Venture capital is playing a growing role in the country’s emerging legal cannabis industry. Attorneys Emily J. Yukich and Matthew R. Kittay of Fox Rothschild’s Emerging Companies & Venture Capital Practice will conduct a panel discussion with industry insiders during the American Bar Association Business Law Section’s annual meeting in Chicago.

Cannabis leafThe Angel Venture Capital Subcommittee, which Yukich and Kittay co-chair, will present an in-depth 360-degree examination of venture capital investing in cannabis companies, featuring:

Panelists:

  • Jeremy Unruh, general counsel and director of external communications at PharmaCann, a medical cannabis provider based in Oak Park, Illinois.
  • Charlie Bachtell, founder and CEO of Cresco Labs, LLC, a Chicago-based medical cannabis cultivating and manufacturing company.
  • William Bogot, co-chair of the Cannabis Practice Group at Fox Rothschild LLP.

Date: Thursday, Sept. 14

Time: 10 a.m. to 11 a.m.

Venue: Chicago Ballroom VIII, Ballroom Level, Sheraton Grand, Chicago, Illinois.

Quick quiz:

  • If your startup is seeking investors, will you have more success with private equity or venture capital firms?
  • How about when you’re looking to sell that company?

Businessman giving Vulcan greeting from Star TrekThe answers are (1) venture capital and (2) private equity.  If you weren’t sure, you’re not alone; the terms are often confused or used interchangeably.  However, PE and VC firms generally have very different investment strategies.  Understanding the distinctions may help save time and money and…perhaps…save face (i.e., not everyone will judge you for confusing Star Wars and Star Trek, but others will never forget).

Like most either/or categorizations, the distinctions blur in the middle, making generalization dangerous.  But in basic terms, here is what you need to know to avoid that awkward Han Sulu moment.

Characteristics of a PE investment (or, investing by Vulcan rationality)

PE firms typically invest in existing companies with a quantifiable track record (including proven cash flow), existing products or services, and potential for value creation.  PE investors may also consider businesses that complement their existing constellation of portfolio companies.  Therefore, whether or not PE firms invest in a company is a highly data-driven decision.  PE firms purchase a majority stake (often 100%) in their target investments.  This permits them to take an active role in their portfolio companies and to create value through financial engineering and restructuring.  In broad brush terms, this investment strategy focuses on value.  PE firms purchase underperforming or undervalued companies intending to guide them to optimal performance, increase their value, and sell them for a profit.  In other words, PE firms help existing companies realize their potential and boldly go where they have not gone before.  Because this strategy applies in many circumstances, PE investments are made across a wide set of industries.

Characteristics of a VC investment (or, investing by Dagobah ecosystem)

VC firms typically invest in emerging companies, which may have no or a limited operating history, but potential for light speed growth.  Therefore, whether or not VCs invest in a company is a holistic decision involving analyzing ideas and people (i.e., the business plan and the founders’ and management team’s ability to execute it).  To mitigate risk, VCs diversify their investments by making minority investments across a universe of startups.  Because they purchase smaller stakes, VCs have less control than PE firms over the day-to-day operations of their portfolio companies; however, VC’s often retain veto rights over certain major decisions.  In broad brush terms, this investment strategy focuses on growth.  VC firms invest early in the hopes of sharing in the upside upon exit or IPO.  These criteria keeps many VC investments industry-specific (e.g. technology and life sciences).  Although startups often fail, VCs can earn attractive returns if even one rebellious company blows up and disrupts an existing empire.

Of course, PE and VC investments have similarities, not the least of which is seeking above market returns.  The primary difference is how they arrive there.  From a company’s perspective, VC and PE firms serve distinct purposes and are appropriate at different stages of a company’s life cycle.  Entrepreneurs must understand the differences between VC and PE firms and their investing philosophies to ensure they’re approaching the appropriate investors at the right time.  Of course, there is much more to consider.  This is just a high level overview intended to demonstrate that there is a difference.  In a critical moment, remembering that PE firms invest like Vulcans and VCs invest like Jedis might remind you of the key distinctions.

An abbreviated version of this article will appear in the American Bar Association’s Business Law Today, Fall 2017 Edition.

Is your startup brand so strong that consumers tattoo the logo on their arm? Or so hard to pronounce that investors, vendors and customers are disinclined to do business with you?

