Start-Ups & Financing

Crowdfunding Made Easy? Not So Much

October 1, 2013 | Structure Law Group, LLP

I have always known that Silicon Valley is home to many innovative companies and has a lot of entrepreneurial talent, but I was still amazed to read that start-ups in Palo Alto, Mountain View, Redwood City, Sunnyvale and San Jose received a combined $980+ million in funding in Q2’13. [Source: Silicon Valley Business Journal, July 16, 2013]. As a business lawyer in San Jose, I have seen a number of attempts to make fundraising for start-up companies easier. Recently, a new technique has come into favor.

The new buzz word for start-ups looking for funding is crowdfunding (sometimes known as crowdsourcing). In this type of deal, a group or entrepreneur will receive contributions from a large number of people for a project. The process started with artists raising money for their projects. Their success led for-profit companies to look at crowdfunding to raise money. Websites like kickstarter.com and indiegogo.com are just a few that provide crowdfunding opportunities.

To encourage crowdfunding, Congress passed the JOBS Act a year ago last September. In response, the Securities and Exchange Commission (SEC) released new regulations intended to encourage crowdfunding. One of the new regulations relaxes the public solicitation limitations that had been imposed for certain types of private financing deals.

New Corporate and LLC Startups May Find Relief with the Passage of a New Bill in California

July 15, 2013 | Structure Law Group, LLP

In Silicon Valley, home to many large technology corporations and thousands of innovative startups, businesses need to move quickly to stay ahead of the competition. As a small business attorney in San Jose, I have formed countless of limited liability companies (LLCs), partnerships and corporations with the Delaware and California Secretaries of State over the years. And one of the first questions my eager small business clients ask me in our initial meetings is almost always, “How long will it take to form my company?”

For many years my answer was that we could have the filed Articles of Incorporation (for a Corporation), Articles of Organization (for an LLC), or Certificate of Partnership within about a week. When the California Secretary of State slowed down a few years ago, I had to tell clients that it could take as much as several weeks. However, in the last year or so the delays crept up to three months or more for the California Secretary of State to process and return a business filing.

Of course, California does provide a 24-hour expedited filing option, for an additional $350 over the usual filing fees. In my more cynical moments I have had to wonder whether it was the California budget crisis that was causing filing times to slow down because of lack of resources, or if the Secretary of State was purposefully taking longer to return routine filings in order to force virtually everyone to pay the “rush” fees.

U.S. Market Entry – Legal Structures for Foreign Startups

June 13, 2012 | Structure Law Group, LLP

In my last blog concerning market entry into Silicon Valley by foreign companies, I discussed some of the basic issues and tasks surrounding the effort. As an attorney practicing corporate law and representing technology startup companies, I am often asked to assist in designing and implementing the legal structures that enable a foreign-owned company to access the US market.

There are a number of factors that guide a company’s decision to enter the US market. First, what is it trying to sell? Second, does the company hope to generate its return on investment through a cash-flow from sales, or by building value and ultimately selling the company or taking it public? Third, does it need funding from US private investors? Let’s look at how each of these factors guide entity form.

The first factor focuses on the best method for product distribution. If the company is trying to sell simple, commodity type products using an established distribution network, it may be able to get by with no entity at all. In other words, it can sell its products directly into the US through a distributor or independent sales representative. Even if the product is complex, but does not require a sophisticated domestic marketing, sales, or support organization, an independent sales representative could be used.

Is a B Corporation the Right Choice of Entity for Your New Company?

April 3, 2012 | Structure Law Group, LLP

I recently taught a program to California lawyers for the Santa Clara County Bar Association concerning B corporations, a subject I covered in a previous blog. As a Silicon Valley business attorney, with an increasing number of clients forming new companies, I want to discuss some attributes of these corporations that should be considered by anyone starting a new business.

The first consideration is whether becoming a B corporation will assist in a company’s funding and operations. B corporations arise from a national movement to allow companies to consider factors other than just profits and shareholder value in making their decisions. Certain types of investors and employees are drawn to companies that share similar values. Because of the attractiveness of value-driven organizations to these constituencies, start-up companies should strongly consider whether becoming a B corporation can provide them with a unique story when soliciting investment, and an edge when recruiting employees.

