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Notice of Scams for California Entities

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Once a new company is registered with the California Secretary of State, the business address becomes public and easily accessible on the Secretary of State’s website. As a result, the entity will likely begin receiving solicitations from private companies trying to sell unnecessary corporate services or outright scams. The California Franchise Tax Board, Board of… Read More

Once a new company is registered with the California Secretary of State, the business address becomes public and easily accessible on the Secretary of State’s website. As a result, the entity will likely begin receiving solicitations from private companies trying to sell unnecessary corporate services or outright scams.

The California Franchise Tax Board, Board of Equalization, and Employment Development Department (EDD) are a few legitimate state government organizations that may send notices to a new entity and should not be ignored. Private companies, however, with names such as “Corporate Compliance Center,” “Compliance Document Services,” and “CBFS” do not have any enforcement authority and are simply trying to make money. These solicitations should be ignored for two main reasons:

  • They ask you to pay them for services that you don’t need. For example, many of these companies offer to get a Certificate of Status for your entity, which is actually only needed in very limited situations and can be obtained by anyone for $5. Another company sends a “Labor Law Compliance Notice” selling employment posters for $84, when these posters are available online from the EDD for free.
  • They are selling “corporate templates” that are not specific to your company. Often the private solicitations offer templates of documents that are necessary for a new entity, such as corporate bylaws or an LLC operating agreement. In order for your new business to run properly and for you to receive liability protection, you need governance documents that reflect the circumstances and needs of your specific business–not generic documents that are meant to apply to every business from software companies to restaurants to car mechanics. We highly recommend working with an attorney to draft these crucial documents, rather than paying $47.99 for documents that may not fit your situation and may subject you to personal liability.

By reading the fine print on documents addressed to your business, you can determine if these are legitimate notices with which you need to comply. All of these private solicitations will include that the organization is not a governmental agency, or that the product or service has not been endorsed or approved by any governmental agency. You are not required to give money to these private businesses.

These private solicitations come in many forms and are constantly changing, so consult with an attorney if you have questions about your company’s compliance with state or local regulations.

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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Three Security Exemptions Founders Should Understand

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A large part of my practice involves assisting companies as they divide up stock amongst the founders and plan for how to best use equity to incentivize service providers, as well as selling securities to investors. Founders should be knowledgeable of securities exemptions under the SEC security laws that are likely to come into play… Read More

A large part of my practice involves assisting companies as they divide up stock amongst the founders and plan for how to best use equity to incentivize service providers, as well as selling securities to investors. Founders should be knowledgeable of securities exemptions under the SEC security laws that are likely to come into play as their company first forms and continues to grow. As all founders should be aware, every issuance of securities must be registered with the SEC unless a particular exemption applies. The three most common exemptions are discussed below.

“Founder’s Stock” and Rule 4(a)(2)

We should start by saying there is no such thing as “founder’s stock.” Rather, it is simply a term given to promoters and other insiders who work to form the company. In the end, it is simply common stock provided to those who played a crucial role in setting up the company.

Under Securities Act Rule 4(a)(2) an exemption from registering an issuance of securities with the SEC is carved out for transactions not involving a public offering, in which stock is sold to those who “take the initiative in founding or organizing the business” (See SEC Release No. 33-4552). However, even if you are selling shares to founders under this exemption, you must also file any necessary filings under “blue sky” laws, which in California tends to be a 25102(f) notice fling with the California Department of Financial Protection and Innovation.

“Reg D” Offering and Rule 506 (and the less commonly used 504 and 505)

A “Reg D offering” is a term used to describe a private placement offering that allows you to raise an unlimited amount of money from accredited investors under Securities Act Rule 506, or up to $5 million under Rule 505 and $1 million under Rule 504 during a 12-month period, and not register the offering with the SEC.

One important thing to remember is that a convertible note is considered a security and the company must comply with the proper SEC exemptions. The abundance of open source documents around convertible notes, and even series seed rounds, have caused many founders to think so long as they use those documents they are all set, and therefore, forget about complying with the rules that apply to a Reg D offering.

