Long-Range Planning for the Successful Sale of a Company

© Paul S. EllisPAUL ELLIS LAW GROUP LLC

Long-Range Planning for the Successful Sale of a Company

New York Technology Council (NYTECH)New York, New YorkJune 26, 2012

Legal Track Leader/Panelist:Paul S. Ellis, Principal, Paul Ellis Law Group LLC

Panelists:

Jack Early, Angel Investor, Cherrystone Angels

Corey L. Massella, Partner, Citrin Cooperman

Don More, Managing Director, Signal Hill


• Paul S. Ellis– Principal, Paul Ellis Law Group LLC– [email protected] 212-949-5900

• Jack Early– Angel Investor, Cherrystone Angels– [email protected] 401-965-6529

• Corey L. Massella– Partner, Citrin Cooperman– [email protected] 212-697-1000

• Don More– Managing Director, Signal Hill– [email protected] 917-621-3664

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Contact Information and Disclaimer

These materials and the information contained in this presentation are provided for informational purposes only and they do not constitute advertising, a solicitation or legal advice. The materials are not represented to be correct, complete or up-to-date. Accordingly, you should not act or rely on any information in this presentation without seeking the advice of an attorney licensed to practice law in your jurisdiction. The materials contained in this presentation do not create and are not intended to create an attorney-client relationship between you and Paul Ellis Law Group LLC.

© Paul S. EllisPAUL ELLIS LAW GROUP LLC3

Speaker Bios

Paul S. Ellis, Principal, Paul Ellis Law Group LLCPaul Ellis is the principal of a six-lawyer firm, Paul Ellis Law Group LLC, and is a founding board member of the New York Technology Council (NYTECH) and leads NYTECH’s bi-monthly series of legal events. He has represented companies ranging from start-ups to multinationals, as well as funds and individual and institutional investors. Mr. Ellis counsels on issues including formation, early-stage financing, joint venture and strategic partnering relationships, employment, equity plans, mergers and acquisitions, and, together with his colleagues, protection and licensing of intellectual property. Beyond the software/internet/IT industries, he has practiced in industries including telecommunications, healthcare, manufacturing, banking, real estate, consumer products and entertainment. Previously, Mr. Ellis practiced with two major New York firms. He has extensive public speaking experience, having spoken on panels presented by organizations including the New York Academy of Sciences, Columbia University, the MIT Enterprise Forum and the National Science Foundation on the legal issues facing early-stage and technology companies. He holds degrees from Harvard University and Georgetown Law School.


Speaker Bios

Jack Early, Angel Investor, Cherrystone AngelsJack Early, who is currently affiliated with Vantage Point Venture Partners, was the co-founder of Early Cloud & Co (ECC) and is considered an expert in the areas of multi channel sales & marketing and the technologies that support Customer Relationship Management. ECC clients included Sears, Citibank, Bank of America, Lend Lease (Austrailia) Bank of Scotland, Allstate, Pac Bell, First Chicago National Bank, and others. The company was sold to IBM in 1995. Upon leaving the company, he consulted with various Fortune 500 companies, including IBM, regarding their IT infrastructure to support alternative channels. Jack is a founding member of the Cherrystone Angles of RI, and in 2005, raised funds for the rebirth of the Narragansett Brewing Company and currently serves as Secretary and a board observer. was an investor in Context Media, which was eventually sold to Oracle in 2005. He was also instrumental in the sale of Clientsoft to Neon Systems in 2004 and the sale of Horizontal to Autodesk in 2011. In 2006, Jack joined the Board of Vistula Communications and subsequently performed as Interim COO. He later served as COO of GeoSentric from 2007 to 2010 and was a board representative of their China subsidiary Gypsii Shanghai. In recognition of his pioneering contributions to the contact center industry, Jack received a Lifetime Achievement Award in spring of 2006.


Speaker Bios

Corey L. Massella, Partner, Citrin CoopermanCorey Massella is a partner of the firm and CEO of Citrin Cooperman’s SEC Solutions Group. With more than 20 years experience, Corey provides business consulting, audit and tax services for clients in a wide range of industries. Corey has deep experience with technology company’s financial service firms, including hedge and private equity funds, banks, broker-dealers and investor relations firms.As a business consultant, he has advised the CEO’s and CFO’s as well as the Boards of both public and non-public clients in various industries. Corey has negotiated mergers and acquisitions, performed due diligence for potential target acquisitions; assisted clients in the analysis of cash flows, productivity, personnel, financing, the preparation and development of business plans, the preparation of public offerings; and represented clients before governmental agencies such as the IRS and SEC. Additionally, Corey is one of the founding members of the firm’s Technology Industry Committee.Corey is a member of the American Institute of Certified Public Accountants and New York State Society of Certified Public Accountants. He presently serves on the NYSSCPA Securities and Exchange Commission Committee and is a board member and sponsor for the Financial Executives Institute (FEI), Keiretsu Forum and the Long Island Capital Alliance.


Speaker Bios

Don More, Managing Director, Signal HillDon More is a Managing Director at Signal Hill and was a Partner at Updata Advisors (which merged with Signal Hill) after joining in 1998. Mr. More focuses on representing companies in emerging sectors. Mr. More has completed more than 70 transactions with portfolio companies of leading financial investors and with public companies including CA, IBM, Oracle, Quest Software, Symantec, and Websense. Mr. More began his investment banking career as an M&A banker at Merrill Lynch. Prior to that, he was a corporate attorney with Davis, Polk & Wardwell and Shearman & Sterling. Mr. More received a J.D. with distinction from Columbia Law School, and a B.A. magna cum laude from Yale University.


Goals of Today’s Session

• Long-range planning• Not focused on the run-up to a specific exit event, but

on the issues that are important long before there is a particular opportunity

• Focused on the issues that will build value, make the company attractive and make the process as smooth and efficient as possible (thereby preserving value)

• For the early-stage or established company• Cannot provide you with all the answers – We’re here

for “Issue-Spotting”


Topics To Be Covered Today

• Entity and Jurisdiction• Founder Relations• Industry Intelligence• Building Value in the Enterprise• Outside Advisors• Attention to Accounting/Tax Matters• Attention to “Corporate Housekeeping”• Shareholders and Their Rights• Contracts and Particular Provisions• Personnel Issues• Protecting Intellectual Property• Compliance with Securities Laws


Starting With the Ending

• The End-Game:– Identifying a potential purchaser– Negotiating a Term Sheet– Diligence– Documenting and closing the transaction

• Factors that will influence the outcome: – Knowing when the time is right– Knowing who potential buyers are– Knowing and being able to deliver what they are looking for– A smooth process – everybody hates surprises

• You need to focus on these factors long before the exit


Entity and Jurisdiction

• Depending on the anticipated financing and exit strategies, the best structure may be a C Corp., an S Corp or an LLC

• Certain tax benefits of LLCs:– Flow-through taxation of LLC reduces tax burden to the individual and

eliminates double-taxation in an asset sale– Enhanced ability to deduct losses

• But, do not ignore difficulties in LLC form:– VC and foreign investment, employee equity plans and other issues

• Jurisdiction should generally be Delaware• Consider early segregation of different lines of business in

subsidiaries• Bottomline? – Consult with legal/accounting professionals

when appropriate


Founder Relations

• Too many promising young companies fail or face significant problems over issues among founders

• Issues that need to be addressed:– Equity percentages– Reverse-vesting– Titles and roles– Succession/Buy-out rights

• Keys to avoiding problems:– Address these issues early – delay only adds complications– Commit informal understandings to signed agreements– A proper Shareholder’s Agreement or LLC Agreement is critical– Advice of counsel is important at this stage


Industry Intelligence

• Knowledge is a critical component to a successful exit; developing and maintaining that knowledge base has to be a regular, ongoing activity

• Types of information that are important:– Who are your competitors, both existing and potential new competitors– How do you define your market and what is its size– What types of offerings are your competitors introducing– Who are the potential buyers – both strategic and financial– What acquisition activity is occurring and on what terms– What are the general trends in your industry– What factors are influencing the degree of acquisition activity among

buyers– What is occurring in the economy that influences the exit climate

• By keeping abreast of this and similar information, you will be in the best possible position to know when the time is right to pursue an exit and to negotiate the best possible deal terms


Building Value in the Enterprise

• In maintaining your industry intelligence on potential buyers of your company and similar deals, be aware of the acquisition metrics that drive purchase price, such as:

– Revenue, EBITA– Intellectual property– Userbase– Particular customers/significant accounts– Employees with industry-recognized expertise

• Orient the development of your business to emphasize growth in the areas that will drive value in an exit

• But don’t fixate on the exit – if you focus on building a successful company, the buyers will find you


Outside Advisors

• Getting the right team in place is critical – accountants, lawyers, financial advisors

• Considerations: – Industry-specific expertise– “Right-size” – Neither too large nor too small – Willingness to offer meaningful time and assistance at the

critical moments• But beware the false mentors


Accounting/Tax Matters

• Value of company can be diminished by inadequate attention to accounting or unknowledgeable accountants

• By way of example:– Incorrect or incomplete financials can slow down a deal or result

in renegotiation of the purchase price– Opportunities for tax incentives can be lost– Errors with respect to state nexus can result in liability for state

income and sales tax– Failure to get clean audit opinion

• As with legal matters, sloppiness in financial practices raises red flags for buyers, resulting in a diminished purchase price or no deal at all


Accounting/Tax Matters (Cont.)

