One of my partners, Jonathan Keselenko, who practices in the Employment area, developed a nice simple termination checklist that I have found useful.  One thing about this list is that it applies to situations where the employee is an “employee at will.” If there is an employment contract, you will also need to review the contract to make sure you meet its requirements as well.  Here is the list, with some additions from me:

EMPLOYMENT TERMINATION CHECKLIST

• Have a good reason for the termination, and make sure that the reason is consistent with the documentation.
• Provide the employee with a truthful explanation for the decision.  For example, if the employee is being terminated for poor performance, do not characterize the termination as a layoff.
• Don’t be gratuitously cruel.  You should inform the employee of the reason for the termination, but you do not need to convince him that you are right or win a debate.
• Conduct the termination in a private and respectful way.
• If you any concerns about litigation, two people from the company should be present at the termination meeting, and both should take detailed notes.
• Pay: be prepared to pay all compensation due, including unused but accrued vacation pay.
• Explain that the employee will receive notice about continuing group health coverage under the Comprehensive Omnibus Budget Reconciliation Act of 1985 (“COBRA”).  Explain that all other benefits will cease as of the termination date.
• Provide state-issued information about filing for unemployment, even if you think the employee is not eligible.
• Collect all company property from the employee.  Consider having the employee sign an acknowledgement form that he has returned everything.
• Allow the employee to collect any personal belongings before leaving the work premises.
• Block the employee’s access to the Company’s premises and electronic access to the Company’s computer systems and email.
• If the employee is listed on your company website, remove him from the site.
• Remind the employee of any restrictive covenants (by this I mean noncompetes, nonsolicits, confidentiality and inventions agreements) and provide an additional copy.
• Think about how you intend to communicate the employee’s departure to customers and other employees, if at all.  Who needs to know and why?  Make sure you have a legitimate business reason for the communication.
• Think about whether you are willing to give the employee a reference. 
• Inform the employee about options that may be exercised (or restricted stock that may be repurchased by the Company).  Be prepared to repurchase restricted stock (if you intend to).  The repurchase agreement may not be “self-executing” with the result that you may have a time frame for acting.

Having said that, there do seem to be some broad buckets that the outcomes fall into.

An Up-Round Scenario

Let’s look at a situation in which the B comes in at a significant increase in valuation compared to the A.  In this situation, the valuation of the company starts off at a point higher than that aggregate of the existing preferences.  If the company were to be sold in the following nanosecond, the B would get its money back and the A would get its money plus, perhaps, some return.  The same result would obtain if the valuation increased over time. 

If, however, the valuation declines over time, and the company is later sold for a valuation below that at which the B invested, then all investors would be at risk of not getting their investment capital back.  If the B is equal to (or – God forbid – below) the A in the preference stack, the B would, in effect, be funding the A’s preference.  For example, if the company were sold at a down valuation shortly after the investment, the A might likely be paid in full and the B might likely receive a reduced return – in effect the B’s money would have gone to pay the A.  New investors (the B in our example) are very unlikely to be willing to do this, unless they are truly eager to get into the deal. 

For this reason, the most typical arrangements in up rounds are for the new money to either have a priority over the old money or to be equal to the old money in the so-called preference stack.

A Down-Round Scenario

Now, let’s consider a situation in which the B comes in at a significant decrease in valuation from the A round – a down round.  For the reason described above, it is hard to imagine that in this scenario, the B would agree to be anywhere other than at the top of the preference stack.  So, let’s assume that is a given. 

How will the B feel about the A keeping any preference? 

The debate will center around how much, if any, of its preference the A should keep.  To focus the issue, let’s assume that there was a really large A round (more likely there have been several early rounds and the new round is the D) and the old preferences add up to a large number, say $50 million.  If the B invested, say $10 million and the A keeps all of its preference, then the company would have to be sold for more than $60 million for the B to start to see a return on its investment (not taking into account anything for the common).  No new investor will agree to that structure in a down round situation.

So, the question is: What happens to the A? 

When the A does not participate

In a down round where the A does not participate in a meaningful way in the new investment, the A holders have very little leverage.  Their bargaining position consists of either holding the deal up altogether, at the risk of watching their entire investment disappear or making a huge concession to the B. 

When all the A participate in an inside round

When all the A participate (without an outside investor), then the question becomes how much can reasonably be stacked on top of the common (typically meaning management’s options) before there is just no incentive for management to stay with the company.  If it is necessary to reduce the aggregate preference that is stacked on top of the common, they can go ahead and do so by amending the A.  In the alternative in a case where there is significant common ownership by persons no longer with the company, the investors may leave the preferences in place but create a management incentive plan that carves out some portion of exit proceeds to be distributed to management.  (This, of course, has its own complexity.  If management has an incentive plan that sits on top of the preference stack, it can affect management’s motivations.  Which suggests another blog topic:  How to structure management incentive plans to properly align management’s motivations, a topic for another day.)

