Category Archives: Practice Tips

What is a Ratchet (IPO Edition)?


Square Reveals Ratchet Right

In corporate speak, a ratchet usually refers to a form of anti-dilution calculation, however, the term has expanded its meaning to apply to initial public offerings. Square, the mobile payment processing company, filed its S-1 with the Securities and Exchange Commission yesterday. In the prospectus, it was revealed that certain institutional investors would be guaranteed a return of at least 20% in the initial public offering (“IPO”), regardless of whether the IPO is valued lower than the last round of private financing.

What is a Ratchet

What is a ratchet in the IPO context? A ratchet in the IPO context is similar to a ratchet in the anti-dilution context and provides that investors will receive additional shares of the company’s stock if the IPO is priced at a low value.

A Lawyer’s Take

This application of the ratchet right is great for lawyers representing investors in a late stage investment where the company is targeting an IPO. Depending on the amount of leverage your client may have, the amount of investment and a host of other factors, this may be a negotiable ask. Square’s prospectus is also a great example that although a prospectus can be lengthy and difficult to sift through, sometimes they contain nuggets of great information that one can use to be a better equipped lawyer. Learn from good examples and expand your knowledge base.

What is Circular 7?


One of the most important jobs of a corporate lawyer is to issue spot and if need be, recruit colleagues in a specialized practice area like intellectual property, employee benefits or tax to opine on a particular issue. Issue spotting is a skill (remember the bar exam?) and it can be particularly tricky when dealing with cross border transactions.

Defining Circular 7

I recently completed a transaction involving a target company with assets in China and the issue of Circular 7 was raised pretty early on. Circular 7 refers to a tax provision by China’s State Administration of Taxation that provides that:

“a nonresident enterprise transferring shares in an offshore intermediary enterprise that directly or indirectly holds an equity interest in a PRC enterprise re subject to PRC tax on the gains from the transfer if the PRC tax authorities determine that the arrangement lacks a bona fide commercial purpose and re-characterizes the indirect transfer as a direct transfer of the PRC enterprise”.

Why Circular 7 Matters to Lawyers

Tax is an area I leave to the experts given the many fine nuances and the financial risks if tax assessment/tax planning is not done well. If you’re interested in learning more about Circular 7, please see the linked article above from Deloitte. Otherwise, remember that if you are working on an M&A where a target company has a connection to China, Circular 7 may be an issue. You may not be able to opine on its particulars, but in spotting this potential issue, you have definitely made a value add to the transaction.

Practice Tips for Drafting Earn-Outs

Covenant of Good Faith and Fair Dealing and Its Application in Earn-Out Provisions

20150603Earn-outs are a common provision in merger agreements, allowing the buyer to defer paying a portion of the purchase price until the seller has “earned” it, meaning that seller has achieved some financial target or other agreed upon condition.  In the recent case of Lazard Technology Partners, LLC, v. Qinetiq North America Operations LLC, April 23, 2015, Strine, L., 2015 WL 1880153, the Delaware Supreme Court made an important ruling regarding the covenant of good faith and fair dealing and its application in earn-out provisions, from which attorneys can learn good practice tips for earn-outs.


Qinetic North America Operations (“Buyer”) acquired Cyveillance, Inc. (“Seller”) for $40M. The merger agreement included an earn out provision that said that if certain revenue targets were achieved, Seller may receive up to an additional $40M. The key language from the earn out provision reads as follows:  Buyer was prohibited from “taking any action to divert or defer revenue with the intent of reducing or limiting the Earn Out Payment” (“Earn Out Provision”).

Not surprisingly, revenue targets weren’t reached and earn out payments weren’t made. Lazard as the seller’s representative brought suit against the Buyer alleging (1) breach of the Earn Out Provision and (2) violation of the covenant of good faith and fair dealing by Buyer for failing to take certain actions that Seller believed would have resulted in the revenue target being reached.


