There's a lot more to winding down a startup than meets the eye. From withdrawing from foreign qualified states, to selling or assigning intellectual property, filing final federal and state tax returns, canceling vendor/lease agreements, and so much more — there's substantial infrastructure and know-how needed to compliantly and efficiently run a dissolution.
At Sunset, we know how hard it is to wind down — emotionally, logistically, financially — because we've been through it ourselves. We started this business because we never want another founder to go through what we did. We're grateful and proud to say that, along with our team of lawyers, accountants, and operations specialists, we've been able to help hundreds of founders wind down.
This guide walks you through an example startup and explains step-by-step the different processes involved. Keep in mind this is an example story and nothing contained in this guide is considered legal or accounting advice.
Let's say you've been working on a tech startup called Ai-Phone, which allows customers to call their parents using AI. It's been a fairly grueling 12 months since you last raised — with constant sleepless nights, user interviews, product experiments, and lots of calls home.
Runway is starting to dwindle. When you open your analytics, the retention curves are not what you're hoping for, and the new features aren't working as planned. Being a first-time founder, you're unsure of what to do next or who to reach out to.
We're here to remind you though that you've built something. We understand just how challenging it is to see the thing you've poured your heart into not take off like you wanted, but you took a seat at the table and anted up — which is always something to be proud of. So, what do you do next?
Before going out and trying to gather opinions or further information, you take stock of where you are. You open your accounting software and determine the following:
To get a sense of your current position, you would also need to:
In our example, Ai-Phone is a Delaware C-Corporation that's foreign qualified in CA, NY, and TX. They raised $1.2M on standard YC SAFEs with no liquidation preferences, have 1 co-founder, a few contractors, and 2 full-time employees, with about 6 months of runway left, 1 year of taxes to back-file, $15,000 of physical inventory, and IP including codebase, logos, domain, and customer lists.
After taking stock, you might be tempted to continue forging ahead while using every last penny of your runway. However, it's important to know that wind downs can easily burn a couple of months' runway (when factoring in legal costs, accounting costs, federal taxes, state taxes, sales taxes, employee severance, vacation pay, etc.). If there is little to no money left in the bank, it might be necessary to look into bankruptcy or insolvency proceedings — which are far more complicated, expensive, time-consuming, and potentially litigious than a voluntary wind down.
As founders, calling up our lawyers oftentimes isn't our favorite thing to do. But because they both have a grasp of what the business does and understand the legal landscape, they should be able to give you some good advice based on the corporate structure and financial picture you put together.
Many lawyers do not like working on dissolutions, and in fact some outright won't. Especially if you begin your search for counsel once you've decided to wind down (and if you have little money left), it might be challenging to find someone who will agree to work with you.
An experienced dissolution lawyer will help you navigate some of the bureaucratic/governmental aspects of the wind down — like foreign qualification withdrawal and dissolution certificates. More importantly, they'll be able to advise on some of the more nuanced legal questions that arise during wind downs, such as "Should I assign the IP pro rata or execute an auction?" or "Where/when do my fiduciary duties as an officer/director start and end after the wind down?"
It's a good idea to connect with your CPA or bookkeeper to double check your stats and get their advice. Beyond that, you're likely going to need a CPA to handle the tax-related elements of your wind down: final federal tax filing (Form 1120), corporate dissolution form (Form 966), relevant state tax filings, applying for tax clearance certificates, paying and/or negotiating franchise taxes, and more.
This is maybe one of the most helpful groups to speak with. Although you should probably stay clear of their legal, accounting, or dissolution advice, we strongly recommend reaching out to someone in your network who has started a company and then had to wind it down.
Most companies don't end up making it, even the incredibly successful founders you hear about on Twitter have many failed startups from the past. The emotional toll a dissolution takes can be heavy, and it's important to normalize the situation. About 70% of our clients create new startups after winding-down.
Officers and directors of companies have fiduciary duties they must uphold — these arise because officers and directors have control over financial interests of others, namely stockholders. For a Delaware Corporation, directors and officers have a "Duty of Care" and a "Duty of Loyalty" to the corporation and its shareholders. The duty of care requires directors to make informed business decisions; the duty of loyalty requires directors to act in good faith to advance the best interests of the corporation.
Each of these serve as legal guardrails for how directors and officers should act in the interest of the company and shareholders, even throughout a dissolution. During insolvencies/bankruptcies, these responsibilities can take on a much more complicated contour; making sure to act before these situations arise can clarify decisions put to officers and directors.
If you believe your company or some of the assets within your company could be of value to potential buyers, then an asset sale or acquihire could be a great option to explore. An asset purchase sale (APA) is when a buyer purchases select assets from your corporation, different from a stock purchase sale where a buyer purchases the stock of the corporation including all assets and liabilities.
Reasons an asset-purchase sale might be a good strategy include: buyers can selectively choose which assets and liabilities to take on, buyers can obtain large tax advantages, sellers don't always need stockholder approval when selling some assets, and an APA can be quicker to close.
If you believe there is a compelling vision to sell to investors, fundraising is another viable option. Down rounds have been more common, and you can always consider pitching existing investors for a bridge round. However, be realistic about the current market conditions and your narrative.
If you've explored the options above and decide they're not right, it might be time to consider winding down. With capital still in the bank, you have more flexibility, options, and decreased stress when going through the process.
One of the first things you should do after deciding to wind things down is reconnect with experts. Dissolving is not nearly as straightforward as starting a company. It's filled with red-tape, hidden traps, and potential liabilities.