"Hello, my name is..." nametagAccording to a study published in the peer-reviewed academic journal Venture Capital, your company name matters even more than you think.  The study, entitled “The Effect of Company Name Fluency on Venture Investment Decisions and IPO Underpricing,” found that a startup’s name can seriously affect how a company is perceived by investors and customers alike.

Names that are easily pronounced, such as Uber and Lyft, are preferred by both early and late-stage investors. They tend to be offered more money, whether its through crowd funders, angel investors, VCs or IPO investors.  The study also found that “uniqueness” is virtue, but only with early-stage investors.  According to the study, since very little is known about a company in the early stages, unique names give the impression there is something special about the company.

On the other hand, difficult names “evoke cues of unfamiliarity and create a perception of high novelty, which is valued by these pre-venture stage investors,” according to the study. The study cautions, however, that novelty wears off by later stages, when unique names can make more risk-adverse investors feel uncomfortable.

This study adds to the list of impacts that name can have on a venture, including:

  • An easy to pronounce and remember company name could get you more funding and customers as you grow
  • Company names and logos which are “unique”, “unobvious” and/or “novel” when associated with your services get stronger trademark protections faster with the USPTO
  • Securing 360-branding including a web domain, Instagram and Twitter handle, and an issued trademark on the name and logo early in the process with the help of an IP attorney saves cost and time as you roll out your product

Often founders launch or pivot on a name only to realize the Instagram account or web domain is taken, causing confusion in the market and requiring expensive litigation or licensing deals to consolidate your brand.  A strategic approach to choosing your company name ensures a consistent and easy brand association across digital and print media as well as adding to your successes with investors and customers, saving you time and money as you go to market.

In an Alert published on Thursday, Andrea Ravich provides an update on changes to Minnesota corporate law regarding limited liability companies (LLCs) that will take effect in January 2018, and notes action items for companies to ensure compliance.

Copyright: tashatuvango / 123RF Stock Photo

An overhaul of Minnesota corporate law on limited liability companies, or LLCs, that was phased in over three years will take full effect in January 2018. The new act differs significantly from the old act, but is modeled after the Revised Uniform Limited Liability Company Act and is similar in many ways to LLC laws in Delaware and other states.

Action Items Prior to January 1, 2018

Now is the time for Minnesota companies to ensure compliance. Within the next 120 days, LLCs should:

— Confirm that your LLC is registered and in good standing with Minnesota Secretary of State (file annual reports and/or renewal, as applicable).
— Review your LLC’s existing governing documents (i.e., any agreements between the members). Unless your LLC adopts a new operating agreement in writing, its current governing documents will continue in effect under the new act.
— With guidance of legal and tax counsel, consider whether there may be any opportunities to update, clarify and/or amend your LLC’s existing membership agreement.

To read Andrea’s full discussion of the impending changes, please visit the Fox Rothschild website.


Andrea L. Ravich is an associate in the firm’s Corporate Department, resident in its Minneapolis office.

Debra L. Gruenstein writes:

Private equity firms have recently been deploying capital to purchase medical and dental practices.

Caduceus casting a dollar sign shadowThe typical transaction would involve the purchase of multiple practices and the establishment of a management company. The physicians would be paid a multiple of earnings and receive some rollover equity in the management company. Although many states have had a prohibition on the corporate practice of medicine for years, recent cases in multiple jurisdictions have made the structuring of these transactions more complex and subject to challenge.

In the recent case of Allstate Insurance Company vs. Northfield Medical Center, P.C., the New Jersey Supreme Court found that the control over the medical practice owned by a chiropractor violated the corporate practice of medicine doctrine, resulting in a verdict in favor of Allstate of almost $4 million. Previously, the District Court for the Eastern District of Louisiana, interpreting Pennsylvania law, found that the ability of the management company to participate in the profits of a dental practice, was akin to a partnership interest, one that would be precluded by the Pennsylvania corporate practice of medicine doctrine. Warren J. Appallon, D.M.D., P.C. vs. OCA, Inc., 592 F. Supp. 2d 906, and the similar case, OCA, Inc. v. Kellyn W. Hodges, D.M.D., M.S., 615 F. Supp. 2d 477.


