Monday, December 19, 2011

What Provisions of an LOI Should be Binding?

The Letter of Intent is an often use document intended to serve as an expression of interest of the parties to enter into a binding business transaction, including an investment, acquisition, distribution, licensing or other contractual relationship.  In essence, it serves as an outline of the important economic and legal aspects of the transaction and becomes the roadmap for the drafting of the definitive contract or transactional documents.  As the Letter of Intent (LOI) is usually intended as a non-binding document, the question is whether any of the provisions of the LOI should be binding on the parties.  As with any legal question, the answer depends on the specific facts and the desire of the parties, but in most cases there are provisions of the LOI that parties will likely want to be binding:  (1) No Shop Clause, (2) Confidentiality, (3) Remedies, (4) Due Diligence, and (5) Governing Law/Venue.    

The concept behind the LOI is that the parties have negotiated the essential terms of a business transaction and therefore wish set down these key terms in a writing that can be used to then draft the binding agreement.  In most circumstances, the LOI is a non-binding document because the parties anticipate that the eventual contract will need to spell out in detail the agreed terms.  Some people question the usefulness of the LOI since it is not binding, but in addition to providing a basis to then draft the binding agreements, it forces the parties to first negotiate the terms and then creates some accountability if a party seeks to drastically alter the terms when it comes to the final contract.  As an example, if a company agrees to sell its assets to a potential dollar for an agreed price, and then later in the contract changes it to more, the potential purchaser can point to the LOI and argue that the seller should stick to what it agreed.  Is that a legally enforceable claim?  No, but in most circumstances the party may recognize that it is bad business practice to renege on an agreed fundamental term.

While the parties may enter into a a non-binding LOI, there are provisions that they should still make binding.  As a practical matter, the LOI can include a statement that it is not binding, except with respect to certain expressly listed provisions.  Of course, the parties can then choose any of the sections to be deemed binding, but the following are the most common terms that will be included in an LOI.

1.  No Shop Clause.  A No Shop Clause is a provision in an agreement between a seller and potential buyer that precludes the seller from seeking other potential buyers during the period of the No Shop.  In simple terms, the seller cannot shop around the business or assets during the prescribed period.  The rationale behind the No Shop is that the potential buyer does not want the seller from using its offer to seek to obtain better offers from a third party or create a bidding war, resulting in a substantial waste of time and money for the potential buyer who is likely expending legal and accounting fees assessing the business opportunity.  The risk for the seller is that the potential buyer decides not to proceed, but this is a term a potential buyer will generally require and therefore a risk the seller will need to accept to move the process forward.  The No Shop clause will include a definite time period, and should include a clear statement as to the remedies available to the potential buyer in the event of a breach.  The remedies may be in the form of equitable relief (i.e., an injunction) or even a stated liquidated damages amount intended to reimburse the potential buyer for the costs incurred in connection with the broken deal.

2. Confidentiality Clause.  In many instances the Confidentiality Clause will have already been part of a Non Disclosure Agreement entered into prior to the LOI.  At the very least, the LOI can refer to the existing NDA and reiterate that the LOI is subject to the NDA, and a breach shall give rise to remedies as set forth in the NDA.

3. Remedies for a Breach.  If the LOI has provisions that are binding then there should be a separate provision setting forth the rights of the non-breaching party in the event of a breach of the LOI's binding provisions.  Therefore, inlcude a section stating in what circumstances equitable relief (injunctive or even specific performance) can be sought or if there is a right to specific liquidated damages for a breach of a binding provision.    

4. Due Diligence.  You may want to include a binding clause that requires the seller to provide the potential buyer an unfettered opportunity to conduct due diligence and have access to the information necessary to conduct the due diligence.  Unlike a No Shop, for example, including a binding due diligence clause is less common place, but if you are concerned about the seriousness of the seller or that it is just using the LOI to solicit offers after the No Shop expires, then you might want to consider requiring reasonable access and an opportunity to conduct due diligence.  The seller may balk on the theory that it is too difficult to define what constitutes adequate compliance, but the easy answer is that as buyer you should have unlimited due diligence, subject only to reasonableness as to notice and non-interference with the operations of the seller's business.           

