CITE BootCamp September 2010

1. Center for Innovation and Technology Entrepreneurship Technology Entrepreneurship from Innovation to Business Venture The Foundation:Structuring Your New Venture and Raising the Cash Stephanie L. Chandler and George Karutz September 11, 2010 Jackson Walker L.L.P. www.jw.com Karutz Flavin Wells Investment Banking www.kfwib.com CITE BootCamp September 2010 1

2. George Karutz, Jr., CFA Stephanie Chandler Partner – Karutz Flavin Wells Regional Investment Bank advising technology start-up ventures on financial, strategic and operational matters Partner – Jackson Walker L.L.P. Firmwide Head of JW’s Technology Section, Startech Board, Emerging Technology Fund Local Selection Committee

3. Choose the Right Entity • Sole Proprietorship • General Partnership (GP) • Corporation • C-Corp • S-Corp • Limited Partnership (LP) • Limited Liability Company (LLC) Tax Designation

4. Corporation Shareholders Ownership Strategy/Direction Board of Directors Officers: President, Vice President, CEO, CFO, Secretary, Treasurer Implementation/ Signing Authority Employees/Operations/Contracts Liabilities

5. Pros Liability limited Ease of creation Most common – easily understood Growth oriented Centralized Management Cons Federal income tax and Texas Margin tax S-election restrictions Corporation

6. Limited Liability Company Shareholders Members Ownership Strategy/Direction Board of Directors Managers Officers: President, Vice President, CEO, CFO, Secretary, Treasurer Officers: President, Vice President, CEO, CFO, Secretary, Treasurer Implementation/ Signing Authority Employees/Operations/Contracts Employees/Operations/Contracts Liabilities

7. Pros Can have tax flow through Limited liability Cons Federal income tax and Texas margin tax Different terminology (i.e. Managers and Members instead of Board and Shareholders) Not as accepted by institutional investors Difficult if option compensation is part of your growth strategy Limited Liability Company (LLC)

9. Annual Maintenance • Annual Minutes • Shareholders Elect Directors • Directors Elect Officers • Special Meeting Minutes • State Filings • Public Information Report (PIR) • Tax Return

10. RULES FOR RAISING FUNDS Starting Place: Registration Required • All offerings must be registered with the SEC • Unless, that offering is exempt from Registration • Doesn’t matter if small private sale or an offering which is immediately listed on the NYSE

11. Offer vs. Sale • Offer triggers compliance requirements • Compliance must happen before selling process starts

12. Privately negotiated sales Must not involve any general solicitation or general advertising Section 4(2)* - the private-offering exemption - “transactions by an issuer not involving any public offering” * Securities Act of 1933(the “Securities Act”) Private Offerings = Exempt

13. Requirements under Section 4(2) The purchasers of the securities must: • have sufficient knowledge and experience in finance and business matters to evaluate the risks and merits of the investment (“sophisticated investor”), or be able to bear the economic risk of investment; • have access to the type of information normally provided in a prospectus; and • agree not to resell or distribute the securities to the public.

14. Regulation A Exempts public offerings not exceeding $5 million in any 12-month period must file an offering statement (called a “Form 1-A) with the SEC for review Regulation D Safe harbor promulgated by the SEC under Section 4(2) Most common and today’s focus Desire Definition

15. Reg D • Rule 504 provides an exemption for the offer and sale of up to $1 million of securities in a 12-month period • Rule 505 provides an exemption for offers and sales of securities totaling up to $5 million in any 12-month period. • Rule 506 provides another exemption for sales of securities under Section 4(2) with no dollar limit.

