Setting up a Company

Setting up the company

• A corporation is formed by filing a certificate of incorporation
• The certificate of incorporation must be signed by an individual acting as the incorporator
• A charter typically sets out a simple common stock-only capital structure
• Sole incorporator appoints the initial board of directors by written consent
• With written consent of initial board of directors, ratify initial formation actions of the incorporator, elect officers, adopt bylaws, and authorize bank accounts
• Initial board of directors action may ratify initial issuances of stock to founders
• "Foreign Qualifications" must exist to do business where the Company "carries on its business," such as employing staff, having a physical presence, or other operations

Choice of entity

• A typical "Silicon Valley" startup is formed as a Delaware corporation
• Corporations are preferred for companies that reinvest profits and ultimately use IPOs or sales to deliver shareholder returns
• LLCs are sometimes used as a preferred vehicle for businesses intended to distribute profits
• An entity formed in a non-Delaware jurisdiction will have to reincorporate or re-domesticate
• Most institutional investors prefer to invest in Delaware-organized entities due to the predictability of Delaware corporate/LLC law
• Some states require the use of mergers to move to another state

Setting authorized capital stock

• At initial formation, growth companies will likely only have common stock
• When the company or investors set terms for a preferred stock financing is the time to designate the terms
• A best practice is to authorize a lot of shares, about 40,000,000, so stock recipients can receive a large number of shares
• It feels better to recipients even though the absolute number does not actually matter
• Classes/series of shares should be designated with a low par value of $0.001 or $0.0001 per share
• Delaware determines annual franchise tax based on the aggregate par value

Initial issuances of capital stock

• Companies issue common stock to founders at nominal or low price
• Founders decide how many shares to issue and consider anticipated share issuances to others, plans for raising capital, and desired size of incentive equity pool for employees and consultants
• Founders may want to impose vesting on their and/or others’ shares so the company can repurchase shares at the original cost if the recipient stops being involved with the company
• Vesting is achieved by giving the company the right to repurchase shares. The repurchase right falls away in ratable amounts over an agreed time, like in quarterly installments over four or five years
• Typical vesting is monthly and time-based over 4 years with a "one-year cliff"
• Each issuance must be documented with a common stock purchase agreement or a restricted stock purchase agreement
• Each issuance must have an applicable securities law exemption

Employees and incentive equity

• Companies must obtain an Employer Identification Number (EIN) before hiring employees
• Adopt forms such as;
  • Employee Offer Letter
    • Should be tailored for where employees reside. Usually at-will.
  • Confidentiality and Invention Assignment Agreement
  • Consulting Agreement
• 409A Valuations
• Companies may adopt equity incentive plans or a typical "long term incentive plan" which covers the issuance of options, restricted stock, "phantom equity", and other equity-linked incentives
• Stockholders need to approve equity incentive plans
• Boards must give approval for each option grant per the terms of the plan
• Option grants must comply with state and federal securities laws

Intellectual property protection

• Need to have a clean break from prior employers and partners to protect intellectual property
• Items to note are: contribution of IP by Founder(s), confidentiality agreements or NDAs, Inventions or Proprietary Rights Agreements, assignments of patents, patent applications, trademarks, copyrights, and trade secrets as well as trademark for company name, logos, slogans, etc
• Consider assignments or licenses from Incubators and Universities

Constituents

• These are all the constituents that are part of a company:
  • Founder(s)
  • Investors and Other Shareholders
  • Advisory Board
  • Mentors, Confidants, and Coaches
  • Board of Directors
  • Board Committees
  • Employees
  • Consultants
  • Advisors
  • Strategic Partners
  • Licensing Partners

Corporate governance - Fiduciary duties

• Directors must act with diligence and prudence, using adequate information gathering and thoughtful deliberation
• Duty of care liability arises in two contexts
  • Liability may be said to follow from a board decision that results in a loss because the decision was ill-advised or negligent
  • Liability may arise from an unconsidered failure of the board to act in circumstances in which due attention would have prevented the loss
• Directors must prioritize the company's interests above their own
• This avoids any personal gain from business opportunities and potential conflicts of interest
• Corporate officers and directors cannot use their position of confidence to further private interests
• Fiduciary obligations that are derivative of the duties of care and loyalty
  • 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 role vs entire fairness

• Delaware courts evaluate board decisions under the Business Judgment Rule (BJR), favoring directors if they act with a rational business purpose. Financial investments and approving down-round financing during financial strain are examples.
• The Entire Fairness Standard is 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
• A special committee or approval of a majority of the minority stockholders is an example of this

Financial distress best practices

• Duties extend to the entire "community of interests", including creditors, once a corporation becomes insolvent where a shift of duties is required
• Once insolvent, creditors gain derivative status to assert claims for breach of fiduciary duties

Managing financial distress best practices

• Assume a presumption of insolvency in precarious financial situations
• Hold frequent meetings, ensuring all decision-makers are well-informed and have access to info
• Utilize special committees and independent directors to avoid self-interest implications and address conflicts of interest
• Prioritize wage & hour considerations and taxes by protecting the interests of employees/ taxing authorities
• Seek expert advice regularly with financial and legal advisors
• Evaluate the necessity and coverage of D&O insurance, where contractual exculpation clauses are included

Conflicts of interest best practices

• Business Judgment Rule evaluates duty of care claims but doesn't cover conflict-of-interest transactions which require heightened scrutiny. It is not enough to assert that a director has a conflict of interest in abstract terms; there must be specific and factual evidence
• If a director is dual fiduciaries, there is conflict if the beneficiaries are aligned. If a lender's designee is on a company's board, the designee should closely monitor the company's financial situation to protect their investments
• Transactions may be "cleansed" if approved by a majority vote of fully informed and disinterested directors or stockholders.

