Closing Time: Sealing the Deal

I’m quite surprised that I can’t find a decent blog post or article explaining the closing process in a typical Angel/VC financing transaction. Given that a lot of the entrepreneurs that we work with have never done this dance before, I’m often asked to walk them through it.  This process is what you’ll usually see in a VC deal, or an Angel deal in which equity is issued.  Signature mechanics would be virtually the same in a convertible debt round, although stock certificates would obviously not be issued.

Outline:

  • Finalize docs
  • Create signature packets
  • Obtain requisite signatures
  • File documents with Secretary of State (DE, TX, etc.)
  • Release signatures
  • Close the deal, and show me the money
Vocab:
Signing: When the main parties to the transaction authorize the “release” of their signatures, often days after they actually signed the docs.  This creates a binding contract.
Closing: When money is transferred and shares are officially issued, though certificates typically won’t be printed until later.  Closing is usually simultaneous with Signing in a typical Angel/VC deal, but not always.

1. Finalize the Docs

Before anything gets done, lawyers and clients have to agree on the docs.  Hopefully this doesn’t take too long, but it depends on the attorneys involved and the nature of the deal.  Choose your attorneys wisely, and don’t let the tail wag the dog.

2. Create Signature Packets

First-timers are often fascinated with the concept of “counterpart” signatures.  While your whole deal may involve hundreds of pages of documents, an experienced firm will usually create a PDF “signature packet” containing only the pages that you need to sign, which they’ll send along with the full documents.  Each party signs his or her own counterparts contained in the appropriate signature packet, scans and e-mails them back to the attorneys, and when “Signing” time comes, everything is compiled together, dated, and deemed to be fully executed.  Much better than flipping through hundreds of pages to figure out where to sign.

Some firms (including yours truly) will go a step further.  They’ll run your signature packets through Docusign, or a similar electronic signature process, which will allow you to electronically execute the documents without having to print or scan a single thing.  Makes things easier for everyone.

3. Obtain Requisite Signatures

At the most basic level, a transaction will usually require approval from both the Board of Directors and the Stockholders of the Company before it can move forward.  The state of incorporation of the Company will usually have default thresholds that need to be met for those two groups, or the Company’s governing documents may have designated thresholds.  If any agreements, such as a Stockholders Agreement or Voting Agreement, are being amended in the deal, those documents will have their own thresholds that need to be met as well.  Usually a junior associate will be tracking the signatures received so that everyone can know when to pull the trigger.

When the main parties send their signatures to each other by e-mail, they’ll typically include language like “hold these in escrow until their authorized release.”  This is basically saying that they’re handing the signatures over to prepare for closing, but that the docs aren’t to be treated as executed until they give the signal.  You’ll also notice that signature pages (other than Board/Stockholder consents) usually don’t have date lines on them, or that you may be instructed to leave the dates blank. That’s because the documents won’t be dated until “Signing” occurs, which can be days after the docs are physically signed.

4. File documents with the Secretary of State (DE, TX, etc.)

Once the requisite signatures have been received, attorneys will work on compiling them together to have nice and neat documents with signatures and all.  In a typical financing, an amended Certificate of Incorporation (Delaware) or Certificate of Formation (Texas) will need to be filed, authorizing the new class of stock, along with certain rights associated with that class.

Delaware typically takes a day or two to confirm the filing of the new Certificate, unless you’re willing to pay a few extra hundred dollars for faster service.  Nothing happens until a file-stamped copy of the Certificate is returned.

5. Release Signatures

With the appropriate signature thresholds met and filed Certificate in hand, attorneys will typically send e-mails to each other authorizing the “release” of their clients’ signatures.  This release means that the deal is considered executed, and the documents will be dated on whichever day this release occurs.

6. “Close” the deal and show me the money

In a smooth, traditional Angel/VC financing, Signing and Closing will occur simultaneously.  Once signatures are released, the funding parties will execute wire transfers, and the Company will confirm receipt of those transfers.  Then the deal is “Closed.”

Sometimes special Closing Conditions will be listed in the Purchase Agreement that have to be met in-between Signing and Closing.  Once all parties are in agreement that those conditions are met, Closing will occur and wire transfers will be initiated.  It’s not uncommon for a financing to have an Initial Closing and multiple Subsequent Closings, each involving their own transfer of funds and issuance of shares for those funds.

7. Wrapping it up

Everything else is details.  Usually a paralegal of the Company’s firm prints physical certificates, has the Company sign them, and then they’re mailed to the investors.  A Form D (SEC filing for private issuances) is filed, and over the next few weeks someone orders bound books of the deal docs so that attorneys can put them on their shelves to show off the deal they worked on.  I prefer a well-bookmarked, searchable PDF and save my shelves for family photos, but I don’t judge.

The rise of the LLC

In startup land, the C-Corp has reigned supreme for a number of reasons, but largely because venture capitalists usually won’t invest in anything but a C-corp.

Background: For a general overview of the benefits/costs of LLCs v. Corps, I usually forward this article to clients What Type of Entity Should I Form? And if you want a simple argument in favor of C-Corps, try Top Reasons to Choose a C-Corp.

All of the above articles provide very good analyses on the legal and tax nuances of the two entity types, but at the end of the day, the real push for someone to use the LLC form is very simple: a single layer of tax without the handcuffs that S-Corp status places on your equity structure. Corporations have two layers. And the real pull away from it is just as simple: VCs only invest in Corps.

In our practice group, we’ve definitely noticed an uptick in the number of entrepreneurs choosing to start as LLCs from the get-go, notwithstanding the fact that our standard start-up fixed-fee package (quite popular) doesn’t apply to LLCs.   This would suggest that something related to the push/pull factors has changed.

The logical explanation for this trend would be unsurprising to anyone who follows the funding environment in the startup ecosystem :

  • Starting & running a startup keeps getting cheaper
  • Bootstrapping is therefore possible for much longer
  • Angel investing has become hip, so more early-stage non-VC capital
  • Strategic investment in startups from established companies is also on the rise

In a nutshell, these trends allow startups to last for longer periods of time without having to raise money from venture capitalists.  Angels and strategic investors are generally not LLC-averse.

If you plan on raising VC money in 6 months after formation, then the tax benefits of an LLC are pretty much null, especially when you factor in the cost of conversion at funding.  But for a number of companies who can now expect to operate for years, generate revenue, and even turn a profit well before raising a traditional Series A (if ever), the cost-benefit analysis of LLC v. Corp has changed.

C-Corp is still king, as it still should be for most tech startups, but the LLC is increasingly gaining credibility as well.  In the legal field, repetition is the mother of efficiency.  As more LLCs are formed, standardized docs will emerge, and the gap in legal costs between forming an LLC v. a C-Corp will continue to shrink.

Here we go.

Let’s see if I can get a real post out before someone in my firm makes me clear this through “the committee.”