Under Rule 506(b) a company may raise unlimited funds from accredited investors and up to 35 non-accredited investors who are “wealthy and sophisticated,” provided the company does not generally solicit the offering, is available to answer questions from non-accredited investors, and provides audited financials.

The burden of providing audited financials (the type of financials required if you were registering the securities with the SEC) leads many startups to lean on Rule 506(c). Under 506(c) all purchasers must be accredited, which includes taking reasonable steps to verify they are accredited, but there is not the same requirement for audited financials.

Less frequent Reg D offerings include offerings that rely on Rules 504 and 505. These exemptions are less commonly used as they have limits on the amount raised, geographical restrictions, and increase the burden as to disclosures. Using Rules 504 and 505 can widen the investor base from which you can raise capital, but as a general rule of thumb the increased requirements around disclosures and the simple reality that taking money from someone who cannot afford to lose it makes using 506(c) the better option for most companies.

Much like stock issued to founders, even if exemptions apply for a private placement such that you do not need to register with the SEC, you must still look to satisfy blue sky laws within the state you solicit and sell securities within.

Incentivizing service providers under Rule 701

Under Rule 701 of the Securities Act, a startup is permitted to offer equity as part of a written compensation agreement to consultants, employees, and directors without having to comply with complex federal securities registration. In order to stay within the parameters of Rule 701, however, the total sales of stock during a twelve month period must not exceed the greater of (1) $1 million, (2) 15% of the issuer’s total assets, or (3) 15% of all the outstanding securities of that class.

Additionally, the offering of securities must not be included in any other offering of equity (such as for capital raising purposes as discussed above), and all optionees and shareholders must be given a copy of the plan under which the securities are being granted. If total sales exceed $5 million, additional disclosure requirements can come into play. Furthermore, just because the offering fits into an exemption does not excuse the antifraud provisions, which means any and all disclosures cannot be materially false or misleading.

Offerings under Rule 701 must still comply with any applicable “blue sky” laws (noticing a trend?!), and in California this typically involves filing a 25102(o) notice with the Department of Business Oversight when crafting an equity incentive plan.

Informed founders can take the first step to proper upfront planning to avoid downstream complications when it comes to issuing securities to other founders, service providers and investors. Additional rules and requirements may apply to your situation and you are strongly encouraged to speak with an experienced attorney as the penalties can be quite harsh. If you have any questions, don’t hesitate to reach out to us at 415-633-6841, or 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 Convenient and Practical Features of a Delaware Corporation

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If you are a California resident considering starting a company, you’ve probably heard by now why investors traditionally prefer the Delaware Corporation over a California Corporation. These reasons include, but are not limited to, a well-established legal precedent that makes disputes easier to resolve, corporate attorneys’ familiarity with Delaware corporate law, and making VC deals… Read More

If you are a California resident considering starting a company, you’ve probably heard by now why investors traditionally prefer the Delaware Corporation over a California Corporation. These reasons include, but are not limited to, a well-established legal precedent that makes disputes easier to resolve, corporate attorneys’ familiarity with Delaware corporate law, and making VC deals easier to execute. While there are many viable reasons for selecting a Delaware Corporation, there are a couple of less frequently mentioned reasons to consider.

1. A Consistent and Reliable Secretary of State

In my experience, if the Delaware Secretary of State catches a typo, has trouble reading the last four digits on your credit card, or any other matter that may slow up the process, they will email or give you a call and work to fix the problem over the phone. Additionally, the Delaware secretary of state is open until 8 PM to ensure those operating from the West Coast do not lose out due to the time difference.

California is quite the opposite. Rather than call, email or take any extra steps to simplify the process, the California Secretary of State will simply mail back the requested modifications using standard mail, and after revising, you will then need to mail everything back and play the waiting game. With business moving at the speed of light, this uncertainty can make corporate filings much harder to execute.

2. Only One Director, Despite Multiple Shareholders

Nearly all entrepreneurs who start a venture envision they will remain in control of big decisions (at least for the foreseeable future). Under California law, a corporation may only have one director if in fact there is only one shareholder. Once the shareholders expand to two, there must be at least two directors, and once the shareholders expand to three or more, there must be at least three directors (CA Corporations Code 212).

