Getting Your Legal Ducks in a Row: Legal Guide to Attracting Investors


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This session was presented by Mark Graffagnini, Managing Member of Graffagnini & Associates. Find out more at

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Getting Your Legal Ducks in a Row: Legal Guide to Attracting Investors

  1. 1. RAISING ANGEL & VENTURE CAPITAL: GETTING YOUR LEGAL DUCKS IN A ROW Mark J. Graffagnini Managing Member Graffagnini + Associates, LLC New Orleans, LA @GraffagniniLaw
  2. 2. BACKGROUND  Graffagnini + Associates was founded in 2010  Focus on start-up company, venture capital investor, securities reporting and M&A issues over last 10 years  We represent companies around world in financing, M&A and formation transactions  Founding Board of Directors, NO/LA Angel Network, Inc.  Entrepreneur & Investor  Aestus Power  Collector App  CaliBurger  Cleantech Systems  Data company in stealth mode 
  3. 3. OVERVIEW  Early Stage Legal Issues Entity Choice Founders Issues Employee Incentives Seed Capital Venture & Angel Capital Managing Legal Costs
  4. 4. 1. FORMATION & CHOICE OF ENTITY Factor LLC C-Corp Taxation Pass-through •Profits/Losses flow through to owners Double-taxation: •Corp. pays tax on profits •Stockholders pay on dividends Type of Investor Not generally preferred for VCs, but some PE groups prefer: •Exit Issues •Distribution of income Generally preferred for VCs •Limited partners •Certainty Management/ Governance Flexible •Single manager •Board of Managers •Member-managed Less Flexible: •Board of Directors •Officers •Stockholders Employee Incentive Plans More difficult profits interests & less favorable tax treatment Incentive Stock Options
  5. 5. ADDITIONAL CONSIDERATIONS IN ENTITY CHOICE  Of Louisiana-based companies receiving venture funding, slightly less than half were corporations  DE is the most common jurisdiction used, regardless of entity type from 2011-2013.  LA was a close 2nd.  NOTE: If your investors are out-of-state investors, you will almost certainly be required to use a DE company.  S-corp tax status is likely the wrong choice unless you are purely a service company that will not raise angel or venture capital  Limitation on number of shareholders (means no IPO)  Taxation issues of the LLC form  Conversion later introduces additional complexity  Switch from LLC to C-Corporation later  May be your preferred strategy
  6. 6. 2. NOW YOU’VE CHOSEN THE RIGHT ENTITY FOR YOU— FOUNDERS ISSUES Membership Interest Purchase Agreement A/K/A Subscription Agreement A/K/A Contribution Agreement LLC [Restricted] Stock Purchase Agreement A/K/A Subscription Agreement A/K/A Buy-Sell Agreement C-Corp
  7. 7. 4 KEY ELEMENTS OF FOUNDERS/EMPLOYEE EQUITY AGREEMENTS Vesting of Shares or LLC Interests Company Re-purchase Option (“ROFR”); Right of other Equityholders to purchase Acceleration Provisions Lock-ups, Other Reps & Warranties Key Features of Founders Agreements
  8. 8. FOUNDERS/EMPLOYEE ISSUES (CONT’D)  Clean IP Assignments  Confidential Information & Invention Assignment Agreement (w/ non-competition)  Applies to ALL employees, contractors, etc. and in various agreements  Full coverage is beyond scope of this presentation  Pay for your stock/interests!!  Should be able to document payment and issuance  “Fully paid and non-assessable”  Mistakes:  Case of mistaken identity  “Woodwork” or “Social Network” issues  Poor documentation can lead to disputes  Not keeping “cap table” clean
  9. 9. WHAT’S A “CAP TABLE” XYZ Company XYZ % Units Type Capital Price Founder A 15% - Common 25,000$ 0.01$ Founder B 15% - Common 25,000$ 0.01$ Founder C 50% 500,000 Working Founder D 12% - Common 250,000$ 0.01$ Reserve 8% - Working Total 1,000,000
