LEGAL ISSUES FOR STARTUPS

Anil AdvaniManaging Partner

anil@inventuslaw.com

PRESENTS

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Agenda

PART I: STRUCTURING U.S. OPERATIONS

• Reincorporate Indian Company as a U.S. Parent Company• Incorporate a U.S. Subsidiary • Incorporate an entirely independent Company

PART II: LEGAL ISSUES RELATING TO A STARTUP COMPANY

Incorporation Process

Employment Issues; IP Ownership Issues

Equity Structure

Financing Options

Strategic Transactions

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PART I: STRUCTURING U.S. OPERATIONS

• Option 1: Reincorporate Indian Company as a U.S. Parent Company

• Option 2: Incorporate a U.S. Subsidiary

• Option 3: Incorporate an Independent U.S. Company

INVESTORS U.S. Parent

Indian Sub

Investment

100%

INVESTORS Indian Parent

U.S. Company

Founder Stock Investment

100%

Founder Stock

Option Plan

Option Plan

U.S. Company

Ownership, Investment

and Management

will be unclear

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Reincorporate Indian Company as a U.S. Parent company:

• Only viable option where the investors and/or potential exit and/or most strategic customers and/or partners located in the U.S.

• Tax issues need to be handled carefully; valuation of Indian company shares needed

• All IP, founder stock, Option Pool, Investors, Customers and Revenues will be held in the U.S. Company

• Need to carefully structure management, Board and Shareholding

• IP can be licensed to Indian company for sale in India, or directly to Indian customers through website

• Transfer Pricing Issues; Immigration related issues

Incorporate a U.S. Subsidiary Company:

• Good option where the purpose of U.S. company is limited. For example, for collections from, or marketing and managing, U.S. customers of the Indian company

• Easy to set up and operate

Incorporation a completely independent company:

• Easy to set up and operate

• Not a good option if need to restructure for U.S. financing, licensing and/or potential exit

SETTING UP U.S. OPERATIONS (CONTD.)

Part II: Life Cycle of a Startup

EXIT: ACQUISITION

BRIDGE ROUND

FO

RM

AT

ION

INITIAL PUBLIC

OFFERING

SERIES C

SERIES B

SERIES A

BIG CUSTOMER

SMALLCUSTOMER

ANGEL ROUND

SERIES D

Incorporation

Founders Stock

Stock Incentive Plans Selecting and Negotiating with VCs

Debt vs. Equity

Employee Matters

IP Protection

Licensing and other IP Matters

Strategic Partnerships

The big question: when and

how to exit????

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Equity Structure

Initial Capital Structure

• Total Authorized: 10MM shares of Common Stock

• Difference between Authorized, Issued, and Outstanding Capital

• Founder Stock: 7-8MM

• Issue stock early to avoid tax issues

• Vesting (look back period for vesting)

• Acceleration: Single Trigger versus Double Trigger

• 83(b) elections: file on time (within 30 days of purchase)!

• Option Pool: 2-3MM

• Vesting: Straight 4 year vesting, 1 year “cliff”, with monthly vesting thereafter

• Acceleration: Could hamper acquisition

• Outside Investors: Preferred Stock

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Seed Financings:

• Founders, Friends, Family, Angels, Early Stage VCs

• Incubators: YC, Idea labs, Citrix Accelerator, 500 Startups, Tandem, and Alchemist

• Convertible Notes with a “kicker”, either a discount or warrant coverage

• Typically between $250k to $1MM

• Debt that converts into preferred equity in the “next qualified financing”

• Avoid any additional rights to seed investors, although institutional investors may require right to lead the next round, management rights, board seat and protective provisions

• Look out for any issues that may affect future financings.

Venture Capital Financings:

• Valuations

• Preferred Stock

Strategic Transactions:

• Licensing Arrangements

• Revenue Share; Affiliation Agreements; Reseller Agreements

• Mergers and Acquisitions

Financing Options

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Venture Financing - Term Sheet

Three Main Purposes of Term Sheet

• Pricing/Valuation

• Percentage of the Company to be sold (Pre and Post Money)

• Liquidation Preferences

• Dividends

• Anti-Dilution Protections

• Management/Controls

• Board Rights

• Protective Provisions

• Covenants

• Liquidity Rights

• Co-Sale/Right of First Refusal

• Registration Rights

• Drag-Along Rights

• Redemption Rights

Venture Financing (cont’d.)

Valuation

• Methodology for valuation:

• Discounted Cash Flow

• Multiple of Revenues/Sales, Multiple of Earnings

• Customers, Revenues, Management Team, Patent Strategy, Competition, Size of the market, other precedents

• Getting multiple term sheets always helps, but be careful how you play your horses!

• Watch out for milestone based investments

• Not the only issue to think about

Time, Process, and Expense

• Time: 2-3 months from start to finish

• Process: IP diligence, Legal diligence, Schedule of Exceptions, Financing Documents

• Expenses: Legal fees (both sides), Investor expenses

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Privileges of Preferred Stock

• Voting (Board) rights

• Protective Provisions

• Dividends: Cumulative versus non-cumulative; should be non-cumulative and discretionary, i.e., “when, as and if declared by the Board”

• Conversion Rights: Right to convert into Common Stock; Upon requisite preferred holders’ consent or upon a “qualified” IPO

• Anti-dilution Protection: Full Ratchet is bad; Broad-based weighted average is good and standard

• Redemption: Watch out, not a good sign; right should be at least 5 years out and spread over a period of time

• Registration rights: standard registration rights OK, nothing to fight over

• Information Rights: standard information rights OK, nothing to fight over; limit to “Major Investors”

• Right of First Offer: maintain their pro rata ownership; right to “gobble up”; limit to “Major Investors”

• Right of First Refusal and Co-Sale Agreement: OK, but understand how it works

• Board Observer Rights: OK, but need to be careful as VCs don’t like the distraction of too many observers

Venture Financing (cont’d.)

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Strategic Transactions

Licensing Arrangements

• License Terms:

• Exclusive versus Non-Exclusive

• Geographical Limitations

• Ownership of IP and “Work Product”

• Other Material Provisions: Fee Structure, Term, Termination, Assignment, and Indemnification.

Partnerships

• Affiliate Agreements

• Reseller Agreements

Mergers and Acquisitions

• Set up right legal structure

• Ownership of IP is critical

• Contract terms play a big role in valuation

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Terms of Use and Privacy Policy

Why are these policies important?• Contract with Users

• Subject Users to terms and conditions

• Key Terms: Registration requirements (Restrict use of site or app to users of a certain age), IP Ownership, Define fee structure, Limit Company’s liability, Define publicity rights, Indemnification, Assignment, Jurisdiction, Customer Support and Questions

• Content License: • Limited license for use of your site and content to users• Users assign their content ownership rights to the company• Compliance with Digital Millennium Copyright Act

• Restrict User Activity• Don’t post hate speech• No spam• No harassment of other users

• Data Security• Ensure compliance with the terms you’ve set

• Inform users of the data the Company collects: Personally Identifiable Information (PII) versus Non-PII

• Inform users of the Company’s use of their data• Provide users with the opportunity to Opt-Out of use of Cookies

Terms of Use and Privacy Policy

Risks if you don’t have these policies in place?• Unchecked liability• Collecting User Data without consent• No restrictions on User activity• Lost value

• Unclear ownership of content/contributions• Copyright, patent, and trademark implications

Challenges with these policies?• Acceptance of the policies by users

• Should ‘Manifest Consent’• Evolving Rules

• EU new standards on cookies differ from other countries• Global Enforcement issues

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Q&A

Thank you!