5. Governing Law/Venue/Attorney's Fees.  The LOI should state the law that governs the (binding terms) and the court where claims can be instituted in the event of a dispute or a need to enforce the LOI.  Depending on certain factors such as whether you are likely to be the one bringing the claim and how deep your pockets are, you may want to include a requirement that the court award attorney's fees and costs to the prevailing party.  If you win the lawsuit, you can seek reimbursement of your legal fees and costs but the risk is that if you lose, you will be responsible for fees of the other party -- which no doubt can be quite substantial.

The lesson here is do not take the LOI for granted or view it as a waste of time.  First, if you spend the time to negotiate the fundamental terms of the transaction and then put the terms in an LOI, the parties will have a good structure to draft the definitive documents.  Of course, terms can change, as they often do, as a result of due diligence, but at least the LOI provides a starting point for the further negotiations.  Second, even a non-binding LOI should contain certain binding provisions that protect the parties in the interim period between signing the LOI and execution of the definitive agreement.   

Disclaimer:  This Article is for discussion purposes only and does not constitute legal advice or create an attorney-client relationship.  You should seek the counsel of an experienced lawyer with respect to your business law matters.


Thursday, December 15, 2011

Small and Large Companies Need to Understand Open Source Software

The development, licensing and/or use of software has become essential to the operation of many businesses.  Whether a company is in the business of selling a new application, platform or program or relies on such for its business operations, it may choose to (a) develop the software in house, (b) outsource the development to a third party or (c) it may obtain the proprietary products in connection with the purchase of a business.  One of the big issues to emerge with respect to the development of software is the integration of open source software in the application, platform or program.  Any company developing software, outsourcing the development thereof, or obtaining software through an acquisition, must properly diligence whether the software incorporates open source code, understand the risks associated with its use, and establish precautions to prevent the unknown integration of open source software into its key technologies.      

1.  What is Open Source Software?

Open source software is distinguished from the compiled ready-to-run version of software in that the program must include the source code, and it can be modified and redistributed as any developer desires.  If you are not technology savvy, then imagine a screenplay for a movie that is open for use to the general public, can be revised and then freely redistributed/incorporated into another movie.  This all sounds great since it seems you are getting the fruits of the labor of a software developer without having to pay for it.  The issue, however, is that the use (i.e., the free license allowing the incorporation of open source into another program) is subject to certain conditions which can create big issues for a company unfamiliar with these issues.

2.  How Does A Company End Up Having a Program with Open Source Source Software?

A company will end up with a program incorporating open source code if the company (a) develops a program in house and the developer(s) rely in part on open source for the development of the program, (b) outsources the development and the third party incorporates it into the program, or (c) acquires the business of a third party that is using programs developed in whole or part with open source software.

3. Why Should a Company Care if it Has Open Source Software in a Program? 

Use of open source software raises three significant issues relating to:  (a) legitimacy, (b) weakening of intellectual property rights and (c) licensing obligations.

              (a)  Legitimacy of the Code:  The essence of open source software is that it is created through the contributions of many different developers.  Again, think of the movie script written by a community of unaffiliated screenplay writers who contribute ideas and dialogue through the Internet, eventually creating the final screenplay.  The writers never meet each other, and no one can be certain if the ideas are even original.  With open source software, the community of programmers develop the program over time, without any certainty as to the original source of the code or the developer's rights, if any, to the contributed code.  If you are a company that has software incorporating open source code, you have to be concerned about whether the program infringes the intellectual property rights of a third party.  Because the intellectual property rights to the programs cannot be verified, and are made available generally on an "as-is" basis (i.e., without any warranties), the company using the program risks (i) infringement claims arising from its own use and (ii) indemnification claims asserted by end users (i.e., customers) and licensees of the company's technology.   

            (b) Intellectual Property Rights:  Software not only is protected by copyright laws but may also can be patented.  However, if the software contains open source, the program may be subject to obligations arising from an express or implied patent license whereby users are granted a license with respect to any claims -- in layman's terms, aspects of the patent -- incorporating open source.  Moreover, some open source licenses are contingent on an understanding that use of the program precludes any patent infringement claims against a third party using and/or distributing a program incorporating the open source into their products.

