Transcript Overview of Early Stage Financings: Energy Efficiency and

Overview of Legal Issues in
Early Stage Financings
(Energy Efficiency and Renewables)
August 11, 2006
Michael Jay Brown
Dorsey & Whitney LLP
(206) 903-8811
[email protected]
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Topics
• Types of early stage financings in energy
efficiency and renewables
• What kind of funding is available?
• Case study of early stage round
• Securities law overview
• Legal pitfalls in early stage deals
• The deal team
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Types of early stage deals
• Is it a product or is it a company ?
• Type of financing depends on stage, nature of company or
product
• What kinds of technologies or companies are being
financed?
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Information technology
Devices
Tech-based services
Projects small, medium and large
Products
Pure research
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Types of Funding
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Angel
Venture
Small Institutional
Debt (particularly for projects)
Strategic Partnerships
Grants
Bank Funding
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Role of Counsel
• Different roles of company, individual, patent and project finance
counsel
• Understanding the role, getting client buy-in and defining your duties
• Where issues most commonly arise in representing early stage
companies:
– founders and their relationship with the company (reverse vesting,
employment agreements, scope of authority, ownership of intellectual
property, other issues)
– VCs and their representatives on the board
– explaining fiduciary duties to various constituencies, including significant
shareholders
– Protecting i.p.
– Financing snafus (addressed below)
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Case Study
• Early stage financing for technology company (as opposed
to project finance or service deal)
• Agnostic as to type of technology (could be device,
information technology, production, distribution, material
science, etc.)
• Two founders, demonstrable technology, pre-revenue, preformation
• Requires $3 million => cash flow break-even in 18 months
• Venture returns predicted
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Case Study (cont.)
• Choice of entity: LLC vs. corporation
• Typical corporate structure and levels of authority
– Shareholders elect directors and vote on major matters
– Directors elect officers and formulate policy
– Officers follow directives of board and act for entity
• Funding:
– First round: $500K, accredited individuals (see below),
convertible note with discount or warrants
– Second round: $2.5 million Series A venture funding
after milestones hit (e.g. technology, revenues, hiring
C-level positions)
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Case Study (cont.)
• Valuation considerations: what is “premoney” and how is it arrived at?
• Cap table: Founders with common equity,
convertible notes and preferred holders,
options, warrants
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Case Study (cont.)
• VC package: nature of preferred equity
(liquidation preference, voting as a class,
investor rights and protective provisions,
board seats)
• Founder reverse vesting
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Case Study (cont.)
• Board of directors (reason for individuals’ service,
number and typical makeup of board, function in
private company, no proxies, to whom duties
owed, nature of duties, indemnification, authority,
and compensation)
• Board of advisors (liability considerations and
nature of service; industry, technology and finance
members)
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Case Study (cont.)
• The process:
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Formation
Business plan
Structure of offering
Private placement memorandum
Securities offering
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Securities Law Considerations
• What is a security? Risk capital, Howey
test (gain from efforts of another), state law
definitions
• Triggers application of securities laws
• Federal and state statutory and regulatory
schemes
• Two principal thrusts of securities laws:
registration and disclosure
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Securities Law Considerations (cont.)
• Disclosure:
– 10b-5 and state analogs
– Always must make disclosure to standard of
materiality
– Usually provided in Private Placement
Memorandum (“PPM”) or similar document
– Generally, no formal, prospectus-like disclosure
requirements
– General categories of information in PPMs
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Securities Law Considerations (cont.)
• Registration (and exemptions therefrom):
– Private placements under federal and state law
– Regulation D (“safe harbor”)
– Conventions/requirements of Reg. D usually adhered
to:
• Accredited-only offerees ($1MM net worth, certain income
tests, entity standards of accreditation)
• No general advertising or solicitation
• Certain filings
• Disclosure documentation including business plan, description
of securities, capitalization, risks, etc.
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Pitfalls in Early Stage Financing
• Taking non-accredited investors
• Commencing accredited round within 6 months of “seed”
round (“integration” issue)
• “Finders” fees and compensating non-broker-dealers
• Assessing materiality in disclosure
• Early stage structuring leading to later problems (e.g. nonmarket anti-dilution protection, certain founder or early
investor rights, etc.)
• “Founderitis” issues: control issues, compensation, director
status, reverse vesting, equity and dilution, etc.
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The Deal Team
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Lawyers
Accountants
Valuation firms and their utility
Investment bankers
Broker-dealers
Venture capital firms
Technical experts
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