Term Sheet A contract is an agreement between two parties, a concept that seems simple enough.

Yet contracts come in all shapes and sizes, and run the gamut from spoken oral promises all the way to documents so extensive and cumbersome that they resemble a textbook. The prevalence of the latter kind is the result of the complexity of most modern-day transactions; given the financial, legal, and regulatory landscape that most startups must face, there are endless items to address, each of which must have a place in a final agreement. Of course, startups dont always have the time or the money to pay attorneys to draft long contracts at the start of business negotiations. As a result, startups may turn to term sheets as a first step in defining the relationship between two parties. Term sheets are typically viewed as non-binding documents used in anticipation of a formalized, full-length agreement. That said, term sheets are still legal documents, and depending upon their wording and the manner in which they are executed such documents may very well be binding in court. Thus, it is important to run a draft term sheet by an attorney prior to execution or signing of the document, bearing in mind that simply because you dont consider it to be binding does not mean that it isnt. Of course, even without an attorney, there are ways to determine whether or not what you are signing will be binding in court. The main test for this is whether or not the term sheet has what is known as promissory language, i.e. language indicating that a promise is being made, and that something is being provided in return for that promise. What is being provided in return may very well be another promise, but whatever it is, that is a commitment that a party might be held to later on. Even where the agreement is labeled term sheet or letter of intent, that alone will not prevent a party from enforcing the term sheet on the other parties to the agreement. Again, the question is whether there is promissory language in the term sheet, and the effect of that language. More often than not, a term sheet will be used in connection with garnering investment for a startup. If that is the case, the material terms of the investment will have to be set forth in the term sheet, namely the amount to be invested, what is to be received by the investor in return, and the details of each partys expectations for one other. These material terms, combined with the many additional details inserted by an experienced attorney, will eventually come to form the full-length, binding agreement that will govern the terms of the investment.

Preferred Stock Purchase Agreement

A preferred stock purchase agreement is exactly what it sounds like; it is an agreement to purchase stock, specifically preferred stock. Of course, that doesnt necessarily explain very much. To understand what the document itself is and exactly how it operates, we should start with a definition of preferred stock shares themselves, which are really just shares that provide owners of those shares with special privileges relative to common stock owners. For example, preferred stock may pay out a higher dividend per share than does common stock or alternatively, pay out a dividend regardless of corporate earnings. Preferred shares may be less susceptible to dilution, and may possess a debt as well as an equity component. Furthermore, preferred shares will sometimes be convertible, i.e. come with an option to convert those shares into common stock shares at a particular ratio of common to preferred. Given this vast potential for customization in the creation of preferred shares, it is important to clearly delineate the terms of the stock transfer in the preferred stock purchase agreement, and dividend payments, convertibility, dilatability, and debt/equity hybridity are just the tip of the iceberg. Both parties to the agreement must make the necessary representations and warranties, including most notably their right to actually buy or sell the shares at issue as per the terms of both partys Articles of Incorporation, corporate bylaws, or any other applicable rule or requirement with which a party would ordinarily need to comply. Furthermore, both parties must ensure and protect against non-compliance with other agreements into which either side may have already entered. For example, if the seller has already signed an agreement granting a right of first refusal on all shares to a third party, entering into a preferred stock purchase agreement would be a violation of the agreement, and the buyer could conceivably become the target of a tortious interference suit. Thus, there are a lot of issues to consider, a lot of due diligence to be performed, and generally a lot to think about when entering into this sort of agreement. That said, the good news is that a startup may not have nearly as many issues to grapple with as larger, more well-established companies. Startups may be simpler in terms of their organization, they likely have signed fewer contracts obligate them in various ways, and they may be more nimble as a result. Nevertheless, consideration of these issues is paramount when entering into a preferred stock purchase agreement, and the goal of spotting as many potential issues as possible should be paramount in the minds of those parties to the agreement.

