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Dorsey & Whitney LLP (206) 903-8811 brown.michael@dorsey

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

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Dorsey & Whitney LLP (206) 903-8811 brown.michael@dorsey

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  1. Overview of Legal Issues in Early Stage Financings(Energy Efficiency and Renewables)August 11, 2006Michael Jay Brown Dorsey & Whitney LLP (206) 903-8811 brown.michael@dorsey.com

  2. Topics • 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

  3. 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

  4. Types of Funding • Angel • Venture • Small Institutional • Debt (particularly for projects) • Strategic Partnerships • Grants • Bank Funding

  5. 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)

  6. 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

  7. 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)

  8. 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

  9. 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

  10. 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)

  11. Case Study (cont.) • The process: • Formation • Business plan • Structure of offering • Private placement memorandum • Securities offering

  12. 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

  13. 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

  14. 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.

  15. 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.

  16. The Deal Team • Lawyers • Accountants • Valuation firms and their utility • Investment bankers • Broker-dealers • Venture capital firms • Technical experts

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