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Submitted questions

Q: How can I alter the definition of confidential information to be more suitable for a data analytics company?

A: If you will be receiving or gathering anonymized data, or anonymizing personal data, you will ideally want to be able to use it free of any contractual encumbrance. As such, where the definition of confidential information might include information about officers, directors, employees, customers or potential customers, customer lists or customer data, you may wish to stress that such information should only be subject to confidentiality if it is not anonymized.

As NDAs are typically signed early on in the contemplation of a business relationship to give parties the confidence they need to proceed with the transaction, this point will usually be negotiated later on in larger agreements that will supersede the NDA (such as a Master Services Agreement or MSA).

Q: In the standard of care clause, what is meant by “comparable” companies?

A: If this clause were to come under dispute and there was no further specification of what was meant by “comparable”, the matter would be determined at the judge’s discretion. This can be dangerous because it could work in your favour or it could be disastrous for you, based on what the judge decides. You can reduce the amount of uncertainty around the judge’s decision by including further specifications and qualifiers. Since judges must interpret what is written in the contract, this can bound the possible number of outcomes to a more reasonable range.

For example, if you specify “comparable companies in [YOUR JURISDICTION]”, the judge will only be able to judge your company’s practices against industry standards for companies in your specified jurisdiction as opposed to global standards which may be higher.

Q: What privacy laws apply to any “personal information” I receive?

A: Although the following language may seem standard, it creates a very high bar for you to meet your contractual obligations:

“The Receiving Party will collect, use, store, disclose, dispose of , provide access to and otherwise handle Personal Information received, collected or accessible to the Receiving Party hereunder in accordance with all privacy laws applicable to such information.”

If some of the information you receive is personal information of an EU citizen, for example, you will then be required to be compliant as per Europe’s General Data Protection Regulation (GDPR), which has famously high standards. The cost of compliance might not be an amount you had originally contemplated.

As NDAs are typically signed early on in the contemplation of a business relationship to give parties the confidence they need to proceed with the transaction, this point will usually be negotiated later on in larger agreements that will supersede the NDA (such as a Master Services Agreement or MSA).

Q: Who should bear the expense for information requests?

A: It’s likely that you might incur expenses complying with an information request from the counterparty in terms of employee hours, opportunity cost, etc. Thus, ideally, you’d want to specify that the party requesting the information does so at its own expense. In many cases, however, it is fairly obvious that one party will be making most of the requests, and they may be unwilling to bear the expense. If your goal is to get a quick signature however, you may wish to leave the clause as is.

Q: Who is responsible for ensuring compliance with privacy laws?

A: There may be a positive obligation placed upon you to preserve personal information and confirm that you are compliant – it may be worthwhile to confirm that your practices are indeed compliant through your own audit. Keep an eye out for language such as the following which may create a right for the counterparty to audit your business practices:

“[counterparty] or a third party authorized by it may, during normal business hours, from time to time on prior written notice, enter upon any premises of Company at which Personal Information is stored or used and audit the procedures, processes and information pertaining to Company’s compliance with this Agreement”

Q: Can a licensee of my software retain backups of my software?

A: Technically, yes, if there is an exemption created for backups and archives in the “Return or Destruction of Confidential Information” clause – however if your software is inaccessible without a valid license, this should not be a major concern.

DECEMBER 7 2018

 

Submitted questions

17 OCTOBER 2018

When investing, if an investor has an outlook of a certain return on investment, what’s the best way to make sure they can achieve that? Can they impose/enforce an exit strategy?

Insisting upon the Liquidation Preference clause and asking to have the investor liquidation amount equal to 3 times the original purchase price, is one way to minimize the risk of the investor.  However this is often an unpopular term, and founders with competitive investor offers might push back on this point. The investor should think about whether the company is at a stage of revenues and growth, and a trajectory of future growth, that, based on current investor multiples, would likely result in a price per share in a future round that is within their acceptable return on investment.  E.g. if a company is growing 50% month over month and is earning $100,000 per month, then it is possible to build a financial model that can project their value in the next round or two of financing. If the projected price per share in that future round of financing is above the return on investment of the investor – they can proceed to invest on this point (and will need to consider other quantitative and qualitative points).   Founders will be reluctant to accept this type of provision because if the company isn’t doing well, the investor will leave with all/most of the money, and this makes continuing to operate the business a disheartening activity. A savvy investor will either (1) know that this is the case and will avoid creating undue stress on the founders with a ridiculously harsh liquidation preference clause or (2) provide a harsh clause so that the founders eventually leave (possibly at a discounted price per share) only to be replaced by appointed professional management.

