[PREMONEY 2014] Gunderson Dettmer >> Joshua Cook, "The Wind-Down Round: Navigating Liability When Startups Fail"


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"The Wind-Down Round: Navigating Liability When Startups Fail"

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[PREMONEY 2014] Gunderson Dettmer >> Joshua Cook, "The Wind-Down Round: Navigating Liability When Startups Fail"

  1. 1. Light at the end of tunnel . . .
  2. 2. Series A Crunch??
  3. 3. The Result??
  4. 4. So What Are We Talking About? • Asset Sales • Wind Downs (Shut downs) • Recaps • Dissolving
  5. 5. Asset Deals • Could be multiple asset sales – Patent Portfolio, platform, acqui-hires and more • Pros – Purchaser only assumes specified liabilities – No Purchaser shareholder vote required • Cons – Liabilities not specifically assumed by Purchaser remain with Seller • There are exceptions to even an asset purchaser’s ability to exclude certain types of liabilities, including certain taxes, product liabilities, environmental liabilities, ERISA liabilities and Cobra liabilities – Third party consents will likely be required (“assignment of contracts”) – Very difficult to meet tax-free requirements – but tax considerations likely not important – Post closing distributions and wind down matters
  6. 6. Multiple Asset Deals • Difficulty separating IP assets • May need to negotiate license back for sale of remaining assets –Can be complicated with sale of patent portfolio
  7. 7. Recaps
  8. 8. Recaps Mechanics • Conversion – Convert existing preferred stock to common stock – may need some syndicate of non investing preferred investors to approve • Reduce preference overhang – investors will need to consider target preference post closing • Preserve (or restore) value of prior preference based upon participation – this is the exchange or “pull through” – Common Stock (from old preferred stock) exchanged for new preferred stock at exchange ratio tied to preference pull through • Effect reverse stock split of common stock – reduces old common and old preferred ownership
  9. 9. Recaps Mechanics • Consult with company and investor counsel on fiduciary obligations (if board member) and ways to mitigate litigation exposure • Some key considerations: – Disinterested lead investor in new financing (if possible) – Clear record of thorough search for disinterested lead investor – Rights offering to all affected stockholders – Disinterested approval of special committee of board of directors – Disinterested stockholder approval – Price-based antidilution likely triggered – don’t forget to consider impact – Process and paperwork pricey
  10. 10. Alternatives to Recaps Convertible Notes with Multiple on Sale • Simpler and cheaper paperwork • Still must consider “fairness” issues • Does not address preference overhang – Consider success bonus or carveout plans to address overhang – set aside portion of exit proceeds for employees who stick around • May be able to secure debt with Company assets – Consider existing lender rights
  11. 11. Wind Downs • PREPARE PREPARE PREPARE • GET YOUR NUMBERS DOWN • And then do the numbers over again • And remember to run them without a “going concern” assumption
  12. 12. Personal Liability
  13. 13. Risks • YEP, IF YOU’RE ON THE BOARD OR AN OFFICER, YOUR PERSONAL ASSETS CAN BE AT RISK • Some key areas to ensure company counsel (or your counsel) locks down: – Unpaid wages (including vacation, benefits and other compensation) – Continued employment when the company doesn’t have the cash to pay – Use of taxes withheld from employees’ pay for other purposes – Nonpayment of unemployment, workers’ compensation, disability and other payroll-related taxes – Nonpayment of municipal, state sales and use taxes – WARN act issues
  14. 14. Wind Downs How to manage: –Self-managed? –Assignment for benefit of creditors? –Bankruptcy filing? –Friendly foreclosure?
  15. 15. Sample Checklist • Identify all bank accounts and money market accounts. Revisit signature authority • Identify all lease agreements. Identify associated security deposits, and consider negotiating to apply deposits to rent as it comes due. In hot market, consider terminating early • Identify and review material contracts, particularly contracts critical to the company’s continued operations. Identify contracts where the company is in default and evaluate penalties • Identify and review all secured loans • Identify continuing obligations (those that may survive sales, mergers or shutdowns) • Identify all prepaid expenses and try to recoup them • Collect and cancel all corporate credit cards
  16. 16. Recap on the Wind Down • Communicate Communicate Communicate • I typically refer to interested parties as “Stakeholders” – Employees – Stockholders – Creditors – Bridge Note holders – Secured Creditors
  17. 17. Recap on Wind Downs • Four Star Word Time – “Fiduciary obligations” – I’m an investor, so who do I look out for? Yourself – I’m also a board member, so what now? Oh yeah. Obligations owed to Company and stockholders – And creditors? Lawyers often advise D&Os on shifting obligations to creditors in “zone of insolvency” • BUT Delaware cases over the last few years have reduced (or eliminated) director duties to creditors • Nuanced advice: Maximize enterprise value without considering the effect on creditors • Not so nuanced advice: Be sure to understand stakeholders’ contractual rights • When can secured creditor trigger repayment? • When about remaining severance obligations?
  18. 18. Who Should Lead the Charge on the Process? • Short Answer: Company management should manage process with guidance from Board • Longer harder answer: Oftentimes, management has no incentive to stick around. Conflicting stakeholder interests may make “by the book” process difficult • IMPORTANT TIP: VCs should not usurp functions of the Company board. But there’s nothing wrong with creditors negotiating • SUPER IMPORTANT REMINDER: COMMUNICATE COMMUNICATE COMMUNICATE
  19. 19. A Note on “Dissolution” • Filing a “Certificate of Dissolution” only BEGINS the wind down process • Company continues to survive with limited authority to process wind down activities • Not unusual to forego filing Certificate of Dissolution – DE generally doesn’t pursue for franchise taxes • BUT be sure to withdraw registration in other states. CA will come looking for $$
  20. 20. Contact Josh Cook, Gunderson Dettmer 650-463-5267 jcook@gunder.com @joshcook Gunderson Dettmer 140 Second Street, Second Floor San Francisco CA p: 650-321-2400 Twitter: @gundersonlaw www.gunder.com
  21. 21. Gunderson Dettmer Stats • More than 2,000 company clients • More than 950 venture financings each year • More than 60 venture fund formations annually
  22. 22. 500 Startups And, of course, >500 deals for