The speaker will highlight and discuss of a number of case stories which illustrate frequent missteps made by entrepreneurs and start ups. Topics will include when and how to document your deal, capitalization, raising funds and attracting investors, etc. The discussion will use real case stories to illustrate each topic in a meaningful and easy to understand manner. By understanding these common missteps, entrepreneurs and startups will be better able to more successfully navigate the pitfalls and traps that can keep their startup from getting off the ground.
4. klgates.com 4
Introduction
Alidad Vakili, Esq.
415.882.8039
alidad.vakili@klgates.com
Practices in the San Francisco office of K&L
Gates
Advised founders, startups, and investors in
many transactions over the years.
5. klgates.com 5
Overview
Sharing war stories is more
acceptable these days. The
Internet is full of articles and
blogs about startup failures,
successes and the many
lessons learned in between.
"Failure is simply the opportunity to begin
again, this time more intelligently."
Henry Ford
6. klgates.com 6
Overview
There seems to be a renewed focus on
failure as the pathway to success.
“Without failure there is no
achievement."
Henry Ford
7. klgates.com 7
Overview
Sometimes the best way to learn is
vicariously…from war stories told by others
who have been in the trenches and lived to tell
about it.
Focus of presentation – common missteps
made by entrepreneurs and startups.
Goal of presentation – to provide you a better
understanding of those missteps and how to
avoid them.
8. klgates.com 8
Documenting the Deal
An Expensive Breakup:
• Startup with innovative product in the arts industry
• Founder’s friend had a manufacturing business
• Founder decided to save money by inviting his
friend to be a part of the company
• Signed a deal without getting proper legal guidance:
• Friend got 50% equity in business when deal signed
• Friend’s only contribution was agreement to manufacture
products (time and labor included, but costs were not)
• Friend couldn’t deliver on manufacturing
• Delays, cost-overruns, and defective products
• Relationship soured
9. klgates.com 9
Documenting the Deal
An Expensive Breakup Cont.:
• Resolution:
• Founder bought out friend for $75,000
• Key Takeaways:
• Before you sign, do your diligence on your partner-
to-be
• Troubleshoot where problems could arise (ask the
“What if’s?)
• Get a lawyer to help you document your deal.
• Paying for good legal advice in advance will save you
in the long run
• Cost to negotiate buyout was 10+ times more than
what it would have cost to have a lawyer document
deal from beginning.
10. klgates.com 10
Documenting the Deal
An Expensive Breakup Cont.:
• Documenting your deal:
• Term Sheet, Letter of Intent (“LOI”), Memorandum of
Understanding (“MOU”)
• Should clearly outline the proposed relationship
• Parties
• Key terms
• Timetable and obligations of parties
• Binding vs. non-binding or hybrid of both?
• Confidentiality
• Exclusivity
• Transaction expenses
11. klgates.com 11
Capitalization
Two (Mis)Steps Forward, 10,000 Steps Back:
• Software startup working in defense industry
• Company formed with minimal shares authorized
• Two forward splits stock
• Documentation handled internally by company
• Company issued shares based on split numbers
• Articles never amended:
• Share splits never authorized (i.e., never happened)
• Company exceed authorized number of shares
12. klgates.com 12
Capitalization
Two (Mis)Steps Forward, 10,000 Steps Back
• Resolution:
• Had to clean up the capitalization
• Had to go out to existing shareholders to explain the
problem
• Key Takeaways:
• Capitalization structure and changes requires proper
planning and guidance
• Documentation needs to be prepared and in case of
doing splits, authorizing more shares, creating new
classes of shares (i.e., preferred stock), etc. must be
filed with the Secretary of State
• Again – resolution cost significantly more than
necessary
13. klgates.com 13
Capitalization
To Give or not to Give?
• Striking the right balance between giving
up too much or not enough
• Capitalization
• Think backwards when planning
capitalization
• Ownership
• Control
• Dilution (plan for it – it’ll happen)
• Incentivizing your employees,
consultants, etc.
14. klgates.com 14
Good Corporate Hygiene
Laundry List of Missteps for the Unwary:
• Invalid or defective shareholder actions
• Invalid or defective board actions
• In some cases can be fixed by having
board or stockholders ratify action.
15. klgates.com 15
Good Corporate Hygiene
Laundry List of Missteps for the Unwary :
• Waking a Sleeping Devil: Stock and option
pricing:
• Company issues options to employees and
consultants – but did not price them properly
creating 409A issues.
• Issue discovered during diligence in middle of
merger transaction
• Employees cashed out paid extra to cover the
additional tax from being priced too low.
16. klgates.com 16
Good Corporate Hygiene
Laundry List of Missteps for the Unwary :
• Contract (mis)management
• Not keeping track of agreements or
important terms
• Not seemingly important until there is
a deal in play and the other side is
asking questions
17. klgates.com 17
Good Corporate Hygiene
Laundry List of Missteps for the Unwary :
• Grabbing the Company by its Crown
Jewels:
• Startup with key consultant developer
• Startup did not have proper
agreements to protect IP developed by
consultant
• Agreement contained fine print giving
rights to discoveries by consultant to
consultant and not company
18. klgates.com 18
Good Corporate Hygiene
Laundry List of Missteps for the Unwary :
• Grabbing the Company by its Crown Jewels:
• Resolution:
• Negotiated settlement with consultant
• Key Takeaways:
• Protect the Crown Jewels – Document your rights
• CIIAAs / PIIAAs
• Know the devil in the details in agreements you
sign with consultants, venders, etc. Read the fine
print
• States laws differ – may need specific language
tailored to specific state’s laws to be enforceable
• Again – resolution cost significantly more than
necessary
19. klgates.com 19
Preparing for Your First Deal
Prepare before your start preparing:
• Organization
• Answer the investors questions before they
ask them
• Set up your documents, data room, etc.
before you sign your term sheet.
• Use advisors efficiently
“Before anything else, preparation is the key to success.”
Alexander Graham Bell
20. klgates.com 20
Diligence
The Snack Food SNAFU:
• Snack food company approached by
distributor looking for new snack food
• Company negotiates verbal deal with
distributor and starts working on initial
order of 500K snack products
• Distributor fronts costs for new equipment
• Company finally gets around to calling their
lawyer to “document their deal”
• Disaster ensues at meeting
21. klgates.com 21
Diligence
The Snack Food SNAFU:
• Resolution:
• Company couldn’t deliver on order
• Had to pay distributor back for advances
costs for equipment
• Key Takeaways:
• Do your diligence before you enter into a deal
• Misstep cost company its largest order and any
future orders it may have received
22. klgates.com 22
Parting Thoughts…
Spend the time upfront to organize your
startup and establish procedures and
organizational habits that will make future
transactions more efficient and less costly
