Oil and Gas Startups Podcast

0:01 This episode of the Willing gas service podcast is brought to you by Encino Environmental Services. Now picture this, you're an operator in the Willing gas industry and you're constantly juggling

0:09 demands of drilling, production and compliance, going to be overwhelming, right? That's where Encino comes in. Encino is revolutionizing environmental compliance and sustainability and the energy

0:20 sector. They offer emissions monitoring and tailored solutions through cutting edge technologies to meet the ever changing industry standards and policies Encino offers comprehensive services such as

0:29 air permitting, stack testing, leak detection and repair, environmental site assessments, and much more. They like the ultimate support team for your environmental needs, ensuring that you're

0:38 not only meeting regulatory requirements, but also setting new standards for sustainability. Here's the best part. Encino understands the unique challenges of the oil and gas industry. They know

0:46 that time is money and they've designed their services to be efficient, effective, and hassle-free. You can focus on what you do best, pump and oil, drive and growth, maximizing production. So

0:55 if you're an operator who's looking to streamline compliance processes, minimize risk and enhance sustainability, go check out Encino Environmental Services, head over the website Encino and Vyron

1:04 ENVIRONcom to learn more and just tell them we sent you. What's up, Walkhead is welcome back to another episode of the Lulling S-RUS

1:16 podcast. You actually got me in calling here today. We're sitting down with our man Scott at Latham and Watkins Scott in from Austin, man. Thanks for coming Yeah, absolutely happy to be here

1:26 looking forward to talking to you guys again. So might, uh, might recognize, uh, Scott, if you were at energy tech night and saw him going through the hot wing challenge. Man, dude, you're a

1:36 champ though. Like people are talking about it. Like those hot wings just did not seem to phase you, uh, eating spicy food for a long time. So, uh, I get, you know, they were good, they were

1:45 good. It broke me off. I thought the whole point was to break you off. But you said now you're into it, right? I'm into it. Yeah. Yeah. It like changed my taste buds forever There you go. Now

1:52 you handle it like a champ. you prepared for it. So we wanted to bring you in today, 'cause,

2:00 you know, a few weeks ago, I had posted something. It's like, you know, we're raising capital for digital wall caters and wanted to start creating content, like documenting the process of

2:11 raising capital because in the energy industry, it's just kind of this vague thing. And there's not a lot of good information out there from people in the energy industry that are actually raising

2:22 And so it's great to have you on today to talk about capital raises and building startups, especially from the legal perspective and the legal angle. And so, you know, I think that we should start

2:35 off with, you know, first kind of tell us your background and your experience and we'll go from there. Yeah, I've been doing venture capital law and helping venture back companies for 17, 18

2:48 years now, all in Austin, but, you know, being in Austin, you're kind of like. as far as Texas goes, you're kind of on the front end of the tech boom, but I have represented companies from

3:01 incorporation all the way through IPO, and we did the Rackspace IPO a long time ago, but you know, we really work to help companies grow. I mean, that's essentially what I always see my role as

3:14 with private companies is we want to work with companies that have plans for high growth and want to grow, and because there's a lot of growing pains that come with that, and that's what we're there

3:23 for. So, you know, whether it's one round or multiple rounds, we are helping our companies grow, grow, grow until they get to that exit. Yeah, so from your experience, is it all based around

3:35 capital raising and finance, or are there other elements that you focus on too as a company grows, because I mean, as a company grows different liabilities, things of that nature come up, and so

3:48 is it kind of crossed the full spectrum, or do you really just focus on No, I'm basically outside general counsel to most of my clients, so I always say I'm a point guard and I do the capital

3:58 raising, I do the MA, but whether it's employment law, employee equity, technology, commercial contracts, privacy, international things, like we've got specialists and most law firms have

4:09 specialists that handle all of that, so I get called, then I pass it off to whoever is gonna work on it, but as far as what's important, I think we like to get in as early as possible because

4:20 there are mistakes that can be made when the company's formed that can create real problems at the first financing or maybe it's even missed for a while and it creates problems later. The obvious one

4:31 is just if there's multiple founders what that's gonna look like. We've seen situations in the past where three or four people start a company and six months in, one of them really isn't into it

4:42 anymore and wants to hit eject, and there's not a way to claw back that person's shares, and all of a sudden you've got a quarter of your cap table, It's sort of dead weight.

