Wednesday, May 8, 2013

Names, Numbers, Dates, and Signatures – Cleaning Up Your Legal Documentation

As most of the entrepreneurial community in Minnesota is well aware, the funding still available under the state’s Angel Tax Credit program, which gives investors in tech start-ups a tax credit on qualified investments, is fast dwindling. I’m sure ours is not the only law firm in town working with clients that are still hoping to take advantage of the remaining allocation of credits, and reaching out to potential investors with their business summaries, financial information, and perfectly-crafted elevator pitches

These aren’t the only requirements of the savvy investor, however. Potential business partners also often want to understand the precise equity structure of company in which they are investing, who comprises the company’s board of directors, what the requirements are of the governing documents (articles, bylaws, buy/sell or member control agreements), and other corporate matters. These issues, while often easy to discuss and agree upon in theory, are not technically (or legally) solidified unless they exist in writing, with appropriate names, numbers, dates—and signatures. For some of our entrepreneurial clients, who are often working at break-neck speed, these items exist in spreadsheets, word documents, or emails, but not in legally-binding agreements. And the need to step back and complete this documentation in order to present it accurately to investors seems like a frustrating, stilted, “lawyerly” process that just delays the finalization of key partnerships and funding. 

Despite the seeming insignificance of some of these items, the importance of the technicalities surrounding these types of business decisions cannot be understated. Promising an investor that they will receive 10% equity in your company in exchange for their investment, without clear documentation illustrating who owns the other 90%, when they received it, and for how much, does not instill much confidence in the certainty of that 10% (or in compliance with applicable state and federal securities regulation). And promising an investor a board seat without confirming to them how much power this may yield (will they be one of two, or one of seven board members?) may not add the value to their investment that a company thinks it should. 

According to West’s Encyclopedia of American Law, a signature is “a mark or sign made by an individual on an instrument or document to signify knowledge, approval, acceptance, or obligation,” with the purpose of “authenticat[ing] a writing . . . and bind[ing] the individual signing the writing by the provisions contained in the document.” I recently assisted a client who insisted that his company’s capitalization table reflected three current owners. However, the third owner had continually delayed providing his signature on the subscription documents evidencing his investment and ownership in the company. Ultimately, when push came to shove and the importance of reflecting the company’s ownership accurately was required, it became clear that there was no true meeting of the minds, and the company was left with its two, official founders. Signatures are the talismans that turn mere conversations (or that “hand-shake” deal) into something that companies – and investors – can rely on as permanent and secure.

I have also recently been working with a client that is attempting to raise money, and an investor inquired about composition of the company’s board of directors. The client had multiple notes as to who was supposed to have been on its board at different times throughout the company’s two-year history, but (much to the surprise of its super skilled legal team) had never followed the statutory process required for the election of directors, or properly documented decisions that had been made regarding the structure of the board. While getting these documents in order was not a very large undertaking, it did take additional time, delaying the company’s receipt of its equity capital and adding some undue headache to the process.

Dates are important as well. Providing a snapshot of your company’s capital structure requires that the documentation leading up to that point is dated and executed prior to the date of the snapshot. And as most business owners realize, subsequent investments dilute previous investors, so solidifying the order of who came in first, second, and third, is critical.

With the potential for at least one incentive to invest, the Minnesota Angel Tax Credit, appearing close to running out for the year (unless proposed legislation like this is passed to increase it), companies are realizing that any delay in communicating with an investor is a set-back. Getting your legal “house in order” with accurate and complete documentation can save time and energy down the road – when these attributes will surely be needed to polish that elevator pitch!

A Post by Karen Wenzel, Guest Blogger

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