SWIPE RIGHT TO ISSUE EQUITY

The Importance of Choosing the Right Co-Founder

& Proactive Measures to Help in Case You Don’t

A Drexel Entrepreneurial Law Clinic Seminar

Travis Aldous

Brian Paul Bozzo

Zachary Blake Schaeffer

Jeremy Sichel

November 29, 2017

INTRODUCTION

TRAVIS ALDOUS

MEET THE FALL 2017 ELC TEAM

ZACHARY B. SCHAEFFER

BRIAN P. BOZZO

JEREMY S ICHEL

STEVEN ROSARD

OVERVIEW

1. Introduction

2. Cofounder Selection Exercise

3. Legal Issues

- Equity Splits

- Vesting

- Roles and Responsibilities

- Immigration Issues

- Deadlock

- Firing a Co-Founder

- Reclaiming Equity

- Intellectual Property Assignments

- Buy/Sell Agreements

4. Revisiting our Cofounders

5. Questions & Answers

THE RISE OF CO-FOUNDER MATCHMAKING SITES

• International matching in the U.S.,

Finland, Spain and Germany

• Users create a profile providing

preferences of location, skill set, time

commitment, former projects and

background in fundraising.

• Entrepreneur hits submit, list of

possible co-founder suitors is provided

• Entrepreneurs post ideas and also rank

and comment other ideas provided by

various entrepreneurs.

- CoFoundersLab.com

- FounderDating.com

- TechCofounder.com

- Founder2be.com

NEW MANIFESTATION OF AN OLD PROBLEM

• Founder drama happens even in

situations where you wouldn’t

expect it to crop up. Success will

cover up many sins

• When things are going up and to the

right, things might be going wrong

underneath and you won’t be aware

of it. It’s the black ice of startups

• Every startup will hit the skids

sooner or later. You can’t count on

good times forever — winter is

coming

• Conflicts are exacerbated when

closer, more established

relationships are in play and at

stake

• Families, friends and colleagues can

be surprised at how tense things

Don’t Let Your Business/Family

Get This Complicated!

CO-FOUNDER SELECTION HYPOTHETICAL

WUPHF.COM: A GREAT NEW BUSINESS IDEA

You are a recent graduate from the Wharton School, excited to start applying all

of the things you’ve learned about entrepreneurship. You’ve just wrapped up

your capstone project: a pitch for a social network for pet-owners that leverages

profiles for the animals, instead of their owners.

You have committed to developing a means of communicating through all of

these channels at once, with WUPHF: a membership based, integrated

communication platform.

Although you are prepared to run the company’s marketing, you lack the

managerial, technical, logistical and financial skills the company will require to

succeed.

Your friend told you about Co-founder Tinder (CoFinder) and you’ve

decided to give it a swipe.

CO-FOUNDER #1

Match

PendingMichael, 46

• MBA from the Wharton School,

Specialization in Technical Management,

Class of ‘07

• Currently manages a multi-disciplinary

team at Dulloyt, a well reputed consulting

firm, where he delivers executive training

and tools to a variety of clients, including

promising start ups and behemoth

powerhouses

• Is willing to contribute up to $10,000 in the

beta to facilitate the a faster launch date

• A close friend of your family, is willing to

bring his skillsets to WUPFH as a favor to

your parents

THE WORLD’S BEST BOSS

CO-FOUNDER #2

• BSSE, MSSE Software Engineer from

Drexel University, Class of ‘15

• Proficient in Object Oriented C, Java and

C++

• Ten years experience at MoonGuard, a

powerhouse software firm with a

specialization in cloud computing and

global networking

• Has previously conceived of a comparable

integration algorithm, which will give your

team a tremendous headstart towards

bringing WUPHF to market

• Brings an extensive network of third party

contractors and developers to help bring

his wireframe concepts to life

Match

Pending

THE TECHIE

Ryan, 25

CO-FOUNDER #3

Match

PendingDwight, 32

THE LOGISTICS GURU

• Did not attend college, but immediately began

driving trucks for FedOx, a popular shipping

company after graduating from Jenkintown

High School in 2003

• In 2006, was promoted into corporate, due to

his extensive knowledge of FedOx’s logistic

operations and ability to map more efficient

routes based on improved communications

between drivers

• In 2009, left FedOx to develop OxCall, a new

way for driver’s to communicate with each other

without having to rely on CB radios

• Has an extensive network of investors from his

previous venture

• Exited OxCall in 2015, after selling his

ownership to FedOx

• From Canada

Congratulations, you’re in

business!

I guess none of you

look completely

incompetent…

State your color

karate belt

I don’t play karate,

but have a reversible

belt, black & brown.

Will text when back

from Sandals.

01001000

01101001

00100001

You all seem really

exciting and talented!

What could possibly

go wrong?!