The Cram down and the Pull-Through: when some, but not all, of the A participate

When some of the A participate and some do not, the negotiation can get interesting.  The ones that participate (particularly if they lead and comprise substantially all of the B round) will be in a pretty strong position to hold onto their position in the preference stack.  But, free riding by the non- participating A investors will be anathema to the participating investors. 

Often the result of this situation is the pure cram down.  The non-participating A investors end up converted into common stock (sometimes a pay-to-play is used to convert them into a preferred “lite”). 

Sometimes, however, the new investors are willing to leave the non-participating investors with some preference over the common (and presumably over the profit potential to (as opposed to the return of invested amounts) the participating investors).  Having observed this dynamic on a variety of occasions, I can’t say that I have seen any pattern to when it arises.  One situation that seems to have some logic to it is when some of the A round investors were the sorts of angel and early stage investors whom nobody expected to see invest in later rounds.  Another situation that I have seen arise is when some of the early round investors were brought in by the larger VC investors or are persons with whom the larger VC investors have ongoing relationships.

In these situations, you sometimes see a so-called “pull through”.  It works like this:  for every $XX of B that an existing investor buys, he gets to convert some number of shares of A into shares of B.  In this arrangement, the B is ahead of the A in the preference stack. 

Final Thought

The negotiation of all this is usually done among the investors and away from the sight of the company and management.  Actually, it may be even more arbitrary than that suggests.  It is often discussed among a small “inner” group of investors, who try and guess what they think it will take to get the deal done.  When they finally come out with the offer, it is often a self-fulfilling prophecy.  They are often so invested in the solution they propose that it is impossible to get them off it, with the result that it becomes their offer or nothing.

However, how the preference stack works can affect exits.  At certain price ranges some investors at the top of the stack will get a return (or perhaps their bait back) while others will get nothing.  As a result, there may be very different opinions around when and at what price investors will support an exit. 

About a year after the initial close, my client went to raise a medium sized extension round.  They found a lead for the extension and everything went well.  After some negotiation, we got to the last issue in the term sheet: redemption.  The investor insisted that its redemption right be timed four years out to coincide with the redemption for the initial investment.  The company, of course, insisted that redemption start at five years.  They quickly reached impasse. 

The CFO then asked me what to do.  He sent along an email from the investor who explained carefully and reasonably that he did not want to be behind the initial investors. 

I then sent an email to the group stating that our understanding was that all preferred would have the same redemption schedule – beginning five years after the extension closing not four years. 

Needless to say, that closed the gap.  The point is, I think, that there never was a gap. 

It doesn’t make sense to have different redemption dates for different series.  The result of such an arrangement is that one series is in danger of funding out another series.  No investor should ever agree to such an arrangement.  Also, as time passes and new investments are made the issuer is not going to want to be in a position to have to spend money to buy out investors rather than fund its business.

Redemption itself is not all that common a practice.  It appears in only a small percentage of west coast deals and only about half (somewhat more than that actually) of New England deals.  It is a rarely used provision.  I can’t say never but ask a few practitioners how often they have seen it used.  I bet the answer is almost never.  I bet several will say they have never themselves seen it used in their practice.  The fact that it is a rarely used provision makes it an easy give.  This, I believe, is the reason why it is a minority provision on the west coast.

If you are going to have it, however, you probably want to make sure it really works.  Investors in Thoughtworks, tired to use their redemption provision and discovered that the then usual and customary language about how redemption was subject to the board’s discretion around availability of capital.  The NVCA form has addressed this issue and created a redemption provision that actually works.

• Size of the option pool
• Number of options that have been granted
• Number of options remaining and available for future grant
• Names of employees and numbers of options proposed to be granted at the particular meeting, if any
• Exercise price

The directors often have a couple of questions about who is getting how many and why and whether the remaining options will be sufficient for planned hires etc.  After a brief discussion, the grants are approved.  Good housekeeping suggests that there be a brief presentation of the status of the option plan at each board meeting whether or not you are asking for specific grants – just to keep the board current.

BTW: after the approval, the CFO typically completes the actual option grant forms, they are then signed by the CEO (sometimes the CFO) and distributed to the employees.

Sounds simple, until you don’t do it, and you want to ask for approval of option grants.

If you don’t do it (and by “it” I mean prepare a slide with all the relevant information) regularly (and by “regularly”, I mean at each board meeting), an alert board member is likely to be annoyed and have a lot of questions, when you do ask for approval of grants.  While it may seem like a small amount of information to convey and absorb to you, this is likely to be because you have thought about it in connection with determining what grants to ask for.  To your board member it is likely a matter of first (or at least not recent) impression.  No matter how much you try to explain it, the director is likely to ask for better information, time to consider and then decide to take it up at the next meeting.

You, of course, will be embarrassed because you will have promised grants to various people and will then have to explain that they won’t get the grants until the next board meeting.

