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© Orrick, Herrington & Sutcliffe LLP 2004

Welcome to the first quarterly newsletter from the Corporate Department of Orrick’s Silicon Valley office. We’ve created this newsletter for our clients and business associates to share information about recent legal developments and their implications for emerging companies and venture capital firms, as well as news from our office, upcoming events, and thoughts and opinions. We hope you find this publication interesting and informative. We welcome your comments and suggestions to help us improve future editions.

Sarbanes-Oxley Issues for Private Companies to Consider

The Sarbanes-Oxley Act of 2002 (the “Act”) generally applies to public companies. Some of its provisions, however, have important indirect consequences for private companies, and a few of its provisions are directly applicable to private companies. Here are certain key provisions that directly apply to private companies:

·     Penalties for retaliation against whistleblowers.

·     Penalties for destroying or tampering with documents.

·     Extension of the statute of limitations for securities fraud.

·     Bankruptcy does not discharge debts arising from securities law violations.

·     Increased criminal penalties for mail and wire fraud.

·     Individuals may be barred from serving as directors or officers of public companies due to serious securities law violations.

Indirect CONSEQUENCES

Sarbanes-Oxley and related rules also may have the following indirect consequences for private companies:

·     Loans to Insiders. The Act prohibits public companies from making loans to insiders. Private companies which anticipate an initial public offering or a sale to a public company, should consider the impact of this rule when deciding to make loans to insiders (e.g., permitting management to purchase capital stock through promissory notes).

·     Adequate stock option plans. An adequate and flexible stock option plan must be adopted prior to an initial public offering or a sale to a public company as a result of recent shareholder approved requirements, which may significantly impair flexibility after the IPO.

·     Use of off-balance sheet transactions. Private companies which anticipate an initial public offering or a sale to a public company, need to be cautious in using this form of financing as the Act requires that public companies disclose all off-balance sheet transactions, including contingent liabilities.

·     Director and officer insurance risks (e.g., increases in premiums and exclusions as well as policy cancellations).

·     Auditor independence and restrictions on non-audit services. Private companies should monitor auditor services so they can be compliant in the event of an initial public offering or a sale to a public company.

·     Corporate governance. Corporate governance overhauls; internal controls; codes of ethics; independent and competent audit committees; independent compensation and nominating committees; corporate governance committees; and new corporate governance ratings. Private companies will need to review and implement internal controls in advance of an initial public offering or a sale to a public company.

·     Codes of ethics and whistleblower procedures. Private companies will need to adopt codes of ethics and whistleblower protections prior to an initial public offering or a sale to a public company.

·     Expanded duties of independent audit committees and composition of audit committees. Private companies should review the rules (e.g., the Act, the New York Stock Exchange rules and the NASDAQ rules) relating to audit committee member independence as well as the inclusion of financial experts.

·     Chief Executive Officer and Chief Financial Officer certifications and forfeiture of bonus and equity compensation. The Act exposes Chief Executive Officers and Chief Financial Officers to personal liability (which may include the forfeiture of bonuses and equity compensation) for non-compliance with disclosure requirements and securities/accounting fraud. Private companies should consider this potential liability when weighing an initial public offering.

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Drafting Confidentiality Provisions for Private Equity Funds

On December 29, 2003, the Treasury Department issued revised regulations (the “Regulations”) that address the situations under which confidentiality provisions will cause a transaction to be treated as a “tax shelter” that must be registered with the IRS.

The Regulations appear to remove most, if not all, private equity fund transactions from treatment as a “tax shelter” as a result of provisions restricting the disclosure of information concerning the fund or its investments. As revised, the Regulations will treat a transaction as a “confidential transaction” that therefore must be registered with the IRS only if an advisor (such as a law firm or accounting firm, but not including a party to the transaction acting in such capacity, such as the general partner of the fund) that is paid a specified minimum fee places a limitation on disclosure by the taxpayer of the tax treatment or tax structure of the transaction and the limitation on disclosure protects the confidentiality of that advisor’s tax strategies.