Registration Rights Agreement (Investor Rights Agreement) A Registration Rights Agreement or Investor Rights Agreement relates to one of the many hurdles that a startup will likely have to face at some point during its growth, namely, the regulatory oversight of the Securities and Exchange Commission (SEC). The SEC is responsible for regulating publicly-traded companies by requiring disclosures from those companies on a consistent basis. However, despite the fact that registration with the SEC is mandatory for publicly-traded companies, it cannot be done without the consent of investors. Thus, a Registration Rights Agreement, or Investor Rights Agreement must be executed prior to registration with the SEC. The Registration Rights Agreement must delineate which investors are entitled to register their shares with the SEC and which investors are not. It is possible that the agreement would allow all investors to do so, but certainly not required. Typically, if there are disparities in terms of which investors have a right to register their shares and which do not, it will be based upon the price that was paid for the shares. In other words, the right to register with the SEC will typically command a higher price per share. While the Registration Rights Agreement does typically grant investors a right to register their shares with the SEC, that right is not unfettered. Rather, there are material limits on the right to register based upon the general welfare of the corporation. For example, in situations where registration would lead to a disclosure that would adversely impact the corporation, a corporation would not want an investor registering shares. As a result, there will usually be areas of the agreement that limit investors ability to register with the SEC. Other limitations on this right include a fairly typical time horizon following the initial public offering (IPO) of the corporation. For example, the Registration Rights Agreement might provide that investors cannot register any shares for six months following the IPO. Furthermore, the agreement might also provide for a certain minimum share registration requirement, such that the corporation can avoid the hassle of registering very small amounts of shares. Corporations will also need to endeavor to provide accurate information to investors, which will materialize in the form of a term in the Registration Rights Agreement. Investors will typically want a measure of protection from material misstatements or omissions of the corporation depending upon their level of sophistication, and this would come in the form of an indemnification clause contained within the Registration Rights Agreement. While such indemnification may not be desirable from the standpoint of the startup, it may very well be necessary to get sophisticated investors on board.

Right of First Refusal and Co-Sale Agreement One of the dangers inherent to most startups, and to any relatively small corporation for that matter, is the ability of a single individual to fundamentally affect the overall welfare of the corporation. For example, a founder or major stakeholder can sell his or her shares to a competitor whose only interest is to dissolve the corporation and prevent it from competing. As a result, it is important for a corporation to place checks and controls on the ability of large stakeholders to sell their shares, and the execution of a Right of First Refusal and Co-Sale Agreement is one way to do that. That said, founders and large stakeholders in the corporation will generally want to limit the amount of investors subject to a Right of First Refusal, namely because of all the legal and administrative hassles that arise in connection with subsequent financing rounds. In such cases, Rights of First Refusal may have to be amended. Smaller investors, on the other hand, will more likely than not favor having these agreements in place, given that the value of their investment in the company is subject to the whims of larger shareholders. The balance between these competing interests will be struck in the form of an agreeable Right of First Refusal and Co-Sale Agreement. The Right of First Refusal is typically granted first to the company itself and accords the company the right to receive notice of any intention of a person covered by the agreement to sell his or her shares, and grants the company sufficient time to make a decision as to whether it will make an offer to purchase those shares. If the company chooses not to exercise its right to purchase the shares, then the preferred shareholders will typically be given a right to make a bid to purchase the shares as well. As among the preferred shareholders the Right of First Refusal is distributed on a pro rata basis. Ultimately, a Right of First Refusal and Co-Sale Agreement is an all but necessary component of financing a startup, but it is not the sort of thing that will tend to raise frequent concerns among investors or corporate officers. That said, it should not be ignored but dealt with upfront with respect to shareholders above a certain threshold such that the company itself is protected from large stakeholders seeking to divest their stake in the corporation.

Voting Agreement A voting agreement, or a voting trust, is an agreement that effectively pools the voting rights of a number of shareholders, such that the trust will vote as a group rather than individually. As is the case with most trust arrangements, a trustee will appointed to make decisions as to how the shares will be voted. These are also known as voting proxies, and are quite common in large corporate settings where individual shareholders often divest their authority to vote to others. Voting agreements or voting trust arrangements are created by a legal document, which typically specifies a termination date for the arrangement, or at the very least conditions under which the voting trust arrangement will come to an end. There are a number of benefits relating to voting trust agreements, namely the added leverage associated with a voting block. Whereas individually, shareholders may not have very much power, collectively their vote may command substantially more influence. Furthermore, shareholders are often not particularly interested in making informed voting decisions, and merely wish to invest passively. In such circumstances, a voting agreement or voting trust allows shareholders to allow others, who are in a better position to make an educated decision, to vote shares on their behalf. Of course, with the benefits of a voting agreement or voting trust there are also a number of disadvantages to be mindful of when entering into such an arrangement. Clearly the most obvious of potential difficulties associated with voting trust arrangements is the danger that those who temporarily divest their right to vote may not be adequately represented by the trustee that votes their shares. For this reason, it is important for parties to voting agreements to ensure that their interests are properly aligned with the trustee of the voting trust. Furthermore, there are legal complications that arise relating to voting trusts depending upon the laws of the jurisdiction to which the corporation is subject. Many states do not permit a complete separation between the ownership of shares and the right to vote, and a voting trust may be declared invalid under certain circumstances. In short, voting agreements and voting trusts can be extremely useful devices when it comes to effectively leveraging shareholder power. That said, there are a number of potential complications that can arise, and it is important to be mindful of these limitations.

