Timing and Preparation for the Next Equity Financing

Timing and Preparation for the Next Equity Financing

After hunkering down for some time and receiving some initial responses from the flurry of grant applications that were submitted in the Spring of this year, many Midwest early stage technology companies are once again beginning to consider the private capital markets for funding.
In this column, I discuss both the timing and preparation for the next round of equity financing.
Companies should factor in at least 4-6 months time between circulating an executive summary or business plan to prospective investors and closing a round of financing with new outside investors. For most companies, that range of time is likely the best case scenario. While there has been some modestly positive signs recently of transactions and valuations picking up, it may be prudent for companies to consider at least 6-8 months time as a more realistic period to raise capital.
Preparation for the Next Round
Regardless of whether a company chooses to put together and use a private placement memorandum, it is a good idea to do some internal checks and corporate cleanup prior to the offering. Not only does it marginally improve the chances of getting funding at a better valuation, it should also decrease the fundraising time because fewer issues and surprises come up during the investor diligence period.
Below are some questions to consider before starting your next private offering.
Corporation and Limited Liability Company Issues

  • For corporations:
    • Have you been following corporate formalities, such as the following:
      • Holding shareholder and board of director meetings at least annually and preparing minutes of these meetings;
      • Keeping separate your corporate and personal bank accounts; and
      • Signing corporate documents in a corporate capacity (i.e., as an officer of the corporation).
    • Do you have a stock ledger and option/warrant ledger, are they up to date, has all issued stock been properly authorized (e.g., board approval) and issued?
    • Are the Bylaws up to date and have you complied with them?
  • For LLCs:
    • Does your operating agreement accurately reflect current ownership?
    • Does your operating agreement accurately reflect the management structure?
    • Does your operating agreement appropriately and accurately address allocation of profits, losses, and cash flow and does it address minimum distributions?
    • Does your operating agreement address information rights?
    • Does your operating agreement appropriately “opt-in” and “opt-out” of applicable statutory defaults (e.g., the ability to cause the LLC to dissolve)?
    • Have you complied with the member managed or manager managed requirements?
  • Is your company current with its state filings and foreign registrations?
  • Are your financial statements current and accurate?
  • Have you been complying with Section 409A in valuing your stock options and other equity-based incentives?
  • Has the company obtained applicable certifications for investor tax credits/incentives?

Contracts and Leases

  • Are all your key contracts in writing and signed?
  • Do you have copies of the key contracts readily available?
  • Do you have a system in place to keep track of contracts, including knowing those that are up for renewal, require notice for termination, require a payment, etc.?
  • Have your significant contracts received necessary corporate/LLC approvals?
  • Do you have standard terms and conditions for the sale of your products and services and do you use them consistently?
    • If you sell products to other companies, do you understand the basics of “battle of the forms” issues and do your contracting procedures take advantage of the rules?
    • Do your standard terms and conditions for product sales address warranties, disclaimers, liability limitations, indemnity, risk of loss, interest rate and cost of collection (including attorneys fees), jurisdiction, forum, and choice of law issues?
    • Do your standard terms and conditions for services address warranties, disclaimers, liability limitations, confidentiality/privacy, indemnity, intellectual property ownership, interest rate and cost of collection (including attorneys fees), jurisdiction, forum, and choice of law issues?
  • Does your lease contain a renewal option, right of first refusal on adjacent space, and caps on tenant repair obligations?

Employee Matters

  • Have your key employees signed confidentiality, invention assignment, and noncompetition agreements, as applicable?
  • Do you comply with the federal requirements regarding documenting the citizenship of your employees?
  • Do you comply with the applicable requirements regarding classifying individuals as employees or independent contractors (e.g., tax, workers compensation, unemployment)?
  • Do you comply with applicable law concerning compensating employees for overtime?
  • Do you understand how to limit exposure for wrongful termination and employment description lawsuits and have you taken steps to limit that exposure?
  • Do you regularly document decisions made regarding employees in order to be able to support these decisions should they be challenged on the basis of discrimination?

Intellectual Property

  • Do you have third parties sign non-disclosure agreements before they are allowed to view or hear about your confidential information?
  • Do you have a standard non-disclosure agreement form that you use that has been reviewed by an attorney (rather than one that you found on the Internet)?
  • Do you have trade secrets and if so, what steps do you take to maintain their confidentiality?
  • Have you obtained trademarks or service marks to protect the names and logos of your business, products, and services?
  • Are you taking steps to ensure that you are complying with the U.S. and foreign general rules as to the timing of whether an invention can be patented?
  • If anyone working with or for the company is associated with a university or uses university equipment in connection with company matters, do you understand the basics under the Bayh Dole Act and have you taken steps to avoid Bayh-Dole issues?
  • In contracts with outside vendors and providers that involve intellectual property, do the contracts have work made for hire provisions?

The items listed above are just some of the items that may come up during investor legal and business due diligence. There are a number of industry or niche specific questions that typically come up as well. For example, for software companies, investors will want assurances that no open source, copyleft, or community source code is contained in any of the company’s software products. For a medical device or biotech company, investors will likely spend more time on intellectual property and possibly FDA matters. In either case, more scrutiny should be spent prior to the private offering in those areas where investors are likely to focus. The fewer number of avoidable issues discovered during investor due diligence, the more confident prospective investors will be in management.
Recent articles by Matt Storms

Matt Storms is the president and founder of AlphaTech Counsel, S.C. , which works primarily with high growth companies with operations in the Midwest. In addition to his many articles on WTN News, Matt posts regularly on the AlphaTech blog, which can be found at http://alphatechcounsel.com/blog/. He can be reached at mstorms@alphatechcounsel.com.