Archive for July, 2009

Winding Down a Co-Founder Equity Relationship

July 31st, 2009

I have had several questions about this topic recently from different angles, so here are the basic concepts when a co-founder or early employee leaves a company.  Note that there are overlapping employment, noncompetition and other issues here that I am not going to touch in this post.

The Setup

CloudWidget, Inc. has three co-founders.  They own equal 1/3 shares of the company and everything goes along swimmingly until Founder B moves away/gets a new job/has irreconcilable differences with Founders A&C.  Whatever the reason, B decides to exit CloudWidget and move on.

A&C come to me and ask questions that include:

-> Does B own his stock?
-> Can we get some or all of it back?
-> What should we do?

Threshold Questions

We start with the following key points:

1)  Does B own *stock* outright or stock options?  This is a critical point that many first-time entrepreneurs gloss over and that colors everything else that follows.

2)  Is there a vesting period attached to the stock/stock options?  If so, what is it?

Important Concept #1 – Earning into Equity

Every participant in a startup should earn into his/her shares over time so that if/when the person leaves s/he won’t get a free ride on the backs of the people still plugging away.  If B’s equity was stock options, then almost certainly the options are subject to vesting.  Leaving the company stops the vesting and B must exercise the option and pay the purchase price to get actual shares within 90 days (usually) or the option expires and all right to buy shares vanishes.

It is more common for co-founders to buy stock at the outset than to get stock options, though.  I encourage all my startup clients to put this founder stock on a vesting schedule as well.  This gives the company the right to buy the stock back at the price paid by the founder.  The right expires over time: typically 25% of the shares are owned outright and not subject to repurchase after 1 year, and the repurchase right lapses as to the remainder in monthly increments for another 3 years after that.

For some reason lots of people accept the idea of stock option vesting as a matter of course, but don’t put stock on a repurchase schedule.  Again, I highly advise that everyone do this.

Important Concept #2 – Getting the Stock Back

If B holds a stock option CloudWidget needs to do very little.  On termination the option automatically stops vesting.  Good employment practice dictates that CloudWidget give notice that any vested shares must be exercised within [90] days or will lapse, but that’s the extent of CloudWidget’s affirmative duties.

Let’s assume instead that B bought his stock outright, that it was subject to a repurchase right and that some, but not all of the right had lapsed.  CloudWidget needs to find B’s stock purchase agreement and read it carefully. Some agreements require that CloudWidget buy back the stock within a set period of time (90 days) and some say that the repurchase is automatic on termination.  It is important to know what B’s agreement says so that CloudWidget doesn’t blow its opportunity.

If procedures are followed and the agreement is written correctly, B agreed to the repurchase terms when he signed the agreement, so his consent is not required now.  CloudWidget merely needs to exercise the repurchase right, cancel his stock certificate (hopefully in escrow with CloudWidget or its attorneys) and send him a check along with a new certificate for the vested, un-repurchased shares.  If B had vested in 1/3 of his shares he will end up with 1/9th of CloudWidget; A&C each own 4/9ths going forward.

Important Concept #3 – Not Burning Bridges in the Process

This is frequently the hardest part of the whole situation.  Companies need to know what their rights are, and then exercise them judiciously.  Circumstances vary dramatically case by case, and I always let my clients now that the agreement is the baseline for ending a relationship but is not definitive- everyone is free to reach any other agreement that makes sense, and it is often worth trading a little cash or equity in order to maintain a friendly relationship where possible.

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Ideas Becoming Conversations on the Web

July 28th, 2009

I had a happy milestone this week, when Carolyn Elefant picked up on my recent post about free and low-cost legal services.  She looked at the concepts from the angle of solo and small firm practice.  Her post was then subjected to close scrutiny at AdamsDrafting before finally ending up on the ABA Journal’s web site.

This is clearly a topic of great interest to lawyers and I am thrilled to see it discussed.  It was also a first for me to see a meme posted in this blog picked up and analyzed by others from multiple viewpoints.  Thanks to Carolyn, Ken at AdamsDrafting and Sarah at the ABA Journal for adding your thoughts.  The discussion becomes a fluid, roving one and I learned a lot from your posts.

