My blog post last week addressed angel financing and included five legal tips for entrepreneurs to help them through the angel financing process.  I had intended to post a part 2 (adding five more tips), but I thought I would try something different to break things up a little.  Accordingly, below is a brief video of three lessons that I learned in the big-firm trenches as a young corporate associate in New York City.  

Oddly enough, I actually look back with fondness on those eight years (including all the all-nighters and weekends working on deals) because of the solid training that I received – which I can finally appreciate practicing law out here in California.  Here are the three lessons: (1) do your due diligence; (2) watch-out using forms from other deals or off the web; and (3) create a competitive environment.  This is part one of an ongoing series.  (Note: videos are tricky and can put some people off; thus, I have also included below the substance of the video in written format.) 

http://www.youtube.com/watch?v=hqAmVCkSmhA

Lesson #1 – The Importance of Due Diligence

Let me set the scene very quickly:  I’m a second-year associate, and my firm is representing Sony in connection with its acquisition of CBS Records (a $2 billion deal).   I’m spending 15+ hours a day at Blackrock, the CBS Building in New York City, reviewing corporate documents as part of a legal due-diligence team of six other corporate associates.  We’re all young and inexperienced — and we really don’t know what we’re looking for.  But then we found so-called “change of control” provisions in the contracts for Michael Jackson, Bruce Springsteen and some other major artists, which provided that if there were a change of control – e.g., if Sony bought CBS Records – the contracts would automatically terminate unless the artists consented in writing.  Obviously, these provisions were very important to Sony – and the value of CBS Records would be much less if those artists did not consent.  So there was my first lesson: the importance of legal due diligence. 

If you’re buying a company or investing in a company (or if you’re selling a company and getting stock as part of the purchase price), you have to get the lawyers and business guys (and gals) to review the material contracts.  Entrepreneurs must understand this – and they also must understand that if they’re trying to raise capital, the prospective investors (including angels and VC’s) are going to conduct legal due diligence, and thus all their papers need to be in order; and contracts (such as IP assignments and employment arrangements) need to be buttoned down.

Lesson #2 – Watch Out When You’re Using Forms from Other Deals

Here it is a couple of months after the Sony-CBS Records deal closed, and I get tapped for another major acquisition; and the senior associate on the deal instructs me to take the first crack at the acquisition agreement.  Being a clever guy, I figured – OK, I’ll just take the agreement from the Sony-CBS deal I just worked on, and mark it up, plug in the new deal terms and change the names.  So I got a copy of the executed agreement, I mark it up, I give it my secretary and then send it to the senior associate for her review.  Little did I realize that I had included a number of pro-seller provisions that had been negotiated by Cravath, which is the prestigious law firm in New York City that represented CBS, the seller.  Boy did I get a chewing-out from the associate (luckily it wasn’t a partner).  The lesson, of course, is that you have to be very careful when you take agreements from other deals and start using them for your deal.  So when you are playing lawyer and pulling forms off of the Web, you better remember that the agreements are final, executed agreements, which have been negotiated often over many months and reflect input from both sides of the table.    

Lesson #3 – Create a Competive Environment

Now I’m a third-year associate and I have two deals on my plate: one is a divestiture – the sale of a division of a multinational corporation being auctioned by an investment bank – and the other is the sale of a private company to a competitor (with no bankers involved).  In both deals, my firm is representing the sellers, but as we worked our way through the negotiation process of each deal, we ended-up with two completely different agreements with respect to the material legal provisions.  In the auctioned deal, because the ibanker was able to play the prospective buyers off of each other and create a competitive environment, the final agreement was extremely seller friendly (including broad materiality qualifications, a huge basket and a cap on liability of 10% of the purchase price).  In the private-company transaction, there was only one prospective buyer, and he knew the seller was anxious to sell and thus was playing hardball.  Accordingly, in that deal, the deals terms ended-up being extremely buyer friendly, including a big escrow of the purchase price and a cap on the seller’s liability equal to 100% of the purchase price.  

The lesson I learned here, of course – which applies to all deals – is that you must create a competitive environment (or the perception of same) in order to have strong negotiating leverage.  (See tip #3 of my post “Doing Deals with the Big Boys: Ten Tips for Entrepreneurs.”)

Yesterday evening, Michael Arrington of TechCrunch posted an interesting piece entitled “TweetPhoto CEO Says Too Much In Interview, Gets Fired. And That’s Just The Beginning…” (which has been subsequently re-posted throughout the blogosphere).  Unfortunately, Arrington has gotten his facts all wrong — at least according to Dan Caulfield, the CEO in question.

Arrington sets forth in his post that Caulfield “apparently said too much in [his podcast] interview [with Frank Peters], disclosing confidential information about partnerships [and] was fired by the company for the transgression.”  In the comments section to the post, however, Caulfield denied that there was any connection between his firing and the interview.  First, yesterday evening, he noted that: “I conducted this interview on [the] Morning of Nov 9th.  It had nothing to do with me leaving the company”; and then, this morning, he added that: “I was terminated a week prior to anyone hearing the interview.  Events not connected.”  Caulfield also retweeted the TechCrunch link to the post yesterday evening with a “Totally false!” insertion.

