I have tried to provide on my blog answers to most frequently asked questions relating to company formation and obtaining investment. If there are other general interest topics that you would like to see covered, please make a note of it in the comments section and maybe sometime soon you will see an answer posted on this blog!
General
Company Formation & Corporate Maintenance
Fundraising Process
Investment Terms
Investors' Perspective
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!
 | 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. |
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.
However, if you are an entrepreneur looking for funding for your startup, this knowledge alone does not help because it does not answer the question “what does an entrepreneur need to convey to the investor, for the investor to have the right emotional reaction which leads him to write the check”.
What then do early-stage investors in the tech sector look for when they are evaluating a project? What are the factors that make them excited about one project but not another?
People. The investor needs to believe in, in fact, be inspired by, the entrepreneur and his initial team. He needs to be convinced that this particular team has at least the following characteristics:
Some ways to demonstrate to an investor that the team has what it takes, to name just a few, are (i) a history of working together as a team on a prior successful project, or (ii) external validation of the project for which funding is being sought through market traction.
Opportunity.
Economic. To elicit the right emotional response from an investor, an entrepreneur needs to persuade the investor that, when properly executed by the right team, there is tremendous economic opportunity in the project. That may mean that the project is in a fast-growing market and that its premise is promising in light of what are perceived to be future trends. It also means that the investor can (and does) imagine a scenario where, with the right execution, the project will generate a significant economic upside, a return on investment of 10 to 30X.
Impact. Some investors will be looking specifically for projects which promise to generate a measurable, beneficial social or environmental impact alongside a compelling financial return. This is called impact investing and it is becoming more widespread. When pitching, it is critical for the entrepreneur to know whether the investor subscribes to this investment mandate. If so, he will be a lot more excited about a project that seeks to build literacy than the next “Cut the Rope” app.
Competitive Advantage. Finally, there needs to be a convincible competitive advantage, one that will allow this particular project to succeed over others in the same space. Its people, with deep specific expertise in an obscure area highly relevant to the project, for example, may be such competitive advantage. It may also be the technology behind the project, preferably protected by strong patents. Having a significant head start in an industry with a high barrier to entry might be another.
One way or another, an investor needs to feel that the horse he is asked to put his money on, the particular project that he is asked to invest in, in keeping with the metaphor, will come in first. The factors listed above, when applied to a startup especially, are highly subjective. It is the entrepreneur who is able to convince investors that his project excels in all three categories that attracts capital easily and gracefully!
Happy company making!
Inna
| 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. |
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.
Generally speaking, if a company is targeting angel investors, and especially if the idea is to get a group of angel investors to participate on substantially the same terms, it is fairly typical to approach these investors with a company-prepared term sheet.
Note, however, that in a bridge (convertible note) financing, and if the amount requested from each angel investor is small, it may be prudent to skip the term sheet step altogether, and to present investors with a draft convertible promissory note instead of a term sheet. This can save time and costs. In an equity financing, the simplest of which are still more complex than an average bridge financing, a term sheet may be unavoidable.
Approaching venture capital firms with a term sheet, unless it's for a follow-on financing on terms from the previous round, is unlikely to be beneficial. In fact, if anything, it might hurt the startup: the venture capital firm that will lead the round will prepare its own term sheet, but if the startups presented its own term sheet with concessions (investor-favorable terms), those investor favorable terms are very likely to be incorporated into the term sheet ultimately presented by the venture capital firm, even though it may not be a standard term for that stage of financing for the fund.
Stage of Financing: First Financing vs. Successive Financing
In the context of a rolling bridge financing, once the first investor has invested, the terms of that investment can be used as a benchmark with other investors that the startup targets. If there is a shift in leverage, making it easier to the startup to raise money (as it gains traction, for instance), the terms might stay substantially, but not exactly the same, with the valuation cap increasing or falling away entirely, as an example.
The first time that a company raises funding through the sale of equity (stock financing), negotiating the right terms is of utmost importance. The bulk of the terms will stay the same, or get worse, through successive rounds. The only term that will, hopefully, improve is valuation. But the control terms will, at best, stay the same, and very commonly will get more complicated and cumbersome as more investors are involved.
When a startup is doing well, and has supportive existing venture capital investors, who are going to invest in the new round, it is quite typical for the startup to mark-up the term sheet from the last round of financing and to use that as the starting point for negotiations with the new investor. The support of the existing investor cannot be understated in this situation. When Accel, Kleiner Perkins, Sequoia or Andreessen Horowitz (it certainly helps to have a first tier VC as an investor) tell the new investor that they like the terms from the prior round and expect them to stay substantially the same in this round, that's what happens.
Where Does a Startup Get a Term Sheet?
