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BEST LEGAL PRACTICES

BEST

LEGAL

PRACTICES

BEST LEGAL PRACTICES

2016

BEST

LEGAL

PRACTICES

2016 BEST LEGAL PRACTICES
TABLE OF CONTENTS BEST 10 22 40 48 LEGAL PRACTICES 3 Introduction WHAT LEGAL WHAT

TABLE OF CONTENTS

BEST

10

22

40

48

LEGAL

PRACTICES

3

Introduction

WHAT LEGAL

WHAT DO I NEED

WHY AND

HOW SHOULD I

4

About MassChallenge

ENTITY SHOULD

TO KNOW ABOUT

HOW CAN WE

STRUCTURE OUR

5

About Greenberg Traurig

I FORM?

FUNDRAISING?

PROTECT OUR IP?

EQUITY?

and Arturo Pérez

 

7 Introduction

13

Introduction

22

Introduction

26

Introduction

5

Special Thanks to…

 

8 Different Legal Entities

13

How do valuations

23

Explanation of

26

Employee Option Pool

6

Disclaimer

Explained

work?

the Four Types of IP

 

27

Vesting Explained

 

9 Analysis of Different Legal

14

Explanation and

24

IP Protection Checklist

Structures

Analysis of Terms

29

Taxation on Shares in the Event of a Liquidation Event

 

25

IP Assignment

 

22

Do’s and Don’t’sDon’ts’s

Clause Template

 

25

Privacy Policy Template

4

MASSCHALENGE | GREENBERG TRAURIG

MASSCHALENGE | GREENBERG TRAURIG

5

INTRODUCTION

The entrepreneurial ecosystem in

Mexico has grown rapidly since 2008.

The amount of startups, acceleration

programs, as well as investment capital

funds has quickly expanded. Mexican

startups have received series A and

series B funding; they are expanding

throughout LATAM and entering other

economies and the US. Although the

ecosystem has grown, there is still

a lack of legal content specifically targeted to Mexican startups.

6 MASSCHALENGE | GREENBERG TRAURIG

MassChallenge and Green-

berg Traurig have partner

together to create this study

that will allow entrepreneurs

and startups have a deeper

understanding in the following

relevant issues in their entre-

preneurial development: (a)

where and what type of entity

shall the startup form depend-

ing on their goals; (b) fundrais-

ing, what to take into account

when negotiating term-sheets;

(c) IP Protection and (d) how

to and when to structure an

option pool for employees.

As part of the study we

interviewed founders of early

stage and later stage startups,

venture capital firms as well as

lawyers. We asked questions about what they wished they knew, what they should had known and areas that should be taken into account. This in- put helped us as a guideline to understand were the biggest gaps of knowledge were and

how to approach them in this

document.

Our objective with this

project is not to give legal ad-

vice, but to help entrepreneurs

understand areas to be taken

into account in the different

stages of development of their

startup. We want them to have

a clear understanding of the

legal implications on where

they want to go, how they

want to grow, who they want

to partner up with, and under

which terms. We are providing

legal information for educa-

tional purposes only, not as

legal advice.

We hope this document

helps build the basis for a more prepared generation of startups, but most of all helps to build a better and improved entrepreneurial ecosystem.

MASSCHALENGE | GREENBERG TRAURIG

7

About

MassChallenge

M assChallenge is the most start-

up-friendly accelerator on the planet. No equity and not-for-profit, we are

obsessed with helping entrepreneurs

across all industries. We also reward the high-

est-impact startups through a competition to

win a portion of several million dollars in equi-

ty-free cash awards. Through our global net-

work of accelerators in Boston, the UK, Israel,

Switzerland, and Mexico, and unrivaled access

to our corporate partners, we can have a mas-

sive impact – driving growth and creating value

the world over. To date, 835 MassChallenge

alumni have raised over $1.4 billion in invest-

ment, generated over $575 million in revenue,

and created over 50,000 jobs.

MassChallenge works with some of the

world’s best brands to help them innovate with

startups. Top corporate partners in Mexico in-

clude: SEDECO, FONDESO, INADEM, Gentera,

Greenberg Traurig, Aeromexico, and Promotora

Social México.

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MASSCHALENGE | GREENBERG TRAURIG

About Greenberg Traurig

G reenberg Traurig helps clients bridge diverse legal systems and cultures, with a focus on efficient and ef- fective strategic advice and legal services. Greenberg Traurig’s growth to 2000 lawyers and 38 locations is an

example of the firm’s instincts for leveraging a changing market-

place. The need for lawyers to help clients navigate change con- tinues to escalate. For Greenberg Traurig, merging with other law firms to be in new markets overnight is not the way to respond to

the market need. Preserving the firm’s “built for change” culture

is. The firm’s leaders travel across the country handpicking law-

yers with the talents to guide clients through the very moments

their businesses and markets are changing most. It is this rare

combination of talents around which we relentlessly hire – legal,

business and leadership skills. That’s why we refer to Greenberg

Traurig lawyers as “3-D lawyers.”

About Arturo Pérez

A rturo Perez-Estrada is a corporate partner in the Mexi-

co City office of Greenberg Traurig. He focuses on the

representation of domestic and international compa-

nies doing business in Mexico and other Latin Ameri-

can countries. He is an active advisor to startup and emerging

growth companies, and also seed and venture capital funds that

invest in those companies; Arturo specializes in all areas of cor-

porate and securities, including the formation and financing of

its clients, corporate governance, M&A, debt and equity financ-

ings. He is an active mentor, judge and panelist under several ac-

celeration programs and collaborates proposing changes to the

legal framework applicable to the entrepreneurship ecosystem in Mexico with the Mexican and U.S. Government through the Mex- ico – United States Entrepreneurship and Innovation Committee (MUSEIC). Arturo received his law degree from “Escuela Libre de Dere- cho” in Mexico City and his master’s degree from The University of Texas at Austin. He enjoys reading, scuba diving, soccer and innovation.

MASSCHALENGE | GREENBERG TRAURIG

9

Disclaimer

Special Thanks to…

The attorneys at Greenberg Traurig, LLP, which we often refer to as “GT”, are happy to collabo-

Greenberg Traurig Team

rate in the preparation of the “Thought Leader- ship Program” document. Please note that we are providing legal infor-

Arturo Pérez Estrada Chinh H. Pham Robert L. Hover

mation for educational purposes only. We are

Jeff K. Joyner

not providing legal advice or business advice;

Ryan P. Kelley

and you should not take what we say as that.

Rocío Olea

This document is not intended as one be-

tween an attorney and client, and will not create

MassChallenge Team

an attorney-client relationship between GT and

Andrea Escalante

you. Additionally, this document should not be

Camila Lecaros

considered or relied on to be or to create that.

Riley Soward

Likewise, the ethical rules which prevent at-

Paola Toledo

torneys from representing one client adversely

to another client will not apply here, since you,

acting as readers, are not a client.

If you decide to proceed with a venture or

idea, we strongly encourage you to seek legal

counsel from an experienced and knowledge-

able attorney of your choice. You may of course

consider GT for that role; but we are not solicit-

ing that. Many other attorneys are also available

to you; and you have no obligation to consider

or pursue that with us. Rather, you can and

should feel to choose whomever you decide,

irrespective of your having met with GT attor-

neys today.