Before you get steamed at the board member, here are a few things that are likely to be running through his or her mind (remember they are not on top of the facts because you have not been reminding them regularly):

• What percentage of the fully diluted is the pool?
• Has the percentage of the fully diluted represented by the pool changed due to recent issuances?
• What is the exercise price?
• Do we need a 409(A) valuation?  Do we need an update of our old 409(A) valuation?
• How much of the option pool has been used up?
• What planned hires do we have, and how many options will we need for them?
• Will we have to increase the pool, and how much will that dilute the investors?
• Is there acceleration on an exit? 
• Is there a double trigger?
• Why am I being put in the position of being the bad guy and delaying grants to employees when the CFO should have a slide with all this in the board package?

These and other questions are likely to come at you rapid fire.  No matter how crisp your answers, at some point your director is going to say something along the lines of “I am not prepared to decide on this now, let’s put it over to our next meeting.” 

Once those words are spoken, the likelihood of anyone saying, “nope, we have to decide now…” is vanishingly small.  Furthermore, can you imagine a director’s reaction if you said that? 

So, guess what, your employees are going to be waiting until the next board meeting.

The problem is that we are all prisoners of our own experience.  I have represented a lot of technology startups over the years, but it is still not a representative sample.  Time is also a factor the “going rate” (if there can be said to be such a thing) was different ten years ago that it is today. 

Perhaps some of the larger more active VC funds can get a representative current sample by looking at their existing portfolio companies.  But, most people really need industry data. 

So, here is a web site CompStudy that looks like it may fill the data gap, and you can get their data.  Below are two paragraphs taken from the CompStudy site.

The CompStudy surveys focus on private companies in the Technology and Life Sciences industries. We have conducted these surveys annually since 2000. (I collaborate on the surveys with Ernst & Young, law firm WilmerHale, and executive-search firm Park Square.) Last year, more than 800 private startups participated, giving us an extremely detailed dataset to help you understand the market for executive talent. The first decade of CompStudy surveys – which included almost 10,000 founders from 3,600 startups – served as the data backbone of my book, The Founder’s Dilemmas: Anticipating and Avoiding the Pitfalls That Can Sink a Startup.

As in past years, survey participants will receive free access to our sophisticated reporting/analysis website, including salaries, bonuses, and equity holdings for C-level and VP-level executives. To qualify for the free access, please complete the questionnaire by June 30th, 2012

If this survey lives up to its promise, it will be very useful.

I can’t help but note that a similar phenomena sort of exists (that is lack of actual data) with respect to other aspects of startups: for example, terms and valuation. 

Now, for some of this data you can go to our publication Perspectives (that covers New England, and shortly New York as well) or a similar publication from Fenwick & West (that covers the valley).  But although we (and I believe Fenwick) track every VC financing in our region, we don’t publish everything we know (I don’t believe Fenwick does either – although I have never discussed this with any of their attorneys).

So, when you hear someone say market is …..  You are probably hearing their subjective impression and, human nature being what it is, an impression designed to support the speaker’s agenda – good, bad or indifferent.

Aside from yet again reviewing the significance of 409A and why startups should care about it, this webinar brought together a variety of perspectives on 409A in one place.  So, for example, by listening to it you can get a good sense of how the apraisal process works, how often you have to do it and so on. 

My favorite moment came in the Q&A when someone asked what to do if they had been issuing large numbers of options with exercise prices far below market over long periods of time.  I suspect that this situation may not be so uncommon.

Anyway here is the video:

(1)  Be wary of “standard.”  There are some items legal things that are truly “standard” but not as many as some lawyers may imply. 

(2)  You can under most circumstances get some up front vesting from VC type investors.  My experience is that for many startups in which the founders have invested some sweat, investors will give you some credit in the form of fully vested stock.  So, a typical arrangement (again depending on the facts) might be 10% to 25% fully vested at the Series Seed (or Series A, as the case may be) closing with the remaining amount vesting ratable on a monthly basis over three years.

(3)  The notion of a “cliff” seems out of place for founders who have been working on a startup for some months (or longer).

(4)  I see a lot of so-called double triggers (as opposed to full acceleration upon a sale).  So, sometimes you see everything that is unvested vest upon a sale (a liquidity event other than an IPO).  More often, however, I see something along the lines of half of the unvested vests with the remainder subject to the “old” vesting schedule provided that (and here is the second trigger) if the founder is terminated by the acquirer in the liquidity event (or the founder quits for good reason) within some agree upon time after the liquidity event (say six months, but sometimes more) then the remainder vests. 

(5)  Vesting stops when the founder ceases to work for the company.  The notion that unvested shares might vest immediately upon termination other than for cause has some appeal to founders, for obvious reasons, but you may need to come to a parting of the ways with one of your co-founders.  If you do, that fully vested block of shares (typically a big percentage of the common stock) may loom very large.

With respect to series A deals, New York and New England each had 22 deals in Q1.  According to us, there were 223 series A deals nationally.  So, NY and NE collectively represented approximately 20% of the national market.

With respect to later stage transactions, there were 25 NY deals and 43 NE deals.  Again, according to us there were 368 deals nationally.  So collectively NY and NE represent about 18% of the market.