           (c) Licensing Issues:  The fact that open source software is developed by a community of developers does not mean the program lacks any intellectual property rights.  Instead, those incorporating open source into other works are utilizing the open source based on a license.  Understanding the parameters of the license is important as this will dictate the license you may have to grant to third party's in your own products.  The conditions relating to the redistribution of of products containing open source differ  depending on whether it is subject to a permissive free software license or the copyleft licenses:

                  (i) Permissive:  The BSD license is a permissive free licenses having relatively little requirements with respect to redistribution of the software.  Permissive licences permit the redistributor to combine the licensed material with non-open source code, effectively adding restrictions to a program derived from the open source code.

                  (ii) Copyleft:  Contrast the BSD with the GNU General Public License ("GPL"), which is a reciprocal "copyleft" license requiring that the entire source code for any programs/products incorporating the open source becomes freely available to be used, modified, and distributed by your licensees.  The derived works from the source code must be distributed under the same license terms as the open source license.  The result is that any modifications and derived works must be offered free under the same terms as the relevant GPL.   Therefore, if source code is used in a proprietary product under a GPL, it is not only the open source but the entire source code that can be used, modified and redistributed, by your licensees.  Conversely, if you distribute copies of the work without abiding by the terms of the GPL you can be sued for copyright infringement (arising from a breach of the license terms) by the original author under copyright law. 

Also, be ware that there are different versions of Permissive and Copyleft licenses so the terms and conditions of the licenses can vary within each type of license. 

4.  How Should a Company Address Open Source Issues?

Since open source has become a significant aspect software development, below are some considerations for addressing potential issues relating to open source software.

      (a)  Developing Software in-house or through outsourcing:   If you are developing software through your in-house programmers or outsourcing the development, take the following precautions:  (i) all employee-developers and third party developers should be advised of the importance of discussing with appropriate management personnel the need or desire to incorporate open source; (ii) management and legal counsel need to review the relevant open source license(s) to determine the ramifications of using the open source code; (iii) if the company decides to proceed, the developers need to document properly the open source code that has been used; and (iv) the company needs an Invention Assignment Agreement with its employees or a clause in the outsourcing contract detailing the company's procedures with respect to integration of open source into its programs.

    (b) Business Acquisition:  In the context of a business acquisition, a company must due diligence the programs/technology of the target company to determine if any of the proprietary products include open source.  Once the acquirer gets the complete picture with respect to open source matters, your counsel should include representations, warranties and indemnities in the purchase agreement to protect the acquirer.  From a standpoint of the economics of the transaction, the acquirer also needs to determine if the utilization of open source by the target company has a negative impact on the value of the target's products and intellectual property portfolio.  In addition, counsel needs to consider whether the target has properly documented the use of open source, is adhering to the relevant licenses, and if there exists a potential for claims based on misuse of the open source resulting in a revocation of the license.

The availability of open source software has provided companies with a more efficient means, both from  financial and development time standpoints, to create new programs, platforms, applications and other products.  However, with these new technology development opportunities comes new risks that both small and large companies need to understand.  In sum, if your company is developing new technologies have proper policies and procedures in place with respect to use of open source; or if you are acquiring a company with proprietary products, scrutinize the software programs and address all open source issues before proceeding with the acquisition.  

Disclaimer:  The contents of this blog are for discussion purposes only and do not constitute legal advise or create an attorney-client relationship.

Monday, December 12, 2011

The Miscellaneous Contract Terms: They Aren't Boiler Plate (Part II)

The previous installment discussing the terms generally relegated to the "Miscellaneous" article of the contract reviewed the meaning and importance of the (1) Severability, (2) Notice, (3) Amendments and Waiver, (4) Counterparts and (5) Construction and Headings sections.  See the prior Installment  This installment concludes the discussion of the common "Miscellaneous" provisions by reviewing the (6) Remedies, (7) Third Party Beneficiaries, (8) Assignment, and (9) Integration provisions of an agreement. 