1010

MASSCHALENGE | GREENBERG TRAURIG

Independent Collaborators

Pablo Rena (Mayoreo Total)

Manuel Alejandro Villegas López (Capptu)

Roberto Rogel (Learny)

Matías Recchia (IguanaFix)

Angel Mejía Santiago (Iventive Power)

Francisco Ruiz (RankTab)

Alejandro Cantú Segura (Sky Alert)

Adolfo Babatz (Clip)

Ricardo Elizondo (Ideas y Capital)

Xavier Ponce de León (Ideas y Capital)

Sergio Romo (Investomex)

Daniel Green (Gunderson Dettmer)

Vicente Encarnación (E-De)

MASSCHALENGE | GREENBERG TRAURIG

1111

TÍTULO DEL MANUAL
TÍTULO DEL MANUAL

12 MASSCHALENGE

TÍTULO DEL MANUAL 12 MASSCHALENGE WHAT LEGAL ENTITY SHOULD I FORM? MASSCHALENGE | GREENBERG TRAURIG 13

WHAT

LEGAL

ENTITY

SHOULD

I FORM?

MASSCHALENGE | GREENBERG TRAURIG

13

BEST LEGAL PRACTICES

Introduction

BEST LEGAL PRACTICES Introduction As you begin your company, there is a range of legal entities

As you begin your company, there is a range of legal entities you can choose from. The one you pick will

significantly impact all aspects of your business –

from fundraising, to hiring employees, from pay-

ing taxes, to (potentially) selling your company.

Unfortunately, one legal entity does not stand

out from all others. There’s not a clear answer

for you – there are strengths and weaknesses to

each entity. The information below is formatted

to help you think about all the important ques-

tions you should consider when deciding which

legal entity to form. We’ve provided an analysis of each legal entity depending on where you hope to fundraise, operate, grow, and sell. But first, let’s quickly go over explanations of the dif- ferent types of legal entities!

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MASSCHALENGE

WHAT LEGAL ENTITY SHOULD FORM?

DIFFERENT LEGAL ENTITIES EXPLAINED

Entity

Explanation

SAPI

SAPI was created in Mexico more than 10 years ago to pro-

vide more adequate protection for shareholders’ rights and,

in particular, more effective minority rights than those tradi-

tionally available for shareholders of a SA with the purpose to

encourage and facilitate the participation of investors, such

as private equity/venture capital funds, and other institutional

investors

Over this time, SAPI has become a very customary

corporate structure for investors and is well known by prac-

titioners (notary publics, accountants and lawyers), govern-

ment officers and courts.

Notwithstanding, SAPI is regulated under Mexican Stock

Market Law (“LMV”), SAPI is (i) not supervised or inspected

by the Mexican National Banking and Securities Commission

(Comisión Nacional Bancaria y de Valores) and (ii) mandated

to evolve, although it can, into a public company (which stock

is publicly listed and traded in a stock exchange).

As a limited liability stock corporation, SAPI offers cor-

porate liability protection to its shareholders, which are only

liable for the amount of capital each of them made to the

SAPI. Capital stock is divided into shares, each of which rep-

resent a portion of the capital paid in by SAPI’s shareholders.

SAPI’s corporate governance structure is quite flexible and

is managed by a Board of Directors, formed by at least two

(2) directors, and the general shareholders’ meeting. Formation of a SAPI requires intervention of a Mexican no- tary or commercial broker (corredor público) and could take

from one (1) to three (3) weeks. If interested, you may find additional information about SAPI in the following link http://www.gtlaw.com/supplemen-

tal/MA-Report-Vol7-Ed1-5

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BESTBEST LEGALLEGAL PRACTICESPRACTICES

BEST LEGAL PRACTICES

WHAT LEGAL ENTITY SHOULD FORM?

WHAT LEGAL ENTITY SHOULD FORM?

 

A

corporation (“C-Corp”) formed in Delaware offers a fa-

Over the last few years, there has been a trend driven by some venture capital funds to consider corporate structures for startups including a Cayman Islands corporation as a holding company. Our understanding is that companies in-

Delaware

miliar and useful form of entity. The state of Delaware is the

Cayman

C-Corp

most popular and sophisticated location used to form enti-

Islands

ties in the United State. Delaware C-Corps are the standard form of entity for venture capital investments. Formation of

Holding

Compa-

corporated in the Cayman Islands are similar in most respects

C-Corp in Delaware can be accomplished in one (1) day. Delaware C-Corps can have an unlimited number and type

a

ny with

to companies and corporations formed elsewhere in Mexico or the US (i.e. shareholder’s liability is usually limited and the Board of Directors manage the business of the company).

Delaware

of

owners, called shareholders. The liability of a Delaware

LLC and

C-Corp’s shareholder for the debts and obligations of the entity is limited to the amount of capital he or she contrib-

uted to the Delaware C-Corp. Taxation of all C-Corps occurs

SAPI

In

this structure, a Cayman company is formed to be-

come a holding company for international business whose main activities are to be carried out of the Cayman Islands. Companies falling into this category are known as exempted companies.

in

two stages: First, a C-Corp’s income is taxed at the corpo-

rate tax rate. Second, any distribution of profits made by a

 

C-Corp to shareholders is taxed as personal income of those

 

shareholders.

You should seek counsel and ask your investors prior to

 

considering this alternative as some investors may have be

prevented either by their formation documents or their inves-

   

tors to make investments in this jurisdiction.

Delaware

A

Delaware C-Corp, as described in detail above, can be a

C-Corp

valuable entity to use as a holding company because it can

 

In

this structure, the Cayman Island entity A Cayman Is-

Holding

provide significant tax savings in some cases, such as a Dela-

lands entity would own a Delaware LLC, and the Delaware

Company

ware C-Corp whose only function is to maintain and manage

LLC would own all other entities in the group – (i.e. Mexican

with SAPI

intangible assets such as the stock of other companies. Com-

SAPI for example).

panies that meet these requirements can be exempt from

paying Delaware state taxes.

A

limited liability company (“LLC”) is an entity with cer-

 

tain differences from a C-Corp. In Delaware, the liability of an

owner of an LLC (which is referred to as “member”) is also

 
 

limited to the amount of capital he or she contributed to the

Delaware LLC. But LLCs generally require fewer administra-

tive formalities than C-Corps, and can be managed directly

by their members. The primary distinction, and advantage, of

an LLC is the manner of taxation. An LLC can be taxed as a

“pass-through” entity, which means that the LLC is not sub-

ject to income tax but rather its members are taxed directly

for their portions of the LLC’s income and losses. An LLC can

also choose to be taxed as a C-Corporation instead. This flexi- bility is another attribute of an LLC.

SAPI – see our description of SAPI above.

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17

BEST LEGAL PRACTICES

WHAT LEGAL ENTITY SHOULD FORM?

WHAT LEGAL ENTITY SHOULD FORM?

ANALYSIS OF DIFFERENT LEGAL STRUCTURES

Financial Analysis

Where are you going to raise money?

Mexico

Analysis Where are you going to raise money? Mexico r SAPI: Most Mexican investors strongly pre-

r

SAPI: Most Mexican investors strongly pre-

fer SAPIs. As explained before, SAPI has

become a customary corporate vehicle to

receive third party investments due to its

r

corporate flexibility.

You should also consider that certain VC

funds might be restricted to invest in Mex-

ican companies as those, which have re-

ceived or plan receiving federal funds INA-

DEM.

r

As an alternative to SAPI, a corporation

(sociedad anónima) may also work for

the purposes of receiving venture capital

financing. SAPI is a special form of socie-

dad anónima and thus, these vehicles share

many of its most important features. None-

theless, SAPI is normally preferred over a S.A.

r

C-Corp: _Although this has been changing over the last months, and as such may vary between different investors, Mexican inves- tors would normally prefer investing in a Mexican corporate structure rather than an offshore vehicle such as a C-Corp.

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MASSCHALENGE | GREENBERG TRAURIG

By whom do you hope to get acquired (if applicable)?