I imagine that the relatively smaller number of later stage deals in New York reflects a number of things.  One might be that the boom in NY deals is relatively recent so there may not be as many companies in the pipeline that are ready for a second or later round investment.  Another might be that the mix of investment opportunities in New York is more “capital efficient” than in NE (and maybe other places).

With respect to that later point, here is a breakdown of some categories.  We categorize deals into one of four categories technology, life science, cleantech and other. 

With respect to series A deals in NE in Q1 40% of deals were in the technology category, 14% were in life science and the rest were other.  That is there were no cleantech deals.  In NY 30% were technology and 70% were other.  There were no life science or cleantech deals.

With respect to later stage deals, in NE 37% were life science and 35% were technology.  In NY 72% were other and 16% were technology.

I suspect that most of the other deals in NY were companies with revenue models based on advertising revenue. 

All this leads to the conclusion that NY is a pretty exciting place for investors.  I predict that the upswing in NY deals will continue.  Stats over the next few quarters will tell the story.

Having now answered (to the extent I am comfortable doing so in the absence of any specific knowledge or facts of any particular case) the only question any client ever asks about advisory boards, I hasten to note that there are a lot of other – far far better – questions that could be asked about advisory boards.  Here are a couple:  What value can I reasonably expect from a member of my advisory board?  How do I get that value?  Why do I need an advisory board at all?  How do I find good advisors?

I don’t have any objective or quantifiable information around whether and how much value start-ups derive from their advisory boards.  My gut sense, based only on my law practice, is not much.  Mostly, what start-ups get is the opportunity to name a few luminaries on a slide towards the back of their deck.  The second thing they probably get is some introductions, probably to investors. 

I am sure there are some companies and entrepreneurs that have benefited greatly from advisory boards, but I have to believe this is a small number.  Below are a couple of links to blog posts on the subject of advisory boards.  The one from venture hacks seems to me to be particularly good in that it covers a lot more than just compensation, although it also covers comp.

Venture Hacks “Everything you ever wanted to know about advisors”

Ask the VC “Are Advisory Boards Helpful?”

Ask the VC “Advisory Board Compensation”

Sometimes it is good to be reminded of the past -- even if you lived through it.  Here is a link to a lengthy, but thoughtful, blog post on the "bubble" of the late '90s.  Peter Thiel's Startup Class Notes.  My favorite quote from this post is "Bubbles arise when there is (1) widespread, intense belief that’s (2) not true."  This is, of course, in different words what Mr. Mackay might have said about Dutch Tulips or witches in Salem.

It seems to me that bubbles (good, bad or indifferent) airse when there is a lot of money hanging around with the result that people do irrational things with it.  The recent $646 million lottery is a good example.  As the pot got bigger the odds got smaller, but the rate at which money poured in increase.  More money chasing smaller odds?  Go figure.

Congress has just passed, and the President has just signed, a new law that is supposed to support capital raising by smaller companies.  It contains the so-called crowd-sourcing provisions that have gotten so much press.  It will be seen if this does something or nothing for small companies, but one thing it might do is send a lot of small investor money chasing every smaller odds of success. 

I finally got around to my quarterly comparison of deal terms published by our firm, Fenwick (a Valley based firm that reports on transactions in the Valley) and Cooley (a firm with many offices that reports on transactions handled by it).

And here of New York:  No one that I am aware of reports on New York transactions.  But, starting with Q1 o f 2012, we will, because we are doing increasing amounts of emerging company work there.

So here is part 1 of my thesis:  I expect that terms will be most favorable to entrepreneurs in the Valley, least favorable in New England and somewhere in between for the rest.  Of course, I think that the “somewhere in between” number will include Cooley’s New England transactions (which will have the effect of making them generally seem less favorable to entrepreneurs).  We should all note that Cooley feels compelled (at least in some instances) to report numbers for Northern California separately from the others.

So, without further fanfare, below is the table that compares certain of the deal terms reported on by the three firms for Q4 of 2011.

Fourth Quarter 2011 Transaction Terms

Of course I knew what the chart would say before I made the prediction, so no surprise that it supports my thesis.

Here, however, is part 2 of my thesis:  When we start reporting on New York separately (which we will be doing starting with a Q1, 2012 report – to come out soon), it will show that terms in New York are far closer to those in the Valley than to those in New England.  Now I don’t’ know the answer to that question, but we are doing the research now and will have an answer soon.

Keep in mind that New York has gone from nowhere just a few years ago to equaling (or passing by some measures) New England.  Could it be that NYC is just a friendlier place for entrepreneurs than New England?

My hypothesis that the greatest increase is between the A and B rounds bears out very clearly in the technology sector. You can also see it in the biopharma data. The cleantech data may be unreliable because the sample size is small.

The reason I have been looking at this data is that I have a couple of clients that are debating internally whether to raise a B round or try for an early exit.  While I think there are many factors to weigh in this type of decision (obviously valuation is one issue, expected size of exit is another and time to the eventual exit is yet another), these statistics are, I think, the first step in an analysis that could well lead to the conclusion that, in most cases, the best return for the entrepreneur is going to be in an early exit.