How can minority shareholders be protected if they are being forced to sell their stocks?

To protect their position, “minority” investors may hold less than a majority voting position (possibly even a very small number of votes) but can entrench themselves in the company, with their stock protected from acquisition, with (1) one or more board seats, (2) protective provisions that require their board seat vote be required in order to pass a merger decision — essentially a board veto right; (3) or a similar requirement that their vote be included in a shareholder vote on the topic of sale of stock.  Obviously this would be controversial – the founders would want to push back against veto power in the hands of a minority shareholder. There are a few “step downs” – for example, instead of offering veto to the minority shareholder, veto, or (a further step down), a board vote, or (an even further step-down), an observer seat could be offered to the minority shareholder’s “class” of shares. If they hold preferred shares for example, then those preferred shareholders could be granted – as a group – one of these “step-downs.”   An even further step-down would be to offer nothing at all and the shareholder would then have only standard shareholder recourse – like an “oppression remedy” or “derivative action” remedy that would be invoked in court, if they were unfairly treated. You will want to discuss these options with the litigators in your jurisdiction.

When are preemptive rights an unwelcome clause?

For companies that are raising funds fast and in multiple rounds within a short period of time, the process of providing notice and allowing shareholders to exercise this right can delay the corporation’s issuing of shares.   There is no requirement to include this clause. Shareholders who are worried about being overly diluted can likely participate in future rounds if they are in close communication with the founders before each funding round. Removing this clause is a negotiation, of course, as shareholders are often reluctant to leave out any clauses that provide information on the activities of the business.

If you can’t get founders and investors to agree to a board composition, what fallbacks do you have?

Here are two ideas – consult with your counsel to consider further:  (1) The board composition could be a mix of founders, investors and observers – with observers who are appointed by both founders and investors; (2) a time-based “changing of the guard” that allows for power to shift from founders to investors or investors to founders over time (or possibly based on milestones).  There are loads of other creative ideas – consult with the learning points in this section for more suggestions.

What kind of protection can investors require with respect to dividends

A restriction that dividends cannot be declared or issued unless the company has liquid assets on hand that would cover at least 6 months of operating costs could provide comfort to investors.  OR – that the dividend would not result in the startup’s cash on hand dropping below some number of months of years of future cash flow . Or possibly if the price per share has fallen, that dividends cannot be issued.There are many restrictions that can be placed on the issuance of dividends.  Within a term sheet the parties can simply state that dividends require board approval – or major investor approval, that might be sufficient to create protection.

Member submitted questions

25 SEPTEMBER 2018

Naming your not-for-profit

When provincially incorporating as a not-for-profit, the full legal name must include something to identify the nature of the company (e.g. “Society” or “Association”). There is a similar requirement when incorporating as a for-profit or as a special entity such as a benefit corporation (e.g. “Inc” or “Co.”). However, federally incorporated not-for-profits do not have to follow similar naming conventions. This may be a consideration when deciding to incorporate.

When registering a business, how detailed does the purpose of the corporation need to be?

Often, jurisdictions will require that all of the business activities will be engaged in on a not-for-profit basis (check with your local counsel to confirm). The effect of stating this, practically, is that no funds generated from these activities can flow to the members, unlike in a for-profit corporation in which the purpose of the company is precisely to generate money for shareholders. Profits must be reinvested in the company’s activities so that it can accomplish its social purpose, whatever that is.

However, your jurisdiction may also require that if you were going to apply for charitable status (possibly at a future time), setting out very specific “purposes”.

Can a not-for-profit company pay its directors?

NFPs (in many jurisdictions – check with your local laws) cannot pay their directors – it is one of the key measures to ensure that an NFP is actually operating on a not-for-profit basis. If a director were to receive payment, they would be in a conflict of interest between their personal gain and the organization’s purposes. Directors can occupy other roles within the NFP which can be paid, as long as they are being paid only for that role and not as a functional substitute for directors’ fees (e.g. if a director happens to design the website for the NFP, they can be paid a fair wage for designing the website but no portion of that wage should depend on their role as a director).

When making the decision to pay a director for some non-director role within the NFP, it is important to consider the optics of the arrangement. To clarify, if you have a small number of directors, and those are the only people from among whom the NFP is hiring and then paying, it appears that the organization’s purposes are being subordinated to provide the directors personal benefits. This is likely to attract the scrutiny of regulatory authorities.  Review our library for a discussion on conflict of interest disclosure.