Company in Mexico

Company in US

r

SAPI and/or other Mexi- can entity: Factors relat- ed with labor, regulatory and tax issues may be relevant for a Mexican acquirer performing an

r

SAPI: See comments above regarding investors’ prefer- ence to invest in corporate structures to which they are familiar. However, this may not be relevant if the

acquisition. However,

acquirer is seeking to enter

the most important part

into the Mexican market

would always be where

and the target business

the main portion of the

becomes a wholly-owned

business is located.

subsidiary.

r

C-Corp: Mexican com-

r

C-Corp: US acquirers

panies/investors doing

would be familiar with a

business only in Mexico

C-Corp. However, if the

may want to focus their

business is actively operat-

investments in Mexican

ing in Mexico, the creation

entities especially if the

of Mexican opCo may still

business is generally

be necessary. C-Corp &

based in Mexico. How-

 

ever, having an offshore

Company in another

structure may be per-

LATAM country

ceived as convenient if

r

It is difficult to anticipate

the nature of the busi-

any trend herein as several

ness allows to consider

factors may impact the

an expansion to other

decision.

LatAm countries.

 

r

C-Corp & SAPI: Having an offshore holding structure, as explained above, may be benefi- cial if the nature of the business foresees an expansion to countries other than Mexico.

US

r r Another r Country in LATAM r Nationality of the investor
r
r
Another
r
Country
in LATAM
r
Nationality of
the investor

and tax consid-

erations related

thereto would be factors that investors from other LatAm countries may take into con- sidering an investment.

LatAm countries may take into con- sidering an investment. SAPI: US investors would prefer to invest

SAPI: US investors would prefer to invest in a familiar corporate structure such as a C-Corp.

C-Corp: US investors will

normally prefer to invest in C-Corps, and specifi- cally in C-Corps formed in Delaware. One reason

for this preference is

the predictability that

working with Delaware

laws provides. Another

reason is their desire not

to be taxed for pass-

through income of an

LLC without receiving

the associated distri-

butions of profit, also

referred to as “phantom

income.”

Both US and Mexico

Considering investors,

regardless of their na-

tionality, would typical-

ly use common used

structures which they

are familiar to it is hard

to predict where a mix of investors would pre- fer to invest in. Factors such as who the major investor is may incline the decision whether to use a domestic, offshore entity or a combination thereof.

MASSCHALENGE | GREENBERG TRAURIG

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19

BEST LEGAL PRACTICES

Operations Analysis

WHAT LEGAL ENTITY SHOULD FORM?

Where are you going to hire your team?

 

Where are you

going to sell your product?

Mexico

 

US

Another Country in LATAM

r

SAPI: Forming a Mexican company is recommendable if the business will be operating in Mexico. Even if there is a US holding Company, forming a Mexican

r

C-Corp: A C-Corp formed

 

in the US can automatically hire its team and conduct business in the state in which it was formed. If the

r

LaborLabour & tax laws and regulations may need to be carefully reviewed and considered when con-

Mexico

r

SAPI: If you’re selling a product in Mexico forming a MX entity is recommended be-

entity to act as the employer would limit

cause of product liability and consumer pro-

labor liability to the US parent and would

C-Corp wants to conduct

sidering hiring personnel

tection issues. Other factors such as access

be easier to deal with regarding labor and

business in a different

from an offhsoreoffshore

to opening local bank accounts, tax issues

social security obligations.

state, then it would need to

company.

and unwillingness from local suppliers/ven-

 

register to do business in

dors to enter into agreements with foreign

r

C-Corp: In principle, it would depend on

that state by making rel-

entities are also relevant.

where the company will be operating.

evant filings with the au-

Both US and Mexico

 

A

Delaware C-Corp that wants to hire a

thorities and it would often

r

See comments above for

r

C-Corp: See factors above.

team in Mexico would most likely need

pay state taxes there as

C-Corp and SAPI structure.

to

register to do business in Mexico at

well. This is usually a sim-

the federal level as a branch office or by

ple registration process. An

US

forming a subsidiary company that it

alternative approach would

r

SAPI: The same factors listed above when

owns and that will conduct business in

be to form a subsidiary in

products are to be sold in Mexico would

Mexico. Seek tax advice in order to deter-

the state where the C-Corp

inversely apply if products are to be sold in

mine the best method.

wants to conduct business.

the US from a Mexicanx company.

 

Seek tax advice in order to

r

C-Corp & SAPI: Idem.

determine the best meth-

r

C-Corp: As a US entity a C-Corp would be

 

od.

able to conduct business where authorized

r

C-Corp & SAPI: Provided

to operate in the US.

that the C-Corp and SAPI

are respectively registered

to conduct business in the

Both US and Mexico

localities where they want to hire their teams, this entity structure would pro- vide flexibility for hiring in both the US and in Mexico.

r

Formation of a US and Mexican entity may be convenient if products are directly sold at these markets.

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BEST LEGAL PRACTICES

Strategy Analysis

Where do I hope to be based out of?

Mexico

r Where your business operations are go- ing to be located is an important factor when considering where to incorpo- rate. Similar factors as those described above in connection with the hiring of a team and product sales are applica-

ble. Domestic operations carried out

by Mexican would be customary for tax,

legal and accoutingaccounting counsel.

US

r Same comments as above.

Another

Country in LATAM

r See comments as above.

Both US and Mexico

r Incorporation in different jurisdictions might be necessary if operations

are to be carried separate countries. A global law firm such as Greenberg Traurig

offers comprehensive ad-

vice on cross-border issues

such as these, and can rec-

ommend accountants with

cross-border expertise as

well.

How rapidly do I want to scale and where do I

hope to expand into other countries in the future

(if applicable)?

Mexico

r Input analysis here

US

r Input analysis here

Another

Country in LATAM

r Input analysis here

Both US and Mexico

r Input analysis here

Slowly

r Input analysis here

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MASSCHALENGE | GREENBERG TRAURIG

Rapidly

r Input analysis here

Cost Analysis

WHAT LEGAL ENTITY SHOULD FORM?

Type of Cost

Type of Company

Cost

 

SAPI

$$

Set-Up Cost

C-Corp

$$

C-Corp / SAPI

$$$$

Cayman / LLC / SAPI

$$$$

 

SAPI

$$

Maintenance

C-Corp

$$

Cost

C-Corp / SAPI

$$$$

Cayman / LLC / SAPI

$$$$

 

SAPI

$$

Switching Cost

C-Corp

$$$

C-Corp / SAPI

$$$$

Cayman / LLC / SAPI

$$$$

MASSCHALENGE | GREENBERG TRAURIG

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TÍTULO DEL MANUAL 24 MASSCHALENGE
TÍTULO DEL MANUAL
24
MASSCHALENGE

WHAT DO

I NEED

TO KNOW

ABOUT

FUNDRAIS-

ING?

MASSCHALENGE | GREENBERG TRAURIG

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BEST LEGAL PRACTICES

Introduction

BEST LEGAL PRACTICES Introduction Fundraising is a huge part of most startups’ journeys. Many startups take

Fundraising is a huge part of most startups’ journeys. Many startups take investment from angel investors or venture capital funds at some

point, however, the amount of money they take and the terms

that they agree to generally differ greatly.

There is much more to consider when negotiating an in-

vestment deal than simply trying to receive the highest val-

uation or the largest investment. The terms of an investment

deal, such as liquidation preference, conditional funding, and

protective provisions, in many cases will impact your startup

just as much as the valuation or amount of investment you

receive.

This piece first discusses how valuations work and then ex-

plains the different terms normally included in a term sheet and provides analysis on what is standard for these terms, what is important to negotiate, and what you should not wor- ry about. After that, we’ll cover a few do’s and don’ts for fund- raising.

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MASSCHALENGE | GREENBERG TRAURIG

WHAT DO I NEED TO KNOW ABOUT FUNDRAISING?

HOW DO VALUATIONS WORK?

