Corporate Legal Structure & Operating Documents

2015 Technology
Entrepreneurship Boot Camp
Stephanie L. Chandler
• Chair – San Antonio Corporate & Securities
Practice Group
• Firm-wide Section Head – Technology Practice
University of Nebraska, B.S.B.A. in Finance;
University of Virginia, Juris Doctorate
Lauren A. Prew
• Attorney: Business Transactions
(Corporate/Securities/M&A) and Health Care
Texas A&M University, B.A. in English;
Michigan State University, Juris Doctorate
Structuring Your
Entity for
When Should You
Formalize Structure?
Initiation of Business Operations
Asset Protection
Capital Raising
Succession Planning
Other Factors...
What structure is right
for your entity?
• Sole Proprietorship
• General Partnership (GP)
• Corporation
– C-Corp
– S-Corp
• Limited Partnership (LP)
• Limited Liability Company (LLC)
Sole Proprietorship/General Partnership (GP)
* Even in Texas your homestead
protection may be limited
depending on the specific facts
so your home may still be at risk.
Default Entity
No liability protection,
partners are jointly
and severally liable
for all partnership
The fallacy of a DBA
filing: county DBAs
and State of Texas
Board of Directors
President, Vice President,
CEO, CFO, Secretary, Treasurer
Duties to
Signing Authority
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CITE BootCamp February 2015
Slide 8
Examples Provided On Website
Incorporation Questionnaire
Certificate of Formation (For-Profit Corporation)
Organizational Consent (Texas Corporation)
Bylaws (Texas Corporation)
Buy-Sell Considerations Matrix
Stock Option Plan
Independent Contractor Services Agreement
Convertible Bridge Note and Term Sheet
CITE BootCamp February 2015
Slide 9
Incorporation Questionnaire
• Provides a framework to think through the
skeleton of the entity
– Primer to preparing your documents
• Gathering the information necessary to form
the entity and thinking through the key roles
in the entity:
– Officers
– Directors
• Shares, Debt and Taxes
• Shareholder Rights and Meetings
• The KEY to success is being as organized as possible
from the beginning. You’ll save money, time, and
energy as your entity grows. Hard work on the front
end of formation pays dividends long term.
CITE BootCamp February 2015
Slide 10
Certificate of Formation
(Texas For-Profit Corporation)
• Document filed with the Secretary of State to form
an entity
• Maintained on the Secretary of State’s website
• Conforms to requirements of the Texas Business
Organizations Code (TBOC)
• These have different names in different states:
– Delaware: Certificate of Incorporation
– Texas: Certificate of Formation
– Others: Articles of Incorporation, Corporate Charter
• For Texas Secretary of State:
CITE BootCamp February 2015
Slide 11
Bylaws (Texas Corporation)
• Bylaws govern the entity – define purpose; determine
governance; outline rights and responsibilities of directors,
officers, and shareholders; meeting structure and
frequency; voting rights; etc.
• Think of these literally as the “laws” of the company –
they govern all action that can and cannot be taken
• Bylaws must be carefully thought through because they
will determine your day-to-day operation and how your
corporation will function in the future
• Note: Bylaws may be amended and/or restated, but
doing so will be costly and require consent prior to
adopting any amendment or restatement. Drafting welltailored and thought-out bylaws earlier is much easier
than doing so later and having to “fix” poor bylaws later.
CITE BootCamp February 2015
Slide 12
Organizational Consent
(Texas Corporation)
• In general, written consents enable the Board of Directors to
take certain actions (TBOC and/or Bylaws provide rules)
• The organizational consent is the first action that the Board of
Directors takes:
Adopt the Certificate of Formation
Acknowledge the appointment of each director to the Board
Approve and ratify the Bylaws
Elect Officers
Adopt the form for the Certificate of Stock, Corporate Seal (if required)
Empower officers to issue stock, open a bank account on behalf of the
Take actions necessary to protect the entity: NDA, proprietary information
and inventions agreement, IP agreements/licensing
Authorize the officers to take various administrative actions
Approve any contracts, leases or other agreements entered into by the
Authorize signatures on behalf of the corporation
• Can also have a meeting to adopt these items…
CITE BootCamp February 2015
Slide 13
Limited Liability Company
Board of Directors
President, Vice President,
CEO, CFO, Secretary, Treasurer
President, Vice President,
CEO, CFO, Secretary, Treasurer
Signing Authority
Other Steps
• Get the company a “social security number” –
Employer Identification Number (EIN) -
Sales Tax Numbers
Make any tax elections you need (i.e. S-election)
Confirm Founder Vesting/83(b) Elections
Employees = Texas Workforce Commission
Foreign qualification if acting in other
states/formed a Delaware entity, etc.
