The Start-Up Board of Directors

Posted on by

Many start-ups are rightly absorbed in technological and product development, protection of innovation, hiring, market research and– oh yes, money to survive.  Although CEOs abstractly admit that having an experienced  board of directors could indeed be very helpful, as a practical matter the building of a robust early board often get short shrift.  It takes time, wooing people, and finding some mode of compensation for the time cost and assumed risks to fiduciary board members.

Many start-up boards thus include founders and a very early seed-level financial backer who is rightly concerned with how a new enterprise takes care of their money.  Sometimes scientists, doctors or others with domain expertise find their way onto a non-fiduciary advisory board, in exchange for modest amounts of equity which accrue over time; these advisory folks often are important links to satisfy inquiries and concerns of early stage investors who want someone other than the CEO or CTO to explain in detail the proposed performance of the product or service contemplated, but are not privy typically to the nuts and bolts operational decisions that get considered by a full board.

Lawyers will tell entrepreneurs that they are nonetheless wise to spend the effort to add experienced expertise to the board.  There is nothing like advice from someone who has been there and done that, and has the time (and corporate duty) to do deep dives into the myriad decisions that are of mixed content: finance, domain and investor expertise.  This advice is of course echoed by the “directorship community” as witnessed by an article in the current magazine of the National Association of Corporate Directors (confession: this writer is a member of the NACD New England Chapter).

In furtherance of this viewpoint, I respectfully refer you to the immediately prior post to this blog site, which makes clear that current  Federal Administration policy will make entrepreneurship more difficult in many ways; investors and acquirers are going to be more cautious in making investments in new ventures of any sort, and the presence of a senior person who is neither a founder (whose enthusiasm is vital but indeed viewed with caution) nor an early stage investor (whose experience and vision can be skewed to a narrower view with a weather eye on the burn rate eating up initial investments) can be of comfort to future investors who are concerned about the experience level of management in many start-up enterprises.

Medtech Federal Freezes

Posted on by

No secret that the Administration is cutting funding in many ways, including University research and the FDA.  Although we do not know the full extent of these cuts as to substance and time, no doubt start-ups and M&A activity will be affected.

Many start-ups roll out of university research.  With less funding new enterprises will need to spin out more quickly, meaning need for more time and money to get to an inflection point in the business plan.  VCs will evaluate the greater risk, may step back or alternately price their investments with greater return and thus dilute founders.

Cuts at FDA will negatively impact FDA ability to monitor technology progress, will increase review times, and similarly will increase investment risk and make early stage money more expensive. Delay means longer to get to market/cash flow.

Depending on the facts of a given case, M&A approaches will be impacted; in some instances emerging companies may join forces for greater strength to persevere; in some cases doing so might simply make the investment nut just so much larger.  Established companies may be tempted to do a quick early-stage acquisition, which could enhance existing products and/or fund further and faster development, but with less return to entrepreneurs and to any seed stage investors.  Low current value also could attract larger enterprises with established markets to “catch and kill” innovation at a low price.

Further afield, think about possible shrinking of Federal financial support for insuring/covering medical costs.  Markets for cures for less common diseases, often with high development cost for palliatives, may be negatively impacted as successful costly cures may not find reimbursement.

All the above also ignores a possible growing pessimism as to financial support for emerging technologies, not even just restricted to med-tech– fear and caution surrounding equity markets bespeaks difficulty in exits as well as dampening of entrepreneurial zeal.

Delaware Modernizes Corporate Law

Posted on by

My post of March 14 discussed pending legislation in Delaware to stop the migration of companies from  that State to jurisdictions less protective of shareholder rights (such as Texas and Nevada). These new laws have just been passed, with Delaware expressly saying that they were intended to keep Delaware as the “premier” jurisdiction for business.

These changes, briefly summarized below, affect different constituencies differently: control persons will have greater latitude to effect deals that are in their interest; other shareholders will have a more difficult time challenging deals that are thought to be too favorable to control persons; and, lawyers will continue to be really necessary in the complex area of corporate governance, because the new laws make changes but do not eliminate the need for careful corporate process.

