Company Formation, Maslow's Hierarchy of Needs

Class 2 Agenda: February 3, 2025

• Class includes a recap of Class 1 alongside housekeeping matters.
• Discussion points include Maslow's hierarchy of needs, G2G (Government-to-Government), mission statements, and core values.
• The class covers formation and organizational matters, constituents, corporate governance and Q&A.

Setting Up a Company

• A corporation is formed by filing a certificate of incorporation.
• The certificate must be signed by an individual acting as the "incorporator".
• The charter will typically set a simple common stock-only capital structure.
• The initial board of directors is appointed via written consent of the sole incorporator.
• The initial board of directors ratifies initial formation actions, elects officers, adopts bylaws, and authorizes bank accounts, among other things with written consent.
• Actions by the initial board may include ratifying initial stock issuances to founders.
• If a company "carries on its business" in a foreign jurisdiction, it must acquire foreign qualifications to do business there, examples include having employees, a physical presence, or operations.

Choice of Entity

• A typical startup in Silicon Valley is formed as a Delaware corporation.
• Corporations are preferred for companies that will reinvest profits, use an IPO, or engage in a sale to deliver shareholder returns.
• LLCs (Limited Liability Companies) are sometimes used.
• LLCs are often preferred for businesses intended to distribute profits.
• Entities formed in non-Delaware jurisdictions may need to reincorporate or re-domesticate.
• Most institutional investors prefer to invest in Delaware entities due to familiarity with Delaware corporate and LLC law and its predictability.
• Some states require a merger to move an entity to another state.

Setting Authorized Capital Stock

• Growth companies will have only common stock at initial formation.
• It is not necessary to create preferred stock until the company or investors set the terms for preferred stock financing.
• Authorizing a lot of shares (e.g., around 40,000,000) is best practice.
• A large number of shares looks better, even though the absolute number does not affect the actual financials.
• Designate classes or series of shares with a low par value (e.g., $0.001 or $0.0001 per share).
• Delaware determines the annual franchise tax on the basis of aggregate par value in some instances.

Initial Issuances of Capital Stock

• Common stock is issued to founders at a nominal or low price.
• Founders should decide how many shares to issue to themselves, considering future issuances, plans for raising capital, and the desired size of the employee equity pool.
• Founders may impose "vesting" on shares, allowing the company to repurchase shares at the original cost if the recipient ceases to be involved.
• Vesting is implemented by granting the company the right to repurchase shares, with the repurchase right lapsing over an agreed period, such as quarterly installments over four or five years.
• Each share issuance is documented either through a common stock purchase agreement or a 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.
• Various forms should be adopted, including:
  • Employee Offer Letter tailored to the state where the employee resides, usually “at-will.”
  • Confidentiality and Invention Assignment Agreement.
  • Consulting Agreement.
• 409A Valuations should be performed.
• A company may adopt an equity incentive plan.
• A "long term incentive plan" covers issuances of options, restricted stock, phantom equity, and other forms of equity-linked incentives.
• An equity incentive plan needs approval by stockholders.
• Each option grant requires approval by the Board as per the plan's terms.
• Option grants must comply with state and federal securities laws.

Intellectual Property Protection

• Need clean break from prior employers and partners concerning intellectual property.
• Founders should contribute their IP (intellectual property).
• There should be Confidentiality Agreements (NDAs).
• Inventions and Proprietary Rights Agreements are nessecary.
• Assingments of Patents, Patent Applications, Trademarks, Copyrights, and Trade Secrets are all key.
• Trademarks for Company Name, Logos, and Slogans are nessecary.
• Assignments and Licenses from Incubators, Universities, etc. should be gathered.

Constituents

• Key constituents of an organization 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

Fiduciary Duties

• Duty of Care dictates Directors must act with diligence and prudence, making decisions after adequate information gathering and thoughtful deliberation.
• Liability for breach of the duty of care arises in two contexts, it may be said to follow from a board decision or from an unconsidered failure of the board to act.
• Duty of Loyalty dictates Directors must prioritize the company's interests above their own, avoiding any personal gain from business opportunities and potential conflicts of interest.
• Corporate officers and directors cannot use their position of confidence to further their private interests, which requires undivided and unselfish loyalty to the corporation.
• Derivative Obligations dictates that Corporate directors have other fiduciary obligations derivative of the duties of care and loyalty.
• This includes obligations to exercise proper oversight and monitoring, to candidly disclose information to shareholders, and to avoid wasting corporate assets.

