S E S S I O N 8 : L E G A L C O N S I D E R A T I O N S F O R T E C H N O L O G Y E N T R E P R E N E U R S

E 1 4 5 - T E C H N O L O G Y E N T R E P R E N E U R S H I P

D A N D O R O S I N F E N W I C K & W E S T L L P

S T A N F O R D U N I V E R S I T Y

H T T P : / / E 1 4 5 . S T A N F O R D . E D U

A U T U M N 2 0 1 4 Copyright © 2014 by the Board of Trustees of the Leland Stanford Junior University and Stanford Technology Ventures Program (STVP). This document may be reproduced for educational purposes only.

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Overview

■  How do lawyers work with start ups?

■  What is IP and why does IP matter?

■  Key Ideas for today.

Please ask your questions!

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Assumptions for Today’s Discussion

■  High growth venture, likely technology-based

■  Initially funded by angels and/or VC investors

■  Will hire employees, who expect equity incentives

■  IP a core asset

■  Any free cash flow reinvested in business rather than distributed to owners

Role of Start Up Lawyer ■  Help entrepreneurs grow business, from an idea

to successful enterprise

■  Navigate legal aspects of the business issues that arise during start up’s life cycle

■  Familiarity with the business and legal practices and norms of “Silicon Valley” business community

■  Earn role of trusted advisor

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“Corporate” Life Cycle”

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Beyond ??

Pursue Opportunity

Seed Financing

Series A, Etc.

Acquisition ?

IPO ?

Founding Team/

Incorporate

When Does Lawyer Get Involved?

■  When is the “right” time to incorporate?

■  Why incorporate?

•  Benefits (shield from personal liability) – Follow formalities

•  Consequences – Memorialize the relationship among the founders

– IP ownership crystallized (assign to corporation)

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Company Formation

■  “Today’s” assumption (don’t create objections)

■  Entity Type

•  Typically a Delaware “C” corporation

•  Familiarity to investors

•  Relatively inexpensive to set up

•  Flexible capital structure, including for equity comp

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Founding Team Considerations

■  Incorporation process often raises important team considerations

■  Functional roles and contributions

■  Stock allocation and terms

•  Equal likely may not be the answer

•  Honestly assess relative contributions, commitments and roles

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Founder Equity Arrangements

■  Vesting •  What and why have it?

•  Silicon Valley “standard”

•  Acceleration?

•  Red face test

■  Other Stock Terms (ROFR, etc.)

■  Tax Considerations

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Financing Process

■  Guidance navigating the process

■  Intro’s to investors

■  Insights into market trends and terms

■  Long term financing strategy

•  Milestones need to raise new rounds

■  Structuring alternatives and trade-offs (see below)

■  Negotiation of term sheets (see below)

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Financing Process Seed Notes v. Preferred Stock?

■  Notes = debt; no valuation set or specific ownership % (but see caps)

•  Typically (very) few governance rights

•  Simplicity

■  Preferred stock = equity; valuation of company, ownership % specified

•  More governance rights to investors

•  (Somewhat) more complex

■  What structure will your seed investors do? 11

Financing Process Seed Note Term Sheet

■  Conversion discount and cap

■  Change of control premium

■  “Default” conversion rights

■  Maturity date

■  Amendment

■  Pre-emptive rights?

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Financing Process Preferred Stock Term Sheet

■  Valuation, including option pool size

■  Liquidation preferences

■  Protective provisions

■  Board composition

■  Anti dilution protections

■  Investor rights (ROFR, info, etc.)

■  Exclusivity

■  Other? (drag along?, founder re-vesting??) 13

Series A Dilution Example

Shares

Valuation

% Company Pre A

% Company Post A

Founders (issued at incorp.)

5,000,000 Nominal 100% 48.6%

Option Pool (Increased as part of Pre)

1,542,200 TBD* _ 15%

Pre Money Fully Diluted

6,542,200 $7M (or $1.07 per share A)**

100% _

$4M Series A 3,738,400*** _ _ 36.4%

Post A Fully Diluted

10,280,600 $11M _ 100%

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Example: Raise $4M Series A at $7M Pre with 15% Post Pool

* 409A Valuation typically obtained after financing closing.