CITE BootCamp February 2015
Slide 15
Issues with Joint Ownership
Not only your partner, but …
What if I don’t
want to keep doing this?
What if my partner
dies? Gets divorced?
Files for bankruptcy?
What if we don’t agree?
Issues are always easier to
resolve before money is a factor
Other Startup Tasks
Equity Plan for
Advisory Board
Work for Hire Agreement
for Anyone that Touches
the Product
NDAs (Pro-Disclosing/
Convertible Bridge Note
(Initial Capital In)
(discussed later)
Stock Equity Plan
• Options/Restricted Stock for
employees, directors, consultants, etc.
• In theory, this incentivizes employees to
grow the company by providing them
with a “stake” in the company
• Can lower the costs of compensation
• Need to consider:
Exercise Price
Accelerated Vesting Triggers
Transfer Restrictions
CITE BootCamp February 2015
Slide 18
Stock Equity Plan
• Knowledge is half the battle
– Phantom Gains/setting the value of the
option can be difficult and expensive
• The IRS and 409(A)
– It is still a security – compliance with Rule
701 (The “Google” Problem)
– Separate Grant Agreement needs to be
– Approval requirements: shareholders must
consent for tax preferred grants
CITE BootCamp February 2015
Slide 19
Establishing an Advisory Board
• Permits the Board of Directors to consult experts who will often
provide strategic advice to the Board
• The Advisory Board member cannot vote and does not
maintain a fiduciary relationship with the corporation
• The agreement outlines the Advisory Board member’s role,
compensation, term, etc.
• Similar to an employment agreement but for the purpose of
advising the board
• Very common for small, emerging companies to consult with
advisory board members
CITE BootCamp February 2015
Slide 20
Who’s Helping You With the Business?
• Example: Independent Contractor Agreement
– Scope of services, fees, term and a variety of other
clauses dependent on the nature of work
– Work for hire clauses or you don’t own the product
– Confidentiality and trade secrets
– Non-solicitation of clients, customers, and employees
– Tax treatment
• Employee Documentation
• Ask: is the work being performed by an
employee or by an independent contractor?
• NDAs – Pro-Disclosing and Pro-Receiving
CITE BootCamp February 2015
Slide 21
Sources of Funding:
From traditional
bank loans to
angel investors to
venture capital
funds, this is
where you should
be looking for
money in Texas…
CITE BootCamp February 2015
Local Case Study
• First Deal was a Geekdom Bridge Note… then
off the races…
• Larger Bridge Note Round
• Factoring/Bank Financing/Manufacturing Terms
• Series A Round
• and now….
CITE BootCamp February 2015
Slide 23
Always Be Preparing for the Deal
• Need for the “right” package
– Raising Funds
– Acquisition
• Create the diligence binder from the start
• First Deal – Often a Bridge Note
– Don’t have to price (but may have to Cap Price)
– Understand:
Conversion (Mandatory/Optional)
Cap Price
CITE BootCamp February 2015
Slide 24
Angel Investors
Friends and Family
Angel Funding – wealthy private
individuals, with backgrounds in
business, typically smaller than VC’s
($25K - $250K). They prefer to deal
directly with the entrepreneur, like
local deals, often want to develop a
relationship with owners.
Angels are limited in the number of
investments they may invest in
concurrently. Typically easier to deal
with than VC’s. Angels support is
invaluable to start-ups.
Must Still Comply with Applicable Securities Laws:
• Exemption (“accredited investors”)
• Notice Filings
Angel Investors (continued)
Provide necessary capital for start-ups, usually seek smaller deals,
like early stage enterprises, higher risk threshold, less formal
investment criteria, often very enthusiastic, can attract additional
investors, require little control, often bring vast amount of
knowledge & experience, usually look beyond monetary gain,
located everywhere
Rarely make follow-up investments, tend to be less patient than
VC’s, may require some form of control (board seat), may lack
industry knowledge, do not have national recognition so they
may be difficult to find, they choose to be “hidden” to avoid
being pestered with business plans and telephone calls
Regulation D
• Read the Practical Guide To Raising Capital on CITE
Bootcamp Page
• Rule 504 provides an exemption for the offer and sale of
up to $1 million of securities in a 12-month period
• Rule 505 provides an exemption for offers and sales of
securities totaling up to $5 million in any 12-month period
– Unlimited accredited investors; max. 35 unaccredited
• Rule 506 provides another exemption for sales of securities
under Section 4(2) with no dollar limit.
