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  • 1. General Corporate Overviewfor Early-Stage Startups<br />Presented by: Inna Efimchik<br />
  • 2. Topics<br /><ul><li> When is the right time to incorporate and why
  • 3. What do investors look at in diligence
  • 4. Funding term sheets: vocabulary and trends</li></li></ul><li>Incorporating Your Business<br />
  • 5. When is the right time to incorporate?<br /><ul><li> Co-founders
  • 6. Commitment
  • 7. Risk of liability
  • 8. VC or angel funding</li></li></ul><li>What can happen if you don’t incorporate?<br />Let’s Suppose:<br /><ul><li> you start with 2 other co-founders
  • 9. you are saving $, so you don’t hire an attorney
  • 10. you write out the terms of your “partnership” and</li></ul> everyone signs it<br />
  • 11. Personal Liability<br />Let’s Suppose:<br /><ul><li> you start with 2 other co-founders
  • 12. you are saving $, so you don’t hire an attorney
  • 13. you write out the terms of your “partnership” and</li></ul> everyone signs it<br />Scenario 1: on the way to a<br />prospective customer meeting<br />a co-founder is in a serious car<br />accident & injures a pedestrian<br />
  • 14. IP in Limbo<br />Let’s Suppose:<br /><ul><li> you start with 2 other co-founders
  • 15. you are saving $, so you don’t hire an attorney
  • 16. you write out the terms of your “partnership” and</li></ul> everyone signs it<br />Scenario 2: a co-founder takes<br />a job at another company & plans<br />to use the technology he has been<br />developing for that company<br />
  • 17. IP &/or Equity in Limbo<br />Let’s Suppose:<br /><ul><li> you start with 2 other co-founders
  • 18. you are saving $, so you don’t hire an attorney
  • 19. you write out the terms of your “partnership” and</li></ul> everyone signs it<br />Scenario 3: a co-founder decides<br />not to pursue the venture any more;<br />has a falling out with other co-founders<br />
  • 20. Corporate Advantage<br /><ul><li>Scenario 1: injured pedestrian could sue only the corporation, but not the co-founders personally
  • 21. Scenario 2: co-founder’s IP belongs to company
  • 22. Scenario 3: co-founder’s IP assigned to company; will keep small amount of vested shares; unvested shares repurchased for nominal $</li></li></ul><li>Investors’ Due Diligence<br />
  • 23. Why is it important?<br /><ul><li> Sophisticated investors (VCs & super angels) take investing seriously
  • 24. Their lawyers will conduct thorough legal due diligence
  • 25. Investors don’t like surprises
  • 26. They are conservative pattern-recognition experts
  • 27. Legal diligence review that unveils</li></ul>red flags can slow down or even<br /> jeopardize a financing altogether<br />
  • 28. What can be a “red flag”?<br /><ul><li> Founder equity not subject to vesting
  • 29. Founder equity vesting subject to acceleration
  • 30. Founder equity improperly granted (e.g. w/out board approval)
  • 31. Biggest red flag: problems with IP (ownership/proper assignment)</li></li></ul><li>What do investors like to see in first-round legal diligence?<br /><ul><li> Delaware corporations – it’s a deep-seated bias of the VC community
  • 32. Detailed cap table with a small number of stockholders with properly</li></ul>issued shares subject to vesting; minimal dilution from other sources<br /><ul><li> Board and stockholder actions that support the company’s cap table
  • 33. Executed invention assignment agreements
  • 34. Clean ownership of core IP</li></li></ul><li>Preparing for Diligence Review<br /><ul><li> If you maintain proper corporate records  easy
  • 35. If you don’t maintain proper corporate records  nightmare
  • 36. Corporate records are like health:</li></ul>much easier & cheaper to maintain than to “repair” later<br /><ul><li> You can task your law firm with</li></ul> keeping your corporate records<br /> and responding to diligence requests<br />
  • 37. Term Sheets<br />
  • 38. Equity vs. Debt Financing<br />Preferred Stock Financing (Series A, Series B, etc.) – equity <br /><ul><li> sell shares of the company to investors
