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The Importance of Stock Purchase Agreements for Founders

By: Alyssa Ziegenhorn You had a great idea, and you’ve just started your company – congratulations! At this early stage, the company is most likely just you and a few close friends or relatives. Without a large roster of executives, employees, and investors to keep track of, you might think that it isn’t necessary to… Read More

By: Alyssa Ziegenhorn

You had a great idea, and you’ve just started your company – congratulations! At this early stage, the company is most likely just you and a few close friends or relatives. Without a large roster of executives, employees, and investors to keep track of, you might think that it isn’t necessary to document your company’s stock ownership with a stock purchase agreement. After all, you and your sibling/college roommate/spouse are the only owners of the business. It’s obvious who owns the shares.

Or is it? Often founders of early-stage companies don’t feel it necessary to execute stock purchase agreements between themselves and the company. As sensible as this may feel at the time – you’re saving time and legal expenses, and reducing unnecessary documentation! – it can cause significant issues later on.

Ambiguity on ownership and decision-making

If the company has multiple founders or owners, not executing stock purchase agreements can make it unclear who has decision-making power. Is the ownership 50/50, or 49/51? If there is a disagreement down the road, it can be difficult to prove decisively what the ownership split was at the beginning of the company, especially if significant time has passed.  

Issues with future investors

If things are going well, your company might attract investors. That’s great! But part of landing an investor is due diligence – they’re going to want to see all the company’s records. If there is no documented stock purchase for the founders, investor confidence in your project may decrease. Having proper documentation from the beginning makes your company look more professional and increases confidence in your future success.

Significantly increased legal costs

Say you end up in the scenario from #2, and you need to get your documents in order for potential investors – fast! You can hire a law firm to help with that, but diving into old documents and records takes time. It might also involve tracking down old founders or employees who are no longer with the company and getting them to execute documents retroactively. This can be time-consuming and difficult, especially if the relationship with former co-founders or advisors has become negative. All of this means you are looking at significant legal costs; much higher than they would be to execute the agreements at the start.    

Increased tax burden on future shares (no backdating)

If you do need to execute stock agreements later on, it can also increase the tax burden for whoever receives the shares. Backdating stock agreements is strictly against the law. If you execute agreements for your company that was formed five years ago, the effective date has to be the date they are signed. That means if the value of your company shares has gone up, perhaps due to investor interest or successful revenue years, you are going to be responsible for the value of the shares at the time of the agreement – not the time of the company formation.

For all of these reasons, executing stock agreements at the time of formation is a crucial step to set your company up for success, whether you are a small business or an early-stage startup. For more information or help with your company formation, please contact us at info@bendlawoffice.com.

Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction. Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.

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The Six Factors For Determining A Fair Valuation Cap For Your Startup

This article was originally published in Forbes. By: Doug Bend We have helped dozens of startups raise their seed round of financing. Most of these companies have used the template Simple Agreement for Future Equity (better known as a SAFE) with a valuation cap that Y Combinator has open-sourced here. One of the best attributes of… Read More

This article was originally published in Forbes.

By: Doug Bend

We have helped dozens of startups raise their seed round of financing. Most of these companies have used the template Simple Agreement for Future Equity (better known as a SAFE) with a valuation cap that Y Combinator has open-sourced here.

One of the best attributes of the SAFE is the S, which stands for “simple” because only a few terms typically need to be negotiated with an investor. This helps to decrease the amount of time that the founders and the company’s attorney need to spend on negotiating terms.

The most important of these is often the valuation cap, which provides the investor with a ceiling valuation for calculating the number of shares the investor will own if the SAFE converts. The valuation cap, therefore, provides the investor with the peace of mind of knowing that even if the company is valued at a much higher amount, the investor will still have a floor ownership percentage in the company if the SAFE converts.

Determining the amount of the valuation cap is more of an art than a science, but there are typically six key factors—let’s take a look at them.

1. The Overall Fundraising Market

The first factor is the overall fundraising environment for early-stage startups.

For example, the current market for raising capital for startups has cooled off in recent months and is more pro-investor than it was in 2021.