LEGAL ISSUES

OVERVIEW OF LEGAL ISSUES

1. Equity Splits

2. Vesting

3. Immigration Issues

4. Roles and Responsibilities

5. Intellectual Property

Assignments

6. Deadlock

7. Buy/Sell Agreements

8. Firing a Co-Founder

9. Reclaiming Equity

Vetting Co-Founders

Structuring the Company

Setting Expectations

Dispute Resolution

Restoring the Company

EQUITY SPLITS

EQUITY SPLITS

Who get’s what?

WHEN TO SPLIT

Split Earlier

● Attract key players who need

equity incentive

● If already worked extensively

with cofounders in another

startup

● Negotiate calmly before

you’re under pressure to split

Split Later

● Learn about cofounders’

contributions

● Solidify startup’s strategy

and business model

● Solidify roles

● Learn about cofounders’

commitment; strengthen

incentives

● Avoid continual

renegotiations as things

change

CAUTION: There are also tax consequences to waiting to split the equity, including

having a higher “basis” for the stock and a later start for the long-term capital gains tax

clock.

FACTORS FOR EQUITY SPLIT

• Past contributions

• Opportunity Cost

• Future Contributions

• Founder Motivations and preferences

“Remember, when the pie is split, 95% of the work

required for success remains in the future.”

EQUAL VERSUS UNEQUAL EQUITY SPLITS

• A threshold of psychological pain versus financial gain

• Showing unity (we’re a team)

• Quick handshakes versus thoughtful equal splits

STATIC VERSUS DYNAMIC SPLITS

VESTING

VESTING

• What is Vesting?

- Each founder agrees to a certain

amount of equity

- The company retains a right to re-

purchase “unvested” equity

- “Vested” shares or units are

unencumbered by such a “Re-Purchase

Right”

• So, what do I technically own?

- What you agreed to upon executing the

Agreement and capitalization table

- An obligation to understand, and comply

with the vesting schedule

BENEFITS OF VESTING

• Protects the Company

- Employees have a reason to stay with the company long-term

- Co-Founders may earn unencumbered rights to their equity after a

predetermined number of years

- Vesting may also be tied to the completion of specific performance milestones or

objectives

- If a Co-Founder leaves the Company prior to their shares vesting, the Company

can recover those shares at a favorable price

STANDARD VESTING PROVISIONS

• Four Years and a Cliff

- Vesting will occur based on the

following schedule:

- Until and through [FIRST VESTING

DATE], neither Founder’s shares will

vest

- On and not before [FIRST VESTING

DATE]– [25% ] of each Founder’s

shares will vest

- On and not before the 1st of every

month thereafter, an additional

[1/48TH] of the total options package

will vest

- Thus, on [END DATE] (the "Full

Vesting Date"), each Founder will be

100% vested.

PERFORMANCE BASEDVESTING PROVISIONS

• Performance Based Vesting

- Except as otherwise provided in Section 6(a) or Section 2(b) of this

Agreement, the number of Options designated as Performance Options

specified on the signature page hereof (the Performance Options) shall

become vested upon satisfaction of the fiscal year performance goals set forth

on Schedule A to this Agreement.

- Vesting is subject to the continuous employment of the Employee with the

Company until the last day of the applicable fiscal year.

- In the event that the Employees employment terminates (other than for

Cause) following the end of a fiscal year but prior to the determination by the

Board as to whether the applicable fiscal year performance goal has been

met, the vesting and forfeiture of the related Performance Options, and any

applicable post-termination exercise period, will be tolled until the date of such

determination, and, if any portion of the Performance Options vest based on

such determination, the post-termination exercise period applicable to such

portion of the Performance Option will commence as of the date of such

determination.

UNCONVENTIONAL VESTING PROVISIONS

• Voting/Performance Based Vesting

- First year “cliff”

- Founding Members convene to

vote on each Member’s

“Performance Milestones”

- Uninterested Founding Members

vote on whether the achievement

of the Performance Milestones

- Unanimous vote vests that

Period’s equity

CAUTION: The further away from a standard, the more risk the company

assumes!

CASE STUDY: SNAP, INC.

• Founding members were friends at Stanford, worked on an app then known as

“Picaboo”

• One member came up with the idea of “disappearing” photos

• A disagreement erupted, that member was ousted from the Company

• In 2013, Snap was sued by the ousted member for breach of a joint venture

• Settled for $158M on the verge of a $3B IPO… they got off easy!

• Could vesting have helped?

Become this?!How can this….

THINGS TO CONSIDER

• There are Different Types of

Equity

• Ensure Members/Employees

file an 83B

• As a Co-Founder, Know Your

Terms for Claiming Your Vested

Shares

IMMIGRATION ISSUES

IMMIGRATION ISSUES

• Relatively common to have immigrant co-founders in start-up

companies

• Common in tech and engineering companies

• Many successful US companies have immigrant co-founders

• ISSUES

• Limited options

• Immigration reform?