Debra L. Gruenstein is a partner in the firm’s Health Law and Corporate departments, practicing in the Philadelphia and Denver offices.  This piece is slated to appear in an upcoming edition of the American Bar Association’s Business Law Today.

Barbara P. Alonso writes:

The Committee on Foreign Investment in the United States (CFIUS), an inter-agency committee led by the U.S. Treasury Department that reviews foreign direct investment transactions, is likely to be applied in a more stringent manner by the Trump Administration. Members of Congress and of the Trump administration have advocated for enhanced CFIUS reviews of transactions that involve the change of control of U.S. companies (or foreign companies with U.S. assets) to foreign interests.

Globe on financial reportsSince its creation in 1988, CFIUS reviews have remained voluntary in nature. Parties to M&A/private equity cross-border transactions, however, go through the time and expense of seeking CFIUS review because a transaction that is not reviewed may be subject to divestment or similar actions. In most cases, parties receive a “no action” determination within 30 days of filing, and in some cases, the Committee undertakes an additional 45-day review which sometimes results in the Committee proposing additional deal terms to address concerns raised during the review process.

Recently, however, CFIUS has blocked several deals. For example, in December 2016, the Obama administration blocked the purchase by a Chinese investment fund of a German semiconductor supplier which had U.S. assets.

Current options under consideration for expanding CFIUS review include enlarging the “scope” of CFIUS to include an economic test; expanding the definition of what constitutes a “national security” issue by adding such critical infrastructure assets such as telecommunication, water and energy assets; and adding a retroactivity element to potentially unwind previous “no action” positions.

In the current environment, transactions that involve the transfer of ownership to a foreign party, even when a foreign company is selling U.S. assets to another foreign company, should be weighing carefully whether a voluntary CFIUS filing would be prudent.


Barbara P. Alonso is a partner in the firm’s Corporate Department, resident in its Miami office. This piece is slated to appear in an upcoming edition of the American Bar Association’s Business Law Today.

The Problem

As every founder knows, starting and scaling a company is an extremely difficult and multi-faceted undertaking. In addition to the primary goals of developing a viable product, finding (and in some cases building from scratch) a robust market, and raising the capital necessary to sustain their business and operations, founders and their core teams also grapple with the day-to-day management and operations of a growing enterprise, whether that be personnel issues, forecasting cash needs and burn rates or tackling the legal and regulatory hurdles that often go hand-in-hand with the creation of disruptive technologies. Unfortunately, given the size and complexity of the average founder’s workload, it is no surprise that emerging companies of all sizes occasionally neglect to heed the advice of their attorneys and ensure that any and all corporate actions taken by the company and its officers are properly authorized and, if necessary, approved by the company’s Board and stockholders.

The Exposure

Copyright: tang90246 / 123RF Stock Photo

Under the Delaware General Corporation Law (the “DGCL”) otherwise permissible corporate acts that do not satisfy the consent and other procedural requirements of the DGCL, the corporation’s organizational documents or any other agreement to which the corporation is a party, are deemed to be “defective corporate acts” and are generally held to be void and of no legal force and effect.[i] The pre-2014 historical body of Delaware case law held such corporate acts, taken without “scrupulous adherence to the statutory formalities” of the DGCL, to be acts undertaken “without the authority of law” and therefore necessarily void.[ii] Prior to the enactment of Sections 204 and 205 of the DGCL, the relevant line of Delaware case law held that corporate acts, transactions and equity issuances that were void or voidable as a result of the corporation’s failure to comply with the procedural requirements of the DGCL and the corporation’s governing documents could not be retroactively ratified or validated by either (i) unilateral acts of the Corporation intended to cure the procedural misstep or (ii) on equitable grounds in the context of litigation or a formal petition for relief to the Court of Chancery.[iii] In short, there was no legally recognized cure for such defective actions and the company was left forever exposed to future claims by disgruntled shareholders, which could ultimately jeopardize future financings, exits and ultimately the very existence of the company.