16. Rule 506 • Unlimited number of “accredited investors” and 35 “sophisticated” nonaccredited investors • Popular if Integration is a concern • Popular to comply with Blue Sky (National Securities Markets Improvement Act of 1996 (NSMIA) removed offerings under Rule 506 from state regulation)

17. “Accredited Investor” • a bank, insurance company, registered investment company, etc. • an employee benefit plan • a charitable organization, corporation or partnership with assets ≥ $5 million • a director, executive officer or general partner of the company selling the securities • a business in which all the equity owners are accredited investors • a natural person with a net worth of at least $1 million • a natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 • a trust with assets of at least $5 million

18. Why Only Accredited Investors? • Private placement memorandum (“PPM”) that meets Reg D requirements = $$$$$ • If more than $1 million is raised in a 12-month period, Rule 504 is not available • Under Rule 505 and 506, a PPM would be required to offer securities to nonaccredited investors • Even if not required, delivering a PPM or at least a detailed business plan is probably advisable for liability and marketing reasons, particularly in fulfilling the antifraud requirement.

19. Initial Public Offering • Registered with the SEC • Underwritten • i.e. Google, Rackspace... $$ Invest in Growing Operations and Revenue

20. Traditional and Non-Traditional Lenders Most major traditional banks do not lend tostartups/do so only rarely Comerica, Square 1 Bank, Silicon Valley Bank lend to entrepreneurial companies (positive c/f) Accts Receivable, Inventory, Fixed Assets Very sensitive to market conditions – this last down turn caused them to become risk adverse Terms may include: company’s stock, fees, collateral, agreement to pay for AR audits, monthly reporting, audited financial statements, compliance reporting, financial covenants plus all banking relationships – checking, credit cards, investments, etc. must be with lender

21. Angel Investors • Friends and Family • Angel Funding – wealthy private individuals, with background in business, usually smaller than VC’s ($25K - $250K). They prefer to deal directly with the entrepreneur, like local deals, often want to develop a relationship with owners, they are limited in the number of investments they will do concurrently. Usually easier to deal with than VC’s. Invaluable to start-ups. • Must Still Comply with Applicable Securities Laws: • Exemption (“accredited investors”) • Notice Filings

22. Venture Capital ($1 million - $50 million) Advantages • Excellent source of capital / funding committed to your business • VC’s often are prepared to invest in continued rounds as the business grows and achieve it’s milestones • Bring valuable skills, contacts, experience and discipline to your business • VC’s have common goals with the entrepreneur – growth, profitability and increased value of the business • VC’s time horizon is often 3 – 7 years before exiting. • Looking to have a 3 – 7 times return on their capital • Exiting usually in the form of a Public Offering or Sale to a larger business after reaching certain milestones.

23. Grants • GRANTS.gov • STTR (Small Business Technology Transfer) • 5 federal departments participate • 0.3% of the relevant agencies' extramural research budgets • CPRIT (Cancer Prevention and Research Institute of Texas)

24. Governmental Funds • Texas Emerging Technology Fund (ETF) • Apply through Startech (South Texas) • Emerging scientific or technology fields that have a reasonable probability of enhancing this state ’s national and global economic competitiveness. • Additional preference is given to proposals that: • May result in a medical or scientific breakthrough; • Have previous equity investment into the company; • Have a demonstrable economic development benefit to this state; or • Guarantee commercialization or manufacturing in Texas if successful • Must have partnership with Texas State institution

25. Strategic Partnering • Strategic Private Investors/Partners • Large corporations • Potential Acquirors • Potential Customers

26. Getting Comfortable with Investor Terminology • NVCA Model Legal Documents • www.nvca.org - Model Legal Docs Button • Know Offering Terminology

27. Investors • Investor No. 1: Gringotts VC: 5,000,000 shares at $1.00 per share • Investor No. 2: Olivanders VC: 1,000,000 shares at $1.00 per share

28. Amount Raised • $6,000,000, including $500,000 from the conversion of Subordinated Convertible Promissory Notes of Gringotts VC • $1,000,000 to be invested at the Closing • $2,000,000 to be invested upon completion of a prototype of the Firebolt • $2,000,000 to be invested upon achieving actual manufacturing of the Firebolt • $1,000,000 to be invested upon achieving initial sales of $250,000

29. Pre-Money Valuation • The Original Purchase Price is based upon a fully-diluted pre-money valuation of $4,000,000 and a fully-diluted post-money valuation of $10,000,000 (including an employee pool representing 10% of the fully-diluted post-money capitalization).

