5 Things about 5 Things for Startups - If you are a startup entrepreneur, you need to know these things. Fredlaw SURGE lawyers guide you

1. © 2015 Fredrikson & Byron, P.A.
STARTUP WEEK EVENT
5 THINGS ABOUT 5 THINGS THAT
EVERY STARTUP SHOULD KNOW
Presented by:

2. Discussion Leaders
Kevin Spreng, Shareholder, Fredrikson &
Byron
Kim Lowe, Shareholder, Fredrikson & Byron

3. 1. Getting Started
1. Entity choice matters, sort of.
– Operating your business through some sort of
entity is far more important than which entity
• Liability protection for personal assets
• Gets the rights parts in the right bucket from the
beginning
– Any entity will accomplish the above and we
can easily change between corporations and
LLCs in the early stages

4. 1. Getting Started
2. Founder vesting is a must.
- Founder vesting must be considered to avoid “free-riding.”
- Free riding occurs when a founder receives shares that are not
subject to vesting and leaves. He or she continues to have benefit
of ownership while others do all the work.
- Founder vesting is usually in the form of a lapsing repurchase right
that allows the company to repurchase the shares at the original
issue price.
- Repurchase right usually lapses in 3 or 4 years but is sometimes
based on performance milestones.
- Investors often insist upon founder vesting. This can be hotly
negotiated.

5. 1. Getting Started
3. Don’t forget assignment of IP.
– Founders (and other service providers) should assign to the
company all code, patents, business ideas and other
intellectual property related to the company’s business.
– This is usually a simple uncontroversial document for
founders and employees but if it is not done at formation or
prior to employment it can cause significant issues at
financing or acquisition.
– Consultants may request carve-outs and/or right to use
developed IP.
– Investors and acquirers want “clear title” to all IP.

6. 1. Getting Started
4. Each founder should get what’s fair.
– Consider the current economic contribution to
the business, not relationship or friendship.
• Cash, IP, Property can be valued at the beginning
• A promise to work cannot be valued until it is actually
delivered upon and results in value to the business
– Always consider what will happen when the
founders hate each other

7. 1. Getting Started
5. Do it right and in writing and don’t make
promises you might not want to keep.
– Often in the early stages of a company/idea people
come and go, ideas are shared, collaborations occur
and through this promises are made. Be sure any such
promises are made deliberately, are tied to
performance and are in writing, ideally prepared by a
lawyer.
– “Back of the napkin” deals (e.g. “you’ll get 10% of the
company if you …”) often come back just before a
financing or acquisition.

8. 2. Raising Money
1. It’s illegal to sell stock, units or notes,
except when it’s not.
– The sale of equity interest in an enterprise is
generally covered by state and federal
securities laws, there are many exceptions to
these laws
– The identity of the buyer(s) (or potential
buyer(s)) drives this issue not the type of
security offered or sold

9. 2. Raising Money
2. No fibs or lies or cover-ups!
– Some sales of equity are “exempt” from registration (i.e., don’t
have to be registered with the SEC) but they are NOT exempt for
the anti-fraud provision of securities laws.
– The company and control persons can be held liable for providing
information that includes an untrue statement of a material fact or
omits a material fact required to make other statements not
misleading.
– Some exempt offerings have no specific disclosure requirements
but what is provided must be true and not misleading.
– Purchasers can seek damages or rescission.

10. 2. Raising Money
3. There are big differences among convertible
notes, SAFE, common stock, and preferred stock
but in the end the investors almost always get
their money back first with subtle or significant
variations.
– Expect investors to get their money back before founders share
in proceeds.
– Occasionally investors will purchase common stock.
– Be sure to understand and model liquidation preference.

11. 2. Raising Money
4. You need to understand how shares (and
your business) are valued. Take the time to
discuss with lawyer or read up.
– Investor Values the business, not you:
• Pre-Money = the value of your company now
• Post-Money = the value of your company after the
investor puts the money in
– Valuation methods -- vary

12. 2. Raising Money
5. Most investor’s rights are fairly benign and
standard (although wordy) but be cautious with
board seat, protective provisions and liquidation
preferences.
– Convertible notes - try to avoid repayment at maturity or maturity at all.
– Preferred stock - push for simple liquidation preference – investors get money back or convert
to common and participate in up side but not both. Avoid participating preferred and liquidation
multiples if possible.
– Try to maintain control of the board of directors, if possible. The board controls hiring and firing
of CEO and key corporate decisions including financing and sale of company.
– Limit protective provision – protective provisions are essentially a list of actions that the
company can not take without the investors consent. These provisions shift control of the
included items from the board to the investors.
– Information, registration, pre-emptive, co-sale and first refusal rights are fairly standard.

