Legal Hacking for Startups with Donna Petkanics Igniters Meetup igniterSV.com

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Get Legal advice for your startup with Donna Petkanics. Learn how not to get tripped up on legal matters while setting up your startup. …

Get Legal advice for your startup with Donna Petkanics. Learn how not to get tripped up on legal matters while setting up your startup.

Donna Petkanics was named by the Silicon Valley Business Journal as a "Woman of Influence," 2013 and honored by The Recorder as one of the "Women Leaders in Technology Law," 2013.

Petkanics has provided legal counsel to some of the country's most innovative technology companies. She has represented hundreds of startups and advised companies and underwriters in more than 65 public offerings during the course of her career. In addition, she has served in a number of management positions during her tenure at Wilson Sonsini and is a founding member of the firm's Women's Initiative Network.


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EXPERIENCE:

Donna Petkanics is a partner in the Palo Alto office of Wilson Sonsini Goodrich & Rosati. Her law practice focuses on the representation of growth companies, with a particular emphasis on corporate and securities issues. She represents both privately held and public companies across a broad range of industries, including telecommunications, Internet infrastructure, networking, life sciences, computer software and hardware, clean technology and energy, and electronics. She has experience representing companies in many types of corporate transactions, including mergers and acquisitions, initial public offerings, and joint ventures. She also counsels clients who are starting new businesses with respect to general corporate matters and protection of their intellectual property.

During her tenure at the firm, Donna has served in a number of management positions, including managing director of operations and chair of the Operations Committee from 2000 to 2006; member of the firm's board of directors, Policy Committee, and Compensation Committee; associate managing partner of the firm; and co-chair of the Hiring Committee and Nominating Committee. She served on the board of directors of the Wilson Sonsini Goodrich & Rosati Foundation from 2000 to 2010.

Prior to attending law school, Donna was a staff economist in the Executive Office of the President during Jimmy Carter's administration and also worked for the House of Representatives. She began practicing at Wilson Sonsini Goodrich & Rosati in 1985.