What member classes are available to an NFP?

On the for-profit side, shareholders have certain packages of rights based on the class of shares they hold (e.g. voting, dividends, anti-dilution etc.). On the not-for-profit side, share rights are similar with respect to voting, but note that in many jurisdictions, finance-based rights do not carry over (e.g. dividend rights because members cannot receive payment for being members).

Having voting and non-voting members in an NFP is typically only relevant from a logistics and administration perspective. They can be distinguished based on the level of membership fees they pay, and the resulting rights and privileges they receive. Membership in a class may also be contingent on approval by the board of directors. It is typical to have a smaller class of voting members so that it is easier to give notice, get quorum, count votes, get approvals, etc.

Another scenario in which multiple classes of members might be useful is when each class represents the interests of a different group. For example, in an arts organization, you might have one group of members representing photographers, filmmakers, visual artists, etc.

What are the rules surrounding acceptance of gifts and donations? Is there a grey area between a legitimate acceptance and use of donation/gift proceeds, and a misuse of the same?

The legal definition of a gift is giving something of value to another party with no strings attached. If there are strings attached, then it can potentially become a conflict of interest/breach of a director’s duties if accepted. There are rules around gifts and donations, generally for charities, but all NFPs must be accountable to members and (likely also, depending on the local legislation) the public.

The trickiest area for NFPs is when they are given donations for a specific purpose (e.g. fundraising campaign for a certain type of hospital equipment). If the fundraising goal is exceeded, the NFP might be inclined to use it for other purposes, but there have been cases where that has been prevented. One way of avoiding such an outcome, is to structure the wording on fundraising campaigns appropriately.

Member submitted questions

24 SEPTEMBER 2018

What are differences in the terms that angel investors would be looking for versus venture capitalists?

This will depend on what the stage the company is in. Angel Investors (often just called Angels) are involved in the earlier stages of the company when there is a lot more uncertainty. In theory, Angels will only be involved in the earliest of (often) several rounds of investments. They will likely have a more difficult time retaining voting rights and investor protections than Venture Capitalists (VCs), who tend to have deeper pockets, and could potentially continue to invest in many rounds up until the company goes public. VCs will be more likely to want to adhere to the business plan, and will “grind” the company to follow the scaling strategy, that the company has set out in their business plan very strictly, whereas, an AI would assume that the company still has to figure out a scaling strategy and allows for more creativity.

How do you come up with a pre-money valuation if some startups don’t have defined cost structures or revenue models? How does the investor value a start up with limited financial resources or clientele base?

A multiple of EBITDA (short for earnings before interest, taxes, depreciation and amortization) is one of the ways to set a valuation, and is based on tax-authority submitted financial statements. This approach might undervalue the “goodwill” of the company (i.e. the perceived value of the brand and/or its customers) which is captured when a third party sets that value by making an offer for the purchase of shares (or with reference to a recent prior offer of purchased shares, which is a second approach to setting valuation). – Excerpted from “Valuation approaches in the context of a share purchase/transaction” under “” within our library.

However, using financial metrics alone is also the worst way to determine value because it is based entirely on numbers but ignores the growth potential. A savvy founder will convey that their company will be growing from A to B in value over the course of the investment period and that investors will need to invest today to be a part of that growth or miss out on that future value which includes the company “Secret sauce” founder abilities and the angel investment.

Does the valuation in the LOI and effective valuation differ a lot? (Do investors overestimate the value in the beginning just to get to the table?)

The valuation could change as a result of due diligence in uncovering deficiencies, which could result in adjustments to the overall company value. In addition, depending on how competitively investors are interested in taking part in the deal, they may accept speculative values on the premise that future investors will continue to buy shares at higher levels/multiples/values and are therefore gambling on making money on a future flip. Flip is hard to achieve in a private company until it “goes public”. That being said, companies will usually try to find a lead investor who will help to set the terms and the balance of the investors will typically follow suit if they want to be part of the deal. In addition, click into the tag and read our Clause Concept titled “Valuation approaches in the context of a share purchase/sale transaction”.

If the company uses its proceeds in ways that were not agreed upon in the term sheet, what type of legal action can be taken against them? Does this depend on whether or not the investors have a controlling stake in the company?

It is important for the company to adhere to the use of proceeds or seek permission from investors to make changes. The approval process can protect the company, it is realistic for business decisions to change, and funds be needed for other purposes, but permission must be sought — there is a risk if the company uses funds not as planned, the investor can sue to unwind the transaction, and request money back.

