Wednesday, August 10, 2016

“Silicon Valley” Series – a corporate law perspective

Over the past week or two, I binge-watched the first three seasons of HBO’s much talked-about series “Silicon Valley.” In truth, I only started watching because everyone was talking about it, and I felt that, given what I do, I needed to be able to participate in the conversation. But, I confess, I got sucked in, despite what, in my book, is an overabundance of profanity.

Given that counseling startups on corporate matters is my life, and one that I enjoy immensely, for that matter, I thought it would be interesting to analyze the legal basis to support Pied Piper’s predicament.

SPOILER ALERT! Don’t read any further if you don’t want to know what happens in the series through the end of the third season.


Board of Directors. The Board of Directors plays a key role in the fate of any company and we see the Board meet maybe four or five times throughout the series to make some pretty key decisions. But what is actually required for a Board to make a decision, legally-speaking? Here’s where the show took some liberties, for dramatic effect. There are only two ways that a Board can vote – by unanimous written consent, or at a meeting of the Board. The meeting must be attended by at least a majority of the directors, but all directors must be aware of the meeting. Meetings can be either regular (based on a pre-approved scheduled) or special. Each director must, typically, be given at least 48 hours’ prior notice of a special board meeting. Board meetings can be called on shorter notice, but only if each director waives notice.

If you’d like to get technical, notice requirements for special board meetings along with other corporate governance matters, can be found in the bylaws of a company. If you are a stockholder of a US corporation, the corporation is required to provide you with a copy of its bylaws on request.

How is it possible that Richard Hendricks did not know he was being fired as the CEO? In the show, Monica is the one to tell him. It’s a huge surprise and disappointment! But only the Board of Directors can fire or hire the CEO. They didn’t do it by written consent, because it has to be unanimous and Richard did not sign it. So they did it at a meeting, which he did not attend. That the CEO would miss a Board meeting is possible, though unlikely. However, It seems, he did not even know that a meeting of the Board was being held. Oops, that’s a problem from a corporate law perspective!

We see the same flop when Jack Barker, the outside CEO, gets fired in the next season. Richard and his co-founders come to the office to find his empty chair and Laurie Bream cleaning out his office. After Russ Hanneman sells his position to Raviga, Raviga acquires control of Pied Piper’s Board (three votes to Richard and Erlich’s two), so at a meeting they could certainly outvote the other members. But how ever did they meet in secret, without Richard knowing? But, let’s admit, the version in Silicon Valley is more fun! Laurie unexpectedly retaliating against Jack for his arrogance – a total Hollywood trope, no?

Convertible Loan. When Hanneman first offers a term sheet, the Pied Piper team is very excited. It saves them from having to sell to Hooli, and Jared (the only one to read it) thinks the term sheet isn’t bad. “It’s even structured as a loan,” they say, or something along those lines, making it sound like that’s the next best thing since sliced bread. Since we are talking startups, I can only assume they meant that he offered them a convertible promissory note.

For a $5M investment, at an early stage, using a convertible note is odd. Typically, we see convertible loans being used for much smaller investments early on. It is especially odd given that Hanneman apparently included a number of significant rights for himself, which aren’t usually given in a bridge financing. The primary reason why startups like convertible note financings is the simpler framework, which can be put in place in a matter of days, if needed, and at a fraction of the cost of a full-blown equity round.

An equity financing (the sale of shares), on the other hand, usually comes with all kinds of bells and whistles, which can take weeks or even months to properly negotiate with the investor and his counsel. Basically, doing a complex convertible note deal defeats the purpose of such investment structure for the company. So, let’s just say, whatever Hanneman’s term sheet said, it was a far cry from a standard Silicon Valley bridge financing deal, though certainly possible. For the sake of honesty, I will say that I have seen very simple equity deals with almost no bells and whistles and unduly complex convertible debt financings loaded with investor rights, even for much smaller investments than $5M. So, sometimes reality can be even stranger than fiction.

Later in the series, Hanneman’s assets fall below a billion, and he is no long a member of the three comma club. To remedy this, he sells his interest in Pied Piper to Raviga Capital. But what exactly did he sell? It sounded like he was selling shares. But if his investment had been in the form of a convertible note financing (a “loan”), he would not have had shares. Convertible notes will normally convert in a qualified (sufficiently large) equity financing round, which Pied Piper did not have. So, if Hanneman invested on a note, it should still be a note. Ok, maybe in the series they didn’t get into the fine details that I find so interesting. Maybe Raviga Capital acquired the promissory note. But it sure didn’t sound like it. In fact, on CrunchBase – yes, Pied Piper has a CrunchBase profile – Hanneman is listed as a Series A investor (https://www.crunchbase.com/organization/pied-piper/investors). Series A is a series of preferred shares, which are typically sold in an early equity financing (following Series Seed and preceding Series B).