2. Traction

The second factor is how much traction the company has. Investors are more likely to invest with a higher valuation cap if the startup can demonstrate that it has product-market fit. For example, does the company have any contracts that generate revenue? If so, how much revenue and who are those contracts with?

Another indicator of product market fit is the amount of user and revenue growth. For example, investors are more likely to invest in an early-stage startup if it has at least 20% in month-over-month revenue growth or steady, significant increases in the number of users.

3. The Prior Financial Returns Of The Founders

If the founders have a proven track record of prior exits, they are more likely to have a higher valuation cap.

Investors are more likely to invest with a higher valuation cap if the founder has previously provided the investor with a solid return. If the founder has done it before, they are more likely to do it again.

4. The Experience Of The Founders

Founders are likely to have a higher valuation cap if they have experience that is relevant to the startup, particularly if that experience is helping to grow and scale other startups in the same industry.

Investors are more likely to invest with a higher valuation cap not only if it is a great idea, but also if the right team is implementing that idea.

5. Industry

The industry the startup is in can also impact the valuation cap for the SAFE. For example, software companies often have a higher valuation cap because they can quickly grow and scale.

6. Leverage

Lastly, the valuation cap will likely be higher the more leverage the startup has. For example, the more interest there is in the investment round, the higher the valuation cap the startup will likely negotiate.

In contrast, if the startup has a short financial runway, the investor might use that as leverage to negotiate a lower valuation cap or not invest at all if they believe the startup is not as likely to be financially solvent.

As you can see, the valuation cap for a startup’s seed round is based on several variables. Founders are best served working with their company’s CPA and attorney to gauge what valuation cap amount is market and fair for both their company and its investors.

Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction. Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.

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Challenging USPTO Trademark Registrations Based on Lack of Use: Trademark Expungement and Reexamination

By: Vivek Vaidya When a trademark application is filed with the United States Patent and Trademark Office (USPTO), it is examined for a host of issues including whether there are confusingly similar trademarks that have already registered.  However, the USPTO doesn’t perform a deep dive of actual use when a trademark application is first filed,… Read More

By: Vivek Vaidya

When a trademark application is filed with the United States Patent and Trademark Office (USPTO), it is examined for a host of issues including whether there are confusingly similar trademarks that have already registered.  However, the USPTO doesn’t perform a deep dive of actual use when a trademark application is first filed, so it is possible that a trademark may register fraudulently in the US, even though the registrant never sold a good or provided a service in the country.

For years, the only way to challenge a trademark registration was through Cancellation Proceedings before the Trademark Trial and Appeal Board (TTAB).  However, that process places a heavy burden on those challenging trademarks from a time and cost perspective. 

The Trademark Modernization Act seeks to simplify the process of challenging certain types of trademark registrations by asserting that certain goods and services were never used in the United States, so a particular trademark registration should be altered or altogether cancelled.  This is done by filing either a Petition for Expungement or a Petition for Reexamination.

A petition for expungement would be used if the registered trademark has never been used in commerce or connected with some or all of the goods and/or services listed in the registration. The time frame for filing a petition for expungement is between three and ten years after the registration date.

A petition for reexamination would be used to claim that the trademark was not in use in commerce on or in connection with some or all of the goods and/or services listed in the registration on or before the date that the USPTO required the registrant to file its proof of use (whether with the application or, later, through a Statement of Use.) The time frame for filing a petition for reexamination is within the first five years after registration.

Once either filing is submitted, the petitioner no longer needs to participate and the USPTO takes it from there – which is a much simpler procedure than a full-blown Cancellation Proceeding that can take up to 18 months.

If you have a situation where a registered trademark that is not actually is in use in the US is blocking your trademark application, Expungement or Reexamination may be a viable option to remedy your situation.

Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.

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Should I Use SAFEs Or Convertible Promissory Notes For My Startup’s First Investment Round?

This article was originally published on Forbes. By: Doug Bend Startups raising their first round of capital have to decide which type of investment vehicle to use. The two most popular options are convertible promissory notes and SAFEs, or simple agreement for future equity. Convertible promissory notes and SAFEs are similar in that the startup… Read More

This article was originally published on Forbes.

By: Doug Bend

Startups raising their first round of capital have to decide which type of investment vehicle to use.

