© Copyright 2017 by K&L Gates LLP. All rights reserved.

Presented by Alidad Vakilialidad.vakili@klgates.com415.882.8039September 7, 2017

Startup War Stories: Tales from the Trenches

Silicon Valley Startup: Idea to IPO

klgates.com 2

These materials have been prepared solely for educational purposes.The presentation of these materials does not establish any form ofattorney-client relationship with the author or K&L Gates. Particularlegal issues should be addressed through consultation with your ownlegal counsel, not by reliance on this presentation or these materials.Attorney Advertising. Prior results do not guarantee a similar outcome.© K&L Gates LLP 2017.

Circular 230 DisclosureTo ensure compliance with requirements imposed by the IRS, pleasebe advised that any U.S. federal tax advice contained in thiscommunication (including any attachments) is not intended or written tobe used, and cannot be used, for the purpose of (i) avoiding penaltiesunder the Internal Revenue Code or (ii) promoting, marketing orrecommending to another party any transaction or matter addressedwithin.

klgates.com 3

klgates.com 4

Introduction

Alidad Vakili, Esq.415.882.8039 alidad.vakili@klgates.com

Practices in the San Francisco office of K&L Gates

Advised founders, startups, and investors in many transactions over the years.

klgates.com 5

Overview

Sharing war stories is more acceptable these days. The Internet is full of articles and blogs about startup failures, successes and the many lessons learned in between.

"Failure is simply the opportunity to begin again, this time more intelligently."

Henry Ford

klgates.com 6

Overview

There seems to be a renewed focus on failure as the pathway to success.

“Without failure there is no achievement."

Henry Ford

klgates.com 7

OverviewSometimes the best way to learn is vicariously…from war stories told by others who have been in the trenches and lived to tell about it.Focus of presentation – common missteps made by entrepreneurs and startups.Goal of presentation – to provide you a better understanding of those missteps and how to avoid them.

klgates.com 8

Documenting the Deal

An Expensive Breakup:• Startup with innovative product in the arts industry• Founder’s friend had a manufacturing business• Founder decided to save money by inviting his

friend to be a part of the company• Signed a deal without getting proper legal guidance:

• Friend got 50% equity in business when deal signed• Friend’s only contribution was agreement to manufacture

products (time and labor included, but costs were not)• Friend couldn’t deliver on manufacturing• Delays, cost-overruns, and defective products• Relationship soured

klgates.com 9

Documenting the DealAn Expensive Breakup Cont.:• Resolution:

• Founder bought out friend for $75,000• Key Takeaways:

• Before you sign, do your diligence on your partner-to-be

• Troubleshoot where problems could arise (ask the “What if’s?)

• Get a lawyer to help you document your deal.• Paying for good legal advice in advance will save you

in the long run• Cost to negotiate buyout was 10+ times more than

what it would have cost to have a lawyer document deal from beginning.

klgates.com 10

Documenting the Deal

An Expensive Breakup Cont.:• Documenting your deal:

• Term Sheet, Letter of Intent (“LOI”), Memorandum of Understanding (“MOU”)• Should clearly outline the proposed relationship• Parties• Key terms• Timetable and obligations of parties• Binding vs. non-binding or hybrid of both?• Confidentiality• Exclusivity• Transaction expenses

klgates.com 11

Capitalization

Two (Mis)Steps Forward, 10,000 Steps Back:• Software startup working in defense industry• Company formed with minimal shares authorized• Two forward splits stock• Documentation handled internally by company• Company issued shares based on split numbers• Articles never amended:

• Share splits never authorized (i.e., never happened)• Company exceed authorized number of shares

klgates.com 12

CapitalizationTwo (Mis)Steps Forward, 10,000 Steps Back• Resolution:

• Had to clean up the capitalization• Had to go out to existing shareholders to explain the

problem• Key Takeaways:

• Capitalization structure and changes requires proper planning and guidance

• Documentation needs to be prepared and in case of doing splits, authorizing more shares, creating new classes of shares (i.e., preferred stock), etc. must be filed with the Secretary of State

• Again – resolution cost significantly more than necessary

klgates.com 13

CapitalizationTo Give or not to Give?• Striking the right balance between giving

up too much or not enough• Capitalization

• Think backwards when planning capitalization• Ownership• Control• Dilution (plan for it – it’ll happen)• Incentivizing your employees,

consultants, etc.

klgates.com 14

Good Corporate Hygiene

Laundry List of Missteps for the Unwary:• Invalid or defective shareholder actions• Invalid or defective board actions

• In some cases can be fixed by having board or stockholders ratify action.

klgates.com 15

Good Corporate Hygiene

Laundry List of Missteps for the Unwary :• Waking a Sleeping Devil: Stock and option

pricing: • Company issues options to employees and

consultants – but did not price them properly creating 409A issues.

• Issue discovered during diligence in middle of merger transaction

• Employees cashed out paid extra to cover the additional tax from being priced too low.

klgates.com 16

Good Corporate Hygiene

Laundry List of Missteps for the Unwary :• Contract (mis)management

• Not keeping track of agreements or important terms

• Not seemingly important until there is a deal in play and the other side is asking questions

klgates.com 17

Good Corporate HygieneLaundry List of Missteps for the Unwary :

• Grabbing the Company by its Crown Jewels:• Startup with key consultant developer • Startup did not have proper

agreements to protect IP developed by consultant

• Agreement contained fine print giving rights to discoveries by consultant to consultant and not company

klgates.com 18

Good Corporate HygieneLaundry List of Missteps for the Unwary :• Grabbing the Company by its Crown Jewels:

• Resolution:• Negotiated settlement with consultant

• Key Takeaways:• Protect the Crown Jewels – Document your rights

• CIIAAs / PIIAAs• Know the devil in the details in agreements you

sign with consultants, venders, etc. Read the fine print

• States laws differ – may need specific language tailored to specific state’s laws to be enforceable

• Again – resolution cost significantly more than necessary

klgates.com 19

Preparing for Your First DealPrepare before your start preparing:• Organization• Answer the investors questions before they

ask them• Set up your documents, data room, etc.

before you sign your term sheet.• Use advisors efficiently

“Before anything else, preparation is the key to success.” Alexander Graham Bell

klgates.com 20

Diligence

The Snack Food SNAFU:• Snack food company approached by

distributor looking for new snack food• Company negotiates verbal deal with

distributor and starts working on initial order of 500K snack products

• Distributor fronts costs for new equipment• Company finally gets around to calling their

lawyer to “document their deal”• Disaster ensues at meeting

klgates.com 21

Diligence

The Snack Food SNAFU:• Resolution:

• Company couldn’t deliver on order• Had to pay distributor back for advances

costs for equipment• Key Takeaways:

• Do your diligence before you enter into a deal• Misstep cost company its largest order and any

future orders it may have received

klgates.com 22

Parting Thoughts…

Spend the time upfront to organize your startup and establish procedures and organizational habits that will make future transactions more efficient and less costly

Thank YouQuestions?