The Statutory Cure

Luckily, for those founders who make the potentially serious misstep of failing to obtain the required consents and approvals before taking a particular action (e.g. issuing options to employees or executing a convertible note or SAFE without the prior consent of the Board), in 2014 Delaware enacted Sections 204 and 205 of the DGCL, which served to clarify the state of the law in Delaware and fill a perceived gap in the DGCL by providing new mechanisms for a corporation to unilaterally ratify defective corporate acts or otherwise seek relief from the Court of Chancery.[iv]

While both Sections 204 and 205 were intended to remedy the same underlying issue and provide a clear process for ratifying or validating a defective corporate act, the mechanics set forth in the respective sections take disparate routes to arrive at the intended result:

  • Section 205 provides a pathway for ratification that runs through the courts, allowing a corporation, on an ex parte basis, to request that the court determine the validity of any corporate act.
  • Section 204, on the other hand, is considered a “self-help statute” in the sense that the procedural mechanic provided for in the statute allows a company to ratify the previously defective act unilaterally, without the time and expense involved with petitioning the court for validation of the corporate act in question.

In the case of early stage companies, the expenditure of the heavy costs and valuable time associated with seeking validation in the Court of Chancery render Section 205 a less than ideal tool for curing defective acts. This post therefore focuses on Section 204, which provides a far less onerous mechanic for ratifying defective corporate acts, allowing a corporation to cure past errors “without disproportionately disruptive consequences.”[v]

Section 204 in Practice

Section 204 provides Delaware corporations with a procedure to remedy otherwise void or voidable corporate acts, providing that “no defective corporate act or putative stock shall be void or voidable solely as a result of a failure of authorization if ratified as provided in [Section 204].”[vi] Pursuant to Section 204, a corporation’s Board may retroactively ratify defective corporate acts by adopting written resolutions setting forth:

  • the specific defective corporate act(s) to be ratified;
  • the date on which such act(s) occurred;
  • the underlying facts that render the act(s) in question defective (e.g., failure to obtain the authorization of the Board or inadequate number of authorized shares); and
  • that the Board has approved the ratification of the defective corporate act(s).

Additionally, if a vote of one or more classes of stockholders was initially required to authorize the defective act at the time such act was taken (e.g., the approval of a majority of the Series A preferred stockholders in the case of an act that falls within the purview of the Series A protective provisions), then ratifying resolutions of the relevant class of stockholders are also required in order to cure the prior defect in the corporate act.

In sum, founders and their Boards should, at minimum, undertake the below listed procedural steps* in order to ensure that otherwise defective corporate acts are cured and ratified in the manner prescribed by the DGCL.

  • A resolution by the Board setting forth (i) the defective corporate act to be ratified, (ii) the date of the defective act, (iii) if shares or other equity is involved, the number, class and date of the equity issuance, (iv) the reason for the defect, and (v) the approval and ratification by the Board of the defective corporate act.
  • Approval of the stockholders or a particular class of stockholders (in the form of a written consent) if such an approval was required at the time of the defective corporate act.
  • Proper notice of the ratification sent to all stockholders (including stock that may have been invalidly issued). The notice must include a copy of the ratifying resolution/consent and an explanation that any claim that the ratification in question is not effective must be brought before the Court of Chancery no later than 120 days from the effective date of the ratification.
  • In certain circumstances, the filing of a “Certificate of Validation” with the Delaware Department of State to cure the defective corporate act being ratified (e.g., if shares were issued without filing the necessary Certificate of Amendment to increase the authorized shares of a corporation).

*This list should not be considered all-inclusive. Each situation is unique and further actions may be required depending on the underlying facts and the cause of the defect in question.

Startups represented by seedling growthTakeaways

The potential adverse impact of an uncured defective corporate act cannot be understated. For an early stage company seeking to raise capital from venture investors or other outside parties (or eventually exit through an acquisition), the risks associated with such defective acts are particularly acute. As a practical example, a corporation’s failure to observe the proper procedures in the election of a director can result in the invalidation of such election. In the event of such a defective election, actions taken by, or with the approval of, the improperly elected Board may be void or voidable. This or other defective corporate acts may result in the corporation being in breach of representations and warranties in any number of contracts, including stock purchase agreements executed as part of a financing round or M&A transaction.

Generally speaking, relatively extensive due diligence is typically the first step in all venture financings and other major corporate transactions. As part of this process, counsel for the investor or acquiror will undoubtedly review all material actions of the company along with the corresponding Board and stockholder consents as a means of “tying out” the company’s cap table. Any defective corporate act that was not later ratified by the company in accordance with Section 204 or 205 will at best need to be ratified or validated in advance of the closing of the transaction, and at worst may result in either (i) a reduction in the company’s valuation due to the perceived risk that past actions are ultimately void or unenforceable, or (ii) in extreme situations, the abandonment or termination of the transaction.

