Our podcast, Torys in 10, features quick, candid conversations with our lawyers on issues affecting your business: critical changes in the law, deal trends, market and industry developments and more.
Founders of companies getting ready for their first round of financing should tune in to hear Kristine Di Bacco and Marko Trivun discuss two of the things investors are most interested in when assessing whether to deploy capital in a startup. Kristine explains these practical and applicable tips based on her years of experience advising companies at various stages of their life cycle from conception to sale or IPO.
A full episode transcript follows.
Kristine Di Bacco (00:12): Hi, I’m Kristine Di Bacco, I’m a partner at Torys LLP and also chair of the Emerging Companies and Venture Capital practice, here.
Marko Trivun (00:19): And I’m Marko Trivun, a Senior Associate at Torys LLP in the Emerging Companies and Venture Capital group and also in the M&A group.
Today we’re going to talk about tips for founders getting ready for their first round of financing. Kristine, do you want to tell us a bit about your background because I think it’s very relevant for our listeners to hear.
KDB (00:41): Sure. I’ve worked in this startup space for a very long time. I’m a Canadian and just moved back to Canada a few months ago, but spent a large part of my career working, in the U.S. technology world; so, nine years in Silicon Valley and then three years with the same firm in the leading their New York City office and in that really exciting tech space there. So, I’ve spent a long time working with some of the most disruptive kind of game changing household technology companies from, you know, two founders getting started through to seeing those companies through a sale or IPO. And [I’ve] also spent a big chunk of my time working with some of the leading venture capital and strategic investors as they deploy capital into startups. So that’s the perspective from which we’ll talk about today in terms of how you can get a company ready for raising that first round of institutional funding.
MT (01:33): So, what are two big tips that you would give founders before they go out and raise their first round of money?
KDB (01:41): Yeah, I think they’re tied to the two big things that investors care most about. One is intellectual property—so the company’s IP—and the other is team. And those are kind of the most critical parts of building a venture-backable business. So, I think we can unpack those because in each of those categories there’s a few things to think about.
Maybe we’ll tackle IP first. You know the critical thing here is making sure that the company itself, right, you need to be incorporated and have an entity. Make sure that the company itself owns the intellectual property, not the founders or not people who work for the company in their personal capacity. So, a few things flow out of that. One is, it’s pretty common for founders to start working on a business before they’ve actually formally, legally incorporated the company. And so when you do get around you incorporating, which you should do sooner rather than later, you need to make sure that all that pre-incorporation IP—so the stuff you created before you had an entity—gets assigned into the company. And there’s different ways to structure that and your counsel can help you through that. But, you need to make sure the intellectual property gets assigned into the company. I think there can be some hairy issues here if you’ve been working for another employer before you left, or you’ve been working at a prior employer kind of while you’re starting a new business on the side, you’ll need to make sure that there aren’t any limitations in your ability to do that and make sure that new co owns the IP. So, I do flag that issue for people who are moonlighting new learning for their new startup.
KDB (03:16): The other related piece here is making sure that once you have an entity—in that initial IP is assigned in—then on a going forward basis, the company owns everything. And the way you achieve that is making sure that anybody who works for the company in any capacity, so that’s, founders, employees, contractors, advisers, on day one of their relationship with a company, they need to sign a document. The document’s a little different depending on the category they fall into but sign a document with a company where it’s very clear that that IP is owned by the company itself and not by the person. These are very standard forms that you should get from your counsel and they’ll need to have the magic language in them and then you just need to make sure that on day one everybody signs the appropriate documentation. It’s something investors will ask about. They may want to see each and every agreement. You’ll certainly have to give reps that everybody has signed these, and it’s really tough sometimes to go find people later if they’ve left company, especially on bad terms. So, the best practice here is on day one of the person’s relationship with a company they sign the appropriate document,
MT (04:20): Which is why, in our package to our clients, we always include, as part of that, a standard form document for IP assignment.
KBD (4:31): Yeah, exactly. And the form’s a little different depending on, like I said, whether someone’s an employee or a contractor or adviser. At its core, they all do the same thing, which is get that IP ownership into the company.