Delaware Supreme Court affirmed the Court of Chancery’s decision in favor of Buyer, finding that (1) there was no proof that Buyer intended to avoid the earn out and (2) the implied covenant of good faith and fair dealing couldn’t be relied on because “there was no gap to be filled”, i.e. the Earn Out Provision was clear on the obligations of Buyer.  Both courts took a 4 corners approach to the merger agreement and found that there was no violation.

Practice Tips for Drafting Earn-Outs

The Lazard Qinetic case yields good practice tips for drafting earn-outs that attorneys representing either buyer or seller can apply.

In representing the buyer attorneys should either (a) disclaim any implied duty of good faith and fair dealing or (b) make very clear in the earn out provision of the merger agreement what the express post-closing obligation of Buyer is, including the standard to be used. In this case, the Earn Out Provision was clear that it was an intent based standard.  What helped in this case was that there was a track record during negotiation that Buyer rejected all attempts by Seller to include more stringent post closing covenant (ex: act in good faith to maintain level of business, preserve customer relationships, etc.). Seller agreed to not include these provisions so the court wasn’t going to second guess the final merger agreement.

In representing the seller attorneys should (a) seek an express good faith obligation to maximize the earn out and (b) be weary of using an intent standard in a post closing affirmative covenant.

In general, I think another good practice tip is to not assume that the implied covenant of good faith and fair dealing will help to expand a party’s obligations in a dispute involving earn-outs. Attorneys should draft the merger agreement to very clearly lay out each party’s obligations.

Distinction between Ownership, Management and Control


I just finished reading Zero to One: Notes on Startups, which is a good read not only for those interested in or working on their own startup but also for lawyers representing startups. One of the things author Peter Thiel mentions is the distinction between ownership, management and control. This distinction is key for any corporate lawyer and something which I try to teach early on to junior associates.

What Does Ownership Mean?

Ownership means who owns stock in a corporation or who are the stockholders. Initially, ownership is limited to the founders of a startup but over time, the owners expand into new hires and investors. Stockholders have certain rights as owners of the corporation as provided by the state laws of the corporation’s state of incorporation and the corporation’s organizational documents. As lawyers, we should be aware of all the rights afforded to stockholders by virtue of their ownership of stock, for example, information rights. Ownership however does not always translate into influence over the corporation (see Management and Control below).

What Does Management Mean?

Management means who has the ability to make daily business decisions for the corporation or who are the officers and key personnel in a corporation. Management makes a plethora of decisions which impact the operations of a corporation, however, they are limited from taking certain key actions by those who exert control (see Control below). As lawyers, we should be aware of the distinction between management and control in order to properly advise management when they need to seek approval prior to taking certain actions.

What Does Control Mean?

Control means who has the power to effect important changes for a corporation. Control is held by two groups, the board of directors and the controlling stockholders. The board of directors is empowered with the responsibility to oversee the activities of a corporation. There can be overlap with the board of directors and management as certain officers like the CEO or President may also sit on the board of directors, however, that officer cannot act unilaterally to effect change. There is also overlap between controlling stockholders and owners of a company. The distinction between ownership and control is that not all owners can exert control over the company. As lawyers, we must determine which stockholders are in fact controlling stockholders based on their individual or combined percentage holdings of the company. Keep in mind, that it’s not always a test of who owns majority of the stock. Depending on what the corporation’s organizational documents or agreements say, a larger percentage approval may be required for certain actions.

Remember that Distinction between Ownership, Management and Control is Fluid

Knowing the distinction between ownership, management and control is key to advising your corporate clients on how to take actions. Just remember that the composition of each group is subject to change based on new stock issuances, capital raises and appointments to officer/director roles.

Legally Lean: 4 Tips for Counseling Lean Startup Clients


What is a Lean Startup?

Lean Startup is a business approach first developed by Eric Ries which advocates that startups take a scientific approach to the development and deployment of their products and services. The key is quick iterations and validated learning. Ries’ book ‘The Lean Startup’ is a New York Times best seller and widely regarded as a must read book for anyone looking to form a startup.