Under Delaware law, there can be multiple shareholders while maintaining a single director board. This gives entrepreneurs maximum control as things get started. It also lowers the burden of finding qualified directors to serve on your board, and removes the risk of a deadlock with two directors, or even worse, the other board members out voting you.

3. Electing the Board of Directors on Paper

I hear it all the time – “I’ve got this great idea, but I’m bootstrapping the whole thing.” The reality is that even after you incorporate you’ll likely continue to feel “bootstrapped” for the first couple of years.

Corporate law requires the shareholders to elect who will serve on the board of directors for the coming year. California permits the company to elect by paper vote only if they receive unanimous written consent from all shareholders (CA Corporations Code 603(d)). There is a big difference in time commitment and cost between holding an in-person meeting for all shareholders and obtaining a majority vote with written approval. A shareholder may simply be unavailable (finally taking that three month trip to backpack across Europe!) and therefore, the company must shoulder the burden of holding an in person meeting because it cannot obtain unanimous written approval.

Delaware, on the other hand, does not require unanimous written approval (DE Corporations Code 228(a)). If less than unanimous consent is obtained, then Delaware must provide notice to those who did not provide their consent, but this notice requirement is much easier to meet than holding an in person meeting.

4. Open Source Documents to Facilitate Financing

As your product or service begins to take shape many startups can experience exponential growth with a small round of financing. The goal here is to use the money you’ve raised as judiciously as possible to ensure it goes towards what makes you great.

Open source material from Y Combinator and Series Seed Documents help facilitate raising money in a Delaware Corporation and have made the financing process much, much easier. This allows lawyers to focus on the necessary vetting of investors, securities exemptions and increases the likelihood of quick legal advice due to familiarity with the documents at hand.

Unfortunately, California has no such open source documents. Furthermore, because the California Secretary of State is much harder to deal with, actually filing the documents successfully the first time, and with any kind of speed, is hard to predict.

There is no one-size-fits-all when it comes to selecting the proper entity for your business, but when making the decision be sure to consider some of the convenience, flexibility and certainty a Delaware Corporation can provide.

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 Your Business Be an LLC or a Corporation?

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This post was originally published on Yahoo Small Business Advisor Entrepreneurs can generally choose from a number of different entities when incorporating their business. Due to the fluid nature of businesses, however, the advantages and disadvantages are not always clear at the time of formation. Limited liability companies (LLCs) and corporations are the two most… Read More

This post was originally published on Yahoo Small Business Advisor

Entrepreneurs can generally choose from a number of different entities when incorporating their business. Due to the fluid nature of businesses, however, the advantages and disadvantages are not always clear at the time of formation.

Limited liability companies (LLCs) and corporations are the two most typically attractive options for small businesses considering incorporation. Unlike sole proprietorships and general partnerships, members of LLCs and shareholders of corporations have limited liability and greater protection for their personal assets. Members and shareholders can limit their liability and protect their personal assets from creditors.

But if both options offer owners liability protection, why do some business owners choose to form an LLC instead of a corporation, and vice versa? Below are some considerations to help you decide what type of entity might be the best fit for your business.

1. Corporate Formalities

Unlike a corporation, an LLC does not have to hold regular meetings and keep corporate minutes, which reduces the paperwork of maintaining your entity.

2. Taxation

The tax default for an LLC is treated as a pass-through entity, meaning the profits or losses from the entity pass through directly to the owners. Owners of an LLC can instead elect for it to be taxed as a C or S corporation so they can access certain tax advantages based the company’s income and expenses. The tax default for a corporation is subject to taxation at both the entity and the owner level. A corporation can also elect to be taxed as an S corporation which, like LLCs, allows for pass-through taxation. However, additional restrictions regarding who can be a shareholder of the corporation exist if you elect to be taxed as an S corporation. For example, S corporations can have no more than 100 shareholders and can have only one class of stock.

