Incorporationand other early-stage legal issues

August 11, 2009

Yoichiro (“Yokum”) Taku Jesse ChewDirect: (650) 354-4251 Direct: (650) 565-3839ytaku@wsgr.com jchew@wsgr.comwww.startupcompanylawyer.com

Troy FosterDirect: (650) 565-3600tfoster@wsgr.com

DOC# 2

When do I need to incorporate a company?

• Pitching investors at TheFunded Founder Institute• More than one founder working on project• IP creation• Hiring employees or third party contractors• Option grants• Launching product/service• Corporate liabilities (i.e. office lease)• Start long-term capital gain• Visa issues

DOC# 3

What situations might require special consideration?

• 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

• Most of the business is non-U.S.• Pre-incorporation agreements

DOC# 4

What documents should I review if I still am employed?

• Offer letter• Proprietary Information and Invention Assignment

Agreement• Conflict of interest policy• Other employee documents

DOC# 5

What if I already incorporated a company?

• If non-DE corporation, then create a DE parent holding company using Founder Institute form documents

– Eventually dissolve existing corporation before end of year• If DE corporation, then amend and restate Certificate of

Incorporation using Founder Institute form documents• If investors or non-founder equity holders, then probably leave

things alone unless something is broken

DOC# 6

Why shouldn’t I incorporate an LLC?

• Venture capital investors do not want Unrelated Business Taxable Income and cannot invest in LLCs

• Stock options difficult to grant• Complicated to mimic typical preferred stock rights in an LLC

operating agreement• Attorney fees are higher

• S corporations are okay until they have entity shareholders

DOC# 7

What happens during the incorporation process?

• Founder needs to sign WSGR engagement letter and provide a check to cover out of pocket expenses

• Founder fills out incorporation questionnaire• WSGR reviews to ensure completeness• WSGR checks for obvious trademark issues on

name and sends summary report• WSGR provides founder with customized

incorporation documents

DOC# 8

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, confidential information,

invention assignment and arbitration agreement

DOC# 9

What incorporation documents are created? (continued)

• Equity incentive plan• Stock option agreement• Restricted stock purchase agreement• Indemnification agreement

• WSGR will also provide forms of offer letter, consulting agreement and NDAs as part of incorporation process

DOC# 10

What happens during the incorporation process? (continued)

• Founder signs certificate of incorporation– WSGR files with Delaware Secretary of State– Confirmation back within 24 to 48 hours (expedited filing

available) • Other documents signed• Founder obtains employer identification number (IRS)• Open bank account• Deposit checks for founders stock• 83(b) filing – founder responsible (WSGR will NOT file)• Securities law filings (WSGR will file)

DOC# 11

Should I worry about trademark issues?

• Do you own research before deciding on a name• Please review WSGR Guide to Trademark Issues for a New

Company which we will send with initial company name screening (or online below)

– http://www.startupcompanylawyer.com/2008/03/07/what-trademark-and-other-legal-issues-are-involved-in-selecting-a-company-name/

• Please fill out business description in incorporation questionnaire• Basic WSGR trademark search to avoid any obvious issues (~$400)

– Included in incorporation process for Founder Institute companies

• In-depth search (~$1300)• Trademark application ( ~$4500)

– If not controversial

DOC# 12

What should the company’s capitalization table look like?

• 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 5,000,000 shares of Class A common authorized for future issuances

DOC# 13

What happens if I have additional founders or need 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 of Incorporation if there aren’t enough authorized shares

• Need to amend and restate the Certificate of Incorporation to create preferred stock at the time of a financing

DOC# 14

What is Class F common stock?

• Super-voting (10 votes per share)• Election of Class F director (with 2 votes per

director)• Protective provisions• Convertible into Class A common stock

DOC# 15

What happens to Class F when investors invest?

• Companies like Google, Broadcom and at least one mentor company with top tier VCs has super-voting common stock

• Company potentially has additional leverage when negotiating with VCs (more chips to trade)

• All of these “founder favorable” provisions can be eliminated upon a financing, but it is simply a negotiation

• The best way to preserve some of these provisions is to outperform competitors because only elite companies will have real leverage

DOC# 16

How should founders stock vest?

• Stock is issued and voting, but subject to repurchase by the company if the founder is terminated 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 change of

control– Please note that this is very founder favorable

DOC# 17

What is in the restricted stock purchase agreement?

• Purchase price– Typically set very low (i.e. $0.001 per share)– May not be appropriate if founder is contributing

valuable IP

• Repurchase right/vesting/acceleration• Right of first refusal on transfers• Escrow of shares• IPO lockup• 83(b) election

DOC# 18

What are out of pocket costs of incorporation?

• Certificate of Incorporation– Delaware fees - $130– Filing service fees - $135– Accelerated filing available ($40 for 24 hour, $500 for two

hour confirmation)• Qualification to do business

– California - $350 (includes state and filing service fees)– Other states

• Agent for Service of Process– Delaware - $185– California - $185 (most use business address)– Other states

DOC# 19

What are out of pocket costs of incorporation? (continued)

• Securities filings– CA 25102(f) – ~$25 (depends on issue price)– CA 25102(o) – ~$200 (varies based on issue price)

Attached consent to service of process needs to be notarized

– Form D - $300 per state (rare)

• Franchise taxes– Delaware - $75 minimum + $25 filing fee– California - $800 minimum

• Recurring costs– Agent for service of process– State franchise taxes

DOC# 20

How do I keep incorporation costs to a minimum?

• Be educated• Completely fill out incorporation questionnaire

– Do not make WSGR ask for follow-up information

• Do not make changes– Every change requires time to revise documents

• Avoid custom drafting– Custom acceleration on termination without cause or

resignation for good reason

• Keep good records

DOC# 21

Why should I avoid online incorporation services?

• Documents generally need to be redone anyway• Most people ignore the package of paper they

receive after initial incorporation• No restricted stock purchase agreement to impose

founder vesting, right of first refusal on stock transfers, IPO lockup

• IP assignment clauses typically do not exist or are inadequate

DOC# 22

Questions

• Please read www.startupcompanylawyer.com first