Lean Startup has also become an adjective for certain startups, who pride themselves on being dynamic, cost conscious and ready to pivot their model based on early feedback. This can be appealing to both prospective employees and investors; as it’s a chance to be involved with a company which is fast moving, fiscally resourceful, responsive to customer feedback and (if you believe the tenets espoused in ‘The Lean Startup’) more likely to hit the acclaimed unicorn status. See: What is a Unicorn? 

Tips for Counseling Lean Startup Clients

Your Lean Startup clients are going to want to move fast, and they will want their lawyer to do the same. Tailoring your counsel accordingly will help you and your Lean Startup clients succeed. Here are 4 tips for counseling Lean Startup clients:

1. Provide quick and timely turn around of any work product

With all clients, it is safe to assume that they want work product as soon as possible. For Lean Startup clients, this is even more imperative as delays are detrimental to the Lean Startup methodology. When counseling Lean Startup clients, lawyers should ensure that they provide all work product when promised and be upfront as to when work product will be ready.

2. Provide a useful tailored NDA

One of the key agreements Lean Startup clients need is a non-disclosure agreement (NDA), particularly one that is lean yet broadly protective, admittedly a tough order. Resist the urge to provide the standard long form NDA as many Lean Startup clients face push back from prospective customers and partners who may be put off by lengthy legal documents at such a preliminary stage in the business relationship. Take the time to tailor the purpose clause and protective provisions. Walk through with your Lean Startup clients how the NDA works and the process they should go through to have third parties sign the NDA.

3. Pick up the phone and limit round trip turns of legal agreements via email

So much of business nowadays is conducted via email and through the electronic exchange of marked up agreements, but for Lean Startup clients, this can cause unnecessary delays waiting for schedules to be synced and lawyers to find the time to markup agreements. Maximize efficiency by picking up the phone to discuss lengthy markups or to answer questions your Lean Startup clients may have.

4. Counsel Lean Startup clients to get key terms in writing

Your Lean Startup clients are busy doing exciting things and the legal formalities are surely the last thing on their minds. Protect your client’s interests and make your job easier when the time comes to draft a formal agreement by counseling Lean Startup clients to get all key deal terms in writing. Although it may be quicker to verbally agree on terms, encourage your Lean Startup clients to get all key deal terms in writing, even if it’s informal bullet points on a back of a napkin. This will help to avoid unnecessary disputes between the parties when the formal agreement is prepared and help your Lean Startup clients quickly move on to the next step in their ever evolving business plan.

Water Cooler Syndrome and Lawyers

What is Water Cooler Syndrome and How Lawyers Can Avoid It

20150506- Water CoolerDefining Water Cooler Syndrome

Water cooler syndrome for lawyers is an organizational behavior phenomenon where lawyers find it difficult to do their job or meet their ethical obligations because they interact regularly with certain personnel. This may be an issue for in house lawyers or law firm lawyers who are on secondment to a client. The people you see every day become your friends and as a result, it can be more challenging to speak up or take a difficult action especially if it directly involves your friends.

Corporate lawyers represent the corporation. This can be a tricky distinction when the corporation is small and lawyers have formed strong business relationships and even friendships with management and key personnel. Water cooler syndrome can come into play when lawyers find it challenging to do their job because it is hard to say no to someone you see every day by the proverbial water cooler.

Tips for Avoiding Water Cooler Syndrome

My friends who work as in house counsel often talk about how the legal department is physically segregated from the rest of the company, often times working in a completely different building detached from the majority of the office. Physically distancing yourself may not be possible or preferable, but there are  other actions that lawyers can take to avoid water cooler syndrome.

1. Don’t give legal advice to individual personnel

Remember that your client is the corporation and that all legal advice given should be in the best interest of the corporation and not any one person. When legal advice for an individual is warranted (e.g. issues related to refresher grants to the CEO, advising a board member on how to disclose a conflict of interest to the entire board), err on the side of caution and put the advice in writing.

2.  Consider consulting outside counsel

Sometimes a second opinion is helpful. Outside counsel can provide an unbiased opinion as they likely will not have the same relationship with key personnel. You can also point to outside counsel in the blame game if needed.