– Unlimited number of accredited investors and:
• (b): With no general solicitation  max. 35 unaccredited
• (c): With general solicitation (JOBS Act)  ONLY accredited
Who is an “Accredited Investor”?
a bank, insurance company, registered investment company, etc.
an employee benefit plan
a charitable organization, corporation or partnership with assets ≥ $5
a director, executive officer or general partner of the company selling
the securities
a business in which all of the equity owners are accredited investors
a natural person with a net worth of at least $1 million (not
including his/her house)
a natural person with income exceeding $200,000 in each of
the two most recent years or joint income with a spouse
exceeding $300,000
a trust with assets of at least $5 million
Where do I find them?
Traditional and Non-Traditional Lenders
Most major traditional banks
do not lend to startups or
do so only rarely
Silicon Valley Bank, Square 1
Bank lend to entrepreneurial
companies (positive c/f)
Accounts Receivable, Inventory,
Fixed Assets all impact funding
Terms may include: company’s stock, fees, collateral, agreement to
pay for A/R audits, monthly reporting, audited financial statements,
compliance reporting, financial covenants plus all banking
relationships – checking, credit cards, investments, etc. must be
established with lender
Can I advertise my deal?
• JOBs Act: New Rule 506(c)—General
solicitation and advertising permitted
– Sales only to accredited investors
– Reasonable steps must be taken to
verify A/I status
• 506(d): Bad Actor disqualification
– Rule 506 is unavailable if a Covered Person has
had a Disqualifying Event
• 506(e): Reporting prior “bad actor events”
Can I advertise my deal?
• Once you go 506(c), you can’t turn back
• Extra requirements and complications
may scare off some potential investors
• Securities Fraud Rules still very much
• Lack of case history dealing with the
solicitation and advertising provisions –
difficult to know the limits
What’s the buzz about and should you consider
“kick-starting” your fundraising in Texas?
CITE BootCamp February 2015; photo:
hnology/personaltech/crowdfundingtips-for-turning-inspiration-intoSlide 32
What do you mean by “crowdfunding”?
• Non-Equity Crowdfunding
• Equity Crowdfunding
– Accredited Investors (Angel List, etc.)
– New Texas portals – must be approved
by the State Securities Board
CITE BootCamp February 2015
Slide 33
New portals are interesting…
• As part of the JOBS Act, the SEC passed legislation
permitting crowdfunding, but has delayed formal
regulations for crowdfunding until sometime this year
[Reg A+]
• Must be conducted through a registered BD or
“funding portal”
• Issuers can raise up to $1,000,000 in a year
• Investors can invest, in any 12-month period, across all
4(a)(6) offerings:
– Greater of $2,000 or 5% of income or net worth, if both income and net
worth are < $100,000
– 10% of income or net worth, if either income or net worth is ≥ $100,000,
up to a max of $100,000.
But are they practical…
…and the Disclosure
Form C, which must be filed on EDGAR and provided to the intermediary and
investors, includes, among other things:
• Description of business, capitalization, management and ownership
• Risk factor disclosures
• Detailed descriptions of any exempt offerings conducted within the last
three years
• A financial description including discussion of results of operations,
liquidity, and capital resources
• Financial statements, which need to be (taking into account the targeted
amount for the offering):
Certified by the PEO for issuers with $100,000 or less in 4(a)(6) offerings in the
last year;
Reviewed by an independent public accountant (and include the review
report) for $100,000 to $500,000; and
Audited by an independent public accountant (and include audit report) for
over $500,000.
and annual reporting requirements…
and more rules in Texas…
As of 11/17/14, Texas State Securities Board issued rules regarding the
registration of portals and intrastate crowdfunding exemptions.
The rules issued by Texas are still relying on Section 3(a)(11) of the
Securities Act (i.e. the JOBS Act that the SEC has yet to issue formal
rules for).
Issuer may issue securities only to investors residing within Texas, and
the Issuer must also be a resident of Texas. This exempts you from
registration with the SEC.
Up to $1M per 12-mo period and Non-Accredited investors may
contribute up to $5,000 per offering.
The offering must take place online with a registered broker dealer or a
registered crowdfunding portal.
