LEGAL ASPECTS OF START-UPS Jeffrey C. Robbins, Esq. Messerli & Kramer P.A. May 23, 2013 ©2013 Messerli & Kramer P.A.

LEGAL ASPECTS OF START-UPS

Jeffrey C. Robbins, Esq.Messerli & Kramer P.A.

May 23, 2013

©2013 Messerli & Kramer P.A.

THE IDEAL START-UP OPPORTUNITY

• Unique and protected technology• Substantial economic value to

real customers• Experienced management

team • Enough capital• Alignment of the stars

LAW TO ALIGN YOUR STARS

• Intellectual Property Protection• Company Formation• Attracting and Retaining Talent• Fundraising

PROTECTING IP• Patents– Identify all inventors and their rights,

including those of any research institution or the government

– File before publication or other public disclosure

– New “first to file” rules effective in March 2013

– Accelerated review ($2,400 forsmall entities)

– Avoid joint ownership– Consider foreign protection– Get license for third-party patents

PROTECTING IP

• Domain Name (pay attention to who owns it)

• Copyrights and Trademarks (federal, state and common law)

• Trade Secrets• Confidentiality Agreements

INVENTION ASSIGNMENTS

• Cover both employees and consultants (work for hire)

• Legal exclusions• Pay for the assignment

NON-COMPETITION AGREEMENTS

• Reference in any employment offer letter

• Type of employee• Geographic area and time period of

restriction• Payment for the agreement (continued

employment is usually inadequate)• Some states won’t enforce

BUSINESS ENTITY SELECTION

• Use of a Business Entity– Limited liability– Facilitates equity ownership– Tax advantages

• Types of Business Entities– Corporation – C versus S– Limited Liability Company

• Timing for Forming a Business Entity• Where to Form a Business Entity

MANAGEMENT

• Shareholders /Members• Board of Directors /Managers– Duties of loyalty and care

• Officers• Employees

STOCK• Common Stock – each share has equal

economic and voting rights• Preferred Stock – contractually defined

economic and voting rights– Special voting rights– Dividends– Liquidation preferences– Anti-dilution protection– Redemption rights

• Par value• Rights set out in Articles of

Incorporation

CONVERTIBLE NOTES

• Often used in early rounds when valuation is uncertain

• Investor typically gets to convert into the next round security at a price discount

• Mandatory versus option conversion

NEGOTIABLE DEAL POINTS

• Preemptive rights• Cumulative voting rights• Board/ shareholder action in writing• Tag Along/ Drag Along rights• Rights of First Refusal• Registration Rights• Buy-Sell Agreements

EQUITY INCENTIVES

• Allows employees, consultants and directors to share in upside of business growth

• Aligns business objectives• Can act as a “golden handcuff” to help

in retention of key personnel• May allow income (and tax) deferral to

later date• May convert ordinary income into

capital gains (taxed at lower rates)

EQUITY INCENTIVES

• Incentive Stock Options– Employees only– Exercise price = fair market value– $100,000 vesting maximum per year–Maximum 10-year term– 90 days to exercise after leaving

employment• Non-Qualified Options• Cashless Exercise• Restricted Stock– Section 83(b) election

FUNDRAISING 101WHAT IS A SECURITY?

WHAT IS A SECURITY?

WHAT IS A SECURITY?

Investment of MoneyCommon Enterprise

Expectation of ProfitsEfforts of Others

CROWDFUNDING IS HERE!

But What Does That Mean?

