Legal Issues and Valley Trends

Financing Issues – Getting Your Money

Capital Issues – Spending Your Money

Formation Issues – Saving Your Money

FINANCING ISSUES

1. More Bridge Financings

2. Tougher Financing Terms

More Bridge Financings• Typically cheaper than a full-blown financing• Can close on funds without establishing a valuation•  Difficulty in raising funds (especially follow-on financings)• Can create value before seeking VC Funding• Company pays a risk premium to the Note Holders (up to 35-

40%)a. Warrants – defer dilution and no cheap stock issueb. Discounting – results in immediate dilution and

possible cheap stock issue 

Tougher Financing Terms

• Ratchet Provisions – up to 24 months! a. Historically for high risk companies.

b. Undesirable – causes significant dilution , which demotivates management team and deters

new investors

•  Two Traunch Dealsa. To change deal valuation – increase shares if

milestones not hitb. To reduce amount of initial investment until performance

Tougher Financing Terms cont’d

• Liquidation Preference

a. Used to be 1X, with variations

b. Now 3X is typical (with prejudice to earlier preferred

shareholders (e.g., 1X to B, 1X to A, participate

Common and B only)

Tougher Financing Terms cont’d

Indemnity• Investors want to be indemnified if Company breaches

Reps and Warranties.• Purpose – give investors alternate venue and Cause of

Action other than Securities Law • Does not make sense in equity deals

a. “Double Dipping”b. Unlimited risk to Company

c. Investors paying legal fees out of their own pockets (e.g., funds paid to Company)

Tougher Financing Terms cont’d

• Shares to Investors on Board

a. Historically not given to VCs because own substantial

equity in company

b. Many VC funds have side funds for individuals and

employees and insist on shares for board service –

same as granted to other directors

CAPITAL ISSUES

1. Valuations

2. Finder’s Fees

3. Legal Fees

Valuations

• Financings: decrease in valuations by 50%

• Compromises

a. Performance-based measures, such as two tranche deals and milestones

b. Greater down-side protection, such as

limited ratchet, greater liquidation

preference

c. Do more frequent financings – less money = less

dilution until create greater value

Finder’s Fees

• Finder’s Fees: Harder to raise money means higher feesa. Lehman’s Formula outdatedb. Range: 5% fixed up to 10% fixed, plus warrant

coveragec. Exclusive vs. Non-Exclusive arrangements

i. Exclusive can be more effective, but tie fees to performance only (no up-front fees) ii. Set firm time limit on exclusivityiii. Get references from Finderiv. Limit exclusivity to funds found by Finder, not by Company sources – Ideally, list.

Legal Fees

• Legal Fees: Equity to Attorneys

a. Historically, 2% or more was standard

b. Now, with market correction 1% is standard

i. Vest it over a reasonable term (e.g., 12 months)

ii. Negotiate discount in fees for stock

iii. Grant in exchange for deferred fees

FORMATION ISSUES

1. Incorporate in Delaware

2. Protect Intellectual Property

3. Address Acceleration Issues

4. Keep Capital Structure Clean

Incorporate in DE rather than CA

• Much easier to get filings done (e.g., fax signatures)• Much quicker response time (e.g., same day

service for amendment to Charter) • Cheaper – expedited service in CA = $300• Pre-approved filings: 4 hours, but cost $350• More flexible and “corporation friendly” (e.g.,

unwind merger – CA: court proceeding; DE:simple filing)

• Likely to end up in Delaware if acquired by apublic company, or if IPO

Protect Intellectual Property

• Proprietary Information Assignment Agreements for

EVERYONE, even founders

• Patent, trademark and copyright protection – Steve

Weinberg will discuss

Address Acceleration Issues Up Front

• Carefully define “without cause”

• Clarify “double trigger”

• Balance protection from outside ousting (e.g., investors)

vs. inside ousting (e.g., management team)

• Don’t jeopardize acquisition opportunities by permitting across-the-board acceleration

Keep Capital Structure Clean

• Initially, permit attorneys to keep cap. table – work with one in-house designee

• Hold board meetings regularly (at least 4x per year) and insist on capitalization being clean for each

board meeting• File form 25102(o) for option plan – and each increase – to save cost of permit application and

rescission offer• Make sure founders pay for stock to avoid issues if

depart• Make sure 83(b) elections filed, because can’t cure