Best practices for managing conflicts of interest

• Maintain meticulous records that demonstrate careful and informed consideration of all relevant issues This includes documenting the rationale behind each decision and the steps taken to ensure fairness
• Obtain fairness opinions from independent financial advisors to affirm the transaction's overall fairness
• Rely on insights from independent management or external advisors, minimizing reliance on information from parties with potential conflicts This helps to maintain the integrity of the decision-making process
• Gain approval of transactions by fully informed and disinterested directors/stockholders after comprehensive disclosures of conflicts
• All director and lender/equity holder transactions must be transparently reported and reviewed
• Enforce separation of duties/roles to prevent conflicts of interest
• Establish the Limited Partner Advisory Committee (LPAC) for PE funds to oversee and approve sensitive/conflict-prone transactions, especially if a sponsor has dual roles

Disseminating confidential information

• Unauthorized sharing of confidential information is a breach of duty of loyalty
• Some examples of confidential information are directors in a portfolio company disclose info to an outside PE firm, that is then used in loan negotiations or leads to insider training activities
• Establish a LPAC to assist with the review of confidential information and to guard against claims of breach of fiduciary duties
• Define and separate internal roles for equity and other investments, ensure the internal compliance team restricts sharing of confidential data

Fiduciary duty waivers

• Delaware Chancery Court supports contractual waivers of fiduciary duties among sophisticated parties if they are tailored and negotiated
• LLCs can waive fiduciary duties entirely in their operating agreements
• For waivers, ensure provisions are specific, clear, and narrowly tailored to transactions to avoid unenforceability
• Counsel represent all parties in negotiations to ensure fairness and sophistication
• Negotiate corporate waivers in exchange for something valuable, without protection from liability for bad faith or harm

Co-founder relationships

• Key areas regarding co-founders are:
  • Choosing your co-founder(s)
    • Consider if they are "Good to Great"
    • Consider a mission statement, core values, and their skillset, network, symbiosis, etc.
  • Structure your co-founder partnership
    • Founders' Equity
    • Vesting
• Case study discussions such as Zuckerberg/Saverin and Cruise Automation / YCombinator can provide insight

Contractual terms for co-founders

• Important factors: -Equity Splits Among Co-Founders -Restricted Stock versus stock options - Form 83(b) filings -Timing of incorporation and initial stock issuance: very important -Vesting - Whether founder stock should be subjected to vesting -Consider vesting schedules, accelerations, and forfeitures

Form documents for co-founders

• Important docs include:
  • Certificate of Incorporation -Bylaws -Founder Employment Agreement -Compensation (base, bonus, and equity) -Vesting -Severance -Other specifics -Proprietary Rights Agreement

Capitalization Tables

• They are important because they; -Track new issuances of stock and stock equivalents, e.g., notes, options and warrants. -Help understand who owns a company and who gets paid how much upon certain events
• Some things you should know about them;
  • Who owns the company, the impact of an equity financing or issuance, and payments in connection with a company sale
• You need to understand; -Basic math for pricing a new round. -Dilution which is 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 is founder stock
• Version 2 is founder stock plus stock options

Key terminology and ubiquitous provisions for contracts

• Key aspects include: -Parties and preliminary contract -Legally enforceable agreements -Licenses -Representations and warranties and disclaimers of warranties -Covenants: promises to do/refrain; compliance with Applicable Law -Conditions, indemnification and limitations on liability, and termination -Remedies and the effect of a change of control and assignability -Governing law versus governing forum, jurisdiction, arbitration, or mediation

Minimum requirements for an enforceable contract

• Must have Legal Capacity as well as Mutual Assent (Written vs. Verbal): "Meeting of the Minds"
  • This includes a valid offer, valid acceptance, and the effect of counteroffers
• There must be a distinct Intent to Contract and Consideration (Value Exchange)
• Other areas to consider inclue authority (designated authority and board approvals) and Certainty/Clarity which is if it is against ambiguity

Drafting tips

• Draft with Specificity Unless Tactically Determined and approach it with a Journalistic Approach -Who, what, where, why, how, and when

Non-disclosure agreements

• A legal contract that establishes confidentiality obligations between the disclosing party (seller) and the receiving party (potential buyer or investor)
• It specifies the types of information considered confidential and the permissible uses of the information
• The scope of confidential information is defined by categories subject to confidentiality protection These include financial records, customer data, intellectual property, and trade secrets
• It also clarifies exclusions from confidentiality that include information already in the public domain or independently developed by the receiving party