The two most popular options are convertible promissory notes and SAFEs, or simple agreement for future equity.

Convertible promissory notes and SAFEs are similar in that the startup gets investment capital now in exchange for the investor having an opportunity for their investment to convert into equity if there is a triggering event—such as a Series A round—down the road. A key difference is, unlike convertible promissory notes, SAFEs do not have an interest rate nor do they have a maturity date.

Convertible promissory notes used to be more popular, but the increasing trend is that most startups are instead using SAFEs—for four reasons.

1. No Interest Rate

Unlike convertible promissory notes, SAFEs do not include an interest rate.

As such, startup founders have to give up less equity in their company by using SAFEs instead of convertible promissory notes with comparable valuation terms.

2. No Maturity Date

Also unlike convertible promissory notes, SAFEs do not have a maturity date.

The maturity date for convertible promissory notes is often 18 or 24 months. Startups that instead use SAFEs do not have a looming maturity date deadline.

If a startup uses a convertible promissory note and the note has not converted by the maturity date, the investors have the leverage to negotiate better terms in exchange for extending the maturity date.

3. Speed And Simplicity

SAFE stands for simple agreement for future equity, which can lead to faster investment rounds that not only often cost less money in legal fees but also are less likely to burn through the relationship capital the founders have with the investors.

For example, founders can send investors a redline showing what changes have been made to the SAFE templates that have been open sourced by Y combinator. Experienced investors often review those redlines, nod their heads and only focus on the valuation cap that is in the SAFE as they know the other terms in the SAFE are market and fair.

This helps to facilitate quick rounds of raising capital, which not only eats up less of the founders’ time but also decreases the risk that an investor might lose interest in the investment. This feature is particularly valuable now when the investment landscape is quickly changing.

4. Not A Debt Instrument

Unlike a convertible promissory note, a SAFE is not a debt obligation. This might make it easier for a startup to get traditional financing from banks because there is less debt on the books with a SAFE compared to a convertible promissory note.

Of course, the reasons why founders prefer SAFEs are the same reasons why investors often prefer convertible promissory notes. Investors would prefer for their investment to earn interest and to have the opportunity to renegotiate the terms of the investment if the triggering event has not occurred by the maturity date. In addition, the investors might be more familiar and comfortable with convertible promissory notes as they have been in the startup ecosystem longer than SAFEs.

Long lawyer-story short, if you are a startup founder, you most likely would be best served using SAFEs. Whereas if you are an investor, you most likely would prefer a convertible promissory note.

Either way, founders need to be careful and collaborate with their attorney and CPA to help make sure that the terms and the amount of capital being raised will not overly dilute their ownership allocation in their company.

Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.

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Should You Convert Your Startup From A California LLC To A Delaware Corporation?

This article was originally published on Forbes. By: Doug Bend Most California LLCs that are small businesses never convert to a Delaware corporation for five reasons. 1. In addition to paying the California annual franchise tax you would also need to pay the Delaware annual franchise tax. 2. You would also need to have a… Read More

This article was originally published on Forbes.

By: Doug Bend

Most California LLCs that are small businesses never convert to a Delaware corporation for five reasons.

1. In addition to paying the California annual franchise tax you would also need to pay the Delaware annual franchise tax.

2. You would also need to have a registered agent for service of process in Delaware.

3. It often costs more to have a CPA prepare a corporate tax return than a partnership tax return for a multiple member LLC that has not made a tax election. A single member LLC that has not made a tax election does not need to file a tax return at all.

4. It costs several thousand dollars in legal and government filing fees to convert a California LLC to a Delaware corporation.

5. There are additional basic requirements for maintaining a Delaware corporation. For example, Delaware corporations are required to have annual Board and shareholder meetings or written consents in lieu of a meeting whereas this is not the case for California LLCs. Also, if you convert your California LLC to a Delaware corporation you would also have to file the Delaware annual report by March 1st of each year. The annual consents and reports do not take long to complete, but they are not fun and are items you do not have to worry about as a California LLC.

These additional costs and compliance headaches are why most small business owners never convert their California LLC to a Delaware corporation.

But startups are not like most small business owners.

