e145 - technology entrepreneurship session 8: legal considerations for technology...
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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