3.  Be prepared and confident to say no to avoid ethics being compromised

Lawyers can’t force their client to take any actions. It’s our duty to relay the law and advise on best actions but at the end of the day, the ball is in their court. If you ever find yourself in a serious ethical dilemma where your integrity as a lawyer is at stake, be prepared and confident to say no, and if need be, to walk away.


Standstill Agreement and Revlon Duties

20150504-Standstill-RevlonM&A Tips in Light of Potential Salesforce Acquisition

Rumor has it that Salesforce has been approached with an acquisition offer by a large technology company. The identity of the buyer (and the certainty of such an acquisition) are unknown but news articles are throwing out names including IBM, Oracle and Microsoft. Given Salesforces’ high market cap of $47 million, the list of potential acquirers is fairly short and being narrowed each day.

While a Salesforce acquisition is still speculation, its potential is a great reason to discuss 2 important items for corporate lawyers to remember when it comes to mergers and acquisitions: standstill agreement and Revlon duties.

Standstill and Silent: Ensure that Any Potential Acquirer Signs a Confidentiality and Standstill Agreement

Depending on the exact details of a proposed merger and acquisition transaction, but particularly in a merger and acquisition involving a public company, the parties should enter into a confidentiality and standstill agreement. A potential acquirer will rightfully want to do a due diligence review of a target company, however the target company should protect itself before providing access to its confidential information and business records. A standstill agreement is usually included as part of a confidentiality or non-disclosure agreement but it may be structured as a separate agreement.

There are 2 types of standstill agreement:

(1) One type provides that the parties agree to deal exclusively with each other for a certain period of time. This helps to align the parties’ incentives to undertake due diligence and negotiations in good faith and steady force.

(2) The second type is a form of anti-takeover protection which helps to ensure that a potential acquirer will not use the confidential information they have obtained as part of the due diligence review to undertake a hostile bid of the target company. The standstill agreement will typically provide an exhaustive list of coercive actions including tender offers and proxy fights which the potential acquirer is precluded from doing for a certain period of time.

Remember Revlon Duties: Target Board Must Obtain the Best Price for Stockholders in a Sale of a Company

In Revlon, Inc. v. MacAndrews & Forves Holdings, Inc., the Supreme Court of Delaware held that in a transaction involving a change of control, the board of the target company must act according to their fiduciary duties and obtain the best price possible for stockholders. For lawyers, it is our job to ensure that the board of the target company is documenting with detail the discussions, analysis and extra steps taken to ensure they meet their Revlon duties. Salesforce is one of the largest cloud computing companies and although any serious acquisition offer will likely involve a hefty consideration amount, the board is still obligated to act to maximize value for its shareholders and the lawyers representing Salesforce will certainly be reminding them of this duty.

Standstill Agreement and Revlon Duties

A standstill agreement should be drafted with full consideration of the board’s Revlon duties. Entering into a standstill agreement cannot preclude the board from fulfilling its Revlon duties. Exclusivity for a finite period of time is encouraged to protect a deal and align incentives but it cannot preclude consideration of other parties or transactions which may yield higher value for stockholders.

Mergers and Acquisitions Weekly Watch


Comcast Withdraws from Merger with Time Warner Cable

Comcast has announced that it is formally withdrawing its proposed $45B merger with Time Warner Cable, after it failed to convince regulators at the Federal Communications Commission (FCC) to approve the transaction. Opponents of the merger argued that the transaction would result in Comcast controlling more than fifty percent of broadband.

Takeaways for Lawyers from the Failed Comcast Time Warner Merger

The failed Comcast Time Warner merger has two important takeaways for lawyers with respect to working with regulatory agencies:

1. Always Consider Which Regulatory Agencies Needs to Approve the Merger

When working on a merger, we’re trained to automatically consider if Hart Scott Rodino (HSR) approval is needed, but what about other regulatory agencies. In the Comcast Time Warner proposed merger, approval by the FCC was required. According to the FCC website:

Before a company may assign an FCC license to another company or acquire a company holding an FCC license, it must receive the Commission’s approval. The Commission reviews applications for the transfer of control and assignment of licenses and authorizations to ensure that the public interest would be served by approving the applications.