3. Debt Inclusion

Early on, a startup or small business will often operate at a loss. Corporation shareholders may not deduct losses beyond their basis in their stock or debt obligations. In contrast, LLC owners can include their proportionate share of the debt from the LLC, so they can deduct a larger share of the losses.

4. Management

An LLC’s members or managers can manage the company. In contrast, a board of directors and its chief executive officer are in charge of managing corporations.

5. Distributions

A corporation must allocate its distributions in proportion to each shareholder’s ownership share. An LLC, on the other hand, does not necessarily have to allocate its profits or losses in proportion to each owner’s membership interest. Instead, the LLC’s operating agreement (which is subject to certain IRS restrictions against negative capital accounts) can determine the distributive share of gains, losses, deductions or credits. Additionally, members of an LLC can transfer and withdraw property into the LLC without the recognition of taxable gain by the LLC or the member with whom the property has been distributed. In the case of corporations, property distributions can result in taxable gain.

6. Investment

Entrepreneurs hoping to achieve venture seed funding typically choose the Delaware C Corporation. Venture capital firms won’t automatically screen out businesses that are not incorporated in Delaware, but they prefer it due to their friendly corporate governance benefits and predictable corporate laws.

Selecting an entity that is appropriate for your business will depend on how you plan to run the business and where you hope to take it. One size does not fit all. Crafting a strategic entity can mean a world of difference as your business begins to take off.

By Alex King & Doug Bend

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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How To Sweeten the Deal for Convertible Note Investors

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By Doug Bend and Luthien Niland This article first appeared on Forbes Startups seeking seed investment do what they can to entice investors, especially investors who are deciding whether to invest in your company or elsewhere. One common method for raising seed funding is a convertible note, which is a loan from an investor to a… Read More

By Doug Bend and Luthien Niland

This article first appeared on Forbes

Startups seeking seed investment do what they can to entice investors, especially investors who are deciding whether to invest in your company or elsewhere.

One common method for raising seed funding is a convertible note, which is a loan from an investor to a company that has the upside of converting into equity if the company raises a certain amount of financing within a set amount of time. There are several reasons why the vast majority of seed stage investment rounds use convertible notes, including that it defers the valuation of the startup until a later round of financing and is a relatively inexpensive investment vehicle for infusing cash into a startup without a significant amount of legal time.

Our law group has helped close dozens of seed rounds for startups raising investment capital using convertible notes, and in the process, we’ve noticed that there are a few ways to “sweeten the deal” through convertible-note provisions—things investors may be looking for that could be effective bargaining tools for you.

Prepayment Only With Approval

Some convertible-note documents allow the startup to prepay. While this gives the company flexibility, it may not be attractive to investors who are aiming to hit a home run, rather than just interest on a loan.

An investor’s nightmare is to pick a winner, but the startup prepays the note before it converts and the investor misses out on the company’s upside. To assure a potential investor that this will not happen, you can offer a convertible note that may only be prepaid with the consent of the holders of at least a majority of the outstanding principal amount of the notes.

Favorable Investor Provisions

Early investors may be concerned that a startup will leverage their funding to grow confidence in the company, and then be in a position to offer later investors more favorable investment terms. Reassure investors that their early participation in the company will not put them at a disadvantage, and if the company offers better terms to other investors, they will also benefit from those terms with a provision that will automatically apply all favorable changes to the terms of the convertible note to all of the notes.

Cap On Conversion Price (aka the “Instagram Provision”)

Most convertible notes provide a 20 percent discount if the note converts into equity compared to the price paid by the next round of investors, to reward the risk taken by early stage investors.

However, if the company takes off, even after a 20 percent discount the seed-stage investment might not translate into a significant stake in the company. For example, a $25,000 seed stage investment in Instagram without a conversion cap would have translated into a very small equity stake, because the company was valued so highly at the next round of investment.

A conversion cap helps to align the incentives for the founders and the seed investors to seek as high a valuation as possible in the next round; without a cap, a seed stage investor’s investment will become worthless as the company’s valuation increases. By adding a conversion cap to the convertible note, your startup can tell investors that their investments will convert into a fair equity stake, and your investors will want the company to grow in value as much as possible.