The pre-money valuation is the valuation of your company ex- cluding the money an investor is going to invest in your company. The post-money valuation is the valuation of your company in-

cluding the money an investor is going to invest in your company, which is the same as the invested capital added to the pre-mon- ey valuation. The amount of equity an investor receives is de-

termined by the amount they invest divided by the post-money

valuation. Thus:

The equity an investor receives is equal to:

invested capital

(pre-money valuation + invested capital)

Which is the same as:

invested capital

(post-money valuation)

For example, if an investor gives you $1M at a $4M pre-money

valuation, your post-money valuation will be $5M and the inves-

tor will receive 20% equity in your company ($1M / $5M).

pre-money

invested

post-money

equity

valuation

capital

valuation

received by

 

=

investor

=

=

$4M + $1M =

= $1M / $5M =

$4M

$1M

$5M

20%

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BEST LEGAL PRACTICES

BESTBESTBESTBEST LEGALLEGALLEGALLEGAL PRACTICESPRACTICESPRACTICESPRACTICES

EXPLANATION AND ANALYSIS OF TERMS

Price

Option Pool

Example

“Upon the Closing of the financing, 15.0% of the fully diluted capital stock of the

Company (on an as--converted to Common Stock basis), will be reserved for fu-

ture grants pursuant to the Company’s unallocated employee option pool (for pur-

poses of clarity, which number will equal XXXXX shares of Common Stock).”

Explana-

An option pool is the percentage of equity a company sets aside for their employ-

tion

ees. This allows companies to incentivize employees to work their hardest by align-

ing the interests of the company with the interests of the employees.

Investors almost always include the option pool in the pre-money valuation.

Doing this makes a VC’s valuation of your company seem higher than it actually is.

For example, assume a company is presented with the following terms: a $1M

investment at a pre-money valuation of $4M, including an option pool equal to

20% of the post-money valuation.

20% of the post-money valuation is $1M. This means out of the pre-money valu-

ation of $4M, $1M is dedicated to creating an employee option. Thus, the effective

pre-money valuation is really $3M.

Analysis

Generally option pools aren’t part of the term sheet during a seed round. During a

Series A round they might be included in the term sheet. Investors rarely will agree to not include the option pool in the pre-money val- uation. Thus, it’s not worth trying to negotiate with investors to move this option pool to the post-money valuation. However, if the option pool is 15 – 20%, it’s worth negotiating down to a lower

option pool. Ultimately, it’s just very important to realize that a large option pool will make an investor’s valuation seem higher than it actually is.

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MASSCHALENGE | GREENBERG TRAURIG

Conditional Funding

WHAT DO I NEED TO KNOW ABOUT FUNDRAISING?

Example

“In the event that the Company meets the conditions set forth on Exhibit A as of

no later than XXXX, 2017, then the conversion price at which the investor’s shares

of preferred stock convert into common stock will be adjusted concurrently such

that it reflects a higher agreed upon pre-money valuation, equal to $XXXX.”

Explana-

Investors will sometimes include certain conditions that must be met or milestones

tion

you have to hit in order to get part of your money or equity.

In some cases, investors will say they will give you a certain amount of equity

back if you hit certain milestones. For example, they might try to get 50% of the

company initially and then give you 20% back if you hit certain milestones.

Examples of milestones include: passing a certain number of users or revenue;

getting investors to commit a certain amount of funding; or closing a certain im-

portant partnership.

Analysis

While investors in Mexico commonly include conditions or milestones in their term

sheets, you should do your best to avoid these.

Conditions force you to focus on very specific things that might not be good

for the long-term interest of your business. Furthermore, startups sometimes

struggle before doing well, but these conditions give investors the power to pull

out too quickly without giving you the actual amount of time you need to succeed

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29

BEST LEGAL PRACTICES

Liquidation Event

Preferred Shares

WHAT DO I NEED TO KNOW ABOUT FUNDRAISING?

Liquidation Preference

Example

“The securities sold in this financing will be Series X Preferred Stock (the “Series X Preferred”), and will be entitled to the rights and privileges set forth in this Term Sheet.”

Example

“The proceeds of any liquidation, dissolution, or winding up of the Company will be paid as follows: First pay one times the applicable Original Purchase Price (as adjusted for stock splits, stock dividends, recapitalizations, and etc.), plus declared and unpaid dividends on each share of Series X Preferred (the “Liqui- dation Preference”)…”

Explana-

Investors generally are issued preferred shares, as opposed to founders and employees who are issued common shares.

tion

 

Preferred stockholders get certain privileges. These include

 

protective provisions (explained later) and the priority to get

Explana-

Liquidation preference is usually a multiple of the investor’s ini-

money before any of the common stockholders do.

tion

tial investment, such as 1x, 1.5x, or 2x. This multiple dictates how

 

much money the investor gets before common stockholders

receive their money. Preference exists to protect investors from

“downside risk.” It helps investors in the case that your company

   

does not have a very profitable acquisition.

Analysis

This is completely normal.

For example, assume an investor invested $1M originally and

soon the company is acquired for $2M. If the liquidation prefer-

 

ence is 1x, the investor would receive $1M before anyone else gets

any more. If the liquidation preference is 2x, then the investor

would receive all $2M.

 

Analysis

You should negotiate for a 1x liquidation preference. 1x is very

 

common in the US, but often Mexican investors will try to negoti-

ate a higher liquidation preference.

This is especially important because the terms you agree to

here will likely set precedence for future investors. Even though

giving away a generous liquidation multiple in a seed round may

not seem like a big deal, investors in your Series A, Series B, and

so on will likely ask for the same or better terms than you agreed

on in the seed round.

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31

BEST LEGAL PRACTICES

Participation

Conversion to Common Stock

WHAT DO I NEED TO KNOW ABOUT FUNDRAISING?

Example

“The proceeds of any liquidation, dissolution, or winding up of the Company will be paid as follows: …Thereafter theThereafter the Series X Preferred participates with the Common Stock pro rata on an as-converted basis.”

Example

“A merger, acquisition, sale of voting control, exclusive license, or sale of all or substantially all of the assets of the Company or any other transaction or series of transactions as a result of which the stockholders of the Company do not own a majority of the outstanding shares of the surviving corporation (but excluding the issuance of stock pursuant to customary venture capital financings by the Compa- ny) will be deemed to be a liquidation or winding up of the Company (a “Liquida- tion Event”). Upon a Liquidation Event, unless the holders of at least a majority of the outstanding shares of Series X Preferred (“Requisite Holders”) elect otherwise, the holders of Series X Preferred will be entitled to receive at the closing (and at each date after the closing on which additional amounts (such as earn-out pay-

Explana-

Participation details what occurs after the preferred stockholders get the money from their liquidation preference. There are three different types (detailed below). To make things clear, assume a situation where an investor

tion

invested $1M for 20% equity of a company and had a 1x liquida-

ments, escrow amounts, and other contingent payments) are paid to stockhold-

tion preference.

ers of the Company) the greater of (1) the amount they are entitled to receive as

Non-Participating – The investor does not receive anything

holders of Series X Preferred above, or (2) the amount they would be entitled to

after getting their liquidation preference. Thus, if the company

receive had such holder of Series X Preferred converted such shares into Common

were acquired for $2M, the investor would receive $1M and then

Stock prior to the closing of the transaction giving rise to the Liquidation Event.”

the remaining $1M would be split proportionally across all of the

common shareholders.

 

Fully Participating – The investor gets part of the remaining

Explana-

As discussed above, investors are generally granted preferred stock. This stock

money, equal to their ownership percentage. In the case above,

tion

allows them to get their money first in the case of a liquidation event.

the investor would receive a total of $1.2M. They would get $1M

However, depending on the size of the exit, it might be more lucrative for inves-

from their 1x liquidation preference and then 20% of the remain-

tors to have common stock rather than to benefit from the liquidation preference.

ing $1M.