The Regulations are effective for transactions entered into on or after December 29, 2003; however, they may be relied upon for all transactions entered into on or after January 1, 2003. We believe that the controversies that we have been encountering recently in connection with the negotiation of carve-outs to confidentiality provisions in private equity funds should no longer arise.

Any questions concerning the application of the Regulations to private equity funds may be directed to Gary Herrmann at (415) 773-5451 or Grady Bolding at (415) 773-5716 in our San Francisco office.

The Four Critical Issues In Technology Escrow Agreements

Technology Escrow Agreements have become commonplace in all segments of the technology industry, from information technology to biotech, and every day licensors are placing into escrow software, biological material, chemical compounds, and other embodiments of valuable intellectual property. The preparation of Technology Escrow Agreements has become routine, and several prominent escrow agency services provide ready-to-use form agreements on their websites. These forms are useful and they reduce the transaction costs, but they invariably need review and revision to address the following four critical issues.

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The Benchmark Case and Implications for Dilutive Financings

Dilutive financings are often heavily negotiated and there may be a tendency to compromise by using vague language in the Charter.  In addition, dilutive financings often require complex liquidation preference provisions to get the deal done.  In light of these tendencies, it is important to review the lessons of the Benchmark case when negotiating a dilutive financing.

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We are seeing far more activity across the board at the beginning of 2004 than we did at the beginning of 2003. Specifically, we are seeing more financing activity, both by new startups and existing VC funded companies. The private equity market obviously lags behind the public equity market, but public stocks did very well in 2003. Even so, there were about the same number of VC funded company IPOs in 2003 as there were in 2002 and 2001 (around 20 or so each year compared to several hundred in 1999). We expect the much anticipated IPO for Google to pry open the IPO window a bit wider, although we expect this to be tempered somewhat by the added costs associated with being a public company resulting from the Sarbanes-Oxley Act of 2002. As a general matter, we think the first quarter of 2004 will bring a slow and steady growth in venture capital deal flow, with continued activity in mergers and acquisitions as an alternative exist strategy while the IPO window slowly opens.

About Orrick

Orrick is a leading international law firm with 700 lawyers in 14 offices around the world. The firm has been involved in innovative financings in the Bay Area for over a century. In Silicon Valley, our corporate lawyers represent both emerging and established technology companies, as well as leading venture capital firms and investment banks. We advise clients in a wide variety of industries, from semiconductor manufacturers and enterprise software developers to medical device companies and biotechnology firms. At Orrick, our top-ranked IP, employment, and executive compensation practices enable our clients to turn to a single firm for all their critical legal needs.  We make it a priority to build strong relationships and connect with our clients to help them achieve their specific business objectives.

Meet Our Partners

Whether you’ve worked with us for years, or are just meeting us for the first time, we are always eager to talk to exciting startups, fast-growing established companies, and the people who fund them and help them grow. We have extensive experience advising clients in company formation, fund formation, private equity, M&A, public offerings, and licensing transactions.  Don’t hesitate to email us or give us a call.

Welcome New Clients

Orrick works with many of the Silicon Valley’s up-and-coming technology and life sciences companies.

Meet two of our newest clients:

On February 3rd and 4th, Orrick hosted a VC Mixer and a CEO Workshop in association with FundingPost and Grant Thornton.  The VC Mixer attracted approximately 30 local venture capitalists for cocktails and networking.  The following morning, the CEO workshop drew 60 founders and CEOs to hear from VCs about what it takes in today’s market to secure funding. Immediately following the workshop, five companies had the opportunity to pitch to a group of venture capitalists.

In conjunction with the events, we distributed a survey to the venture capitalist attendees designed to take the pulse of the Silicon Valley venture community.  There were both serious and fun questions included.  Venture capital reporter for the Wall Street Journal, Ann Grimes, found the results amusing and published highlights in the Journal’s Digits column on February 12th. To view the complete survey and results, please visit our Web site.

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