My firm has decided to start accepting payment via bitcoin. We had our first bitcoin transaction yesterday from a client that just so happens to be in the bitcoin space. The firm decided to go with Coinbase as our “international digital wallet”.
The firm made the decision to accept bitcoin since we represent tech savvy individuals and entities, many of which are international clients. International wires tend to have transactions costs and sometimes take too long. Of course, there is an exchange rate risk, but we like to think we’re at least half as risk-loving compared to our clients.
Many founders choose to maintain a full-time job (i.e., “day job”) during the initial stages of their startup, whether or not the startup is incorporated. This is a common way to self-fund or otherwise hedge prior to a friends & family or seed round.
If in the technology field, however, a day job likely requires their employees to sign an invention assignment in conjunction with or as part of their employment agreement. In a nutshell, the invention assignment defines parameters that an employee assigns intellectual property to its employer. Some invention assignments are broad while others are very narrow in scope. Certain jurisdictions like California place boundaries on how broad employers can make their invention assignment.
The broader the scope of the invention assignment, the greater the potential problem for the founder and his or her startup, as the founder may be unknowingly assigning intellectual property to the day job rather than the startup. If the startup or the technology involved is in any way related to the day job, the risk of such an assignment increases.
Thus, it is very important that startup founders who choose to maintain a day job first locate their employment contract and then look closely at applicable invention assignment. Determine under what parameters intellectual property is being assigned to the day job. Founders should at least be aware of the scope of any applicable invention assignment – even if their startup is a completely different product or service relative to their day job.
In conversation at various startup events, I hear a common but potential misconception relating to “control” and the board of directors. For example, I often overhear “it’s great that the founders only had to give up 1 board seat, so they still retain control of the board/company.” But board composition is not necessarily the sole determinant of control, as certain mechanisms can erode or supersede the traditional majority rules formula of control.
Beginning at a significant seed round, it is not uncommon for an investor to require certain elements of control, in addition to a board seat. For example, they may require that in order for a certain corporate action to be approved, a specified board member such as the board member appointed by the investor, must approve such action (in addition to a majority vote of the board). This can allow an investor, through their board seat, to maintain control over specified matters while possessing a minority of the board seats. Additionally, certain corporate actions may require approval of certain a class or series of a startup’s stock (in addition to a majority vote of the board).
Alternatively, and rarely, a startup may set up a board structure that gives certain directors more than 1 vote per seat. Thus, one person on a three-person board could ‘control’ the board if they were given enough votes for their board seat. This is another instance of control being retained by a minority of the board in terms of the numbers. (Note: I don’t recommend startups start working this mechanism into their docs.)
A startup needs to look closely and understand each and every control aspect of a deal, as it could be giving up only one board seat in absolute terms but effectively relinquishing control if there are certain strings attached to the investment. The founders should know exactly how much control they are losing — and that it is not always determined solely by the number of board seats.
I thought I would expand upon and update my “If I Launched a Startup” post from 2010 to include recent issues such as incubators and crowdfunding.
So in 2014, here’s what I’d do in the beginning:
(1) When: As soon as I was serious about making my startup a business, but after I checked my current job’s employment contract
(2) Type of Legal Entity: C Corporation, and not an S Corporation or LLC
(3) State of Incorporation: Delaware (since I’m at least potentially looking to raise capital)
(4) Authorized Shares in Certificate of Incorporation: 10,000,000 shares of Common Stock
(5) Par Value of Common Stock: $0.00001 per share
(6) Aggregate Stock Issuance to the Initial Founders: 6,000,000 shares
(7) Founders Equity Split: Depends on the Team, But Quickly but only after the Difficult Conversation(s)
(8) Vesting For All Founders?: Heck yeah
(9) Vesting Schedule: 4 years with a 1-year Cliff with Double-trigger Acceleration
(10) Payment for Founders’ Shares: Cash and Intellectual Property
(11) Handling of “Lost Founders”: Get an Assignment and/or Release (then wish them well)
(12) Freak-Out on My Lawyer When I get My Delaware Franchise Tax Bill?: No
Incubators, Mentors, Advisors and Developers
(1) Choosing an Incubator: It’s all about the mentorship
(2) Incubator Funding Documents: Easy and Light
(3) Strike a Deal with a Mentor During the Incubator Program?: Probably not
(4) Raise a Round Before Demo Day?: No, wait until after…unless it’s a great Series A.
(5) Option Grant Size to an Advisor: 0.10% to 0.50%, but only after execution of an Advisor Agreement
(6) Outsource all Technical Development?: No
(1) Length of Investor NDA: 0 pages
(2) Fees Paid to Pitch: $0
(3) Investors: Accredited only (no crowdfunding until the rules are easier on startups)
(4) Seed Round Structure: Convertible Notes
(5) Convertible Note Incentive: Discount and Price Cap, but with a liquidation preference regulator.
(6) Convertible Note Interest: 2-8%, but hopefully 2%
(7) When to Hold Closing: On a Rolling Basis
(8) First Purchase after Closing: A Legit Scanner
Best of luck to you in 2014!
I typically advise issuing 50% to 80% of the authorized shares of Common Stock to the initial founders upon incorporation.
