five things about five things that every start should know

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STARTUP WEEK EVENT 5 THINGS ABOUT 5 THINGS THAT EVERY STARTUP SHOULD KNOW Presented by:

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Page 1: Five Things About Five Things That Every Start Should Know

STARTUP WEEK EVENT 5 THINGS ABOUT 5 THINGS THAT EVERY STARTUP SHOULD KNOW

Presented by:

Page 2: Five Things About Five Things That Every Start Should Know

Discussion Leaders Kevin Spreng, Shareholder, Fredrikson

& Byron David Winkler, Senior Associate, Fredrikson & Byron

© 2015 Fredrikson & Byron, P.A.

Page 3: Five Things About Five Things That Every Start Should Know

1. Getting Started

1. Entity choice matters, sort of. – Operating your business through some sort of

entity is far more important than which entity • Liability protection for personal assets • Gets the rights parts in the right bucket from

the beginning – Any entity will accomplish the above and we

can easily change between corporations and LLCs in the early stages

© 2015 Fredrikson & Byron, P.A.

Page 4: Five Things About Five Things That Every Start Should Know

1. Getting Started

2. Founder vesting is a must. - Founder vesting must be considered to avoid “free-riding.” - Free riding occurs when a founder receives shares that are

not subject to vesting and leaves. He or she continues to have benefit of ownership while others do all the work.

- Founder vesting is usually in the form of a lapsing repurchase right that allows the company to repurchase the shares at the original issue price.

- Repurchase right usually lapses in 3 or 4 years but is sometimes based on performance milestones.

- Investors often insist upon founder vesting. This can be hotly negotiated.

© 2015 Fredrikson & Byron, P.A.

Page 5: Five Things About Five Things That Every Start Should Know

1. Getting Started

3. Don’t forget assignment of IP. – Founders (and other service providers) should assign

to the company all code, patents, business ideas and other intellectual property related to the company’s business.

– This is usually a simple uncontroversial document for founders and employees but if it is not done at formation or prior to employment it can cause significant issues at financing or acquisition.

– Consultants may request carve-outs and/or right to use developed IP.

– Investors and acquirers want “clear title” to all IP.

© 2015 Fredrikson & Byron, P.A.

Page 6: Five Things About Five Things That Every Start Should Know

1. Getting Started

4. Each founder should get what’s fair. – Consider the current economic contribution to

the business, not relationship or friendship. • Cash, IP, Property can be valued at the

beginning • A promise to work cannot be valued until it is

actually delivered upon and results in value to the business

– Always consider what will happen when the founders hate each other

© 2015 Fredrikson & Byron, P.A.

Page 7: Five Things About Five Things That Every Start Should Know

1. Getting Started

5. Do it right and in writing and don’t make promises you might not want to keep. – Often in the early stages of a company/idea people

come and go, ideas are shared, collaborations occur and through this promises are made. Be sure any such promises are made deliberately, are tied to performance and are in writing, ideally prepared by a lawyer.

– “Back of the napkin” deals (e.g. “you’ll get 10% of the company if you …”) often come back just before a financing or acquisition.

© 2015 Fredrikson & Byron, P.A.

Page 8: Five Things About Five Things That Every Start Should Know

2. Raising Money

1. It’s illegal to sell stock, units or notes, except when it’s not. – The sale of equity interest in an enterprise is

generally covered by state and federal securities laws, there are many exceptions to these laws

– The identity of the buyer(s) (or potential buyer(s)) drives this issue not the type of security offered or sold

© 2015 Fredrikson & Byron, P.A.

Page 9: Five Things About Five Things That Every Start Should Know

2. Raising Money

2. No fibs or lies or cover-ups! – Some sales of equity are “exempt” from registration (i.e.,

don’t have to be registered with the SEC) but they are NOT exempt for the anti-fraud provision of securities laws.

– The company and control persons can be held liable for providing information that includes an untrue statement of a material fact or omits a material fact required to make other statements not misleading.

– Some exempt offerings have no specific disclosure requirements but what is provided must be true and not misleading.

– Purchasers can seek damages or rescission.

© 2015 Fredrikson & Byron, P.A.

Page 10: Five Things About Five Things That Every Start Should Know

2. Raising Money 3. There are big differences among

convertible notes, SAFE, common stock, and preferred stock but in the end the investors almost always get their money back first with subtle or significant variations. – Expect investors to get their money back before

founders share in proceeds. – Occasionally investors will purchase common stock. – Be sure to understand and model liquidation

preference.

© 2015 Fredrikson & Byron, P.A.

Page 11: Five Things About Five Things That Every Start Should Know

2. Raising Money

4. You need to understand how shares (and your business) are valued. Take the time to discuss with lawyer or read up. – Investor Values the business, not you:

• Pre-Money = the value of your company now • Post-Money = the value of your company

after the investor puts the money in – Valuation methods -- vary

© 2015 Fredrikson & Byron, P.A.

Page 12: Five Things About Five Things That Every Start Should Know

2. Raising Money

5. Most investor’s rights are fairly benign and standard (although wordy) but be cautious with board seat, protective provisions and liquidation preferences. – Convertible notes - try to avoid repayment at maturity or maturity at all. – Preferred stock - push for simple liquidation preference – investors get money back or

convert to common and participate in up side but not both. Avoid participating preferred and liquidation multiples if possible.

– Try to maintain control of the board of directors, if possible. The board controls hiring and firing of CEO and key corporate decisions including financing and sale of company.

– Limit protective provision – protective provisions are essentially a list of actions that the company can not take without the investors consent. These provisions shift control of the included items from the board to the investors.

– Information, registration, pre-emptive, co-sale and first refusal rights are fairly standard.

