Over the last few months I have had the chance to speak to entrepreneurs from Brazil, China, Estonia, France, Germany, Guatemala, Israel, Norway, Singapore and Ukraine seeking to operate and solicit investment here in the U.S. As an attorney, I’m expected to focus on best legal practices. They’re indeed important, but perhaps not worth quite so much energy if the company isn’t on a course to succeed as a business.
Among my first questions, I’m curious to know what a company has, why it’s great, who’s willing to pay, and how much. Then, I explore other challenges facing the business.
For start-up companies that still want to talk, here’s my simplified rundown of business and legal items (for information purposes only, not legal advice):
- Structure – An LLC can be customized, but such customizations are labor intensive to maintain. VCs typically prefer a C-Corp, which easily accommodates multiple classes of stock and stock option plans. Avoid one-off or undocumented investments or other arrangements and track debt conversion triggers, dilution and liquidation preferences. Companies with an offshore presence indeed need to consult a tax expert early.
- Jurisdiction – Delaware, with a deep body of predictable law and sophisticated courts, continues to be the most popular U.S. jurisdiction in which to incorporate. It doesn’t mean that you’ll actually operate the business there.
- Founders Agreement – Founders should agree on assigning their inventions to the company, stock vesting schedules, restrictions on stock transfer, and non-compete/non-solicit covenants.
- Intellectual Property Protection – IP protected by contract (NDA, founder agreement, employee inventions assignments) or registration is a key vehicle for staking out a market position and attracting investment. File patents (useful, non-obvious inventions/designs), copyrights (original works of authorship fixed in a tangible medium) and trademarks (identifying words, names, symbols, slogans, sounds, smells, devices), all in a timely manner. Maintain the secrecy of trade secrets. Know which written code is proprietary or subject to open source requirements. Maintain valid licenses for critical inputs. Technology transfer arrangements usually must satisfy funding and R&D milestones and should allow the company to maintain ownership of improvements to the base technology.
- Record Keeping – If a company has successfully broken into the market and attracted the attention of financers or a strategic partner, the last thing it wants is a due diligence process that stalls because records are in disarray. Keep track of required corporate filings, board authorizations for major corporate actions, the nature and length of warranties, the circumstances under which ‘unlimited liability’ applies, restrictions on assignment, unusual employment/severance arrangements, and which users have clicked on which version of online terms.
- Compliance Program – Entrepreneurs are often afraid of compromising the family-like culture of a young business, but taking compliance seriously may save the company and has the added benefit of showing credibility with investors. Get buy-in early with a handbook and framework to address confidentiality, data privacy, document retention, cyber breach response, harassment, code of ethics, foreign corrupt practices, and training. For internal controls, begin with contract approval and signature processes as well as mechanisms for employee feedback relating to revenue. Track contract amendments, product changes, and dealings with regulators.
- Securities Laws – Issuances of a share of stock, limited liability company or limited partnership interest, an option, or other security in the U.S. are typically subject to federal and state regulation imposing registration and disclosure requirements for the offering, including a description of investment risks and containing, among other things, audited financial statements. Certain exemptions from these regulations may be available, including under the Regulation D safe harbor where private placements can be made to accredited investors (who may be better able to accept the associated risk) and a limited number of other investors, either with or without public solicitation. In addition, Regulation Crowdfunding, adopted by the U.S. Securities and Exchange Commission in 2015, is designed to permit limited capital raises of up to $1 million with relaxed restrictions on solicitation and financial wherewithal of investors, but still imposes various disclosure and audit requirements. While this model is still being tested in the market and courtroom, it is possible to raise investment capital from an online non-equity crowdfunding campaign! Compliance with any of these securities laws alternatives is complicated, and those involved may be required to be properly registered under various provisions such as broker-dealer or advisory laws.
- Employment– Avoid incorrectly classifying an employee as an “independent contractor,” which is often narrowly defined as someone who provides services outside of the company’s usual course of business. Employees must be paid in accordance with local laws.
- U.S. Focus– To allay concerns that some domestic investors have, consider whether to incorporate here, develop here, license here, protect IP here, find expert advisers here, partner here, sell here or otherwise be here.
- Show Traction– It is customary to provide to investors a 1 – 2 page executive summary of the company’s business plans, as well as a more detailed “slide” presentation. They should describe your company’s product or service. How does it fit within industry trends? Who in the market will pay for it, and how will it get to them? Why is the company well positioned to maximize the available opportunity? Companies must show through team building, partner relationships, IP filings, validation of data, customer testimonials, an advisory board, revenue or otherwise that they are on a “de-risking” course that is both systematic and productive. Describe the development, manufacturing, hiring, marketing, or sales that can reasonably be accomplished with the financing sought. Together with an identification of assumptions and risks, explain plans to scale and plot the projected revenue and break-even point.
* * *
Development life cycles, available investor exits, market-specific risks, competitive landscape, and other variables make each circumstance different. At some fitting point, counsel from an attorney with a good dose of business savvy is certainly recommended.