6.  Remedies.  Some contracts will include a separate section with respect to "Remedies" available to the parties in the event of a breach.  The section requires particular attention because, to the extent not addressed elsewhere, it will set forth the remedies the parties can seek for breach and enforcement of the contract.  The section may detail specific damages a party can seek in the event of a breach (for example, liquidated damages), but the other points to be on watch for include:

             a.  Specific Performance:  Does the clause provide the parties the right to seek specific performance of the agreement.  In some circumstances, a party may be equally or even more concerned with the other party actually performing the services or obligations under the agreement and not just obtaining damages for a failure to perform (i.e., breach).  An obvious example might be a contract to purchase a home.  If actual performance is important to you, then make sure the contract includes specific performance as a right in the "Remedies" section, if not in another section  Without the specific performance remedy, a court may only be able to award damages, which may not be satisfactory in the mind of the person seeking performance.

           b.  Equitable Remedies:  The contract may make reference to the right of the parties seek other equitable remedies, like an injunction, in the event of a breach.  This is common, for example, in licensing agreements.  In addition, the clause may state that the parties waive the obligation of posting a bond even if it would otherwise be required as a precondition to seeking the remedy.  The bond provides security to the defendant and a means to obtain damages in the event of a false injunction.  If you are the party against whom the remedy is more likely to be sought -- in the case of a licensing agreement that would be the licensee -- you may not want to agree to waive the necessity of posting the bond.  Again, another reason why you need to read carefully all terms of the contract.         

          c.  Cumulative Remedies:  Some contracts state that the remedies are cumulative and do not require a party to seek one type of remedy before seeking alternative remedy.  You will often see this provision in a promissory note, giving the lender the right to enforce the note in any manner without any precondition that one remedy be sought before another type of remedy.  
7.  Third Party Beneficiaries.  Often the agreement will expressly state that there are no third party beneficiaries.  The section means that no one other than the actual parties to the agreement can claim any rights or seek to enforce any obligations under the agreement.  it may seem an obvious point that only the parties have rights under an contract, but there can be circumstances where a contract may appear to confer a benefit on a third party.  The inclusion of the clause will make clear that the contract should not be read to offer any benefits to anyone else.  Less frequently, the clause can be included for the the opposite purpose and actually confer the benefits of the contract on a third party where the parties desire such an effect.

8.  Assignment/Successors and Assigns.  

          a.  Assignment:  There are some contracts that one or more of the parties may wish to be able to assign and there are others which may not be appropriate for assignment.  If you are contracting for the services of a software developer, for example, you probably spent a great deal of time vetting the developer and therefore would be unhappy if the developer then assigned the contract to someone else.  Thus, you can understand why it is important to set forth whether the contract is assignable or requires consent of the parties.  Another context where assignment can be an issue is the event of a sale of the business where the absence of a right of an assignment can be an issue if the contract is important to the buyer:  one typical example is a license.  Bottom line:  think about whether you would prefer to have a right to consent to the assignment of the contract.

         b.  Successors and Assigns:   The "Successors and Assigns" clause determines whether the successors and assigns of a party or of the parties under the agreement are subject to the rights/benefits and obligations of the agreement. The clause may (i) bind the non-assigning party to perform the contractual obligations in the favor of the assignee, and (ii) bind the assignee to perform the contractual obligations in favor of the non-assigning party.

9. Integration/Entire Agreement
The "Entire Agreement" or "Integration" clause essentially provides that unless set forth in the contract an obligation, right, or term is not considered part of the agreement.  The clause incorporates the concept found in the parol evidence rule that the final agreement as made by the parties supercedes any terms that may have been discussed in prior negotiations.  A party cannot make an argument that it negotiated for a right if it is not included in the contract because the parties (and courts) must look to the "four corners" of the contract -- of course there are exceptions to this rule but the Integration concept incorporates the parties' intention that the contract is the final expression of the terms agreed to by the parties.     

While you should at least generally understand the meaning of these Miscelleaneous provisions, if there is just one take away it should be that they are not simply boiler plate just because they are found at the end of the contract.  As with any section of a contract, the ultimate meaning and effect of each of these sections depends on how they are drafted, and therefore each clause should be read with the same scrutiny applied to the other terms of the agreement.  

