A Checklist for Startups
Top 10 Critical Legal Issues in Planning the Growth of your Company
DLA Piper’s Atlanta Tech Team
Jeffrey Leavitt
Began practice at large Wall Street firm in NYC
Founded software startup in New York (backed by Draper Richards and Benchmark)
Kauffman Fellow (class 8) and venture capitalist at Alliance Technology Ventures
Brian Gordon
Began career at large Boston firm focused on technology practice
Experience representing venture-backed companies, venture capitalists, public companies and venture capital funds
Graduate of Harvard College (1997) and Harvard Law School (2000)
Growing the Practice
Opened the office in June, 2006
Doug Spear, Joey Silver, Dan Falstad, Mike Rubinger, Sarah Roadcap
Assembling the top venture and tech lawyers in Atlanta
Involved in 11 of the 19 venture financing deals reported in Q4 2006.
Agenda
Getting Started – Entity and Jurisdiction
Founder Agreements and Incentives
Employee Agreements and Incentives
Basic IP Protection
Intellectual Property Pitfalls
Regulatory Issues
Documentation and Due Diligence Preparation
Financing Strategy
Getting Expert Advice
Top 10 Legal Pitfalls
Top 5 Things to Prepare for Financing
1. Choice of Entity and Jurisdiction
Venture-backed companies typically formed as Delaware C corporations:
Easiest and most familiar to investors
Clear rules on corporate veil piercing
Clear rules on director liability
Can accommodate unlimited number of investors
Can easily go public or get acquired
Delaware has well developed case law and corporate statute
LLCs have distinct tax advantages (taxed as partnership) but result in significant additional complexity as capitalization table grows
Georgia corporations are often appealing to local investors and counsel
May be more Founder-friendly (common stock class votes)
Less costly in the short-run; however, most Georgia corporations will be required to reincorporate in Delaware as part of venture transaction, costing approximately $3,000-$5,000.
2. Founders’ Agreements and Incentives
Purpose: Anticipate unfortunate possibility of founder disputes
Bare Bones
Subscription Agreement (with limited transfer restrictions) to issue stock
Paying for stock vs “sweat equity” and related traps
Restrictive Covenants Agreement (See #4)
The Next Level
Restricted Stock Agreements
Reverse vesting and 83(b) elections
ROFR (Right of First Refusal) on equity issuances
Voting Agreements
Full Shareholder Agreement (Buy-Sell + all of above)
Bells and Whistles
Founder Liquidity Equity (“FF Preferred”)
3. Employee Agreements and Incentives
Employment Agreements
Do you need them?
GA is an “at-will” state
Consider the level of hire and competing considerations:
May want to lock-in senior mgmt
Must consider precedent for term, severance, accelerated vesting, etc.
Potentially limits flexibility in RIFs
Acceleration on change of control a potentially sticky issue for investors
What constitutes an agreement?
Be mindful of offer letters and what you promise
Can be interpreted as an agreement
Must have conditional language re: Board approval if discussing options
Restrictive Covenants Agreements (See #4)
Legal review necessary (Section 409A)
3. Employee Agreements and Incentives (cont.)
Employee Equity Incentives
Restricted Stock v. Options
Typically tax advantages to restricted stock if 83(b) is filed
Restricted Stock generally requires employee to pay out-of-pocket
Full and partial recourse promissory notes
Additional tax advantages to incentive stock options (ISOs)
Equity Incentive Plans
Ease securities law compliance
Provide easier administration in liquidity events
Expected by venture investors (although size of pool differs)
If using options or restricted stock to motivate employees, make sure employees understand potential value and how realization occurs
Fair Market Value / 409A Issues for Stock Options
4. Basic IP Protection – Employees
Restrictive Covenants Agreement
GA law will most likely apply if employee works in GA
Assignment of Intellectual Property
Non-disclosure of Trade Secrets and Confidential Information
Non-solicitation of customers (limited in GA)
Non-solicitation of employees (limited in GA)
Non-competes (severely limited, difficult to enforce, and potentially risky in GA). No blue-pencil law in GA suggests omission of non-compete.
