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Angel Financing: 4 Things Startups Must Know

In Entrepreneurs and Social Media, Technology Issues and the Law on July 2012 at 8:44 pm
 Angel financing is loosely defined, as it runs the gamut in terms of executions.  We’ve seen angels simply hand a check to a startup; while other angels hire aggressive large law firms with armies of associates working on an angel financing round.

Because the experience with angel financing can vary, it’s important for startups and entrepreneurs to understand some of the basic legalities behind this type of financing.  Below are 4 tips as a starting point.

(1) Understand the Key Business Terms. This is not an option, it’s a necessity in any financing round.  Just because an investor is called an angel does not mean they represent those famed characteristics completely.  For a preferred stock financing (this is most likely to occur when there is an aggressive large law firm behind the angel in a deal) key business terms include:  (1) pre-money valuation; (2) liquidation preference terms; (3) anti-dilution provisions; (4)Board composition; (5) dividend-related issues; (6) vesting imposition on founders’ shares; (7) protective provisions.  Take the time and learn the terms; grab a book or talk to your attorney.  Of course, having a corporate attorney versed in startup financing will be a great help here, but it’s in your best interest to have at least a base knowledge of the business terms.

(2) Push for Convertible Notes. For startups raising less than $800,000, its generally not in the entrepreneur’s best interest to issue equity in terms of preferred stock.  In fact, the entrepreneur is best served by issuing convertible notes, not equity, to angel investors.  First, issuance of preferred stock is costly, complicated and time-intensive.  It involves company valuation and potentially high-dilution for startup founders.  At the initial stages of your company, that’s not what you want.  In contrast, a convertible note would allow the angel to loan the money to the startup, with automatic conversion into equity after the first institutional funding round (Series A).  The convertible note allows the startup to keep their costs low, and defer costly valuation to a larger funding round.  If an angel insists on equity at the outset, push for issuance of common stock – which places the founders and the angel in the same boat – and try to avoid preferred stock.

(3) Never accept terms with personal liability.  It seems common-sense that founders should not be personally liable to angel investors if their company fails (barring fraud of course).  However, it’s a mistake that is commonly made by inexperience startups and entrepreneurs.  There are also inexperienced business attorneys (that don’t work in the startup world) who will request that founders personally take on certain personal liabilities.  Make sure your ready to drop a deal if they are pushing for personal warranties of any kind; and have your owncounsel so they can push back on such terms.  The tip here is simple:  never agree to potential personal liability.  It’s not worth it.  And it tells you something about the angel as well; every sophisticated investor knows that angel investing is high-risk, high-reward.

(4) Due Diligence on the Angel.  The hardest thing to do when someone across the table wants to write you a check that can breath life into your idea is to step back, take a moment and think “why are they handing me this money?”  Themost common mistake entrepreneurs make in these financing deals is the failure to investigate the person(s) offering to give them money.  The angel isn’t just in the picture for the moment of handing over a check; he or she is essentially married to your company for years to come.  Check references, see what else they  have invested in, and talk to those startups as well.  Make an informed decision as to whether this angel is the right type of investor for your company.  You don’t want to end up with an angel who is a controlling jerk with a bad reputation in the investment world; it could have an impact on future investments, and the future of your company.

For more information on startup legal services, email us at sardar@sardarlawfirm.com or join us for a class taught by Benish Shah and Sheheryar Sardar.

Upcoming Classes:

Pitching Your Company: Hands On Workshop (July 25 7:30-9:00) – Register HERE 

What past students have said:

“Great personalized and relevant advice! Made me and my partner see things in a whole new way. ” – Mike Abadi

Fundamentals of a Startup (August 1 & 8 7:30-9:00 pm) – Register HERE

What past students have said about this class:

Benish and Sheheryar provided many useful insights about the startup world and launching a company. I thought I knew the best way to launch before the class, but they helped fill in the gaps in my knowledge about forming a corporation, raising capital, and other various legal considerations. Highly recommended.” – Chris Macke 

“This is a great class to understand the basics of how to establish and grow a startup from the legal/investment perspectiveBenish and Sheheryar are both passionate about the startup world and are able to provide an angle that most entrepreneurs would not naturally consider.” – Ashek Ahmed

Great breakdown of legal advice for a startup– the information was personalized, relatable and clearly presented. My partner and I expected to walk away confused, but we left knowing the right moves for our business.” – Sisi Recht

 

via Angel Financing: 4 Things Startups Must Know on Corporate Counsel NY

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VC Financing for Startups: Understanding Cost Drivers

In Entrepreneurs and Social Media, Technology Issues and the Law on July 2012 at 4:09 pm

There has been a lot of debate on the legal costs associated with financing rounds for startups.  Fred Wilson’s challenge to startup lawyers called for legal costs to be reduced to $5,000.00 for a seed financing round.   The issue, brought up by many lawyers is this: (1) large firms are not going to drop their rates from $17k+ to $5k because their costs are too high based on the army of associates working on each piece of the matter; (2) startup focused firms aren’t well known enough to VCs but they could get the work done in between $5K-$10k because they are lean and understand the startup world because they themselves are startups.