Business Judgment Rule and Entire Fairness

• Delaware courts evaluate board decisions under the Business Judgment Rule (BJR), favoring directors if they act with a rational business purpose.
• Examples of this include financial investments like boards divesting a non-core subsidiarity or approving down-round financing during financial strain.
• The Entire Fairness Standard is applied in conflict-of-interest or other heightened scrutiny scenarios.
• Directors must affirmatively prove their decisions or transactions are entirely fair in both process and pricing.
• Burden Shifting Mechanisms must have special committee or approval of a majority of the minority stockholders.

Best Practices: Financial Distress

• Assume a presumption of insolvency in precarious financial situations.
• Conduct frequent meetings and ensure all decision-makers are well-informed.
• Use special committees and independent directors to avoid self-interest implications.
• Focus on protecting the interests of employees and taxing authorities.
• Regularly consult with financial and legal advisors.
• Evaluate the necessity and coverage of D&O insurance, and consider including contractual exculpation clauses where feasible.
• Duties extend to the entire "community of interests,” including creditors.
• Once a corporation becomes insolvent, creditors gain derivative status to assert claims for breach of fiduciary duties.

Best Practices: Conflicts of Interest

• Business judgment rule evaluates duty of care claims but does not cover conflict-of-interest transactions.
• It is not enough to argue in the abstract that a director has a conflict of interest, there must be specific allegations, and actual evidence to support the allegations.
• If a director holds dual fiduciaries, there is no conflict if the interests of the beneficiaries are aligned.
• Decisions that seek to maximize value of the entity as a whole but do not confer direct or specific benefits on a fiduciary.
• "[I]t was not unusual for lenders to have designees on a company's board, particularly when the company was a distressed one".
• Transactions may be "cleansed" if approved by a majority vote of fully informed and disinterested directors or stockholders.
• Keep meticulous records that demonstrate careful and informed consideration of all relevant issues including the rationale behind each decision.
• Obtain fairness opinions from independent financial advisors to affirm the transaction's fairness.
• Rely on insights from independent management or external advisors, minimizing reliance on information from parties with potential conflicts.
• Gain approval of transactions by fully informed and disinterested directors or stockholders after comprehensive disclosures of all conflicts.
• All transactions involving directors who are also lenders or equity holders must be transparently reported and reviewed.
• Enforce a strict separation of duties and roles to prevent conflicts of interest.
• Establishing a Limited Partner Advisory Committee (LPAC) may be advisable.

Best Practices: Treatment of Confidential Info

• Unauthorized sharing of confidential information that harms the company can result in a breach of the duty of loyalty.
• Example: A director at a portfolio company discloses confidential information to a PE firm, which then uses this information in loan negotiations against the portfolio company.
• A director's duty of loyalty may be breached by this.
• Example: A director at a portfolio company shares insider information with a PE firm, potentially leading to insider trading activities.
• Establishing a Limited Partner Advisory Committee (LPAC) may be useful.
• Separation of Sponsor Representatives is needed, defining internal roles with respect to equity and other investments.
• Informing the internal compliance team to ensure internal walls established is important.

Best Practices: Fiduciary Duty Waivers

• The Delaware Chancery Court supports contractual waivers of fiduciary duties among sophisticated parties if tailored and negotiated.
• LLCs can waive fiduciary duties entirely in their operating agreements.
• Ensure provisions are specific, clear, and narrowly tailored to avoid unenforceability by using appropriate specificity.
• All parties should engage counsel to represent them.
• Waivers should exchange for "valuable consideration" to ensure a bargained-for exchange.
• There is no protection for liability for bad faith or intentional harm.

Class on Co-Founder Relationships: Feb 10 2025

• The class includes the following topics: -Co-Founder Relationships -Capitalization -Breakout Session (Time Permitting)
• Q&A
• Assigned Readings for Today's Class

Choosing Your Co-Founder

• Focus should be on ensuring your co-founder(s) are "Good to Great" rather than just mediocre.
• A good Mission Statement is important.
• Core Values should be in alignment.
• Skillset, Network, and Symbiosis can be key factors.

Structuring Your Co-Founder Partnership

• Founding members Equity should be considered and aligned.
• Vesting requirements for co-founders.
• Case study discussions include the Facebook: Zuckerberg/Saverin and Cruise Automation: Vogt/Guillory situations.

