How Does Law Matter for VC Finance?

1. How Does Law Matter for VC Finance? Hermann Hauser Amadeus Capital Partners

2. Agenda • Terms of investment • Employment law considerations • Exits • Business Angel Issues • The role of lawyers • Insolvency law • Company law • Tax • Fund structure

3. Terms of Investment • Becoming more ‘valley style’ • No confidentiality agreements please! • Participating redeemable preferred structure • preference amounts increasing in multiples,impractical above ~3x • ‘Financeable milestone’ driven • Control over key business decisions held by VCs • Board seat plus observer • 10% to 20% Options, founder vesting • Ratchets not ideal,but occasionally the only way to bridge valuation gap • ‘Pay to Play’ becoming more common with anti-dilution • Non-competes in investment agreement

4. Employment law considerations • Option grants align CEO interests well • Reasonable non-competes • Pass/fail test • Vesting linked to non-competes (untested) • Redundancy laws make labour market less efficient (Sweden vs UK) • Harmonisation possibly harmful? • Use of confidential information from previous employer • ‘Service agreements are liabilities’

5. Exits • Size matters in IPOs (£50m free float) • Institutions want liquid shares (and so do VCs) • Despite relaxation of full list rules, AIM still suits smaller market cap companies • UK still smaller market for tech • Neuer Markt and EASDAQ less favoured • IPO is perhaps the ‘end of the beginning’ and not an exit • Trade sales more common (80:20) and often are an exit • NASDAQ less favoured (high ‘running costs’) • Often choose ‘best of breed’ GAAP (software)

6. Business Angel Issues • Capital gains tax taper relief is big incentive • AIM market tax benefits • No longer the % threshold to qualify for rollover, now employment test • Importance of networks (GEIF, Cambridge Angels)

7. The role of lawyers • Lawyers • UK less commercial input than in the US • Warranties and indemnities • Less experienced in UK with early stage deals cf MBOs etc • Registration rights in US • Some equity billing though less common now….. • Price adjustment through warranty claim! • VCs do not give warranties (escrow yes)!

8. Insolvency law • Chapter 11 is better • Worldpop (article in FT) • Attitude • Debtors gaol vs Henry Ford • good article in economist article on The Valley

9. Company law • Most problems have workarounds • But don’t become a plc too early! • Corporate governance can be dovetailed with regular board meetings • Management accounts /board disclosure stronger requirements than statutes • Financial assistance rules not forming a barrier

10. Tax • Recent generous improvements to CGT • business asset taper relief • EMI options: now on disposal of shares • Share options NI bad history

11. Fund structure • ERISA if have US-sourced funds • Rights of use to VCs regardless • Similar structures to US • Differing tax regimes • Limited liability company LLC

12. Conclusions • Silicon Valley is still the model • UK law getting closer to US • Share options • GAAP • Insolvency LLC Structures getting US like as well