Company Formation & Governance

Class 2 - February 3, 2025

• Today's agenda includes a Class 1 recap and housekeeping, formation and organizational matters, constituents, corporate governance, and Q&A.

Setting up the Company

• Corporations can be formed by filing a certificate of incorporation, which must be signed by an individual acting as the incorporator.
• The charter typically sets a simple common stock-only capital structure.
• A sole incorporator appoints the initial board of directors via written consent.
• The initial board of directors ratifies the incorporator's actions, elects officers, adopts bylaws, and authorizes bank accounts through written consent.
• Stock issuances to founders can be ratified.
• Foreign qualifications are required to legally conduct business in locations where the company operates.

Choice of Entity

• "Silicon Valley" startups are typically formed as Delaware corporations.
• C corporations are preferred for companies reinvesting profits, planning for an IPO, or a sale to generate shareholder returns.
• LLCs are sometimes used as a preferred vehicle for businesses intending to distribute profits.
• Entities already formed in non-Delaware jurisdictions may need to reincorporate/re-domesticate.
• Institutional investors commonly prefer Delaware-organized entities because of familiarity with corporate/LLC law and predictability.
• Some states require a merger to move to another state.

Setting Authorized Capital Stock

• Growth companies typically have only common stock at initial formation.
• Creating preferred stock is unnecessary initially, as terms aren't designated until company or investors set them.
• Authorizing ~40,000,000 shares is a best practice, giving recipients a large number of shares.
• Classes or series of shares should be designated with a low par value of $0.001 or $0.0001 per share.
• Delaware's annual franchise tax relies on aggregate par value.

Initial Issuances of Capital Stock

• Companies will typically issue common stock to founders at nominal or low prices.
• Founders decide how many shares to issue and consider future issuances, capital raising, and the equity pool's size.
• Founders may want to impose "vesting" so the company can repurchase shares at the original cost if involvement ends.
• Vesting is achieved by granting the company repurchase rights that fall away over time such as monthly, over four years, with a one-year cliff.
• Each issuance is documented with a common stock purchase agreement or restricted stock purchase agreement.
• Each issuance must have an applicable securities law exemption.

Employees and Incentive Equity

• A company must obtain an Employer Identification Number (EIN) before hiring employees.
• Employer Offer Letters should be tailored for the state and usually be "at-will".
• Companies use Confidentiality and Invention Assignment Agreements and Consulting Agreements.
• 409A Valuations.
• A company may adopt an equity incentive plan.
• The long-term incentive plan covers issuances of options, restricted stock, phantom equity, and other equity-linked incentives.
• Equity incentive plans must be approved by stockholders.
• Each option grant needs Board approval along with compliance with state and federal security laws.

Intellectual Property Protection

• Ensure a clean break from prior employers and partners.
• Contribution of IP by Founder(s).
• Confidentiality Agreements / NDAs.
• Inventions, Proprietary Rights Agreements.
• Keep Assignments of Patents, Patent Applications, Trademarks, Copyrights and Trade Secrets.
• Trademark Company Names, Logos, Slogans.
• Assignments / Licenses from Incubators, Universities.

Constituents

• Constituents include
  • Founder(s)
  • 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 are required to act with diligence and prudence, making decisions after gathering information and thoughtful deliberation.
  • Liability for a breach of the duty of care can arise from a bad board decision or from an unconsidered failure of the board to act in circumstances where due attention would have prevented the loss.
• Duty of Loyalty: Directors must prioritize the company's interests and avoid using the position to gain personal gain.
• Corporate officers and directors are not permitted to use their position of confidence to further their private interests.
• Derivative Obligations: Corporate directors have fiduciary obligations like oversight and monitoring of the corporate entity and candidly disclosing information to shareholders.

Business Judgement Rule and Entire Fairness

• Business Judgment Rule (BJR): Delaware courts evaluate board decisions, favoring directors with rational business purpose.
• Financial Investments: The board divests a non-core subsidiary to reinvest in higher return areas, backed by extensive analysis.
• Approving Down-Round Financing: The board approves necessary down-round financing during financial strain after assessing all available options, prioritizing company survival.
• Entire Fairness Standard: Applied in conflict-of-interest or heightened scrutiny. Directors must prove decisions are fair.
  • Burden Shifting Mechanisms: A special committee or approval of a majority of the minority stockholders.

Best Practices: Financial Distress

• Duties extend to the entire "community of interests,” including creditors, during corporate insolvency.
• Derivative Status: Once insolvent, creditors gain derivative status to assert claims for breach of fiduciary duties.
• Best practices managing include:
  • Assume Insolvency
  • Hold frequent meetings, ensuring all decision-makers are well-informed.
  • Utilize special committees and independent directors to avoid self-interest implications.
  • Prioritize Wage & Hour; Taxes
  • Seek Expert Advice, and evaluate the necessity and coverage of D&O insurance

Best Practices: Conflict of Interests.

• Business judgment rule evaluates care claims but not conflict-of-interest transactions, which require scrutiny.
• Need specific allegations with conflicts.
• Decisions need to maximize value, and continue to be protected.
• A director on board to watch finances, is used for distressed companies.