Contractual Terms for Co-Founders

• The distribution of Equity Splits Among Co-Founders is important.
• Restricted Stock considerations include considering stock restrictions instead of just stock options due to taxes.
• Form 83(b) filings.
• Proper Timing of incorporation and initial stock issuance is very important.
• Each member should agree on Vesting Schedules, Acceleration, and Forfeiture.

Form Documents

• Certificate of Incorporation
• Be sure to properly establish Bylaws
• Founder Employment Agreements are key, be sure to address Compensation (Base, Bonus and Equity), Vesting, Severance, and Other details.
• Establish Proprietary Rights Agreements.

Real-World Examples

• Facebook's case study on the relationship of Zuckerberg/Saverin and the troubles they faced.
• Cruise Automations analysis of the Vogt/Guillory case.

Capitalization Tables

• Capitalization Tables are important as they Track new issuances of stock and stock equivalents, e.g., notes, options and warrants.
• Cap tables help understand the distribution of ownership, as well as how the owners will be paid.
• It enables you to explain who owns a company, and the impact of an equity financing or other issuance on a company's cap table.
• Should be able to allocate payments in connection with a company sale.
• Basic math for pricing a new round is needed through a Cap Table.
• A cap Table details the impact of new issuances on existing equity.
• The impact of down-round pricing on the conversion terms of outstanding equity is important.

Capitalization Table Iterations

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

Version 1: Founder Stock

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

Version 2: Founder Stock + Options

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

Key Terminology and Ubiquitous Provisions

• Key Terminology and Ubiquitous Provisions in contracts can include:
  • 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 is needed to form a contract.
• Mutual Assent must be gained "Meeting of the Minds”.
  • This can be gained by making a Valid Offer and Acceptance etc.
• The contract should have Intent to Contract
• There should be a form of Consideration (Value Exchange)
• Consider Other Potential Issues, like Authority (Designated Authority; Board Approvals) and Certainty/Clarity (vs. Ambiguity and/or Material Holes

Be a Journalist

• Ensure documents are Draft with Specificity Unless Tactically Determined
• Follow a Journalistic Approach and report on the:
  • Who
  • What
  • Where
  • Why
  • How
  • When

Non-Disclosure Agreements

• These agreements establish confidentiality obligations between the disclosing party (seller) and the receiving party (potential buyer or investor).
• They must specify the types of information considered confidential and the permissible uses of such information.

Scope of Confidential Information:

• Define the categories of information subject to confidentiality protection, including financial records, customer data, intellectual property, and trade secrets.
• Clarify 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.
• It can also be called a "Term Sheet" or "Memorandum of Understanding".
• Strategy should reflect if Short-Form or Long-Form style agreement is needed.

Key components must include:

• Parties involved, description of the transaction or agreement, and key terms (e.g., economics, timeline, indemnification, conditions).
• Indicate a stance on Confidentiality and Exclusivity.

Exclusivity Letters

• Serve the Purpose to enable the parties to deal exclusively for a set period of time, and to motivate parties to allocate time, money and other resources in pursuit of a deal.
• These contracts are Binding and legally enforceable.

Key Terms

• Establish the agreement's Length of time.
• Automatic extension periods are used in some instances.
• Certain Types of deals can be excluded (e.g., internal or even external minority financings).
• Unsolicited in-bound inquiries can also be excluded.
• Establish the agreements stance on Non-solicitation of employees.

Major Commercial contract types

Services contracts can include:

• Master Services Agreements (MSAS)
• Statements of Work (SOWs) -Other Services Agreements
• Purchase Contracts are common
• When considering End-User Agreements, consider if the client is Enterprise vs. Per-Seat license type.
• OEM Agreements are a major form of commerical contract
• Distribution Agreements
• Licenses

License Agreements

• Grant partial conveyance of ownership and permission to do something.
• Licenses can come in the form of Inbound vs. Outbound.
• Could be Unilateral vs. Mutual/Cross-Licenses.
• Establish Scope vs. Restrictions on Use: Time, Place (Worldwide vs. Other), Manner (Fields of Use).
• Establish Applicable Intellectual Property to which the License applies.
• Ensure licensees have rights to a licenses Rights to Source Code.
• Licensors must have Maintenance and Support in place
• Licenses can have Right to Sublicense if granted. Licenses can be Exclusive vs. Non-Exclusive vs. Partial Exclusivity between multiple parties.
• Licenses must establish Payment Terms: Upfront vs. Scheduled vs. Royalties.
• Licenses can be Perpetual/Time-Based.
• Licenses can be Revocable vs. Irrevocable.
• Click-Through Agreements can be binding license, but should be checked with legal advisor.