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  • 1. Donna M. Petkanics © 1 Speaker: Donna Petkanics Igniters Meetup Legal Hacking for Start-ups Sponsored by: Hosted by: http://www.vorkspace.com - Workspace of the Future http://meetup.com/igniter
  • 2. Organization and Legal Issues: Structuring the Venture How not to get tripped up on legal matters Donna M. Petkanics dpetkanics@wsgr.com 650.493.9300
  • 3. Donna M. Petkanics © 3 Why Legal Issues Matter In Setting up your Business • Keeps the “house” in order • Creates & Protects Value • Manage the risks • Investors will be happier
  • 4. Donna M. Petkanics © 4 Top Ten Tips for Setting up Your Company
  • 5. Donna M. Petkanics © 5 Tip #1: Set a Good Foundation Pre-Formation Issues • Leaving prior employers – dos & don’ts • IP ownership • Restrictions on competition, solicitation • Deciding on management structure and allocation of roles among founders, sources of investment, and exit strategy
  • 6. Donna M. Petkanics © 6 Tip # 2: Limit your liability Selecting the Form of Business Entity • Four fundamental types of organizations – Sole proprietorship – General or limited partnership – Limited liability company – Corporation
  • 7. Donna M. Petkanics © 7 Tip # 2: Limit your liability (cont’d) The Corporation: Advantages • Limited liability • Separation of ownership from management • Equity compensation norms • Allocation of interests • Transferability • Familiarity
  • 8. Donna M. Petkanics © 8 Tip # 2: Limit your liability (cont’d) The Corporation: Disadvantages • Double taxation: – Corporation level – Stockholder level • No pass through of tax benefits – Subchapter C Corporation: taxed as a separate legal entity (unlike the partnership or LLC); additional level of taxation on shareholder distributions • Exception is the Subchapter S Corporation – Tax benefits and losses passed through to the individual shareholders (i.e., a single level of taxation) – Early stage start-ups will sometimes take advantage of “S Corporation” status: losses get passed through, subject to certain limitations
  • 9. Donna M. Petkanics © 9 Tip # 3: Keep it simple • Pre- investors: Simple capitalization – Stock is a proxy for contributions/ roles – One form of common stock – Not a lot of bells & whistles
  • 10. Donna M. Petkanics © 10 Tip # 3: Keep it simple (cont’d) I. Formation of Company Founders A, B and C each purchase 2,000,000 shares of Common Stock at a purchase price of $.001 per share. Person No. of Shares % of Shares Purchase Price Founder A 2,000,000 33.33% $2,000 Founder B 2,000,000 33.33% $2,000 Founder C 2,000,000 33.33% $2,000 Total 6,000,000 100.0% $6,000 Founder B 33% $2,000 Founder C 33% $2,000 Founder A 33% $2,000
  • 11. Donna M. Petkanics © 11 Tip #4: Get it in writing • Founders Stock Agreements • Vesting agreements • Transfer of Intellectual Property
  • 12. Donna M. Petkanics © 12 Tip # 5: Be clear re: roles • Founders/ management • Investors • Board
  • 13. Donna M. Petkanics © 13 Tip # 5: Be clear re: roles (cont’d) OthersInvestors Employees Shareholders Optionees Typical Corporate Structure Board of Directors VP VP VP VPVP Other Employees CEO
  • 14. Donna M. Petkanics © 14 Tip # 6: Mind the basics • Authority to issue stock • Authorized capital stock • Board of Directors vs. Board of Advisors • Consultants vs. employees
  • 15. Donna M. Petkanics © 15 Tip # 6: Mind the basics (cont’d) Basic Concepts • Board of Directors has exclusive authority to issue stock • Security must exist before it is issued • Ownership of shares in a company is not ownership of the corporation’s property
  • 16. Donna M. Petkanics © 16 Tip # 7: Understand the Vocabulary • Preferred Stock • Common Stock • Vesting • Liquidity Event • Valuation – – Pre Money – Post Money
  • 17. Donna M. Petkanics © 17 Tip # 7: Understand the Vocabulary (cont’d) The Private Company Capital Structure • Dual-class structure: preferred and common stock • Stock represents the equity ownership of the company • Equity appreciation, risk and the venture capital model • Key Terms – Authorized – Outstanding – Employee Reserve • Founders’ stock: the first step in capitalizing the start-up – Usually common stock – Typically issued in exchange for technology, hard assets, past services or nominal cash.
  • 18. Donna M. Petkanics © 18 Tip # 7: Understand the Vocabulary (cont’d) Dual Class Stock Structure • The two-class capital structure: preferred and common stock – Common stock for compensatory purposes – Preferred stock for investment – Tax and accounting implications
  • 19. Donna M. Petkanics © 19 Tip # 7: Understand the Vocabulary (cont’d) Two-Class Stock Structure Preferred Stock Common Stock Compensatory Low price Residual Rights Investment High Price Senior Rights Investors Founders Management and Employees
