Download - Legal Stuff Entrepreneurs Should Know
Legal Stuff Every Entrepreneur Should Know
Benjamin M. Hron
McCarter & English, LLP
265 Franklin StreetBoston, MA 02110
@HronEsq
Overview
�Organization & Governance
�Equity & Capital Structures
�Valuation & Taxes
�Intellectual Property
�Employees & Contractors
�B2B Contracts
�Questions
Organization & Governance
Types of Legal Entities
�Partnership
�Limited Partnership
�Limited Liability Partnership
�Corporation
– C-Corporation
– S-Corporation
�Limited Liability Company
Types of Legal Entities
�Partnership
�Limited Partnership
�Limited Liability Partnership
�Corporation
– C-Corporation
– S-Corporation
�Limited Liability Company
Organization Documents
�Corporations
– Charter (aka Certificate/Articles of Incorporation)
�Filed with state to create corporation
�Defines types and amounts of equity authorized
�Establishes rights of each type of equity
– Bylaws
�Governance Structure
�Other mundane details (ex. fiscal year)
�Typically track corporate statute
Organization Documents
�Limited Liability Companies
– Charter (aka Certificate/Articles of Organization)
�Name and limited detail about entity
�No info about type or rights of equity
– Operating Agreement
�Defines types, amounts and rights of equity
�Governance structure
�Usually includes complex tax provisions
�Little mandated by statute, so lots of variation
Governance Structure
�Corporations
– Owners = Stockholders/Shareholders
– Stockholders elect Directors
– Directors appoint and oversee officers
– Officers run day-to-day operations
�Limited Liability Companies
– Owners = Members
– May be “managed” by Members or Managers
– May also have officers, but not required
Equity & Capital Structure
Corporations
�Stock
– Common: share of value of the company
�Sometimes subject to vesting (i.e. “restricted”)
– Preferred has special rights/privileges
�Options to purchase stock
– Incentive Stock Options (ISOs)
�Can only be issued to employees
�Preferred tax treatment if conditions are met
– Non-Qualified Stock Options (NQSOs)
Corporations
�Authorized, Issued and Outstanding Stock
– Authorized
�Set in corporation’s charter
�Total that can be issued without amending charter
�Fees typically increase with # of authorized shares
– Issued: shares corporation has sold/granted
– Outstanding: shares issued and not repurchased
– Authorized stock not outstanding has no rights
�Vested v. Exercisable Options
� Vested = all rights have matured
� Exercisable = able to be exercised for stock
LLCs
�Ownership Interests Generally
– Set in operating agreement, not charter
– No impact on state fees
– Can be unlimited
�Capital Interest v. Profits Interest
– Capital Interest: share of value of the company
– Profits Interest: share of profits from given date
�Used as incentive compensation
�Somewhat equivalent to options … but not really
Fully Diluted Capital
�Overall capital with claim on company’s assets
�Typically Includes:
– outstanding stock (as-if-converted to common)
– outstanding derivative securities (as-if-converted to common) (ex. options, warrants)
– shares underlying options reserved for issuance
�Does NOT include authorized shares of common stock not outstanding or reserved
�Broad v. Narrow
Fully Diluted Capital
�Pop Quiz: What is FDC of company with…
– 1M shares of Common Stock outstanding
– 300K shares of Preferred Stock outstanding that convert to Common Stock 1:1
– Options to purchase 200K shares of Common Stock reserved for issuance, of which
� 100K options are outstanding, but not vested
� 50K are vested and exercisable
– $500K of convertible debt with a conversion cap of $5M
Fully Diluted Capital
�Answer:
– Narrow FDC
� 1M Common + 300K Preferred + 50K options vested and exercisable = 1,350,000 Common
– Middle of the Road
� Add 100K options outstanding, but not vested and exercisable = 1,450,000 Common
– Broad
� Add 50K options reserved = 1,500,000 Common
– Very Broad
� Add Convertible Debt, but at what $?
Vesting
�Sets limitations on rights of stockholder:
– For period of time; or
– Until occurrence of specified event (milestone)
�Stock not yet vested can be repurchased …
– If stockholder’s service ends
– Upon occurrence of certain events (ex. acquisition)
�Vesting may accelerate upon
– Acquisition
– Termination of service in certain circumstances
Splitting Equity
�Even split usually isn’t the right answer
�Key factors to consider
– Time invested and commitment going forward
– Role in the company
– Contribution of IP, cash or other assets
�Require most/all founders’ equity to vest
– Time based: compensates for “time served”
– Milestone base: compensates for achieving goals
– Unvested equity is repurchased if founder leaves
�Split will usually change over time
Securities Laws
�Federal and State securities laws apply to every
offer and sale of securities
�Securities must be “registered” or the securities or transaction must be exempt from registration
�Details of exemption dictate how and to whom securities can be offered and sold
�Penalty for failure to comply: purchaser of securities has right to get their money back
Valuation & Taxes
How does valuation impact taxes?