4. Basic IP Protection – Non-Employees
Independent Contractor Agreements
Key Components of Agreement
Scope of Work
Compensation
Work Product & Confidential Information
Assignment of Other IP
Equity Grants to consultants, independent contractors, partners should be carefully reviewed by counsel in context of cap table and incentive plan
NDA – Potential Contexts
Investor solicitation: unlikely with professional investors and VCs; necessary with knowledgeable angel or strategic investor
Customer/Partner – usually mutual NDA
M&A – usually one-way NDA
5. Intellectual Property Pitfalls
Patents
Failure to file foreign patent applications before commercializing or disclosing
Failure to file US patent application within 1 year of commercializing or disclosing
Waiting to seek patent protection until competitor exists
Presuming something is not patentable – sometimes the least technological feature is the most valuable
Trademarks
Failing to conduct TM search on Company name
Registering TMs under Founder’s name
Failing to register TM
5. Intellectual Property Pitfalls (cont.)
Government Contracts
Assuming government grants are free – potential licenses to government can result
Failing to fully review and understand compliance regime of government agency
Other IP Issues
Waiting too long to cure IP ownership issues
Granting exclusivity rights
Failing to get NDA
Over-indemnifying
Punchline: Good IP Counsel is worth the extra money!
6. Regulatory Issues
Specialized areas are complicated and often require expert advice – important to spot potential issues in advance: examples
Privacy
FDA
Homeland Security
Labor and Employment
Environmental and OSHA
Government Contracts
International Licensing, Contracting and Equity Issuances
Don’t assume anything regarding enforceability with foreign counterparty
7. Documentation and Due Diligence Preparation
Reasons for keeping good files and documentation
Aids due diligence process, making financing rounds easier and cheaper and impressing investors and potential acquirers
Fixing issues after the fact is always costlier (and sometimes not possible)
Preserves the agreed-upon business deal
Agreements without signatures can be difficult or impossible to enforce
Minuted board meetings with clear resolutions are part of the fiduciary duties of directors
Significant issues with stock not duly authorized, options not correctly granted
Don’t want to successfully attract investor or acquirer, only to have deal delayed or scuttled due to poor document management
8. Financing
Importance of a “game plan”
Start from the exit, and work backwards
Potential financing sources
Founders (and their credit cards)
Customers
Angels
Venture Capital Firms
Debt
Strategic Investors
Setting milestones to drive valuation upwards
Avoiding founder dilution
Interaction between financing strategy and exit strategy
9. Expert Advice - Using Your Attorney
Seek advisor and friend as much as counsel
Look for “free time”
Accessibility and mindshare
Consider resources of firm, in addition to relationship attorney
Leverage firm’s non-legal resources
Customer introductions
Investor introductions (formal, thoughtful process is best)
Venture Pipeline
Aggregate questions and requests to reduce fees
Use Specialists
Even if high fees per hour, greater knowledge and efficiency will keep total cost lower
Better quality protection and representation
Keep your attorney informed! Let your attorney understand your business.
10. Top 10 Legal Pitfalls
Choosing an entity or jurisdiction without carefully considering game plan and exit strategy
Awarding fully vested founder stock to founder not fully invested
Failing to pay employee salaries or make required withholdings
Unauthorized stock issuance or option grants; non-409A compliant stock grants
Failing to have key employees and consultants sign necessary restrictive covenant agreements and NDAs. Failure to initiate patent protection or get NDA in place before revealing technology to customers or partners
Presuming something isn’t patentable just because it isn’t using advanced technology
Beware cheap IP lawyers – you get what you pay for (and don’t know it for 3 years)
Not keeping good or complete files; not having the Board meet or not keeping minutes of those meetings.
Keeping your attorney in the dark and thinking he or she is just a “scrivener” or just there to fix problems, as opposed to an experienced partner/advisor
Signing an LOI or Term Sheet without review by counsel
Bonus: Top 5 Things to Prepare for Financing
Surround yourself with good advisors
Lawyer, Accountant, others
Self Due Diligence & Clean-Up
Examine as if you were investor/investor’s counsel
3. Execute agreements with Key Employees & IC’s
At a minimum non-disclosure/assignment of inventions; consider restrictive covenants (non-compete and non-solicit)
Keep the Cap Table Simple
Fewer shareholders is better
Understand “Founder” vs “Company” issues
Dilution and ownership of the pie
Who does your lawyer represent
Jeffrey Leavitt: 404-736-7818
@
Brian Gordon: 404-736-7819
@
