Avoiding Common Pitfalls in Financing Transactions

Presenter:

Benjamin T.R. Fox, Partner, Morrison Foerster

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June 3, 2026

Disclaimer

This presentation is educational in nature, and not legal advice.

The material in this presentation does not address all of the legal issues relevant to the subject matter.

The application of this material to any particular facts or circumstances requires consultation with an attorney.

Although we hope that you find this presentation helpful, it does not constitute legal advice or form an attorney‐client relationship.

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MoFo Presenter

Benjamin T.R. Fox

Partner, Sustainability + Corporate Responsibility and Social Enterprise + Impact Investing practices, Morrison Foerster

San Francisco

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benjaminfox@mofo.com | (415) 268-6275

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Benjamin Fox co-chairs the Social Enterprise + Impact Investing practice and is a partner in the firm’s Transaction Department based in San Francisco. Benjamin’s practice focuses on the representation of clients in broad array of corporate and transactional matters, including early-stage and late-stage financings, secondary transactions, mergers, acquisitions, asset purchases and sales, joint ventures and corporate structuring and governance.

For over a decade, Benjamin has advised leading private equity and venture capital funds, family offices and venture-backed companies focused on solving some of society’s most pressing challenges. His practice spans the energy transition and decarbonization, scientific R&D, natural capital and conservation investments, food innovation and security and breakthrough technologies in life sciences, space and AI. As the co-lead of the firm’s Social Enterprise and Impact Investing Group, Benjamin regularly advises clients on creative legal structures with respect to aggregating and deploying capital to maximize impact and returns, including hybrid or “tandem” structuring arrangements between nonprofit and for-profit entities.

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Agenda

This presentation is going to cover –

• Common issues when founding and building a company
• Common issues when seeking to raise capital
• How to balance complexity and bespoke considerations with “what is market”

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Categories of Common Formation Mistakes

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Common Formation Mistakes – Organizational

• Jeopardizes limited liability of corporate form (i.e., exposes shareholders to personal liability for corporate obligations)
• creditors can “pierce the corporate veil” and assert claims against shareholders if corporation lacks substance and acts as mere alter ego of shareholders
• observe corporate formalities (make organizational resolutions, adopt bylaws, hold annual meetings, elect directors and officers, observe titles, and segregate personal and corporate assets)
• Uncertainty of equity ownership
• disputes arising from (i) oral agreements and offers of stock and options (most acute in the case of a fractured founder group) or (ii) promises of a percentage of ownership rather than a specified number of shares
• compliance with corporate and securities statutes (type of consideration, authorized capital, and investor representations)
• rights among shareholders (voting agreements, buy-sell agreements, pre-emptive rights, drag-along rights)
• Undermines investor confidence in due diligence

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Failing to properly maintain corporate records

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Common Formation Mistakes – Stock Issuances

1. Failure to Properly Address Restricted Stock Taxation (83(b) Elections)

• Restricted stock awards (i.e., stock subject to risk of forfeiture that lapses)
• Tax imposed on spread between FMV and purchase price at time of lapse
• 83(b) election to be taxed on spread (i.e., zero) at time of grant
• Election must be filed within 30 days of issuance of stock subject to vesting – no exceptions

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2. Issuing Equity Without Adequate Valuation Support

• Delaying incorporation until day before seed financing
• difficult to argue that the founder stock was only worth $0.001 per share one day before investors pay higher price for their stock
• convertible note seed financing avoids valuation issue
• Discounted stock issuances
• options or restricted stock granted at below-market prices are taxable (409A excise tax)
• avoid backdating option grants (see backdating scandal circa 2006)
• Carefully assess value of stock at time of issuance
• business developments (e.g., achievement of milestones)
• consider contemporaneous sales to third parties and secondary transfers among shareholders
• don’t overestimate discount of common stock from preferred stock (it is NOT 10:1)
• third-party valuations at time of the grant (e.g., independent appraisals under 409A)

Improper stock issuances

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Common Formation Mistakes – Employment