Of course, your attorney will be happy to provide you with a term sheet, drafted for your specific needs. No amount of reading insightful blog posts, such as this one, will fully replace consulting with a knowledgeable startup attorney. But if you are not going to be using your attorney for this, or if you would just like to educate yourself about term sheets before talking to an attorney or to investors, here are some resources:
Happy company making!
Inna
| 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. |
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.
ABOUT WHITE SUMMERS AND WORKING WITH LEGAL COUNSEL
Please tell me a little bit about yourself, your background, and what you do now?
I obtained my JD from Berkeley Law in 2005 (it was then still called Boalt Hall). After law school I joined the Venture Law Group at Heller Ehrman, where I focused on documenting venture capital investments and working with startups. Heller Ehrman imploded in 2008, and my group joined the emerging companies group at Cooley. After Cooley, I worked briefly for Electronics for Imaging. However, I realized that in-house counsel work – only supporting one client, is not for me. I enjoy working with a number of clients at the same time. I hung out my own shingle, but quickly realized that solo practice did not provide the kind of scale that was needed to support my practice. To get better clients, I needed a bigger platform. Two years ago, I took my practice to White Summers, a boutique corporate and transactional law firm, with 10 attorneys. White Summers has offices in the Silicon Valley (Redwood City, California) and in the Pacific Northwest (Portland, Oregon) and specializes on structuring and formation of legal entities, financings, mergers and acquisitions, and commercial contracts.
Do you represent only U.S.-based startups?
Incorporation. When a startup consists of a single founder programming away in his proverbial garage without involving others, it can wait to talk to an attorney. But at a certain point, as the sole founder attracts team members and starts to actually do business, it becomes beneficial to form an entity with limited liability (usually a corporation). Of course, It is possible, even easy, to incorporate without working with a startup attorney, but will it be done right, in a manner most beneficial to the startup given its long- and short-term goals? At the point when a company is ready to form an entity for doing business, it is best to speak to an attorney to get advice on the best jurisdiction and time to incorporate as well as to get the other formation in place, such as stock issuance and transfer of intellectual property.
Commercial Agreements. Another time to seek legal counsel is when the startup is negotiating and about to enter into a commercial relationship. Whether this is a license of technology to or from the startup, a bank loan, or even an agreement with a consultant, it is best to consult a professional, who can review the contract terms, explain the risks associated with the particular agreement, and help to negotiate the best terms for the startup.
Term Sheet. Very frequently I am engaged by a startup that has been presented with a term sheet from an interested investor and needs advice on how to proceed. I provide an analysis of the term sheet and offer a negotiation strategy. My role is to identify the terms that do not conform to best practices in a way detrimental to the startup or the founder, and to review those with the startup. In most of these cases, the founders did not work with legal counsel previously, and are missing important documents. In those situations, I will do corporate cleanup, in other words, generate proper documentation that the investors’ legal counsel will require when they conduct diligence review.
Financing. Finally, sometimes I am engaged at a stage when the term sheet with investors has been signed and the company needs representation for documenting the financing itself.
What is the best jurisdiction for a startup to incorporate?
That said, not every startup intends to raise funding in the United States. A startup based outside the United States may look to investors locally or in other jurisdictions, such as Europe or Asia, where investors’ jurisdictional requirements are very different from those of U.S. investors.
If there is a desire to enter the American market or to work with American investors, then at least one of the companies in the family of companies that constitutes the business must be incorporated in the United States, preferably in Delaware. In fact, the vast majority of startups that are incorporated in the United States, are incorporated in Delaware.
But that’s history. Bottom line is that investors are familiar with Delaware. They understand how the Delaware laws affect their rights are shareholders. For investors who have large portfolios, investments in 30 to 50 companies or more, it would be an impossible task, having to track their rights across 15 or 20 jurisdictions. Delaware is the industry-standard, and while you don’t have to always adhere to the industry-standard, if you don’t, you should have a very good reason for swimming against the current.
Are there any benefits to incorporating in a local jurisdiction (outside the U.S.)?
When we are talking about global business, we have to talk about families of companies. Thus, having a legal entity in the jurisdiction where a company is actually located can be very convenient for its operations. For example, it is easier for a company incorporated locally to enter into contracts with employees or to obtain a lease for office space.
For foreign startups that are targeting the U.S. for investment, the local company will typically be a wholly-owned subsidiary of a U.S. corporation. For startups that are looking to U.S. as a market for its products or services, the U.S. company may be a subsidiary or a sister-company. In either case, the relationships between the family of companies that constitute a business can (and should) be documented by commercial agreements.
