Here is an interesting post by Chris Dixon on options. Well worth the read. Having said that, I don't change my advice to the effect that the option grant (and the offer letter or whatever) needs to state the number of shares that can be acquired with the option. If you want to elaborate on that and state that such number represents thus and such a percentage of the company's outstanding shares on a particular day -- fine.
For the most part, the startup companies we represent fit into the tech category in one flavor or other, whether its internet, mobile, cleantech, life sciences, etc. But like the VCs, we follow the entrepreneurs. So despite Foley Hoag not being a Hollywood power house, when a great entrepreneur, Marc Fienberg, had the crazy idea that despite having no Hollywood connections he was going to take a script he wrote and somehow manage to start his own production company, raise the money needed to produce the film himself as a first time writer/director/producer, attract top actors and actresses and actually make it happen, I happily signed on. The culmination of all that happens this weekend when Play the Game, starring Andy Griffith, Paul Campbell, Liz Sheridan, Doris Roberts and Marla Sokolov opens in select cities nationwide today, August 28, including in the Boston area (Kendall Square, West Newton and South Dennis). I had no idea how long it would take and how much fun it would be along the way...
83(b) elections seem simple but can be tricky. The general rule is that the recipient of restricted stock (stock subject to vesting) has 30 days from the date of issuance of the stock to file her 83(b) election. Unfortunately, ambiguity often creeps in. For example, what if you sign the contract for the restricted stock on day 1 but the stock is not issued until day 10? What happens if the stock is issued without restriction on day 1 and restrictions are imposed (that is a contract providing for vesting is entered into) by an investor on day 2? And is the result different if the restrictions are imposed on day 15? Day 30? Day 365? Often facts intervene to make life complicated. You need to talk to your accountant, lawyer or tax professional to make sure you get it right. The consequences of getting it wrong can be really unpleasant.
Issues around the dating of stock certificates do not often come up because they are usually prepared for a closing or a specific transfer and the dating is clear. But, sometimes for a number of possible reasons, time passes and stock certificates need to be prepared for transfers that occurred some time in the past. Our firm’s practice, and I believe the practice of most firms is to date the stock certificate when it is prepared by the paralegal or secretary who makes up the certificate itself. Our view is that anything else may lead to confusion in the stock records of the company and that the date on the certificate does not control things like the determination of the holding period for tax purposes. A common problem with backdating (holding aside any discussion of fraudulent behavior) is that if there are other intervening issuances, the company could end up with a stock certificate bearing a later number in the sequence of certificates in the ledger having an earlier issue date than a stock certificate with an earlier number in the sequence ledger. This is a very bad idea since it is likely to cast doubt upon the accuracy of the stock ledger.
I ran into an entrepreneur that I know pretty well at a social gathering. As is often the case, the conversation turned to capital raising. It turns out that he has raised several hundred thousand dollars of "growth" capital through a loan from brokerage house. As I understand it the entrepreneur went to a number of wealth individuals and convinced them to open trading accounts at the brokerage house and use the securities in the account to collateralize/guarantee a loan to the entrepreneur’s company (in effect a margin loan with the proceeds being used to fund the business). In consideration of this loan, the company is doing two things: (1) it is paying the carrying cost (interest charged by the brokerage house) and (2) it issued some warrants to purchase common stock to the investors (the guarantors of the margin loan). As I understand it, the deal is that the loan will be repaid in one year. I also understand that the cost of capital is relatively low, although I don’t know all the numbers. Now, this particular company is really an execution play at this point in its life. It has real customers and now it needs to sell its product. It also has a robust pipeline of prospects. As a result, there is a credible basis for thinking that the carrying cost of the loan can be paid and that the loan can be paid in full in one year. Making this structure work for a pre-revenue company would take some changes, but it might be doable.
