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Negotiating Initial Financing

A key to successful relationship between a startup and its investors is the careful crafting of the legal structure of the investment transaction. Venture capital investing is a long-term commitment of support to a startup. The legal documents must foresee the evolution of the startup from a new venture stage to a publicly held company or viable acquisition target. The investment documents represent a charter of the legal rights of the parties spanning the growth cycle of the startup. They also set the tone of the relationships between the founders/management and the investors of the startup, helping to resolution their often differing concerns.

Investors Concerns

1. Reasonable reward based on the risk they undertake and the startup's stage of development;

2. Sufficient control of the development of the startup (Board of Directors; negative covenants on mergers or acquisitions, distributions to shareholders, creation of debt;

3. Rights of first refusal in future rounds of financings;

4. Registration rights to insure liquidity;

5. Minimization of taxes resulting from various types of cash flows to investors (cumulative dividends on preferred shares versus interest income on debt);

6. Minimization of cash flow drain on the startup during its development;

7. Future yield;

8. Protection and liquidity if and when the startup goes public, gets acquired, stagnates or becomes insolvent;

9. Voting control if and when performance of the startup is below expectations and management team has to be replaced;

10. Priority rights in the event of liquidation, dissolution and insolvency.

Management Concerns

1. Flexibility in operating and strategic control of the startup;

2. Liquidity and financial rewards for creating the startup;

3. Adequate working capital to achieve goals of the startup;

4. Minimization of tax exposure for buying “cheap stock”' when founder/managers of the startup have no cash to pay taxes.

Mutual Concerns of Investors and Founder/Management

1. Flexibility of the legal and financial arrangements to adapt for future capital needs;

2. Share incentives for management through pricing differentials on shares held by employees versus shares held by investors to provide “cheap equity”' for management;

3. Retention of shares inside the startup if management departs;

4. Attractiveness of the startup balance sheet for commercial lenders;

5. Retention of key employees through adequate equity participation and incentives.