To understand what drives legal fees (aside from an army of associates) during a financing round, it’s important for startups, especially those going through their first few rounds, to understand why a transaction costs more than a few hundred dollars.  It’s also important to understand why choosing a firm that’s a good fit for a startup matters in these rounds.

Leveraging Knowledge 

Few things can hurt a startup more than a vague or hurried term sheet that will result in increased costs down the road.  To avoid these problems, smart entrepreneurs and investors involve counsel early on in the term sheet process to make it as smooth as possible.  For entrepreneurs, they need to understand that aVC’s counsel is not the startup’s counsel and that they absolutely need their own counsel as well. It’s like buying an insurance policy that will cost your startup much less than potential future problems stemming from vague term sheets.

Involving attorneys from the get go also allows lawyers to provide increased value-add through market knowledgeentrepreneurs and investors can leverage that knowledge and experience for their own benefit.  For startups, they can also discuss with their lawyers what is “normal” or “market-value” and what safeguards they should be pushing for, and what they can be more lenient on.  Lawyers have a knack for seeing what can cause a potentially massive lawsuit down the road, but clients need to involve them early on to leverage such knowledge.

Understanding Due Diligence

In most funding rounds, costs start increasing due to due diligence required by investors before a deal is closed.  This means due diligence on the following (if not more) subjects:

(1) Litigation Diligence:  Investors want to ensure that there are no pending or threatened suits against the startup that could materially reduce its value  (they cannot just take your word on this).

(2) Tax and Liability Diligence: Investors need assurance that the startup is up to date on all taxes and potential obligations.

(3) IP Diligence:  The assurance that each IP the startup claims as its own really belongs to the startup and not anyone else. This also includes review of whether there are any open source or similar issues, that all former/current employees/consultants/contractors/founders have legally and properly assigned rights to any IP to the startup, and if reverse vesting of common stock held by key employees is necessary.

(4) Employee Diligence: Ensuring that employees/contractors/consultants/founders have signed properly drafted non-compete, non-disclosure and non-solicitation agreements.  Also ensuring thatemployees & contractors are properly classified to avoid potential liabilities.  

(5) Corporate Governance Diligence:  Investors want to ensure that theentity is properly formed and corporate governance matters have been properly followed (i.e. startup’s corporate records must be in order; if they are not, lawyers and the startup must go into overdrive conducting a “cleanup” to ensure that everything is up to date, properly documented, and ready for inspection – this can add significant costs and often can be delay, or kill, a deal closing).

(6) Stock Option Diligence: Legal diligence to ensure that all stock option grants were properly approved and 409A compliant; this may also result in a change to the price per share if contemplated on a “pre-money valuation” basis.

(There are more aspects that can drive up the costs, but those listed above can be some of the most time-consuming).

Setting a Cap

Anytime a startup (or an investor) hires counsel, they should ask for a cap on the legal fees; SLF works to ensure that in closing deals such as early financing rounds, our legal bill comes under the cap, however other firms have been known to bill at the cap regardless of complexity or simplicity of the deal.

If an attorney or firm does not want to talk in terms of a cap on the legal fee, it may be prudent to search around a little more.

For more information on startup legal services, email us at sardar@sardarlawfirm.com or join us for a class taught by Benish Shah and Sheheryar Sardar.

Originally published in Corporate Counsel NY (republished with permission)

Are Twitter Followers a “Client List” – and Who Owns the Account?

In Social Media on July 2012 at 5:55 pm

When you start tweeting as part of your corporate position, the lines between what is a personal Twitter account and one made for business purposes is blurred – especially in the world of startups, new ventures, and media companies.  What happens when you leave the company?  Who has ownership rights over the Twitter account – the company, or the employee?

Recently, PhoneDog Media LLC sued former employee Noah Kravitz over exactly this.  Noah Kravitz, while employed by PhoneDog, tweeted under the name “Phonedog_Noah” and upon his departure from the company, Kravitz was allegedly given the rights to keep the Twitter account in exchange for occasional tweets about PhoneDog.  However, Kravitz switched his Twitter handle from “PhoneDog_Noah” to “NoahKravitz” while keep the followers and the good will from the initial Twitter handle.