If a startup has not incorporated and does not have a corporate bank account, how is it going to take money from investors? It is, of course, always possible to shake hands and accept a suitcase full of cash under the table. However, this is not a good business practice. If something goes very wrong, the founders will be subject to personal liability because they will be found to have been operating as a common law partnership. To minimize liability and make it easier to conduct business, ventures should be incorporated when they business outgrow the embryonic state and begin to have relationships with the outside world, whether it’s taking investment, uploading a mobile application to the AppStore, or hiring engineers.
As I mentioned in the discussion about engaging counsel, if a startup consists of a single founder, that founder can exist for quite a while on his own, without incorporating. However, if there are multiple founders involved and the company is not incorporated, the company structure becomes volatile.
By way of example, let’s say that five founders are working together on a startup without documenting their relationship. By the time an investor enters the scene, only three founders are still working on the project and the remaining founders incorporate the business.
But what about the two founders who left? Because of the lack of proper documentation, we are faced with many questions the answers to which depend on who you ask. Do the founders who left own a share of the company? If so, is it clear what their share is? Is it proportionate to their contribution? Is intellectual property that they created being used by the company? If so, does the company actually have the right to use it? Do the founders have the right to use it as well in a competing venture?
More often than not, an investor will not want to get involved in this type of situation because the risks are too high. Investors require that the cap table and IP ownership be clear and unambiguous. And this kind of a situation is exactly the type of issue that investors worry about uncovering when they conduct legal due diligence of a company.
This is why, the more people that are involved in a project, the more important it is to structure and document everything correctly and in a timely manner. Then, if something does not go according to plan, which is often the case, it’s a minor hiccup that does not derail the entire venture.
GETTING READY TO TAKE INVESTMENT
What types of documents should an entrepreneur have in place before talking to investors?
That can happen even when we are talking about savvy investors. For example, about six months ago we closed a deal in which our client received funding from Khosla Ventures, a top-tier venture fund. Vinod Khosla met the founder at a conference and he believed in the team and the technology. At that time, the company was formed as an LLC. There was nothing else done; it was an empty shell company. The client received a term sheet and we prepared the proper formation and financing documents.
In other words, there is no minimum set of documents that a startup is required to have to engage with investors, if there is a sufficiently high level of interest from the investors. But some investors might see a complete lack of corporate documentation as evidence of a lack of commitment by the founders. After all, if the founders have not been willing to invest even the small amount of their own funds necessary to properly set up the company, they must not have a lot of faith in the success of the project. But, ultimately, the importance that is placed on proper corporate documentation pre- first investment is going to be individual to the investor and to his interest in the company.
If you were to do things “by the book” so to speak, you would form a Delaware corporation, distribute Common Stock to the founding team, impose vesting on the shares, transfer all technology and other intellectual property created by the founders pre-incorporation to the corporation, and enter into agreements with everyone generating intellectual property for the company that make this intellectual property the property of the corporation from the time of creation. That’s the basics. Of course, if the company has any operations, you would properly document those as well.
Legal services can come with a hefty price tag. If the investors are performing due diligence, who pays the bill?
Of course, if we are talking about a very small investment amount, we work with the company to create minimalistic (yet sufficient) documentation, where the legal fees will make sense in the context of the transaction. Usually, a small investment can be documented as a bridge financing using a convertible promissory note that we’ll prepare for the company, based on the investment terms that it would like to offer to its investors. (For more information about convertible promissory notes, see my blog post on the topic.)
On the other hand, if we are talking about a financing in excess of $500,000, U.S. investors will expect the startup to pay their legal fees. Depending on the transaction, the cost of services of an attorney from the investor side is usually limited to $10,000 -$35,000. Since the attorney for the startup performs the majority of the work in an investment transaction, the cost for company counsel’s fees averages 1.5 to 2 times the cost of legal services for the investor (assuming comparable law firms with comparable rates on both sides of the transaction).
LEGAL PITFALLS
What are some legal difficulties that a startup might face at different stages of its life?
Legal difficulties often arise when something that needs to be documented is put off for later. Then suddenly it becomes too late, and it’s no longer an item at the bottom of a long to-do list, but a mistake which carries a cost and needs to be fixed. Some mistakes can be fixed afterwards, but it is typically more expensive than doing it right the first time.
Misunderstandings between counterparties also potentially create legal difficulties. If an agreement was rushed, it is possible that it was not thought through fully. After the fact, it may turn out that one party had meant one thing, and the other something else. Sometimes, when documentation wasn’t sufficiently well thought through, the plain text of the contract may not be enough to provide guidance on a point of contention.
Bottom line, good communication between the parties about their expectations with respect to their relationship will help to minimize many potential conflicts and legal difficulties.