13. 3. Building the Team
1. You can’t just decide who will be an
employee or contractor, and it makes a
difference.
– Various state agencies make determination, not
the worker or the buyer of services
– Agreement does not change status
– Consequences of wrong choice are bad and the
authorities are cracking down

14. 3. Building the Team
2. Don’t forget to get IP assignments!
– All workers (employees or independent
contractors and working owners) need to sign
an IP assignment agreement at
commencement of engagement
– Get a confidentiality agreement and non-
compete as well if you can
– Don’t just rely on common law

15. 3. Building the Team
3. Equity grants should be subject to vesting
and no acceleration when possible.
– Equity (options and stock) is typically granted to service providers (i.e.,
founders, employees) in exchange for service to be provided in the future,
and should not be vested until such service has been provided. Vesting is
usually time based but can be tied to performance milestones.
– Investors generally object to accelerated vesting in connection with a sale
of the company because it transfers value from stockholders to service
providers before it has been earned.
– Founders and key executives can often negotiate accelerated vesting.

16. 3. Building the Team
4. Avoid severance, except when you can’t.
– Severance should not be offered, it should be
requested
– Only provide severance to valuable contracted
team members; tie severance to noncompete
– Don’t put severance in your employee
handbook either

17. 3. Building the Team
5. On termination always get a release, if you
can.
– Release of claims by the terminated employee
– Typically mutual
– There are timing and rescission rules to take
into account
– Good area to engage a competent lawyer.

18. 4. Protecting your ideas.
1. Did I forget to mention, get an IP
assignment from everyone?
– Get an assignment from all employees,
contractors, and collaborators.
– Investors and acquirers will want to see them.

19. 4. Protecting your ideas.
2. Use your open source deliberately.
– Using open source software can speed development but comes
with obligations under the applicable license agreement.
– Understand the obligations before you use the software.
– Some open source licenses require free distribution of your
software if you use the open source code. This can be a significant
business model problem and issue for investors and/or acquirers.
– Keep track of where the open source is used, the applicable license
and don’t incorporate into key software without consulting a lawyer.

20. 4. Protecting your ideas.
3. Patent when possible. Yes, you need a
good patent lawyer.
– The importance of patents depends on industry – patenting is
more common in medical device, semiconductor and hardware
industries and may help in securing funding.
– In software and ecommerce patenting is less common and less
likely to help with financing.
– Hire a good patent lawyer to help decide whether to pursue a
patent strategy

21. 4. Protecting your ideas.
4. Use a confidentiality agreement.
– ALWAYS!!!
– Develop your own form agreement and require
any party who might have access to your idea(s)
to execute it before sharing any information
with them
– Savvy players will expect to sign an
confidentiality agreement so if someone is
shocked you asked, reconsider

22. 4. Protecting your ideas.
5. Registration of copyright and trademark
are secondary concerns, except when
they’re not – ask your lawyer.
– Sector and market specific
– Branding can be very valuable
– Not all ideas are patentable or justify the cost of
a patent

23. 5. Finding the Exit
1. Preparing for sale starts at the beginning.
– So how are you and your investors going to get
your money (or value) out of the enterprise
– Exit is more than 100% sale:
• Liquidity event
• Strategic buyer
– Entity choice matters (a little) when
considering exit

24. 5. Finding the Exit
2. Do everything right and in writing and don’t
make promises you might not want to
keep.
– The night before selling the company is when skeletons creep out of the
closet.
– Remember the woman that sat next to you at CoCo for a few weeks while
you were hatching the idea for your company. You told her that you would
give her 5% of the company if she created a key feature of your
software. She started but flaked out and you never used any of her
code. She is going to want her 5%.
– And it could be worse if you did use her code but didn’t get an IP
assignment.
– Do it right and do it in writing.

25. 5. Finding the Exit
3. You must keep track of ownership, every
share, unit, option, and every promise on a
napkin.
– Clean it up if you have not been good to date
– Going forward write everything down
– Even one undocumented claim on equity can
kill a deal – buyers hate the unknown

26. 5. Finding the Exit
4. One last time, always get assignment of IP
ownership.
– See Item 2

27. 5. Finding the Exit
5. Engage with strategic investors carefully.
– Consider long term exit before you take their
money
– Strategic investors have their best interest mind
and not yours when they invest.
– Document the relationship and goals carefully
and watch out for control grabs

28. Contact Information
Kevin Spreng
Fredrikson & Byron, PA
kspreng@fredlaw.com
612-492-7395
Kim Lowe
Fredrikson & Byron, PA
klowe@fredlaw.com
612-492-7324