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Legal Landmines
What to Know When Starting Your Start-Up
Jackie Ammon
October 4, 2016
WilmerHale 2
Categories of Most Common (and costly)
Mistakes
• Choice of Legal Entity
• Founders’ Equity
• Protecting Intellectual Property (IP)
• Fundraising
• Employees v. Independent Contractors
• Compensating Employees
• Working With (Managing) Legal Counsel
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Choice of Legal Entity
• Typical Entity Alternatives:
• Limited Liability Company
• Subchapter C Corporation
• Considerations:
• Tax
• Liability
• Number and Types of Owners
• Funding Plans
• Complexity/Administration
• Cost
Which type of entity should we choose?
Most common: Delaware C-Corp
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Choice of Legal Entity
Pros Cons
LLC • Tax benefits
• Flexibility of management
• Flexibility of economics
• Not standard for VC
• Tax benefits rarely used
• Higher legal, accounting
costs
• Employee equity not easy
C-Corp • Preferred for VC
• Decades of established
law
• Lower legal fees
• Equity incentives are easy
• Double taxation
• Follow corporate formalities
• Not as flexible
Other forms (not as common) :
B-Corp, S-Corp
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Founders’ Equity
• Authorized v. Issued Stock
• Promising a set ownership percentage
• Complicating the capitalization table
• Shares not subject to vesting
• Missing the filing deadline for 83(b) elections
• Failing to comply with securities laws
• Waiting too long to issue equity to founders
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Protecting Intellectual Property
• Founders, employees, consultants not assigning IP
• Using third party IP without a license
• Failing to adequately protect trade secrets
• Not addressing IP developed when employed by
someone else
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Employee Compensation
• Failing to adopt an appropriate equity incentive plan
• Creating stock valuation problems (409A)
• Vesting and acceleration, revisited
• Post-termination acceleration
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Capital Raising
• Having a poorly articulated pitch
• Misunderstanding financing structures and/or terms
• Not doing “due diligence” on the investor
• Utilizing a “finder” to secure investments
• Failing to comply with securities regulations
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Raising Capital: Preferred Stock
Preferred Stock
• Pros
• Some investors insist upon a “priced” round
• Can use standard terms
• Cons
• Need to set a valuation
• High transaction costs
• Gives up too much control to a seed investor for too little money
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Raising Capital: Convertible Debt
Convertible Debt
• Pros
• Quick
• Low transaction costs
• No current valuation
• Cons:
• Ultimately issuing more preferred
• Converts at a discount in the next round
• Often includes a “cap” on conversion price into next round
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Raising Capital: Safe
Safe
• Pros
• Quick
• Low transaction costs
• No current valuation
• Cons:
• Converts at a discount in the next round
• Often includes a “cap” on conversion price into next round
• Pro-rata rights are part of the standard template
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Independent Contractors and Interns
• Substantive (20 factor) test
• Misclassifying employees as “independent
contractors” or “consultants”
• Income tax obligations (W2 v. 1099)
• Back taxes, penalties and interest
• Classifying anyone you can’t afford to pay as an
“intern”
• School credit
• Back taxes, penalties and interest (yes, it applies here too)
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Working With (Managing) Legal Counsel
• Hiring a lawyer who has no start-up experience
• Hiring a lawyer who has some start-up experience
• Allowing too many (legal) cooks in the kitchen
(“over-lawyering”)
• Over-complicating the incorporation process
• Failing (or being afraid) to seek advice
• Managing (or mismanaging) expectations and costs
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Questions? Contact:
Jaclyn Ammon| WilmerHale
950 Page Mill Road
Palo Alto, CA 94304 USA
+1 650 600 5037(t)
Visit www.WilmerHaleLaunch.com
Follow @WHLaunch