[In ~2 years of blogging I think this is my very first post *about* blogging.  I promise not to do it often.  I love to see ideas turn into conversations- as long as the conversations are about more than the blogs themselves]

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HUB Berkeley Fireside Chat on the Edge Between Nonprofit and for-Profits

July 28th, 2009

I attended a fascinating talk on social entrepreneurship at the brand new HUB Berkeley last night.  HUB is a shared workspace concept especially for socially innovative people.  They have facilities in 12 cities around the world, including the brand new, gorgeous David Brower Center in Berkeley, CA.  This event + last week’s Cleantech Open event at AutoDesk’s One Market gallery made for two LEED Platinum building visits for me in a week, which was a minor milestone for me.

The talk featured Matt Flannery from Kiva.org, Steve Newcomb from Virgance and Ben Rattray from Change.org.  Discussion was lively and instructive on a number of levels.  I was especially fascinated by the fact that all three businesses stand on the line between traditional nonprofits and for-profit businesses.  All three panelists spoke about why they chose one form over another.  If I understood them correctly, Kiva’s founders simply felt that non-profit status was the right fit; Virgance and Change.org both raised money from investors and that required them to use for-profit entities.

From the discussion, though, I got the impression that any of them could have gone either way with their businesses.  As Newcomb said, it is a great moment in history when people can be capitalists and activists at the same time.

The legal framework needed to build businesses at this balance point is not fully developed, but through the efforts of B corporation and others they are coming into shape quickly.  I love working in this space and look forward to its full development.

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On Commoditized Free and Low Cost Legal Work and the Future of Legal Services

July 24th, 2009

This post weaves together several threads for me: a speech by “legal futurist” Richard Susskind I just finished listening to on the future of legal services (he talks about a move toward commoditized, low-cost legal services), Orrick’s free library of basic corporate documents and the extraordinary amount of hand-wringing and teeth-gnashing I see around me in the legal industry these days.

Here’s the premise: legal services are mostly offered on an individualized, fully custom basis for each client. Attorney rules of professional conduct create a duty of care to clients that make it hard to give people forms and help them a little.  Firms can give away documents with disclaimers about making any changes, but the duty of care makes it hard (today) to create a high volume/low margin business of this.

Orrick has released a set of corporate forms that anyone can download and use; WSGR has a term sheet generator for venture financings that uses a detailed questionnaire to produce a term sheet based (presumably) on WSGR’s extensive expertise negotiating these types of arrangements.  D.C. Toedt’s Firstdrafter project works along the same lines, allowing anyone to find, fill in and use various contract forms.

These are great steps and very much in line with Susskind’s premise.  They aren’t quite the same thing, though.  First, they are freemium products intended to bring new clients in the door.  By giving away a teaser, the firms hope to sign up a bunch of new clients to customize and work through the transactions behind the documents.

I was fortunate to demo a product recently called FirstDocs that promises to change the landscape significantly. FirstDocs lets law firms use best-of-breed documents to create document templates with fill-in or multiple-choice sections for custom terms.  Things like names can be entered once and populated across multiple documents, saving a bunch of time.

More to the point of this post, a law firm could give clients access to this forms library so that the clients themselves can create documents, but with only limited ability to make changes (note: I haven’t talked to FirstDocs about this and I am not sure if their product currently allows exactly this ability).  Alteration of substantive terms would need to come back to the lawyer, which would help ensure that the documents are used only for their intended purposes.

I know there are firms and companies doing things like this today and I am sure FirstDocs is not the only company innovating in this area, but it was an eye-opener for me to see it in action.  It became immediately clear to me that this type of document preparation is the future of legal services.  So much of what we do is form and template-based already, but our habits and tools still require us to maintain substantial oversight of each project.  We need ways to generate careful, top-quality documents with less attorney input on each project.

As Susskind says, more and more legal services are going to slide across the spectrum from custom/high-cost to commoditized/low-cost.  Figuring out which ones, how to make it happen without sacrificing the duty of care to each client and how quickly it will all come about is the fun part.  VLP is developing organizational and technology structures that will let us work at the vanguard of this trend and it is exciting to be part of.

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On Not Making a Federal Case of Every Transaction

July 21st, 2009

Clients hire me for subject matter expertise and to help negotiate transactions. Having worked through a lot of deals in my 10 years as a lawyer, I have some sense of what works, what doesn’t, how to evaluate risk in a deal and how to draft an agreement that takes on just the right amount of risk.

The other side in the deal has an attorney doing the same thing, and once the deal is done we both step out and let the business principals begin the relationship that the agreement covers. In this process it is really easy for the lawyers to get hung up trying to perfectly craft every term in the agreement. This can drag out the negotiation and run up costs. If the negotiations are especially bruising it can also create a bit of tension for the principals at the start of the relationship.