What is the normal conversion rate from preferred to common shares?

The conversion rate is usually an anti-dilution calculation if it’s anything other than 1 to 1. For a company that requires that they maintain a certain amount of their ownership, they may require that their shares convert even if other investors invest money. The percentage ownership of an individual shareholder is determined by dividing the number of their shares held (numerator) by the total number of shares issued by the corporation (denominator). When a company issues new shares, and an individual ownership does not receive any new shares out of the new ones issued, the denominator increases, but the numerator stay s the same. Their ratio of ownership will therefore be smaller. Many investors will opt for anti-dilution protections which grant them the right to purchase, upon every subsequent issuance of shares, additional shares up to the amount that will keep the ratio between their numerator and denominator the same, thereby maintaining their percentage ownership of the company. It may be hard to picture this without seeing the calculations.

 

Member submitted questions

21 SEPTEMBER 2018

 

Is it possible to give the Series A Preferred stock more weight when voting (e.g 5:1 ratio)?

Typically, the board seats will determine votes, and shareholders will determine the board members based on their share ownership or some other determining factors (described elsewhere in this library). When shareholders own preferred shares they might convert on a 1:1 or 2:1 basis which gives them more voting rights. It is a negotiable point which founders will fight very hard against for many reasons, including that it will be hard to raise new money with a complicated or entrenched voter class.

What is the role of the “Angels Director” as assigned in the Board of Directors covenant on the term sheet? How would this term sheet be applied to an already mature company where it is more difficult to modify the existing Board of Director structure?

As a company grows over time, the number of board seats will increase, but it is important for the founder to have control of their company’s future. Depending on how the company grows, it may only need two rounds of financing, or up to five or six. In each round, the founder’s control is chipped away by, and distributed to, new investors (e.g. the founder will give up 10% in the first round, another 10% in the next round, etc.). Thus, even though a successful round of financing is great for a company, the founder’s goal isn’t necessarily to get to a fifth or sixth round of financing because the founder owns less and less each time. However, the bigger the company, the less this would be an issue (e.g. Amazon at $1 trillion vs. a smaller company valued at $5 million).

In subsequent rounds, most new investors will want a seat on the board (unless they already have one) which leads to a burgeoning board and more voices telling the founder what to do. By giving out seats, but retaining the rights to those seats, the founder can still attempt to balance attracting new investment while retaining strategic control of the business.

What are Observer seats?

Observer Seats serve as a solution for when parties (company founders and investors) absolutely cannot come to an agreement regarding the allocation of board seats. In this case, the investor may compromise that they will forego a board seat if they can have an observer in the room at all meetings. This observer must be made aware of all meetings that are planned.  The founder and investors may compromise to include observers who are experts in the industry. The value of the observer for the investors is a “voice in the room” which can sway a vote and have influence. Once inside the room, it’s unlikely that the observer’s voice would be ignored by the founders – because they would risk losing the confidence of their investors and would face reputation risk as well.

How many LOIs (or NDAs) really turn into investments? Can it also be used just to get more information about a company/competitor?

It is possible that negotiations could be seen as a waste of time by the investor or founder if the other party does not seem to be taking the investment seriously. There are a few mechanisms that deal with this.

For example, a break fee could place responsibility for all (or some proportion) of the expenses incurred in the course of closing the transaction on the founders if the transaction fails to close. Said another way, even if the deal isn’t closed, the founder is on the hook for some money. This might trigger if they leave the deal early or fail to provide information in a timely manner. This confirms the founder’s seriousness from the investor’s perspective. The provision could also apply to the investor.

From the Founder’s perspective, you might want to look at the investor’s reputation, and only allow for a small time period between signing the term sheet and closing the deal (e.g. 30/40 days) so the investor doesn’t dally or use the time to harm your company. Additionally, if confidentiality is a concern, there are companies which provide services to anonymize customers’ names but give out accurate numbers, so investors know the numbers they are looking for, but the names of your customers are protected.

If accountability is a concern, from the Investor perspective, there is also the option of unwinding the transaction (e.g. if the actual use of proceeds is not what was agreed to on paper). So, if the founder is not truthful about the how the investment money was spent, the investor can unwind the transaction, and sue for their money. Further, depending on the size of the deal, the investor might not get any information because they trust the founder; or they see that the founder has a number of investors lined up, and they gamble on the fact that the lead investor has done the due diligence and they will trust that, instead of spend time and expense of doing their own due diligence.

Is there an option to set up a royalty agreement on a percentage of sales if the business model functions based off commission based sales revenue?