Blocking Rights. Remember when Laurie buys Erlich’s shares for next to nothing, giving him just enough to cover his debt? She then explains to Richard, when he confronts her, in an exasperated manner, that under the terms that she inherited from Hanneman, she had the right to block any sale by Erlich. Full blocking rights on a sale by another stockholder? That is very unusual! Company right of first refusal on transfers by founders – sure! That’s quite standard. But all that would do is give Pied Piper the right to buy out Erlich if he had a third-party buyer for his shares, having to match the price offered to him by his buyer (in this case, $5M for half of his shares). Investor’s right of first refusal – could be. But that would give Raviga Capital the right to match Russ Hanneman’s price, and buy the shares that Erlich was offering to Russ Hanneman. No standard rights offered to investors would grant Raviga Capital the kind of blocking rights that it seems to enjoy in the series. In the U.S. and especially in Silicon Valley deals, we just don’t see an outright block by an investor on the sale of shares by another. So that was a bit sensationalist. Of course, just because the series is called “Silicon Valley” doesn’t actually mean it has to depict its protagonists being offered middle-of-the-road standard investment terms, and this is another instance where they weren’t.

Drag-Along. How was Raviga able to force the sale of Pied Piper? Control of the Board alone is not enough here. Such a sale would require an affirmative stockholder vote by, at a minimum, a majority of the outstanding shares, and Raviga is not a majority stockholder. I can only assume that among the terms that Pied Piper accepted from Russ Hanneman was a drag-along. A drag-along is a voting agreement among stockholders, which allows one group of stockholders to force the others to vote to approve an acquisition of their choosing. The group of stockholders that can force the sale depends on the deal. In certain scenarios, it can be a single influential investor. A drag-along would provide the necessary mechanism to support the forced sale of Pied Piper to Bachmanity.

Lawyer. How is it that Pied Piper does not have its own corporate lawyer after two rounds of financing? We are initially led to believe that Ronald LaFlamme, the extravagant guitar-playing chap, is Pied Piper’s lawyer. But he is actually counsel to Raviga! It’s on Raviga’s website – yes, Raviga has a website (http://www.raviga.com/index.html). When Pied Piper is about to enter into a white-label licensing agreement for its box, it’s Monica, who catches the grant of exclusive intellectual property rights to the customer. If it wasn’t clear enough in the show, that really is a huge red flag in a commercial agreement. So here we are, about to sign a multi-million dollar commercial agreement and an attorney representing Pied Piper hasn’t so much as laid eyes on it? Sure, Pied Piper is next-to-broke for much of the show, but this episode was actually at the height of its glory. Then again, maybe if Pied Piper had corporate representation from the outset, the founders wouldn’t have found themselves at the total mercy of their investors! And that is not a bad self-serving message for me to conclude on.

Happy company-making and enjoy Season 4, coming in 2017!


White Summers  Inna Efimchik, a Partner at White Summers Caffee & James LLP, specializes in assisting emerging technology companies in Silicon Valley and beyond, providing incorporation, financing, and licensing services as well as general corporate counseling.
LEGAL DISCLAIMER

Copyright Notice. The copyright for all original content in this post and any linked files is owned by Inna Efimchik. All rights are reserved.

No Attorney-Client Relationship. This post has been prepared by Inna Efimchik of White Summers for general informational purposes only. The information provided herein does not constitute advertising, a solicitation or legal advice. Neither the availability, transmission, receipt nor use of any information included herein is intended to create, or constitutes formation of, an attorney-client relationship or any other special relationship or privilege. You should not rely upon this post for any purpose without seeking legal advice from licensed attorneys in the relevant state(s).

Compliance with Laws. You agree to use the information provided herein in compliance with all applicable laws, including applicable securities laws, and you agree to indemnify and hold Inna Efimchik and White Summers Caffee & James LLP harmless from and against any and all claims, damages, losses or obligations arising from your failure to comply.

Disclaimer of Liability. ALL INFORMATION IS PROVIDED AS-IS WITH NO REPRESENTATIONS OR WARRANTIES, EITHER EXPRESS OR IMPLIED, INCLUDING, BUT NOT LIMITED TO, IMPLIED WARRANTIES OF MERCHANTABILITY, FITNESS FOR A PARTICULAR PURPOSE AND NONINFRINGEMENT. YOU ASSUME COMPLETE RESPONSIBILITY AND RISK FOR USE OF THE INFORMATION IN THIS POST.

Inna Efimchik expressly disclaims all liability, loss or risk incurred as a direct or indirect consequence of the use of any information provided herein. By using any information in this post, you waive any rights or claims you may have against Inna Efimchik and White Summers Caffee & James LLP in connection therewith.




3 comments:

  1. I think this is one of the most important information for me.
    And i'm glad reading your article. But want to remark on some general things, The website style is perfect, the articles is really nice : D. Good job, cheers
    Web Design and Development company
    online business ideas for startups

    ReplyDelete
  2. Valuable information in your blog and I really appreciate your work and keep it up dude I really very informative blog about the Social Startup Ventures good work.
    Social Startup Ventures

    ReplyDelete
  3. Also it is good to build up your network during every start up meet up. Try to make a few connections at an event each time, and you will be surprised how much valuable people you will get. https://www.wesettle.com

    ReplyDelete