Brad Feld

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Legal Lexicon for an Economic Meltdown

Oct 22, 2008

Today’s special guest post is from Sarah Reed of Lowenstein Sandler PC.  Sarah is a good friend and collaborator with my partner Jason on the NVCA Model Legal Document task force.  She also has a wicked sense of humor.  After sitting through ten days of meetings hearing a variety of VC-lingo tossed around as though it was LA-trendy-speak (seriously dude), I was amused to get the following unsolicited email from Sarah with a guest post attached. 

While Sarah’s post is on the gloomy side of the optimism / pessimism coin, Sarah’s vocabulary builder covers a bunch of words and phrases that are once again becoming trendy.  Ignore them – and their implications – at your own peril.  And don’t forget – make sure you keep your sense of humor and always carry a towel with you wherever you go.

As Brad has noted, the blogosphere is abuzz with lectures from VCs to their portfolio companies – ranging the gamut from scolding to spirit-boosting. Clearly, they are on to this much: we are in the midst of what our children’s elementary school teachers have trained us to recognize as a “teachable moment.” I’m a business lawyer, so I’m all about Brad’s message “let’s get practical.” Here then let me pile on with some vocabulary you should probably learn, if you don’t know it already – and, being a lawyer, I can’t resist the urge to equivocate a bit: while the words themselves are a bit of a buzz-kill, you can hum the lesson – “fun!” (everyone knows the ABC tune).

So come and hum along with me:

A is for “ABC” or Assignment for the Benefit of Creditors: a state law statutory remedy in which a company is liquidated by an appointed independent trustee. It is cheaper and faster than a bankruptcy court proceeding, but affords similar protections in that it insulates officers and directors from creditor claims of unfair treatment.

B is for Bankruptcy Proceedings: both kinds: chapter 7, where the company is liquidating, and chapter 11, where the company “reorganizes” in order to continue as a going concern, or position itself for a sale of the company as a whole by getting out from under burdensome contractual responsibilities.

C is for Cartage Costs: additional payments by VCs to dispose of the corpse of a company, in extreme cases, as when the company has unpaid wages for which the directors may be personally liable.

D is for Down Round: expect this to simply be a synonym for “follow-on financing” for some period of time. Oh, did you miss the metatags in the Sequoia slides? “Reset your expectations, entrepreneurs.”

E is for Escrow (of Shut-Down Costs): wages, accrued PTO, tax liabilities – if you have enough money to cover ‘em, and failure is an option, set the funds aside now. Otherwise, see “Cartage Costs.”

F is for Furlough: send the employees home for an unpaid “break” — see “Quality Time.” Find out what your state law permits

G is for Going Chapter: advice to VC directors – don’t even think about it. The bankruptcy trustee’s job is to look for assets: the company’s best asset may be its D&O policy, and so the trustee may be highly motivated to find a cause of action against the directors and officers.

H is for Hail Mary Pass: the company has 75 days of cash, no suitors, and weary inside investors. But you’ve already hired the banker, and you have not completely exhausted your rolodex of other VCs who might be willing to take a look. Are you at legal risk if you do anything other than just calling it quits now? Probably not – even a small (but legitimate) chance of an outcome that preserves some value in the company is probably worth the try.

I is for Independent Director: oh, now you wish you’d found one earlier. If you are lucky enough to have one or more, let them form an independent committee to vote on the Down Round (see above), so that the transaction, if ever questioned, will not be evaluated under the higher “entire fairness” standard of judicial review.

J is for Jerk: ok, now stop beating up on yourself. You knew when you went into this that not only is failure an option, it is a significant part of the business model of backing start-ups.

K is for Key Engineers: if your exit plan is to sell technology/IP, recognize that it may be worthless without the people who know how to deploy it, and hence you may want to provide them with some type of retention bonus.

L is for The Letter: the one that Ron Conway repurposed from 2000; Ron, let’s just hope none (editors note from Brad: I’d change this to “all” – this will happen again, and again) of us live long enough for you to have to send it a third time.

M is for Management Bonus Plan: it’s what the VCs put in place when the entire management team threatens to mutiny, upon realizing that their current stake in the company is worthless.

N is for No: brace yourself for that response if you are looking for money – from LPs, from VCs, from customers, from venture debt lenders. Start thinking of creative ways of explaining why are different (cloud computing, on-demand services, disciplined deployment of capital, blah blah blah).

O is for Oh Sh** Why Me?: When a Delaware company files for dissolution, it needs to name one director who will continue to serve for a year. Let it not be you.

P is for Peace with Honor: it’s what you get when you sell the company for just enough so that all creditors are paid and the VCs get back some fraction of their money. Declare victory, go home.

Q is for Quality Time: the silver lining in all this! Go mentor those employees you have been too busy to pay attention to these past years, take off at 4 on a weekday to see your kid’s soccer game, stop complaining and go to the gym for god’s sake!

R is for Roll-Up: tuna fish, light mayo – it’s what you will be bringing in your bag lunch for the next twelve months, and it’s what will happen to your company if it has either 1) cash and no product or purpose or 2) a product and a market, but no cash. Put the two together, and, voila, live another day.

S is for Severance: if you were a well-advised VC, you made sure the agreements with your PC CEO’s provided that it was not payable if the CEO’s employment was terminated as the result of the company ceasing to do business. While it is OK to pay (limited – e.g., two weeks) severance to employees, be aware that in a wind-down creditors may question large severance payments (and it makes directors look bad, too).

T is for Terminate: the health, 401K and any other benefit plans; the phones, the bank accounts….. make a checklist so you don’t overlook anything.

U is for Underperformer: time to identify them and ruthlessly cull them.

V is for Voting: when you vote as a stockholder, it’s OK to be selfish and mean-spirited; when you vote as a director, remember those pesky fiduciary duties. See “Down Round.”

W is for WARN Act: does the company have 100 or more employees (or, in CA, 75 or more employees at any time within the preceding 12 months)? If yes, be for
eWARNED: this Federal law will subject you to non-trivial advance notice (aka disguised severance) obligations in the case of a shut-down or large lay-off.

X is for X-it Strategy: If you never had one in the first place, it’s too late now – see “Underperformer.”

Y is for Yes: you should get off of the Board when it’s pretty clear it is no longer a good use of your time – unless you fear that the other Board members will try to pin bad stuff on you, in which case you’d better stick around to review the minutes.

Z is for Zone of Insolvency: it’s like pornography – undefinable, but you’re supposed to recognize it when it’s in your face. The case law out there on this is sufficiently complex and confusing that all I can say on this one is that, if you are really in a sweat about it, time to consult a lawyer. My direct line is 617-399-5999 and now that I’m done writing this I’m turning to updating my web bio to show my workout experience.