There is no reason why you could not have a special royalty deal attached to the term sheet as a separate agreement. Such agreements could be listed as one of the definitive agreements to enter into and would be negotiated outside of the term sheet. There are, however, several reasons terms concerning commercial arrangements are not included within the LOI itself. The scope of a typical LOI is limited to resolving ownership and voting matters. When lawyers review term sheets, they only review it with respect to these types of provisions, not commercial deal terms. Negotiating and reviewing such vastly different terms could slow down how fast the transaction closes, and undermine the entire purpose of using an LOI in the first place. It is, thus, advantageous to compartmentalize these deals within documents which have a narrow scope.

The “Exclusivity” clause seems to make it hard to negotiate with other potential investors. How can a company position itself to attract new investors to safeguard their expansion?

If a company is trying to raise money, then they likely need money to continue to operate, which creates the urgency to close a deal quickly (in 30 days or less). Typically, the exclusivity clause only operates during this short period because its purpose is only to create exclusivity during the period of the deal – not beyond. However, keep an eye out for a right of first refusal clause or a pre-emptive rights clause (both of which are described in this library) as these could potentially slow down future investment from other investors.

 

Ryerson's Law Practice Program (LPP) Member submitted question

 

7 SEPTEMBER 2018
 
Perhaps you could go over some of the mechanisms for poison pills in a founders’ agreement. I don’t know as much as I would like to about them, but I understand they are mechanisms to protect the company from hostile takeover, including takeovers engineered by one of the founders. I would just like to know a bit more about setting something like that up – or, from the other point of view, how such a thing could be de-fanged if one was the person hoping to sell out.
When reading a prospectus this past week, one of our researchers uncovered this language which we’ve clipped for your interest.  This sets out the mechanisms that this particular company has used to protect itself from an unwanted takeover.
Anti-takeover provisions in our charter documents and under Delaware law could make an acquisition of our company more difficult, limit attempts by our stockholders to replace or remove our current management and limit the market price of our common stock.
Provisions in our amended and restated certificate of incorporation and amended and restated bylaws to be effective in connection with the closing of this offering, may have the effect of delaying or preventing a change of control or changes in our management. Our amended and restated certificate of incorporation and amended and restated bylaws include provisions that:
  • authorize our board of directors to issue, without further action by the stockholders, shares of undesignated preferred stock with terms, rights, and preferences determined by our board of directors that may be senior to our common stock;
  • require that any action to be taken by our stockholders be effected at a duly called annual or special meeting and not by written consent;
  • specify that special meetings of our stockholders can be called only by our board of directors, the chairperson of our board of directors, or our chief executive officer;
  • establish an advance notice procedure for stockholder proposals to be brought before an annual meeting, including proposed nominations of persons for election to our board of directors;
  • establish that our board of directors is divided into three classes, with each class serving three-year staggered terms;
  • prohibit cumulative voting in the election of directors;
  • provide that our directors may be removed for cause only upon the vote of sixty-six and two-thirds percent (66 2⁄3%) of our outstanding shares of common stock;
 These provisions may frustrate or prevent any attempts by our stockholders to replace or remove our current management by making it more difficult for stockholders to replace members of our board of directors, which is responsible for appointing the members of our management. In addition, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which generally prohibits a Delaware corporation from engaging in any of a broad range of business combinations with any “interested” stockholder for a period of three years following the date on which the stockholder became an “interested” stockholder. Any delay or prevention of a change of control transaction or changes in our management could cause the market price of our common stock to decline.

 

Member submitted question.

 

22 AUGUST 2018

 

In the services agreement on Clausehound: Complying with policies and procedures is a very general term. How can a consultant be aware of ALL policies and procedures? It takes a very long amount of time to achieve such familiarity. It also requires disclosure of such policies and procedures somehow.

Although the contractor may not be aware of all policies and procedures, you can provide them with reasonable notice (that may possibly align with the notice of termination – e.g. the policy will not come into effect for 30 days, so that if the contractor is unhappy, they are able to walk away) on changes to any policies or procedures that affect this agreement. The employer can also offer additional compensation for signing the amendment to policy or procedure as additional consideration so there is no confusion that the new changes in policy are non-binding (under contract law in many jurisdictions, new terms that are struck after a deal closes that have no “consideration” are considered non-binding.  The topic of consideration is also discussed within our library for your reference). The employer may also require that the contractor go through additional training and sign off on some sort of acknowledgement regarding to the change in policy.

How are employees protected from changes to policy and procedure if they affect their work?