The second consideration is whether the goods or services “fit” with the concept of a B corporation. Fortunately, a B corporation does not necessarily need to exist solely to pursue its social goal. Almost any business can be a B corporation if it adopts the kind of public purpose that is required under one of California’s two B corporation statutes. For a “benefit corporation“, the purpose needs to one which creates a material positive impact on society and the environment, taken as a whole. For the “flexible purpose corporation”, the purpose needs to be one which could be pursued by a California nonprofit benefit corporation, or one which promotes or mitigates the effect of the corporation’s activities on the corporation’s stakeholder, the community or society, or the environment. The open ended nature of these purposes allows a wide variety of businesses to organize as a B corporation.

Because California created two different types of B corporations, you will need to consider which type of B corporation your new company should form. One way to approach this decision is to ask yourself how much the corporation should be forced to consider its public purpose. In the “benefit corporation”, the board of directors MUST consider the impacts of any action on the company in the short term and long term, and its shareholders, employees, customer, community, and environment, and its ability to accomplish its public purpose. This will force the board to deliberate very carefully, and will require your counsel to prepare corporate documentation carefully to record the board’s deliberations. By contrast, the “flexible purpose corporation” merely allows the board to consider its public purpose when making decisions, but does not require that furthering the purpose be a component of its decision.

In making your decision to conduct your business using a B corporation, you can avoid some common misconceptions. One common myth is that a B corporation needs to be certified. There is nothing in any of California’s B corporation laws that require any type of third party certification. There is, in the “benefit corporation”, a need to compare the efforts toward meeting public purpose to a third party standard, but this falls short of requiring actual certification. Another common question that often arises is whether B corporations are taxed differently. At this time, they are not. Of course, a B corporation does not need to be a nonprofit corporation for tax purposes.

In a future blog, I will cover one of the most critical considerations you face when adopting a B corporation – the disclosure of your company’s activities.

Proposed Filing Deadlines Could Impact Fundraising in California

March 6, 2012 | Structure Law Group, LLP

As a Silicon Valley business attorney, I often help small businesses and start-up companies in San Jose and Santa Clara with their financing transactions. Whether my client is a newly formed software corporation getting capitalization from its founders or an existing company trying to raise money by making a preferred stock offering, as my client’s business lawyer, I need to counsel them in their fundraising efforts to ensure that the company complies with securities laws.

However, a bill recently introduced in the California State Senate will make it harder for small businesses and start-up companies to raise money in California. The bill, SB 978, could eliminate a securities exemption commonly used in fundraising transactions and expose a company to fines, and its controlling persons to individual liability, if a certain filing is not completed in time.

A little background is helpful to understand why this bill is such a disaster. Fundraising to start or grow a company requires compliance with both state and federal securities laws. If an offering violates the securities law, anyone who purchased the securities in that offering can rescind their purchase and get their money back. The aggrieved investor can look to the company for return of funds, or can look to any of its controlling persons individually. If you are considered to be a controlling person of a company that misses a securities filing deadline for an offering, your house may be on the line.

Employment Basics for Employers – Employee Performance Reviews

October 4, 2011 | Structure Law Group, LLP

Silicon Valley is experiencing a “war for talent,” even as the nation struggles with unemployment. The Bay Area has not been unaffected by unemployment, but with the number of high technology startups based in cities such as Palo Alto, Mountain View, San Jose, and Santa Clara, companies are finding themselves competing for talent. The value of human capital is greater than ever, which is why it is essential for companies to perform assessments on their employees. Employees can be a company’s most valuable asset or its greatest liability.

Conducting employee performance reviews is one of the most important and often most dreaded tasks of management. Employee reviews take a lot of time and cause a lot of stress for managers even if the reviews are generally positive. Many employers try to avoid employee performance reviews. However, regardless of the size of your company, not conducting performance reviews can really hurt you both in productivity and in an increased risk of employment-related litigation.

I recently worked with a San Jose consulting business that was sued by a former employee of the corporation. The company had a salesperson in their Mountain View office that was drastically underperforming, but had never documented those failures in any way. The corporation eventually fired her and the salesperson then sued the company for wrongful termination. An employee file documented with poor performance reviews could have made that case go away much faster, and kept the settlement offers much lower. Below are some suggestions to make the most out of review time.

Merger and Acquisition Letters of Intent – Hold Me Back!

June 28, 2011 | Structure Law Group, LLP

Most letters of intent describing acquisitions in Silicon Valley, as elsewhere, will describe the material points of a transaction. Although a properly drafted letter of intent will provide that the business points of the deal are nonbinding, it is difficult in the course of any negotiation to change a business point already agreed upon. As a result, take care to describe those points that are most important to a transaction and to leave others to be negotiated as part of the definitive agreement.