** $7M pre money divided by 6,542,200 pre-money fully diluted.

*** $4M divided by $1.07 Series A price per share.

Additional Key Areas

■  Protection of IP (discussed below)

■  Equity compensation arrangements

■  Governance •  Board composition and dynamics

•  Stockholder rights

■  Partnerships

■  Disputes

■  Exit/Liquidity 15

Key Idea #1 ■  Experienced lawyer can be a valuable advisor,

helping a start up navigate legal risks and grow and achieve business goals

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Intellectual Property ▪  Valuable intangible property that is protectable

under the law

▪  Different types of IP (see following discussion)

▪  Creates competitive advantage

▪  Licensable – multiple authorized users at the same time, creating source of (very high margin) revenue

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Trademark protects branding and marks

■  Trademark gives you the right to prevent others from using “confusingly similar” marks and logos •  Identify source of goods – e.g. Nike Swoosh

■  Trademark protection lasts as long as you are using the mark

■  Trademark registration is optional, but has significant advantages if approved

■  Country by country

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Copyright protects creative works of authorship

■  Copyright gives right to prevent others from copying, distributing or making derivatives of your work

•  Protects “expressions” of ideas but does not protect the underlying ideas

■  (Way) more than just technology: songs, books, movies, photos, etc.

■  Copyright protection lasts (practically) “forever”

■  Copyright does not prevent independent development

■  Registration is optional, but is required to sue for infringement

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Patents ■  A government granted “monopoly” to prevent

others from making, using or selling your invention

•  Even if infringement innocent or accidental

■  Invention must be non-obvious

■  Protection lasts typically for 15-20 years

■  Application and examination is required

■  Must file in U.S. within one year of sale, offer for sale, public disclosure or public use

■  U.S. law changed in 2013 from first to invent to first to file.

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Trade Secrets ■  Information that is kept secret and has economic

value to the business

•  Coke recipe, customer lists

■  No registration required

■  Can last for as long as you take reasonable steps to keep confidential

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Proactively Develop IP Strategy ■  Important for start ups to develop an IP

strategy to map out:

•  Key players and technologies in its market(s)

•  Expectations of where the market is going

•  Opportunities for strategic advantage

■  Strategy will evolve over time, including b/c of changes in available company resources, changes in marketplace, technological advances, etc.

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Key Idea #2 – IP Needs Company Dependent

■  What type of IP matters to a venture, and what it should do to protect IP, is highly company/industry dependent

■  Every company has unique business and IP needs and considerations

•  Medical device company – patents

•  Social network/commerce start up – trademark, copyright

•  Enterprise software company – copyright, trade secret

■  Industry dynamics (need portfolio to trade?)

■  Stage of the company’s development/resources

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Key Idea #3 – IP Creates Value ■  Innovative IP can create company value

■  How carefully you have:

•  Acquired your IP

•  Protected your IP

•  Exploited your IP (including via partnerships)

■  Will be crucial to your ability to realize on value, whether from investors, customers or acquirer

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Common IP Blunders by Start-Ups

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1.  Founders Don’t Make Clean Break with Prior Employer or Research Institution

■  Under CA law, employers may own inventions that are “related to employer’s reasonably anticipated R&D” even if done on “own time”

■  Process important when leaving current employer — “take only memories”

■  University patent policies apply, too

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2.  Company Cannot Clearly Show That it Owns its IP

■  Take the time to create a well documented, clear chain of title to IP

■  Written assignments of IP by founding team

■  Any other “founders” with claims?

■  Independent Contractors need written assignment agreements

■  Employee Invention Assignment Agreements

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3. Company Grants “Challenging” Licenses to IP Limiting Value Created by IP

■  Early licensing/partnering terms can impact value of IP

•  Grant of exclusive rights to IP in key verticals, territories, etc.

•  Grant of “most favored nations” license terms or other licensee-favorable economic terms

•  Key value creating agreement not assignable in acquisition (or, alternatively, not terminable upon acquisition)

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Questions/Discussion

T H A N K Y O U ! E 1 4 5 : S E S S I O N 8

Copyright © 2014 by the Board of Trustees of the Leland Stanford Junior University and Stanford Technology Ventures Program (STVP). This document may be reproduced for educational purposes only.

H T T P : / / E 1 4 5 . S T A N F O R D . E D U