Assume a transaction occurs which has economic benefit for persons in control; there are several ways for control people to avoid getting sued by disgruntled shareholders.  The shareholders by majority vote of disinterested parties can approve it after full disclosure.  The directors by majority vote of disinterested parties can approve it after full disclosure.  If challenged as detrimental and unfair to minority interests, the courts can review the action and decide whether or not it was  entirely fair.

These standards sort of remain, but the roadmap has been altered: now for most interested party transactions you need board approval of a majority of only the independent board members, and the interested members count towards a quorum; you can have a disinterested committee make that determination; in only special cases is it necessary to get both board-level and shareholder approval.  In determining whether a director is independent a clear standard has been set: not a party to nor interested in the transaction nor has a “material relationship” with the control people. And now a minority shareholder not given proper process when a transaction was authorized is able to ratify and consent to it afterwards (think Musk, though he has already gone to Texas).

Another subtle change is that the old law required an affirmative vote of all shareholders to okay a transaction; now the vote of a majority of only those shareholders who actually cast a vote is sufficient.  This alone is a major loosening of standards as many shareholders don’t get around to voting about anything, and that apathy no longer will constitute a negative note.

New law also makes it harder for suspicious shareholders to uncover the details of a transaction; the ability under law to demand documents about a transaction has been shrunk to a specific list.  To get background papers you need to make a court showing justifying suspicion.

The above is not a complete outline and there are nuances; you may suspect I am happy to state the following but it is true: you need to hire a lawyer for this stuff.

Crypto and Securities Regulation

Posted on by

It may be confusing, if you are not a lawyer with securities law background, to understand some of the current chatter about Crypto and whether it is a security such that it need be registered with the SEC.  Before the present administration, the SEC was aggressive in this area; the new SEC is attempting to make rules to guide people in the crypto industry.

Quick primer: a US Supreme Court case now almost a century ago (you may see this case referred to as Howey) defined a security as the offering of a reward for providing money to an organization managed by others and sharing in the profits.  Typically that security is a share of stock or a bond.  In Howey, the business was managing orange groves and the investor got a share of profits from the oranges; no “stock” or debt instrument was issued. It can be seen readily that the economic bargain is the same: I give you money, you make a profit from it and you give me money back and my interest increases in value– whether a stock certificate is generated is irrelevant.

Some early crypto-type interests were digital interest or NTFs (non-fungible tokens) issue by emerging enterprises.  You bought an NFT, the issuing company took your money and created a club or resort or restaurant, you had rights to go there, and by the way the NFT could be sold to third parties.  These NTFs were often hyped by celebrities and appreciated in value while the founders either or both of built a new enterprise and sold their own appreciated coins.  These deals often looked a lot like the Howey case (you didn’t get a stock or a return from the business, or a tiny return, but you earned money by selling the NTF), and the SEC was active against such schemes.

There is another category of digital assets, so-called meme coins, which are issued and are traded but do not create an investment in an enterprise.  These sometimes represent interests in works of art, comic images and the like. It may be that the new SEC will find these not to be securities.

The SEC is now doing a deep dive into identifying how to approach the almost endless variants of coin issuances and NTFs with a goal of creating predictability to the marketplace.

 

 

CTA Declawed

Posted on by

By now all should know that CTA is shorthand for a program requiring a federal filing of ownership and control for businesses in the United States which are below a size threshold.  No doubt many readers here have control or ownership of one or more such entities and many I presume have completed and paid for their filings, or incurred expense in preparation of such filings.

The purpose of CTA was to find out the names of  money launderers and scam artists by making them reveal themselves.

On March 21 the US government issued a release exempting from the program requirements all companies formed under the laws of the United States, even if owned overseas. BELOW ARE PERSONAL OBSERVATIONS, neither legal advice (which is never given in my posts) nor reflecting whether the March 21 action of the government was legally taken.  (There is substantial sentiment that the March 212 announcement is contrary to the statute.)

The original statutory scheme, reduced to brass tacks, was this: if you are a crook please register and tell us who you are.  You don’t have to say you are a crook, of course; just register and leave the accusation to us. We want to be able to find you crooks and assess further liability upon you.  So, it required people who are crooks to register.  It might take a particularly stupid crook, with the nerve to steal and swindle, to actually make a filing but we need not address that anomaly here.