4:51 So that's just an example, but there are a lot of other things around IP, trade secrets, confidentiality that you can tie up really early and can create really good internal controls that'll make

5:03 you look really good to the investors when you go raise your series C to your series A. When you go to those institutionals that are going to really diligence your company. Yeah, I think that's

5:15 important to think about a lot of people to start building and they don't think about ramifications and second, third order effects down the road. And so not only just from a financing perspective,

5:28 but from your company structure and cap table and things of that nature. And so let's talk about when a company actually starts, let's talk about their early stage and let's kind of let's take like

5:40 this. It's like start off like we're going to build an early stage company and we're going to take it all the way through What should we call this company? Let's make them a free company. We've got

5:49 a tennis ball here on the table. So how about analog tigers?

5:54 Analog tigers.

5:56 I like it. The analog puppies or something like that will go the opposite of the cats. Yeah, so we're starting a company and what do we need to look for? Let's say, even before a pre-seed

6:12 financing. You know, look, companies don't have a lot of money when they start, so you gotta be practical. Like, you know, if lawyers wanna come in and want you to do everything perfect, but

6:21 that's not always practical. So, you know, you should do a basic review of what you can find on the internet to make sure that the name of your company's not taken, you know, your logo that you

6:32 might wanna put together is not taken, that's cursory. You don't need to go dive in and go to the trademark office and figure that out, but if you do something that's already taken right away,

6:41 it's a big waste of time. So just do a little bit of that work. Obviously, what I talked about earlier is, Okay, how are the founders going to split things? Who's going to be what officer? How

6:50 are we going to go forward? How are we going to present ourselves to the outside world?

6:55 One of the key inflection points early on prior to funding is you start hiring employees and one of the mistakes. It's hard to say it's a mistake, but one of the problems we see

7:05 is classification and whether someone's a contractor or an employee and early on, I'm not paying him anything. I'm just giving him equity What is he? He's my CFO. Well, presumptively, a CFO is

7:17 an employee and you're supposed to be paying them a certain amount because state of taxes, IRS,

7:24 what's their plan in those days? A lot of startups sort of swissled past the graveyard on it and then once they get some initial funding, they correct it. It's fine. We've seen others that just

7:36 keep it up and they just aren't paying attention to it. It can create real problems again when an institutional investor comes in and does diligence these people were classified as, you know,

7:45 you're paying these people by the hour. They should have been paid an exempt salary or they, their contractors are really were employees and you should have been withholding this whole time. And,

7:54 and so that can be a real pain to clean up. It's nothing that can't be overcome, but it costs money. It, um, your time on the, and, you know, it can be embarrassing to, you know, when you're,

8:05 when you're dealing with the institutionals, um, yeah. It's always, it's like, I mean, I get it Like, you know, we bootstrapped and ran by the seat of our pants. And it's like, sometimes you

8:16 just, and stuff gets pushed to the back burner and then, but then you just get to survive. Yeah. You know, it's like trying to survive, but then when it comes time for, you know, institutional

8:24 financing, like you're not on top of your stuff. And so let's talk about this. I have a very specific question in the early stages. You know, a lot of companies will go out and they'll say, Hey,

8:33 we need to start an entity and they'll opt for an LLC, um, over a Delaware C corp Most of the time probably just out of ignorance. And we did the same thing on digital wallcatters. When we started,

8:44 we started off as an LLC. We thought it was good for us then. Then ended up having to pay a good chunk of money to convert to a Delaware C Corp. So let's talk about that. Like at the beginning of

8:55 incorporation, how should founders be thinking about how or what structure they should be using? Yeah, I mean, I think it depends on the type of company. I'm one of the few venture attorneys that

9:06 will really, I really wanna think about the structure because you're right, it's kind of a default Delaware Corporation, if I'm gonna go raise venture capital. And yeah, nine times out of 10,

9:16 that's right. But the issue is you can start as an LLC and convert to a corporation, you can't go the other way around once the company has any value. It creates a massive tax hit on the founders.

9:27 So I think when we talk to companies, if they're software companies and they're the typical kind of profile for a venture-backed company, yeah, just start as a Delaware Corp. It's easier, the

9:37 employee equity piece, if it's easier, than you won't ever have to do the conversion. In the energy tech space, it's thinking of it more broadly. There are a lot of companies that are more like

9:49 hard science, not software. And there's some world depending on what their return profile looks like. Maybe it's better for them to be in LLC. I've run into that a couple of times where one fund

10:00 raise and that are cash flow positive, and they can start distributing cash to their investors. Well, if it's corporation, you get taxed at the corporation level and you get taxed at the

10:08 shareholder level

10:11 Right. Like I said, nine times out of ten, you want to be a Delaware Corp. There's early on, the stock has qualified small business stock, which has tax incentives. The investors. Let's talk

10:21 about that real quick. Sure. Sure. Is you say stuff along the packet, but let's talk about QSBS, which is a qualified small business. What's that? Stock. Stock. There you go.

