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  1. 1. General Corporate Overviewfor Early-Stage Startups<br />Presented by: Inna Efimchik<br />
  2. 2. Topics<br /><ul><li> When is the right time to incorporate and why
  3. 3. What do investors look at in diligence
  4. 4. Funding term sheets: vocabulary and trends</li></li></ul><li>Incorporating Your Business<br />
  5. 5. When is the right time to incorporate?<br /><ul><li> Co-founders
  6. 6. Commitment
  7. 7. Risk of liability
  8. 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. 9. you are saving $, so you don’t hire an attorney
  10. 10. you write out the terms of your “partnership” and</li></ul> everyone signs it<br />
  11. 11. Personal Liability<br />Let’s Suppose:<br /><ul><li> you start with 2 other co-founders
  12. 12. you are saving $, so you don’t hire an attorney
  13. 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. 14. IP in Limbo<br />Let’s Suppose:<br /><ul><li> you start with 2 other co-founders
  15. 15. you are saving $, so you don’t hire an attorney
  16. 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. 17. IP &/or Equity in Limbo<br />Let’s Suppose:<br /><ul><li> you start with 2 other co-founders
  18. 18. you are saving $, so you don’t hire an attorney
  19. 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. 20. Corporate Advantage<br /><ul><li>Scenario 1: injured pedestrian could sue only the corporation, but not the co-founders personally
  21. 21. Scenario 2: co-founder’s IP belongs to company
  22. 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. 23. Why is it important?<br /><ul><li> Sophisticated investors (VCs & super angels) take investing seriously
  24. 24. Their lawyers will conduct thorough legal due diligence
  25. 25. Investors don’t like surprises
  26. 26. They are conservative pattern-recognition experts
  27. 27. Legal diligence review that unveils</li></ul>red flags can slow down or even<br /> jeopardize a financing altogether<br />
  28. 28. What can be a “red flag”?<br /><ul><li> Founder equity not subject to vesting
  29. 29. Founder equity vesting subject to acceleration
  30. 30. Founder equity improperly granted (e.g. w/out board approval)
  31. 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. 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. 33. Executed invention assignment agreements
  34. 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. 35. If you don’t maintain proper corporate records  nightmare
  36. 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. 37. Term Sheets<br />
  38. 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. 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. 40. debt converts into equity upon</li></ul> a funding event<br />
  41. 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. 42. Dividends — usually 8%, non-cumulative, when, as and if declared
  43. 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. 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. 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. 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. 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. 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. 49. Summary<br /><ul><li> Incorporate when you are ready (with counsel that understands startups)
  50. 50. Maintain organized corporate records (or have counsel do it for you)
  51. 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 />