The High-touch Legal Services® Blog • For Startup Companies

WSJ: How to Ask Friends and Family for Money

Dana — Tue, 22 May 2012 15:58:33 +0000

Yesterday the Wall Street Journal published an informative piece about asking people you know and love for a loan (Do’s and Don’ts of Asking Friends for Money). Here is a recap of the tips offered by experts quoted in the article:

Put yourself in the lender’s shoes.
Borrow the money as you would from a bank.
Bring in a lawyer to draw up the agreement.
Ask for more money than you think you need.
Assume the worst.
Remember “Hamlet”. ["Neither a borrower nor a lender be...."]

Dana H. Shultz, Attorney at Law +1 510 547-0545 dana [at] danashultz [dot] com
This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact a lawyer directly.

What is a Quasi-California Corporation?

Dana — Thu, 17 May 2012 01:10:09 +0000

This post is the result of my research on the duties of a director of a Delaware corporation that is located, and doing much of its business, in California. Specifically, I wanted to confirm that California law governed those duties.

Corporations Code Section 2115 addresses non-California corporations for which (a) most voting shares are held by shareholders in California and (b) the average of the following three factors exceeds 50% (excepting many publicly-held corporations):

The percentage of its property that is located in California
The percentage of its payroll that is paid in California
The percentage of its sales that take place in California

Such corporations are known as quasi-California corporations because, pursuant to Section 2115, they are subject to the following provisions of the California Corporations Code, even if these provisions conflict with the laws in the state of incorporation:

Chapter 1 (general provisions and definitions), to the extent applicable to the following provisions;
Section 301 (annual election of directors);
Section 303 (removal of directors without cause);
Section 304 (removal of directors by court proceedings);
Section 305, subdivision (c) (filling of director vacancies where less than a majority in office elected by shareholders);
Section 309 (directors’ standard of care);
Section 316 (excluding paragraph (3) of subdivision (a) and paragraph (3) of subdivision (f)) (liability of directors for unlawful distributions);
Section 317 (indemnification of directors, officers, and others);
Sections 500 to 505, inclusive (limitations on corporate distributions in cash or property);
Section 506 (liability of shareholder who receives unlawful distribution);
Section 600, subdivisions (b) and (c) (requirement for annual shareholders’ meeting and remedy if same not timely held);
Section 708, subdivisions (a), (b), and (c) (shareholder’s right to cumulate votes at any election of directors);
Section 710 (supermajority vote requirement);
Section 1001, subdivision (d) (limitations on sale of assets);
Section 1101 (provisions following subdivision (e)) (limitations on mergers);
Section 1151 (first sentence only) (limitations on conversions);
Section 1152 (requirements of conversions);
Chapter 12 (commencing with Section 1200) (reorganizations);
Chapter 13 (commencing with Section 1300) (dissenters’ rights);
Sections 1500 and 1501 (records and reports);
Section 1508 (action by Attorney General);
Chapter 16 (commencing with Section 1600) (rights of inspection).

Note: California courts will enforce these provisions against quasi-California corporations, but courts in other states may not.

How Can I Make Sure I Receive My Full Royalty?

Dana — Thu, 26 Apr 2012 23:00:58 +0000

Intellectual property license agreements often include a provision by which the licensor is paid a royalty that is calculated as a percentage of the revenue received by the licensee from licensed products. Given that licensees have a financial incentive to reduce the amount of revenue that is reported*, the prudent licensor includes an audit provision in the license agreement.

The audit provision typically:

Specifies the frequency and nature of audits that may be conducted;
Provides that the licensee will pay any underpayment amount that is discovered plus interest; and
Obligates the licensor to pay for the audit unless the underpayment exceeds X% of the royalty that was due, in which case the licensee must reimburse the licensor for the cost of the audit.

Here is a sample audit provision:

During the term of this Agreement and for two years thereafter, Licensee will keep full, true and accurate records containing information required to confirm all amounts payable to Licensor hereunder. Upon reasonable notice, Licensor or its accountant may inspect and audit said records on an annual basis during normal business hours to verify Licensee’s payments hereunder and compliance with this Agreement. Licensor will bear the fees and expenses of such inspection and audit unless same reveals that Licensee has underpaid Licensor by at least 10% during any calendar year, in which case Licensee will promptly reimburse Licensor for such fees and expenses

* The cynic’s view of licensing: Licensors lie and licensees cheat.

Check out all posts about licensing.