Thus, if the certificate of incorporation authorizes 10,000,000 shares of Common Stock, an aggregate of 5,000,000 to 8,000,000 share should be issued at incorporation.
If the startup plans to bring on additional founders in the very near future, or for some reason wants a large option pool, then that initial number should be closer to 50% than 80%.
While your startup can always authorize additional common stock (upon appropriate board and stockholder consent), keeping a good-sized reserve of unissued, but authorized shares means that you will not have to incur the transaction costs associated with increasing the authorized shares. In order to increase the authorized shares, your startup will have to file a certificate of amendment with the secretary of state which has filing fees associated with it.
At the time a startup compensates an advisor with incentive equity, it is best practice to also have a written agreement typically called an “Advisor Agreement” or “Advisor Letter” in place to protect the startup. The Advisor Agreement also has the side benefit of managing expectations on both sides.
A typical Advisor Agreement defines the startup-advisor relationship. For example, the Advisor Agreement will typically set forth the advisor’s incentive equity amount and type (i.e. options or restricted stock grant) and a vesting schedule. (Note that the Advisor Agreement is not a substitute for the Stock Option Agreement or Stock Grant Agreement.) More importantly, the Advisor Agreement should include, or have attached, various terms and conditions.
The protection of confidential information should be addressed. To be useful as an advisor, they will have to know all about your startup including some or all of the confidential information and/or technology you may have. Advisors aren’t in the business of divulging confidential information, but worst case scenario you will have an agreement in place and set the expectation that your startup’s confidential information is not to be disclosed or used for any other purpose. This type of clause is usually non-negotiable, except maybe for the duration of the obligation. Meaning, if a potential advisor will not agree to the confidential information clause, it’s time to let that ship sail and find a new advisor.
Another essential issue relates to the assignment of intellectual property. While all startup employees should be party to an inventions assignment, the inventions assignment provision in an Advisor Agreement should likely be ‘narrower’ than a typical employee’s inventions assignment clause. And in some cases, it may be deleted.
One asset that startups should consider taking advantage of is advisors. Luckily for startups, advisors are prevalent and can be readily found through incubators, networking and/or personal contacts. The best advisors are in it to pay it forward or give back to the startup community.
If you want to take a very informal advisor relationship to the next level, your startup should consider granting incentive equity to the advisor. Most often, this incentive equity is given in the form of stock options (but can be an outright stock grant).
The usual range for an advisor grant is the 0.10% to 0.50% range of the startup’s fully-diluted capitalization. The most common size of the grant is 0.25% and vesting is usually over 1 or 2 years, monthly, and without a cliff.
Some entrepreneurs are stingy with their equity, and understandably so, but advisors are generally worth the price. Though, obviously, an incentive equity grant and this relationship should not be entered into lightly — do your diligence on the advisor. At the end of the day, these incentive equity grants are typically very small and the return can potentially be very large.
On January 22, 2014, my law firm is putting on a seminar on the topic of Convertible Notes. I will be the presenter and will discuss topics such as the pros and cons of a convertible debt round to specific terms and structural tactics.
The seminar is free for entrepreneurs (and investors) and will be held from 6:30pm to 7:45pm at The Grove, a coworking and collaborative space in Dallas.
Click here to register or find out more information about the seminar
As of right now, we do not plan to stream this seminar but are looking into doing so for future seminars.
When your startup goes through due diligence for an investment round or an exit, investor’s or buyer’s legal counsel will typically send a laundry list of document requests. These documents range from the startup’s bylaws to stock option agreements to third party contracts to prior financing documents.
Quite often, these diligence materials are not readily available and/or can be difficult to track down. Or, only pieces of documents can be found (e.g, a signature page rather than the full document).
This leads to “corporate cleanup” which is ultimately a time consuming and expensive process. Most of this time and expense can be prevented with the use of a quality scanner. (In our experience, online signature services are only good for a one-off contract.)
Good scanners today won’t wreck your burn rate. For example, the fujitsu line of scanners like the iX500 can usually be found in the $420 to $495 range. We have a fujitsu here as a backup scanner to our large Bizhub.
If your startup raises a round in the low six figures or more, it should purchase a scanner soon after the wire comes through. It will save time and money down the road.
There will never be a single standard set of financing documents, whether for seed or venture capital rounds. And interestingly, the variance in documents increases as the deals get smaller.
The closest to a standard set is the NVCA forms, but those are for larger Series A/B/C type rounds. Regardless, it seems like each firm (or fund) has their own set of custom docs based on the current and/or prior versions of the NVCA forms. So while there is general consensus to use the NVCA docs for large investments, deviations still occur.
For seed financings, there are about 4 standard sets of documents. The people and entities that put out these standard seed financing documents have done a great job balancing the interests of company and investor at a seed financing. Yet there always seems to be changes that deviate from the ‘standard’ — whether at the request of the company or investors.
Where it really gets crazy is at the incubator level. Incubator documents and terms vary greatly. Convertible Security, Common Stock, Preferred Stock, Convertible Note + Common Stock, Non-Dilution, Option Pool, no Option pool, etc. You would think that a ‘standard’ incubator set would be much easier to develop and become the norm.
Most probably want to blame the lawyers for not having standard documents (hey, why not!), but it seems like a lot of investors have different preferences which dictate changes to ‘standard’ documents.