Disclaimer:  This Article is intended for informational purposes and does not constitute legal advice nor create any attorney-client relationship.

Wednesday, December 7, 2011

The Miscellaneous Contract Terms: They Aren't Boiler Plate

A prior post discussed the concept that notwithstanding the fact that the governing law and forum selection clauses are usually at the end of a contract they should be reviewed and negotiated with the same emphasis as the business terms.  In the same vein, there are several provisions that will often fall under the "Miscellaneous" section or article of a contract, and therefore you may (erroneously) believe they contain boiler plate language not requiring much attention.  To be clear, do not ignore or give little attention to these miscellaneous contractual provisions simply because they come at the end of the agreement.  This two-part discussion reviews the meaning and importance of the "Miscellaneous" sections of a contract.  In this instalment, the (1) Severability, (2) Notice, (3) Amendments and Waiver and (4) Counterparts, and (5) Construction/Headings clauses are discussed, and the next installment reviews the (6) Remedies, (7) Third Party Beneficiaries, (8) Assignment, and (9) Integration provisions of an agreement.    

1.  Severability.  What happens to the contract if the parties included a provision that is later found unenforceable or invalid under law?  If the agreement includes a Severability clause, in most cases the remainder of the contract will be saved.  The provision is important to prevent the entire contract from being rendered void or unenforceable.  The Severability provision will state that the remainder of the contract and the application of the deficient provision to other persons or circumstances shall not be affected and shall be enforced to the extent permitted by law so long as the economic or legal substance of the transactions is not affected in any manner materially adverse to any party.  Further, if a term or other provision is invalid or unenforceable, make sure the Severability clause states that the parties will negotiate in good faith to modify the agreement to cause the  original intent of the contract is fulfilled to the greatest extent possible.

2. Notice.  The Notice clause defines the method(s) for providing notice to the parties.  OK, that is obvious, but what you include in that provision can actually avoid the failure to provide or receive timely notice under terms of a contract. 

         Example:  You enter into a contract with a printer for the printing a brochure.  The contract includes a provision requiring you to give the printer ten days notice from the date of receipt of draft brochure of any defects.  If you do not provide notice of any defects, the printer will then make 1000 copies.  You receive the brochure by overnight delivery on December 12, 2011.  You find a defect and send the printer an email on December 23, 2011.  He calls and notifies you that it is too late, you need to take delivery of the 1000 brochures, and you owe the full fees under the contract.  You call back and tell him you understood ten days to mean ten business days, and so your notice was timely.  Problem:   the contract does not say business days, and so you made the wrong assumption.

Issues like the above regularly occur, and so here are good ideas for the Notice provision: 

                 (a) all notices must be in writing (not oral);

                 (b) when referring to days, state whether this means business or calendar days;

                 (c) if time periods run from delivery of a product, service or notice, define the permissible delivery methods (i.e., regular mail, certified with return receipt, fax, email, overnight, personal delivery) and when delivery is deemed to have taken place (regular mail:  "x" days after mailing in the US or "y" days outside the US; fax:  upon confirmation of successful transmission; overnight mail:  upon proof of delivery; and personal delivery:  upon proof of personal delivery); 

                 (d) as a precaution, require that copies of all notices to be sent to your attorney; and
                 (e) expressly state the addresses for delivery, and that if the address changes that the party must notify the other parties to the agreement.
3.  Amendments and Waiver.  Contracts should include a provision addressing how (a) amendments to the contract can be made, and (b) provisions/rights in the agreement can be waived by a party.

                (a) Amendment -- The contract should state that any amendments must be in writing signed by all the parties. 

                (b) Waiver -- The provision should state that that:  No waiver by any party of any default, misrepresentation, or breach of warranty or covenant, whether intentional or not, shall extend to any prior or subsequent default, misrepresentation, or breach of warranty or covenant or affect any rights arising as a result of any prior or subsequent occurrence.

4.  CounterpartsThe section entitled "Counterparts" allows for the agreement to be signed separately by the parties on different copies of the signature page, and will generally include that delivery of the signature page can be accomplished by fax. 

            Sample clause:  "This Agreement may be executed and delivered (including by facsimile transmission) in one or more counterparts, each of which shall be deemed an original but all of which together will constitute one and the same instrument."