10:32 I hate acronyms, but essentially, and you can correct me on this, but QSBS is essentially Uh, this structure where all of your equity under it, um, is free of, uh, capital gains tax up to 10

10:48 million, um, for both the team and the investors. And so it's a pretty cool structure to utilize, um, if you're not trying to pay the government taxes, which I'm always trying to do that. So,

11:02 um, talk about QSBS a little bit and what the process for that is. Yeah. I mean, there's really not a process from the company side It's ultimately the investors or the stockholders decision to

11:13 make with their tax, with their accountants and the people that are their tax preparers. But essentially any shares issued in a corporation in the US outs, you know, there's some exceptions, but

11:23 any tech company, really, I can throw in there, uh, that are in the company's got 50 million or less an asset, uh, can be qualified small business stock. And there's some exceptions and you

11:33 want to talk to your lawyers and all preface, I'm not a tax attorney, so I can get over my skis quickly here but ultimately. You're right, if you've got qualified small business stock and you hold

11:44 it for five years, then I think it's the first 10 million of gain you don't have to pay taxes on. That's sweet. And the reason the venture capitalists like it is as I understand it, under the way

11:56 it works currently, they can pass it up, if they're passed through, they can pass it up to their LP. So each LP gets to see up to 10 million dollars. Oh, nice, yeah. And so that's why it's

12:04 really crucial to them. Yeah, what's funny is I was on the phone with Carter last week and if you don't know what Carter is, Carter's cap table management software for startups and really good

12:15 software. And anyways, I was on the phone with our sales team and

12:22 they're like, Do you have a

12:26 station letter? And I was like, The guy's from Jersey. And so we have like classic miscommunication between a Jersey accent and a Texas accent. I was like, Out of station? He's like, Yeah, out

12:36 of station I cannot understand what he's saying. I was like, I don't think we have an out-of-station letter and then going back to our attorneys, Paul Sennelly, I was like, Hey, I don't want an

12:44 out-of-station.

12:47 And anyway, so yeah, you know, the QSBS when I learned about that last year, I was like, Oh, shit. That's cool. Yeah, and it's the reason most companies are Delaware Corps, because

12:60 corporations are easier than if you can have that kind of tax benefit on the gain. It takes away some of the double taxation issue that you have in a corporation There's things that can bust is you

13:12 have to be careful. Always talk to your attorneys. Investors want the reps that the stock's going to be QSBS. There's things like if you do a redemption or a repurchase of shares that can prevent

13:24 stock from being QSBS. Whenever you're issuing that, you need to make sure that if you're making the rep that it actually is QSBS stock. Yeah, it sounds like majority of the time in the startup

13:37 world, Delaware Sea Corps will be the way to go but there are some instances where LLC may make more sense. So you get your entity set up. You know, let's talk about something like a lot of people

13:49 will go to LegalZoom and get documents set up. LegalZoom, Rocket Lawyer. You know, we're guilty. We're guilty. Clerk is just using the chat

14:00 GPT now. Yeah, I love chat GPT for generating contracts. It's got probably that goddamn shit, you know. Take it, then hand it to a lawyer. You probably saved a little time. Yeah, exactly

14:10 Honestly, yeah, but let's talk about that. You know, how the importance of making sure that your documents are squared away, even in the early stages. I mean, it's really important. There's

14:22 some things you can't fix. We talked about founder vesting earlier. If the founders decide, hey, we wanna make sure everyone's in this and they subject their shares to vesting, there's something

14:33 called an 83B that you have to file. You don't file it within 30 days of getting that founder stock, it creates horrible tax consequences for you, and we see people. that. But the documents

14:43 themselves, again, we'll circle back to being practical. I

14:49 think it's better if you find an attorney that can do it for a fix fee or something to get you started up in the right suite of docs. It's better than using LegalZoom or Clerker or any of those. But

15:01 again, you just scare the shit out of me because

15:05 we didn't file an 83B election when we did our conversion. All of our employees, all of our employees have obviously one. I got their shares, but

15:18 I'm guessing y'all are probably okay, but

15:22 I don't want to create any problems here, but this is a real episode. It comes on in stress and critiques our business.

