Getting Your Legal Ducks in a Row: Legal Guide to Attracting Investors
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Transcript of Getting Your Legal Ducks in a Row: Legal Guide to Attracting Investors
RAISING ANGEL & VENTURE CAPITAL: GETTING YOUR LEGAL DUCKS IN A ROW Mark J. Graffagnini Managing Member Graffagnini + Associates, LLC New Orleans, LA [email protected] @GraffagniniLaw graffagninilaw.com
BACKGROUND
Graffagnini + Associates was founded in 2010 Focus on start-up company, venture capital investor,
securities reporting and M&A issues over last 10 years We represent companies around world in financing,
M&A and formation transactions Founding Board of Directors, NO/LA Angel Network, Inc. Entrepreneur & Investor
Aestus Power Collector App CaliBurger Cleantech Systems Data company in stealth mode www.nanolabweb.com
OVERVIEW
Early Stage Legal Issues
Entity Choice
Founders Issues
Employee Incentives Seed Capital
Venture & Angel
Capital
Managing Legal Costs
1. FORMATION & CHOICE OF ENTITY
Factor LLC C-Corp Taxation Pass-through
•Profits/Losses flow through to owners
Double-taxation: •Corp. pays tax on profits •Stockholders pay on dividends
Type of Investor Not generally preferred for VCs, but some PE groups prefer: •Exit Issues •Distribution of income
Generally preferred for VCs •Limited partners •Certainty
Management/ Governance
Flexible •Single manager •Board of Managers •Member-managed
Less Flexible: •Board of Directors •Officers •Stockholders
Employee Incentive Plans More difficult profits interests & less favorable tax treatment
Incentive Stock Options
ADDITIONAL CONSIDERATIONS IN ENTITY CHOICE
Of Louisiana-based companies receiving venture funding, slightly less than half were corporations
DE is the most common jurisdiction used, regardless of entity type from 2011-2013. LA was a close 2nd. NOTE: If your investors are out-of-state investors, you will almost
certainly be required to use a DE company. S-corp tax status is likely the wrong choice unless you are
purely a service company that will not raise angel or venture capital Limitation on number of shareholders (means no IPO) Taxation issues of the LLC form Conversion later introduces additional complexity
Switch from LLC to C-Corporation later May be your preferred strategy
2. NOW YOU’VE CHOSEN THE RIGHT ENTITY FOR YOU—FOUNDERS ISSUES
Membership
Interest Purchase Agreement
A/K/A Subscription Agreement
A/K/A Contribution Agreement
LLC [Restricted] Stock Purchase Agreement
A/K/A Subscription Agreement
A/K/A Buy-Sell Agreement
C-Corp
4 KEY ELEMENTS OF FOUNDERS/EMPLOYEE EQUITY AGREEMENTS
Vesting of Shares or LLC Interests
Company Re-purchase Option (“ROFR”); Right of other
Equityholders to purchase
Acceleration Provisions Lock-ups,
Other Reps & Warranties
Key Features of Founders
Agreements
FOUNDERS/EMPLOYEE ISSUES (CONT’D)
Clean IP Assignments Confidential Information & Invention Assignment Agreement (w/
non-competition) Applies to ALL employees, contractors, etc. and in various
agreements Full coverage is beyond scope of this presentation
Pay for your stock/interests!! Should be able to document payment and issuance “Fully paid and non-assessable”
Mistakes:
Case of mistaken identity “Woodwork” or “Social Network” issues Poor documentation can lead to disputes Not keeping “cap table” clean
WHAT’S A “CAP TABLE”
XYZ CompanyXYZ % Units Type Capital PriceFounder A 15% - Common 25,000$ 0.01$ Founder B 15% - Common 25,000$ 0.01$ Founder C 50% 500,000 WorkingFounder D 12% - Common 250,000$ 0.01$ Reserve 8% - WorkingTotal 1,000,000
Common
Series A and A-1 (7/10/01& 7/8/02)
Series B and B-1
3/31/03
Series C and C-1
7/27/04
Series D and D-1
5/24/07
As-Converted to Common
Shares
% of Total Out-
standing
% of Total Fully
DilutedVC 1A 92,310 886,735 467,704 900,478 2,347,227 #DIV/0! #DIV/0!VC 1B 12,270 117,866 62,168 114,898 307,202 #DIV/0! #DIV/0!VC 1C 236,400 2,270,872 1,197,760 2,361,763 6,066,795 #DIV/0! #DIV/0!VC 1D 2,639,250 25,352,795 13,372,200 26,315,379 67,679,624 #DIV/0! #DIV/0!VC 2A 19,770 189,911 100,168 197,513 507,362 #DIV/0! #DIV/0!VC 2B 138,812 556,873 357,546 669,553 1,722,784 #DIV/0! #DIV/0!