What we do see sometimes are trademark disputes. Here’s how that usually goes:
These days, it can be difficult to invent a relevant and interesting company name for which a domain name is still available. But entrepreneurs are creative people, and eventually find a name and a domain. During the name selection process, they will usually run a Google search for their desired name to see if it’s already being used. If the search does not produce relevant hits, or if the only relevant hit is a chicken farm in New Zealand, they proceed with the name.
The problem is that trademark infringement is broader than using the exact name that another company is using in the same space. The test is “likelihood of confusion” so a company with a similar, not identical name, may have a legitimate claim against a newcomer. Without conducting a thorough trademark search, it is hard to catch those similar but not identical names.
Proceeding with our example, sometimes it turns out that there is, in fact, another company, with a similar but not identical name, that has the resources to do trademark policing. This company will start a cease and desist letter campaign against what they perceive as a violator of their trademark.
The first letter is generally from the company that owns the trademark, and reads something like, “We’ve invested a lot of money in our trademark and you are violating our rights! Stop it, immediately.” Then the “offending” company has to go to their attorney and the attorney will write a response explaining how there is actually no trademark violation and that the marks are sufficiently dissimilar that there could be no likelihood of confusion.
The next letter will typically come from a heavy-hitter law firm hired by the trademark holder. It will say something like “You are violating the rights of our client. Stop immediately or we will sue you.”
Whether there truly is infringement, is largely a matter of opinion and interpretation, and any question of opinion or interpretation can be resolved in court – that’s what courts do. But that’s a very expensive way to get an answer. If the dispute is between a small startup and an established company with a budget allocated specifically towards IP rights enforcement, the startup will have a difficult decision to make. One option is for the startup to change its name. But that means they would have to come up with another, non-infringing name that’s just as good, find a domain name that’s available, and wave goodbye to the time and money spent on developing this brand. Another option is to continue the letter exchange and hope that the other company is bluffing when they say they’ll sue. That’s a big risk, calling their bluff!
To reduce the risk of facing this situation, prior to definitively committing to a name, (1) have your attorneys conduct a thorough trademark search for it, and, if it comes back clear (2) register a trademark for it.
What advice can you give to new/novice entrepreneurs?
Second, you need to be running a continuous assessment of what you bring to the venture. You have to keep track of the components you need for success and be honest about what’s missing. Sometimes, entrepreneurs will start a project on their own and develop a strong personal attachment to it. It is theirs and theirs alone. They don’t want to bring on additional founding team members because they don’t want to share the equity or have to listen to other opinions. That kind of an approach can work for some founders, but it can backfire as well. Two heads are better than one and it is good to be challenged, even if it’s not as comfortable as being king in your own little kingdom. Working alone results in a skewed, one-sided vision.
Founders should seek out other talented like-minded people who will also become obsessed with the project. The more people that are excited about your idea, the more chances you have of persuading clients, customers, investors and business partners to be excited about it as well.
Don’t be paranoid that someone will steal your idea. Don’t be reluctant to seek advice from experts or to issue an equity stake to your partners. Running a startup is a collaborative process. All successful companies are developed by a team. No matter how brilliant an entrepreneur is, he cannot run a successful startup without a team. There will inevitably be gaps, and a strong team can fill those gaps. Every successful entrepreneur I have talked to has said “hire people smarter than yourself to be on your team”!
Lastly, I would say, constantly check and recheck whether the project you are working on is relevant! Does it provide a solution to a real problem? Solving a fictional problem is truly a thankless task.
Happy company making!
Inna
I am a corporate and securities attorney based in Silicon Valley, California, specializing in representing startups and startup investors.
The majority, though not all of our clients, are incorporated in the United States. Where they are physically located, however, is another matter. About half of my clients are headquartered in the CIS countries. One of my partners, Mark White, represents clients from Spain, and throughout Europe. An attorney is joining us, who will be developing the firm’s China practice. Even though many of our clients are located outside of the United States, they all inevitably have some to the U.S. jurisdiction – either they are incorporated in the United States, or they are raising money here, or their products and services target the U.S. market. A common characteristic among our clients is that they must face questions which require answers from a U.S. attorney.
When is the right time for a startup to engage legal counsel?
The best time to seek legal counsel is when the startup begins interacting with the outside world. There are four primary entry points:
The United States legal system is based on precedent. So the more that cases of a certain type are adjudicated in a jurisdiction, the more established and clear the law is relating to those kinds of cases in that jurisdiction. Historically, Delaware was the state of choice for large corporations and remains the state of choice for publicly-trading companies in the United States. Perhaps this was because of the business-oriented administrative system in place, or because Delaware has a separate court, the Chancery Court, that specializes in corporate and securities matters. Regardless of the original causes, the fact remains that over many years Delaware has acquired a very established body of corporate law and a judicial system that is competent in these matters and reasonably predictable.
