Company Formation, Governance & Maslow's Hierarchy

Class 2 Agenda: February 3, 2025

• Recap of the previous class and housekeeping items
• Discussion of Maslow's hierarchy, G2G (government-to-government), mission statements, and core values
• Covering formation and organizational matters related to companies
• Analyzing the constituents of a company
• Discussing corporate governance principles
• Q&A session

Setting Up a Company

• A corporation is formed by filing a certificate of incorporation signed by an individual acting as the "incorporator."
• The charter will typically establish a simple common stock-only capital structure.
• The sole incorporator appoints the initial board of directors by written consent.
• The initial board of directors ratifies the incorporator's initial formation actions, elect officers, adopt bylaws, and authorize bank accounts via written consent.
• Initial stock issuances to founders may be ratified
• Foreign qualifications are required to do business where the Company "carries on its business," such as having employees, a physical presence, or operations.

Choice of Entity

• "Silicon Valley" startups often form as Delaware corporations because it is preferred for companies reinvesting profits for an IPO or sale to deliver shareholder returns.
• There is a difference in which state the company is registered
• LLCs are sometimes used as they are a preferred vehicle for businesses intending to distribute profits.
• Entities already formed in a non-Delaware jurisdiction often need to reincorporate or re-domesticate
• Most institutional investors prefer Delaware-organized entities due to familiarity with Delaware corporate/LLC law and predictability.
• Some states require use of merger to move to another state

Setting Authorized Capital Stock

• Growth companies usually have only common stock upon initial formation.
• Preferred stock is unnecessary until the company or investors designate terms for preferred stock financing.
• Authorize a large number of shares to allow recipients to receive a large number of shares which feels better than a smaller number, even though the absolute number does not actually matter.
• Classes or series of shares should have a low par value like $0.001 or $0.0001 per share, as Delaware sometimes determines its annual franchise tax on the basis of aggregate par value.

Initial Issuances of Capital Stock

• The company will typically issue common stock to founders at a nominal or low price.
• Founders decide how many shares to issue to themselves, anticipating future issuances, capital raising, and the incentive equity pool size for employees/consultants.
• Founders may impose "vesting" so the company can repurchase shares at the original cost if a recipient ceases involvement.
• Vesting involves the company's right to repurchase shares, which falls away over time, often quarterly over four or five years, with a "one-year cliff."
• Vesting could be less for founders.
• Each issuance is documented with a common or restricted stock purchase agreement.
• An applicable securities law exemption must be found for each issuance.

Employee and Incentive Equity

• The company will need to obtain an Employer Identification Number (EIN) before hiring employees.
• Adopt forms such as:
• Employee Offer Letter: Should be tailored for state where employees reside and is usually “at-will.”
• Confidentiality and Invention Assignment Agreement
• Consulting Agreement

409A Valuations

• A company may adopt an equity incentive plan
• A typical "long term incentive plan" is like a Swiss army knife, covering options, restricted stock, phantom equity, and other equity-linked incentives.
• An equity incentive plan needs approval by stockholders.
• The board must approve each option grant per the plan's terms.
• Option grants must comply with the state and federal securities laws.

Intellectual Property Protection

• There should be a clean break from prior employers and partners.
• Founders should contribute their IP.
• Confidentiality Agreements / NDAs should be in place.
• Inventions Agreements / Proprietary Rights Agreements
• Assignments of Patents, Patent Applications, Trademarks, Copyrights, and Trade Secrets
• Trademark for Company Name, Logos, and Slogans, assignments or licenses from incubators and 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.
• 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. These include obligations to exercise proper oversight and monitoring over the corporate entity they serve, to candidly disclose information to shareholders under certain circumstances, and to avoid wasting corporate assets.”

Business Judgment Rule and Entire Fairness

• Business Judgment Rule (BJR): Delaware courts evaluate board decisions under the BJR, favoring directors acting with a rational business purpose, as seen in financial investments and approving down-round financing to prioritize survival.
• Entire Fairness Standard: Applied in conflict-of-interest or other heightened scrutiny scenarios. Directors must affirmatively prove that their decisions or transactions are entirely fair in both process and pricing, potentially using burden-shifting mechanisms.