�Recipient has taxable income on stock when issued = FMV – $ paid
�Options not taxed at grant if strike $ ≥ FMV
– ISOs must be granted at or above FMV
– NQSOs should be granted at or above FMV
�So options are the preferred form of equity incentive compensation
– Recipient not required to pay for stock until it appreciates
Examples
�Ex. 1: Founder A contributes $10K for 50%; Founder B contributes “sweat equity” for 50%
– Does Founder B have $10K of income?
�Ex. 2: Shortly after initial common stock issued to founders for $1 each, company raises $100K by selling 20% of common stock to investor
– Do founders have $400K tax liability?
�Ex. 3: Company raises $3M through sale of Preferred Stock at $2M pre-money
– What is strike price of options post-financing?
Intellectual Property
�Patents – cover inventions
�Copyrights – cover works of authorship, including software code
�Trademarks/Tradenames – cover identifying marks/names used in a trade or business
�Trade Secrets – cover proprietary information used in trade or business
Types of IP
�IP developed before organization of the company belongs to the creator if not assigned
�Contractors own their work product absent a “work for hire” agreement
�Employer owns work product of employees
�Require NDAs and Work-for-Hire agreements for
everyone
Securing IP
Employees & Contractors
Employees & Contractors
�Different federal and state tests
– MA test is very restrictive
– No contracting around law
�Employees must receive:
– minimum wage
– overtime pay
– workers comp
�Interns – nearly impossible to meet requirements
�Penalties are severe and enforcement authorities are “employee-friendly”
B2B Contracts
Key Elements
�Description of goods/services provided
�Timing on and conditions to payment
�Ownership of IP developed
�Non-competition, Non-solicitation
�Confidentiality
�Representations & Warranties
�Covenants
�Indemnification/Limits on Liability
�Choice of Law/Forum
Key Elements
�Description of goods/services provided
– Goods/Services should be clearly described
– Specify timing of delivery
– Set some sort of threshold for quality
– Provide for remedy if goods/services aren’t delivered or don’t meet specifications
Key Elements
�Timing on and conditions to payment
– If payment proceeds delivery, what is the remedy if goods/services are never delivered or don’t meet specifications?
– If delivery proceeds delivery, what is consequence for late payment?
Key Elements
�Ownership of IP developed
– If silent, party developing IP owns it.
– Jointly-owned IP may not be controlled by anyone
�Patents – any owner can deal with freely; NO “duty to account”
�Copyrights – any owner can deal with freely but there IS “duty to account”
Key Elements
�Non-competition, Non-solicitation
– Enforceability depends on scope
– Non-competes hard to enforce
�Illegal in some states
– Typically last 6-12 months after agreement ends
Key Elements
�Confidentiality
– Make sure description of what is covered includes any type of proprietary information your company is going to disclose
– Excluded from “Confidential Information”:
�Info in or that becomes part of the public domain
�Info received from 3rd party not under NDA
�Info independently developed by recipient
– Exception from non-disclosure obligation where compelled by law
Key Elements
�Representations & Warranties
– Statements of fact true as of the date made
– Bridge knowledge gap between parties
– Want other sides R&Ws to cover information material to your decision to enter into the agreement that is much easier for them to provide than for you to determine independently
�Ex. Entering into an agreement with you will not breach any of their other contractual obligations.
Key Elements
�Covenants
– Promises to do something in the future
– Be sure you can perform on your covenants
– Be sure the agreement includes necessary covenants for the other party
Key Elements
�Indemnification/Limits on Liability
– Indemnification is the right to have someone else make you whole for an injury
�Should be tailored to circumstances
�Very complex body of law
– Limits on Liability
�Typically eliminate liability for anything other than direct damages (i.e. no “indirect” damages)
�Usually excludes indemnification obligations and breaches of NDA or IP ownership obligations
�Mutual?
Key Elements
�Choice of Law/Forum
– Determines how agreement will be interpreted
– Determines where disputes will be settled
– Usually determined by relative bargaining power of parties
– Consider how choice of forum will impact your costs if you need to enforce the agreement
Questions?
Benjamin M. Hron
McCarter & English, LLP
265 Franklin StreetBoston, MA 02110
@HronEsq