e145 | october 9, 2015 session 6: legal considerations for...

Copyright © 2015 by the Board of Trustees of Stanford and Stanford Technology Ventures Program (STVP). 

This document may be reproduced for educational purposes only.

Session 6: Legal Considerations for Technology Entrepreneurs

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Dan Dorosin

e145.stanford.edu

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•  Legal aspects of entrepreneurship and launching a new technology venture

•  IP and why IP matters

Please ask your questions!

Overview

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Who Are These Guys?

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Why Are They Famous?

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Who Are These Guys?

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What Happened?

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•  Does “legal” matter in the very earliest stages of a start up’s life?

•  How can a lawyer help entrepreneurs grow their venture?

Threshold Questions

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•  Help entrepreneurs grow business, from an idea to successful enterprise

•  Navigate legal issues that arise during start up’s life cycle

•  Familiarity with the business and legal practices of “Silicon Valley" and entrepreneurial eco-system

•  Earn role of trusted advisor

Role of Start Up Lawyer

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Start Up’s “Corporate Life Cycle”

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•  High growth venture, likely technology-based

•  Initially funded by angels and/or VC investors

•  Will hire employees, who expect equity incentives

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

Context for Today’s Discussion

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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 (more to come …) – IP ownership crystallized (corporation now owns)

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•  Entity Type

§  Typically a Delaware “C” corporation

§  Familiarity to investors

§  Relatively inexpensive to set up

§  Flexible capital structure, including for equity comp

•  Avoiding speed bumps

Company Formation

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•  Incorporation process often raises important team considerations

•  Functional roles, commitments and contributions

•  Stock allocation and terms (see below)

Founding Team Considerations

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•  How allocate founder equity?

§  Equal likely may not be the answer §  Honestly assess relative contributions, commitments

and roles •  Does everyone value founder equity the

same way?

•  Process bring into focus team dynamics

Equity Splits (What should Will do??)

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•  Vesting §  What and why have it? (Important to founders,

too) §  Acceleration? §  Red face test

•  Other Stock Terms

•  Tax Considerations

Founder Equity Arrangements

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•  Guidance navigating the process •  Introductions •  Market trends and terms •  Long-term financing strategy

§  Milestones need to raise new rounds

•  Structuring alternatives and trade-offs (see below)

•  Negotiation and closing

Financing Process

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•  Notes = debt; no valuation set or specific ownership % (but conversion caps)

§  Typically no governance rights §  Simplicity

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

§  Governance rights to investors §  (Somewhat) more complex

•  What structure will your seed investors do?

Structuring the Seed Financing

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•  Key economic terms – conversion, caps, M&A premiums

•  Limited governance terms

Seed Note Term Sheet

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•  Valuation, pool, dilution

•  Economic rights of Preferred Stock

•  Governance rights of Preferred Stock

•  Board of Directors

•  Changes to founders’ arrangements?

Preferred Stock Term Sheet

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Series A Dilution Example

Shares

Valuation

% Company Pre A

% Company Post A

Founders(issuedatincorp.)

5,000,000 Nominal 100% 48.6%

Op>onPool(IncreasedaspartofPre)

1,542,200 TBD* _ 15%

PreMoneyFullyDiluted

6,542,200 $7M(or$1.07pershareA)**

100% _

$4MSeriesA 3,738,400*** _ _ 36.4%

PostAFullyDiluted

10,280,600 $11M _ 100%

Example:Raise$4MSeriesAat$7MPrewith15%PostPool

*409AValua>ontypicallyobtainedaXerfinancingclosing.**$7Mpremoneydividedby6,542,200pre-moneyfullydiluted.***$4Mdividedby$1.07SeriesApricepershare.

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Additional Key Areas •  Governance

§  Board composition and dynamics §  Stockholder rights

•  Protection of IP (discussed below) •  Vetting business model(s) •  Equity compensation arrangements •  Partnerships •  Disputes •  Exit/Liquidity

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•  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

Intellectual Property

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•  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

Trademark protects branding and marks

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•  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

Copyright protects creative works of authorship

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•  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 first to file.

Patents

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•  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

Trade Secrets

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•  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

IP Needs Company Dependent

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•  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.

Proactively Develop IP Strategy

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Common IP Blunders by Start-Ups

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•  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

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

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•  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

2. Company Cannot Clearly Show That it Owns its IP

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•  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)

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

Thank you!

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