Premium on Investment Upon Sale of the Company

Some convertible notes provide that an investor will be repaid only their investment amount plus accrued interest if the company is sold before the note converts. Similar to prepaying the note before it converts, investors may be wary of providing money to a startup as a loan rather than a potential high return investment.

To sweeten the deal, offer to include a provision that provides that the investors will get their money back with interest, plus a premium, if the company is sold before the note converts. Premiums are generally a multiple of the principal amount of the loan, i.e., 1.5 to 2 times the principal amount.

Hopefully offering one or two of these provisions to potential investors will make the investment more appealing while not disadvantaging your company too much. Every set of convertible note agreements is different, so you should consult with your legal counsel prior to including any of the above provisions.

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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8 Tips For Entrepreneurs Buying a First Home

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By Doug Bend This article first appeared on Business Collective. Both Alex and I recently bought a home in California. And while we are excited to be new homeowners, we were quickly faced with the reality of the purchase. Like many first-time homeowners, we were surprised by some costs and the time it took to… Read More

By Doug Bend

This article first appeared on Business Collective.

Both Alex and I recently bought a home in California. And while we are excited to be new homeowners, we were quickly faced with the reality of the purchase. Like many first-time homeowners, we were surprised by some costs and the time it took to get approved for a loan. We share the eight tips below with the hope that they will help ease the pain for others planning to buy a home.

Don’t Mentally Move in Until You Strike the Deal

If you have already mentally moved into your home before closing, you will lose your ability to objectively determine whether that particular property is the best fit for you and your family. You may also lose leverage in negotiating fair terms since the seller can tell if you have taken the bait, hook, line and sinker.

If you proclaim, “I absolutely have to have THIS house,” is the seller likely to drop the price or make any repairs that might be found during the home inspection?

Instead, when you think you may have found your ideal home, do your best to blanket your excitement when negotiating with the seller and stay objective on whether it is indeed the best home for you and your family.

Set Aside Money for Home Repairs

Your potential new home may seem to be operating just fine, but damages may surface just a few weeks down the line. Make sure you set enough aside to cover big ticket expenses.

For example, my friend recently purchased a home with a driveway that needed $12,000 in repairs, and Alex’s home will need a new roof. When buying a home, it is wise to err on the cautious side of how much you think home repairs will cost.

If the seller has either disclosed flaws in the home or a home inspector identifies problems, be prepared to spend money to fix those right away. If the seller has disclosed a troublesome hot water heater, washer and drawer, roof, etc., odds are it will need to be repaired sooner rather than later.

Set Aside Money for Interior Design

In addition to home repairs, you will likely want to make some design changes, including purchasing furniture and other items for your home. I personally am budgeting for patio furniture, since I know I’ll be itching for it once I move in.

Prepare to Close on a Mortgage

Some first-time home buyers are surprised that it costs several thousand dollars to close on a mortgage for their home. It is smart to plan ahead and ask your mortgage broker for an estimate of how much the closing costs will run when you get pre-approved for a loan. That way, you won’t wait to find out how high closing costs are until a few days before closing.

Strategically Select Your Mortgage

A 30-year fixed mortgage is not a one-size-fits-all solution for financing your home. I’m working with a savvy mortgage broker to see whether a 7- or 15-year mortgage would best fit my circumstances, as I may sell my home in the next few years.

Gather All Necessary Paperwork and Information

Getting approved for a home loan can be a tedious, stressful process. Just when you think you have provided every single last possible bit of your financial details, the mortgage broker is likely to ask you for one more piece of information.

To keep from going crazy from the paperwork, plan for the time it will take to complete it. Alex and I had to remind ourselves to ask our broker how much documentation we would need before loaning a large amount of money to a complete stranger.

Time Your Home Purchase Around Other Life Changes

There are only so many hours in a day, and finding your ideal home, purchasing the home, getting approved for a mortgage and planning a move can be extremely time consuming. It’s ideal to focus on buying a home when you do not already have other big time commitments going on in your life. For example, try not to purchase a home when you are expecting a child, planning a wedding, or changing jobs.