Provisions

• Ensure agreements have some from form of Exclusive Dealing restrictions
• Agreements should have a Most-Favored Nation (MFN) / Best-in-Class Provisions
• Ensure agreements have Rights/Benefits with Parity or More Favorable vs. Third Parties and Additional Fee/Top-Up vs. Static
• Decide is you want Holistic vs. Defined Universe of Competitors
• Limitations on Liability must be defined
• Agreements must protect (Relatively) Free Competition (Market Share Assessment) Assessment of Market Dynamics (Monopoly, Oligopoly, Dispersed) Be sure to take a stance on Price-Fixing

Types of Strategic Contracts

• Partnerships can be strategic.
• Joint Ventures can be strategic.
• Strategic Alliances are the most popular.
• Organizational: Charter/COI, Bylaws, and Shareholder Agreements are vital.
• Ensure Employment, Incentive Equity + (Sometimes) Benefit Plans are established.
• Set clear Financing strategies
• Draft M&A Agreements

Remedies to contract breaches include:

• Damages caused.
• Liquidated Damages Provisions can be useful
• Equitable Remedies are a common form of legal remedy. Establish Specific Performance
• Temporary Restraining Orders
• Preliminary Injunction
• Permanent Injunction It must be decided Who Pays Attorneys' Fees and Other Costs of Enforcement A contracts Statute of Limitations should be established Establish Equitable Tolling Establish Jurisdictional Authority to Enforce (Contractual vs. Matter of Law)

Class 5: Technology & the Law

• Class 5 is about Employment Law 101 with guest speaker Emily R. Pidot.
• Topics to be covered include contracts between employers and employees, what EEO is and a discussion of whistleblower claims.

Introduction – Emily R. Pidot

• Emily R. Pidot is a Partner at Paul Hastings LLP and Partner in the Employment Law Department
• She chairs the New York office
• She has 20+ years of experience advising employers and litigating disputes
• Chambers and Partners, The Legal 500, SuperLawyers have all recommended her.
• She is also a member of American Employment Law Council and frequent lecturer on employment law topics.

Employment Law 101 Outline

• It touches on Contracts between employers and employees.
• Explains what EEO is.
• Explains What are “whistleblower” claims?
• Details Wage and Hour law.
• Details Post-employment restrictive covenants and Leave laws.
• Determines if Labor Law is Different is from Employment Law.

Regulation on Multiple Levels

• Common and federal law both need to be considered.
• State and local laws are key to take into account in addition to Concurrent regulation and Federal preemption.
• Enforcement agencies are present at all levels.

Contractual Relationship Between Employer and Employees

• A contract involves a bargained-for exchange supported by consideration, that operates with "At-will" employment doctrine
• An employment contract not need to be written, but must take the Statute of frauds and Promissory estoppel concepts into consideration.
• Written representations can form the basis of a contract claim, such as a handbook or even a document issued by the firm.
• Key terms in the contract should be considered such as:
  • Job description.
  • Hours of work.
  • Compensation and benefits.
  • Fixed term or "at-will" details.
  • Consequences of termination.
  • Confidential information.
  • Inventions.
  • Post-employment restrictions.
  • Arbitration of disputes.

EEO & Equal Employment Opportunity

• An Equal Employment Opportunity (EEO) is a a Statutory exception to "at-will" doctrine.
• Several Laws protect against Discrimination in addition to Disparate Treatment and Disparate Impact, as well as Harassment and Retaliation.

Employment Law 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

• Civil Rights Act of 1964
  • Concurrent Federal, State & Local Coverage
• Title VII establishes the State and Local Statutes
  • Title establishes the New York State Human Rights Law
• Pregnancy Discrimination Act
  • New York Equal Pay Law
• Equal Pay Act
  • New York City Human Rights Law

Anti-Discrimination Laws

• The goal is to Laws permit recovery via damages and/or certain equitable relief, however Certain statutes, like (e.g., Title VII) place limits on monetary relief.
• States have their own anti-discrimination laws and agencies that enforce those laws.
• Several State (e.g., NYC Human Rights Law) may place no limits on monetary relief.