Limited disclosures must still be made using Form 133.17 with the State
Securities Board (no audited or reviewed financial statements required
unless already available prior to the offering).
CITE BootCamp February 2015
Slide 36
VENTURE CAPITAL FUNDS ($1 million - $50 million)
Excellent source of capital/funding committed to your business
VC’s are often prepared to invest in continued rounds as the
business grows and achieves its milestones
Can bring valuable skills, contacts, experience, organization
and discipline to your business
VC’s have common goals with the entrepreneur – growth,
profitability and increased value of the business
VC’s time horizon is often 3 – 7 years before exiting
Looking to have a 3 – 7 times return on their investment
Exiting usually in the form of a Public Offering or Sale to a larger
business after reaching certain milestones
VENTURE CAPITAL FUNDS ($1 million - $50 million)
Raising Equity Capital – demanding, costly, time consuming.
Your business suffers as you devote your time to answering
questions and preparing for their investment.
Due Diligence process can be brutal – background checks,
justification of your business plan, legal review, patent
review, financial forecasts, etc.
Note: this can be a very useful process to force management to
think through every issue earlier than later. This is valuable even if
funding doesn’t occur.
Often the entrepreneur will lose control after the 2nd round
of financing. VC’s may want to bring in a marquee CEO,
CFO, etc. to run the business.
Management reporting to the VC is often onerous, requiring
4 to 6 board meetings per year in addition to answering
questions, providing updates and monthly reporting.
• NVCA Model Legal Documents
– - Model Legal Docs Button
• Offering Terms
Pre-Money Valuation
Anti-Dilution Protections
Registration Rights
SBIR (Small Business Innovation Research)
11 federal departments participate
2.5% of the total extramural research budgets agencies
Funds are non-dilutive – do not have to give up any ownership
Great way to fund your initial invention
Takes tremendous amount of time, drawn out process: 8 to 14 months
No guarantee of application approval
Costs associated with a properly prepared grant application
Significant reporting, follow on audits, strict rules,
SBIR grant may not be perfectly aligned with your company or you may
have trouble finding a grant solicitation that matches your needs
• Private Foundations
• The Robert Wood Johnson Foundation – Health Care
• The Kresge Foundation - Arts and Culture, Community
Development, Detroit, Education, Environment, Health, and
Human Services
• Otto Bremer Foundation – Community-driven Investments
and the Twin Cities
• The Kate B. Reynolds Charitable Trust - Improving the quality
of life and the quality of health for the financially needy of
North Carolina
• Public Foundations
American Heart Association
Juvenile Diabetes Research Fund
National Burn Repository of the American Burn Association
American Cancer Society
• Federal R&D Contracts
– National Institutes of Health
– Department of Energy
– National Science Foundation
– US Department of Agriculture, Cooperative State
research, Education and Extension Service
– Centers for Disease Control and Prevention
– Department of Defense
• Texas Emerging Technology Fund (ETF)*
– Apply through T3DC (South Texas): Focuses on emerging
scientific or technology fields that have a reasonable
probability of enhancing this state ’s national and global
economic competitiveness.
– Must partner with a Texas State institution
– Note: This program may terminate under Gov. Abbott
• States and municipal governments (including San
Antonio) are increasingly investing in emerging
companies, but their ability to responsibly do so are
often questioned:
Strategic Private
– Large corporations
• Potential Acquirers
• Potential Customers
Vendor Payment Terms
• “Boilerplate” – these are the
most important provisions, do
NOT ignore them.
• Don’t assume a provision
cannot be altered – advocate
for your company and your
role in the company.
• Don’t sign contracts until they
are reviewed by a lawyer
Using Forms…
13. Venue. This Agreement and all amendments or
modifications hereof shall be governed by and
interpreted in accordance with the laws of the
State of Confusion governing contracts wholly
executed and performed therein, and shall be
binding upon and inure to the benefit of the parties,
their respective heirs, executors, administrators and
successors. Jurisdiction for any suit filed to enforce the
provisions of this Agreement by either party shall be
filed in the federal or state courts of Mostfavorable
District of Confusion in Hitsville, Confusion or
Miracle County, Confusion.
Stephanie L. Chandler, Esq.
[email protected]
112 E. Pecan Street, Ste. 2400
San Antonio, Texas 78205
Lauren A. Prew, Esq.
[email protected]
112 E. Pecan Street, Ste. 2400
San Antonio, Texas 78205

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