Apparently, the SEC has finally come around to the notition that net neutrality is a really important issue.  I have included three of the salient paragraphs below.

The SEC’s Division of Corporation Finance has advised Sprint Nextel Corporation and AT&T Inc. that they may not omit from their proxy materials shareholder proposals that ask the companies to publicly commit to operate their wireless broadband networks in accordance with network neutrality principles.  The staff explained that, due to the sustained public debate over the last several years about net neutrality and the Internet, and the increasing recognition that the issue raises significant policy consideration, the proposals may not be omitted in reliance on the ordinary business exclusion.

AT&T wrote that the proposal represents an attempt to repackage substantially similar proposals about its network management practices, which the staff, in the past, has concluded were excludable as ordinary business.  In AT&T’s view, the proposal would directly interfere with its network management practices and would seriously impair its ability to provide wireless broadband service to its customers.  AT&T also sought to omit the proposal under Rule 14a-8(i)(2) on the basis that it would impair the company’s ability to comply with federal wireless licensing requirements.

AT&T said the proposal cited the same reports as in a 2011 proposal and that the only substantive addition was a citation to a 2011 survey that presents statistical information similar to that presented in the January 2010 report and cited in the 2011 proposal.  AT&T challenged the notion that net neutrality has emerged as a consistent topic of widespread public debate that would reflect a significant policy issue for purposes of Rule 14a-8(i)(7).

The point is that stockholders of public companies can propose that the stockholders, at the company’s annual meeting, adopt a resolution directing the company to observe principles of net neutrality.  It will be interesting to see how many, if any, companies include this type of resolution and if any of them pass.

It does not seem to matter what the articulated reason for the loss of valuation – market conditions, ineffective management, too early to market, too late to market, technology challenges, long adoption cycles, etc. – in each case one down round leads to another.  With each successive down round the common holders (and option holders) become more and more diluted and demoralized.  Key players start to leave.  Vendors are not paid and they put the company on COD terms.  These things all slow product development and sales and also harm morale.  Eventually the CEO is replaced (perhaps the entire team) and the new team is faced with the almost impossible task of bringing Lazarus back from the dead.

If this observation is really true, even in just a majority of cases, why would anyone ever invest in a down round?  The investor would simply be throwing good money after bad. 

There seem to me to be a lot of reasons potentially at play:  The original investment thesis still seems good.  Investors and management (let alone founders) remain enamoured of the business.  Investors are not eager to admit to their limited partners that a mere 12 months or so after they put a large wad of cash into the business there is a total write off.  Investors are afraid that the next guy will pull off a miracle and make the business a success as a result of which they will look like they bailed too soon.

Well, here are some facts.  We sorted our database of venture capital transactions in New England  first by searching for companies that had follow on rounds since 2008.  We then looked at the follow on rounds to determine how many were up and how many were down.  About 71% were up and the other 29% were down.  We then searched the down rounds to see which ones had a subsequent round of financing (13%, as opposed to 49% of the up rounds).  Out of the financings that followed a down round, 30% were up, 15% were down, and the rest (55%) were even. On average the “up” rounds were up by about 56% from the down round price. 

While the sample size is relatively small, the data shows that down rounds are much less likely to be followed by another round of financing, at least within the 2-year period we’re looking at. If they are followed by another round, there’s a good chance (85%, according to our data) that it will be an even or up round.

 Assuming you made equal bets across all down rounds and only 4% of the down rounds had follow on up rounds, that 4% would have to return a lot more than 56% you to break even on the portfolio portfolion of down round securities. 

Now, among other things, this analysis does not account for (1) the possibility that some of the up rounds will improve even further over time or that some of the down rounds will return something, (2) the time value of money, or (3) a host of other factors that are of lesser importance but not of no importance.  Nonetheless, it does suggest that investors would be far better off betting on the flip of a coin than on a down round.

Parties to the Agreement

Consider who should be a party to the agreement.  Should the agreement cover “affiliates”?   The answer is probably yes.

Mutual or One-way

Consider whether the agreement should be mutual (i.e. each party is obligated to keep the other’s information confidential) or one-way (only one party discloses information and the other party is obligated to keep it confidential). 

How Broad is the Definition of Confidential Information

Usually it is very broad.  In particular note whether or not the information has to be specifically identified as confidential or whether it merely needs to be such that a reasonable person would understand that it is confidential.  Depending on the circumstances you might want to go one way or the other on this.  You may also want to identify certain specific categories of information as either confidential or non-confidential.

Is the Obligation to keep Information Confidential Clearly Stated

The agreement should expressly state that the parties (or party in the case of a one-way) must keep confidential information confidential.  An ancillary point is the standard of care which could be best efforts or reasonable efforts or the same level of effort used in the case of a party’s own information. 