15:32 But

15:34 I'd always prefer folks come to us or to another firm that's got like an an incorporation package that you kind of have a fix fee for it. At the end of the day, these other services, they've been

15:44 vetted, they're not perfect, but they can get you there. But the best way to do it is to work with someone that can also do your seat or your A-round, because they know how to set your docks up.

15:57 Yeah, the other thing I was gonna say too, is that I think when people go to start a business, the first thing they do is like, I need to get an LLC, I need to get incorporated in it. My advice

16:07 is always like, Hey, go focus on product or making money first, because the second that you start setting up an entity, money just starts flowing out. And you have all of these filing fees and

16:18 things of that nature where, when we started Digital Wall Cadders, a member like we had a pretty significant sponsorship check and we didn't have an entity, we didn't have a bank account, we

16:26 didn't have a way to go cash that actual check. But that motivated us to get set up. Yeah, I mean, look, there's liability limitation on the founders by setting the entity up, which is important

16:38 And, you know, I think you can - we would always recommend getting the entity done right away. And then like if you don't want to do any of the other work behind it, at least you've got that

16:47 entity there to open a bank account with and have an EIN number. Even if you want to wait on most of your documents for down the line, you know, if you create value in something and then you start

16:59 the entity and there's real value there, well, are your shares really par value shares? Like, you know, and so that's the other reason is you want to start the entity really early. So there's

17:08 not any value in the company at that point Yeah, and you know, you start your holding period, all that stuff, but yeah, I think it's - That's another thing that we should kind of like dive into

17:18 is ask the tax consequences of shares and equity because, you know, it's pretty much when you incorporate the company. I mean, that's the cap table there. And once the company starts getting

17:33 value in it and you start having a 49a valuation, and you can't just dolt out. you can't just go out equity without consequences. And so let's dive into that a little bit just so that people can

17:48 have that in their mind and their early stages and understand that you can't just dish out equity in the future. Yeah, I think if you look at sort of the Facebook example, that's sort of the

17:58 textbook one that everyone looks at where he just was writing letters to people and saying, I'll give you this percent of the company. You got to be really careful with that. For multiple reasons,

18:07 one, what percent of what? I'm going to give you 5 of the companies at 5 fully diluted, 5 outstanding, 5 as of what date, 5 perpetually. What does that mean? And the other thing to your point

18:19 is, unless you're in that founding group that are there when the company's formed or soon after that, there's value bills in the company. And you can't just give out stock. It's the same as giving

18:31 out cash. And if it's an employee, if you just give the stock out, it's the same as giving out cash so you have withholding. a private company should be handing stock out to employees because of

18:43 that, and that's why we have stock options. Yeah, I was going to say, so yeah, restricted stock units, RSUs, and then you have stock options. And so I guess we can talk about that a little bit

18:53 because it's one

18:56 of the levers of a startup is that, hey, you may be cash poor, but what you do have is the ability to compensate through equity, but it's not just straight line equity So this is

19:11 the topic between RSUs and stock options is actually pretty complex. Yeah. I mean, especially the tax considerations, I really wish we had a just easier way in this country to kind of treat these

19:23 things. But the way that I've always looked at RSUs is that RSUs are really good for the early employees. It kind of represents more straight line equity then once you really start kind of scaling

19:37 the company. options are typically the best, but we'd love to hear how you think about it from a legal perspective. Yeah, with respect to RSUs for private companies,

19:51 when they vest, they settle. And so if I've got

19:57 RSUs and the company's worth a dollar a share when I get them, and then the first chunk vest, and at that point, the companies were 2 a share. It's the same as the company giving me shares at 2 a

20:07 share. And so it's taxable. And so what they do for RSUs is there's a second vesting trigger for private companies, and it's a change of control. And Facebook, a lot of the Silicon Valley

20:18 companies issued a ton of these in the early part of last decade and into the mid-late part of last decade. But

20:27 they also have to have, there's got to be a substantial risk of forfeiture. There's got to be an ability to lose them They're not perpetual. So what you have to put a five or seven year time frame

20:35 on it. So, I The RSU's are nice in the sense that there's no exercise price, so if you vest, if the company goes public or the company gets sold, then you get liquid without the deduct for the

20:48 exercise price. But if that event never happens and you hit that five or seven year mark whenever that RSU expires, you lose it. Now there's a lot of creative things being done in the valley right

20:57 now in Austin because a lot of them are expiring. A lot of these were issued in 2013, '14, '15 when companies weren't going public and the companies that haven't gone public now, the markets are

21:08 closed and these RSU's are expiring and companies are scrambling to figure out what to do because employees are losing equity. The nice thing about the stock option is it only has a 10-year timeframe

21:19 but there's not a taxable event when you issue them as long as the exercise price is fair market value. There's a certain type of option for employees so that when they exercise their option, they

21:31 don't have to pay any taxes and they pay taxes when they sell their option. whether they sell it, or it's a change of control, or whatever. So we guide people away from RSUs typically, and

21:44 outside of like,

21:47 later stage companies where maybe some executives want RSUs, they've seen it before, there's an expectation that the company's gonna exit in the near term. It can't be too near, there's other

21:57 issues there, but we do see RSUs more than we used to, yeah. I mean, if you had a late stage company, an executive comes in and is issued RSUs, you may have to buy those RSUs up front, right?

22:10 Well, I would say that's more of a restricted stock grant. Like you could, like they're buying the shares, so that they're actually buying stock. And so that'd be a little different than RSUs to

22:20 me. I always think of RSUs as when they settle, especially with public companies, people are just really getting paid the cash amount. You're withholding the taxable portion because

22:31 The nice thing about options versus RSUs as well, and at least in the way we use them for private companies, is again, the RSUs vest over time, but they have that secondary vesting on a changing

22:43 control. So you never really get the shares. And so if the company gets bought, you get that,

22:50 you get paid for every share, like the full amount, but you're gonna get taxed at or in your income because you haven't held them. So an option you could exercise, hold it for a year, and if you

23:00 meet the rules behind the options, which we don't have to get into the weeds on that, but there's a way to get capital gain, short-term or long-term capital gains. So the two things to keep in a

23:09 consideration on equity here

23:13 is ordinary income tax and then capital gains tax. And so you have two different forms of tax. Capital gains tax is gonna be more kind of like appreciation on asset, ordinary income taxes, like

23:26 regular compensation, you're getting paid And so - you know, this stuff's like way over, way over my head too. I mean, it's like, there's some pretty complex modeling and scenarios for them.

23:38 But, you know, I like RSU's for early employees because it's like, hey, you know, essentially there's zero value in the company. Right. And I'm a four or nine, a valuation. So you can get

23:48 these. And then once there's a liquidation event, boom. Um, and yeah, you're going to pay, um, tax on them, but if you're structured on our QSBS, it's capital, it's free of capital gains tax,

23:59 um, and the stock options, I think what's interesting is, um, you know, the exercise, when you exercise it, having to put up the money to actually exercise the, uh, the option of, which is

24:15 created this whole business model in itself where you have companies that'll lend out that money. Um, equity be is the one we're seeing right now. Like all of it. Yeah. It's, it's, it's

24:23 interesting It's putting employees in some tough spots. That's, that's crazy. Yeah. Well, I mean, like the founder of fast. I just don't think our collateralized line against your equity. Well,

24:31 there's it's usually not that bad, but there's there's a lot of different things going on. There's some that are a little bit more easier on the employees. There was a founder, a camera for his

24:40 bolt or fast or both shit goes. But I think it was fast and I mean, this is like peak 2021. I mean, just out at the height of everything and they're worth a few billion. Yeah. And he come out

24:53 with like this, you know, he's just on Twitter. And he's like, we're reinventing the way that we provide liquidity to our employees and essentially provided their employees with loans to exercise

25:07 their options. And then the company just, I mean, went south with all of its value. And so now these employees have a

25:20 piece of a very toxic debt that is now

25:26 on their personal balance sheet and it's not even back. by options that have any terminal value because the company has found out an evaluation. And so, I mean, just completely plus their

25:39 employees in a bad position because now your equity is worthless and you have this recourse debt on the top of it. Yeah. This podcast is brought to you by EnergyX. Are you tired of paying huge

25:52 rates for the big cloud providers? Are you worried about being booted off a cloud platform? If your company doesn't meet their ever shifting standards, ready to step up your data security and

26:01 disaster recovery game? Well, ladies and gentlemen, your new cloud is ready. Introducing XCloud, the scalable, resilient computing cloud that is also actually affordable. It's high performance

26:11 compute for half the cost, HPC for HTC. XCloud from Red Team is opening a beta program for new cloud computing customers, and that means you, my friend. This cloud is powered by the XMDC,

26:24 immersion-cooled modular data center from EnergyX. I've seen this data center in operation game changers. If you want more information about the beta launch, go to the URL in the description, type

26:35 in promo code at beta BETA for 50 off of your first instance. And so the URL

26:47 is going to be digitalwalkcutterscom forward slash energy X. Let's talk about, let's talk about vesting. What are you saying? Like, what, what is standard? What are the best practices? What

26:50 are things to look out for? I think mostly we still see for your, for employees for your investing with the cliff If you're doing true uplift grants, maybe you don't have the cliff. If you're, if

27:02 you're giving equity to board members or consultants, you want to consider what's their job? Are they working, are they doing a one-year project for me? Are they doing a three-year project for me?

