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Overview of Legal Issues in Early Stage Financings (Energy Efficiency and Renewables) August 11, 2006 Michael Jay Brown. Dorsey & Whitney LLP (206) 903-8811 [email protected] Topics. Types of early stage financings in energy efficiency and renewables

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Overview of Legal Issues in Early Stage Financings(Energy Efficiency and Renewables)August 11, 2006Michael Jay Brown

Dorsey & Whitney LLP

(206) 903-8811

[email protected]


  • Types of early stage financings in energy efficiency and renewables

  • What kind of funding is available?

  • Case study of early stage round

  • Securities law overview

  • Legal pitfalls in early stage deals

  • The deal team

Types of early stage deals
Types of early stage deals

  • Is it a product or is it a company ?

  • Type of financing depends on stage, nature of company or product

  • What kinds of technologies or companies are being financed?

    • Information technology

    • Devices

    • Tech-based services

    • Projects small, medium and large

    • Products

    • Pure research

Types of funding
Types of Funding

  • Angel

  • Venture

  • Small Institutional

  • Debt (particularly for projects)

  • Strategic Partnerships

  • Grants

  • Bank Funding

Role of counsel
Role of Counsel

  • Different roles of company, individual, patent and project finance counsel

  • Understanding the role, getting client buy-in and defining your duties

  • Where issues most commonly arise in representing early stage companies:

    • founders and their relationship with the company (reverse vesting, employment agreements, scope of authority, ownership of intellectual property, other issues)

    • VCs and their representatives on the board

    • explaining fiduciary duties to various constituencies, including significant shareholders

    • Protecting i.p.

    • Financing snafus (addressed below)

Case study
Case Study

  • Early stage financing for technology company (as opposed to project finance or service deal)

  • Agnostic as to type of technology (could be device, information technology, production, distribution, material science, etc.)

  • Two founders, demonstrable technology, pre-revenue, pre-formation

  • Requires $3 million => cash flow break-even in 18 months

  • Venture returns predicted

Case study cont
Case Study (cont.)

  • Choice of entity: LLC vs. corporation

  • Typical corporate structure and levels of authority

    • Shareholders elect directors and vote on major matters

    • Directors elect officers and formulate policy

    • Officers follow directives of board and act for entity

  • Funding:

    • First round: $500K, accredited individuals (see below), convertible note with discount or warrants

    • Second round: $2.5 million Series A venture funding after milestones hit (e.g. technology, revenues, hiring C-level positions)

Case study cont1
Case Study (cont.)

  • Valuation considerations: what is “pre-money” and how is it arrived at?

  • Cap table: Founders with common equity, convertible notes and preferred holders, options, warrants

Case study cont2
Case Study (cont.)

  • VC package: nature of preferred equity (liquidation preference, voting as a class, investor rights and protective provisions, board seats)

  • Founder reverse vesting

Case study cont3
Case Study (cont.)

  • Board of directors (reason for individuals’ service, number and typical makeup of board, function in private company, no proxies, to whom duties owed, nature of duties, indemnification, authority, and compensation)

  • Board of advisors (liability considerations and nature of service; industry, technology and finance members)

Case study cont4
Case Study (cont.)

  • The process:

    • Formation

    • Business plan

    • Structure of offering

    • Private placement memorandum

    • Securities offering

Securities law considerations
Securities Law Considerations

  • What is a security? Risk capital, Howey test (gain from efforts of another), state law definitions

  • Triggers application of securities laws

  • Federal and state statutory and regulatory schemes

  • Two principal thrusts of securities laws: registration and disclosure

Securities law considerations cont
Securities Law Considerations (cont.)

  • Disclosure:

    • 10b-5 and state analogs

    • Always must make disclosure to standard of materiality

    • Usually provided in Private Placement Memorandum (“PPM”) or similar document

    • Generally, no formal, prospectus-like disclosure requirements

    • General categories of information in PPMs

Securities law considerations cont1
Securities Law Considerations (cont.)

  • Registration (and exemptions therefrom):

    • Private placements under federal and state law

    • Regulation D (“safe harbor”)

    • Conventions/requirements of Reg. D usually adhered to:

      • Accredited-only offerees ($1MM net worth, certain income tests, entity standards of accreditation)

      • No general advertising or solicitation

      • Certain filings

      • Disclosure documentation including business plan, description of securities, capitalization, risks, etc.

Pitfalls in early stage financing
Pitfalls in Early Stage Financing

  • Taking non-accredited investors

  • Commencing accredited round within 6 months of “seed” round (“integration” issue)

  • “Finders” fees and compensating non-broker-dealers

  • Assessing materiality in disclosure

  • Early stage structuring leading to later problems (e.g. non-market anti-dilution protection, certain founder or early investor rights, etc.)

  • “Founderitis” issues: control issues, compensation, director status, reverse vesting, equity and dilution, etc.

The deal team
The Deal Team

  • Lawyers

  • Accountants

  • Valuation firms and their utility

  • Investment bankers

  • Broker-dealers

  • Venture capital firms

  • Technical experts