I would say that waiting to incorporate until a business generates revenue is waiting too long and exposing the founders to too many risks and potential liability. Many startups don’t begin generating revenue for one to two years, or even longer. During that time, they have developers working on valuable intellectual property, officers are meeting with prospective customers, and presumably there is investment being made into the company that is supporting its operations.
Technically, you don’t need anything to talk. It is always possible that the investor will be so excited about the investment opportunity that he will offer you a term sheet even when the startup is not incorporated or does not have all the right documents in place.
It depends on how familiar the founder is with the terminology. I would say that on the whole, investors aren’t trying to purposefully mislead the founders or hide something unpalatable in the term sheet. Investors will include those terms and conditions in the term sheet that are important to them. Founders are expected to understand each term (whether on their own or with the help of an attorney). It is not enough to look at the company valuation, though that is certainly an important term. If a founder is experienced, understands common industry practices and terminology, and has already sold three companies, he can probably handle negotiations with the investor himself. But these types of founders are the exception.
Often in an investment transaction, the startup pays not only for its own attorney, but also for counsel for the investors. This is a very standard practice in the U.S. Sometimes if the investment amount is fairly small ($25,000-$100,000) both parties will agree to pay for their own counsel, or more likely, the investor will not engage counsel in the first place.
We do not run into this problem very frequently. In my practice, I have yet to see a single contract that I’ve drafted litigated. Generally speaking, the documents that we generate are meant to set expectations between counterparties. Even if things don’t go according to plan and one of the parties is dissatisfied with the performance of the other, it does not make a lot of sense to go to court for resolution. Litigation is both a very expensive endeavor and a disruptive one for business. The majority of my clients are not yet at a stage where it makes sense for someone to sue them or where they have the resources to sue someone.
Fortunately, patent infringement claims have not been brought against my clients either. Possibly for the same reasons listed above, but also because, even if their technology potentially infringes a patent, the patent holder simply wouldn’t know about it. Since my clients’ products and services aren’t household names quite yet, someone has to look pretty hard to find them. And then again, there are no deep pockets, so what will a lawsuit, even a successful one, get them? The company will shut down and everyone loses.
The most important piece of advice that I can give is to do what you love! The right motivation to become an entrepreneur is that you cannot do anything else, not because you don’t have the skills, but because you have identified an important problem, and have a solution to that problem that is far superior to what’s out there now. Being an entrepreneur, running a startup, you’ll work harder than you ever have in your life. It's certainly not for everyone, and if you’re going to take the plunge and go for it, be sure you are ready and that this is right for you.
| 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. |
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.
In financings, the total number of directors that constitute the entire board will be negotiated with the investors, who will often insist that the number of directors may not be changed without their consent. (For those who like the technical details, in equity financings you will usually find this in the protective provisions of the certificate of incorporation and in debt financings, in the negative covenants.)
Normally, whether an investor gets a Board seat is negotiated at the term sheet stage and subsequently built into the charter (certificate/articles of incorporation) and voting agreement. The right to nominate an investor will usually be conditional on such investor maintaining some number or percent of shares initially purchased by such investor.
Happy company making!
Inna
| Inna Efimchik 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. |
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.
Of course, as you will hear me repeat again and again, I would discourage anyone from making an investment without the help of legal counsel in navigating the negotiation and review of the documentation for it. Attorneys that specialize in financing work will be able to point out underwater rocks and provide invaluable negotiation advice. In this post, we’ll discuss five points that you should pay attention to in your transaction documents:
Of course, what we’ve covered here just brushes the tip of the iceberg, but I do hope you find it helpful.
Happy investing!
| 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. |
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.
However, we do not live in the perfect world, and some angel investors out there will consider their investment amount too small to engage legal counsel, and will venture out on their own.
If you are in that boat, you should at least conduct your own due diligence. At a bare minimum, there are 3 things you should request from the company in which you are investing, before you sign on the dotted line and before you initiate the wire (or write that check):
Beyond the documents mentioned above, if the amount that you are investing is upwards of $100,000, I would strongly recommend having your counsel conduct full legal diligence review.
Happy investing!
| 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. |
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.
Cost and Timing. The cost of documenting a middle-of-the-road bridge financing is generally going to be significantly lower than the cost of documenting a middle-of-the road equity financing.
The reason is that bridge financings, as the name suggests, are designed to tide a company over until it raises an equity round, and therefore, it leaves much of the negotiation and documentation of material terms to be done at the time of such equity round.