Best Practices: Financial Distress

• Shift of Duties: Duties extend to the entire "community of interests,” including creditors, once a corporation becomes insolvent.
• Derivative Status: Once insolvent, creditors gain derivative status to assert claims for breach of fiduciary duties.
• Assume Insolvency: Presume 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.

Best Practices: Conflicts of Interest

• BJR and Conflicts of Interest: Business judgment rule evaluates the duty of care but does not cover conflict-of-interest transactions, which require heightened scrutiny.
• Cleansing Conflicted Transactions: Transactions may be "cleansed" if approved by a majority vote of fully informed and disinterested directors or stockholders.

Best Practices: Treatment of Confidential Info

• Risks of Sharing Confidential Information:
  • Breach of Duty of Loyalty: Unauthorized sharing of confidential information that harms the company.
• Directors must safeguard sensitive information to maintain trust and integrity.
• Best Practices for Managing Dissemination of Confidential Information:
  • Establishment LPAC to assist with the review of confidential information and ultimate decision-making.
  • Separation of Sponsor Representatives; define and separate internal roles.
  • Compliance Oversight by informing internal compliance team to restrict sharing of confidential information.

Best Practices: Fiduciary Duty Waivers

• Corporate Context: Delaware Chancery Court supports contractual waivers of fiduciary duties among sophisticated parties if they are specifically tailored and negotiated, and provide consideration.
• LLC Flexibility: LLCs can waive fiduciary duties entirely in their operating agreements.
• Best Practices for Waivers:
  • Specificity and Narrowly Tailored to avoid unenforceability.
  • Use of Counsel to represent all parties' negotiation.
  • Consideration for corporate waivers requires valuable consideration to ensure a bargained-for exchange.
  • Limited Scope: No protection from liability for bad faith or other intentional harm.

Fact Pattern

• Composition: Board of Director comprised of the CEO/Founder, two Series A Investors, one representative of the Common Stock holders and one independent director (total of 5 seats).
• Board Decision Making: A majority of the Board is required to make decisions.
• Capital Needs: The Company needs capital, and the Series A Investors proposing an additional $5m investment for a new class of Series B Preferred Stock.
• Break-Out Discussion; what considerations should be taken into account in determining whether to move forward with the proposed capital raise and what are some procedures that should be adopted as part of the process?

Class 3 Agenda: February 10, 2025

• 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), considerations should involve
  • Good to Great
  • Mission Statement
  • Core Values
  • Skillset, Network, and Symbiosis
• Structuring your co-founder partnership
  • Founders' Equity
  • Vesting
• Case study discussions, examples include
  • Zuckerberg/Saverin
  • Cruise Automation / YCombinator.

Contractual Terms for Co-Founders

• Equity Splits Among Co-Founders
• Restricted Stock is preferable to stock options, especially considering Form 83(b) filings and Timing of incorporation and initial stock issuance
• Vesting Considerations; Should founder stock be subject to vesting, including Vesting schedules, Acceleration, and Forfeiture.

Form Documents

• Certificate of Incorporation
• Bylaws
• Founder Employment Agreement
  • Compensation, salary and equity split
  • Vesting
  • Severance
  • Other
• Proprietary Rights Agreement

Examples of Co-Founder Relationships

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

Capitalization

• Tracks new issuances of stock and stock equivalents, e.g., notes, options and warrants.
• Helps you understand who owns a company so that you can determine who gets paid how much upon the occurrence of a "deemed liquidation event".

What You Should Know

• Explain who owns a company
• Discuss the impact of an equity financing or other issuance on a company's cap table
• Allocate payments in connection with a company sale

What You Need to Understand

• Basic math for pricing a new round
• Dilution – the impact of new issuances on existing equity
• The impact of down-round pricing on the conversion terms of outstanding equity

Capitalization Table Iterations

• Version 1 – Founder Stock
• Version 2 – Founder Stock + Stock Options

Version 1: Founder Stock; Assumptions

• Two founders start a company
• Single class of equity – all Common Stock
• Founders split the equity equally
• No option pool

Version 2: Founder Stock + Options; Assumptions

• Two founders start a company
• Single class of equity – all Common Stock
• Founders split the equity equally
• Authorize and fully-allocate an employee option pool (20% fully-diluted)