One Portion of a Complex Cap Table
3. EMPLOYEE INCENTIVE PLANS
Best Practices (LLC or C-Corp) • Written Plan • Consistent administration • Board/Manager Consent + Agreement
• Clear Documentation • Update records after each grant • Keep attorney in the loop!! • File IRS paperwork if vesting • Securities filings (some states)
EMPLOYEE INCENTIVE PLANS (CONT’D)
Worst Practices: • Informal “hand-shake” deals • Switching equity to and from individuals without paper trails • Failing to update records and cap table regularly • Ignoring internal requirements • Deliberating “forever”
Risks: • VCs/Angels will notice • Employee confusion • Tax treatment
4. RAISING SEED CAPITAL: THE “FAMILY & FRIENDS” ROUND
• Issue stock or LLC interests according to your documents
• Comply with securities laws • “Accredited investors” • Private placement memo (“PPM”) (a/k/a
“private offering memo”) • Issue certificates if certificated shares • Present documents professionally
Do’s
• “Handshake” deals • General solicitations in media/events unless you
are prepared to comply with Rule 506(c) • Fail to update records and tables • Fail to consider departure from company
operations
Don’ts
5. ANGEL & VENTURE CAPITAL—DEAL DOCUMENTS & ISSUES
Term sheet
• Non-binding • Outlines basic terms of deal • Actual Terms Beyond scope
Deal Documents:
• Certificate of incorporation/Operating Agreement • Stock Purchase/Subscription Agreement • Investors Rights Agreement • Right of First Refusal/Co-Sale Agreement • Voting Agreement
Due Diligence:
• Dirty IP Assignments • Poor Cap Table Maintenance • General sloppiness—Due Diligence Nightmares!!
Closing
• Initial Closing and subsequent closing • Issue equity, obtain funds and signatures • Make securities filings
Early Stage Legal Issues
Entity Choice
Founders Issues
Employee Incentives Seed Capital
Venture & Angel
Capital
Managing Legal Costs
6. SERIOUSLY?! WHAT’S THIS GONNA COST ME?!
Attorney’s fees vary widely Formation and Initial Financing Packages available:
Use resources to understand options before you begin Take advantage of pro bono services (but be careful to understand
when fees kick in) Alternative fee arrangements, equity
Value Billing/Start-up packages
Beware of the “add-on” model
Hourly rates and lawyers on your file
Investor’s counsel fees & caps
SERIOUSLY?! WHY BOTHER?!
Correcting mistakes is far more costly
Happy employees
Happy investors
Roadmaps
Credibility!!! Quicker Fundraising Better results
ADDITIONAL RESOURCES
Graffagninilaw.com/blog Google/Silicon Bayou News
“Entity choice entrepreneurs” “Equity Incentives LLCs”
Startupcompanylawyer.com (detailed preferred financing issues and startup FAQs)
Many large firms with focus on financing transactions have sample legal documents (e.g., WSGR.com; Orrick.com)
Many incubator programs have them: Series AA Preferred Financing Docs National Venture Capital Association Model Templates Series Seed “Founders Fund” SAFE
CONCLUSION
Entrepreneurship is a difficult road, and you have enough to worry about
Good documents and corporate practices give you peace of mind. Think of it as “code for corporate governance and capitalization”
View them as a roadmap for administration and successful business
Questions? mg@graffagninilaw @GraffagniniLaw 504-265-9955 Graffagninilaw.com