PowerPoint Presentation

Prepare Your Startup for Funding: Equity and Cap TablesEntrepreneurial Law Clinic at Drexel University Thomas R. Kline School of LawFall 2015

1

Thank You to Our Sponsors

2

Presenters: Antonio Bonanni Tony Cassese Ernie Holtzheimer John KrajsaPanelists: Jeffrey Bodle, Morgan Lewis Justin Watkins, Drinker BiddleClinic Director: Steve RosardSlides available at slideshare.net/drexelelc/presentations

3

Presentation AgendaIntroductionStart-Up Initial Capitalization TableHiring of Contractors & EmployeesUpdated Capitalization TableConvertible NoteUpdated Capitalization TableSeries A FinancingUpdated Capitalization TableOverview of Cap Table Resources

4

What is a Cap Table?A capitalization (cap) table lists who owns what in a startup. It lists the companys members and their units.As your company grows, tracking ownership can become more complicated.

5

Start of the CompanyJohn, Tony and Paul founded a company at Start Up Weekend.They name it Dragon-Ware, and incorporate as an LLC.John has a business background and invests a $50,000 loan from his father into the business. His units are not subject to vesting.Tony is a developer and works part-time for another software company. His units are subject to vesting.Paul is also a developer, works hard on the software for four months, and then disappears.

Early ProblemsFounders often feel they dont have time for paperwork or money to pay for legal counsel.However, the freewheeling lifestyle of a startup can create due diligence problems for the future.Lost negotiating traction when dealing with future investors.

Ghost FoundersPaul left after four months and John and Tony have continued on without him. Does that end all liability?Oral contractsImplied contracts

Undocumented LoansHow will you structure your loans from family or friends?

Are they investing in the company or are they lending the money personally?

Equity or debt?

Closing the Loopholes: Key DocumentsFounders AgreementsDecide voting, buyouts, terminations and deadlocksSubscription AgreementsVestingIP AssignmentsOperating AgreementAuthorized Classes and Numbers of Units.

Initial Cap Table

Questions for our Experts:What are some of the most easily avoidable mistakes that founders make right off the bat, and how do they affect investment later on?Why should you start a cap table before your business gets more complicated?

12

John and Tony are looking to hire:An Independent ContractorAn EmployeeHow can they pay them in equity?Hiring

13

Hiring

14

The Non-Dilutible ProblemTony and John own 80%New hires own 20% non-dilutible togetherNew Investor brings in $1,000,000 for 50% of the company.

15

The Non-Dilutible Problem

16

The Non-Dilutible Problem

You have to be fair!Majority HolderMinority Holder

17

The Option PoolOption PoolUnits (shares) reserved for future employees, advisors, etc.Option PlanRule 701 Exemption from Securities Act

18

Unit OptionsWhat is it?Right to buy company units in the future at a specified price.(Holder must pay to exercise)Example:Option to purchase: 50000 units (5%)Strike Price: $0.01 (Fair Market Value)Length: 10 Years

19

Common UnitsTony and John give Independent Contractor 5% of common unitsNOTE: If given equity subject to vesting- make 83(b) election.Pay tax now, instead of later

Vesting Schedule50,000 Units over 4 years.Leave after two years = 25,000 Units 1 year cliff?Leave before one year = 0 Units

Profit InterestsOnly for LLCs, not for CorporationsCommon Units Tax Problem5% of $1,000,000 = $50,000Share in the company profits.

22

Ownership Allocation

23

The Story ContinuesEmployee leaves after 18 months without exercising options

24

The Story Continues

Questions for ExpertsWe discussed a few ways founders can issue equity in lieu of money to new hires. What types of structures have you found to be most effective?Have you seen any effective ways in which employees have been able to protect themselves from dilution?

26

Convertible NoteRaised 18 months into the business operationsTerms:$100,000 investment30% discount$2,500,000 valuation capConverts upon a Qualified Financing of $750,000

27

Updated Cap Table

28

Questions for our Experts:Have you seen more entrepreneurs choosing to raise convertible debt at early stages? Why or why not?Is there a better way to structure the investment, for instance as a Simple Agreement for Future Equity (SAFE)?

29

Series A FinancingCompany needs to raise money for hiring more employeesRaising $1,000,000 with a $3,000,000 pre-money valuationConvertible note will convert at 30% discountVC wants the following:Employee Option Pool increased pre-moneyDue Diligence Issues:One founder isnt vestingNo IP Assignment Agreement for independent contractorNo documentation of $50,000 loan

30

Series A Financing (Continued)Key Terms of Series A FinancingFully diluted v. Non-diluted Cap TablePre-money valuationLiquidation PreferenceMultiples & ParticipationBoard of DirectorsDividendsCumulative and accrued v. When and if declaredBe sure to have counsel represent you when raising money!

31

When Raising Money:Several Factors to Consider:No definite amount determine your true need for the investmentAmount of time before the investment is neededHow long you expect funding to lastExample: Get Satisfaction Raised $10 million at a $50 million valuationSold to Sprinklr for an undisclosed amount

32

Updated Cap Table

33

Questions for our Experts:What are some of the most common surprises youve seen amongst entrepreneurs while raising money?

What are some of the downfalls of raising money at too high of a pre-money valuation?

34

Why Use a Cap Table Service?Consistency (Avoid Mistakes)Can happen at any levelTibco Software Inc. The $100 Milllion MistakeSecurity and FunctionalityWhat if the person with the Cap Table leaves?View v. Edit CapabilitiesComplianceMake your Cap Table a toolTax Compliance/Reminders

35

Panel Experts:Have either of you or your clients used Cap Table Management Services?

36

Cap Table Management ServicesCapsharehttps://www.capshare.com/eShareshttps://www.esharesinc.com/Captable.iohttps://captable.io/home.htmlOthers

37

Consistency (Avoid Mistakes)Regardless of how many cooks get into the Cap Table, it will have the same look and feelEx: CapsharesView v. Edit CapabilitiesAs the business grows, so does the Cap TableNo problems with switching over when the table has become more complex or having the company outgrow its Cap Table abilitiesEx: eSharesMonthly pricing that grows with your needs

38

Security and FunctionalityFrom Terms to TableThere are A LOT of Economic Terms in a Term Sheet or Employment AgreementDividendsVestingConversion DiscountsLiquidation Preference

What do these terms really cost me in an exit?Ex:Captable.ioUser Friendly Exit Modeling

39

ComplianceAdditional ServicesTax and Security Regulations Services409A (Deferred Compensation)83(b)Compliance in Issuing OptionsRule 701Stock Expense ReportsDocument HubKeep a copy of any subscription agreements online with you Cap Table

40

Panel Experts:What are some latent issues that you have found with your clients that ended up costing them more down the line as opposed to catching and fixing them early on?

41

Prepare for Tomorrow, TodayTime = MoneyMaintaining your own Cap Table often takes hours and requires significant effort as the company growsSee eShares: DemosEarly issues can create big problems laterLatent errors can cost $$$ in the long runTibco$100 Million Cap Table DiscrepancyFelt by Shareholders (You)

42

Which Service is Best for My Company?Factors:How many shareholders?How mature is your current Cap Table?When and how do you plan on taking investment?What accounting/tax requirements do you need to meet?How experienced are you with Cap Tables?

43

Who Should I Use?Least Expensive (For Most)Capshare: Free Lite service if under 25 Shareholders/MembersContinual LearningeShareExit Modeling (More Mature Companies)Captable.ioIn General: Shop Around, Ask Questions

44

Thank You to Our Sponsors

45

Thank You to Our Audience

Apply to be a client at www.drexel.edu/law/ELC

46