The March 21 policy announcement stated that if you were a crook but were acting through an entity that you formed in the US then you still did not have to register, because you set up an entity here.  The result is that even you are a foreign crook and were dumb enough to reveal yourself under the original interpretation of the law, all you now need to do (in order to not violate CTA) is spend a couple of grand to set up a simple entity in the US and then you need not undertake the dumb step of opening yourself up to greater peril by failing to file.

It is not clear to this reader that the new interpretations of the law, exempting businesses from filings just because the crook set up a US front, is consistent with the law as enacted by Congress; the new March 21 announcement is functional guidance today but who can say for the long run.

However, one thing IS clear: the statute, as originally embodied in the filing scheme, did address one major issue: foreign crooks defrauding people in the US by setting up a US front had to make some filing in the US if they set up an entity here.  As flawed as the original statute may have been, the current interpretation makes the statute 100% irrelevant to foreign crooks–you may be a crook but there is no greater risk if you set up a US front.   Even though recent public reportage revealed sophisticated foreign operations at work all over the world, including in the US.

Delaware Is Scared of Texas– or rather its Corporate Law

Posted on by

You have likely noted that Elon Musk, and many other CEOs, have been moving their corporate registration to Texas, which has shall we say more management-friendly laws than Delaware.  What you likely did not know is that 20% of Delaware’s state budget is covered by corporate fees.

The Delaware Senate has just passed and sent to the House  an amendment to the Delaware general corporate statute giving more power to management, tracking Texas law.  The thrust of the law, which passed the House unanimously, was two-fold: first, to permit control persons (directors, officers, majority shareholders) to enter into transactions wherein they have a personal interest if endorsed by either, not both, of the independent directors or stockholders; second, to limit the right of stockholders to access corporate records.

One part of the proposed changes did NOT pass: restricting legal fees for lawyers representing disgruntled shareholders upset by management or control stockholder safe-dealing.  So for those companies staying in Delaware, they still will be policed by the so-called “plaintiff’s bar.”

I will update if, as and when these new proposals become law.

Federal Guidance to Universities and Public Schools re DEI

Posted on by

It is no secret that the current Administration is attempting to dismantle DEI initiatives.  It is also to be noted that the 2023 Supreme Court case involving Harvard made clear that Federal funding was at risk for DEI-adherent institutions, and that on January 21 of this year the President issued an executive order demanding “merit-based opportunity.”  The US Attorney General also has stated the the US Department of Justice was urging “the private sector to end discrimination and preferences.”  And indeed the business news has documented numerous private sector businesses retreating from DEI initiatives.

On February 14, the Department of Education issued a non -binding letter proposing guidance to all educational institutions receiving Federal money.  Such guidance is an indication of how the US Government is going to act in withholding funds, however. Those funds assist many Universities and Colleges, fund basic research and assist just about all public school systems down to kindergarten.

In what areas are DEI initiatives illegal today?  Admissions, hiring, promotion, compensation, financial aid, scholarship, discipline, housing, graduation–everything that happens on a campus or in a school.

What are the steps to be taken per the February 14 guidance–what should all affected schools do?

  1. Revise all relevant policies.
  2. Cease efforts to circumvent race reliance by indirect means (literally read, this would ban geographical models, models to diversify admissions for educational purposes, just about anything that has the effect of skewing treatment beyond pro rata treatment of identifiable groups).
  3. Stop using third party contractors to circumvent the ban on what a school cannot do directly.

What’s next?  In terms of government enforcement, the handwriting is on the wall.  There also is pending litigation concerning the constitutionality of the February 14 guidance, as to which I offer no prediction, particularly since the results in controversial litigation theses days seems so dependent on the disposition of the judges in the court in which a case is being heard (that of itself a very unsettling development leading to forum shopping and inconsistent rulings).

CTA Filings Re-re-Visited

Posted on by

Since my most recent post on February 20 concerning CTA, the Feds have issued two more announcements, described below.  The chaos in this Administration, and the confusion it breeds both here at the law office end and without question among clients, is enormous.  And many of you have made your CTA filings, or incurred legal fees in starting the work.

On February 27 FinCEN (the Federal agency administering the CTA filings required for most US businesses which are not very large) announced that no fines would be levied even if filings were not made by the then-deadline of March 21; and there also was a promise of new regulations to prioritize filings only in cases of significant law enforcement or national security risks.  At that point, wise counsel was to be ready to file as there was no clear guidance as to what was covered and who would in fact be exempted or at least given a free pass.