CROWDFUNDING V1

CROWDFUNDING V2THE NEW JOBS ACT

FIVE THINGS TO KNOW

Offering Limit:

$1 million in 12 months

FIVE THINGS TO KNOW

Investor Limits:

Annual income/net worth < $100,000, limit is greater of $2,000 or 5%

Annual income/net worth ≥ $100,000, limit is lesser of $100,000 or 10%

FIVE THINGS TO KNOW

Funding Portals:

Companies must sell through a portalRegistered with the SECHandles funds for the companyPosts company disclosure information

FIVE THINGS TO KNOW

Company Requirements:

Disclosure, including annual reportingFinancial information:-- tax return/financials ≤ $100,000-- reviewed financials ≤ $500,000-- audited financials > $500,000Only can direct investors to the portal

FIVE THINGS TO KNOW

Timing:

SEC had 9 monthsto issue crowdfunding

regulations

CROWDFUNDING IN SUMMARY

Can’t raise much moneyExpensive audit and reporting requirements

Too many shareholders

Not Angel Investor orEntrepreneur Approved

HELLO TO GENERAL SOLICITATIONOF ANGEL INVESTORS

THE CURRENT WORLD

THE ACCREDITED INVESTOR

• Net Worth -- $1MM Excluding Home• Three-Year Income -- $200,000• Three-Year Joint Income -- $300,000

THE PRIVATE PLACEMENT

Unlimited Dollar AmountUnlimited Accredited InvestorsMaximum of 35 Non-Accredited InvestorsNo Public Solicitation of InvestorsPotentially No Mandated Disclosure

(but risk factor disclosure is important)Only a Notice Filing with the SEC

THE JOBS ACT NEW WORLD ORDER

But only for accredited investors(proposed regulations)

IF EVERYONE KNOWS

IF EVERYONE DOESN’T KNOW

TIMING

Angel Dollars Invested Q3 2012

Presentation may constitute public solicitationTalk about your business and not about financingFollow-up only with investor prospects that are “accredited” investors

NETWORKING EVENTS

MN ANGEL TAX CREDIT

25% MN individual income tax credit for Qualified Investments in Qualified Companies by Qualified Investors or Qualified Funds

Qualifying Is Key!!

MN ANGEL TAX CREDIT

Qualified Investments:

-- Cash only-- At least $10,000 ($30,000 if a fund) in a single calendar year-- Purchase equity or mandatorily convertible debt-- Three-year holding period

MN ANGEL TAX CREDIT

Qualified Companies:

-- Headquarters in MN-- 51% of employees and payroll in MN-- Under 25 employees-- Pay minimum qualifying wages-- Business in qualifying high tech/proprietary fields-- Not more than 10 years of operations-- Not more than $4MM of prior equity investments that qualified for the credit

MN ANGEL TAX CREDIT

Qualified Investors:

-- Must be an individual-- Must be certified by the State-- Can be either an “accredited” or “non-accredited” investor-- $10,000 minimum investment

MN ANGEL TAX CREDIT

Qualified Funds:

-- Must have at least three members-- Must be organized as a pass-through entity-- Must be certified by the State-- $30,000 minimum investment

MN ANGEL TAX CREDIT

Company Administrative Requirements:

-- Must pre-clear investment-- Must report investment-- Must do annual reporting

Failure = Company Giveback of Credit

MAKE SUREThe company is registered

The investor registeredThe proposed investment is registered

The actual investment is reportedThe company complies and reports

annually

TOO LATE FOR 2013 2010* 2011 2012** 2013*** certified/invested certified/invested certified/invested

certified

Businesses: 112 / 67 176 / 113 190 / 117 175

Investors: 75 / 258 623 / 563 511 / 465 362

Funds: 5 / 4 21 / 21 19 / 17 19

Amount invested: $28M $63.2M $46.2M$50.8M

Credits issued: $7M $15.8M $11.4M $12.7M

2014: $12.0M credits available* 2010: July launch-Dec** 2012: January-July 24*** 2013: January-May 9

YOUR QUESTIONS?

For further information, contact:

Jeffrey C. Robbins, Esq.Messerli & Kramer P.A.

100 South Fifth Street, Suite 1400Minneapolis, Minnesota 55402

(612) 672-3706 office(612) 940-6660 cell(612) 672-3777 fax

[email protected]