  • 39. investors set valuation, which determines price per share of</li></ul> Preferred Stock<br />Convertible Promissory Note Financing – debt (bridge loan)<br /><ul><li> company takes on debt
  • 40. debt converts into equity upon</li></ul> a funding event<br />
  • 41. Equity Financing Terms<br /><ul><li>Pre-Money Valuation – (arbitrary) $-amount set by the investor</li></ul> based on similar companies & on % of company investor wishes to buy<br /><ul><li>Post-Money Valuation – sum of pre-money valuation & investment
  • 42. Dividends — usually 8%, non-cumulative, when, as and if declared
  • 43. Liquidation Preference — investors’</li></ul> proceeds on a sale of the company;<br /> can be 1x, 2x, etc., participating or<br /> non-participating<br />
  • 44. Equity Financing Terms<br /><ul><li>Redemption – investors’ option to require the company to repurchase</li></ul> their shares after some number of years<br /><ul><li>Qualified IPO – an IPO with aggregate proceeds & pre-money</li></ul> valuation agreeable to investors; triggers automatic conversion of<br />Preferred Stock into Common Stock<br /><ul><li> Pay-to-Play — a mechanism</li></ul> whereby investors failing to<br />participate in future rounds are<br /> penalized (by loss of rights)<br />
  • 45. Equity Financing Terms<br /><ul><li>Antidilution – a protection for investors in down-rounds, which</li></ul> adjusts the number of shares of Common Stock into which their<br /> Preferred Stock convert; there are exclusions to this & it can be waived<br /><ul><li>Protective Provisions – a category of matters deemed especially</li></ul> significant by the investors, which requires a separate vote by Class<br /> or by Series<br /><ul><li> Board of Directors — governing</li></ul>body of the company; investors will<br /> usually request a seat<br />
  • 46. Equity Financing Terms<br /><ul><li>Stock Option Pool – usually between 15 and 20% of the company on</li></ul> a post-money basis; the reserve for employee equity compensation that<br /> investors request; delays dilution to investors as the company grows<br /><ul><li>Right of First Refusal – one of two things:</li></ul> - right of Company to buy shares offered for sale by any founder; or<br /> - right of investors to buy any new shares<br /> offered by Company<br /><ul><li> Co-Sale Right — right of investors</li></ul>to sell their shares when founders<br /> shares with the SEC (going public)<br />
  • 47. Debt Financing Terms<br /><ul><li>Interest rate – promissory notes bear interest because they are debt</li></ul> instruments; interest can be converted or paid when shares convert<br /><ul><li>Maturity date – usually the drop dead date; parties expect that</li></ul> company will either raise equity funding or will go under prior to this<br /> date; no real expectation that the note will be repaid<br /><ul><li> Security interest — protection</li></ul>for worst case scenario; debt holders<br /> with a security interest take priority<br /> for spoils over other debt holders in a<br /> bankruptcy or dissolution<br />
  • 48. Debt Financing Terms<br /><ul><li>Qualified financing – equity funding round with aggregate proceeds</li></ul> agreeable to investors; note automatically converts into Preferred Stock<br /><ul><li>Events of default – certain predefined events which will cause the</li></ul> note to mature immediately (e.g., sale of the company); may have<br /> special repayment terms attached in event of sale of company<br /><ul><li> Cap — maximum pre-money</li></ul>valuation at which note will convert <br /> into Preferred Stock; a reward for<br /> early-stage risk-taking<br />
  • 49. Summary<br /><ul><li> Incorporate when you are ready (with counsel that understands startups)
  • 50. Maintain organized corporate records (or have counsel do it for you)
  • 51. When the time comes to talk to investors, dazzle them with your</li></ul>technology and streamline the financing by being on top of your game<br /><ul><li> Understand the term sheet and, if you don’t, ask your lawyer</li></li></ul><li>Thank you!<br />