Class 4 Agenda Highlights

• 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): "Meeting of the Minds”
  • Valid Offer
• Valid Acceptance
• Effec of Counter-Offers
• Intent to Contract.
• Consideration (Value Exchange).
• Other Potential Issues
  • Authority (Designated Authority; Board Approvals)
  • Certainty/Clarity (vs. Ambiguity and/or Material Holes

Journalistic Approach

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

Non-Disclosure Agreements

• Definition: A legal contract that establishes confidentiality obligations between the disclosing party (seller) and the receiving party (potential buyer or investor).
  • Specifies the types of information considered confidential and the permissible uses of such information.
• Scope of Confidential Information:
  • Defines the categories of information subject to confidentiality protection, including financial records, customer data, intellectual property, and trade secrets. Clarifies exclusions from confidentiality, such as information already in the public domain or independently developed by the receiving party

Letters of Intent

• An LOI is a written document outlining the preliminary understanding between parties involved in a transaction or negotiation
• It expresses the intent to enter into a formal agreement and lays out key terms and conditions. Sometimes called a Term Sheet or Memorandum of Understanding
• Strategy - Short-Form vs. Long-Form -Key Components:
  • Parties involved
  • Description of the transaction or agreement
  • Key terms (e.g., economics, timeline, indemnification, conditions)
  • Confidentiality?
  • Exclusivity

Purpose of Exclusivity Letters

• Enable the parties to deal exclusively for a set period of time
• Motivates parties to allocate time, money and other resources in pursuit of a deal
• Binding and legally enforceable
• Key Terms:
  • Length of time
  • Automatic extension periods- -Types of deals excluded (e.g., internal or even external minority financings) -Unsolicited in-bound inquiries
• Non-solicitation of employees

Types of Commercial Contracts

• Services Contracts
  • Master Services Agreements (MSAS)
  • Statements of Work (SOWs)
  • Other Services Agreements
• Purchase Contracts
• End-User Agreements
  • Enterprise vs. Per-Seat
• OEM Agreements
• Distribution Agreements Licenses.

Licenses

• Definition: Partial Conveyance of Ownership; Permission to Do Something
• Inbound vs. Outbound
• Unilateral vs. Mutual/Cross-Licenses
• Scope vs. Restrictions on Use: Time, Place (Worldwide vs. Other), Manner (Fields of Use)
• Applicable Intellectual Property
• Rights to Source Code
• Maintenance and Support
• Right to Sublicense
• Exclusive vs. Non-Exclusive vs. Partial Exclusivity
• Payment Terms: Upfront vs. Scheduled vs. Royalties
• Perpetual/Time-Based
• Revocable vs. Irrevocable Click-Through Agreements

Other Key Provisions Sometimes Used

• Exclusive Dealing
• Most-Favored Nation (MFN) / Best-in-Class Provisions
  • Rights/Benefits with Parity or More Favorable vs. Third Parties
  • Additional Fee/Top-Up vs. Static
• Holistic vs. Defined Universe of Competitors
• Limitations on Liability
• Antitrust Concerns
  • Protects (Relatively) Free Competition (Market Share Assessment)
  • Assessment of Market Dynamics (Monopoly, Oligopoly, Dispersed)
  • Price-Fixing

Types of 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: Technology & the Law

• Today's Agenda
  • Introduction
  • Employment Law 101

Introduction - Emily R. Pidot

• Partner at Paul Hastings LLP
  • Partner, Employment Law Department
  • Chair of the New York office
  • 20+ years advising employers and litigating disputes Recognized by Chambers and Partners, The Legal 500, SuperLawyers, member of American Employment Law Council and frequent lecturer on employment law topics

Employment Law 101 Outline

• Contracts between employers and employees
• What is EEO
• What are whistleblower claims
• Wage and Hour explained
• Post-employment restrictive covenants
• Leave laws
• Is labor law different from employment law

Regulation on Multiple Levels

• Common law
• Federal law
• State and local law
• Concurrent regulation
• Federal preemption
• Enforcement agencies at all levels

Contractual Relationship Between Employer and Employees

• What is a contract?
  • Bargained for exchange supported by consideration -"At-will" employment doctrine
• Does an employment contract need to be written
  • Statute of frauds
  • Promissory estoppel
• Can written representations form the basis of a contract claim
  • May be included in handbook, example

Key Terms to Consider for Contractual Relationship Between Employer and Employees

• 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.