A very simple note financing (for $10,000 to $50,000) might entail just one document – a promissory note. On the other hand, in a preferred stock equity financing, at the very least an amended and restated certificate of incorporation is required, as well as a stock purchase agreement, and usually a shareholders agreement (or some combination of investors rights agreement, right of first refusal and co-sale agreement, and voting agreement).
A financing that requires less negotiation and fewer documents, can be completed on a shorter timeline. Therefore, on average, a bridge financing allows a company to take in money faster than an equity financing.
Control. Depending on the investor and the amount of the investment, a company may have to give up a measure of control when taking in capital. Control comes in several forms: control by equity holders and control at the board of directors level. A venture capitalist purchasing a significant stake in a company will usually require both, a board seat and special protective provisions that give him veto power as a shareholder over important company decisions. Even if special protective provisions are not negotiated, by law shareholders must approve certain decisions, which adds an administrative burden on the company.
A bridge financing for a small investment amount will generally allow a company to keep the most control. The founders will continue to control the entire board of directors, without having to add the bridge investor to the board. In addition, because a promissory note does not constitute a direct equity ownership and the holders of a promissory note do not become shareholders until the note converts, a company does not have to submit matters which require shareholder approval to the note holders.
Note, however, that a more sophisticated bridge financing, might include negative covenants, which would specify company acts or decisions which expressly require approval of the bridge investors irrespective of the fact that they are not shareholders. Bridge financings with a lower investment amount (< $100,000) will usually not include negative covenants.
Dilution. Before the first outside investment, founders amongst themselves own 100% of the company. With investment comes dilution—by issuing shares to the investors the founders’ share in the company decreases.
In the best-case scenario, using promissory notes will result in less dilution to the founders long-term than selling equity. In the worst, it will be the same. The determining factor, of course, is the company valuation. External factors like market conditions aside, and speaking for companies in the first several years from their formation, the later that a company is valued, the higher generally its valuation will be. In an equity financing, investors purchase shares based on a company’s valuation at the time of their investment. If the company isn’t very far along, doesn’t yet have a product, or has a product in beta and has not demonstrated traction, chances are its valuation will be low ($1,000,000 to $2,000,000) and even a small investment will significantly dilute the founders.
On the other hand, bridge investors are not purchasing shares at the time of their investment, and the number of shares that their investment will convert into will be determined based on the formula specified in the note. If a company can negotiate for the note principal and interest to convert into shares of the company’s preferred stock at a discount (of 15%-30%) of the price for such stock in the company’s next equity round, that will result in the least dilution for the company.
Many investors, however, will ask to cap the maximum valuation at which their notes will convert. In other words, even if a company’s first preferred stock financing is at a valuation of $10,000,000, if the bridge investors negotiated a valuation cap of $5,000,000 in their notes, their notes will convert into the number of shares equal to the (a) principal and accrued interest on the note, divided by (b) a price per share determined as (i) $5,000,000, divided by (ii) all of the shares of the Company outstanding at the time of the conversion.
The conversion cap has become an industry standard for even the smallest bridge financings. However, in my experience, the conversion cap does not generally reflect a company’s valuation at the time of the financing, but rather a valuation that’s somewhere midway between the valuation today and the expected valuation at the next equity financing. Therefore, even a promissory note with cap is frequently less dilutive than a priced seed equity round.
Is it any wonder that given how all these factors play out, convertible notes have become the standard investment tool for low-value seed-stage investments?!
| 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. |
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.
THIS PROMISSORY NOTE HAS NOT BEEN QUALIFIED WITH THE COMMISSIONER OF CORPORATIONS OF THE STATE OF CALIFORNIA AND THE ISSUANCE OF THIS PROMISSORY NOTE OR THE PAYMENT OR RECEIPT OF ANY PART OF THE CONSIDERATION FOR SUCH SECURITIES PRIOR TO SUCH QUALIFICATION IS UNLAWFUL, UNLESS THE SALE OF SECURITIES IS EXEMPT FROM QUALIFICATION BY SECTION 25100, 25102 OR 25105 OF THE CALIFORNIA CORPORATIONS CODE. THE RIGHTS OF ALL PARTIES TO THIS PROMISSORY NOTE ARE EXPRESSLY CONDITIONED UPON SUCH QUALIFICATRION BEING OBTAINED, UNLESS THE SALE IS SO EXEMPT.
[The term “Notes” shall refer to this Note along with all other convertible promissory notes issued by the Company in exchange for cash advances to the Company at any time from [Date Bridge Loan Begins] until [Date Bridge Loan Ends]. The terms “Lenders” may be used herein to refer to the Lender along with all other lenders, if any, who advance or have advanced funds to the Company in exchange for Notes.]
