The Foundation: Structuring Your New Venture

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Leon Lyons
6 years ago
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Entrepreneurship Technology Entrepreneurship

Foundation: Structuring Your New Venture Patrick

Colleges of Business and Engineering Jackson

1 TAKE YOUR TECHNOLOGY TO THE LIMIT! Center for Innovation and Technology Entrepreneurship Technology Entrepreneurship from Innovation to Business Venture The Foundation: Structuring Your New Venture Patrick Tobin October 2, 2009 Center for Innovation and Technology Entrepreneurship UTSA Colleges of Business and Engineering Jackson Walker L.L.P. CITE BootCamp October

2 Patrick Tobin Partner: Corporate/Securities/M&A The University of Texas McCombs School of Business B.B.A. St. Mary s University School of Law Juris Doctorate

3 Choose the Right Entity When Should You Formalize Structure? Initiation of Business Operations Asset Protection Capital Raising Succession Planning Multiple other factors.

4 Choose the Right Entity Sole Proprietorship General Partnership (GP) Corporation C-Corp S-Corp Limited Partnership (LP) Limited Liability Company (LLC)

5 Sole Proprietorship General Partnership (GP) * Even in Texas your homestead protection is limited to $30k if single, $60k if married. Default Entity No liability protection, partners are jointly and severally liable for all partnership liabilities* The fallacy of a DBA filing. county DBAs and State of Texas DBAs

6 Two Biggest Concerns: How the entity will be taxed Who will be liable for its obligations The entity itself will always be liable to extent of its assets and so the question is who will be liable, if anyone, if the entity s assets are not sufficient to satisfy all claims.

7 Double Taxation Personal Tax Corporate Tax Levels of Taxation Federal Tax (IRS) State Tax (Margin Tax)

8 Corporation Shareholders Ownership Board of Directors Strategy/Direction Officers: President, Vice President, CEO, CFO, Secretary, Treasurer Implementation/ Signing Authority Employees/Operations/ Contracts Liabilities

9 Pros Liability limited Ease of creation Most common easily understood Growth oriented Centralized Management Corporation Cons Federal income tax and Texas Margin tax S-election restrictions

10 Limited Liability Company Shareholders Members Ownership Board of Directors Managers Strategy/ Direction Officers: President, Vice President, CEO, CFO, Secretary, Treasurer Officers: President, Vice President, CEO, CFO, Secretary, Treasurer Implementation/ Signing Authority Employees/Operations/ Contracts Employees/Operations/ Contracts Liabilities

11 Limited Liability Company (LLC) Pros Can have tax flow through Limited liability Cons Federal income tax and Texas margin tax Different terminology (i.e. Managers and Members instead of Board and Shareholders) Not as accepted by institutional investors Difficult if option compensation is part of your growth strategy

12 Limited Partnership General Partner (LLC/Corp) Limited Partners Strategy/Direction Implementation/ Signing Authority Ownership Employees/Operations/ Contracts Liabilities

13 Limited Partnership (LP) Pros Federal Tax flow through Liability limited for limited partners Cons Must have a general partner who is liable for all PS obligations Limited partners have to agree to no say in management (can be less attractive to investors) LPs who participate in management of business become liable as GPs Texas Margin tax Expense of maintaining multiple entities

14 Comparison Chart Item C Corp S Corp General Partner in GP or LP* Limited Partner in LP* Entity Level Income Taxable Margin Net Income Texas Margin Tax (replaced Franchise Tax) Taxable Income Of Entity Fed. Income Tax (at 35%) Income After Taxes Owner Level Distribution & Share of Income Self-Employment Tax # Taxable Income of Owner Fed. Dividends Tax (at 15%) Fed. Income Tax (at 35%) Amount Received After Taxes $ $ $ $ 60.45

15 Liability The entity itself will always be liable to extent of its assets and so the question is who will be liable, if anyone, if the entity s assets are not sufficient to satisfy all claims. Owners Liability Limited (Piercing the Veil) *exception: watch for guarantees Fiduciary Duties Directors/Managers; sometimes between partners Duty of Loyalty, Care and Obedience, Minority shareholders

16 Other concerns Liability Protection Management Interest transferability Continuity of life Formation issues such as cost and timing Capital raising

17 Management Who will have control over what decisions? What will be the extent of Control? Generalization: Corporations = defined by law (modified by agreement) Partnership and LLC = defined by agreement

18 Continuity of Life Corporations - perpetual existence LLCs - perpetual existence General Partnership - partnership continues post-withdrawal until the winding up of the partnership Limited Partnership limited life as defined in partnership agreement (or earlier upon agreement or by law)