Sometimes I wonder why legal terms exist that have little or no practicable applicability – my clients wonder the same thing. Sometimes, these provisions really are ridiculous, but most of the time they cover off some eventuality that, although remote, actually could happen. The mere presence of the legal provision prevents the bad thing from happening, with the result that after some number of years, everyone starts to comment that whatever it is never happens and the lawyers have gone overboard. One example recently came to my attention: redemption provisions in venture investments. As everyone who plies these waters knows, a typical VC investment provides that, at the election of the investor, the company will redeem the investors stock after five years in three equal annual installments etc…. The purpose of these provisions, as I understand them, is to give the investor a way out of a landlocked investment in a life style company. In all my years of practice, I have never actually seen this provision at work. I think that is because long before anyone would actually pull the trigger on a redemption everyone sees it coming and something gets worked out. But, that begs the question of what would happen without the provision. So, here is a worthless provision (worthless in the sense that it never gets used) that actually serves its purpose – so well, in fact, that as a practical matter, the problem is extinct.
This issue (how much of a discount should there be on an angel note that converts into the next round of financing?) seems to come up every day. And, there does not seem to be a good answer. So, consider this: a 20% discount is, in effect, a “guaranteed” 25% return on the investment. (Of course it is not really guaranteed since you don’t get liquid until some dim point in the future, if ever.) Perhaps one way to look at what is an appropriate discount is to ask what the return should be over what period of time. 25% in six months justifies a high degree of risk, but 25% over two years does not. So throw this in the hopper along with other typical thoughts such as how will the “next” investor react? How big is the angel investment? What precedent are you setting? And the like.
VentureFizz is a web site that came to my attention though its viral marketing campaign. Having now visited it a few times and checked out a couple of features inlcuding their sections on fundings, news and blogs (which, by the way does not list this blog), I think it is an excellent addition to the information side of the entrepreneurial ecosystem. You should take a look.
As I have noted on many occasions, one of the most common structures for angel investments is a note that converts into shares of a future round at a discount to the price in that round. While this has the advantage, among other advantages, of putting off the moment when a valuation of the company must be agreed to, one client has recently pointed out the flip side to this benefit is that it caps the investor’s upside during the period from the angel investment to the moment of conversion into the future round at an amount equal to the relevant discount. While few angels ever worry about this issue, the point is well taken, especially if you believe that the future investor will require your angel investor to give up some (all?) of her discount in connection with the new round. One possible way to work around the issue of a capped upside is to issue low priced warrants to the angel investor. For some reason, venture investors have less of a tendency to bother with warrants than they do with discounted conversions. Needless to say, using warrants raises a lot of issues including how to price them both in terms of actual dollars and as a percentage of the equity of the company. They also introduce another piece of documentation and therefore complexity and expense, which may be OK or not OK depending in part on how much angel money you are raising.
As everyone in the tech world knows, California has a statute making employment related noncompete agreements illegal. There is now a movement afoot in to make them illegal in Massachusetts. For reasons that I have noted before, I don’t think making these agreements illegal in Massachusetts will make much, if any, difference in the tech community. On the plus side, it will take one irritating concern off the table for employees seeking to move. But will it really change the east coast tech culture to make it more like Silicon Valley? I don’t think so. Having said that, Paul Boutin in a recent article in Wired described the Silicon Valley employment culture with these words, "Worker mobility gives the tech industry fluidity, velocity, and energy. It creates a culture in which people routinely jump from one job to another, looking to get in on the next must-have product or service. As it happens, that lack of loyalty has been a key driver of the Valley’s rapid innovation over the past three decades…" As evidence he sites AnnaLee Saxenian to the effect that job hopping facilitates the flow of knowledge between individuals and firms. I am guessing that New England has certain cultural traits that make a culture of job hopping unlikely, and doing away with noncompetes, while it will take an important irritant off the table for employees seeking to leave companies, it will not turn New England into Silicon Valley. Much more likely to have this result is for local VCs to start behaving more like west coast VCs – but that is a topic for another post.
Dave heads the Emerging Enterprise Center. His practice focuses on representation of technology companies from start up to exit. Dave also handles venture financings, merger...
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Prithvi Tanwar is an Associate in the firm’s Business Department. His practice focuses on advising emerging life science and technology companies as well as U.S....
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Quarterly and Annual Review of Series A Financings and Series B/Later Round Financings: Q4 and Year 2010
Download & read (PDF)The Emerging Enterprise Center Blog is where we plan to cover a wide range of topics that arise from our...
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