For example, imagine an investor invested $1M for 20% ownership of a com-

Capped Participating – The investor gets part of the remaining

pany and has a non-participating 1.5x liquidation preference. If the company sells

money, but only up to a certain overall multiple.

for $5M, the investor would prefer to exercise their preference, as they would get

$1.5M. $1.5M / $5M is 30%, which is greater than their share of the company.

   

However, if the company was sold for $10M, then the investor would rather con-

Analysis

You should negotiate for non-participating. Worst case scenario

vert their preferred shares to common shares so they could receive $2M, which is

you should agree to capped participation. You should carefully

20% of the $10M.

consider the implications of agreeing to fully participating.

As mentioned before, this is especially important as it will set

 

precedent for future investors.

Analysis

This is completely normal and fair for investors. Please note that the term “Liquida-

 

tion Event” when used in the context of a venture capital financing should not be

 

confused with the term “Liquidación” used only in Mexico when a company is be- ing shut down. In this context “Liquidation Event”, as shown above, conceptually encompasses several other event in addition to the winding up of a company.

32

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33

BEST LEGAL PRACTICES

Board of Directors

Board Seat

WHAT DO I NEED TO KNOW ABOUT FUNDRAISING?

Additional Powers Granted to Investor

Pro Rata Rights

Example

At the Closing, the Board shall comprise [ (i) [name] as the representative designated by [

]

members consisting of

Example

“In the event the Company proposes to offer equity securities to any person (excluding Exempted Securities), each stockholder of the Company will have

 

],

as the lead Investor;

(ii) [name] as the representative designated by the remaining Investors; (iii) [name] as the representative designated by the Founders; (iv) the person

the right to purchase their pro rata portion of such equity securities. Each such stockholder will have twenty (20) calendar days after delivery of a notice from the Company describing such offering to elect to purchase their pro rata por- tion. Any such equity securities not purchased by a stockholder may be reallo-

then serving as the Chief Executive Officer of the Company; and (v) [

]

person(s) who are not employed by the Company and who are mutually ac-

 

ceptable [to the Founders and Investors][to the other directors].

 

cated among the other stockholders.”

Explanation

Investors will often ask for a seat on your board of directors. Doing so will put

Explanation

Pro rata rights give the investor the option to invest in a future round to main-

them in a position to oversee and have a lot of control over your company.

tain their percentage of the company.

 

For example, let’s say today an investor invests $1M in your company at a

   

$5M post-money valuation. This means they own 20% of your company.

Analysis

This is normal for the lead investor of a Series A round or later round to get

 

If in one year, your company decides to raise a second round of $4M from

a board seat. In most circumstances, you should strongly negotiate against

other investors at a $16M post-money valuation, then the initial investor’s own-

giving up a board seat during a seed round unless special circumstances sug-

ership is diluted by 25% (4M / 16M).

gest you should consider it otherwise (e.g. fintech company giving a board

Pro rata rights exist so investors can avoid this dilution. In the scenario

seat to the former governor of Banco de Mexico).

above, the initial investor could exercise his or her pro rata rights and invest

When thinking about adding someone to your board, you should think

 

an amount equal to 20% of the second round (keep in mind, this is 20% of the

very carefully about two things:

round, not the valuation), which would be $800,000.

Value to Your Company: Do you want this person to have significant pow-

 

By doing this, the initial investor would own 20% of the new shares being

er over your company? Are they someone you trust to make good decisions

created for the second round, and thus would still own 20% of the overall com-

for your company? Do you want to work with them? It’s vital you trust them,

pany.

as they will have the power to vote to replace you.

 

Implications for Voting Power: How will adding this person to your board

   

impact your company’s control over the board? It’s normal for earlier stage

Analysis

Pro rata rights are very standard and you should keep them in your term sheet.

companies to have a board comprised of one investor, two founders, and

 

In fact, it’s in your best interest for your investors to have pro rata rights, as it

potentially one other outside person. You want to try to maintain majority

aligns your interests with those of your investors: as your company continues

control over the board for as long as you can.

to grow in value, your earlier investors are able to maintain their stakes. If a Mexican company is receiving the investment, you should check with your own counsel as certain corporate entities would mandatorily grant this right to any investor (i.e. no worth negotiating something already afforded un- der applicable law).

 

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35

BEST LEGAL PRACTICES

Protective Provisions

Drag Along

WHAT DO I NEED TO KNOW ABOUT FUNDRAISING?

Example

“For so long as any shares of the Series X Preferred remain outstanding, the vote or written consent of the Requisite Holders, voting together as a single class on an as-if converted basis, will be necessary for the Company to take the following actions:

Example

“Each current and future holder of Common Stock will be required to enter into an agree- ment providing that in the event a majority of the stockholders have approved an acqui- sition of the Company—whether by merger,

I. amend, alter, or repeal any provision of the Certificate of Incorporation or By- laws of the Company;

consolidation, sale of assets, sale of stock or otherwise—such holder will grant any con- sents or approvals reasonably determined by the Board to be necessary in order to ap- prove or participate in the acquisition of the

II. change the authorized number of shares of Series X Preferred or Common Stock;

III. authorize, designate or issue, whether by reclassification or otherwise, of any

new class or series of stock or any other equity or debt securities convertible

Company subject to customary limitations.”

into equity securities of the Company ranking on parity with or senior to the

Series Seed Preferred in right of redemption, liquidation preference, voting or

 

dividends or any increase in the authorized or designated number of any such

Explanation

In the situation that over X% of shareholders

new class or series;

(generally X is equal to or greater than 50)

IV. redeem or repurchase with respect to Common Stock (excluding shares re-

agree to a sale of the company, then all other

purchased upon termination of an employee or consultant pursuant to a re-

shareholders must agree to the sale. The idea

stricted share purchase agreement or right of first refusal);

here is to prevent a situation where a few

V. enter into any agreement regarding an asset transfer of more than $XXXXXX,

shareholders are able to prevent an acquisi-

license of intellectual property out of the ordinary course of business, acquisi-

tion form happening.

tion of the stock or assets of another entity or a Liquidation Event;

For example, let’s say the Drag Along

VI. borrow, loan or guarantee an amount in excess of $XXXXX;

clause dictates that if over 50% of the share-

VII. consummate any interested party transaction;

holders are in favorfavour of a sale, then

VIII. change the number of directors;

everyone else must agree to it. If an acqui-

IX. hire, fire, or change the compensation of the Company’s executive officers;

sition is proposed and 60% of shareholders

X. change the principal business of the Company, enter new lines of business, or

support it, but 40% are strongly opposed to

exit the current line of business;

it, these 40% still have to go through with the

XI. declare or pay any dividend; or

acquisition.

XII. any voluntary dissolution or liquidation of the Company.”

   

Analysis

This is completely normal and fair for inves-

Explanation

Protective provisions are the veto powers you give to your investor. They re-

tors.

quire you to get your investor’s approval before doing things such as taking on debt over a certain amount of money, amending your company’s bylaws, or selling your company.

 
 

Analysis

The sample protective provisions above are standard and are generally accept- able to investors and founders. The investors will want to ensure their ability to control company actions that could impact their investment, while the found- ers and the company will prefer to retain the freedom to operate the company.

36

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37

Tag Along

BEST LEGAL PRACTICES

Right of First Refusal

WHAT DO I NEED TO KNOW ABOUT FUNDRAISING?