• Dichotomy between Tax strategies vs. GAAP Strategies – Capitalization of software development cost– Proper recognition of revenue – Proper recording of Research and Development; correctly

handling for tax benefits and difference in accounting for GAAP• Potential Buyer Issues

– Tracking and accounting for stock, option and warrant issuances – Profit normalization calculation – meaning and importance– Ability to segment report to present different profit centers– Accounting for international operations

• Other – Tax structuring for future investors vs. initial founders– Planning for limitation on tax losses to buyers.– Tax credits available - Federal vs. State


Attention to “Corporate Housekeeping”

• Easy to get right the first time, a nuisance to clean up after the fact

• Particular issues:– Holding meetings required under corporate law and by-laws– Proper documentation of board and shareholder action– Proper documentation of equity issuances

• The penalty for getting it wrong?:– Discrepancies can harm or, more likely, slow down a deal– Sloppy records raises red flags among purchasers = a busted

deal or a lower purchase price– Piercing the corporate veil


Shareholders and Their Rights

• A Shareholders Agreement is critical• Examples of rights company needs in

Shareholders/Investor Rights Agreement:– Drag-along right– Supermajority override over holdout

shareholders/investors• Consider the impact of particular strategic investors on

an exit– Strategic investors can offer financing on attractive terms,

as well as contacts, expertise, credibility, etc.– But beware of the potential to reduce exit opportunities


Contracts and Particular Provisions

• For starters, agreements should be properly-documented• Types of provisions that prove problematic in acquisitions:

– Anti-assignment clauses– Change in control provisions– Rights of first refusal– Long-term leases and contracts with “take or pay” provisions– Unusual limitations on liability or warranty commitments– Exclusivity provisions

• Such provisions can result in delay, fundamental structural changes, a reduced purchase price or tanking of a deal

• If such provisions are material to the contract, then you do what you have to do, but be aware of the potential impact


Personnel Issues (Non-tax)

• Employees are rarely unimportant in a transaction – In some deals they are critical to the value of the company– In other deals, what matters most is a smooth transition

• If you’re only starting to think about employee issues when you’re signing the Term Sheet, you’ve waited far too long

• Retention issues and tools: – Vesting periods– Acceleration on change in control – consider “double-trigger”– Retention bonuses/Severance packages

• Other issues:– Non-disclosure/invention assignment and non-competition

agreements– Work-for-hire agreements


Personnel Issues (Tax)

• Proper characterization of personnel– Cash-poor early-stage companies will often incorrectly treat

employees as independent contractors– Creates potentially significant penalties for non-compliance at the

Federal and state level– In recent years, taxation authorities have become increasingly focused

on this issue• Tax issues with incentive plans

– Stock incentive plans – options v. stock appreciation rights– Types of plans – incentive stock options v. non-qualified options– 83(b) elections – need to be made timely– Rule 409 valuation studies when issuing equity


Protecting Intellectual Property

• Failure to protect IP can bring a deal to a sudden stop

• Particular considerations: – Founders should have signed over IP (and any other assets) upon

formation – especially an issue if any of them have left the company prior to an exit

– Proper employee documents (as per previous slides)

– Patents, trademarks, copyrights registered as necessary

– Do not neglect appropriate policing activity to protect rights

– Policies/procedures with respect to open source software

– Procedures in place and adhered to for protection of trade secrets

– Proper attention to protection of IP rights in agreements


Compliance with Securities Laws

• Potential results of failure to comply with securities laws:– Enforcement actions, criminal/civil penalties and rescission actions– Can derail or slow an acquisition (or IPO) or impact the purchase price

• A broad topic, but there are some general principles:– All issuances of securities must be registered or subject to an exemption

that has been identified and complied with; any other issuance is illegal – Applies to founders, friends, family, angel investors, employees,

consultants, vendors, customers, landlords, in other words, everybody– Applies to many types of debt securities as well as equity securities – Applies to LLCs as well as corporations– Finders that are not registered broker-dealers are generally prohibited

• Compliance is generally not difficult, but cleaning up violations after the fact can be difficult, costly and time-consuming, if possible at all

• The lesson? – consult with a lawyer from the beginning


Questions?


• Paul S. Ellis– Principal, Paul Ellis Law Group LLC– [email protected] 212-949-5900

• Jack Early– Angel Investor, Cherrystone Angels– [email protected] 401-965-6529

• Corey L. Massella– Partner, Citrin Cooperman– [email protected] 212-697-1000

• Don More– Managing Director, Signal Hill– [email protected] 917-621-3664

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Panelists and Contact Information

Long-Range Planning for the Successful Sale of a Company

Education

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