The other related point here around IP is, now that the company owns all the intellectual property, you need to make sure that you’re thoughtful about your IP protection strategy. And that’s a little different for everybody depending on the type of business you’re building. So, you know, in law school, they teach us that IP ownership is actually a basket of rights. And I always kind of like that analogy because there are different tools at your disposal. There’s patent rights, there’s trademark rights, there’s copyright, there’s trade secret, protection. And so, it’s a host of tools and the selection and use of those tools will be different for companies depending on what they’re building. So, the IP strategy and tools for a software or SaaS business is very different probably than what a consumer hardware or consumer eCommerce business would use. So it’s working with a good counsel to figure out, “okay, given where the value is in our business, how do we best protect that and what are the various tools we need to use to make sure that we’re protecting the company’s intellectual property?” making the right filings if it’s going to be, you know, patent or trademark filings and that you’re thoughtful about this. Because if it’s something investors will ask about, and they certainly don’t expect that as a young company with limited resources that you’ve done every filing and every jurisdiction in the world—that’s just not realistic—but they will want to know that you’ve been thoughtful about this and you’ve done kind of the key and core filings you need for your business.
MT (06:07): The next big issue we were going to discuss is the diligence on the team. And a big piece of that is the equity component. Did you want to speak to that a little bit?
KDB (06:18): Yeah. This is super, super important and something that needs to be extremely well-documented and company needs to be very careful about it. Investors will care a lot about what the company’s Cap Table looks like: Who owns what and making sure that everybody who thinks they have an ownership claim in the company is in fact reflected on the Cap Table.
So, there’s a few things coming out of here. You need super-clear documentation from an equity perspective on who owns what. And this should always be expressed as absolute share numbers. You don’t want percentages used because that’s confusing, percentage of what that measured when? You want really clear ownership documentation that, you know, Marko owns 10,000 shares and he has paid for those shares and it’s all good, same on options.
(07:08): The other important piece here is I think we know with founders, especially in the early days there, can be a tendency to make promises around equity to people who are doing things to help the company. And I think that’s fine, but you need to quickly document those promises and reduce them to a subscription agreement or share purchase agreement where people actually get the shares that they had been promised and there’s no dispute about who owns what. So that’s critically important. Investors want to know that they’re putting in X dollars for Y percentage of the company. And if the capitalization records don’t reflect everybody, then those ownership percentages are off of course.
(07:46): The other related piece of this is the concept of vesting. So, it’s 100% standard for anybody who works for a startup, whether they’re an employee, contractor, advisor, that the equity they get, whether it’s restricted stock at the early days or maybe options, is subject to vesting. The concept there is that you need to stick around and add value and earn into that equity, so you need to make sure that those vesting schedules are very clearly documented and that people understand what the requirements are. It’s something that investors will absolutely expect and require, including for the founders. They want to know that the founders are incentivized to stick around over the life of their vesting schedule at least, to earn their equity. So if you’re a founder who does not have vesting on your equity, you should expect that when you go negotiate your first round of funding with an institutional investor, that that will be one of the most important points that’s negotiated, is putting you on a vesting schedule.
MT (08:45): And the standard vesting schedule is?
KDB (08:47): Yeah, it’s a four-year vest, one-year cliff for founders and employees. For advisors and contractors, you sometimes see alternate vesting, maybe a two or three-year vest monthly. So that can be a little different.
So, I think IP and team are the two big things. There’s a whole bunch of other stuff we can cover of course.
MT (09:08): But we have to be true to our name, Torys in 10.
KDB (09:09): Exactly. So, I think the other last piece of advice I give to founders is, you know, when you’re starting on the fundraising journey, start early. The fundraising process always takes longer than you think it will. So, start talking to and meeting investors well in advance of when you actually want to raise your first round of funding.
MT (09:28): Thank you. Well, we’ve certainly covered enough for today and we’ll have to explore future topics in future podcasts.
KDB (09:34): Thanks. Talk soon.
MT (09:35): Thank you.
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