Exceptions

There are a number of usual and customary exceptions to the definition of “confidential information”.  These include: (1) information that is or becomes public without a breach of the NDA, (2) information that becomes available to the recipient on a nonconfidential basis from a source not bound by an NDA that covers the relevant information, (3) information that a party knows (and can demonstrate that it knows) before entering into the NDA, (4) information independently developed by a party without the use of confidential information subject to the NDA, and (5) information required to be disclosed by law (SEC disclosure obligations for example) or judicial process (discovery in a litigation for example).  In this later case (legally compelled disclosure), there is usually a requirement of notice so that the party whose information is about to be disclosed can contest the required disclosure or seek some other protection.

Return or Destroy

There is (or should be) an obligation to return confidential information and destroy all copies at the end of the NDA.  This requirement is often coupled with a requirement that the recipient certify compliance in writing.  Also, some large companies like to retain one archival copy of whatever they get.  This is usually rationalized by arguing that they need it for the record in case of a law suit.

Limitation on Use

Very important.  These agreements should expressly limit the right of parties to use the confidential information they receive to the purpose for which it is delivered: for example, to decide whether or not to proceed with a particular transaction.  So, the agreement should say that the confidential information may only be used for the specified purpose.  If it does not say this, it may turn out that parties use the information for other purposes, such as advancing their own R&D.

Ownership etc.

The NDA should make it expressly and clear that no license or other rights to the confidential information is conveyed.  In a sense, this is part of the limitation on use, but is often stated separately as well.  Similarly, these agreements often state that no joint venture or other entity is formed and that neither party can act for the other in any respect.

Term and Termination

NDAs can be for a stated term (months or years) or they can be perpetual.  The argument for a stated term of years is that at some point the information is old and cold and the parties should be able to stop worrying about their obligations under the agreement.  In any event, the disclosing party should be concerned to make the term long enough so that the information is no longer likely to have value as a result of being confidential when the agreement expires.

With respect to termination, the termination of the agreement should not terminate the obligations of confidentiality and non-use.  The termination provision should expressly state that these obligations survive an otherwise general termination of the agreement.

Equitable Relief

These agreements often state that injunctive relief (a court order prohibiting a disclosure) is an available remedy.  Some companies want an agreement that such relief is automatically available, while others will only agree that the discloser has the right to seek an injunction.    

Governing Law and Venue

There is a distinction between the jurisdiction whose law will govern the contract and where suits may be brought.  I won’t comment on governing law, except to say that your lawyer may have an opinion about it and that in general all U.S. jurisdictions will enforce your garden variety NDA (that is plain vanilla ones).  What about NDAs with odd, different or peculiar provisions – who knows, it will depend on the provision.

Venue is more interesting.  At issue is where cases may be brought.  If you are in Boston, having to enforce your rights in Alaska is likely to be inconvenient and expensive.  Consider that when you agree to a specific venue.

Unusual Provisions

The foregoing list of provisions and comments is by no means exhaustive.  But, if you are presented with an NDA that raises any questions for you, consult your lawyer.  Just because someone from a big company (even a household name company) says “this is our standard NDA” does not mean that it is either standard or, even if it is their standard, that it does not have odd, different and perhaps pernicious provisions. 

Just to give you a flavor, here are a couple of provisions that I consider odd, that I have recently run across:

In a supposedly mutual NDA, I found the following “XXX agrees to use YYY’s Confidential Information for the sole purpose of evaluation or as otherwise agreed upon in writing by YYY.”  This provision looks fine except that YYY never agrees to limit its use of XXX’s confidential information. 

Here is another provision: “This NDA may not be assigned by either party by any means, including without limitation, by operation of law or merger, without the prior written consent of the other party.”  We all get that one can’t just transfer an NDA, but but what happens when you go to sell your business?  Did you just unwittingly make the other party’s consent a precondition to a sale of your business. 

Beware of limitations of liability provisions in NDAs.  Some pro-recipient NDAs include a disclaimer of indirect and consequential damages.  The problem is that almost all of the damages that would arise from misuse of confidential information are indirect or consequential. If the recipient breaches the NDA, it would probably argue that it can be liable only for injunctive relief, but not for damages.  While I have my doubts about the enforceability of a disclaimer of this nature, there is certainly a risk that it results in a fairly toothless NDA from the discloser’s perspective.

Occasionally, an NDA will include provisions which may allow the discloser of information to claim ownership of the IP rights in any modifications that the recipient makes to that information.  These provisions may be hidden in the definition of “Confidential Information”, which is one reason not to gloss over that provision, even if the beginning of the paragraph reads like a laundry list of every type of information and technology that the drafter could think of.

 SOPA is obviously a huge issue these days.  Whether there is more panic than is merited is not clear to me.  But this is not a post about SOPA; it is a post about Quora. 

I was curious about what people were saying about SOPA, so I decided to check out the questions and answers in Quora.  Now, I know there are a million things out there on SOPA and probably anyone interested would read about it elsewhere. 

Having said that, the Quora activity seemed meager, to say the least.  For example, 13 people are following the question What is the Stop Online Piracy Act (SOPA)?  Looking at related questions, the numbers seem to go down from there. 

