Padraig Walsh

Partner, Hong Kong

26 November 2013

Founder Risks & External

Investment

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First risk: Founder disputes

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Risk mitigation: Learn how to fightAbout each other

Are the personality and working styles complementary?

Are skill sets complementary?

What is the foundation of your collaboration? Friendship, need, respect?

Is there a common vision?

What is the long-term plan? Exit or a job?

Money What is the equity split, and why?

What are the personal cash needs?

How do we decide what, and how, we pay?

The business What is outside the scope of our business?

Can we do other things?

How much time commitment is needed? For how long?

Management How do we make decisions?

Can one of us fire the other? If so, what does the other leave with?

Disputes What are the rules of engagement?

What topics are off limits?

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Second risk: Not protecting IPR

“A secret's worth depends on the people from whom it must be kept.”

― Carlos Ruiz Zafón, The Shadow of the Wind

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The management view The employee view

49 of the 100 bosses surveyed are concerned that a potential threat to their company's [confidential data] would lead directly to the loss of their job

59% of employees who leave/are asked to leave take company data with them

79% of those employees admit they had no permission to do so

53 per cent of those questioned felt that not enough was being done to protect their rights.

67% of employees used the data stolen to secure a new job

38% of data transfers involved employees emailing data to personal email accounts

Federation Against Software Theft (FAST), July 2012 Ponemon Insitute LLC: Data Loss Risks During Downsizing (23 February 2009)

IPR and trade secrets

Deliberate harm Inadvertent harm

Possessive geek Inadequately trained

Malicious miscontent Negligent

Venal careerist Inadequately supervised

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Risk mitigation: Secure IPR protection

Identify IPR copyright patents trademarks designs confidential information and trade secrets

Protect IPR record creation of copyright materials register IPR that is registrable secure confidential information and trade

secrets third party warehousing of IPR

Contracts and policies assignments shareholders agreement employment agreements policies and procedures

IT usage employee monitoring resignation protocols

third party contracts

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Third risk: Growing too fast

90 percent of incubators will fail … incubators are really startups, and the oft-cited

rule of thumb is that 9 out of 10 startups fail.

Peter RelanFounder, You Web

Pros Cons

access to mentoring, investors, recruiters, media

too many companies; not enough mentoring

funding for equity and fees

increased credibility

only a handful have real credibility

access to professionals

limited follow through

help with marketing

one-size fits all approach to business growth

IS IT TIME AND MONEY WELL SPENT?

Accelerator and Incubator Programmes

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Risk mitigation: Scaling growth

Low

High

Status quo

Key employee plan

JV partner

Investor

PREMATURE SCALING IS THE PRIMARY CAUSE OF STARTUP FAILURE, AFFLICTING 70 PERCENT OF ALL THE STARTUPS THAT

WENT TO MEET THEIR MAKER.

BLACKBOX, STARTUP GENOME PROJECT 2011

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Fourth risk: Keeping key people

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Employee share plans

Why?

- key employee retention- turn employees into stakeholders- cashless bonus- breed loyalty with reward

Some realities

- often not what employees want- complex documentation- costly and expensive- very risky if not done right

Solutions

- share class rights- share option arrangements- articles of association- employment agreement

Risks

- loss of control- handling employee departure- skewed incentive- confidentiality- dilution on valuations

Why not a bonus scheme?

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Fifth risk: Funding risks

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Fifth risk: Funding risks

Preference share

valuation set now liquidation preference applies in all liquidity events with a participation right? with a cap?

Convertible loan

converts to equity in next series round usually makes sense only when next round is close assumes investors in next round will agree valuation and dilution deferred breaks alignment of investor and founder may require security and collateral with a cap?

How much? 12-18 months target investors for whom the amount sought makes sense be realistic on expenses (as well as revenue)

Investor due diligence

due diligence the investor consider investor options – angel, technical investor, VC where is the VC fund in its investment cycle? there is signalling effect with the investors your choose consider the impact if the investor does not follow subsequent

rounds

And then… keep it lean keep costs focussed to growth stage of company

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Sixth risk: External investors

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Sixth risk: External investors

Statutoryprotection

Board representation

Veto rights

Anti-dilutionprotection

Informationrights

Tag-alongrights

Misfeasanceprotection

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Seventh risk: Complex corporate structures

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Seventh risk: Too complex, too fastBusiness entity

Hold Co in sensible location (royalty income, dividends, and capital gains)

Op Co in Hong Kong (or sphere of operation) understand scope of operation of Hold Co and Op Co transfer pricing in offshore/onshore structures

Jurisdiction nothing exotic consider area of operation and tax environment understand long term options, and keep options open

Useful points

avoid aggregation of small investors structuring for regulation structuring for business lines structuring for succession planning structuring for employee share schemes invest in proper corporate secretarial support

Risks structural subordination too complex, too fast taxation impact

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Eighth risk: Board engagement

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Eighth risk: Governance is goodBoard composition

corporate governance 101: the board governs the business critical to control rights of appointment ensure clear processes for replacement and rotation ensure directors are aware of fiduciary duties and legal obligations consider D&O insurance

Board observer

what is the objective? participation in debate? or silent observer? consider board advisory committees under agreed terms of

reference different to an alternate director

Useful points

agree duration of appointment properly prepare the board; agenda, papers, information properly chair board meetings avoid formal resolutions and votes; move by consensus decide on preferred form of minutes and provide minutes promptly assign responsibility for action points and follow up

Risks board becomes stale directors develop entrenched positions board meetings become a shambles no physical board meetings; resolutions in writing directors cannot be removed, replaced or rotated easily

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Ninth risk: Exit tensions

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Ninth risk: Exit choicesTrade sale /

MBOSecondary

saleRedemption

/ OptionLiquidation IPO

Often a preferred founder option

More of the same?

Usually when the business 'fails' in investor eyes

May arise in a convertible note scenario

Conversion rights of preferred to ordinary shares

Investor will want veto

Or funding at a mature point in corporate growth cycle?

Redemption is a return of capital, is complex, and requires free cash

Only makes sense for an investor if a voluntary option exists

Lock in for up to two years

Be aware of different party's interests and incentives

Permits investor exit

Put option to founders at an exercise price to deliver investor return

Could be the outcome if founders are deadlocked

Be mindful of ratchet rights

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Tenth risk: Professional adviceTenth risk: Professional advice

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Tenth risk: Finding the right guidance

Being pessimistic is almost always a recipe for low levels

of subjective well-being. There is one glaring

exception. Pessimists do better at law.

Daniel H. PinkAuthor, Drive

Perceived advantages Limitation measures

expertise self-research the basicsattend learning sessions join mailing lists for briefings

relationship building does not require paid engagementsopen your own connections

connections to other helpful people deliver a value message on why help should be given

document drafting, tax structuring, fundraising identify core documents that will deliver maximum value for fees

IS IT TIME AND MONEY WELL SPENT?

Tips

plan your meeting

be mindful of time as a limited resource

provide information and documents promptly

review work scopes and assumptions

know when paid service goes live

ask who will perform your work

accept fair fees for work