Then on Sunday March 2 it was announced that even after the new rules take effect there will be no fines or penalties!  Sort of incredible, why would anyone file?  Further the intent is to limit the filings only to “foreign reporting companies.”  Putting aside why even these companies would file if there is no consequence to not filing, it is not clear at least to me  how to understand “foreign reporting company”– does that mean only foreign companies with a location in the US or does it include subsidiaries owned offshore?  English language literally would cover only the former, but I refuse to offer a view (nothing in these posts is legal advice, but I would not even offer a thought) as to what is meant.

The cost to American business by original CTA rules was in some cases significant.  To some of our clients with many US-based subsidiares owned or controlled directly or indirectly overseas, the cost has been greater.  What  overseas business people think of our government must be “interesting” although US businesses seeing the changing general landscape probably are immune to being surprised by anything.

More later if there is a later….

I REPEAT: ABOVE IS ACKNOWLEDGED AS UNCLEAR FROM MY END AND IS NOT LEGAL ADVICE IN SPADES!

CTA Filing Requirement Returns

Posted on by

Yesterday the Federal Government reinstated the obligation for most US companies regardless of form (Corporation, LLC, certain Trusts) to file a detailed report of ownership, control and rights to benefit. For those who have not yet filed in hopes that the obligation would be voided by courts or the new Administration, it seems that the new deadline is in effect and for most companies in existence at the start of this year the filing deadline is now March 21.

Some entities in specific categories had been given a later filing date; if you had such a later date you would in fact be aware of that, and note that the later filing date still does apply to you.

In the future, a re-visitation of requirements for certain smaller US companies, to lighten filing burdens, is promised, BUT it seems that will not happen before your March 21 deadline.

There is detailed guidance on my firm’s website under Alerts: http://www.duanemorris.com/alerts

The Economy

Posted on by

First, apologies for not posting for a while but have been traveling and also working on my publishing; most recent book of poetry, Unrequited Evils, is now available at Amazon books and as always I am appreciative for your support in purchasing and posting a review.  ‘nuf said.

The economy is one of the dominant themes in the news, both generally and perhaps more so today given governmental moves that will impact business (and law) significantly; there is much to touch upon while wholly avoiding politically partisan observations.

Uncertainty has not to this date restrained the stock market, but an early look at my practice indicates no significant uptick in M&A notwithstanding the alleged presence of lots of “dry powder” (I have three client businesses for sale sitting on my desk without clear traction at this very writing).  The legal press recently noted an increase in “down rounds” in VC investments.  It seems clear that turmoil in the medical marketplace is making medtech investment move more slowly.  It may be that the unclear impact, and US governmental view, of  AI also is creating confusion — see my firm’s February 12 “Alerts” post on US government guidance on US of AI in medtech at http://www.duanemorris.com

I also want to give a shout-out to two recent monthly posts by a consulting firm, Capital Restoration.  (Disclosure: a principal in that firm is a personal friend and former client)  Their micro-analyses of current statistics offer a somewhat cautionary look at where the economy is going (which of course impacts your and my business and personal interests). Their advice suggests the following:

*Inflation is back and not at this point do they cite tariffs.  January CPI up .5% (that’s 6% annualized).

*Purchasing is down: retail sales, including in January where typically consumers spend for clearance items; auto sales (down 3%!); e-commerce down almost 2%.  Some of this may be fire-related or weather-related, but one might expect e-commerce to thrive.

*Drastic reductions in Federal spending, triggering lay-offs which of course create unemployment  (citing government agencies, NGOs, hospitals, auditing firms, major tech firms (Meta, Microsoft), airlines, financial services firms)

*Federal budget deficit of $36 Trillion (annual interest cost of $1.4 Trillion) with personal income tax revenue of $2.4 Trillion (and I personally note Trump’s stated intent to extend his income tax cuts) is problematic (quoting Capital Restoration, “the numbers simply do not add up”).

Now this commentary does not address any possible good news arising from the new Administration’s policies (tariffs are protective of American business and the government is very pro-business, etc.).  But unbundling what is happening to arrive at a rational projection for the economy strikes me as not possible as of this moment, and I can offer no clues based on what I see coming across my personal desk.