1 Overview of Legal Issues in Early Stage Financings (Energy Efficiency and Renewables) August 11, 2006 Michael Jay Brown Dorsey & Whitney LLP (206)

2 Topics Types of early stage financings in energy efficiency and renewables What kind of funding is available? Case study of early stage round Securities law overview Legal pitfalls in early stage deals The deal team

3 Types of early stage deals Is it a product or is it a company ? Type of financing depends on stage, nature of company or product What kinds of technologies or companies are being financed? –Information technology –Devices –Tech-based services –Projects small, medium and large –Products –Pure research

4 Types of Funding Angel Venture Small Institutional Debt (particularly for projects) Strategic Partnerships Grants Bank Funding

5 Role of Counsel Different roles of company, individual, patent and project finance counsel Understanding the role, getting client buy-in and defining your duties Where issues most commonly arise in representing early stage companies : –founders and their relationship with the company (reverse vesting, employment agreements, scope of authority, ownership of intellectual property, other issues) –VCs and their representatives on the board –explaining fiduciary duties to various constituencies, including significant shareholders –Protecting i.p. –Financing snafus (addressed below)

6 Case Study Early stage financing for technology company (as opposed to project finance or service deal) Agnostic as to type of technology (could be device, information technology, production, distribution, material science, etc.) Two founders, demonstrable technology, pre-revenue, pre- formation Requires $3 million => cash flow break-even in 18 months Venture returns predicted

7 Case Study (cont.) Choice of entity: LLC vs. corporation Typical corporate structure and levels of authority –Shareholders elect directors and vote on major matters –Directors elect officers and formulate policy –Officers follow directives of board and act for entity Funding: –First round: $500K, accredited individuals (see below), convertible note with discount or warrants –Second round: $2.5 million Series A venture funding after milestones hit (e.g. technology, revenues, hiring C-level positions)

8 Case Study (cont.) Valuation considerations: what is “pre- money” and how is it arrived at? Cap table: Founders with common equity, convertible notes and preferred holders, options, warrants

9 Case Study (cont.) VC package: nature of preferred equity (liquidation preference, voting as a class, investor rights and protective provisions, board seats) Founder reverse vesting

10 Case Study (cont.) Board of directors (reason for individuals’ service, number and typical makeup of board, function in private company, no proxies, to whom duties owed, nature of duties, indemnification, authority, and compensation) Board of advisors (liability considerations and nature of service; industry, technology and finance members)

11 Case Study (cont.) The process: –Formation –Business plan –Structure of offering –Private placement memorandum –Securities offering

12 Securities Law Considerations What is a security? Risk capital, Howey test (gain from efforts of another), state law definitions Triggers application of securities laws Federal and state statutory and regulatory schemes Two principal thrusts of securities laws: registration and disclosure

13 Securities Law Considerations (cont.) Disclosure: –10b-5 and state analogs –Always must make disclosure to standard of materiality –Usually provided in Private Placement Memorandum (“PPM”) or similar document –Generally, no formal, prospectus-like disclosure requirements –General categories of information in PPMs

14 Securities Law Considerations (cont.) Registration (and exemptions therefrom): –Private placements under federal and state law –Regulation D (“safe harbor”) –Conventions/requirements of Reg. D usually adhered to: Accredited-only offerees ($1MM net worth, certain income tests, entity standards of accreditation) No general advertising or solicitation Certain filings Disclosure documentation including business plan, description of securities, capitalization, risks, etc.

15 Pitfalls in Early Stage Financing Taking non-accredited investors Commencing accredited round within 6 months of “seed” round (“integration” issue) “Finders” fees and compensating non-broker-dealers Assessing materiality in disclosure Early stage structuring leading to later problems (e.g. non- market anti-dilution protection, certain founder or early investor rights, etc.) “Founderitis” issues: control issues, compensation, director status, reverse vesting, equity and dilution, etc.

16 The Deal Team Lawyers Accountants Valuation firms and their utility Investment bankers Broker-dealers Venture capital firms Technical experts