Litigation/Operations/Exit Strategies/Partnerships and JVs Flashcards
For litigants: How do I engage with a contingency-fee litigator?
Many litigants do not have the resources or desire to pay a litigator’s hourly rate. Some litigators are willing to work on contingency, meaning that they do not charge anything up front, but rather receive a percentage of any recovery. In the case of employment disputes, be wary of lawyers who represent both employers and employees, as their employer clients are much more stable and lucrative for them in the long-term, so you may not receive their full attention.
For contingency-fee lawyers, the following may signal that the claim is weak, or that the potential client is unreasonable or a bad actor, rather than someone who was wronged and who has a legitimate claim:
“This was a ‘hostile work environment’” followed by examples of harsh negative feedback, names of other people who do not like the co-founder(s) who fired you, or times the co-founder was unpleasant. “Hostile work environment” is a legal term of art, not a descriptor of unkind bosses/partners.
“The company does not want bad press, we should just threaten to go to the press.” This is blackmail, a crime.
“The company will fold as soon as we send a demand letter.” 1% of companies do, 99% do not.
“I won’t settle for less than [7 or 8 figure number].” This signals an unreasonable client, unless you can present actual evidence of 7 or 8 figure damages.
“This is not about the money for me.” This will signal to a contingency-fee lawyer that they payout might be small or zero; you should instead pay an hourly lawyer a retainer to litigate your non-monetary grievances.
Co-founder & employee disputes: What happens when things go wrong?
Sometimes there is a falling out on the co-founding team, or conflict surrounding employee termination. Common root causes include performance, misbehavior, differences in values, commitment, or working styles, divergent visions for the company, changes in personal circumstances, and changes in company needs. Honest, clear, and open communication can often help avoid escalation.
Unfortunately, disagreements do sometimes lead to litigation. A startup is usually not an attractive litigation target because it does not have the resources to pay large settlements or judgments, but, even if a claim has little merit, it can effectively prevent the startup from hiring, attracting investment, and acquiring customers. At best, litigation is a large distraction that delays timelines and requires constant explanation to third-parties, such as investors or acquirers, who may refrain from investment or purchase, or discount the company valuation until the matter is resolved (and even afterward). This gives the litigant some measure of leverage in negotiating their desired outcome.
A departed co-founder or employee who initiates litigation is usually interested in some combination of cash and vested equity. In any settlement agreement, the company will require the claimant to sign a full release of claims and non-disparagement agreement to ensure that the matter is completely and permanently resolved. Each case is different, and is heavily dependent on the facts & circumstances of a particular situation. We highly recommend seeking advice from experienced litigation attorneys.
Below is a non-exhaustive list of claims litigants commonly bring against a company:
Employment Claims
Employee Misclassification
Discrimination against protected class, e.g., race, gender, pregnant
Wrongful Discharge is almost always not an independent cause of action
Federal, State, and Local Wage & Hour Claims, including but not limited to, minimum wage violations, failure to pay final wages, failure to pay earned bonus.
Wage Discrimination Claims under federal state and local equal pay laws: gender discrimination pay in the case of female founders, race discrimination in pay
In the case of race discrimination, often a claim under Title VII, California Fair Employment Housing Act (CAFEHA), or New York City Human Rights Law (NYCHRL). Sometimes also a claim under Section 1981.
Intellectual Property Infringement (if IP assignment not effective)
Shareholder Derivative Suit (e.g., breach of fiduciary duty under Delaware law)
Libel or Slander
Breach of Contract or Breach of Implied-in-Fact Contract
Tortious Interference or Intentional Interference with Contractual Relations
Fraudulent Inducement
Federal and State Whistleblower Claims
Sexual Harassment / Assault
False Imprisonment (for example, being cornered, or brought and kept in a meeting room against one’s wishes)
Retaliation
Abuse of Process
Invasion of Privacy
Intentional/Negligent Infliction of Emotional Distress
What annual filings/payments do I need to make?
There are three categories of filings/payments to make: (1) corporate filings, (2) taxes, and (3) federal & state securities filings.