In an ideal world, companies of all sizes would always observe the proper procedures in authorizing corporate acts and ensuring that all other necessary steps are taken to ensure the validity of such actions. Unfortunately, in the fast-paced and often frenzied world of a startup, certain “housekeeping” items occasionally fall by the wayside. Upon the discovery of a defective corporate act by a company or its counsel, it is vital that the proper ratification procedures be undertaken in order to ensure that any and all past actions that could potentially be rendered defective are rectified and ratified in accordance with Section 204 (or in some cases Section 205) of the DGCL.


[i] A “defective corporate act” includes any corporate act or transaction that was within the power granted to a corporation by the DGCL but was thereafter determined to have been void or voidable for failure to comply with the applicable provisions of the DGCL, the corporation’s governing documents, or any plan or agreement to which the corporation is a party. See 8 Del. C. § 204(h)(1); See also, e.g., Blades v. Wisehart, C.A. No. 5317-VCS, at 8 (Del. Ch. Nov. 17, 2010) (requiring “scrupulous adherence to statutory formalities when a board takes actions changing a corporation’s capital structure”); STAAR Surgical Co. v. Waggoner, 588 A.2d 1130, 1136 (Del. 1991) (“stock issued without authority of law is void and a nullity”).

[ii] See, e.g., Blades v. Wisehart, C.A. No. 5317-VCS, at 8 (Del. Ch. Nov. 17, 2010) (requiring “scrupulous adherence to statutory formalities when a board takes actions changing a corporation’s capital structure”); STAAR Surgical Co. v. Waggoner, 588 A.2d 1130, 1136 (Del. 1991) (“stock issued without authority of law is void and a nullity”).

[iii] Id.

[iv] See H.B. 127, 147th Gen. Assemb., Reg. Sess. (Del. 2013): “Section 204 is intended to overturn the holdings in case law . . . that corporate acts or transactions and stock found to be “void” due to a failure to comply with the applicable provisions of the General Corporation Law or the corporation’s organizational documents may not be ratified or otherwise validated on equitable grounds.”

[v] In re Numoda Corp. S’holders Litig., Consol. C.A. No. 9163-VCN, 2015 WL 402265, at 8 (Del. Ch. Jan. 30, 2015).

[vi] 8 Del. C. § 204(a).

Ethan Zook and Jacob Oksman write:

Attracting and retaining high-performing employees is critical to the success of any emerging company. A key ingredient to securing the right talent base is an attractive and aligned remuneration plan. Most emerging companies will structure their remuneration plan leveraging three key elements: a competitive base salary, a short-term bonus plan, and a long-term incentive plan (LTI) that typically comes in the form of a stock option plan. The base salary and bonus plan are typically structured to align the individual and the company against critical objectives, and normally present in the form of cash compensation. The LTI plan, on the other hand, is structured with a longer-term horizon in mind, and is intended to align the company, employees, and shareholders for long-term value creation.

Business Taxation
Copyright: yupiramos / 123RF Stock Photo

While an integral way for emerging companies to attract top talent, employees need to understand the type of LTI vehicle used, and tax implications from a vesting, exercising and selling perspective.

In general, there are two basic kinds of stock options: statutory stock options and nonstatutory stock options (NSOs). Both generally allow the recipient to buy stock at a fixed price for a defined number of years into the future. By doing so, the option holder takes part in the overall value creation of the company. The award will typically vest over a pre-determined period of time, or upon certain milestone achievements. Once shares are vested, the holder has the option of selling the earned shares. There are, however, significant differences between the two types of awards from a tax perspective.

Statutory stock options include incentive stock options (ISOs) and options granted under employee stock purchase plans. Upon grant and exercise of ISOs, there are generally no tax consequences to the employee. However, the employee may be subject to alternative minimum tax in the year of exercise. Upon sale of the stock received by exercising the ISOs, the employee will generally have capital gain or loss if the stock acquired on exercise is held for at least two years from the date of grant and one year after the ISOs were exercised.