Photo credit: Darren Shaw via stock.xchng

You Can’t Use “Corp” in the Name of an LLC (in CA or NY)

Dana — Tue, 24 Apr 2012 00:29:49 +0000

This post is based on a question that I answered on Quora. (The answer focuses on NY, because that was the questioner’s state, and CA, because that is where I practice.) Q. Can I use the word “Corp” in the name of an LLC (for example, AcmeCorp LLC or WhateverCorp LLC)?

A. No. NY LLC Law Section 204(e) states, inter alia, that the LLC name may not contain “corporation” or “incorporated” or any abbreviation or derivative thereof. This prohibition is not unique to NY. California Corporations Code Section 17052(d) has a similar prohibition for LLC names.

Check out all posts about LLCs.

SVForum East Bay Series: Improving Fundability with Social Media

Dana — Sat, 14 Apr 2012 03:35:28 +0000

The evening of Wednesday, April 18, I will moderate SVForum’s East Bay Series program “Improving Fundability with Social Media”.

Program description:

Social media such as Facebook, Twitter, and Google+ have clearly woven themselves into the very fabric of our personal and professional lives. Their simple and intuitive user experience, and the effective and efficient means they provide to connect people, brands, and consumers are transforming the very way business is conducted. It’s natural that so much of the innovation funded by the venture community is connected in some way with Social Media, whether it’s to reach customers, respond to service issues, or build buzz about new products and services. Our panel will discuss how companies are adopting–and adapting these platforms to increase traffic, conversions, and profit as they extend relationships and make every interaction part of their experience -– and how entrepreneurs can take advantage of this trend to build successful new products and ventures. Join us and learn how having a Social Media platform can impact or improve your start-up’s potential for raising critical funding.

Panel members will include:

* * *

Update: A summary of the event has been prepared by John Mulvihill.

Why You Shouldn’t Use a Finder to Find Venture Capital

Dana — Tue, 10 Apr 2012 02:46:42 +0000

I recently spoke with three startup entrepreneurs who had just retained a finder to locate venture capital in exchange for an equity stake in the form of warrants (the right to purchase shares at a specified price by a specified date). They got very nervous when, after reading their agreement with the finder, I told them the business and legal reasons why retaining the finder was a bad idea:

The finder would start by sending nondisclosure agreements to targets – but VCs generally will not sign NDAs and are likely to think the entrepreneurs don’t know what they are doing.
The finder then would send an Executive Summary to each VC. But virtually no ExSum that is sent to a VC cold is read, let alone responded to.
Next, the finder would make follow-up calls to the VCs. But such follow-ups will be of little, if any utility. The way to get to a VC is via an introduction from someone that the VC knows and trusts. Furthermore, VCs who are interested will not want the finder’s answers to questions – they will want to talk to the entrepreneurs.
More fundamentally, VCs will be suspicious of, and will have little interest in engaging with, entrepreneurs who use finders. The typical VC believes that if you cannot figure out a way to be introduced by someone that the VC knows, you don’t have what it takes to build a successful business.
The finder’s form of warrant agreement gave him anti-dilution protection – a feature that would turn off many VCs and would make them think, again, that the entrepreneurs don’t know what they are doing.
The finder required that the entrepreneurs indemnify him against any claims associated with his activities, even if the claims arise from the finder’s negligence.

A look at the finder’s website helped explain his inappropriate, counterproductive approach: He normally provided investment banking services to established companies seeking up to $100 million – a far cry from the needs of this startup.

So, while the lack of fit made this finder worse than most, the fundamental principle still remains: A finder is unlikely to help you find venture capital, and may cause you more harm than benefit.

Photo credit: Brith-Marie Warn via stock.xchng

Dana H. Shultz, Attorney at Law +1 510 547-0545 dana [at] danashultz [dot] com
This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact a lawyer directly.

What Happens if the Board Doesn’t Approve My Stock Options?

Dana — Wed, 04 Apr 2012 02:25:09 +0000

This post is adapted from a question I answered on OnStartups. Q. I’ve been working for a large private company, and my offer letter said I would receive X number of options as long as the board approved it. It’s been a year and I’ve been stonewalled on the option plan. I’ve sent multiple emails to HR and the controller and the CFO. HR has gotten back to me, but their hands are tied. Can I send a letter and a check to the CFO with $100 to force the issue of exercising some amount of shares and determining the strike price that way?