How, then, can one avoid turning every contract into a major battle? Here are a few ideas:

1) Don’t get personal. Contract negotiation is not a battle of wills. It feels that way sometimes, especially when it seems like the other side is determined to throw out all of my suggestions and force its own terms on my client, but the focus needs to stay on reaching a deal that works, not a document I created.  Egos should be checked at the door so the parties can focus on the facts.

2) Work with those facts. I talk through scenarios with my client and the other side and use concrete examples as much as possible so that everyone can understand why a certain term is important.  Tit-for-tat negotiation where each side can only concede something if the other does can stay in the bazaar as far as I am concerned.  I talk through my client’s economics (without giving up confidential information, of course) so the other side can understand why prices are set where they are, why insurance provisions can’t change for this deal, etc.  When the other side understands the *reasons* they need to work much harder to counter my client’s proposals.

3) Listen actively. Asking questions and making a visible effort to understand the other side’s business requirements pays huge dividends. It might seem counterintuitive based on #2 above (if I ask the other side for its reasoning won’t it be harder for me to say no to them?), but it isn’t.  The acts of listening, acknowledging concerns and finding ways to help the other side cover those concerns encourages them to do the same with us.  When we all understand one another’s needs really well we can jointly work out collaborative solutions.

Every deal is different and some definitely go sideways despite everyone’s best efforts to keep things moving properly. Still, when I am able to approach a negotiation with these best practices in mind I find that the deal moves much more smoothly, quickly and with the best legal fees/contract value ratio.  My clients like that.

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Urgency vs. Panic in Bike Racing and Software Licensing

July 17th, 2009

At the beginning of this year Brad Feld posted a terrific piece on the Difference Between Panic and Urgency.  The concept- that urgency is the steady, relentless pursuit of a goal while panic is overwhelming fear that causes irrational behavior- has been stuck in my head ever since and has begun to influence how I look at a number of situations.  Here are a couple:

#1 Bicycle Racing.  I race bicycles in my spare time.  I entered a race recently that I thought I could win if everything went well.  It didn’t and I had a mechanical problem that caused me to stop my bike while the other 35 people in my race kept on going.

I checked out my bike methodically and quickly, then hopped back on and tried to catch up by riding a little faster than the group.  I knew that if I went all out I might catch up, but would probably run out of gas before the end of the race and finish poorly.

I didn’t catch everyone, but managed to pass a bunch of people and finish ninth.  I would have liked to finish higher, but I was proud of myself for riding steady, smart and salvaging a result from a bad situation instead of surging forward and then blowing up before the finish.

#2 Software Licensing.  I work with a lot of software companies that sell products in negotiated transactions- i.e. ones where I get involved to help work through agreements.  Deadlines are always tight and sales personnel are under constant pressure to close deals.

The salespeople that impress me most in this environment are the ones who view each transaction as essential and work hard to keep things moving quickly, but without creating a fire drill every time or sacrificing terms in order to close a deal by X date.

The people who view each deal as urgent, but not panic-inducing seem to do the best job of conveying their company’s requirements to a customer and working through the deal terms most expeditiously.  I model this behavior in every transaction I do, working through it steadily and with a sense of purpose to reach the best result in the fastest possible time frame.

As I said, the urgency vs. panic idea has been in my head all year.  It’s a great way to think about how to reach goals.

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Keeping Things all in Context

July 10th, 2009

[Note: I have taken about a 5 month hiatus from this blog and am suitably refreshed and ready to get back in the habit.  This is a copy of a newsletter I sent recently.  I hope you enjoy it.]

I worked through a complex contract recently where the other side had heavily revised my client’s standard form agreement. A number of terms were extremely important, and others less so.

I got to one paragraph about shipping requirements and rolled my eyes slightly when I saw that the other side had changed our “FOB origin” term to “FOB customer’s facility”, meaning that my client would be on the hook for lost property until the goods reached the customer’s facility.

The same day, I found the amazing photo below on the Web, courtesy of Clay Shirky‘s Twitter page.

ship

It was a timely visual reminder that much as we might like to take things like shipping for granted, we can’t always count on them.

With that in mind, I looked at the full context of the agreement:

*Do we have insurance to cover these kinds of losses? Yes- good.

*Does the agreement have “time of the essence” language, liquidated damages clauses or other penalties that could apply here? No- terrific.

Knowing that, we determined that this point was not likely to have major repercussions and we could focus on other terms in the deal.

The lesson? Context matters, and little points can turn into big ones if we don’t look at everything together. Great photos help.

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