Arrington responded to Caulfield in the comments section this morning that: “Whatever you did or didn’t do, I think it’s pretty obvious what the company thinks” (citing a letter from the law firm Wilson Sonsini to Frank Peters demanding that he remove the podcast interview from his site).  Caulfield did not respond back to Arrington.

Needless to say, all of this made me scratch my head and wonder what the hell is going on here.  So I picked-up the phone and called Caulfield (he had given his telephone number out during the podcast), and I got the full scoop.

Caulfield’s Version of the Facts

I had a very good telephone conversation with Caulfield, who was gracious enough to take my call and answer all of my questions.  The bottom line is that Caulfield was “voted off of the island” (as he put it).  Indeed, Caulfield reiterated that his firing had nothing to do with the Frank Peters interview — he did the interview at 9am on November 9th (and no one at TweetPhoto was aware of it) and was fired at 2pm that afternoon.  The interview was subsequently posted and available to the public on November 16th (one week later).  According to Caulfield, it was just a matter of the founders “[wanting] to go forward without me.”  He explained that he was originally brought on by the founders to help them as a Board member; he then was appointed CEO.  And he emphasized that he was very disappointed (particularly in light of all the work he has done to help TweetPhoto), but does not want to do anything to hurt the company.

Caulfield seems like a stand-up guy, and if you listen to his podcast with Frank Peters, it is clear that he added a lot of value to TweetPhoto (including executing a significant partnering agreement on behalf of the company with Kodak).

Lessons for Entrepreneurs

The foregoing may be interesting from a personal-interest perspective; however, as a corporate attorney, I am more interested in the lessons that can be learned here.  Below are my takeaways.

Lesson #1: Diligence the Guys on the Other Side of the Table. As I have discussed many times (including in “Mistake #1” in my post “Five Mistakes Entrepreneurs Make in Dealmaking”), in any deal or business relationship, entrepreneurs must investigate the guys on the other side of the table.  This means getting references and speaking with other entrepreneurs or CEO’s who have worked with the guys on the other side of the table in order to make an informed judgment as to whether they are guys with whom the entrepreneur should be doing business.  As Caulfield noted to me, “at the end of the day, people have to work in a harmonious environment.”  The implication, of course, is that things were not “harmonious” at TweetPhoto.  Did the founders diligence Caulfield?  Did Caulfield diligence the founders?  It seems like there was a trial period where they got to know each other while Caulfield was a Board member.  Accordingly, there should not have been any surprises once Caulfield became CEO.

Lesson #2: All Employment Relationships Must be Documented. As I discuss in tip #8 of my post “Launching a Venture: Ten Tips for Entrepreneurs,” if any employees are hired by the company, they should be required to execute two documents: (i) an offer letter agreement and (ii) a confidentiality and IP/invention assignment agreement.  The offer letter agreement will set forth all of the employee’s respective rights and obligations, including position, compensation (including stock options and/or other incentive compensation), benefits and, most importantly, whether the relationship is “at will.”  The confidentiality and IP/invention assignment agreement is designed to prevent disclosure of the company’s trade secrets and other confidential information and to ensure that any IP developed by the employee is legally owned by the company.

Caulfield advised me that he signed the “same agreements” as the founders, which means they were likely pro-company, not pro-employee.  From an employee’s perspective, you obviously do not want your relationship to be “at will”; instead, you want a fixed term with appropriate protections against termination by the company without “cause” or if you (as the employee) terminate the agreement for “good reason” (e.g., because your title/duties have been substantially diminished or if you are forced to re-locate).  Such protections include severance payments, acceleration of vesting of options, etc.; however, as I note in tip #5 of my post, “Founder Vesting: Five Tips for Entrepreneurs,” startups will push back on this issue because (i) they need the flexibility to make personnel changes if things aren’t working out (like at TweetPhoto); and (ii) it is difficult to establish “cause” or negate “good reason” from a legal perspective.

Lesson #3: Employees and Consultants Must be Required to Execute Confidentiality Agreements. As noted above, it is imperative that all employees and consultants be required to execute confidentiality agreements to prevent them from disclosing any of the company’s confidential and proprietary information.  Such confidentiality obligations generally run indefinitely – i.e., apply even after the employment or consultancy relationship has been terminated or has expired.  Perhaps this may have caused Arrington’s confusion – not recognizing that the Wilson Sonsini letter to Frank Peters was citing Caulfield’s “continuing” confidentiality obligations (despite his employment termination for unrelated reasons).

Lesson #4: Retain a Small, Experienced Law Firm for Small Projects. As I discuss in my post “Behind the Big Law Firm Curtain: The Good, The Bad, The Ugly,” it doesn’t make practical sense to retain large law firms to handle small corporate projects.  I’d love to know how much Wilson Sonsini billed TweetPhoto for the one-page letter to Frank Peters.  Indeed, Arrington hits the nail on the head: “amateur hour.”  Having worked at two large New York City law firms, I can only imagine the hours of research and drafting by some young Wilson Sonsini associate trying to meet his annual minimum billable-hour requirements.  What are these guys thinking sending a threatening letter to a blogger for posting a recorded audio interview of a company’s CEO?

Conclusion

Arrington is a superstar blogger, but missed this one.  Caulfield is a solid CEO, but got mixed-up with a couple of flakes.  Frank Peters is sweating bullets.  Wilson Sonsini is spinning their wheels.  And entrepreneurs hopefully can take-away a few lessons.