Letters of intent

• This is a document outlining the preliminary understanding between parties involved in a transaction or negotiation
• It expresses a specific intent to enter an official legal agreement/key terms/conditions
• Sometimes called a Term Sheet or Memorandum of Understanding
• A LOI must: clearly outline the included parties, provide a description of the transaction, list key terms and the condition of confidentiality

Exclusivity letters

• Intended to enable the parties to deal exclusively for a set period of time
• This motivates parties to allocate time, money, and other resources in pursuit of a deal, which is legally enforceable
• Key considerations are: - Length of time - Automatic extension periods - Types of deals excluded - Unsolicited in-bound inquiries - Non-solicitation of employees

Commercial contracts

• 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

Licensing legal aspects

• Definition is Partial Conveyance of Ownership, Permission to Do Something and should cover: - Rights to the Source Code - Maintenance and Support - The aspect of "Sublicense" -Whether it will be Exclusive vs. Non-Exclusive, or include Partial Exclusivity -Payment Terms depending on Upfront vs. Scheduled vs. Royalties -Whether it will be Perpetual vs. Time-Based as well as Revocable vs. Irrevocable

Commercial contracts other key provisions

• Other details you should know are if it is Exclusive Dealing with terms incluing: -What it will Protects (Relatively) Free Competition (Market Share Assessment) -Assessment of Market Dynamics (Monopoly, Oligopoly, Dispersed) -Price-Fixing

Strategic contracts

• Partnerships and Joint Ventures Strategic contracts include:
  • Alliances
  • Organizational, Charter (COI), Bylaws, Shareholder Agreements
  • Compensation for Employee incentive equity with benefit Plans
  • Financing conditions and M&A Agreements,
• Key term is if it will be a Most-Favored Nation (MFN) / Best-in-Class relationship that has:
  • rights that provide parity or be less than/more favorable vs those of Third Parties. -An initial and additional fee incling a Top-Up of the Static Value

Remedies

• Remedies include Damages and Liquidated Damages Provisions and will have varying levels in different situations. Levels include: Specific Performance, Temporary Restraining Orders, Preliminary Injunction, and Permanent Injunction
• Remedies should also state who pays the attorneys Fees and other Costs of Enforcement as well as consider the statute of limitations tolled.

Employment Law 101

• Focus on contracts between employers and employees
  • What is EEO (Equal Employment Opportunity)? -What are "whistleblower" claims? -Wage and Hour -Discuss Post employment restrictive covenants -Discuss regulations as they pertain to Leave laws
• Key term is: Is “labor law" the same as "employment law?”

Employment law environment

• Employment law is regulated on multiple levels
• Regulations exist at: -Common law -Federal law -State and local law -Concurrent regulation -Federal preemption -Enforcement agencies enforce the regulations, at all levels.

The employer/employee contractual relationship

• Considerations when looking at contractual relationship includes: key terms, job descriptions, hours, compensation, and fixed terms.
• Also important are consequences to termination, how confidential info is handled, what are the rules about potential inventions, what post-employment restrictions may exist, and if there is a requirement for arbitration of disputes.

Key factors for EEO

• Equal Employment Opportunity is statutory and exempt from the “at-will” doctrine. Laws are intended to; • Protect against employment discrimination and has concurrent federal, state, and local coverage • Protect against disparate treatment and disparate impact • Protect against harassment and retaliation

Employment and antidiscrimination laws

• Historical and influential employment protection laws incluce: the 1866: Civil Rights Act, the 1935: National Labor Relations Act, the 1938: Fair Labor Standards Act. the 1963: Equal Pay Act as well as the 1964: Civil Rights Act. Other notable laws are the: 1967 Age Discrimination, 1978: Pregnancy Discrimination and 1990: Americans with Disabilities acts

What determines a fair or equal pay?

• Proof of intent to discriminate is unnecessary and focuses on the similarity of job duties
• The employer holds the burden of proof on why discrepancies in pay exist. Federal and state may handle differences depending on cases

EEO, equal pay, affirmative action, and DEI

• While “affirmative action” preferences related to protected characteristics are limited, federal contractors must ensure EEO
• DEI, which encourages civil rights and is driven by employees and ESG movements, is not a legal construct.

Whistleblower laws

• Claim coverage often has concurrent federal, state, and local regulation. In cases of an dispute, state, or federal disputes may be used.

Wage and Hour law

• Wage and Hour Law is both at a federal and a state level.
• Important aspects of Wage and Hour Laws: Minimum and maximum hours ("exempt” vs “non-exempt)
• Calculation of "regular rate" for overtime
• Some states have pay that is more complicated as well as other guidelines

Post-employment restrictive covenants

• Laws restrict state function, favoring disfavor in enforcing restraints, making it an enforceable contract if within reason

Leave laws

• Leave Laws involve Time off for specific circumstances, pay/unpaid circumstances, job protection, private right of action. The leave act is USERRA.