Whenever any payment hereunder shall be stated to be due, or any other date specified hereunder would otherwise occur, on a day other than a Business Day (as defined below), then, except as otherwise provided herein, such payment shall be made, and such payment date or other date shall occur, on the next succeeding Business Day. As used herein, “Business Day” means a day (i) other than Saturday or Sunday, and (ii) on which commercial banks are open for business in [City, State].
(a) Authorization. Lender has full power and authority to enter into this Note and such agreement constitutes its valid and legally binding obligation, enforceable in accordance with its terms.
(b) Purchase Entirely for Own Account. This Note (and any securities issued upon conversion of the Notes, herein, collectively, the “Securities”) has been purchased by the Lender for such Lender’s own account, not as a nominee or agent, and not with a view to the resale or distribution of any part thereof, and such Lender has no present intention of selling, granting any participation in, or otherwise distributing the same. Such Lender does not have any contract, undertaking, agreement or arrangement with any person to sell, transfer, or grant participation to any person with respect to the Securities.
(c) Disclosure of Information. Such Lender acknowledges that it has received all the information that it has requested in connection with the purchase of the Securities. Lender further represents that it has had an opportunity to ask questions and receive answers from the Company, as well as to consult their own legal, tax and other advisors, regarding the information provided and the terms and conditions of the offering of the Securities.
(d) Investment Experience. Lender is an investor in securities of companies in the start-up or early development stage and acknowledges that it is able to fend for itself, can bear the economic risk of its investment and has such knowledge and experience in financial or business matters that it is capable of evaluating the merits and risks of the investment in the Securities. If other than an individual, such Lender also represents it has not been organized for the purpose of acquiring the Securities.
(e) Restricted Securities. Such Lender understands that the Securities are characterized as “restricted securities” under the federal securities laws inasmuch as they are being acquired from the Company in a transaction no involving a public offering and that under such laws and applicable regulations such securities may be resold without registration under the Securities Act of 1933, as amended (the “Act”), only in certain limited circumstances. In this connection, such Lender represents that it is familiar with SEC Rule 144, as presently in effect, and understands the resale limitations imposed thereby and by the Act.
(f) Accredited Lender. Lender is an “accredited investor” as that term is defined under the Act.
(g) Further Limitations on Disposition. Without in any way limiting the representations set forth above, the Lender further agrees not to make any disposition of all or any portion of the Securities unless and until each of the following have been satisfied:
(i) There is then in effect a Registration Statement under the Act covering such proposed disposition and such disposition is made in accordance with such Registration Statement, or (i) the Lender shall have notified the Company of the Proposed disposition and shall have furnished the Company with a detailed statement of the circumstances surrounding the proposed disposition and (ii) the Company shall have obtained an opinion of counsel, reasonably satisfactory to the Company, that such disposition will not require registration under the Act.
(ii) If such transfer is not being made pursuant to Rule 144 or a registration statement under the Act, the transferee shall have agreed in writing, for the benefit of the Company, to be bound by this Section 6.
(iii) Notwithstanding the provisions of paragraphs (i) and (ii) above, no such registration statement or opinion of counsel shall be necessary for a transfer by the Lender which is a partnership to a partner of such partnership or a retired partner of such partnership who retires after the date hereof, or to the estate of any such partner or retired partner or the transfer by gift, will, or in testate succession of any partner to the partner’s spouse or to the siblings, lineal descendants, or ancestors of such partner or spouse, if the transferee agrees in writing to be subject to the terms hereof to the same extent as if he were an original Lender hereunder.
(h) Foreign Investors. If Lender is not a United States person (as defined by Section 7701(a)(30) of the Internal Revenue Code of 1986, as amended), Lender hereby represents that it has satisfied itself as to the full observance of the laws of its jurisdiction in connection with any invitation to purchase the Securities, including (i) the legal requirements within its jurisdiction for the purchase of the Securities, (ii) any foreign exchange restrictions applicable to such purchase, (iii) any governmental or other consents that may need to be obtained, and (iv) the income tax and other tax consequences, if any, that may be relevant to the purchase, holding, redemption, sale or transfer of the Securities. Lender’s payment for, and his or her continued beneficial ownership of the Securities, will not violate any applicable securities or other laws of Lender’s jurisdiction.
(i) Standoff Agreement. Lender agrees, in connection with the Company’s initial public offering of its equity securities, and upon request of the Company or the underwriters managing such offering, not to sell, make any short sale of, loan, grant any option for the purchase of or otherwise dispose of any shares of the Securities (other than those included in the registration, if any) without the prior written consent of the Company or such underwriters, as the case may be, for such period of time (not to exceed one hundred eighty (180) days) from the effective date of such registration as may be requested by the Company or such underwriters; provided, that the officers and directors of the Company who own stock of the Company also agree to such restrictions.