EEO (Equal Employment Opportunity): Meaning

• Statutory exception to "at-will" doctrine
• Laws that protect against:
  • Discrimination
  • Disparate treatment
  • Disparate impact
  • Harassment
  • Retaliation

Employment Laws: A Brief History

• 1866: Civil Rights Act (Section 1981)
• 1935: National Labor Relations Act
• 1938: Fair Labor Standards Act
• 1963: Equal Pay Act
• 1964: Civil Rights Act (Title VII)
• 1967: Age Discrimination in Employment Act
• 1978: Pregnancy Discrimination Act
• 1990: Americans with Disabilities Act

EEO Laws: Concurrent Federal, State & Local Coverage

• A number of laws are covered on a municipal, state and federal level

Anti-Discrimination Laws

• Laws permit recovery of damages and/or certain equitable relief.
• Certain statutes (e.g., Title VII) place limits on monetary relief.
• Certain statutes (e.g., NYC Human Rights Law) place no limits on monetary relief.
• Most states have their own anti-discrimination laws and agencies charged with enforcing those laws.

Prohibited Grounds for Discrimination

• Race
• Color
• Religion/Creed
• Ethnicity
• National origin
• Sex includes gender, gender identity, sexual orientation
• Pregnancy and related conditions
• Age (typically 40+)
• Disability
• Mental and physical
• Genetic information

Additional Prohibited Grounds for Discrimination in Certain Jurisdictions

• Employment status
• Credit history
• Caregiver status and family responsibilities
• Weight and height
• Hair styles
• Participation in activities wholly outside of work (political activities, legal recreational activities)
• Arrest or conviction record
• Sexual or reproductive health decisions
• Marital and domestic partner status
• Status as a victim of domestic violence

Prohibited Conducts Include:

• Disparate Treatment: Intentionally treating an employee or applicant differently based on a protected characteristic.
• Disparate Impact: Seemingly or facially neutral practices that unduly impact employees in a protected class; often unintentional.
• Harassment: Based on a protected characteristic.
• Retaliation: For reporting discrimination or harassment or cooperating with a discrimination investigation.

Fair/Equal Pay Laws

• Proof of intent to discriminate unnecessary
• Focus is on similarity of job duties
• Burden shifts to employer to justify differences in pay
• Federal and state differences (example): The comparator must be substantially similar, but the defense is the job related and consistent with business necessity

EEO, Equal Pay, Affirmative Action and DEI

• Affirmative Action in employment
  • Federal contractor self-critical analysis to ensure EEO
• Voluntary affirmative action-preferences based on protected characteristics-very narrowly available, for now
• Diversity, Equity, and Inclusion
  • Not a legal construct Employer driven programs
  • Response to civil rights, social and ESG movements, as well as globalization
• Promote legal compliance and EEO
• Risk calculus for goal setting

Whistleblower Claims: Key Characteristics

• Include federal, state and local converge
• Common law claims: Functions of state laws, termination in violation of polictic policy, wide variation in how public policy is deficed
• Federal statutory claims such as cases including the False Claims Act or Sarbanes-Oxley
• The dispute may be extraorindary

Wage and Hour Law Notes

• Includes simultaneous federal and state coverage
• Basic issues: minimum wage and maximum hours, 'exempt' versus 'non-exempt status, and calculation of regular rate for overtime
• Furthermore, the laws have requirements relating to frequencies of pay, meal times and breaks.

Post-Employment Restrictive Covenants: Aspects to Consider

• State law, mostly: Common and statutory law, enforceable contact with reasonable scope, remedies for violation & restraints on trade considered -Federal Trade Commission to have rule starting in 2024

Leave Laws: Key Features

• Time off permitted under specified circumstances
• Paid or unpaid
• Job protection
• Private right of action
• Examples: FMLA, USERRA, and New York's Sick & family leave laws

Labor Law Distinct?

• Yes.
• The National Labor Relations Act governs relations between employers and labor unions.
• The NLRA protects the right to concerted activity.
• The National Labor Relations Board enforces the NLRA.