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Day 5 Afternoon - Smith
 

Day 5 Afternoon - Smith

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    Day 5 Afternoon - Smith Day 5 Afternoon - Smith Presentation Transcript

    • Lead to Win Key Legal Issues for Technology Start-ups June 24, 2009 Eric J. Smith Fraser Milner Casgrain LLP © Fraser Milner Casgrain LLP, 2009. See last slide for licensing information.
    • Key Legal Issues for Technology Start-ups
      • My background
      • Technology lawyer, Co-Chair of National Technology Transactions Practice Group, FMC (2001 – Present)
      • Vice-President, General Counsel, and Corporate Secretary – Corel Corporation (1996-2000)
      • Vice-President of a business advisory services company focused on early stage tech sector (2000-2001)
      Slide
    • Agenda
      • Key Legal Issues for Technology Start-ups
      • Threshold Issues
      • Company Formation
      • Co-Founder Issues
      • Shareholder Agreements
      • Financing the Business
      • Employees and Contractors
      Slide
    • Threshold Issues
      • Ownership of Intellectual Property
      • Duties to Previous Employers/Third Parties:
        • Confidentiality
        • Non-solicitation
        • Non-competition
        • Assignment of IP rights
      Slide
    • Choice of Business Organization
      • Corporation
      • Most popular form of business organization
      • Separate legal entity from those who own it (shareholders) and those that operate it (directors, officers and employees)
      • Income taxed in the hands of corporation
      • Shareholders taxed on dividends and capital gains (when selling shares)
      Slide
    • Reasons to use a Corporation
      • Limited liability (although shareholders many have to guarantee obligations)
      • Can exist in perpetuity (individuals can come and go)
      • Flexible investment vehicle – can create different classes of shares
      • Can offer shares or options to buy shares to attract and retain personnel
      Slide
    • How Do I Incorporate?
      • Conduct name search
      • File Articles of Incorporation
      • Pay registration fee
      • Organize company
      Slide
    • Where Do I Incorporate? Canada vs. Ontario
      • Legislation is very similar
      • Federal permits head office in any province
      • Getting desired name more difficult federally
      Slide
    • Where Do I Incorporate? Canada vs. United States
      • Many Canadian tech companies seek financing in U.S.
      • Interests of U.S. Investors often conflict with Canadian founders and employees
      • Can have impact on decision of where to incorporate (or migrate)
      Slide
    • Canadian–Controlled Private Corporation
      • Canadian incorporated; private; not controlled by non-residents or public corporations
      • Advantages:
        • Favourable capital gains treatment
        • Refundable investment tax credits (ITCS)
        • Tax deferred or exercise of stock option
        • Tax deduction on gain from optioned shares
        • Lower tax rate and small business deduction
        • Deduction of allowable business investment loss (for lenders to CCPC)
      Slide
    • Problems For U.S. Investors
      • S.116 Income Tax Act
      • LLC treatment
      • May require complex exchangeable share structure
      • *See handouts for detailed discussion of issues in this and preceding slide
      Slide
    • Weighing the Options
      • Canadian incorporation, if:
        • Company will qualify as a CCPC
        • Company can fund operations without significant foreign investment
        • BDC or labour sponsored fund may be early investor
        • Cannot afford extra expense of U.S. incorporation
      Slide
    • Weighing the Options - cont’d
      • U.S. incorporation, if:
        • Company will not qualify as CCPC
        • Lead investor is U.S. investor
        • Anticipated exit is acquisition by a U.S. entity
        • Company anticipates shifting bulk of operations to U.S.
      Slide
    • Co-Founder Issues
      • Remember threshold issues
      • Beware of automatically treating everyone as equals
      Slide
    • Issuing Shares to Founders
      • No operating history and usually very few assets
      • Founders’ shares usually issued at nominal price (e.g. $0.001 per share)
      • If assets being transferred to corporation – s.85 rollover
      • Consider tax planning (e.g. income splitting through family trust)
      Slide
    • Issuing Shares to Others
      • Contractors/employees/others
      • Must comply with securities laws
      • Must be paid for (money, property, past services)
      Slide
    • Capital Structure
      • Keep structure simple in order to accommodate future financings
      • Generally, founders should purchase all shares they desire at time of founding
      • As investors acquire shares, founders may lose control over future issuances and stock splits
      Slide
    • Cap Table Example
      • After Series “A” Financing
      Slide 21.2% $0.20 1,750,000 Employees 42.5% $2.00 3,500,000 Series “A” 12.1% $0.50 1,000,000 Seed 24.2% $0.001 2,000,000 Founders Ownership Price # of Shares Shareholder
    • Cap Table Example
      • After 3 VC Rounds
      Slide 100% 24,333,333 Total 14% $12.00 3,333,333 Public 25% $4.00 6,000,000 Series “C” 7% $0.20 1,750,000 Employees 20% $2.00 5,000,000 Series “B” 7.2% $0.20 1,750,000 Employees 14.4% $2.00 3,500,000 Series “A” 4.1% $0.50 1,000,000 Seed 8.2% $0.001 2,000,000 Founders Ownership Price # of Shares Shareholder
    • Vesting and Buy-back Rights
      • Should Founders have to “earn” shares?
      • Repurchase option if founder ceases to be participant in business
      • Vesting of 3 to 5 years
      Slide
    • Shareholders’ Agreement
      • Management of Corporation
      • Rights and obligations of shareholders
      • Is agreement needed at start-up stage?
      Slide
    • Key Provisions of Shareholders’ Agreement
      • No “one size fits all” agreement
      • Restrictions on transfer of shares
      • Right to repurchase
      • Pre-emptive rights
      • Right of first refusal
      • Drag-along
      • Piggy-back
      • Composition of Board
      • Super-majority approvals
      Slide
    • Financing the Business
      • Is money the primary issue?
      • Types of financing:
        • Debt
        • Equity
        • Hybrid
        • Government loans/grants
      Slide
    • Debt Financing
      • Shareholder loans (secured or unsecured)
      • Other Individuals
      • Banks/Financial Institutions
      • Credit cards
      Slide
    • Equity Financing
      • Selling of shares from treasury
      • Existing or new class of shares
      • Investors may demand preferential rights
      • Must comply with securities laws
      Slide
    • Convertible Debt
      • Debt which is converted upon occurrence of event
      • e.g. next equity financing
      • Usually has a discount on financing pricing
      • With or without security over assets
      Slide
    • Sources of Financing
      • Founders
      • Friends and family
      • Angel investors
      • Venture Capital
      • Strategic Investor
      • Government (Loans, Grants, ITCs)
      Slide
    • Approaching Investors
      • Very time consuming
      • Research before approaching
      • Seek referrals
      • Understand your market and competition
      • Know how much you need
      • Beware of offering memorandum/securities laws
      Slide
    • Employees
      • Common Pitfalls
      • Lack of proper written agreements
      • Using inappropriate precedents
      • Failure to limit entitlements on termination
      • Improper implementation
      • Faulty IP and confidentiality provisions
      • Over-reaching restrictive covenants
      • “ Deferring” salary
      • Improper termination
      Slide
    • Contractors
      • Regarded as a solution to “employment” liabilities
      • But contractor may still be an employee
      • If employee:
        • EI and CPP liability
        • Fines for not withholding income tax
        • WSIB premiums and/or fines
        • ESA liabilities and fines
        • Termination liabilities
        • IP ownership/waiver of moral rights
      Slide
      • Thank you
    • Licensing Information
      • This work is licensed under Creative Commons Attribution – Non-Commercial – Share Alike License. To view a copy of this license, visit creativecommons.org .