  • 20. Donna M. Petkanics © 20 Tip # 7: Understand the Vocabulary (cont’d) Two-Class Stock Pricing $ 0 $10 $20 1st Round 2nd Round Mezzanine Round IPO Common Stock Stage Preferred Stock $2 $5 $10 $16 $20
  • 21. Donna M. Petkanics © 21 Tip # 7: Understand the Vocabulary (cont’d) Vesting • Vesting: what is it and how does it work? – Company right to repurchase employee stock at original purchase price upon employee termination – Typically a four year time period, with a one year cliff – Typically NOT tied to circumstances of termination
  • 22. Donna M. Petkanics © 22 Tip # 7: Understand the Vocabulary (cont’d) 4 Year Vesting with One Year Cliff 1 year 2 year 3 year 4 year 25,000 shares vested 50,000 shares vested 75,000 shares vested Fully vested Vesting* of remaining 75,000 shares at 1/36th per month (2,083 shares) *Unvested shares subject to company right to repurchase at cost Cliff vesting*
  • 23. Donna M. Petkanics © 23 Tip # 7: Understand the Vocabulary (cont’d) Practical Observations About Founders’ Stock • Vesting can create conflicts between founders • It is one of the focal points of the negotiations between founders and investors – How much should be “unvested” – Vesting acceleration upon a change of control
  • 24. Donna M. Petkanics © 24 Tip # 7 Understand the Vocabulary (cont’d) • Valuation - Percentage of equity interest – “We’re willing to put $2M in at a $3M pre-money valuation” – “We need to have 40% of the company if we are going to invest $2M” – When VC’s say they want a 40% stake in the Company for $2M then the pre-money is $3M and post-money is $5M. • Factors that influence pre-money valuation: – Leverage and the fundraising environment – Technology and business milestones met – Size of market opportunity – Experience of team – Terms of transaction
  • 25. Donna M. Petkanics © 25 Tip # 8: Focus on what matters • Term sheets will have lots of terms • Rely on experienced legal counsel to tell you what matters
  • 26. Donna M. Petkanics © 26 Tip # 8: Focus on what matters (con’t) • Valuation/Capitalization (“Pre-money “and “Post-money”) • Size of Investment and Price Per Share • Dividend Provisions • Liquidation Preference • Redemption Rights • Conversion Rights and Anti-dilution Adjustments • Voting Rights • Protective Provisions • Vesting on Founders’ Stock and Options • Information Rights • Right of First Refusal on Future Company Issuances • Rights of First Refusal and Co-Sale on Founders’ Transfers • Registration of Rights • Board Representation • Expenses of Transaction
  • 27. Donna M. Petkanics © 27 Tip # 9: Understand the endgame • If you take outside money, the Goal = liquidity for investors • Liquidity = IPO or M & A • Keep this in mind when negotiating agreements – Change of control provisions – Termination rights
  • 28. Donna M. Petkanics © 28 Tip # 10: Manage your risks to maximize growth • Securities laws matter • Business risks vs. legal risks
  • 29. Donna M. Petkanics © 29 Tip # 10: Manage your risks to maximize growth (cont’d) Sale of a Security – Regulatory Framework • Regulated by: – The Securities Exchange Commission (“SEC”) pursuant to the Securities Act of 1933 – Individual states – Blue Sky Laws • “Public Offering” under Section 5 of the Securities Act • Exemptions: – Transactions not involving any public offering – The Private Placement Exemption (§4.2) • Regulation D safe harbors
  • 30. Donna M. Petkanics © 30 Summary 1. Set a Good Foundation 2. Limit your liability 3. Keep it simple 4. Get it in Writing 5. Be clear re: roles 6. Mind the basics 7. Understand the Vocabulary 8. Focus on what matters 9. Understand the endgame 10.Manage your risks to maximize growth
  • 31. Donna M. Petkanics © 31 The Expanding Pie Theory • As additional stockholders are added there are more slices to the pie and each Founder holds less of the corporation • As the corporation creates value, each slice of the pie is worth more
  • 32. Donna M. Petkanics © 32 I. Formation of Company Founders A, B and C each purchase 2,000,000 shares of Common Stock at a purchase price of $.001 per share. Founder B 33% $2,000 Founder C 33% $2,000 Founder A 33% $2,000 Person No. of Shares % of Shares Purchase Price Founder A 2,000,000 33.33% $2,000 Founder B 2,000,000 33.33% $2,000 Founder C 2,000,000 33.33% $2,000 Total 6,000,000 100.0% $6,000
  • 33. Donna M. Petkanics © 33 II. Hiring of Chief Executive Officer and Establishment of Option Plan The Company hires a chief executive officer who purchases 2,000,000 shares of Common Stock at a purchase price of $.01 per share. Additionally, in order to attract additional key employees, the Company establishes an employee stock option plan and reserves 2,000,000 shares of Common Stock for issuance under this plan. The pre-financing valuation is $60,000 and the post-financing ownership structure and valuation are depicted in the following table and pie chart. Founder C 20% $20,000 President 20% $20,000 Stock Option Plan 20% $20,000 Founder A 20% $20,000 Founder B 20% $20,000 Person No. of Shares Percent of Shares Purchase price Founder A 2,000,000 20.0% $20,000 Founder B 2,000,000 20.0% $20,000 Founder C 2,000,000 20.0% $20,000 President 2,000,000 20.0% $20,000 Stock Opt. Plan 2,000,000 20.0% $20,000 Total 10,000,000 100.0% $100,000