5. Construction/Headings

              (a)  The "Construction" provision provides the rules of interpreting the contract in the event of the dispute, including an important concept that the parties have deemed the contract to have been jointly drafted and therefore no presumption or burden of proof should be deemed to arise favoring or disfavoring any party by reason of being labeled the drafter of the agreement.  Why is this important?  Without it, all the parties would either need to sit in a room and sign the document or the one, original signature page would need to be circulated to all parties, who would each be required to sign on the same page.
            (b)  The "Headings" clause precludes any party from giving any meaning to the headings, and therefore the headings are simply to facilitate organization of the document.

The next installment discusses the meaning and importance of several other Miscellaneous contract provisions, including the Remedies, Third Party Beneficiaries, Assignment, and the Integration provisions.Disclaimer:  The information in this blog is for discussion only and does not constitute legal advice nor create any attorney client relationship.  You are urged to consult with an experienced lawyer concerning your business/corporate law matters. 

Friday, December 2, 2011

Venture Capital Terms: A Primer

Before you get involved with venture capital financing, whether as a company looking to raise financing, or as a potential investor, make sure you understand important terms and concepts that you will invariably be confronted with in a venture capital transaction.  Even if your business is not at the juncture of raising financing, understanding the key terms in now as they relate to a private equity transaction will help you start to position company for an eventual financing round down the road.  Accordingly, this discussion provides an overview of some of the important terms in a venture deal.

1.  Venture Capital:  You have heard the term thrown about, but what does it mean?  Simply put, venture capital is a broad term used to describe financing provided to startups and early stage businesses as well as turn around situations.  However, the manner in which the financing is provided to a company is where the many variations on potential deal structures arise.  The financing can be raised through debt (i.e., a loan), equity (i.e., shares) or a combination of the two (such as a convertible loan or a loan with stock options).

2. Private Equity:  Equity securities of a company that are not listed on a public market are referred to as private equity.  However, the term is also liberally used to refer to any venture capital deal where the financing does not involve any purchase of shares listed, or any listing of any shares, on a public exchange (i.e., stock market).

3. Valuation:  The value of the company.  A simple statement, but that is the only thing simple about it.  Valuation is usually one of the most important issues in any venture deal, with the company arguing for a high valuation and the investor looking to push valuation as low as possible.  As an investor, you may receive a term sheet with a stated valuation for the company, however, any valuation decision should be based on your independent assessment.  Further, the valuation should adjust based on information you may learn in the due diligence process.

                 a.  Post-Money Valuation:  The valuation of a company immediately after the most recent round of financing. If an investor provides $1 million in a company valued at $3 million "pre-money" (before the investment was made), the post-money valuation of the company is $4 million.

                 b. Pre-Money Valuation:  The valuation of a company prior to the investment. This amount is determined by using various possible formulas (book value, discounted cash flow, multiple of future earnings etc.). 

                 c.  Fully Diluted Basis:  All securities, including preferred stock, options and warrants, that result in additional common shares on a converted basis, are counted in calculating the total amount of shares outstanding for determining ownership or valuation.4. Common Stock:  A security (stock) that evidences proportionate ownership in the company and gives the owner voting rights and proportionate right in the assets and income of the company (after all obligations of the company).

5. Preferred Stock:  Like common stock, preferred stock represents proportionate ownership in the company, but stands a higher position (preferred) to common stock with respect the claims on the asserts and earnings.  Preferred shares may or may not have voting rights depending on what the parties negotiate.  Preferred shares generally will have a number of additional rights that common stockholders do not have, including a dividend preference and liquidation preference.  There are different types of preferred stock, including:

               a.  Participating Preferred:  giving the owner the right to additional dividends if a certain predetermined financial event occurs

               b.  Convertible Preferred:  which convert into common stock either at the option or can occur upon an event requiring mandatory conversion to common stock

               c. Cumulative Preferred/Dividend Preference:  Preferred shares have a dividend preference giving the holder the right to dividends before common stock holders.  Cumulative Preferred Stock gives the holder a right to dividends at a fixed rate of return, and that dividend accumulates each year until paid (before common dividends, if any).  Non-cumulative preferred means if no dividends declared, then the dividend is lost (rather than accumulates until declared).  