• Inevitable in Silicon Valley’s environment of workforce mobility
• Claim is usually misappropriation of trade secrets via doctrine of inevitable disclosure; relief is injunction against hiring
• Beware of restrictive covenants on new hires
• non-compete agreements generally unenforceable in California (but enforceable if in connection with acquisition of former employer)
• Generally, have become disfavored in a number of other jurisdictions
• FTC ban on non-competes is of questionable validity
• non-disclosure agreements generally enforceable
• Institute employment policies that require written acknowledgment at time of hire
• DO NOT ASK FOR NOR ACCEPT MATERIALS FROM PRIOR EMPLOYER!

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Incautiously hiring former employees of a competitor

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Categories of Common Fundraising Mistakes

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Common Fundraising Mistakes – Approach

• Poorly articulated or no business plan
• absent mitigating circumstances (a serial entrepreneur with a golden track record, a cure for cancer, etc.), ideas alone rarely get funded
• full-blown, formally documented business plans rarely get read
• executive summary or 3 – 5 slides must convey subject matter of opportunity, or else nothing else gets read
• sophisticated investors will HELP develop the plan as the business evolves
• all investors are different, but most consider (1) size of addressable market, (2) proprietary or competitive advantage, and (3) team as fundamental
• Finding an investor is like finding a date
• perform research, identify potential investors, find a mutual contact
• scattershot approach reflects no preparation, no attractiveness, and no respect
• investment terms must be analyzed as a package; valuation is not necessarily outcome determinative

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Following an undisciplined fundraising approach

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Common Fundraising Mistakes – Due Diligence

• You should expect to compile key documents and put them in a “virtual data room” for review by investors and their advisors.
• Don’t get a second chance to make a first impressions. Be ready!
• Early-stage emphasis is on business and founder diligence
• intellectual property surveys and reviews
• background checks and reference checks

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Due diligence is the exercise investors undertake to understand your business and its associated risks.

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Common Fundraising Mistakes – Investment Structure

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Is that “market”?

• Jurisdiction: Delaware vs. other?
• Corporate Form: Delaware C Corps vs. other?
• NVCA forms
• Founder governance vs. “good” governance
• How to embed mission:
• New corporate forms (PBC, PPTs, hybrids)
• Golden Shares
• IP licensing

Market practice with respect to VC-backed legal documentation has driven the cost curve down for companies and investors but has also led to homogenized corporate structures that do not fit all entrepreneurs

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Follow-up Questions

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Please reach out with any follow-up questions!��

Benjamin T.R. Fox

Partner, Sustainability + Corporate Responsibility and Social Enterprise + Impact Investing practices, Morrison Foerster

San Francisco

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benjaminfox@mofo.com | (415) 268-6275

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Appendix A – Most Common Formation Mistakes

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Common Formation Mistakes – Stock Issuances

• Issuing equity incentives without board approval
• Stock options, restricted stock purchases, and restricted stock bonuses
• Time-based vesting (e.g., 25% at first anniversary, monthly thereafter) or performance-based vesting
• Tax benefits of incentive stock options (ISOs) defers recognition of gain upon exercise until time of sale
• ISOs must be granted pursuant to qualifying plans:
• in writing
• approved by shareholders within 12 months of adoption
• options must expire within 10 years of the date of grant (5 years for 10% shareholders)
• ISOs granted to employees only, NOT consultants
• ISOs priced at FMV (110% of FMV for 10% shareholders)
• ISOs vest no more than $100,000 worth of stock per year
• Issuing equity incentives to an ineligible recipient

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Failing to adopt an appropriate stock incentive plan

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Common Formation Mistakes – Intellectual Property

• The company (not the people) must own its intellectual property assets
• prevents having the company’s value walk out the door each night
• eliminates opportunistic behavior by inventors
• Founders’ assignment of pre-inception inventions to company
• Assignment of employee inventions conceived on the job
• inducement for employment as consideration
• limitations of California Labor Code 2870
• developed entirely on employee’s own time
• without using employer’s equipment, supplies, facilities, or trade secret information
• does not relate to employer’s business or R&D
• does not result from any work performed by the employee for the employer