Example

If at any time, a Stockholder who (together with its Affiliates) holds no less than [51]% of the outstanding Common Stock of the Company (the “Selling Stockholder”) proposes to sell any shares of its Common Stock to an Independent Third Par- ty (the “Proposed Transferee”) and the Selling Stockholder cannot or has not elected to exercise its drag-along rights set forth in Section [XX], each other Stockholder (each, a “Tag- along Stockholder”) shall be permitted to participate in such sale (a “Tag-along Sale”) on the terms and conditions set forth in this Section [XXX].

Example

Right of First Refusal. At any time, and subject to the terms and conditions specified in this Section [XX], each Stockhold-

er

shall have a right of first refusal if any other Stockholder

(the “Offering Stockholder”) receives an offer from a Third Party that the Offering Stockholder desires to accept to pur- chase all or any portion of the shares owned by the Offering Stockholder (the “Offered Shares”).

Explanation

A

contractual obligation of an stockholder to offer to sell its

 

equity to the other holders, or sometimes back to the compa-

   

ny, after receiving a bona fide offer from a third party to buy

Explanation

In a situation where majority shareholders sell their shares,

that equity stake. The offer to the other stockholders must

the tag along provision allows minority shareholders to “tag

typically be made on substantially the same terms as those

along” and sell their shares at the same terms.

offered by the third party.

Analysis

Also known or referred to as a co-sale right. This provision,

Analysis

This contractual provision covers the circumstances

is often times also used to restrict or condition sale of the

where a shareholder (often times a Founder or Key manage-

Founder’s stock to a third party unless investors are given a

ment) propose to sell any of their shares to a third party. This

first refusal right to purchase the stock or to participate in

provision would require the seller to give the company first,

such stock sale on a pro-rata basis. This is customary and a

and then the investors second, notice of a proposed sale

provision many investors would expect having in any financ-

and grants the company/investors a right of first refusal to

ing.

purchase their shares. It is common for this provision to be

present in combination with the co-sale right provision (tag-

 

along) and for both to operate succesivelysuccessively (i.e.

if

the investor does not exercise its ROFR then it would still

have the right to “tag” its shares to the proposed sale to a

third party).

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MASSCHALENGE | GREENBERG TRAURIG

39

BEST LEGAL PRACTICES

Do’s and Don’ts

DO’S

WHAT DO I NEED TO KNOW ABOUT FUNDRAISING?

DON’TS

Practice giv- Know your Conduct refer- Hire a top Don’t accept The other Cold calls
Practice giv- Know your Conduct refer- Hire a top Don’t accept The other Cold calls
Practice giv- Know your Conduct refer- Hire a top Don’t accept The other Cold calls
Practice giv- Know your Conduct refer- Hire a top Don’t accept The other Cold calls
Practice giv- Know your Conduct refer- Hire a top Don’t accept The other Cold calls
Practice giv- Know your Conduct refer- Hire a top Don’t accept The other Cold calls
Practice giv- Know your Conduct refer- Hire a top Don’t accept The other Cold calls
Practice giv- Know your Conduct refer- Hire a top Don’t accept The other Cold calls
Practice giv- Know your Conduct refer- Hire a top Don’t accept The other Cold calls

Practice giv-

Know your

Conduct refer-

Hire a top

Don’t accept

The other

Cold calls are

ing your pitch

company’s fi-

ence checks by

lawyer – even

the first term

terms and the

often not an

presentation,

nancial details,

chatting with

though it’s

sheet you’re

quality of the

effective way

and review

market poten-

existing portfo-

costly it will

given. Don’t

investor are

to approach-

your company

tial, and pre-

lio companies

pay off in the

only focus on

just as im-

ing a VC.

materials, with

ferred financ-

of investors

long-term.

the valuation

portant.

several differ-

ing numbers.

you’re consid-

and amount

ent people.

ering.

of money an

 

investor is

offering.

Keep in mind Read as much Decide which Be prepared that later in- as you
Keep in mind Read as much Decide which Be prepared that later in- as you
Keep in mind Read as much Decide which Be prepared that later in- as you
Keep in mind Read as much Decide which Be prepared that later in- as you

Keep in mind

Read as much

Decide which

Be prepared

that later in-

as you can

top terms mat-

for tough ques-

vestors will

about each

ter the most

tions related

oftentimes ask

term online

for your com-

with your IP

for terms that

and research

pany and focus

protection,

are the same or

what their im-

on your negoti-

legal barriers,

better than the terms you give earlier inves- tors.

plications are for your com- pany.

ation on these terms.

competitive advantages, and investor’s rights granted to prior inves- tors.

40

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MASSCHALENGE | GREENBERG TRAURIG

41

TÍTULO DEL MANUAL 42 MASSCHALENGE
TÍTULO DEL MANUAL
42
MASSCHALENGE

WHY

AND HOW

CAN WE

PROTECT

OUR IP?

MASSCHALENGE | GREENBERG TRAURIG

43

BEST LEGAL PRACTICES

Introduction

BEST LEGAL PRACTICES Introduction Protecting your company’s intellectual property (IP) is vital to your success. IP

Protecting your company’s intellectual property

(IP) is vital to your success. IP is a huge compo-

nent of the value of your company. This is espe-

cially true in your early days, before you have many users or

much revenue, when all you really have is IP.

When you go out to fundraise money from investors, some-

thing they will often ask is whether or not all IP created by the

employees of your company has been legally assigned to your

company. Investors want to ensure that current or past employ-

ees can’t walk away with your trade secrets or client list or algo-

rithms or anything else. The last thing they want to do is invest

in a company with a great idea and then have a past employee

steal that idea or steal a major component of the company’s IP.

Thus, it’s important from the beginning that you protect

your IP. There are many different things you should be doing

as you start and grow your company. Below we’ve included an

explanation of the different types of IP in your company, an IP

protection checklist, a template for an IP assignment clause of

a labor agreement, and a privacy policy template. But first, let’s

discuss the four types of IP!

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WHY AND HOW CAN WE PROTECT OUR IP?

EXPLANATION OF THE FOUR TYPES OF IP

 
     
 
     
     
     
     
 
     

Copyright

Trademark

Patents

Trade

Secrets

A

copyright protects

A trademark protects

A patent protects a

A

trade secret pro-

original content that

a symbol or word(s)

unique product or

tects a strategy or

you create. For exam-

that uniquely indi-

process you create.

knowledge that gives

ple, one would file a

cates your company’s

For example, one

a

business a com-

copyright for a piece

product or service. For

would file for a patent

petitive advantage

of

artwork, a song,

example, one would

on a machine that

so long as that infor-

or movie. Copyrights

file a trademark for a

cooks food in a new

mation remains a se-

are generally more

product name, logo, or

way or on a novel pro-

cret. Once the trade

relevant to art than to

slogan. It is important

cess for manufactur-

secret is made public,

business.

to note, however, that

ing something.

protection of the trade

a

trademark does not

secret is lost. For ex-

protect a company’s

ample, a trade secret

name. Trademarks are

could be a client list or

generally more rele-

go-to-market strate-

vant to business than

gy. Unlike copyrights,

to

art.

trademarks, and pat-

 

ents, you can’t file to

protect a trade secret.

However, if you have employees sign an IP assignment contract (discussed below) and keep the strategy or knowledge secret from the public, then the trade secret is legally protected.

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45

BEST LEGAL PRACTICES

Understanding the Differences

Understanding the differences between the

four types of IP is critical because no one type alone can provide you with comprehensive protection. Instead, the four types should be

thought of as individual elements of an overall

IP structure. For example, if your product is a

robot, you may want to:

File a patent ap- File for trade- Put protections in File for copyrights plication(s) direct-
File a patent ap- File for trade- Put protections in File for copyrights plication(s) direct-
File a patent ap- File for trade- Put protections in File for copyrights plication(s) direct-
File a patent ap- File for trade- Put protections in File for copyrights plication(s) direct-
File a patent ap- File for trade- Put protections in File for copyrights plication(s) direct-

File a patent ap-

File for trade-

Put protections in

File for copyrights

plication(s) direct-

marks covering

place to keep your

on the owner’s

ed to the robot

the product

marketing strat-

manual, mainte-

itself and any nov-

name/logo;

 

egy and robotic

nance guides, and

el components;

 

control algorithms

any advertising

as trade secrets;

materials.

and

Without all of these four elements working

together, one or more of your technology (the

product), your business reputation (the name/ logo), your marketing strategy, or your support- ing materials could be misappropriated by your competitors and used to neutralize your com- petitive advantage!