(1) Corporate filings include company formation documents and annual reports. When you form your corporation (in Delaware), you must file a certificate of incorporation. You also must have a registered agent in the State of Delaware; most companies use a third-party service, which requires an annual fee. States in which the entity is registered as a foreign corporation may require annual statements of information regarding the board of directors and capitalization of the business. If you change the company name, you’ll need to file applicable amendments and notices with Delaware and other states in which you operate.
(2) The corporation owes applicable city/county, state, and federal income or revenue taxes. For example: San Francisco City & County, California, and Federal corporate taxes. Some taxes do not apply to early-stage companies with less than a certain amount of revenue. In addition to income taxes, all corporations owe franchise taxes. In the case of a Delaware corporation operating in California, the corporation owes franchise tax in both states. (Beware: Delaware has two methods of calculating this tax. Use the “assumed par value” method as opposed to the “authorized shares” method—for an early-stage startup the assumed par value method should come out to $400 [as of this writing, subject to change by Delaware]).
(3) Securities filings are required in many cases when issuing or selling shares. For example, when fundraising, most startups use the “Regulation D” private placement exemption to avoid public registration of the securities offering (akin to an IPO). Reg D filings are made with the Securities and Exchange Commission. In addition, state filings may also be required. For example, California requires the 25102(f) notice for sale of securities and the 25102(o) notice for issuance of options and other compensatory equity (e.g., when creating a stock option plan).
We highly recommend that you work with experienced corporate attorneys and accountants to ensure that you are aware of all requirements and make timely and accurate filings/payments where necessary.
M&A: Merger vs. asset sale vs. stock sale
At a high level, a merger is the consolidation of two companies, joining two distinct legal entities into one legal entity with the combined assets and liabilities of the two original companies. Mergers can be simpler than asset sales because the merged entities become legally combined. And, unlike stock sales, all of the company’s interest can be transferred without obtaining the consent of all stockholders.
A stock sale is when a buyer purchases the outstanding company stock directly from the shareholders. There is no change in your company’s legal status, name, operations, or contracts. Stock sales generally require fewer steps than mergers; shareholders are paid directly for their shares. However, the target company may have many shareholders which may make it difficult to contact them, receive approval, and coordinate the sale.
Asset sales involve the purchase of some or all of a company’s assets by a buyer. Assets often include intellectual property rights and customer contracts. The buyer also can assume none, some, or all of the company’s liabilities. Asset sales allow the buyer flexibility to acquire only the desired assets while leaving unwanted assets with the seller. Additionally, limited asset sales do not always require shareholder approval from the seller. However, asset sales can be time-intensive, expensive, and impractical if only a portion of the company assets are being sold, and the asset sale will not automatically wind down your company. Sometimes the transfer of customer contracts in an asset sale often requires third party consent which can be difficult to obtain.
The biggest pitfalls of partnerships and joint ventures include:
Getting into a partnership or joint venture with a party you do not know to be reputable, credible and trustworthy (contractual protections can only go so far).
Creating a legal partnership, agency or fiduciary relationship unintentionally.
Unintended outcomes with respect to trade secrets or other intellectual property shared with or created by the venture.
Lack of clarity about scope and purpose, commitments, and consequences of failure to perform.
Inability to terminate a relationship and getting “stuck.”
Failing to execute non-solicitation terms with the counterparty to prevent poaching of key employees.
The best way to maximize value and mitigate risk is to involve legal counsel early and often. Most Silicon Valley law firms have entire practice groups devoted to these deals (typically called the “Technology Transactions” or “Tech Trans” group). Experienced legal counsel is an invaluable resource.
What are partnerships and joint ventures? Why enter into them?
Two or more parties may enter into a partnership or joint venture when they believe they will receive some material benefit from collaborating toward a shared purpose over some period of time, and wish to clarify their expectations about how that collaboration would proceed.
Common examples include:
Partnerships between industry and academia: These are quite common and often quite fruitful. Academic institutions generally have rules around the terms of these partnerships and understanding those rules (particularly with respect to rights to publish, ownership of intellectual property and commercialization of jointly-developed intellectual property) is a critical first step. Large companies like Google and Boeing have extensive collaborations with academia. And many startups partner with academia through various mechanisms, including by participating in university accelerator programs or negotiating bespoke partnership arrangements.
