially litigious. If you have any debt obligations, our suggestion is to first create a Debt Schedule i.e. a spreadsheet that lists out your debt obligations.

We’ve created a sample schedule below to give you an idea of what this looks like.

Something important to note, as seen in the columns above, is whether or not your debt obligations are secured and/or if there is a personal guarantee. Secured and unsecured debt are two main types of borrowing, with key differences in how they are structured and the risks involved:

Secured Debt

• Backed by collateral (an asset like a house or car)
• If you default, the lender can seize the collateral
• Examples: mortgages, secured credit cards, venture debt

Unsecured Debt

• Not backed by any collateral
• Based primarily on the creditworthiness of the borrower
• Examples: SaaS subscriptions/vendors

Personal Guarantee

A personal guarantee is a promise made by an individual to repay a debt, typically for a business loan, if the business is unable to do so. Key points about personal guarantees:

• Makes the individual personally liable for the debt
• Often can be in a lease agreement, loan, or lines of credit
• Can put personal assets at risk if the business defaults
• May be required even for some "unsecured" business loans
• Different from collateral, as it's not tied to a specific asset

Personal guarantees effectively turn an unsecured business debt into one that is secured by the guarantor's personal assets (i.e. you the founder).

If you’re winding down with debt on the books and you do not have enough cash to cover the obligations, there are different paths and processes you can take to try and resolve these. Once again, it’s best to consult your attorney or the team at Sunset to learn more about these.

As a brief overview though, a few processes that you might look into are:

1. Dissolution. Depending on your situation and creditors, there are ways to negotiate and resolve your debts by getting a release of claims and then dissolving the entity once all debts have been settled. This process may not work for folks who have large amounts of secured debt and/or creditors.
2. ABCs (assignment for the benefit of the creditors). An ABC, or Assignment for the Benefit of Creditors, is an alternative to formal bankruptcy proceedings. It's a state-level insolvency process (popular within California) where a company voluntarily assigns its assets to a third-party assignee, who then liquidates the assets and distributes the proceeds to creditors. ABCs are often faster and less expensive than formal bankruptcy proceedings but can still be quite pricey ($100K+)
3. Bankruptcy is a federal legal process designed to help businesses eliminate or repay their debts under the protection of the bankruptcy court. There are different types of bankruptcy, such as Chapter 7 (liquidation) and Chapter 11 (reorganization). Bankruptcy provides certain protections, like the automatic stay that halts collection efforts, but it can be a lengthy and expensive ordeal that takes place in court. Bankruptcies can also have long-lasting impacts on credit and future borrowing ability.

Unpaid wages

Another extremely important element in the liquidation preference stack is the priority given to unpaid wages and benefits owed to employees.

These obligations typically sit near the top of the stack - with their high priority reflecting the importance of protecting workers' rights and financial well-being during a company's dissolution.

In some cases, directors and officers (i.e. founders) can be held personally liable for unpaid wages, even if the company is structured as a corporation. This can effectively "pierce the corporate veil" that normally protects individuals from business liabilities.

Make sure as you’re thinking about your “cash-out” date to include any unpaid wages, benefits, or severance owed to any employees you have.

Investors

As you know, there are different types of investors and stockholders in an organization, each with their own liquidation preferences based on their investment agreements. Typically speaking, preferred stockholders (investors) will come before common stockholders (founders, employees) in a liquidation.

When it comes to SAFE holders and convertible note holders, you should consult your attorney and agreements to understand where they may fall in the stack.

Lease agreements

We also think it’s important to call out lease agreements separately here. These can often span multiple years and have personal guarantees. As you’re considering your options or are planning to wind-down, make sure to review your lease agreement(s) to understand the remaining tenure of your lease, how much more is owed, if it’s personally guaranteed/secured, and the termination clauses within.

Annual vendor agreements

Another important spreadsheet to prepare is any recurring subscriptions or annual vendor agreements you may have. We’ve seen many folks who are in the midst of a wind-down, only to get hit with an annual subscription that just renewed (think Carta, Vanta, Plaid, etc.).

One of the easier ways to create this sheet is to go into your accounting software or export your credit card statements to see any monthly recurring charges that you’ll want to cancel. For annual contracts, ask your team or go to your categorized expenses for software to see what’s there. Once again, for annual agreements, you’ll want to review your contracts and look for the termination clauses and how much notice is required to cancel.