Instead, the conversion is often a necessity if you plan to raise outside third-party financing for your startup; the drawbacks are outweighed by the benefit of the investment round costing less in legal expenses if it is a Delaware corporation instead of an LLC. This is because most of the seed stage financing documents that have been open sourced were drafted for corporations and not for LLCs. For example, many early-stage financing rounds use Y Combinator’s SAFE template, which was intended to be used by corporations.

Also, your investors will most likely require that your company be a Delaware corporation for three reasons.

1. Many investors are more familiar and comfortable with Delaware corporations as more than half of publicly traded companies were formed in Delaware.

2. Corporations are taxed differently than LLCs that have not made any tax elections. If an investor invests in an LLC that not has made any tax elections and the LLC has net profits, the investor might get a K-1 for each tax year and need to pay income taxes on their proportionate share of those profits even if the investor might not have received any distribution payments from the company. In contrast, with a Delaware corporation, the profits and losses from the company stay locked up at the entity level unless there are any distribution payments to the shareholders.

3. Startups that are raising capital are usually looking to grow and scale. It is easier to issue equity to employees, advisors and service providers from a corporation with a stock plan than it is from an LLC.

For all of these reasons, while it is very rare to see a Mom and Pop shop, such as a restaurant or a consulting company, convert from a California LLC to a Delaware corporation, it is why you often see startups make the conversion if they are not already a Delaware corporation before raising investment capital from investors.

As you can see, the cost-benefit analysis for whether to convert your California LLC to a Delaware corporation gets complicated quickly. If you are thinking of making the jump, you would be well served to first check in with your corporation’s CPA and business attorney to help make sure that the transition would be the best decision for you and your company.

Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.

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Forming a 501(c)(3) Exempt Entity

By: Alyssa Ziegenhorn Are you interested in forming a tax-exempt nonprofit corporation, or applying for tax-exempt status for your existing nonprofit? Nonprofit entities can file Form 1023 with the IRS to request exemption from taxes under Section 501(c)(3) of the Internal Revenue Code because of the charitable programs or actions they undertake. Tax-exempt status comes… Read More

By: Alyssa Ziegenhorn

Are you interested in forming a tax-exempt nonprofit corporation, or applying for tax-exempt status for your existing nonprofit? Nonprofit entities can file Form 1023 with the IRS to request exemption from taxes under Section 501(c)(3) of the Internal Revenue Code because of the charitable programs or actions they undertake. Tax-exempt status comes with many benefits, but it can be tricky to get approval.

Here we will discuss a very important distinction between the two types of classifications on the application: private foundations and public charities. Having a clear picture of which classification you are requesting will help you avoid potential pitfalls on the application. This means your application can be approved much more quickly. It is standard procedure for the IRS to classify an initial 501(c)(3) request as a private foundation rather than a public charity, although they don’t officially publicize that stance. So what is the difference between the two?

1. Private Foundations

When applying for 501(c)(3) status, the IRS will recognize qualifying nonprofits as a private foundation by default, unless cause is shown and a request made that it should be approved as a public charity. Private foundations are typically established by an individual, family, or corporation to support charitable activities.

Funding Source and Spending

Funding for private foundations usually comes from an individual, a family, or a corporation, who then receives a tax deduction for donations. Private foundations are not required to prove that their funding comes from the public. Private foundations are not prohibited from public fundraising, but it is uncommon.

Private foundations usually make grants to public charities, although they can sometimes conduct their own charitable activities.

Governance

Because a private foundation is usually closely controlled by an individual, family, or organization, they retain much greater control of the organization. They get to choose the mission, how to invest the funds of the foundation, how to spend those funds, and who is included on the foundation’s board. Private foundations can be governed solely by donors or a board made up of family members and individuals chosen by donors, regardless of relationship to each other and/or the foundation.

Reporting Requirements

Private foundations are required to file Form 990-PF, a tax return form which includes the private foundation’s assets, financial activities, trustees and officers, and a complete list of grants awarded for the specified fiscal year, including the recipient’s names, locations, and grant amounts. At least 5% of the private foundation’s assets must be given to charitable causes each year. 