The most important point is obviously the purchase price. This can be expressed, among other ways, as an absolute amount. If the transaction is a merger, the absolute amount is converted into a conversion or exchange rate based on the market value of the acquirer’s stock over a period of time preceding the closing.

It is very unusual for the price to be paid all at once. Typically, the amount ultimately paid will be subject to post-closing adjustments based on issues unrelated to financial performance (often referred to as a holdback) as well as issues related to financial performance or other milestones (often referred to as an earnout). These provisions must be considered very carefully, as they are often a source of litigation. This blog will only discuss the holdback.

Tax Break for Investors in Qualified Small Business Stock

May 16, 2011 | Structure Law Group, LLP

I was talking to a client in Cupertino this week about helping his friend with a start-up business in San Jose. Originally, my client wanted to form a corporation online by himself, but he was not sure if the company should be an S corporation (“S-corp”) or a C corporation (“C-corp”). He was only thinking about the pass-through implications of an S corporation and the “double taxation” of a C corporation, but was unaware of the small business stock tax exclusion in C corporations and the potential benefit to investors.

I explained that as an incentive to investors to make long term investments in small businesses, for investments made after September 27, 2010 but before January 1, 2012, 100% of the capital gain from qualified small business stock held for more than five years will not be taxed. The amount of gain excluded is the greater of $10 million or ten times the taxpayer’s basis in the stock (usually the amount paid for the shares).

To qualify for this incentive, there is a list of rules. The taxpayer must acquire the stock upon its original issuance for cash, property or services. The corporation must be a C corporation with a maximum of $50 million in assets, including the investment. It must not be a regulated investment company, real estate investment trust, real estate mortgage investment trust or other type of entity with special taxation, must not own investments or real estate with a value exceeding 10% of its total assets, must not own portfolio stock or securities with a value exceeding 10% of net assets, and must use at least 80% of the value of its total assets in the active conduct of a trade or business. The corporation’s trade or business cannot include professional services, banking, insurance, financing, leasing or the hotel or restaurant business.

Merger and Acquisition Letters of Intent – Don’t Hold Me To It

May 9, 2011 | Structure Law Group, LLP

Any Silicon Valley mergers and acquisitions lawyer helping clients buy and sell high technology companies is invariably provided with a simple letter of intent, happily signed by a couple of companies without input from their tax and legal advisors, and asked to prepare binding documents. In one case, my San Jose business client was not too worried about the lack of detail in the letter because, after all, it was just a “letter of intent”. She was less than happy when I told her that she had actually signed a binding agreement, particularly since very little due diligence had been performed on the target company and a number of ‘minor’ issues that were important to her still required resolution.

A letter of intent (also called “LOI”, or memorandum of understanding, or “MOU”) is usually a short letter that outlines the basic business terms of a deal. Without language expressly stating that the letter is nonbinding, and that no obligations arise except under a definitive agreement, however, that letter you signed may be a legally binding contract. Even with this kind of language, a letter of intent can morph into a binding contract IF the parties conduct themselves as if the target company has been acquired. Announcing a deal (when not otherwise legally required), combining operations before a closing, and similar actions, can create a contract from conduct. With no definitive agreement signed, the letter of intent may be used as evidence to set the terms of the deal.

Why do you want an LOI to be nonbinding? Letters of intent are usually prepared and signed after the initial business proposition and marketing analysis have been performed. They are typically signed before the acquirer has a chance to really investigate the target. This is because neither party will want to conduct an expensive diligence investigation until each is sure they have a deal. If the letter of intent is binding, then the acquiring company may find itself purchasing a lot of problems of which it wasn’t aware when it signed the letter of intent.

Convertible Notes

April 25, 2011 | Structure Law Group, LLP

Bridge financing for Silicon Valley start-up companies is a fairly standard, relatively inexpensive method to raising money pending a larger investment round. This type of financing is typically provided in the form of debt that converts into shares issued in the next funding round, often at a discount from the per share purchase price.

Recently, the simple convertible bridge loan has changed to provide substantial tax incentives to investors. For any qualified small business stock, or QSBS, purchased before December 31, 2011, the recently enacted 2010 Tax Relief Act allows 100% of the gain recognized from the stock to be excluded from taxable income.

Although a convertible loan will not qualify as QSBS, the stock that a start-up company issues normally will. Bridge loan investors have a great incentive to purchase stock in exchange for their bridge funds instead of a convertible note. Designing stock that has many of the same attributes as convertible debt has provided some additional complexities to what was formerly a plain vanilla transaction.