There are often policies to protect the employee – some of which required by law or for companies of a certain size. Whether or not they are specified in the contract, these policies are intended for the protection of the employee. If an employee is unhappy with policy or work procedure changes, they may seek to speak with an human resources representative of the company, an ombudsperson (if one is appointed at the company), who acts as an independent human resources advisor, or even reach out to government appointees regarding Human Rights protection. There may be rules from the local employment governing body to consider. If such policy changes create an adverse effect for the employee, the employee always has the right to decide on their feet to leave the place of employment if they are unhappy. It is important to note that, other than for human rights standards (which exist in many jurisdictions) the same protections will likely not apply to contractors who are considered temporary staff.  Employees are afforded a higher level of protection in most jurisdictions.

What is the purpose of an “No authorization to make decisions” or “No authority to bind” clause in a consulting or contractor agreement, or employment agreement?

This clause is intended to remind the contracted party that they are not signing officers of the company, and that they must ask an authorized signing representative of the company to “sign off” on company decisions. From time to time vendors will ask an employee or contractor to “sign off” on a decision, but they might not have the authority.  This clause serves as a reminder to such a party that they should seek permission from a higher ranking executive at the company.

Can you request IP rights now and in the future, for work done by your employee?

The language in an intellectual property (“IP”) transfer clause is often “aggressive” from the perspective of the company to make it clear that employees do not own any rights to IP created during the course of the agreement – not now and not later.   Note that this is different than taking IP in their future, not yet created work – that’s not the normal intent of a clause of this nature, the clause intends to create protection for work created TODAY (or during the course of the agreement).

It is important for the company to have that certainty to avoid any confusion or problems down the line because the company, when selling the IP, or when licensing it to a third party is often required to sign off that they have full ownership over the IP. However, if the employee disagrees and wants to carve out ownership of IP, they may certainly do so using a schedule to the agreement (decided normally at the outset of their working relationship) to stipulate what IP they own vs. what is owned by the company.

Member submitted questions.

Should a company pay a contractor in cash and shares?

[HoundCo] wishes to receive the services of the Consultant for the purpose of accelerating the growth of [HoundCo], for which the Consultant shall receive, under this Agreement [cash compensation] [and a grant of options/shares in HoundCo pursuant to a separate agreement dated as of the date hereof].

A contractor agreement might state that the contractor has been granted shares separately and at the outset of the contractual engagement.  The contractor likely would not want to tie the share issuance to their ongoing work because this could result in the The share compensation is usually not dealt with in the contractor agreement, because there should be no concept of employee income associated with those shares, because you don’t know the value of those shares. Consult with accountant and tax lawyer that you are doing this properly.

What is the typical split between cash and shares for a contractor?

To learn more please take a look at this blog post about compensating new team members.

Would consultants be subject to vesting like employees? If they don’t consult for X number of years their shares are worthless?

The provisions of a share/option grant and vesting are normally the subject matter of a “share buyback” or “option” agreement, and often within those agreements there would be a triggering event such as failure to consult or reduction of hours beyond a certain point that would trigger a buyback or stop the vesting.  Make sure that you have checked these agreements carefully to confirm that they contain these provisions/protections.

Why are termination and renewal clauses in agreements? If both parties can terminate at any time, I don’t understand why it’s necessary to state an end date in any agreements  If both parties can terminate at any time, why is it necessary to state an end date in agreements?

A termination date creates an end date at which parties can decide whether or not to continue the engagement. With an automatic renewal – contractually – there is no real mechanism that is triggered. Practically, however, it is good to have an end date in advance to give both parties the time to determine next steps. They may decide to discontinue the agreement, and through an end date, parties should not get upset if the opposing makes this decision. On the other hand, the parties may use an end date to renegotiate the terms of the agreement, such as the number of hours worked or the hourly rate. Ultimately, without an end date, there is no natural point in time at which they can think through whether terms need to be changed or terminated.

Image result for startgbc logoMember submitted question

 

08 AUGUST 2018

 

Would owning company stock make the consultant have interest in the company even after a layoff? Would it constitute a breach of this agreement if the consultant joins another competing company after the stated non competition period?

If you mean a ‘financial interest’, yes owning stock at any time would give the consultant an interest in the company. That is the idea – that the consultant will be motivated to work hard to ensure that the stock will increase in value.

If hours are reduced, many stock vesting agreements would trigger a termination of vesting – so you would need to confirm this against your own vesting agreements/share buyback agreements to see what the result of reduced hours would be on the vesting schedule.