Certificate of Incorporation

A Certificate of Incorporation is the document that evidences a corporations incorporation with the Secretary of State in a particular state. By incorporating and obtaining a Certificate of Incorporation, the corporate entity comes into being for legal purposes. That said, even prior to obtaining the Certificate of Incorporation there may very well have been activities undertaken by the principals of the future corporation that would be considered corporate acts. To be sure, the law provides for such scenarios where a corporate promoter engages in activities that would later be deemed to bind the corporation rather than the individual that originally conducted the activity. Corporate promoters typically solicit investment for the corporation that has not yet been formed, and the agreements they sign in order to garner investment can later obligate the corporation instead of the individual. This is important because one of the major tenets of corporate law is that corporate liability does not extend to the owners of the corporation. That said, corporate promoters can only remove their own liability after the fact and once the corporation is formed, i.e. once the Certificate of Incorporation has issued. A Certificate of Incorporation is typically issued by the Secretary of State in the state in which the promoters of the corporation seek to incorporate. One of the typical realities of incorporation in any given state is that the corporation must consent to the secretary of state as the designated agent for service of process. This means that if a corporation is sued they can be served through the secretary of state in a given state, regardless of whether the corporation would prefer to be personally served at their headquarters or corporate office. Nevertheless, it is important to bear in the mind the specific corporate laws of a given state, as they do vary with respect to service of process. For example, in California service of process on the Secretary of State must be completed only as a last resort, and after reasonable efforts have been made to serve the corporation directly. In New York, on the other hand, service of process can be made on the Secretary of State without having made prior efforts to directly serve the corporation. In short, there are a number of implications relating to the issuance of a Certificate of Incorporation, and nascent corporations should be mindful of these implications when deciding upon an entity type and organizing a company.

Bylaws

Corporate bylaws are a necessary aspect of corporate formation. They are the rules by which the corporation operates, and as a result they must be drafted with great care and with the appropriate mechanisms for their amendment when necessary. First note the difference between bylaws and Articles of Incorporation; corporate bylaws are more like the daily rules that the corporation must follow, whereas the Articles of Incorporation provide a broad outline of the corporation and often will be filed with the Secretary of State. In other words, the details - and thus the hard work - will go into drafting the corporate bylaws. Bylaws will typically cover important information including but not limited to an organizations name, purpose and location, the members of the corporation, the members of the Board of Directors, the various committees operating within the corporation, the officers that run the corporation, the meetings to be held, procedures when conflicts of interest arise, and procedures for amending the bylaws. Board composition is a particularly critical aspect of the bylaws, given that the Board of Directors retains the highest level of control over corporate operations, and is only subject to the shareholders in limited circumstances. The corporate bylaws will typically spell out how Board vacancies will be filled, as well as the minimum and maximum number of board members to complete certain activities, votes etc. A nominating committee is typically organized as well, the purpose of which is to nominate individuals to serve as members of the Board. Bylaws will also normally define the various officer roles including President, Vice President, Treasurer and Secretary, and will describe in detail how people are chosen to serve in these roles, how long they can serve, and the circumstances under which they can be removed. Officers, like members of the Board of Directors, are responsible for overseeing corporate operations at a high level, and so the procedures by which they are retained and removed are critical to consider carefully when organizing a corporation. Elections are a common way for such individuals to be selected, though bylaws can technically provide for selection of officers and Board members by other means, at least to the extent those means do not conflict with the corporate law of the state of incorporation. Corporate bylaws are a critical component of any corporation, and should be drafted with great care prior to incorporating. That said, bylaws can be amended, and if necessary filing a barebones version of the bylaws is definitely permissible provided the appropriate procedures for amending those bylaws have been properly set out.