Under the new Twitter handle, Kravitz increased his Twitter followers from 17,000 to 20,000.  Eight months later, PhoneDog sued Kravitz claiming that those Twitter followers were in fact a proprietary client list, claiming damages of $2.50 per month, per follower – totaling to about $340,000.00 USD.

The question, of course, is whether Twitter followers are in fact proprietary or if they can be considered company property.  This leads to the question: who owns a Twitter account?

Many businesses utilize social media to increase brand awareness, and many employees – especially rainmakers – utilize their personal Twitter accounts to help generate business for their employer.  Since Twitter is not a paid service, the lines are blurred as to who owns the account, especially when the Tweets are related to building business in some manner.

Regardless of the outcome of this case, companies should take steps to develop a written Twitter use policy, establishing the use of Twitter handles for company use.

A few questions employers should pose internally regarding Twitter use:

(1)  If an employee tweets during the work day as part of his/her job description, is that Twitter handle now owned by the company?

(2) Was the Twitter handle created by the employee before joining the company, or after joining the company, and for what purpose?

(3) Were any company resources spent/utilized in the creation and/or use of the Twitter handle?

(4) Can employers restrict/monitor what the employee Tweets about?

(5) Was this a personal Twitter handle that the employee was using for business purposes at the request of the company – and if so, how much of that really “belongs” to the company as opposed to the employee?

(6) Is this something that should discussed and incorporated into an agreement at the outset, or upon the separation of the employee from the company?

For employees, the question comes down to this: how to ensure that their Twitter handle is separate from their employment.  Many journalists face this problem, as they do list in their Twitter accounts where they work, and they also post articles they have written.  While their accounts are personal, there is a clear business crossover.  For some, they put a clear disclaimer in their profile that this is not a company account and is personal; for others, the lines are blurred.  It remains to be seen how and if a disclaimer would be valid in these situations.

The main thing to try and avoid is a “he-said-she-said” battle in the court systems; from both the employer and employee sides.

Originally published in Corporate Counsel NY.

by: Sheheryar Sardar, Esq. & Benish Shah, Esq.Sardar Law Firm LLC

For more information on social media law, contact: Sardar Law Firm at sardar@sardarlawfirm.com.

Follow Sardar Law Firm on Twitter @CorpCounselNYC

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Personal Liability of Corporate Shareholders

In Entrepreneurs and Social Media on July 2012 at 6:42 pm
 Originally published in Corporate Counsel NY.

It’s a little known fact (especially in the startup world) that New York privately held corporations can hold the top 10 shareholders of such corporations personally liable for any unpaid compensation to the corporation’s employees.

The reason for this is that incorporation does not offer absolute protection to the business owners; otherwise the situation would be one of the wild wild west, and the legal profession does not look too fondly on that.  There are sound exceptions to the protections of incorporations, and one of them is that 10 of the largest shareholders of a privately held corporation may be held personally liable for unpaid compensation.

Main Points

Here are 5 key things to note about this exception (found in Section 630(a) of New York Business Corporation Law):

(1) Corporations only.  The law applies only to privately held corporations; this does not include LLCs or investment companies.

(2) All compensation.  Wages and all other types of monetary compensation are within the purview of this exception, including, but not limited to: severance pay, pension or annuity funds, vacation pay, overtime, and/or contributions to insurance or welfare benefits.

(3) Employees, not contractors.  Only employees are covered, notindependent contractors (there is a critical distinction here, see also: Employee Misclassification Can Cost You).

(4) Joint and several liability.  There is joint and several liability amongst the shareholders, allowing the employees to go after only one of the shareholders (likely with the deepest pockets) for the whole amount owed.  The shareholder then can seek pro rata contributions from the other largest shareholders.  

(5) Strict procedure.  Employees need to first attempt to recover unpaid compensation from the corporation; if the judgment remains unsatisfied, then they move towards the shareholders. (There is a procedure that employees must follow, including a written notice under Section 630(a)).

Escape Clause?

This rule applies only to companies that were… click HERE for the remainder of the article.

By:  Benish Shah
Sardar Law Firm LLC
New York, New York
Core Practice Areas:  Fashion/Retail, E-commerce, Commercial Litigation, Art Law, Startup Law, Social Media, Mergers & Acquisitions, and Corporate & General Counsel
Contact us at bshah [at] sardarlawfirm [.] com