  10. 10. Common Series A and A-1 (7/10/01 & 7/8/02) Series B and B-1 3/31/03 Series C and C-1 7/27/04 Series D and D-1 5/24/07 As-Converted to Common Shares % of Total Out- standing % of Total Fully Diluted VC 1A 92,310 886,735 467,704 900,478 2,347,227 #DIV/0! #DIV/0! VC 1B 12,270 117,866 62,168 114,898 307,202 #DIV/0! #DIV/0! VC 1C 236,400 2,270,872 1,197,760 2,361,763 6,066,795 #DIV/0! #DIV/0! VC 1D 2,639,250 25,352,795 13,372,200 26,315,379 67,679,624 #DIV/0! #DIV/0! VC 2A 19,770 189,911 100,168 197,513 507,362 #DIV/0! #DIV/0! VC 2B 138,812 556,873 357,546 669,553 1,722,784 #DIV/0! #DIV/0! One Portion of a Complex Cap Table
  11. 11. 3. EMPLOYEE INCENTIVE PLANS Best Practices (LLC or C-Corp) • Written Plan • Consistent administration • Board/Manager Consent + Agreement • Clear Documentation • Update records after each grant • Keep attorney in the loop!! • File IRS paperwork if vesting • Securities filings (some states)
  12. 12. EMPLOYEE INCENTIVE PLANS (CONT’D) Worst Practices: • Informal “hand-shake” deals • Switching equity to and from individuals without paper trails • Failing to update records and cap table regularly • Ignoring internal requirements • Deliberating “forever” Risks: • VCs/Angels will notice • Employee confusion • Tax treatment
  13. 13. 4. RAISING SEED CAPITAL: THE “FAMILY & FRIENDS” ROUND • Issue stock or LLC interests according to your documents • Comply with securities laws • “Accredited investors” • Private placement memo (“PPM”) (a/k/a “private offering memo”) • Issue certificates if certificated shares • Present documents professionally Do’s • “Handshake” deals • General solicitations in media/events unless you are prepared to comply with Rule 506(c) • Fail to update records and tables • Fail to consider departure from company operations Don’ts
  14. 14. 5. ANGEL & VENTURE CAPITAL—DEAL DOCUMENTS & ISSUES Term sheet • Non-binding • Outlines basic terms of deal • Actual Terms Beyond scope Deal Documents: • Certificate of incorporation/Operating Agreement • Stock Purchase/Subscription Agreement • Investors Rights Agreement • Right of First Refusal/Co-Sale Agreement • Voting Agreement Due Diligence: • Dirty IP Assignments • Poor Cap Table Maintenance • General sloppiness—Due Diligence Nightmares!! Closing • Initial Closing and subsequent closing • Issue equity, obtain funds and signatures • Make securities filings
  15. 15.  Early Stage Legal Issues Entity Choice Founders Issues Employee Incentives Seed Capital Venture & Angel Capital Managing Legal Costs
  16. 16. 6. SERIOUSLY?! WHAT’S THIS GONNA COST ME?!  Attorney’s fees vary widely  Formation and Initial Financing Packages available:  Use resources to understand options before you begin  Take advantage of pro bono services (but be careful to understand when fees kick in)  Alternative fee arrangements, equity  Value Billing/Start-up packages  Beware of the “add-on” model  Hourly rates and lawyers on your file  Investor’s counsel fees & caps
  17. 17. SERIOUSLY?! WHY BOTHER?!  Correcting mistakes is far more costly  Happy employees  Happy investors  Roadmaps  Credibility!!!  Quicker Fundraising  Better results
  18. 18. ADDITIONAL RESOURCES   Google/Silicon Bayou News  “Entity choice entrepreneurs”  “Equity Incentives LLCs”  (detailed preferred financing issues and startup FAQs)  Many large firms with focus on financing transactions have sample legal documents (e.g.,;  Many incubator programs have them:  Series AA Preferred Financing Docs  National Venture Capital Association Model Templates  Series Seed  “Founders Fund”  SAFE
  19. 19. CONCLUSION  Entrepreneurship is a difficult road, and you have enough to worry about  Good documents and corporate practices give you peace of mind. Think of it as “code for corporate governance and capitalization”  View them as a roadmap for administration and successful business  Questions?  mg@graffagninilaw @GraffagniniLaw  504-265-9955 