Before initiating any tasks, create a well-documented plan. The typical dissolution timeline for a tech startup is 8+ months. One of the most common pain points we hear is that founders don't know where to start or what steps are needed.
The coordination required is substantial. Even a small component like withdrawing foreign qualification from a single state requires calls between your lawyer, accountant, and state governments, filing forms, getting tax clearance, and more. All this needs to happen on top of communicating with and managing investors, customers, employees, vendors, and more.
After counsel has reviewed your investment documents and provided you with a redistribution schedule, it's time to communicate to your investors. In the message, we recommend:
Important: Do not BCC your investors on this email. Send individual emails to each investor. Investors take note of this.
Also important: Investors need a copy of the Certificate of Dissolution to write-off their investment with the IRS. Being able to write-off an investment is a big deal for tax purposes.
Before telling employees, consult legal and do a compliance check. Employee rights can be one of the areas where officers and directors can be held personally liable. Employee commitments can include healthcare, outstanding bonuses, retirement, insurance, and severance.
Have a plan, document everything, tell them the honest facts, treat everyone fairly, help them as much as you can with references and referrals, collect company property, ensure final pay including severance, vacation pay, and sick pay, and explain benefits like health insurance and retirement plans.
Devise a clear communication plan with your existing customer base. Notify them, be honest, share the impact on your product, protect their data and privacy, offer a replacement list of comparable tools, give thanks, and be supportive.
Because a Delaware C-Corporation is required to get consent both from your Board and shareholders to authorize the dissolution. Your Board and Shareholder Consent documents should clearly detail the Plan of Dissolution, who will be responsible for winding things down, debt obligation repayments, employee and contractor issues, communication plan, record keeping, compensation, and more.
SAFE holders are typically not stockholders and are thus not required to sign the Stockholder Consent Agreement.
In most states, you'll need to deal with 2+ different Government Agencies, typically the Department of Revenue/Taxation and the Secretary of State. You'll need to withdraw from each state where you're foreign qualified.
In every state you're registered to do business, you'll typically need to:
Most guides suggest just paying Delaware Franchise Tax and immediately filing your Certificate of Dissolution. However, we often advise against this. If you still have debt obligations, capital to redistribute, bank accounts open, or potential creditors, it can become more complicated after the corporate structure has been dissolved. We recommend organizing and executing as much of the dissolution as possible before filing the certificate.
In addition to state and sales taxes, you'll also need to prepare and file:
Make sure you have the prior year tax returns to double check they were prepared and received by the IRS before fully winding things down.
Create a list of any non-cash assets your business possesses and apply a fair market value. These include domain names, IP, codebases, computers, monitors, office furniture, and so forth.
As a fiduciary, it's your responsibility to try and liquidate these assets for the best possible price and put forth a good effort in doing so. You can reach out to known vendors, engage a liquidation agent, or work with a company like Sunset where we've helped many clients liquidate their non-cash assets.
For IP, options include selling to an interested buyer or assigning it to stockholders pro-rata. When it comes to IP assignment or asset sales, it's important to consult your legal counsel.
Do a full audit of all your subscriptions and contracts. Cancel all monthly and annual plans where you're no longer being charged. Keep certain accounts open for the remainder of the wind down (email, accounting software, bank account, etc.).
As a general rule of thumb, subscriptions tied to your core business/product can go early. Software tied to your corporate entity should go later.
For annual contracts or long-term agreements, have counsel review early termination clauses and negotiate satisfactory release terms.
Important: codify any benefits or insurance plans your company has and start notifying your providers early. Things like 401K plans can be fairly difficult to wind down.
Watch out: Some early terminations of contracts will require you to pay certain fees, making the dissolution more expensive than you may have thought.
Once all expenses and debts have been paid (especially any outstanding wages), you can calculate your final distribution schedule for investors. We highly recommend using counsel or attorneys to calculate this waterfall before sending out any wires.
When sending wires, include an email to each investor that explains how much they're getting, why they're receiving that amount, and invite questions. You'll typically be asking for wiring instructions at the same time.
Either at this point or earlier in the process, you've officially filed your Delaware Certificate of Dissolution and received confirmation from the state. With that document in hand, send it to investors so they can recoup the tax loss from the IRS. This is an extremely crucial step and investors will greatly appreciate it.
Keep records of all tax filings, certificates of withdrawals, cancellation documents, email backups, and more for a few years after the wind down. Delaware has statutes noting a 3-year period post-wind-down for which the company still has certain responsibilities. The IRS requires record keeping of all tax-related documents for at least 7 years.
At Sunset, we help store all your documents for you in case anything comes up in the future.
If you're considering winding down your business or exploring potential options, please reach out to our team at Sunset. We've helped hundreds of startups wind down operations quickly and compliantly — allowing you and your investors to move onto what's next.
Even for seemingly "simple" cases like a small tech startup, there are countless steps involved when trying to properly shut down. Dissolutions are far more complicated, expensive, and potentially litigious than most founders and even investors know.
All of the steps described above and many more our team handles entirely for startup founders. Once you integrate with our system and get onboarded (about 30 minutes of your time), our team will create your custom plan of dissolution, manage the entire process, and execute the majority of the steps on your behalf. Most founders we work with are able to immediately start creating a new startup, without worrying about dissolving their old one.
Every situation is different. Book a call and we'll walk you through the process, answer your questions, and help you figure out the best path forward.