My initial (and continuing) reaction to Quora is that it is a great way to cluster commentary and opinion around topics.  I wonder though if it is not losing steam/market share.  If this is the case, and I suspect that it is, there are probably several reasons for it. 

One reason might be that Quora is not really all that easy to use.  Like many techie things, it sometimes seems as though the technology stands between the user and the use.  Here is a post from Semil Shah (on Quora)that touches on this issue.  His first point:  Make it easier for Quora users to ask questions, especially on the mobile app, goes to the heart of the matter.  If Semil Shah has this reaction, imagine the experience of a less tech savvy user.

Like many things technological, ultimate success does not depend so much on capturing the fancy of Semil Shah, Michael Lopp and other members of the tech vanguard, but on massive adoption by people for whom the site is a means not an end. 

One more thought about SOPA, old distribution and revenue models will not come roaring back into fashion because SOPA is passed.  Hollywood’s content creators will still have to change their business models as technology and social networking continues to grow up. 

What is 409A and why do you care?

409A is a section of the Internal Revenue Code that governs the tax treatment of certain options.  409A provides that an option either (1) be an option for common stock of the employer and have a per share exercise price on the date of the grant equal to or greater than the fair market value of a share of common or (2) if the option has an exercise price of less than the fair market value of a share of common stock the recipient and the issuing company suffer some pretty draconian tax consequences.  (There are other ways to comply, but relate to less usual situations, such as options that are only exercisable on a liquidity event, and I am not going into that level of detail here and now.)

What are the draconian tax consequences?

There are three particularly nasty tax consequences:  (1) The recipient of the option will have income equal to the difference between the fair market value of a share of common stock and the exercise price of the option multiplied by the number of options, at the time the option vests, even if the recipient does not exercise the option.  (2) The recipient will get to pay a surtax of 20% over and above his or her normal income tax on the option related income.  (3) For each year for which the option remains outstanding, the recipient will suffer the same nasty tax consequences with respect to any increase in the value of the common stock. 

Why on earth would the IRS create such a rule?

Consider what could happen if the issuing company were publicly traded and was issuing options with below marked exercise prices to its execs.  Need I say more?  Unfortunately, 409A applies to all companies – not solely public ones.

What can I do to avoid the bad tax consequence?

Issue your options with an exercise price equal to or greater than the fair market value of the underlying shares.

How do I know what the fair market value of a share of my privately held technology start-up is?

Here are some ways to price your options:

(1) You can take a guess at the fair market value.  If you guess wrong you are toast.  And, by the way, your guess will be judged with 20/20 hindsight by the IRS.  So, that does not seem like a good solution.

(2) If there is a recent actual arms-length transaction in which common stock was sold, then you have price.  Note that I said “actual,” “recent,” and “arms-length.”  The fact that your lawyer took a few shares a year ago in consideration of an old invoice won’t cut it. 

(3) If you have a financially sophisticated person on your board (or as your CFO), and your company has been in business fewer than 10 years, 409A provides that such person can perform a valuation. 

(4) You can pay an outside appraiser to perform a valuation.   Most (all?), of my clients who have professional money invested in them end up doing this.  It is a toll and it is unfortunate that you have this cost, but that is you tax dollars at work. 

Like my entrepreneur friend, you can want to price options at $.03 but if you sold common stock last week  in an arms-length transaction for $.30 per share, don’t do it.

Sometimes it seems like all clients have the same issue at once.  One series of issues that seems to be among the popular issues du jour is what to do to secure domain names and corporate names.  Needless to say, this should also dovetail with securing appropriate trademarks. 

Here are some strategies you can consider when registering domain names:

1. Register with the most popular top-level domains. Obviously, .com domains are the most popular by far, followed by .net and .org. You might also register domain names in the .biz registry, and in the .info, and .us registries. The Columbian registry (.co) is also making a big push to be an alternate .com (though it’s not clear it has much traction yet), so you might consider that as well.

2. You might consider registering some of the popular country-code top-level domains such as .co.uk, .ca, .asia, .de, .cn, .eu, .jp, and so forth, and country domains for any country where you expect to have significant business activity.

3. You might consider applying to register a “non-resolving” (inactive) .xxx domain name once they become available on December 6, 2011, or if you already owned a trademark registration prior to September 1, 2011, you may be able to take advantage of the cost-effective .xxx “Sunrise B,” which allows trademark owners to block a domain name for at least ten years for a one-time fee.  See http://www.icmregistry.com/launch/general-availability/.  Josh Jarvis, one of my colleagues writes a blog on trademarks, copyrights and related matters, and you might check his blog out for more on these topics.