Best Practices: Treatment of Confidential Info

• Sharing of confidential data without permission that can harm the company can breach of the duty of loyalty. Directors protect sensitive information. Example: a director at a portfolio company discloses data to a PE firm which that then uses it to negotiate loan terms. This is a breach.
• Best practices to manage that include: Establishment of a LPAC to review and decide on sensitive information and/or transactions. Separation of sponsor to define equity. Compliance: inform the internal teams to ensure secure and restricted sharing of data is in place.

Best Practices: Fiduciary Duty Waivers

• The Delaware Chancery Court supports contractual waivers of fiduciary duties, these need be a clear and provides value.
• LLC has the ability to waive if stated in its operating agreements.
• This allows members more freedom of defining duties and obligations.
• Best way to protect that is: Specific, Use counsel, Consider negotiations, and Have limited liability where is possible.

Class 3 - February 10, 2025

• Today's agenda includes a Class 1 recap and housekeeping, co-founder relationships, capitalization, a breakout session, Q&A, and a review of assigned readings.

Co-Founder Relationships

• Choosing a co-founder should involve considering factors like Good to Great, your mission statement, core values, skillset, network, and potential for symbiosis.
• Structuring includes vesting and equity.

Contractual Terms for Co-Founders

• Decide on Equity Splits Among Co-Founders.
• Restrict Stock
  • Consider why restricted stock is more beneficial over stock options.
  • File correct Form 83(b).
  • Note the timing for incorporation and stock issuance.
• Vesting
  • Founder stock should be subject to vesting with different schedules (Acceleration and Forfeiture).

Form Documents

• Form documents include:
  • Certificate of Incorporation
  • Bylaws
  • Founder Employment Agreement
    • Compensation, benefits, vesting, severance, etc.
  • Proprietary Rights Agreement.

Real-World Examples

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

Capitalization Tables

• They are important because can help to track all stock issuances and allow to clarify ownership when there's a liquidation event.
• Should be able to explain and discuss the impact of financial issues on equity.
• Should be understood and can be used for pricing.

Version 1: Founder Stock

• In this version there's two founders who will split both equally, they will have only one class of equity (all common stock), but they will have No option pool.

Version 2: Founder Stock + Options

• In this version the founders have agreed to split the equity, but an employee option pool has been fully allocated.

Class 4

• Today's agenda includes housekeeping and check-in, key terminology and ubiquitous provisions, legal requirements for an enforceable contract, preliminary contracts, commercial contracts, strategic contracts, remedies, and Q&A.

Key Terminology and Ubiquitous Provisions

• Terms to consider and understand include:
  • Parties, Preliminary Contract, Contract: Legally Enforceable Agreement, License.
  • Representations & Warranties & Disclaimers of Warranties.
  • Covenants, Promises, etc.

Legal Requirements for an Enforceable Contract

• Requirement include:
  • Legal Capacity
  • Mutual Assent (Written. vs. Verbal), Valid Offer, Valid Acceptance, Effects of Offers. -Intent to Contract
  • Other Potential issues, Authority, Clarity

Be a Journalist

• Draft with Specificity Unless Tactically Determined.
• Journalistic Approach including:
  • Who - What - Where - Why - How - When.

Preliminary Contracts

• These include Non-Disclosure Agreements
  • Establishing an agreement of no disclosure to obligate someone to not be able to disclose it.
  • Include all data needed such as records, customer data information.

Letters of Intent

• This involves:
  • An outline with the intention of certain parts to continue with an negotiation.
  • This involves key: parties, agreement, terms, confidentiality, Strategy of short vs long form.
• Types of deals and length expected.

Commercial Contracts

• Examples includes:
  • Contracts of services.
  • Agreements
  • Licensing.

Licenses

• This involves Partial Conveyance, this allows them to create a something by Inbound.
• May have restrictions on time, place
• Can have options if exclusive is better or not.

Other Key Provisions Sometimes Used

• Exclusive Dealing
• Most Favored Nations (MFN) / vs Tier partners

Strategic Contracts

• Partnerships, Joint Ventures, Alliances.
• Financing is a agreement for employment and benefit.
• Agreements for financial or companies.

Remedies

• The remedies for breached include:
• Damages and provisions, Equitable matters.
• Pay for attorney fees . Limit statute
• Jurisdictional Authority to Enforce.

Class 5

• Agenda: Intro and Employment Law 101

Emily R. Pidot

• Is a partner at Paul Hastings LLP. Specializes in Employment Law at New York.

Employment Law 101 Outline

• Considers contracts. What is equal? what is the differences, claims in time.

Regulation on multiple level

• Common law. Includes rules at states, federal, and levels.

Employees

• Is important to consider: to have an agreement, can have basis of a handbook.

What does the contract consider

• Job description, Benefits or hours
• Consequence of termination if is needed
• Is confidential to have Inventions.

Disparate treatment

• In summary, is important to have an opportunity to work for everyone, giving the basics parameters and also equal options. Includes those with certain Acts.

Discrimination and grounds

• Is certain ground parameters (race, color, origin, etc).
• Not apply to some status like marital or certain activities.