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Failing to obtain good title to intellectual property

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Common Formation Mistakes – Intellectual Property

• Must obtain rights to use patented or copyrighted material of others
• rights must cover your intended use of the technology
• Beware of use of open-source components that expose your inventions to public disclosure or public license obligations
• Beware of employees using materials of former employers

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Failing to properly license technology protected by others

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Common Formation Mistakes – Intellectual Property

• Trade secret = confidential business information + limited availability + economic value derived from limited availability + reasonable precautions to maintain secrecy
• employee proprietary information confidentiality agreements
• third-party NDAs (but not sophisticated venture capital investors)
• limit access to need-to-know basis
• beware of leakage from departing employees
• If patentable, trade secret law may protect invention up until publication of patent application
• Must balance desire to maintain secrecy with need to exploit perishable market opportunities (e.g., first to market faces risk of copycats)

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Failing to protect trade secrets

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Common Formation Mistakes – Employment

• Employers must withhold income taxes and pay Social Security, Medicare, and unemployment tax on wages paid to employees (reported on Form W-2)
• Payments to independent contractors (reported on Form 1099-MISC) are generally not subject to withholding
• Complicated, 20-factor test applied to determine true characterization of a service provider
• the stronger the evidence of the degree of employer’s control over the service provider and the weaker the evidence of the service provider’s independence from the employer, the more likely the classification as an employee
• Improper classification may expose corporation to back taxes, penalties, and interest
• Only employees can receive incentive stock options (ISOs)

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Misclassifying employees as independent contractors

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Appendix B – Most Common Fundraising Mistakes

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Common Fundraising Mistakes – Due Diligence

Typical Subject Matters

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Common Fundraising Mistakes – Due Diligence

Typical Subject Matters

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Common Fundraising Mistakes – Due Diligence

Typical Subject Matters

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Common Fundraising Mistakes – Due Diligence

Typical Subject Matters

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Common Fundraising Mistakes – Investor Solicitation

• No dollar limit on size of financing
• No limit on number of investors
• No required disclosures
• Resale limitations (i.e., no resale without registration or an exemption from registration)
• Securities may be sold to accredited investors only
• Company must take reasonable steps to verify accredited investor status (non‐exclusive list of methods includes tax returns, bank statements, credit agency reports, etc.)
• Company may use third-party verification (broker-dealer, investment advisor, attorney, or CPA)
• No “bad actors” at company (including > 20% stockholders), promoters, or investment managers

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General solicitation and general advertising are permitted for offerings under Rule 506(c) of Regulation D:

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Common Fundraising Mistakes – Investor Solicitation

• Finding investors can be hard – many will offer to help
• Be wary of unlicensed broker dealers – hallmark is transaction-based compensation
• Recission rights
• Enforcement actions
• Bad Boy
• Limits on who you can contact and how

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Securities rules and regulations

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Common Fundraising Mistakes – Stock Issuances

• Take advantage of the “safe harbor” exemption from registration (Regulation D)
• Stringent conditions and disclosure requirements for sales to unaccredited investors in offerings over $1 million
• “Accredited investor” = director, executive officer, $1 million net worth, or $200K/$300K income alone/with spouse in each of two most recent years with reasonable expectation of same in current year
• Use investor questionnaires
• Blown issuance may result in rescission rights for ALL investors in the transaction (i.e., a “money back” guarantee) or enforcement proceeding
• Venture capital investors won’t want to invest in a startup with rescission liability
• More difficult to acquire startup with unaccredited investors if acquisition proceeds include acquirer stock
• General solicitation permitted under Rule 506(c), but verification and sales to accredited investors only
• “Crowdfunding” rules under JOBS Act became effective May 16, 2016, but substantial limitations on amount and manner of capital raising

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Selling securities to unaccredited investors

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