Beware of Your Own Hubris

The idea of paying a real estate agent 2.5 to 3 percent of the purchase price of your home might seem absurd at first, but involving an expert makes sense when you are making one of the biggest investments of your life. Get the help you need and don’t be overconfident that you can figure out all of the home-buying wrinkles on your own. The right real estate agent is likely to earn every penny of their commission by not only being a knowledgeable resource but by also being emotionally supportive and trustworthy. You will be glad you had them during the home buying process.

Buying a home is an exciting but also a stressful time. Hopefully these tips will help make the process one more of celebration than of regret.

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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Top 7 “Gotcha” Provisions For Investors To Watch Out For In Convertible Notes

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Bend Law Group has helped close dozens of seed rounds for startups raising investment capital, the vast majority of which are still completed using convertible notes. Here are the top seven provisions investors should be on the lookout for when negotiating convertible notes with startups. 1.  Prepayment Of The Note Some convertible note documents allow… Read More

Bend Law Group has helped close dozens of seed rounds for startups raising investment capital, the vast majority of which are still completed using convertible notes.

Here are the top seven provisions investors should be on the lookout for when negotiating convertible notes with startups.

1.  Prepayment Of The Note

Some convertible note documents allow the startup to prepay the convertible notes.

An investor nightmare is to pick a winner, but the startup prepays the note before the note converts and the investor misses out on the company’s upside. Instead, the convertible note should provide that it may only be prepaid with the consent of the holders of at least a majority of the outstanding principal amount of notes.

2.  Most Favorable Investor Provision

If the company offers better terms to other investors, you should also benefit from those terms. You can do so by adding in a provision that provides any changes in the terms of the convertible notes that are more favorable to investors shall automatically apply to all of the notes.

3.  Cap On Conversion Price, aka the “Instagram Provision”

Most convertible notes provide a 20% discount if the note converts into equity compared to the price paid by the next round of investors. This conversion discount is intended to reward the risk early stage investors take for supporting the company.

However, if the company really takes off, even after a 20% discount the seed stage investment might not translate into a significant stake in the company. For example, a $25,000 seed stage investment in Instagram without a conversion cap would only have translated into a very small equity stake because the company was valued so highly at the next round of investment.

A conversion cap helps to align the incentives for the founders and the seed investors to seek as high a valuation as possible in the next round. To make sure your seed stage investment still converts into a fair equity stake, the convertible note should include a conversion cap.

4.  Sale Of The Company

Some convertible notes provide that an investor will only be repaid their investment amount plus accrued interest if the company is sold before the note converts.

If you invest in a startup that is purchased before the note converts you should be adequately rewarded.

Instead, you include a provision that provides that the investor will get 1.5 or 2 times a return on the initial investment if the company is sold before the note converts.

5.  Voluntary Conversion

Most convertible notes do not convert by the note’s maturity date. It is important to bake in a provision that provides the investor with the option to still have the note convert into equity at the maturity date at an agreed upon conversion price.

6.  Right to Invest

One incentive to act as a seed investor is to be on the inside of a new company, and hopefully this “insider” status will give you the ability to invest more later if the company takes off. However, these investment rights are not automatically guaranteed, and if a company is hot then there will be plenty of other investors ready to buy during the next round.

Guarantee your right to invest later by adding a Right of First Offer provision into the convertible note, so that you are informed of and given the chance to participate in all equity offerings.

7.  Warranties and Representations

Just as important as the above economic provisions is including strong warranties and representations to kick the tires of the company. You would, for example, certainly want to dig deeper if a company is not willing to include a warranty and representation that there are no threatened or pending actions against the company.

Every set of convertible note agreements is different and so you should consult with your legal counsel prior to making an investment. However, the above list is a good starting point to make sure that the risks of investing in an early stage startup pays off it the startup becomes successful. If you have any questions, give Bend Law Group a call at (415) 633-6841 or email at info@bendlawoffice.com.

By Doug Bend and Luthien Niland.

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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