  • 34. Donna M. Petkanics © 34 The Company needs capital to complete product development. Accordingly, the Company completes a $10,000,000 venture capital financing at a purchase price of $1.00 per share, representing a pre-financing valuation of $10,000,000 (10,000,000 shares with a value of $1.00 per share). The shares sold in the financing are Series A Preferred Stock with each share being convertible into one share of Common Stock. This financing results in the following ownership structure and post-financing valuation: III. Initial Venture Financing Round Founder A 10% $2,000,000 Series A Inv. 50% $10,000,000 Stock Option Plan 10% $2,000,000 Founder C 10% $2,000,000 Founder B 10% $2,000,000 Person No. of Shares Percent of SharesPurchase Price Founder A 2,000,000 10.0% Founder B 2,000,000 10.0% Founder C 2,000,000 10.0% President 2,000,000 10.0% Stock Opt. Plan 2,000,000 10.0% Series A Inv. 10,000,000 50.0% $10,000,000 20,000,000 100.0%$20,000,000* President 10% $2,000,000 Total Post-Financing Capitalization *Post money valuation
  • 35. Donna M. Petkanics © 35 The Company’s product development is progressing favorably, but an additional $20,000,000 will be required to complete development. Accordingly, the Company undertakes a $ 20,000,000 Series B Preferred Stock financing at a purchase price of $2.00 per share, representing a pre- financing valuation of $40,000,000 (20,000,000 shares with a value of $2.00 per share). Like the Series A preferred Stock, each share of Series B Preferred Stock is convertible into one share of Common Stock. This financing results in the following ownership structure and post- financing valuation: IV. Series B Preferred Stock Financing Series A Inv. 33.3% $20,000,000 Founder C 6.66% $4,000,000 Person No. of Shares Percent of SharesPurchase Price Founder A 2,000,000 6.66% Founder B 2,000,000 6.66% Founder C 2,000,000 6.66% President 2,000,000 6.66% Stock Opt. Plan 2,000,000 6.66% Series A Inv. 10,000,000 33.33% Series B Inv. 10,000,000 33.33% $20,000,000 Total Post-Financing Capitalization *Post money valuation 30,000,000 100.0%$60,000,000* Series B Inv. 33.3% $20,000,000 Founder B 6.66% $4,000,000 Founder A 6.66% $4,000,000 President 6.66% $4,000,000 Stock Option Plan 6.66% $4,000,000
  • 36. Donna M. Petkanics © 36 The Company needs substantial additional capital to expand the scope of its manufacturing and sales and marketing operations. Accordingly, the Company decides to undertake an initial public offering. As a result of the offering, the shares of Series A and Series B Preferred Stock held by the venture capital investors will be automatically converted into Common Stock at the conversion rate of 1 share of Common Stock for each share of Preferred Stock, and all shares sold in the offering will be Common Stock. A total of 10,000,000 are to be sold by the Company. The shares will be sold at a price of $10.00 per share, representing a pre-financing valuation of $300,000,000 (30,000,000 shares with a value of $10.00 per share). This public offering will result in the following ownership structure and post- financing valuation. V. Initial Public Offering Series A Inv. 25% $100,000,000 Founder C 5% $20,000,000 Person No. of Shares Percent of Shares Value Founder A 2,000,000 5% $20,000,000 Founder B 2,000,000 5% $20,000,000 Founder C 2,000,000 5% $20,000,000 President 2,000,000 5% $20,000,000 Stock Opt. Plan 2,000,000 5% $20,000,000 Series A Inv. 10,000,000 25% $100,000,000 Series B Inv. 10,000,000 25% $100,000,000 Public Investors 10,000,000 25% $100,000,000 Total Post-Financing Capitalization 40,000,000 100.0% $400,000,000 Series B Inv. 25% $100,000,000 Public Investors 25% $100,000,000 SeriesAInv. 25% $100,000,000 Founder C 5% $20,000,000 SeriesBInv. 25% $100,000,000 Founder B 5% $20,000,000 FounderA 5% $20,000,000 President5%$20,000,000 StockOptionPlan5% $20,000,000 PublicInvestors 25% $100,000,000
  • 37. Donna M. Petkanics © 37 The Expanding Pie Theory - Conclusions • The interest of each founder decreased from 33.33% at the formation of the company to 5.0% following the initial public offering • The value of the interest of each founder increased from $2,000 to $20,000,000
  • 38. Donna M. Petkanics Wilson Sonsini Goodrich & Rosati, P.C. dpetkanics@wsgr.com 650-493-9300 www.wsgr.com 38
  • 39. Donna M. Petkanics © 39 Speaker: Donna Petkanics Igniters Meetup Legal Hacking for Start-ups Sponsored by: Hosted by: http://www.vorkspace.com - Workspace of the Future http://meetup.com/igniter