Can you own stock in the company and work for a competitor?

When a person leaves a company either through voluntary termination, layoff, requested termination or otherwise, unless specifically prohibited from doing this, yes, it’s fine to own shares in a company that you previously had worked for.  This is trickier where the employee is also a board member of the prior company because a fiduciary duty would exist to the shareholders of the prior company that could result in an actionable conflict between old company and new (best to resign from the board position.

Sometimes shareholder agreements will state that shareholders who are also consultants (or other key employees) cannot own shares in a competitor or work for a competitor while they are shareholders. In that case, there will be provisions for the company to redeem the consultant’s stock (shares). A non-competition obligation prohibits the consultant from engaging in any activities directly competing with the Business of the company during the term of the Agreement and for a limited time afterwards. After that time has expired there is no long a non-competition obligation. If you are concerned that ownership of shares in the company might violate a non-competition clause in the next consulting agreement, simple ownership of shares (if the shareholder is a minority shareholder without power to influence decision making) is not generally considered to constitute competition. Many agreements provide that ownership of less than a specific % of shares (e.g. 5%) for investment purposes does not constitute competition or a conflict.  

Best to discuss this with counsel to make sure you’re carefully navigating this situation.

Isn’t it better to select a specific arbitrator to avoid leakage of confidential information before going to court or else?

A: If a dispute is resolved using the courts, information disclosed in court will be part of the public record, but confidentiality agreements generally provide that it is not a breach of the agreement to disclose information which is required to be disclosed by law e.g. a court. Parties can bring a motion before the court to limit the type and amount of information that is disclosed, and they can request that the court deal with certain matters ‘in camera’ i.e. not in public. The court will have to be persuaded that this lack of public disclosure is required in the circumstances.

It is likely correct that the arbitration process will roll out confidential information slowly and possibly under complete confidentiality.   In the early parts of the arbitration process, the only information disclosed to a potential arbitrators will be the name of the parties, the general nature of the dispute, and the time frame for scheduling purposes, giving the parties plenty of opportunity to negotiate a settlement with no information transferred.  Over the course of the arbitration a requirement for confidentiality can be placed upon the proceedings as well.

What is an example of a conflict of interest in the business/consultant or business/contractor in this following scenario?

This question is intended to uncover what might arise as a conflict that this clause is intended to protect from?

Conflict of Interest. The Consultant warrants that the Consultant will report to [HoundCo] any instance of conflict of interest, as soon as the existence or potential for conflict of interest becomes known to the Consultant. Should [HoundCo] determine, after a reasonable period, that a conflict of interest exists or has the potential to arise, [HoundCo] will inform the Consultant of such decision, and the Parties shall make arrangements for another outside consultant to perform the Services.

Since consultants often work for a variety of clients, potential conflicts can arise. For example, if the consultant has confidential and competitive business information – that for such company provides a competitive advantage – that the consultant had obtained through another relationship, a potential conflict/issue could arise if they enter into a working relationship with a competitor that isn’t supposed to have access to the information.  Another example would be if the consultant is assigned to work for a competitor of another current or previous client of the consultant. While the consultant might be able to do their best for each client without violating any confidentiality obligations, the perception of a conflict will often make clients of the consultant’s employer uncomfortable. Sometimes clients will specify that the consultant cannot work for a competitor within a specified time period. A consultant may desire to charge more for this exclusivity.

Does the Consultant hold the right to copyright their work (i.e. if a website consulting company created a website, what sort of rights will they have over their work?)?

The author of the material would have the original copyright. Consider this clause:

Licensing. The Consultant further agrees that to the extent that the Proprietary Information contains any intellectual property owned by the Consultant prior to entrance into this Agreement, the Consultant hereby grants to [HoundCo] a perpetual, royalty-free, worldwide license to (a) use, execute, reproduce, display, perform, distribute copies of, modify and prepare derivative works based on such material and (b) make, use and sell products and services under such rights, revocable only in the event of material breach of this Agreement.

The purpose of this clause is to have the consultant (who authored material before entering into the consulting agreement) give a license to the ‘employer’ to use the material as described in the license. This does not transfer the copyright, but grants a license to use the materials.

There is also significant writing within our library on ownership of pre-existing IP.

How would you reflect project-based compensation (i.e, consultants getting paid for a project, not by hours)?

This can be done by changing the compensation in the Schedule to payment upon completion of the Services or completed Work Product. The agreement would then clearly have to describe what Services are needed to be completed or what the final Work Product would be, as well as the acceptance procedure, and once delivered and accepted by the company the contractor can be paid. A payment schedule can be added based on achievement of ‘milestones’ as defined in the project.