30. Capitalization

31. Terms to Negotiate • Dividends: Example: The Series A Preferred will carry an annual 10% cumulative dividend compounded annually, payable upon a liquidation or redemption. For any other dividends or distributions, participation with Common Stock on an as-converted basis. • Liquidation Preference: In the event of any liquidation, dissolution or winding up of the Company, the proceeds shall be paid as follows… non-participating Preferred Stock… full participating Preferred Stock

32. Liquidation Preference (cont.)

33. Terms to Negotiate: Right of First Refusal/Co-Sale Agreement and Voting Agreement • Right of First Refusal • Right of Co-Sale • Board of Directors • Drag Along

34. Board of Directors • At the initial Closing, the Board shall consist of five members comprised of • Hermione Granger as the representative designated by Gringotts, VC, as the lead Investor, • Lucius Malfoy as the representative designated by the remaining Investors, • Albus Dumbledore as the representative designated by the Founders, • the person then serving as the Chief Executive Officer of the Company, currently Rubeus Hagrid, and • 1 person who is not employed by the Company and who is mutually acceptable to the Founders and Investors, who shall initially be Dudley Dursley.

35. Corporate Board & Advisory Board • Corporate Board – elected by shareholders to set direction for Company • Advisory Board – Company’s resources (scientific, experience, connections)

36. Representations and Warranties/ Closing Conditions • Founders on the Hook -- Representations and warranties by Albus Dumbledore and Rubeus Hagrid (the “Founders”) regarding technology ownership, etc. • Standard conditions to Closing • completion of financial and legal due diligence • qualification of the shares under applicable Blue Sky laws • the filing of a Certificate of Incorporation establishing the rights and preferences of the Series A Preferred • opinion of counsel to the Company • … and the approval of the Ministry of Magic.

37. Joint Ownership Issues • Not only your partner, but … • Buy-sell/Shareholders agreements • What if I don’t want to keep doing this? • What if my partnerdies? Gets divorced?Files for bankruptcy? • Issues are always easier to resolve before money is a factor

38. READ EVERYTHING … • “Boilerplate” = Most important provisions, do NOT ignore • Don’t assume a provision can’t be changed • Don’t sign contracts until reviewed by a lawyer

39. Use of Forms The parties hereto agree that any disputes or questions arising hereunder, including the construction or application for this agreement, shall be settled by arbitration, in accordance with the Code of Civil Procedure 1280. Said arbitration to be accomplished by a single arbitrator appointed by the presiding judge of the Superior Court of Dallas County Texas.

40. Use of Forms 13. Venue. This Agreement and all amendments or modifications hereof shall be governed by and interpreted in accordance with the laws of the State of Confusion governing contracts wholly executed and performed therein, and shall be binding upon and inure to the benefit of the parties, their respective heirs, executors, administrators and successors. Jurisdiction for any suit filed to enforce the provisions of this Agreement by either party shall be filed in the federal or state courts of Mostfavorable District of Confusion in Hitsville, Confusion or Miracle County, Confusion.

41. Stephanie Chandler Jackson Walker L.L.P. George KarutzKarutz Flavin 210.978.7704 schandler@jw.com 112 E. Pecan Street, Ste. 2400 San Antonio, Texas 78205 www.jw.com 210. 804.4240 karutz@kwfib.com 7373 Broadway, Suite 503 San Antonio, Texas 78209 www.kfwib.com

42. Center for Innovation and Technology Entrepreneurship Technology Entrepreneurship from Innovation to Business Venture The Foundation:Structuring Your New Venture and Raising the Cash Stephanie L. Chandler and George Karutz September 11, 2010 Jackson Walker L.L.P. www.jw.com Karutz Flavin Wells Investment Banking www.kfwib.com CITE BootCamp September 2010 42