Partnerships between two established companies: Large companies team in many contexts. They may do so where each brings a useful skill-set / expertise or specific assets to a given venture and/or as a means of sharing financial risk associated with a new venture. They are also common between companies with similar or complementary businesses operating in different countries or companies testing the waters for a merger or acquisition. Examples include Sony and Honda’s joint venture in electric vehicles and NBC and Disney’s joint venture to form Hulu.
Partnerships between an established company and an early stage company: This is also quite common, and may be viewed by many startups as a key element of their business development and growth plans. Startups pursue them for a variety of reasons: access to the expertise, data, facilities, and, most importantly, market of a large enterprise; access to capital (either for the venture itself or as a coupled equity investment into the start-up, which is quite common); opportunity to validate the market for their product (particularly for partnerships with potential customers) or secure purchase commitments; and opportunity to gain credibility with investors and other market participants through association with a reputable, established company. Established companies also have a variety of reasons to pursue them: the startup’s business or products complement their own business; the venture provides a low-risk, low-commitment way to delve into a business in which the large company is interested; and the company is interested in eventually acquiring the company for its product or team. Perhaps most importantly, the conventional wisdom is that startups provide better settings for fast product development and innovation than large corporations, which may be slowed by the formal internal processes and more complex stakeholder dynamics. Examples of these types of partnerships include Rivian’s partnership with Amazon and Stripe’s partnership with Visa (each launching when Rivian and Stripe were early-stage).
Partnerships between two early-stage companies: In some cases, two early stage companies will enter into a long-term collaboration, where they have complementary businesses. Formal collaboration is less common - or at least receives less fanfare - than the other types of partnerships identified here, but informal collaboration, sharing of learnings and sometimes personnel or facilities, is quite common, particularly in venture hot spots.
What are the key considerations and terms of a partnership or joint venture?
The key considerations and terms of a partnership or joint venture include:
Who are the parties?
What is each party’s commitment, in terms of capital, assets, services?
How are any profits or other benefits from the endeavor divided?
If more resources are required to be committed, what is the procedure for agreeing to increased commitments?
What are the consequences of a party failing to satisfy its commitments?
What assets will be owned by the joint venture entity (or jointly owned by the participants in an unincorporated joint venture or partnership) and how will they be managed? Will there be personnel dedicated to the endeavor?
How are decisions made regarding the operations of the endeavor?
How is intellectual property created or used in the venture treated (ownership, license, etc.)?
How are liabilities shared between the parties?
What is the timing and process for ending the relationship?
How are joint ventures structured?
There are two types of joint ventures (“JVs”): Incorporated and unincorporated (contractual JVs).
Incorporated JVs are a category of JVs in which the JV itself is incorporated as a new entity that is co-owned by the parties. The intellectual property, business revenue, and other assets or liabilities are held at the entity level. Negotiations between the parties will center on ownership and governance of the entity, as well as the way in which the entity will be funded, staffed, and resourced.
Unincorporated or contractual JVs are a category of JV in which there is no separate entity - the parties must negotiate contributions, ownership, and governance on a contractual basis.
Examples:
Incorporated JVs: Fluence Energy was a JV company formed by AES Corp. and Siemens, which eventually became a publicly traded entity.
Unincorporated JVs: The Rivian / Amazon and Stripe / Visa deals are examples of contractual JVs.
What’s the difference between a “partnership” and a “joint venture”?
A “partnership” can have a specific legal and tax meaning: describing the most simple vehicle for running a business among multiple persons, which lacks the limited liability protection of an LLC or corporation (partners may be found personally liable for their actions). A legal partnership has important characteristics relating to the sharing of assets and liabilities, abilities to bind other members, and tax burdens. Legal partnerships are rarely formed as vehicles for early-stage technology companies or their third party collaborations - the tax and liability structures do not lend themselves to taking on investment capital for technology businesses. Legal partnerships are more commonly used for professional businesses (e.g., law firms), real estate and some energy investments, investment funds, and closely held small businesses.
The term “partnership” is also often used in a broader, lay manner, and can cover any manner of collaborations by multiple people or companies, usually toward some common purpose and usually beyond a one-off transaction.
The term “joint venture” does not carry a specific meaning at law, and is used similarly to the more broadly defined version of partnerships, though it usually carries the connotation of multiple business entities jointly pursuing a common purpose in some structured and formal manner.