A. Unfortunately, “subject to board approval” is a common contingency for stock option grants. At this point, I’m not sure there is much you can do about it.

Last year I represented two founders whose small company was purchased by a large software company. A sizable portion of the payment price was in stock options, which had a board approval contingency. I asked the acquirer’s lawyer, “What happens if the stock option grant is not approved?” A couple of days later, he forwarded a copy of the board’s resolution approving the grant. It appears, regrettably, that your situation does not nearly give you that much clout.

Why Does the Other Party Want to Apply NY Law?

Dana — Fri, 30 Mar 2012 23:19:48 +0000

This post is based on a question that I answered on OnStartups. Q. I’m in the process of closing a deal with a new client, and the only sticking point is the choice of applicable law. I am located in state A, the client in state B. My contract says it will be governed by the law of state A. The client wants to change this to New York. Why? Would doing so open my company up to any unintended side effects/liabilities (e.g., taxes)?

A. The reason for the change is precisely because NY law is neutral (neither A nor B), not to mention well-known and well-respected. As a result, the choice-of-law issue disappears – neither party wins, and neither loses on this negotiation point. In other words, the other party is removing this issue in an effort to reach agreement.

Don’t spend time or money worrying about unintended side effects / liabilities – you probably cannot readily determine whether they exist or what they are at this time, or which party they would favor, and they probably are not material, in any event.

The issue you didn’t mention is whether there is a forum-selection clause – i.e., whether the parties agree to (perhaps exclusive) jurisdiction and venue in A or B. That’s the provision that gives one party a noticeable tactical advantage if litigation occurs.

Equity-Based Crowd Funding: Pro and Con

Dana — Tue, 20 Mar 2012 02:55:59 +0000

Congress is considering legislation by which the Securities and Exchange Commission would lift limits on private equity investments, letting companies sell equity interests to investors online (“crowd funding”). Today the Wall Street Journal published a debate on this topic (Should Equity-Based Crowd Funding Be Legal?).

Some of the arguments in favor:

In an era of tight capital, small businesses need access to more investors.
The Internet can provide millions of potential investors to companies at little cost.
Those potential investors, in turn, will have the potential for investment returns that previously were limited to a relatively few well-heeled angels.

Some of the arguments against:

Many companies will not have audited financial statements, creating a risk that companies will portray themselves more favorably than is justified.
Managing lots of small, unsophisticated investors can create significant administrative overhead.
If a company can’t attract traditional angel investors, then it probably is not a good equity investment for the crowd.

My thoughts:

I would be concerned for both naive entrepreneurs and naive investors if effectively-unrestricted crowd funding were allowed.
However, if equity-based crowd funding were subject to reasonable limits on the amount invested and required certain disclosures by the company, I would feel more comfortable.
Furthermore, legislation could provide incentives for companies to behave properly by providing a “safe harbor” against certain types of liability if such limits and disclosures were complied with and if certain provisions were included in stock purchase agreements.

* * *

Update: On April 5, President Obama signed H.R. 3606, the Jumpstart Our Business Startups (JOBS) Act. Title III of that legislation is called the “Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act of 2012″ or the “CROWDFUND Act“.

The CROWDFUND Act permits equity-based crowd funding subject to certain restrictions, such as limits on the total amount raised and the amount raised from any single investor, and the the offering be conducted via a broker or funding portal (an intermediary that exists specifically for the purposes of the CROWDFUND Act). Furthermore, the issuer must make financial and other disclosures.

The Securities and Exchange Commission is seeking public comments as it develops regulations to implement the JOBS Act.

Should I Send Myself Notice of Annual Meetings?

Dana — Sat, 17 Mar 2012 00:15:56 +0000

This post is adapted from an OnStartups.com question that I answered. The questioner wondered whether, as sole shareholder of a corporation, he needs to give himself notice of annual shareholder meetings.

Q. If I am the only shareholder in a corporation, do I have to give myself notice of annual meetings? It seems silly that I would have to notify myself, but is this required to stay legal?

A. While is certainly is possible to provide notice to yourself, there are at least two commonly-used ways to avoid that task:

By attending the meeting (other than to object to its being held without notice), the shareholder consents to the meeting being held and waives any objection pertaining to lack of notice.
In many closely-held corporations, shareholders dispense with the fiction of actually holding an annual meeting and, instead, prepare and sign a Unanimous Written Consent in Lieu of Annual Meeting.

Check out all posts about annual meetings.