(j) Legends. It is understood that in addition to or in place of the legends currently on the Securities, the Securities may bear any legend required by the laws of the State of California, including any legend required by the California Department of Corporations and Sections 417 and 418 of the California Corporations Code or other applicable state blue sky laws, and a legend referring to the restrictions on transfer described in this Section 6.
(a) Assignment. This Note, and the conversion rights described herein, shall not be assignable by the holder without the prior written consent of the Company, which consent shall not be unreasonably withheld. Subject to the restrictions set forth in the foregoing sentence, the rights and obligations of the Company and the holder of this Note shall be binding upon and benefit the successors, assigns, heirs, administrators and transferees of the parties.
(b) Waiver and Amendment. Any provision of this Note may be amended, waived or modified upon the written consent of the Company and the [Lender][Lenders holding Notes with cumulative outstanding principal amounts representing at least a majority of the total principal amount of all Notes, so long as such amendment, waiver or modification applies equally to all Notes].
(c) Interpretation. Whenever possible, each provision of this Note shall be interpreted in such manner as to be effective and valid under all applicable laws and regulations. If, however, any provision of this Note shall be prohibited by or invalid under any such law or regulation in any jurisdiction, it shall, as to such jurisdiction, be deemed modified to conform to the minimum requirements of such law or regulation, or, if for any reason it is not deemed so modified, it shall be ineffective and invalid only to the extent of such prohibition or invalidity without affecting the remaining provision of this Note, or the validity or effectiveness of such provision in any other jurisdiction.
(d) Jurisdiction. The Company and each Lender hereby (i) submit to the exclusive jurisdiction of the courts of the State of California and the United States Federal courts of the United States sitting in the State of California for the purpose of any action or proceeding arising out of or relating to this Note and any other documents and instruments relating hereto, (ii) agree that all claims in respect of any such action or proceeding may be heard and determined in such courts, (iii) irrevocable waive (to the extent permitted by applicable law) any objection which it now or hereafter may have to the laying of venue of any such action or proceeding brought in any of the foregoing courts, and any objection on the ground that any such action or proceeding in any such court has been brought in an inconvenient forum and (iv) agree that a final judgment in any such action or proceeding shall be conclusive and may be enforced in other jurisdictions by suit on the judgment or in any other manner permitted by law. This Note shall be governed by the law of the State of California, without regard to choice of law principals.
(e) Notices. Any notice required or permitted by this Note shall be in writing and shall be deemed sufficient upon receipt, when delivered personally or by courier, overnight delivery service or confirmed facsimile or confirmed electronic mail, or three business days after being deposited in the U.S. mail as certified or registered mail with postage prepaid, if the notice is addressed to the party to be notified at the party’s mailing or email address or facsimile number as set forth below or as subsequently modified by written notice.
To the Company:
To the Lender:
(f) Arbitration. Any claims arising under this Note, except for any such claims for which injunctive relief is sought, shall be resolved in binding arbitration with a duly authorized representative of the American Arbitration Association (“AAA”) in accordance with the provisions hereof and thereof. Either the Company or the Lender may submit the matter to binding arbitration before the AAA in [San Francisco County, California], which arbitration shall be final and binding on the parties and the exclusive method, absent agreement between the Company and the Lender, for purposes of determining the ability of the Company or the Lender to satisfy such claim. All claims shall be settled by a single arbitrator appointed in accordance with the Commercial Arbitration Rules then in effect of the AAA (the “AAA Rules”). The arbitrator shall render a final decision pursuant to the AAA Rules within thirty (30) days after filing of the claim. The final decision of the arbitrator shall be furnished to the Company and the Lender in writing and shall constitute the conclusive determination of the issue in question binding upon the Company and the Lender, and shall not be contested by any of them. Such decision may be used in a court of law only for the purpose of seeking enforcement of the arbitrator’s decision. The prevailing party shall be entitled to reasonable attorneys’ fees, costs and necessary disbursements in addition to any other relief that such party may be entitled. For purposes of this Agreement, the prevailing party shall be that party in whose favor final judgment is rendered or who substantially prevails, if both parties are awarded judgment.
(g) Counterparts. This Note may be executed in two or more counterparts, each of which shall be deemed an original and all of which together shall constitute one instrument.
(h) Entire Agreement. This Note is the entire agreement between the parties hereto relating to the subject matter hereof and supersedes any prior arrangement or agreement, written or oral.
Inna Efimchik
| | Inna Efimchik 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. |