46

MASSCHALENGE | GREENBERG TRAURIG

IP PROTECTION CHECKLIST

WHY AND HOW CAN WE PROTECT OUR IP?

Item

Why this is important

Include an IP assignment

Employees come and go. You want to make

clause in the labor agree-

sure that any work an employee does while

ment every time you hire a

employed by you is owned by your company.

new employee

Investors will ask about this when you fundraise.

Registration of patent/

Patents and trademarks, as explained above

trademarks with the Patent

need to be registered to protect the company’s

and Trademark Office

IP rights

Costs and expenses would depend

upon the number of trademarks involved and

the jurisdiction at which registry is sought. Reg-

istration of a patent requires specialized coun-

sel to be involved and thus, the process and

expenses associated to it are higher than those

associated with a trademark registration.

Registration of copyrights

Usually, this is not an expensive procedure. Both

with the Copyrights Office

in the US and in Mexico, copyright protection

attaches as soon as content is created and me-

morialized on a medium (e.g., on paper, a web-

site, etc.). One can then put a ©, followed by

the year and company name to indicate copy-

right ownership. Filing a copyright application

is necessary if litigation is likely to occur.

Execute an NDA (Non-dis- closure Agreement) with the company’s employees.

You want to make sure that the employee pro- tects the company’s confidential information (i.e., trade secrets and any other type of infor- mation that is not subject to

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47

BEST LEGAL PRACTICES

Item

Why this is important

Execute an NDA with third parties (inves- tors, vendors, suppli- ers, manufacturers, distributors, contrac- tors, etc.)

You want to make sure that the businesses and people you collaborate with as you grow your business protect the company’s confidential in- formation and don’t try to use it for their own gain. Remember, an NDA allows you to sue but it won’t bring back your competitive advantage if the NDA is broken so discuss/disclose as little as possible. Additionally, an NDA does not prevent someone from filing a patent application, so to be certain you should file a patent application before a meeting or discussing your IP.

Develop internal sys- tems to promote IP capture

Your competitive advantage is often driven by IP but you can’t capitalize

on that IP if you don’t know about it! Make invention disclosure forms

readily available to your employees. Regularly ask your employees what

 

they are working on, what ideas they have, what problems they are

solving or trying to solve, and what successes, no matter how small, that

they’ve achieved. This applies equally to patentable ideas, ideas that are

protectable as trade secrets, confidential information such as customer

contacts or business contacts, and ideas for logos, trademarks, or orna-

mental designs. These are the ideas that IP comes from but engineers

and business staff are often quick to dismiss them as insignificant

Develop internal procedures to keep information confi- dential (and train your employees)

These can include:

Restrict access to those who need it.

Keep technology secret until the patent application is filed! That means

not publishing white papers or marketing materials and, whenever pos-

sible, not even discussing with investors, contractors, or potential licens-

 

ees.

Use encrypted and password protected systems.

Have automatically locked, restricted access doors that require keys/

FOBs/badges to enter.

Monitor visitors/guests in your offices.

Have a document retention policy.

Monitor your IP

Regularly identify and observe competitors, identify and observe com- petitive products, and perform internet searches to detect unauthorized use of trademarks or potentially infringing technology and products.

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MASSCHALENGE | GREENBERG TRAURIG

WHY AND HOW CAN WE PROTECT OUR IP?

IP

Privacy

Assignment

Policy

Clause Template

Template

As discussed above, including an IP assignment

Privacy Policies cover what information is

clause in your labor agreement when you hire

collected on a site or app and how it will be

someone is an easy and critical part of protect-

used. It is very important to have a privacy

ing your company’s IP. The clause should at

policy if you are collecting any information,

least include the language “I hereby assign, and

even if it’s as simple as just collecting email

agree to assign in the future

This clause is frequently left out of labour

agreements but can be an important tool in the

event an employee becomes a former employee

or even hostile to the company. Templates for

IP assignment clauses can be found on a num-

ber of websites, including, for example:

.”

addresses for a newsletter. The data a com-

pany collects from its users is a valuable

piece of a company’s IP. If a company doesn’t

have a privacy policy and is collecting in-

formation from its users, then the company

doesn’t own this information. This creates

problems when fundraising or getting ac-

quired. Privacy Policy templates can be

https://www.legalzoom.com/legalforms/intel- found on a number of websites, including, for

lectual-property-assignment

example:

IP rights often times are critical assets you

must carefully protect. You should seek special-

ized counsel adviseadvice to ensure your com-

pany’s rights are well protected.

https://www.legalzoom.com/business/busi-

ness-operations/website-terms-and-condi-

tions-overview.html

http://inicio.ifai.org.mx/SitePages/Mod-

elos-De-Aviso-De-Privacidad.aspx

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TÍTULO DEL MANUAL 50 MASSCHALENGE
TÍTULO DEL MANUAL
50
MASSCHALENGE

HOW

SHOULD I

STRUCTURE

OUR

EQUITY?

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BEST LEGAL PRACTICES

Introduction

BEST LEGAL PRACTICES Introduction Equity is always a difficult area as it often involves uncomfort- able

Equity is always a difficult area as it often involves uncomfort- able conversations and decisions.

However, ownership in your company is a key

motivator for founders and employees, so it’s im-

portant you dedicate significant thought to how

you structure equity. Doing so will help you avoid

major conflicts in the case of a liquidation event.

Below we discuss equity for yourselves, your

employees, and mechanisms you can implement

to make sure you get the most out of equity.

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HOW SHOULD I STRUCTURE OUR EQUITY?

EMPLOYEE OPTION POOL

What is an employee option pool and why should I have one? An employee option pool

is a portion of equity you set aside to give to current and future employees.

Even though creating an

option pool dilutes the found-

ers’ equity, it’s in your best in-

terest to create one. There are

two main reasons for this:

1. Giving your employ-

ees equity aligns their

long-term interests with

those of the business.

It incentivizes them to

make decisions based

on the long-term suc-

cess of the business,

rather than short-term

benefits.

2. Giving your employees

equity motivates them

to stay with your com-

pany longer, reducing

turnover. With equity,

employees both feel

a closer tie to your

company and want to stay to benefit from the

upside in the case of a liquidation event.

How can I implement an em- ployee option pool? SAPI; Creating and implement- ing an option pool for a SAPI or any other Mexican entity had been traditionally consid-

ered as part of high-level em-

ployees’ total compensation,

especially if the employer is

a member of an international

company group. Nonetheless,

recently implementation of

participation in share plans has

become more common for

startups seeking to attract and

retain talent. While the corpo-

rate and contractual documen-

tation generally encompasses

(i) a board or shareholders

resolution, (ii) general plan

guidelines and policies, and

(iii) a stock option agreement,

companies must carefully re-

view the plan terms so as to

avoid the benefits under such

plan to be consider labor ben-

efits (in which case, such ben-

efits would be part of the inte-

grated salary upon which labor

severance is calculated). Also, accountants and tax counsel should review and communi- cate tax advantages and costs related to both the grantor and the beneficiary of the plan.