What to do next

Now that you’ve gotten an understanding of your debt obligations, liquidation preference stack, as well as any other contracts/subscriptions/agreements - you may be ready to start the wind-down process.

Below, we’ve outlined some of the common steps that go into a dissolution process. These aren’t necessarily in the exact order one might follow, as the steps change based on the individual entity and situation:

1. Board and Stockholder Consent Agreements: these are legal documents that are drafted, which get consent from your Board members as well as your stockholders to approve of the orderly wind-down of your business
2. Payroll: As mentioned, you’ll want to ensure you’ve paid any outstanding wages, benefits, or severance to employees. The founders will also typically remove themself from payroll as they’re winding down to preserve as much capital for other creditors/investors.
3. Subscriptions/Vendors: As mentioned above, it’s good to create a list of your vendors and start canceling any month-to-month and annual agreements so as not to be surprised with a bill later on.
4. Customers: If you still have any active customers or paying customers, you’ll want to figure out your communication plan and any potential refunds you’ll need to make if cutting the service short.
5. Assets: If your business still retains any assets or IP, you’ll need to figure out what to do with them. Some common options are:some text
   1. Selling your assets - this is where you’d find a buyer for your assets, typically structured in an asset purchase agreement
   2. Auctioning your assets - this is where you’d put on an auction for your assets. This allows your stockholders, founders, and potentially other buyers to bid on your assets
   3. Assigning your assets - this is where you’d assign assets to an individual or separate entity for $X
   4. Open-sourcing your IP
   5. Trashing your assets - this is where you might draft something in the consent docs that states the assets aren’t worth anything and aren’t going to be used by anyone in the future
   6. Liquidating your non-cash assets - this is typically where you’d hire a liquidator for things like IT equipment and furniture
6. Creditors: Depending on the process you follow and if you have any debt obligations, you may need to get an understanding of all the outstanding claims against your business and then start working to resolve these obligations.
7. Waterfall of Distributions: Typically after the non-cash assets have been dealt with, you’ll create a waterfall based on the liquidation preference stack to understand how the cash or any remaining assets are to be distributed to investors or creditors.
8. Communication: It’s important to note that during this process, you should be communicating with your investors and/or creditors about the state of the business. As you’re preparing for any redistributions based on the waterfall, you’ll want to prepare notices to your investors/creditors letting them know of the wind-down and what they’ll be receiving in the distribution. You’ll also need to gather their wiring details and actually wire the capital to them.
9. Notify the IRS: You’ll need to notify the IRS via Form 966 that your business is winding down and cancel your EIN number
10. Taxes: You’ll need to prepare and file your final state and federal tax returns
11. Delaware: Most of you reading this will be incorporated in Delaware as a C-Corp. If this is the case, you’ll need to pay your final Delaware Franchise taxes and then file your Certificate of Dissolution with the state. If done properly, Delaware will stamp-certify your certificate and mail it back. Once received, you should distribute this to your investors for their records.
12. State Withdrawals: For any states, you’re foreign qualified in (if not using a PEO, these are typically states that you had full-time employees in), you’ll need to notify their different state agencies (Department of Revenue, Secretary of State, etc.) that you’re winding down and follow each state’s procedures for withdrawing.
13. Document Storage & Notices: It’s good to keep a record of all your documents and filings that you’ve made throughout the dissolution. As you might imagine, certain states or agencies may correctly or incorrectly send you notices in the mail months after dissolving that you’ll need to respond to.

How long does this take?

It’s a tough question to answer as this can vary drastically based on the company and type of wind-down process you’re following. That being said, most dissolutions can take 6+ months if using corporate legal counsel or even longer if trying to do it yourself (mine personally took 8 months when I was using legal counsel a few years back).

At Sunset, we’ve been able to drastically reduce this timeline to 6-10 weeks for most clients (where founders aren’t spending more than 1-2 hours per week working with us).

How we can help

If you’re a Hustle Fund portfolio company, please reach out to your lead investor for any guidance as you’re considering your options. We’re always here to help.

Also, if you want to understand more about the dissolution process, please feel free to reach out to the team at Sunset directly at www.sunsethq.com or email brendan@sunsethq.com directly. They are also a Hustle Fund portfolio company and have helped 100s of VC-backed tech startups with the end-to-end dissolution process — handling all the legal, tax, and operational work that goes into winding down.

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