• Costly

ISSUES CONCERNING EMPLOYMENT-BASED NONIMMIGRANT VISAS

• Temporary Visas

• H-1B Visa

• F: Student Visa

• Not an option for foreign entrepreneurs itself UNLESS used with OPT

• Optional Practical Training

• Tied to F Visa

CURRENT STATE OF IMMIGRATION

• Startup Visa Program

• Existing type of visa in other developed countries

• International Entrepreneur Rule

• Temporary stay for foreign entrepreneurs

• H1-B Visa

• “Buy American, Hire American”

• Future of H1-B visa?

ADDRESSING AND SOLVING IMMIGRATION ISSUES

• Be aware of your co-founders immigration status

• Address it immediately

• Weigh risk v. reward

• Explore the viability of certain options and/or workarounds

• Global Entrepreneur-in-Residence Program

• Availability of other types of visas

• Seek the help of an immigration attorney

ROLES & RESPONSIBILITIES

ROLES AND RESPONSIBILITIES OF CO-FOUNDERS

“Entrepreneurial success rarely comes from the idea. Instead, it comes

from the founding team’s never-say-die attitude and relentless

execution.” – Salim Ismail

• Roles vs. Responsibilities

• Defining Roles

• Prior relationships?

IMPORTANCE OF DISTINCT ROLES AND RESPONSIBILITIES

• Decision Making

• Deadlock

• Vesting

• Milestone/goal based

• Equity Split

• Miscellaneous Provisions in an

Operating/Founders’ Agreement

• Devotion of Time

• Tax Matters Member

• Meetings

• Intangibles

• Productivity/Efficiency

INTELLECTUAL PROPERTY ASSIGNMENTS

INTELLECTUAL PROPERTY ASSIGNMENTS

• What is Intellectual Property?

- An innovative concept, design or invention

- A new way of doing business

- Your company name or logo

• Why is Intellectual Property Important?

- Create questions of ownership

- Requires well constructed, enforceable

contractual forms for employees, contractors

and members

- Could effect venture capital

STRATEGIES FOR ASSIGNING INTELLECTUAL PROPERTY

Famous Trade SecretsFamous TrademarksFamous Patents

POTENTIAL INTELLECTUAL PROPERTY ISSUES

• Inventor vs. Owner

• Prior Ventures

• Current Employment

Obligations

• Protecting Trademarks

STRATEGIES FOR PROPER MANAGEMENT OF INTELLECTUAL

PROPERTY

• Separate employment from your new idea

• Protect and Leverage Your Contributions

• Assign IP to the Company

• Take care in using open source software

• Be careful in hiring new employees

DEADLOCK

DEADLOCK

Co-founders are the best of friends and can agree on everything….right?

DEADLOCK

WRONG

DEADLOCK

• What is Deadlock?

- Deadlock means that the founders

cannot seem to agree on making

some decision or matter

- The consequences of deadlock

may be minor if the debated matter

is minor in nature

- However, a Fundamental Issue

subject to deadlock could halt

business or even cause a

complete falling out

FUNDAMENTAL ISSUES

• So, what are Fundamental Issues?

- Fundamental Issues are traditionally such decisions that greatly impact

the company and sometimes requires, by law, for unanimous approval

- Adopting or amending the Company's business plans and budgets

- Choosing whether to raise capital

- Engaging in an M&A transaction

- Initiating an IPO

- Dissolving the Company

- Initiating or settling any legal claim or action

RESOLVING DEADLOCK

• Majority Approval

- Pros: Simple means of passing or

denying a decision without

antagonizing co-founders

- Cons: Skewed majority may exist

where one or more founders will

always be a minority

- Founder A – 60%

- Founder B – 30%

- Founder C – 10%

RESOLVING DEADLOCK

• Appointed Tie-Breakers

- Pros: Always have an ultimate decision maker

- Cons:

- Decision maker may not be familiar with the issue at

hand

- Decides based on self-interest and not in best interest

of the Company

- May be biased

• Chance Games

- Pros: A decision can be made

- Cons: Leaving a Fundamental Issue to chance is NOT

likely considered acting in good faith or making a sound

business decision

RESOLVING DEADLOCK

• Cooling Off

- Pros:

- Enables more time to the consider issue and discuss

without the immediate pressure of deciding

- Allows for status quo until decided

- Cons:

- Decision may be time sensitive

- Still requires agreement

RESOLVING DEADLOCK

• Mediation

- Pros:

- Helps to facilitate good faith negotiation

- Removes emotional aspect

- Cons:

- Usually costly and time consuming,

- Mediator may not have Company insider

knowledge

- Founders ultimately still need to agree

BUY/SELL AGREEMENT

BUY/SELL AGREEMENTS

RUSSIAN ROULETTE

• Departing founder names a buy-sell price

- The departing founder sends notice of his

intent to either buy OR sell his ownership to

the other founders

• Other founders decide to buy or sell

- After receiving the departing founder’s price,

the other founders decide:

- SELL their ownership at the departing

founder’s price and thus leave the

Company

OR

- BUY the departing founder’s ownership at

the stated price and continue on with the

Company

TEXAS SHOOT-OUT

• Founders name their HIGHEST BUY price

- The founders submits a sealed bid containing

the highest price offer each one is willing to

pay for the other founders’ share of the

company

• Highest bidder BUYS the other founders’

ownership interest

- The founder that submitted the highest price

must then buy the shares of the other

founders at that price.

- Founder A - $2.00/share

- Founder B - $1.00/share

- *A buys B at $2.00/share

DUTCH AUCTION

• Founders name their LOWEST SELL price

- The founders submits a sealed bid containing

the lowest price offer each one is willing to

accept if they were to sell their ownership

interest

• Lowest bidder SELLS its ownership

interest to the other founders

- The founder that submitted the highest price

must then buy the shares of the other

founders at that price.

- Founder A - $2.00/share

- Founder B - $1.00/share

- *A buys B at $1.00/share

DETERRENCE APPROACH

• Appraiser is brought in to determine the

company’s Fair Market Value (FMV)

- The appraiser determines the value of the

ownership interests of the founders that did not

invoke the buy-sell clause

• Invoking Founder decides to buy OR sell

- BUY (PREMIUM) – Invoking founder will buy the

other founders’ ownership interest at a premium

(i.e. 125%)

OR

- SELL (DISCOUNT) – Invoking founder will sell its

ownership interest to the other founders at an

equivalent discount (i.e. 75%)

FIRING A CO-FOUNDER

FIRING A CO-FOUNDER

POSSIBLE SITUATIONS

• The forgotten founder

• The backstabber

• The underachiever

• The beacher

• The fighter

• The quitter

FIRE A COFOUNDER?

• Should you be able to fire a cofounder?

• YES!

• WHY? • Protect your equity

• Vesting

• Roles and responsibilities

HOW TO FIRE A COFOUNDER

FOUNDERS AGREEMENT: PREEMPTIVE SOLUTIONS

● Break-up (Termination) Provisions: Define the

process● Vote by majority of shareholders?

● Failure to perform defined duty?

● Resignation?

● Transfer Restrictions ● Block unwanted transfers

● Repurchase Rights● Pre-negotiated buyout process

RECLAIMING EQUITY

RECLAIMING EQUITY – REPURCHASE RIGHTS

• Repurchase Rights

- Allow for the company or remaining founders to purchase any

vested units upon a founder’s termination

- Repurchase rights can apply to various forms of termination

- For Cause

- Without Cause

- Voluntary Resignation

- Death or Disability

• Establish Valuation Mechanism

- Founders should establish the rules by which a terminated

founder’s ownership interest is valued for the repurchase rights

- Good faith negotiation of the fair market value

- Hire an appraiser or arbitrator to make determination

CO-FOUNDER FOLLOW-UP

Match PendingMichael, 46

CO-FOUNDER #1

Problems Encountered

• How to compensate for $10k contribution?

• Relationship pressure and impact on

measuring performance

Lessons Learned

• Evaluate granting equity v. a loan to the

company

• Specify the terms of either choice

• Define clear roles and responsibilities,

including consequences of failing to

perform

THE WORLD’S BEST BOSS

Match PendingRyan, 25

CO-FOUNDER #2THE TECHIE

Problems Encountered

• Potentially infringed previous employer’s

IP

• Exited WUPHF without assigning new IP

to the company

Lessons Learned

• Clearly distinguish new IP from prior

employment IP

• Draft and execute IP assignments

Match PendingDwight, 32

CO-FOUNDER #3THE LOGISTICS GURU

Problems Encountered

• Very stubborn; cannot agree with

cofounders

• Canadian citizen with a temporary work

visa

Lessons Learned

• Define roles to assist with decision making

• Create Deadlock provisions

• Seek assistance of counsel and inquire

about the Global Entrepreneurship-in-

Residence Program

CONCLUSIONS

Know Your Co-Founders

• Finding the right skillsets is great

• Establish procedures early in Founder’s Agreement

• Understand previous obligations

Founder’s Agreements

• Give it the attention it deserves

THANK YOU TO OUR GUEST EXPERT

Geoff Weber

Weber Law

weberbusinesslaw.com

THANK YOU TO OUR AUDIENCE

Apply to be a client at

www.drexel.edu/law/ELC