2. Public Charities

To be recognized as a public charity as opposed to a private foundation, the applicant must specifically request public charity status and be able to demonstrate that they meet the requirements. The two most important requirements are funding source and governing body. Public charities provide higher tax benefits for their donors, but are subject to stricter qualifications than private foundations.

Funding Source and Spending

Public charities get most of their financial support from the public via fundraising: soliciting donations or grants from individuals, the government, corporations, and private foundations. To maintain tax-exempt status, a public charity must verify to the IRS that they receive a substantial portion (33.33% or more) of their support from the general public.

Public charities spend their money to conduct charitable activities and/or provide services. They rarely make grants (although they can).

Governance

Public charities must have a diverse board of directors, and no more than 49% of the board can be made up of “interested directors.” Interested directors are anyone who has been compensated by the corporation for their services in the last 12 months or any member of that person’s family. The majority of the board also cannot be related by blood or marriage.

Reporting Requirements

Public charities are required to file Form 990, which is similar to form 990-PF but requires less information. Public charities must report their assets, total figures for donations and grants received (but not the names, addresses, or amounts of contributors), board and top staff members, and whether the charity makes grants.

So, Which One do I Pick? There are pros and cons to each classification, and the determination of which one makes the most sense for your nonprofit will depend on your corporate structure, your mission, and your fundraising goals. If you are interested in learning more about starting a nonprofit corporation, or submitting a 501(c)(3) application for an existing nonprofit, please reach out to us at info@bendlawoffice.com or (415) 633-6841.

Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.

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The 10 Steps For Converting Your California LLC To A Delaware Corporation

This articles was originally published on Forbes. By: Doug Bend and Robin O’Donnell Most startup founders form a Delaware C corporation as it is the preferred legal entity of most investors. However, some founders instead form a California LLC when they expect to have losses their first few years and would like for those losses… Read More

This articles was originally published on Forbes.

By: Doug Bend and Robin O’Donnell

Most startup founders form a Delaware C corporation as it is the preferred legal entity of most investors. However, some founders instead form a California LLC when they expect to have losses their first few years and would like for those losses to flow down to schedule C of their individual tax return to offset other income.

Once the company has gained traction and is ready to raise outside venture capital financing, the founder might then convert the LLC to a Delaware corporation by completing the following 10 steps:

1. Member Approval

A plan of conversion will need to be approved by the members of the converting LLC.

2. Filings with California and Delaware Secretary of State’s Office

Separate conversion filings will be required in both California and Delaware. In addition, a Certificate of Incorporation must be filed in Delaware.

3. Internal Documents

Once the conversion filings have been approved, you will need to prepare all of the internal documents for the corporation such as the bylaws, stock purchase agreements, indemnification agreements and the initial Board consent.

4. City Business Registration Certificate

In addition to the internal documents, you will need to update the city business license to include the new legal name of the entity.

5. Fictitious Business Name Statement

If will be conducting business under a name other than the full legal name of the corporation, you will need to file a new Fictitious Business Name Statement with the county clerk’s office.

6. Publication of the Fictitious Business Name Statement

Once you get the endorsed Fictitious Business Name back from the county clerk’s office, you will need to have it published in a legally adjudicated newspaper.

7. California Employment Development Department

If your company is running payroll for employees, you will need to update the Employment Development Department (EDD) of the entity conversion.

8. Seller’s Permit

If your company collects sales tax, you will need to update the company’s account with the California Department of Tax and Fee Administration. If you have any trouble, you can call the Department at 1-800-400-7115 and they will walk you through the process.

9. IRS

You will need to work with your CPA to update the IRS on the conversion. You can read more here on whether you will need to get a new Federal Employer Identification Number (EIN).

10. Vendors

Lastly, you will need to update the company’s vendors on the entity conversion. For example, you will need to update the company’s bank account and insurance policies to include the new legal name of the corporation.

You should consult with your attorney as your company might have different requirements and with your CPA to make sure that you understand the tax ramifications of converting your California LLC to a Delaware corporation, but this checklist is a good starting point for putting together a game plan for the conversion. As you can see, several government agencies and vendors would need to be updated, so you should make sure that the benefits of making the conversion will outweigh the time and costs.

Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.

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