LAFI 2014 Legal Umansky

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© Sheppard Mullin Richter & Hampton LLP 2013© Sheppard, Mullin, Richter & Hampton LLP 2010

March 2015

Incorporation Process and Legal

Issues

Presented to:

The Founder Institute



2

When do I need to incorporate a company?

Pitching investors

More than one founder working on project

IP creation Hiring employees or third party contractors

Equity grants

Launching product/service Corporate liabilities (i.e. office lease)



3

What situations might require specialconsideration?

Founder is an employee of another company Founder is not a U.S. citizen/permanent resident

Founder already has incorporated an entity

–LLCs, S corps, non-DE corps Pre-incorporation agreements



4

What documents should I review if I still amemployed?

Offer letter Proprietary Information and Invention

Assignment Agreement

Conflict of interest policy

Other employee documents



5

Why shouldn’t I form an LLC?

Venture capital investors do not want UnrelatedBusiness Taxable Income and often cannotinvest in LLCs

Stock options difficult to grant

Complicated to mimic typical preferred stockrights in an LLC operating agreement

Attorney fees are higher

S corporations are okay until they have entityshareholders



6

What happens during the incorporation process?

Incorporation Package is $1,250 exclusive ofcosts (approx. $750).

Founder needs to sign SMRH engagement letterand provide a check of $1,000.

Founder fills out incorporation questionnaire.

SMRH reviews to ensure completeness.

SMRH searches for name availability.

SMRH provides founder with customizedincorporation documents.



What incorporation documents are created?

Certificate of incorporation

Action by incorporator

Bylaws

Certificate of adoption of bylaws Initial board consent

Initial stockholders consent

At-will employment offer letter, confidentialinformation, invention assignment and arbitrationagreement



What incorporation documents are created?(continued)

Equity incentive plan

Stock option agreement

Restricted stock purchase agreement

Indemnification agreement

SMRH will also provide forms of offer letter,consulting agreement and NDAs as part ofincorporation process



What happens during the incorporation process?(continued)

Founder signs certificate of incorporation andother documentation

SMRH coordinates filings with Delaware andCalifornia Secretary of State

Founder obtains employer identification number(IRS)

Open bank account

Securities law filings (SMRH will file)



What happens during the incorporation process?(continued)

Deposit checks for founders stock

83(b) filing –founder responsible (SMRH willNOT file)





Capitalization of your company

Authorized

–Class A common –15,000,000

–Class F common –9,000,000

Fully-diluted capitalization at initial formation –Class A common –none

–Class F common –9,000,000

–Option pool (Class A common) –1,000,000

Please note that there is an extra 5,000,000shares of Class A common authorized for futureissuances



Capitalization (cont’d)

Example: Investor invests $500,000 at a $5,000,000 pre-

money valuation.

Based on a 9,000,000 shares outstanding and1,000,000 option pool, the per share price forthe investor will be $.50 ($5,000,000/10,000,000fully-diluted shares)

Investor will get 1,000,000 shares and will own.9% of the Company after the funding (1,000,000shares to investor/11,000,000 fully-dilutedshares)



What happens if I have additional founders orneed to sell stock to investors?

Newly issued shares are sold by the company

–Founders do not sell their existing shares

May require amending the Certificate ofIncorporation if there aren’t enough authorizedshares

Need to amend and restate the Certificate ofIncorporation to create preferred stock at the

time of a financing Should consider issuing convertible debt





What happens to Class F when investors invest?

Some companies with top tier VCs have super-voting common stock

Company potentially has additional leveragewhen negotiating with VCs (more chips to trade)

All of these “founder favorable” provisions canbe (and likely will be) eliminated upon afinancing, but it is simply a negotiation

The best way to preserve some of theseprovisions is to outperform competitors becauseonly elite companies will have real leverage



How should founders stock vest?

Stock is issued and voting, but subject torepurchase by the company if the founder isterminated for any reason

Vesting commencement date

–Credit for pre-incorporation time

Founder Institute recommendation

–1/48th per month with no cliff

–Acceleration –single trigger upon a changeof control

–Please note that this is very founder

favorable



What is in the restricted stock purchaseagreement?

Purchase price –Typically set very low (i.e. $0.001 pershare)

–May not be appropriate if founder iscontributing valuable IP

Repurchase right/vesting/acceleration

Right of first refusal on transfers

Escrow of shares

IPO lockup

83(b) election



What are out of pocket costs of incorporation?

Delaware –Delaware fees -$287

–Filing service fees -$217 (includes servingas agent for process)

Qualification to do business in CA

–$250 (includes state and filing service fees,assumes founder is agent for service)



20

What are out of pocket costs of incorporation?(cont’d)

Securities filings –CA 25102(f) –~$25 (depends on issue price)

–CA 25102(o) –~$220 (varies based on issue price)

Franchise taxes (Not paid immediately)

–Delaware -$75 minimum + $25 filing fee (Due inMarch of next year)

–California -$800 minimum (Due in April of next year)

City Business License (depends on city (approx.

$100.00)) Recurring costs

–Agent for service of process

--State franchise taxes



21

How do I ensure a smooth incorporation?

Completely fill out incorporation questionnaire

Try to avoid changes

–Every change requires time to revisedocuments

Limit custom drafting

Keep good records



22

Why should I avoid online incorporation services?

Documents generally need to be redone anyway

No restricted stock purchase agreement toimpose founder vesting, right of first refusal onstock transfers, IPO lockup

IP assignment clauses typically do not exist or

are inadequate



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Michael Umansky858.720.7470/[email protected]

Sean [email protected]

Contact Information