19 Formation Cost and Timing Entity Type Fees and Other Costs Timing Corporation Filing Fee: $300 Legal Fees: $700- $1200 LLC Filing Fee: $200 Legal Fee: $1000- $5000 SOSDirect Basic documents (may also do shareholders agreement) SOSDirect Documents can be complex Limited Partnership Filing Fee: $750 Legal Fees: $2000- $5000 SOSDirect Documents can be complex Requires 2-tier filing

20 Desire to Deal with Complexity Do you want to live by the terms of the Regulations or Partnership Agreement/ hire someone to assist? Will you earn enough money to justify complex structure (if tax savings filing fees)

21 Capital Raising/Interest Transferability Corporation Preferred Stock Authorization Understood by typical investors Can I buy stock in your company Voids S-election Allows for flexibility (redemption rights, conversion rights, preferences) Limited Partnerships for pooling LLCs for creative rights and pass through of losses

22 Getting Comfortable with Investor Terminology NVCA Model Legal Documents - Model Legal Docs Button Offering Terms Closing Date Investors Amount Raised Price Per Share Pre-Money Valuation Capitalization

23 Investors Investor No. 1: Gringotts VC: 5,000,000 shares at $1.00 per share Investor No. 2: Ollivanders VC: 1,000,000 shares at $1.00 per share

24 Amount Raised $6,000,000, including $500,000 from the conversion of Subordinated Convertible Promissory Notes of Gringotts VC $1,000,000 to be invested at the Closing $2,000,000 to be invested upon completion of a prototype of the Firebolt $2,000,000 to be invested upon achieving actual manufacturing of the Firebolt $1,000,000 to be invested upon achieving initial sales of $250,000

25 Price Per Share $1.00 per share (based on the capitalization of the Company set forth below) (the Original Purchase Price ).

fully-diluted post-money valuation of $10,000,000 (including an

26 Pre-Money Valuation The Original Purchase Price is based upon a fully-diluted pre-money valuation of $4,000,000 and a fully-diluted post-money valuation of $10,000,000 (including an employee pool representing 10% of the fully-diluted post-money capitalization).

27 Capitalization Pre- Financing Post- Financing Security # of Shares % # of Shares % Common Founders Common ESOP Series A Preferred 3,000, % 3,000,000 30% 0 0% 1,000,000 10% 0 0% 6,000,000 60% Total 3,000, % 10,000, %

28 Charter Dividends Liquidation Preference Voting Rights Protective Provisions Optional Conversion Anti-Dilution Provisions Mandatory Conversion Pay-to-Play Redemption Rights

29 Provisions Dividends: Example: The Series A Preferred will carry an annual 10% cumulative dividend compounded annually, payable upon a liquidation or redemption. For any other dividends or distributions, participation with Common Stock on an as-converted basis. Liquidation Preference: In the event of any liquidation, dissolution or winding up of the Company, the proceeds shall be paid as follows non-participating

30 Liquidation Preference (cont.) Liquidation Pref. Alt. Total Amount Received Conversion to Common $60,000,000 Non-Participating $6,000,000 Full Participating $62,400,000 Full Participating with Cap $36,000,000

31 Voting Rights The Series A Preferred Stock shall vote together with the Common Stock on an asconverted basis, and not as a separate class, except (i) the Series A Preferred as a class shall be entitled to elect two (2) members of the Board (the Series A Directors ), one of whom shall be designated by Gringotts VC and one of whom shall be designated by a majority of the Series A Preferred Stock, (ii) as provided

32 Protective Provisions So long as any shares of Series A Preferred are outstanding, the Company will not, without the written consent of the holders of at least 66 2/3% of the Company s Series A Preferred, either directly or by amendment, merger, consolidation, or otherwise: liquidate, dissolve or wind-up the affairs of the Company, or effect any Deemed Liquidation Event; amend, alter, or repeal any provision of the Certificate of Incorporation or Bylaws; create or authorize the creation of or issue any other security having rights, preferences or privileges senior to or on parity with the Series A Preferred, or increase the authorized number of shares of Series A Preferred; purchase or redeem or pay any dividend on any capital stock prior to the Series A Preferred, other than stock repurchased from former employees or consultants in connection with the cessation of their employment/services, at the lower of fair market value or cost; or increase or decrease the size of the Board of Directors.

33 Conversion and AntiDilution Assume 1,000,000 new shares issued at $0.50 per share Anti-Dilution Provisions (Weighted Average) CP2 = CP1 * (A+B) / (A+C) CP2 = $1.00 * (10,000,000 + ($500,000/$1.00) 10,000, ,000,000 CP2 = $1.00 * 10,500,000 11,000,000 CP2 = $1.00 *.95 CP2 = $0.95 Conversion Ratio = 1.05 shares of Common for every 1 share of Preferred Anti-Dilution Provisions (Full Ratchet) The Math: New Series A Conversion Price reduced to $0.50 per share Conversion Ratio = 2 shares of Common for every 1 share of Preferred

34 Redemption Rights The Series A Preferred shall be redeemable from funds legally available for distribution at the option of holders of at least 66 2/3% of the Series A Preferred commencing any time after the fifth anniversary of the Closing at a price equal to the Original Purchase Price, plus all accrued but unpaid dividends. Redemption shall occur in three equal annual portions. Upon a redemption request from the holders of the required percentage of the Series A Preferred, all Series A Preferred shares shall be redeemed (except for any Series A holders who affirmatively opt-out).

Investor Rights Agreement Demand Registrations Form S-3 Registrations Piggyback Registrations Expenses Lock-up Management and Information Rights Right to

35 Investor Rights Agreement Demand Registrations Form S-3 Registrations Piggyback Registrations Expenses Lock-up Management and Information Rights Right to Participate in Future Rounds Non-Competition and Non- Solicitation Agreements Non-Disclosure and Development Agreements Board Matters Employee Stock Options Key-Person

36 Non-Competition, Solicitation and Disclosure Agreements Each Founder and key employee will enter into a one year non-competition and nonsolicitation agreement in a form reasonably acceptable to the Investors. Each current and former Founder, employee and consultant with access to Company confidential information/trade secrets will enter into a non-disclosure and proprietary rights assignment agreement in a form

37 Right of First Refusal/ Co-Sale Agreement and Voting Agreement Right of First Refusal Right of Co-Sale Board of Directors Drag Along Termination

38 Board of Directors At the initial Closing, the Board shall consist of five members comprised of (i) Hermione Granger as the representative designated by Gringotts, VC, as the lead Investor (ii) Lucius Malfoy as the representative designated by the remaining Investors (iii) Albus Dumbledore as the representative designated by the Founders (iv) the person then serving as the Chief Executive Officer of the Company, currently Rubeus Hagrid, and (v) 1 person who is not employed by the Company and who is mutually acceptable to the Founders and Investors, who shall initially be Dudley Dursley.

39 Qualify to Do Business Texas v. Delaware v. Nevada Texas Qualified to Business = $750 filing fee To transact business in Texas a foreign entity must register with the Secretary of State - TBOC 9.001

40 Accounting Books Corporate Records Accounting Books: Income Statement, Balance Sheet, etc. Corporate Books: Articles of Incorporation, Bylaws, Minutes, Stock Transfer Ledger, etc.

41 Joint Ownership Issues Not only your partner, but Buy-sell/Shareholders agreements What if I don t want to keep doing this? What if my partner dies? Gets divorced? Files for bankruptcy? Issues are always easier to resolve before money is a factor

42 READ EVERYTHING Boilerplate = Most important provisions, do NOT ignore Don t assume a provision can t be changed Don t sign contracts until reviewed by a lawyer

43 Retain Experienced Advisors Attorneys Transactional attorneys, litigators and intellectual property attorneys Accountant determine when the corporation s first fiscal year will end what tax elections should or could be made by the directors and/or shareholders matters related to the preparation and filing of tax returns Ask them to work together, meet at least annually

Patrick Tobin Jackson Walker L.L.P. 210.978.7785 ptobin@jw.

44 Patrick Tobin Jackson Walker L.L.P E. Pecan Street, Ste San Antonio, Texas

45 TAKE YOUR TECHNOLOGY TO THE LIMIT! Center for Innovation and Technology Entrepreneurship Technology Entrepreneurship from Innovation to Business Venture The Foundation: Structuring Your New Venture Patrick Tobin October 2, 2009 Center for Innovation and Technology Entrepreneurship UTSA Colleges of Business and Engineering Jackson Walker L.L.P. CITE BootCamp October

Negotiating Series A Term Sheets

Negotiating Series A Term Sheets Benjamin M. Hron Bhron@mccarter.com 617.449.6584 @HronEsq Part I: 10.06.16 Part II: 10.20.16 What is a Term Sheet Control Terms v. Economic Terms Standard Agreements Stock