Although the FCC had not formally rejected the merger, news reports indicate that the FCC would have recommended issuing a “hearing designation order” which would have let an administrative judge decide the merits of the proposed transaction and would very likely have resulted in a no-go for the merger. The Comcast Time Warner proposed merger highlights that lawyers should always consider whether any regulatory agencies need to approve the merger based on the business of the client and the proposed transaction, and ensure that the proper specialist is contacted early to get the approval process under way as soon as possible.

2. When Regulatory Approval is Required, Ensure that the Transaction Agreements Include a Way Out for the Buyer if Regulatory Approval is Not Obtained

Many proposed mergers, particularly those with a high consideration amount and where approvals need to be obtained to effect the merger are structured as a two part, sign then close transaction. These approvals can include shareholder approvals and third party approvals, such as approvals from lenders and regulatory agencies. As the Comcast Time Warner proposed merger shows, obtaining regulatory approval is not always an easy task. If that regulatory approval isn’t obtained, the buyer in a transaction is not going to want to be sued for breach of contract for failure to close on the deal or be left with a worthless asset they cannot use because they are barred by regulatory restrictions. When regulatory approval is required, lawyers should always include a provision in the transaction agreements that essentially gives the buyer an opportunity to walk away, just as Comcast did. This is frequently structured as a closing condition; if the closing condition of the regulatory agency approval is not obtained, then the transaction cannot close and the parties are free to part ways without any breakup fees being paid.

Happy Administrative Professionals’ Day

20150422_Administrative-Professionals-DayThe Pixley Bouquet from Bloom That

One of the first things I tell first year associates is to not forget two things: First, don’t forget to close out your time each week lest you get a scathing email from the powers that be. Second, don’t forget your assistant on their birthday or on administrative professional / staff appreciation day.  Assistants are an invaluable resource and for the first year (maybe even longer) they tend to know more than a first year associate. Small gestures to show your appreciation will go a long way.

To all the administrative assistants and legal staff, thank you for all you do and happy administrative professionals day.

What is a Micro Acquisition?

20150420_Micro Acquisition

Defining Micro Acquisition

Micro acquisition is a term used by Amit Paka, a co-founder at Parable and a contributing writer to Techcrunch, to describe a particular type of acquisition of a small startup, which has the following characteristics:

Acquiree has a small number of specialized employees

In a micro acquisition, the acquiree only has a handful of team members. More often than not, the team is comprised of just the founders. Although the number of people in the company is small, the expertise is great. These individuals are experts in their particular field. A micro acquisition has at its core an acquihire objective (See: What is an Acquihire?) where the acquiror seeks to benefit from the people more so than the product or service of the acquiree. For the acquiror, a micro acquisition is an opportunity to bring great talent in house without the complications that can arise in a larger acquisition involving a greater number of people, such as issues of culture fit, individually negotiated offers and compensation packages.

Acquiree is early stage with few investors

Not only is the team small, but the investor base is few in number for an acquiree in a micro acquisition. The acquiree is usually an early stage startup, with a relatively low valuation compared. This may make negotiations on acquisition consideration easier since there are fewer parties to consider in the liquidation analysis, and the bulk of the consideration can go to retention packages of the employees.

Acquiree’s product or service is rarely stand alone

In a micro acquisition, the product or service of the acquiree is rarely something that can generate high revenue without being integrated into a larger well known product or service. Such product or service is a refinement or a potential solution to a particular issue. This is attractive to acquirors who can save money by simply buying an existing solution rather than trying to develop it in house.

Implications of Micro Acquisitions for Lawyers Representing Startups

The potential rise of micro acquisitions means that lawyers need to be ready to represent their startup clients in an M&A deal sooner rather than later. Traditionally, the path for our clients was incorporation, a few rounds of financing (including a mixture of debt and equity), and finally for the chosen few, the crossroads of M&A or IPO. This process could take several years. If micro acquisitions become more prevalent, it is possible that more startup companies could be acquired within just a few years of their formation. Lawyers should start thinking earlier rather than later about M&A issues, including consent requirements, vesting schedules, and acceleration provisions.