© 2015 Fredrikson & Byron, P.A.

Page 13: Five Things About Five Things That Every Start Should Know

3. Building the Team

1. You can’t just decide who will be an employee or contractor, and it makes a difference. – Various state agencies make determination, not

the worker or the buyer of services – Agreement does not change status – Consequences of wrong choice are bad and the

authorities are cracking down

© 2015 Fredrikson & Byron, P.A.

Page 14: Five Things About Five Things That Every Start Should Know

3. Building the Team

2. Don’t forget to get IP assignments! – All workers (employees or independent

contractors and working owners) need to sign an IP assignment agreement at commencement of engagement

– Get a confidentiality agreement and non-compete as well if you can

– Don’t just rely on common law

© 2015 Fredrikson & Byron, P.A.

Page 15: Five Things About Five Things That Every Start Should Know

3. Building the Team

3. Equity grants should be subject to vesting and no acceleration when possible. – Equity (options and stock) is typically granted to service providers

(i.e., founders, employees) in exchange for service to be provided in the future, and should not be vested until such service has been provided. Vesting is usually time based but can be tied to performance milestones.

– Investors generally object to accelerated vesting in connection with a sale of the company because it transfers value from stockholders to service providers before it has been earned.

– Founders and key executives can often negotiate accelerated vesting.

© 2015 Fredrikson & Byron, P.A.

Page 16: Five Things About Five Things That Every Start Should Know

3. Building the Team

4. Avoid severance, except when you can’t. – Severance should not be offered, it should be

requested – Only provide severance to valuable contracted

team members; tie severance to noncompete – Don’t put severance in your employee

handbook either

© 2015 Fredrikson & Byron, P.A.

Page 17: Five Things About Five Things That Every Start Should Know

3. Building the Team

5. On termination always get a release, if you can. – Release of claims by the terminated employee – Typically mutual – There are timing and rescission rules to take

into account – Good area to engage a competent lawyer.

© 2015 Fredrikson & Byron, P.A.

Page 18: Five Things About Five Things That Every Start Should Know

4. Protecting your ideas.

1. Did I forget to mention, get an IP assignment from everyone? – Get an assignment from all employees,

contractors, and collaborators. – Investors and acquirers will want to see

them.

© 2015 Fredrikson & Byron, P.A.

Page 19: Five Things About Five Things That Every Start Should Know

4. Protecting your ideas.

2. Use your open source deliberately. – Using open source software can speed development but

comes with obligations under the applicable license agreement.

– Understand the obligations before you use the software. – Some open source licenses require free distribution of

your software if you use the open source code. This can be a significant business model problem and issue for investors and/or acquirers.

– Keep track of where the open source is used, the applicable license and don’t incorporate into key software without consulting a lawyer.

© 2015 Fredrikson & Byron, P.A.

Page 20: Five Things About Five Things That Every Start Should Know

4. Protecting your ideas.

3. Patent when possible. Yes, you need a good patent lawyer. – The importance of patents depends on industry – patenting is

more common in medical device, semiconductor and hardware industries and may help in securing funding.

– In software and ecommerce patenting is less common and less likely to help with financing.

– Hire a good patent lawyer to help decide whether to pursue a patent strategy

© 2015 Fredrikson & Byron, P.A.

Page 21: Five Things About Five Things That Every Start Should Know

4. Protecting your ideas.

4. Use a confidentiality agreement. – ALWAYS!!! – Develop your own form agreement and require any

party who might have access to your idea(s) to execute it before sharing any information with them

– Savvy players will expect to sign an confidentiality agreement so if someone is shocked you asked, reconsider

© 2015 Fredrikson & Byron, P.A.

Page 22: Five Things About Five Things That Every Start Should Know

4. Protecting your ideas.

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

of a patent

© 2015 Fredrikson & Byron, P.A.

Page 23: Five Things About Five Things That Every Start Should Know

5. Finding the Exit

1. Preparing for sale starts at the beginning. – So how are you and your investors going to get your

money (or value) out of the enterprise – Exit is more than 100% sale:

• Liquidity event • Strategic buyer

– Entity choice matters (a little) when considering exit

© 2015 Fredrikson & Byron, P.A.

Page 24: Five Things About Five Things That Every Start Should Know

5. Finding the Exit

2. Do everything right and in writing and don’t make promises you might not want to keep. – The night before selling the company is when skeletons creep out of the

closet. – Remember the woman that sat next to you at CoCo for a few weeks

while you were hatching the idea for your company. You told her that you would give her 5% of the company if she created a key feature of your software. She started but flaked out and you never used any of her code. She is going to want her 5%.

– And it could be worse if you did use her code but didn’t get an IP assignment.

– Do it right and do it in writing.

© 2015 Fredrikson & Byron, P.A.

Page 25: Five Things About Five Things That Every Start Should Know

5. Finding the Exit

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

kill a deal – buyers hate the unknown

© 2015 Fredrikson & Byron, P.A.

Page 26: Five Things About Five Things That Every Start Should Know

5. Finding the Exit

4. One last time, always get assignment of IP ownership. – See Item 2

© 2015 Fredrikson & Byron, P.A.

Page 27: Five Things About Five Things That Every Start Should Know

5. Finding the Exit

5. Engage with strategic investors carefully. – Consider long term exit before you take their

money – Strategic investors have their best interest

mind and not yours when they invest. – Document the relationship and goals carefully

and watch out for control grabs

© 2015 Fredrikson & Byron, P.A.

Page 28: Five Things About Five Things That Every Start Should Know

Contact Information

Kevin Spreng Fredrikson & Byron, [email protected] 612-492-7395

David WinklerFredrikson & Byron, [email protected] 612-492-7233