Is it necessary to put the estimated number of years for which confidentiality is preserved?

Consider this clause:

Unless specifically authorized in writing by [HoundCo], either during the Consulting Agreement Term or after termination of the Consulting Agreement, the Consultant shall use best efforts to do all actions and take all steps to preserve the secrecy of the Confidential Information..

The Term of the consulting agreement should typically be included within the agreement. Whether or not the confidentiality obligation is limited by a stated period of years post termination is a matter of negotiation (and possibly a matter of local case law), but generally there is no reason that a secret should not be secret after a period of time.   The requirement to preserve confidentiality will depend on external factors too, including the employer’s obligations to their clients, which are also often unlimited in time. The consultant should and often contractually must be bound for a period of time that will match the employer’s obligations to their clients.

 How would I change the contractor agreement to be applicable to a part time software developer?

This can be done by specifying that the services provided are relating to the software developer job title. In the expected hours section you can refer to part time hours between a certain range.

Protected Relationships – what is best practice for this for both employers and contractors if it’s an industry where everyone uses the same relationships (e.g. software developers interacting with hardware manufacturers and media outlets). Is it best just to forgo this or limit it to a very specific agreed upon type of relationship that can immediately damage sales?

In the sample agreement, it seems like the Indemnity and Limitation of Liability sections are heavily skewed towards the employer. Are there typical fair clauses which a contractor may want to present to employers and that employers would typically agree to?

Is it possible to sign a contract with a date of execution that has already passed?

Yes! It is possible. Please see the now updated knowledge pointer included in the Founder’s Agreement on Clausehound. I’ve also included the knowledge pointer here:

What is the best practice in a situation in which your business has already started operation and no Founders’ Agreement has been signed?

Ideally, as soon as you can get to a written record is best practice. The potential to dispute the terms in the future is higher when there is no written record, especially if those terms have in fact not been agreed to.

Does “Business Concept” mean some document (presentation or vision document) which is attached to this contract or is this a simple text paragraph in definition section of contract?

We’ve updated the Founder’s Agreement to say “business of the company” on Clausehound. Take a look at the language on the Founder’s Agreement and see if this change has made the contract easier to understand.

If one of the partners provide loan to company and want to get back this loan on next stage of investment with new investors (VC for example) how we could put this option to contract? Is it normal practice?

Yes, this can be included under the “Contribution” clause in the Founder’s Agreement. You can include special details about the type of contribution (e.g. loans, equipment, other capital contributions etc,). Please see here:

Is “Future Employee Interest” related to ESOP?

Yes this would be used, we’ve changed the clause to “Future Employee Stock Option Plan Interest” to reflect that this will be used for future employees.

Typically there are 3 mechanisms that are useful to protect existing shareholders’ from a rebalancing of shares without permission.

(1) shareholder or director approval requirements (2) right of first refusal, and (3) pre-emptive rights.

Some but not all of these are in the standard founders agreement.

We’ve updated and simplified the Founder’s Agreement to include a clause (“Transfer of Interest”) that requires consent and the above 3 mechanisms to further protect existing Founders’ interest. We’ve included the updated clause here.

Member submitted questions.

Can you add co-founders even after incorporation and product development (ex: I’m 4 months into the business)?

Yes. We’ve also updated the Founder’s Agreement to include a start date for each Founder, allowing you to pre-determine when they will start with the Company.

How do people build in variability in regards to the value of their equity stake? How can you assess value of work and then adjust equity %’s accordingly?

To learn more about this topic, please see this blog article.

Can you force someone to sell their shares at cost if they leave after a cliff?

The company may reserve a right to buy back fully vested shares.  Employees may decide not to work for a company if the scheme is too harsh.  Considerations will include (1) what the price per share will be at the time of buy back, and what the time period is for the company to repurchase.  Companies may take the stance that the growing company has issued shares for the purpose of working together to achieve a common goal of selling the business or reaching sustainability, and until the company gets to the point of sustainability, the shares need to be reserved for the employees who are still “in the trenches.”

Does a vesting period have an implied cliff or is it pro-rated? Example: If someone gets 25% of their share over 4 years with a 1 year cliff, my understanding is that: After 1 year they immediately get 25% 6 months into the second year, they have 37.5% (pro-rated)…..is that correct

Yes, looking at the language of this clause, that looks right. You could also could add that after 6 months the employee would get nothing.