6.  Liquidation Preference:  Preferred shareholders will have a right to receive a payment upon a triggering event, such as the winding down of the company or a merger or acquisition.  The question is what is the nature of the preference:  (a) how much is paid, (b) what is the priority among different classes (common vs. preferred) and series (like Series A vs. Series B, and (c) the right, if any, of the preferred to share in any remaining amounts (i.e., along side the common shareholders).

7. Series A, etc.:   Stock of a company can be divided into different series, which will occur when there is more than one round of financing.  For example, if preferred (Series A) shares were already issued, and the company does another round it can call the new preferreds Series B.  The other important aspect is that each Series can have different dividend, liquidation, voting and other rights.

8. Convertible Stock:  Most people are aware of convertible stock or convertible rights which gives the holder of preferred shares to convert them into common stock upon a triggering event.  However, the real issue is negotiating the conversion ratio/formula, for example will it be 1:1 meaning one common for one preferred or another formula where the preferred gets more than one share of common for each preferred share. 

9. Anti-Dilution Protection:  One of the biggest concerns of any investor in a company is that it will be diluted if the company subsequently issues more shares at a lower price.   As a result, investors often demand an antidilution right, and then the question is what is the nature of that right:

                  a.  Full Ratchet gives the shareholder the right to always retain its percentage of ownership in the company.  Therefore, the shareholder is given a right to a number of shares necessary to maintain its ownership percentage in the company.  While this term is very favorable for the investor, it has the effect of substantially diluting other shareholders without the right and thus the full-ratchet provision is less common.

                  b.  Broad-Based Weighted Average results in dilution of the holder of the right, the percentage decline is tempered so as to not result in the full dilution that other shareholders will experience.  The issuance of new shares at a lower price will result in a re-weighting of the average share price, and the investor with the anti-dilution protection will have a right to additional shares to lessen the effect of the new round (however, the investor will still see a reduction in its ownership percentage).

10. Tag Along/Co-Sale:  The Tag Along right gives a minority shareholder the right to sell its shares upon the sale by a majority shareholder on a percentage basis.  If you are a minority shareholder, this is an important right because you do not want the founders or majority to be able to exit the company without giving you a right to exit in part as well.

11. Drag Along:  Means that if a set percentage of shareholders wish to sell the company's share to a third party, the other shareholders must agree and are dragged along into accepting the deal and the negotiated terms.

12. Right of First Refusal/Preemptive Right:  This right can work to the benefit of the shareholder, giving it a right to buy shares on the same terms offered to a third party.  It also can benefit the company, providing the company a right to purchase its shares rather than allowing a third party to buy them from an existing shareholder.

13. Right of Redemption:  A right of redemption gives the holder the right to demand that the company repurchase its shares at a specified price upon the occurrence of a triggering event.

14. Registration Right:  Investors with registration rights are given the right to require the company to register its restricted shares either on demand (subject to certain terms) or a piggyback right (when the company files a registration statement).  For a company, allowing the demand right is not generally favored
because registration is expensive, complex and the timing may not be right for a registration.

15. Board Seats:  A company seeking to raise funds should be aware that an investor may seek one or more seats on the company's board of directors.

16. Restrictive Covenants:  It is common place for loans to include restrictive covenants limiting certain the company from taking certain actions while the loan is outstanding, but an investor may also ask for such rights, including limitations on spending, sale of important assets, issuing additional shares, increases in salaries and other major business decisions.

17. Non-Compete Clause:  A company may want to require an investor to sign a non-compete, especially a large investor.  The investor will likely push back arguing as a passive investor it is not necessary.
Above are some of the more important terms you will need to address in a venture financing transaction.  Of course, the investor will take a markedly different position regarding some of the rights as the company.  Therefore, as your company is moving toward the financing stage, begin considering how you will address the important rights that the investor will likely demand.

Disclaimer:  The discussions in this blog do not constitute legal advise nor create any attorney-client relationship.  You are urged to seek the advice of an experienced lawyer who can provide counsel with respect to your corporate/business law matters.