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BEST LEGAL PRACTICES

BEST LEGAL PRACTICES

C-Corp: Creating and implementing an option

pool for a C-Corp is easy, though it does require careful monitoring with your legal counsel in order to ensure compliance with law. A C-Corp’s formation document that is filed with the State of Delaware, or a resolution of its Board of Di- rectors, creates the option pool by establishing the number of shares of stock reserved for the option pool and stating the terms and condi-

tions that govern the issuance of options to em-

ployees, officers, and directors along with the

administration of those options. US federal law

and Delaware law impose many requirements

on stock options, so the advice of knowledge-

able legal counsel is essential.

A typical option pool for a C-Corp in its early

stages ranges from 5% to 15% of the C-Corp’s

fully-diluted capital stock, although some inves-

tors will ask for 20%. Most investors will require

the inclusion of an option pool in the pre-money

valuation of the C-Corp, which means that the

option pool will dilute the ownership percentag-

es of the existing shareholders. While investors

will have an idea of the option pool size that

they want, and while existing shareholders will

want to resist the dilution, the most important

thing to consider when creating the option pool

is the expected number of employees that the

C-Corp will need and how many options will be

used to grow and retain that expected number

of employees.

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VESTING

EXPLAINED

HOW SHOULD I STRUCTURE OUR EQUITY?

What is vesting? Vesting allows you to give equity incremen- tally over a period of time instead of all at once. It helps you to motivate your team to stay working for your startup for a longer period of time and prevents uncommitted team members from receiving all of their equity if they quit your startup early on in your journey. The normal structure is vesting on a monthly basis over a four-year period with a one-year cliff.

What does “vesting on a monthly basis over a four-year period

with a one-year cliff” mean? This is best explained with an ex-

ample.

Assume an employee is allocated 4,800 shares. If you do

not have vesting in place, this employee could leave the

second day with all 4,800 shares, even though they haven’t

contributed that much to your company yet.

With monthly vesting over a four-year period, this employee

would “earn” 100 of their shares (which is equal to 1 / 48 of

their allocated shares) each month. If a one-year cliff isn’t in

place, the employee would receive 100 shares at the end of

month 1, end of month 2, end of month 3, and so on.

With a one-year cliff in place, any equity is delayed from

being earned until an individual stays for at least one year.

In practice, this employee would not get any equity until

the end of the first year, when they would receive all of their

equity for the first 12 months.

Thus, the employee in this example would receive 0 shares for the first 11 months, then 1,200 shares at the end of month 12, and then 100 shares a month for months 13 – 48. If they stay for 48 months, then they would receive all 4,800 shares. If they only stayed for 10 months, they would receive 0 shares. If they stayed for 14 months, they’d receive 1,400 shares.

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BEST LEGAL PRACTICES

Why should we include a cliff? You should have a cliff in place so you can avoid giving equity to bad hires who might leave or who you might fire within the first few months of joining. This allows you to avoid having to deal with a cluttered cap table that has a bunch of people with very small amounts of equity. It also strongly discourages anyone from leaving in their first year.

Who should be subject to vesting? A startup should have vesting for both the founders and the employees.

As discussed earlier, vesting for your employ-

ees serves to award them for their contributions

to your team and prevent employee turnover.

With the standard four year vesting period, em-

ployees have significant incentive to work for

your startup for at least 4 years.

Founders should also be subject to vesting for

two major reasons:

1. There’s always a very small chance

something happens between you and

your other founder(s) and you want to

make sure they can’t walk away with

huge pieces of your company.

2. As a founder, it’s your job to set the

standard for your company. If all of your

employees are subject to vesting, you

should lead by example and be subject

to vesting too

How can I implement vesting? SAPI: although vesting terms for founder stock

are legally possible to implement in a SAPI, they are uncommon in Mexico and generally most companies when formed, does not create any vesting schedule for the stock granted to the founders. As explained before, founders must consider including certain transfer restrictions for founders or a repurchase right granted to the company to deal with certain issues such as founder’s lack of achievement of certain milestones or to prevent founders leaving the company and preserve their stock. Vesting for

founders stock may be addressed directly in

the company’s bylaws and the stock certificates

issued to the founders.

C-Corp: For each grant of stock or options sub-

ject to vesting, the Board of Directors will estab-

lish the timing and the amount of the vesting.

The restricted stock agreement (for founders)

or the option agreement will contain language

that echoes the vesting terms established by

the Board of Directors. Note that “vesting” in

terms of founders’ shares is a term commonly

used to describe the lapse of the restrictions

placed on those shares. The founders own their

shares completely as of the date they are grant-

ed, but those shares are subject to restrictions

on transfer and can often be repurchased by the

company if the founder leaves before a certain

date. Accordingly, the “vesting” is actually a

lapse of these restrictions.

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HOW SHOULD I STRUCTURE OUR EQUITY?

What happens when our company is acquired and some individuals’ shares have not fully vested? Some companies will implement something called “accel- erated vesting” for this exact situation. Accelerated vesting is where an individual receives some or all of their unvested shares in the case of an event, usually an acquisition. The idea accelerated vesting is to reward employees for achieving a great out- come. If employees work very hard for a year and manage to build a successful enough company that a larger company wants to acquire it, then the accelerated vesting would reward them for their efforts.

There are two types of acceleration: single-trigger acceleration and dou- ble-trigger acceleration.

Term

Explanation

Example

Single-Trigger

Single-trigger means that only one event

Imagine an executive at a start-

Acceleration

has to happen to trigger the acceleration

up has been allocated 10,000

of some or all unvested shares. When

shares at a startup. After the

single-trigger acceleration is usually im-

executive has been at the

plemented, the trigger is an acquisition.

startup for one year, they are

However, in some cases, the trigger could

acquired. Thus, at this moment,

be someone being involuntarily terminated

the executive only has vested

from the startup.

2,500 shares.

   

If the executive was originally

Double-Trig-

Double-trigger means that two events

guaranteed the acceleration of

ger Acceler-

have to happen to trigger the acceleration

25% of his unvested stock in

ation

of some or all unvested shares. Generally

the event of an acquisition (sin-

these two triggers would be an acquisition

gle-trigger acceleration), then

combined with an involuntary termination.

25% of his/her remaining 7,500

shares would instantly vest

Acquisitions sometimes will result in layoffs

(which is 1,785 shares).

in the acquired startup, since the acquirer

might not need the whole team of the orig-

If the executive was originally

inal startup. Double-trigger acceleration benefits employees who worked very hard to help the startup get acquired but got terminated after the acquisition.

guaranteed the acceleration of 25% of his stock if the start- up is acquired and he/she is terminated (double-trigger

acceleration), then 1,785 shares would instantly vest only if the executive is terminated when the company is acquired.

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BEST LEGAL PRACTICES

TAXATION ON SHARES IN THE EVENT OF A LIQUIDATION EVENT

Employee joins

• Company issues common stock options to employee

• Company and employ-

ee agree on strike price,

the amount for which an

employee can buy their

shares in the future

• Taxes: No taxes are in-

curred by employee or

company at this moment

Company creates option pool

• Company allocates a por-

tion of common shares

that you can issue to cur-

rent and future employees

• Company determines the

rights of these common

shares

Company is acquired

• Employee receives money for the shares he /she has exercised

• Taxes: At this moment, the ac-

quisition price per share is likely

higher than the FMV of the

shares when the employee exer-

cised their stock options. Thus,

taxes must be paid on the dif-

ference between the acquisition

share price and the fair market

price at the time the employee

exercised their options

Employee exercises

vested stock options

• Employee pays strike price

for each share of vested stock

they’ve been allocated

• Taxes: At this moment, the

fair market value (FMV),

which is the amount a share

is currently worth based on the valuation of the compa- ny, is generally higher than the strike price. Taxes must be paid on the difference between strike price and fair market value of share

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