NSOs are not taxed to the employee receiving them when granted unless the options have a readily ascertainable fair market value at that time (this generally includes marketable securities). If the options do not have a readily ascertainable fair market value when granted, the employee is taxed on the gain from the options at the time of exercise or transfer (even if the fair market value becomes readily ascertainable before the exercise or transfer). Unlike statutory stock options, upon exercise of NSOs, an employee will have compensation income (taxed as ordinary income) equal to the difference between the fair market value of the stock at the time of exercise and the price paid for the stock (if any). If the options are sold, then the employee will have compensation income equal to the gain on disposition. The sale of the stock received by exercising NSOs will generally result in capital gain or loss (and are not subject to the special holding period requirement discussed above for ISOs).

ISOs are generally considered more tax friendly than NSOs, but both employees and employers need to be aware of the tax scheme.

Navigating the tax treatment of options can get complex quickly; it would be wise to reach out to a tax professional before making the ultimate decision of receiving or exercising equity compensation.


Ethan Zook is an associate in the firm’s Corporate Department, resident in its Exton, PA office.

Jacob M. Oksman is an associate in the firm’s Taxation & Wealth Planning Department, resident in its New York office.

The Trump administration recently announced it is delaying – and likely rescinding – the Obama-era International Entrepreneur Rule (the “Rule”). The Rule was slated to go into effect on July 17, 2017. It would have made it easier for foreign entrepreneurs to establish startup companies in the U.S. We blogged in detail on the final Rule when it was published in early 2017.

The White House, Washington, D.C.Now the Rule’s effective date has been delayed until March 14, 2018; however, implementation seems highly unlikely: the delay is to allow the Department of Homeland Security (DHS) an opportunity to obtain public comment on a proposal to rescind the Rule.

The Rule establishes criteria for granting “parole” (temporary permission to be in the U.S.) to certain foreign entrepreneurs to permit them to oversee and grow their stateside startups. To obtain parole, entrepreneurs would need to show that their startups have potential to grow rapidly, create jobs and provide a significant public benefit to the United States. Startups would be judged by, among other things, how much venture, angel or accelerator capital and/or government grants they’d received.

DHS decided to delay the Rule after President Trump signed an executive order on January 25, 2017 relating to border security and improving immigration enforcement. The order required DHS to ensure that parole is only granted on a case-by-case basis involving urgent humanitarian reasons or a significant public benefit. DHS is seeking public comment on the delay until August 10, 2017.

The move has drawn criticism from notable investors, business leaders and other stakeholders, including the National Venture Capital Association, a trade association for startup investors. Critics note the substantial contributions made by immigrants to the U.S. entrepreneurial ecosystem, especially in the tech sector. For example, 60% percent of the top 25 tech companies and 42% of Fortune 500 companies were founded by first- or second-generation Americans according to a 2013 report published by the venture-capital firm Kleiner Perkins Caufield and Byers. The Rule is not dead yet, but the prognosis is grim. The uncertainty alone seems likely to make the U.S. less competitive in the global market for ambitious and innovative minds.

A study of interest for those in the Philadelphia region has recently been released.

Philadelphia skyline
Copyright: sepavo / 123RF Stock Photo

Rising two spots from last year, Philadelphia has been ranked fifth on the list of life science clusters in the United States recently published by professional services and research firm JLL.  Following Boston, San Francisco, San Diego and Raleigh-Durham, Philadelphia was cited as the leader in the “Breakout Cluster”, which are regions “making strides in life sciences through new development and a growing scientific community.”  The study weighted various factors such as life science employment concentration, venture capital funding, lab supply, employment growth, establishment concentration, NIH funding, market occupancy rates and average asking rent.

The study states, “The Greater Philadelphia region is home to many elite academic and research institutions, as well as numerous hospitals and a strong pharmaceutical industry. Nearly 400,000 students attend one of the region’s 90 plus colleges or universities. The region is a top winner in federal research funding, attracting $900 million in NIH awards in 2016. As of 2015, 567,000 people in the Philadelphia metropolitan area worked in the “eds and meds” sectors. Eds and meds institutions are proactive partners in the life sciences economy.”

From The Navy Yard, a hub of life science activity, and the expansions at Drexel University in the city proper to activity throughout the suburbs, including the planned expansion of the Pennsylvania Biotechnology Center in nearby Bucks County, the region’s boasts a growing life sciences sector. The study cites as a priority for the future the growth of access to regional venture capital.

Congratulations Philadelphia!