Getting Started Corporate Formation, Founder and Funding Considerations By: Gordon Empey, Special Co

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Getting Started - Corporate Formation, Founder
and Funding ConsiderationsBy Gordon Empey,
Special CounselCooley Godward Kronish LLP

• From Invention to Start-Up

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Legal Entity

• Considerations are
• Taxation
• Stockholder liability
• Raising investment funds
• C Corporation
• Subject to double-taxation
• Can usually only pierce the corporate veil in
  case of bad faith
• Most common structure for venture capital (VC)
  investors
• Limited Liability Company (LLC), S Corporation,
  and Partnerships
• LLCs avoid double taxation, complex operating
  agreements, higher maintenance costs (accounting,
  tax, etc.), members hold units
• S Corp file as a C Corp, but make election
  within 3.5 months, Same tax pass-through as an
  LLC, High restrictions 75 shareholders, only
  individuals, one class of stock, but easy to
  convert to C Corp

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State of Incorporation

• Delaware
• Well-developed body of law historically
  favorable to company, directors and management
  team
• More expensive franchise fees
• Favored by many investors
• Washington
• Less clarity on certain corporate issues because
  less developed body of law
• Some arcane features originals for filings,
  appraisal rights
• Less expensive

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Roles in the Company

• Board of Directors
• Ultimate power and duty to manage this business
  of the company
• Fiduciary duties (care and loyalty)
• Committees (Audit, Compensation, Special)
• Tasks and functions delegated by Board of
  Directors
• Management
• Day-to-day responsibility for running the Company
• Ultimately responsible to the Board of Directors
• Stockholders
• Responsible for final decision of key corporate
  events
• Advisory Board
• For benefit of management

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Typical Organizational Documents

• Appointment of Directors and Officers
• Bylaws
• Powers responsibilities of officers and
  directors
• Meeting procedures
• Indemnification obligations of the Company
• Certificate of Incorporation
• Number and class of stock authorized
• Stock Plan
• Proprietary Information and Invention Assignment
  Agreement (PIIA)

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Licensing in the Technology

• Option to license prior to Series A funding.
• Key terms of Option
• Option Fee
• Term of Option
• Exclusivity
• Territory
• Fields of Use
• Up-Front Consideration
• Annual Maintenance Fee
• Equity
• Royalty (both for products and services)
• Minimum Annual Royalty Amount
• Sublicensing Consideration
• Performance Milestones
• Financial Milestones (filing IND, first dosing in
  Phase II, NDA, FDA approval, Other county
  approval)
• Patent Prosecution reimbursement

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Founders Stock Issuances

• Common Stock Purchase Agreement
• Stock subject to vesting 4 years typical
• Restrictions on Transfer
• Drag-Along Rights

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Employment Agreement Terms

• Usually entered in connection with funding
• Salary
• Stock Subject to Vesting
• At-Will
• Protect Equity Termination or Change of Control
• Severance
• Venture Capital Mentality

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Issuing Stock or Debt

• Should be approved by the Board of Directors
  written record
• Fully-executed document
• Securities laws compliance need exemption from
  registration
• Accredited investors
• Finders/Brokers
• Issuing options to employees written valuations
  (409A)
• Dont promise equity to anyone

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Sample Capitalization TablePre-Series A
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Bridge Financings

• Convertible Notes
• Convert in Next Equity Financing
• Interest
• Warrants
• Percentage Coverage, Exercise Price
• Avoids Valuation, Gets Seed Money

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Valuation for Financings

• Pre vs. Post-Money
• Sample Cap Table - 7M Pre-money 0.70 per
  share
• Milestones/Tranches for Large Investments

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Sample Capitalization TablePost-Series A 7M
Pre-Money, Raise 5M
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Terms of Series A Preferred Stock

• Liquidation Preference
• Money off the top
• Participation
• Cap on participation
• Anti-Dilution
• Redemption
• Protective Voting Provisions
• Board Seats
• Pro Rata Rights
• Information Rights
• Registration Rights

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Series A Process

• 4-6 weeks from signed term sheet
• Draft and negotiate key agreements
• Series A Purchase Agreement
• Amend and Restate the Certificate of
  Incorporation
• Investor Rights Agreement
• Voting Agreement
• Registration Rights Agreement
• Due Diligence (IP, capitalization, materials
  agreements, founder deals, corporate formalities)
• Obtain board and shareholder approvals
• Third Party consents

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Summary

• The Three Fs
• Formation
• Founders
• Funding