4.  To protect against competitors and cybersquatters, you may wish to “defensively” register certain variations of "yourdomainname"  in at least the most popular domains (.com, .net, and .org). Some tricks used by competitors and cybersquatters include:

a. Changing singular to plural, or vice-versa.

b. Common misspellings or spelling variations -- e.g., using “z” instead of “s”.

c. Hyphens in obvious phrase breaks -- e.g., “soft-boiled.com.”

c. Typos -- e.g., sofboiled.com (missing letter) or substituting “d” for “s” or vice versa because it’s adjacent on keyboards

5. To protect against disgruntled customers or unscrupulous competitors, you may wish to “defensively” register so-called “gripe” domain names, at least in the most popular domains (.com, .net, and .org).  Ever popular creative favorites among the disgruntled are “Sucks” (e.g., softboiledsucks.com) which is by far the most popular of these, though other obvious four letter words are used.

Generally, it’s easy to get carried away -- it’s simply not possible to capture every possible misspelling, typo, or gripe variation in a single top-level domain, let alone multiple top-level domains. This is especially the case where the number of top-level domains is expected to increase exponentially over the next few years. The key is to get the most obvious and most likely suspects, at least in the .com registry if nowhere else. Keep in mind that you may have legal recourse available in the event of future bad-faith cybersquatting.

With respect to corporate names, as with domain names, you can't, as a practical matter, get every similar name in every relevant jurisdiction, but again you should think defensively and get whatever makes common sense in Delaware.  You might consider, but I also think it may be going too far, other big jurisdictions such as New York, California, Texas, and Mass.  Getting the corporate name, really means forming a corporation (even if it is an inactive shell) in the relevant jurisdiction.

Here is what my partner, Dave Pierson, had to say about Q1 activity, “The total number of New England Series A transactions dropped 46% from Q4 …. The total number of New Englsnd Series B and Later round transactions during Q1 decreased 21% from Q4…”

Fenwick had similar observations.  Fenwick had this to say, “Venture capitalists invested $6.4 billion in 661 deals in the U.S. in 1Q11, compared to $7.6 billion in 735 deals reported in January 2011 for 4Q10, according to Dow Jones VentureSource (“VentureSource”). Although this represents a 16% decline in dollars and a 10% decline in deal volume from 4Q10, the 1Q11 results were generally flat with the average of $6.6 billion raised per quarter in 2010.”

All I can say is that either Foley Hoag is lucky or the venture world took off in Q2.

Here is the open question, given the turmoil in the public markets, will I have written plenty of new posts and be lamenting the amount of time available for such pursuits?

Without further adieu, below is the same table I produce each quarter.  This is, of course, a table reflecting Q1 activity.

There is no surprise in these numbers.  They have followed a consistent pattern from quarter to quarter for as long as I have been tracking them.  Note the greater frequency of dividends and redemption provisions in New England deals.  Having wondered about why there is not convergence on terms, given that so many of the leading venture firms do deals on both coasts and having asked a number of people in the business about it, I have come to the conclusion that it the divergence in these terms reflects a basic cultural bias.  New England just has more of a lender mentality than the Valley.

My blogger friends (and the firm’s blogger consultants), indeed, it seems the entire blogosphere seems to agree that blogs are not really an optimal publication platform for dissemination of pure content.  I take that to mean that putting law review articles (or any substantive articles on legal (or other) topics) is really not what blogs are “about.”  

Instead, blogs are supposed to be pithy comments on other people’s posts (or perhaps some other thing going on in the real or virtual world).  Hence the prevalence of blog posts that begin with some reference like, “Harry has a great post about his date with Sally….”  Harry’s post, it turns out, is likely to be some observatlon about something Sally wrote on her blog.  Sally’s blog, in turn, refers to Tom and Dick….

So, the consultants appear to say, blog posts should be pithy comments about pithy comments.

And, the occasional pithy comment is probably a good idea, but when I look at the statistical data concerning this blog and I consider which posts seem to have generated interest and which have not, the numbers (meager as they are) support a completely different notion. 

Readers want content more than conversation – at least as much as conversation.

I am, for example, under the impression that Fred Wilson was very successful with MBA Mondays.  (Now, his entire blog is a huge success.)

Switching gears, Prithvi has told me on many occasions that the content posts I have done in the past are more geared for consumption by lawyers than by entrepreneurs. 

So, I am going to try and take a trick from Fred’s book and apply Prithvi’s advice and write a series of posts (I will try for weekly) that will be both substantive and usable by entrepreneurs.  The posts will be checklists for things that are legal in nature.  The idea is to put the entrepreneur in a position to think about whether he or she has covered everything he or she needs to cover in a document or deal. 

Of course, the usual caveats about how this is not legal advice and does not create a lawyer client relationship etc. apply. 

I thought I would tackle seed preferred term sheets first.  Although these can vary from one pagers to 5 pagers (or more), for the purpose of creating a checklist, I am going with the longish form.  After all, it is the purpose of a checklist to be over inclusive.  Also, I have linked each of the terms (and some other items) to the glossary defining these terms on the EEC microsite and, where it seemed relevant, to my blog. 

Please send me thoughts on the checklist.  If the checklists seem useful (or popular) I will post them on their own site on an easy to use open source basis.

Here goes: