Company Formation and Governance

Class 2 Agenda: February 3, 2025

• The agenda includes a recap of Class 1, formation and organizational matters, constituents, corporate governance, and a Q&A session.
• Class 1 recap covers Maslow, G2G, Mission Statements, and Core Values

Setting Up a Company

• Forming a corporation involves filing a certificate of incorporation, which is signed by an individual acting as the "incorporator."
• A charter typically defines a simple capital structure based on common stock exclusively.
• The sole incorporator appoints the initial board of directors through written consent.
• The initial board of directors ratifies the actions of the incorporator, elects officers, adopts bylaws, and authorizes bank accounts.
• Foreign qualifications needed to conduct business where the company operates, such as having employees, physical presence, or performing operations.

Choice of Entity

• Startups in "Silicon Valley" typically form as Delaware corporations.
• Corporations reinvest profits and aim for an IPO or sale to deliver shareholder returns.
• LLCs are used when the business is intended to distribute profits.
• Institutional investors often prefer Delaware-organized entities due to familiarity and predictability of corporate/LLC law.
• Some states mandate the use of a merger to move to another state.

Setting Authorized Capital Stock

• Growth companies initially have only common stock at formation.
• There is no need to create preferred stock initially until the need arises and terms are set by investors.
• Best practice is to authorize a lot of shares which is approximately ~40,000,000.
• Stock is designated should be designated with either a low par value of $0.001 or $0.0001 per share.

Initial Issuances of Capital Stock

• Companies typically issue common stock to founders at a nominal or low price.
• Founders decide on the number of shares to issue, considering future issuances, capital raising, and equity pool for employees/consultants.
• Founders may impose "vesting" so that the receiver of shares can repurchase at original cost if a recipient ceases to be involved with the company.
• Vesting gives the company the right to repurchase shares, with the repurchase right falling away over time, such as quarterly installments over 4 to 5 years, commonly with a one-year cliff.
• Each issuance is documented with a common stock purchase agreement or a restricted stock purchase agreement.

Employees and Incentive Equity

• Companies need to obtain an Employer Identification Number (EIN) before hiring employees.
• Companies should adopt forms such as:
  • Employee Offer Letters; should be tailored for the state and "at-will".
  • Confidentiality and Invention Assignment Agreement
  • Consulting Agreement
• Companies may adopt equity incentive plans
  • These Incentive plans include options, restricted stock, phantom equity, and other forms of equity-linked incentives.
  • Equity incentive plans need to be approved by stockholders.
  • Option grants must comply with state and federal securities laws and each option grant must be approved by the Board per the terms of the plan.

Intellectual Property (IP) Protection

• Companies need a clean break from prior employers and partners.
• Founders need to contribute to IPs.
• Confidentiality Agreements / NDAs are needed.
• Agreements for Inventions / Proprietary Rights.
• Trademark for Company Name, Logos, Slogans.
• Assignments / Licenses from Incubators, Universities.

Constituents

• Founders
• Investors and Other Shareholders
• Advisory Board
• Mentors, Confidants and Coaches
• Board of Directors
• Board Committees
• Employees
• Consultants
• Advisors
• Strategic Partners
• Licensing Partners

Introduction to Fiduciary Duties

• Duty of Care: Directors must act with diligence and prudence, ensuring decisions are made after adequate information gathering and thoughtful deliberation.
• There are two contexts in which liability for a breach of the duty of care can arise: "First, such liability may be said to follow from a board decision that results in a loss because that decision was ill advised or 'negligent'.
• Duty of Loyalty: Directors must prioritize the company's interests above their own, avoiding any personal gain from business opportunities and potential conflicts of interest.
• Derivative Obligations: “Corporate directors have several other fiduciary obligations that are derivative of the duties of care and loyalty.

Business Judgement Rule and Entire Fairness

• Business Judgment Rule (BJR): Delaware courts evaluate board decisions under the BJR, favoring directors if they act with a rational business purpose.
• Entire Fairness Standard: Applied in conflict-of-interest or other heightened scrutiny scenarios.
• Directors prove that their decisions or transactions are entirely fair in both process and pricing.

Best Practices: Financial Distress

• Shift of Duties: When a corporation becomes insolvent, duties extend to the entire "community of interests," including creditors.
• Derivative Status: Creditors can assert claims for breach of fiduciary duties once a company is insolvent.
• Companies should:
  • Assume Insolvency; assume a presumption of insolvency in precarious financial situations.
  • Meeting Frequency; Access to Information; Hold frequent meetings, ensuring all decision-makers are well-informed.
  • Address Conflicts of Interest; Utilize special committees and independent directors to avoid self-interest implications.
  • Prioritize Wage & Hour; Taxes; Focus on protecting the interests of employees and taxing authorities.
  • Insurance Assessment: Evaluate D&O insurance coverage and consider contractual exculpation clauses.
  • Seek Expert Advice: Regularly consult with financial and legal advisors.

Best Practices: Conflicts of Interest

• BJR and Conflicts of Interest: The business judgment rule evaluates only duty of care claims not conflict-of-interest transactions which require more scrutiny.
• However, “[i]t is not enough . . . to argue in the abstract that a particular director has a conflict of interest or is acting in bad faith because she is affiliated with a particular type of institution that may be pursuing a particular business strategy or have a particular interest.
• Conflicts can be "cleansed" if approved by a majority vote of fully informed and disinterested directors or stockholders.

Best Practices: Conflicts of Interest (Cont.)

Companies should:

• Maintain Detailed Records: Keep meticulous records that clearly demonstrate careful and informed consideration of all relevant issues.
• Secure Fairness Opinions: Obtain fairness opinions from independent financial advisors to affirm the transaction's fairness to the company.
• Depend on Independent Advice: Rely on insights from independent management or external advisors, minimizing reliance on information from parties with potential conflicts.
• Require Director and Stockholder Approvals: Gain approval of transactions by fully informed and disinterested directors or stockholders after comprehensive disclosures of all conflicts.
• Transparency: All transactions involving directors who are also lenders or equity holders must be transparently reported and reviewed.
• Establishment of LPAC: A governance body within PE funds designed to oversee and approve sensitive and conflict-prone transactions.
• Separation of Roles: Enforce a strict separation of duties and roles to prevent conflicts of interest.

Risks of Sharing Confidential Information

• Unauthorized sharing of confidential information that harms the company can result in a breach of the duty of loyalty; safeguards should be in place to secure integrity.
• Disclosing confidential information that then allows a PE firm to use this to manipulate a transaction likely constitutes a breach of the director's duty of loyalty.
• Companies should:
  • Establish a LPAC to assist with review of confidential information and ultimate decision-making with respect to transactions.
  • Establish Separation of Sponsor Representatives, clearly define and separate internal roles with respect to equity and other investments.
  • Ensure internal compliance team established to restrict sharing of confidential information with Compliance Oversight.

Best Practices: Fiduciary Duty Waivers

• Delaware Chancery Court supports contractual waivers of fiduciary duties among sophisticated parties if they are specifically tailored and negotiated, clear, and provide valuable consideration.
• LLCs offer unique ability to waive fiduciary duties entirely in their operating agreements and define their obligations.
• When waiving, companies should:
  • Use Specificity; Narrowly Tailor; ensure provisions are specific, clear, and narrowly tailored to particular transactions to avoid unenforceability.
  • Use Counsel: Engage counsel to represent all parties in negotiations to ensure fairness and sophistication.
  • Ensure there's Consideration: Negotiate corporate waivers in exchange for valuable consideration to ensure a bargained-for exchange.
  • Limit Scope: Be aware that there is No protection from liability for bad faith or other intentional harm.

Break-Out Discussion Assignment Fact Pattern

• The Board of Director comprises CEO/Founder, two Series A Investors, one representative of Common Stock holders, and on independent director; for a total of 5 seats.
• Majority of the Board is required to make decisions.
• There is Break-Out Discussion considering whether to move forward with the proposed capital raise.

Class 3 Agenda: February 10, 2025

The agenda includes:

• Class 1 Recap + Housekeeping
• Co-Founder Relationships
• Capitalization
• Breakout Session (Time Permitting)
• Q&A
• Assigned Readings for Today's Class

Co-Founder Relationships

• Choosing your co-founder(s); Good to Great, Mission Statement, Core Values, Skills.
• Structuring your co-founder partnership; Founders' Equity & Vesting.
• There are case study discussions; Zuckerberg/Saverin and Cruise Automation / YCombinator.

Contractual Terms for Co-Founders

Including:

• Equity Splits Among Co-Founders
• Restricted Stock
• Vesting

Form Documents

Including:

• Certificate of Incorporation
• Bylaws
• Founder Employment Agreement
• Proprietary Rights Agreement

Real-World Examples

Including:

• Facebook: Zuckerberg/Saverin
• Cruise Automation: Vogt/Guillory

Capitalization

• Tracks new issuances of stock and stock equivalents, e.g., notes, options and warrants.
• These tables should explain who owns a company and allocate payments in connection with a company sale.
• Understanding new issuances, dilution impacts to existing equity is needed.
• The impact of down-round pricing is needed on conversion terms of outstanding equity.
• Version 1 - Founder Stock
• Version 2 – Founder Stock + Stock Options

Assigned Readings for Today's Class

• https://www.ycombinator.com/library/5x-how-to-split-equity-among-co-founders
• https://www.ycombinator.com/library/lm-keys-to-successful-co-founder-relationships
• Cruise Automation: https://www.vox.com/2016/4/19/11586228/cruise-autonomous-car-sues-kyle-vogt
• Zoning/Saverin: https://www.businessinsider.com/how-mark-zuckerberg-booted-his-co-founder-out-of-the-company-2012-5
• Forms: (1) Emerging Growth Company - Employee Confidentiality and Invention Assignment (2) Co-Founder Term Sheet; (4) Certificate of Incorporation; (5) Bylaws

Capitalization Table Iterations

• Version 1: Founder Stock
  • Assumptions are that two founders start a company, with a single equity class, and no option pool, which founders share equally.
• Version 2: Founder Stock + Options -Assumptions are that two founders start a company; Single class of equity, equity is split equally and an employee option pool is authorized.

Class 4 - Agenda

Agenda Includes:

• Housekeeping / Check-In
• Key Terminology and Ubiquitous Provisions
• Legal Requirements for an Enforceable Contract
• Preliminary Contracts
• Commercial Contracts
• Strategic Contracts
• Remedies
• Q&A

Key Terminology and Ubiquitous Provisions

• Parties
• Preliminary Contract
• Contract: Legally Enforceable Agreement
• License
• Representations and Warranties and Disclaimers of Warranties
• Covenants
  • Promises to Do/Refrain
  • Compliance with Applicable Law
• Conditions
• Indemnification and Limitations on Liability
• Termination
• Remedies
• Effect of Change of Control and Assignability
• Governing Law and Forum/Jurisdiction vs. Arbitration vs. Mediation (Binding vs. Non-Binding)

Legal Requirements for an Enforceable Contract

• Legal Capacity
• Mutual Assent (Written vs. Verbal)
• Intent to Contract
• Consideration (Value Exchange)
• Other Potential Issues
• Authority (Designated Authority; Board Approvals)
• Certainty/Clarity

Preliminary Contracts

• These entail Non-Disclosure Agreements, Letters of Intent and Exclusivity Letters.
  • NDA's define confidentiality obligations between disclosing and receiving parties.
  • LOI is a written document outlining preliminary understanding; intent to enter a formal agreement -Exclusivity letters; enable the parties to deal exclusively for a set period of time.

Be a Journalist

• Individuals should draft with Specificity Unless Tactically Determined.
• There should be a Journalistic Approach including, Who, What, Where, Why, How, When.

Commercial Contracts

• These entail Services Contracts, Purchase Agreements, End-User Agreements, OEM Agreements, Distribution Agreements, and Licenses.
• Licenses: partial Conveyance of Ownership; Permission to Do Something.

Other Key Provisions Sometimes Used

• Exclusive Dealing
• Most-Favored Nation/Best-in-Class Provisions
• Rights/Benefits w/ Parity or favorable vs. 3rd parities
• Antitrust Concerns
• Assessment of Market Dynamics
• Price-Fixing

Strategic Contracts

• Partnerships
• Joint Ventures
• Strategic Alliances
• Organizational: Charter/COI, Bylaws, Shareholder Agreements
• Employment, Incentive Equity + (Sometimes) Benefit Plans
• Financings
• M&A Agreements

Remedies

• Damages
• Liquidated Damages Provisions
• Equitable Remedies
  • Specific Performance
  • Temporary Restraining Orders
  • Preliminary Injunction
  • Permanent Injunction
• Who Pays Attorneys' Fees and Other Costs of Enforcement?
• Statute of Limitations
• Equitable Tolling
• Jurisdictional Authority to Enforce (Contractual vs. Matter of Law)

Class 5

Today's Agenda

• Introduction of Emily R. Pidot, Partner at Paul Hastings LLP.
• The agenda includes Employment Law 101

Employment Law 101 Outline

• Contracts between employers and employees
• Overview on what is EEO
• Overview of "whistleblower" claims
• Wage and Hour explained
• Post-employment restrictive covenants
• Leave laws
• Overview on if labor law is different from employment law

Regulation on multiple levels

• Regulation on multiple levels is Common law, Federal law, state and local law, as well as concurrent regulation, and enforcement agencies at all levels.
• Federal preemption

Contractual relationship between employer and employees

• Job description; hours of work, compensation and benefits fixed term or ''at-will'', confidential information inventions, post employment; restrictions (at-will).
• What is under terms to consider: -Job description -Hours of work -Compensation and benefits -Fixed term or "at-will" -Consequences of termination -Confidential information -Inventions -Post-employment restrictions -Arbitration of disputes

Key Points to consider for EEO: Equal Employment Opportunity

• Statutory exception to "at-will" doctrine -Discrimination, disparate threatment, disparate impact, harassment and retaliation.

Employment Laws

• A Brief History dates back from the 1866: Civil Rights Act (section 1981).
• Other Laws includes: -1935- National Labor Relations Act -1938- Fair Labor Standards Act -1963- Equal Pay Act

1964: Civil Rights Act (Title VII)

The following also exits: -Age discrimination in Employment Act Pregnancy discrimination act

The following is concurrent Federal, State & Local Coverage

Federal statutes includes Title VII of the Civil Rights Act of 1964, Genetic Information Nondiscrimination Act, and Equal Pay Act. State and Local coverage includes New York State Human Rights Law, and Pregnancy Discrimination Act.

The following is includes under Anti-discrimination laws

• Laws permit recovery,
• Certain states have their own anti-discrimination laws and agencies that can enforce those laws.

Prohibited Grounds for Discrimination

• The following entail Religion/Creed, Sex, pregnancy and related conditions, genetic information, ethnicity, disability and race.
• In some jurisdictions it prohibits employment status, credit history, sexual or reproduction health decisions, status as a victim of domestic violence, and marital and domestic partner status. There needs to be an understanding that prohibits Conduction discrimination. This includes intentional or unintentional harm based under protected circumstance.

The following is includes under Equal Pay.

• Burden shifts to employer to justify differences in pay. This must be focus on job duty and not based on intent.

Additional to Affirmative Action in employment

• Federal contract self-critical analysis to ensure EEO.
• There is voluntary affirmative action-that's based on protected characters.
• Diversity can include; Not a legal construct, employer driven programs, promoter legal compliance a goal setting can occur.

What are whistleblower claims?

• Common law claims Function of state law, wide variation in how public policy is defined.
• Federal statutory claims (examples) False Claims Act Sarbanes-Oxley, this may be more significant.

Concurrent federal laws

• Basic issues; must be a basic salary. Some basic laws have more complicated requirements. These include pay frequency and pay stubs.

Post-employment restrictive covenants

Function of state law, mostly or can be the federal trade commission.