27:14 It's a one-year project that maybe, it's fair, like they'll vest over the course of a year or whatever the grant is. But we try to keep it pretty standard for employees. You know, there's all

27:23 sorts of bells and whistles you can have, what happens on a change of control, or can they early exercise? Early exercise is something early in the company's life that can be attractive because the

27:38 share price is so low. And so maybe somebody can afford to write that check and own the shares immediately. Even then they'll best through it. And that again, there's some things you have to do to

27:49 make that work, but we see that quite a bit. But for the most part, standard, besting over four years, I think that's still been the market. Some people get creative, but that's usually what we

27:60 say. So one of the things that I saw, I've seen this multiple times. I wanna bring this up specifically, 'cause I've seen this in an energy tech, where I've seen, I'll talk to a founder,

28:08 they're going out and they're willing to raise money. And we'll talk a little bit about who was involved and the other founders and stuff. And I've seen multiple times where they'll say, Oh, we've

28:17 got 30 of the cap table is held by an advisor who is not actively involved Right. some person who says they're well-connected or whatever, they're not actually putting any money in whatsoever. What

28:29 are you seeing on it? 'Cause we kind of have our own kind of philosophy on what that's really worth in the market. I'm kind of curious what you've seen. Well, I mean, if that's an advice, I

28:40 guess it depends on how much value they're adding to the company, but it's similar to the - No, I know it provides that much value. Yeah, it's so investable at that point. Similar to the founder

28:48 that's left that you didn't subject to vesting and they get to walk away with a quarter of the cap table. It's the same issue They've got a big chunk of the cap table that's tied up with somebody

28:57 that's not offering that commit certain level of value or didn't earn that amount of value. And so your investors are going to be, there's going to be a little side eye there. And because at the

29:07 end

29:18 of the day, the investors are going to want to come in and create an option pool to incentivize the employees to help their investment go up. And they don't want people taking a big chunk of the cap

29:19 table that don't really add value. especially in the common stock level, yeah. Yeah. So let's talk about, you get to series A stage, you know? You've built something, maybe have a little bit

29:35 of traction, maybe raised a little bit of seed funding. Now you're going into series A. Let's say that you put together a great pitch deck, you've got interest, and I'm just gonna like talk out

29:49 of my personal experience like, what should be in your data room? Like what's an impressive data room from a legal perspective? I think it depends on who your investor is. I mean, if you're kind

30:01 of doing a consortium and no one's really interested in doing a ton of diligence on you, just put the basic stuff out there, you're gonna have a purchase agreement with representations and

30:10 warranties that are a disclosure schedule behind that. So anything that's on the disclosure schedule should be in the data room. But if you're going to a Silicon Valley fund or a Texas venture fund,

30:25 It depends on the kind of business, if you're direct to consumer, you're not going to have a lot of customer contracts, right? If you're enterprise software, you might have a ton, but they're

30:32 all in the same form. All of that basic piping for your business should be in the data room because they're not just doing legal diligence, they're going to be doing business diligence. Yeah. And

30:42 to your point, the earlier you have a data room, even if it's sort of on a on freeware and you're keeping track of it and you've got internal controls, then the easier it's going to be free to you

30:52 to create something for a third party to see under NDA. Yeah. So keeping track of all those documents, keeping like clean HR files, having a folder with every employee, you know, with all that,

31:04 you know, that's super important and it'll make the data room that much easier. You know, I think

31:11 you should go in not, you know, not hiding the ball on anything. Yeah. Because they're going to, people are going to find out and it's worse if they find out

31:22 for lots of reasons. Yeah, somatic commentary on the data room and just being organized from the get-go. We had an attorney that helped us out on the early stages and he was just like adamant on,

31:32 hey, I want you to keep all your legal documents like really organized because it looks very impressive when the company comes to acquire and you can just open up a data room and you have everything

31:42 here. He's like, I can't tell you how long, how far that goes in the MA process. And so we personally use Notion and have a whole legal data room over there. We're all of our legal docs are over

31:54 there and financial statements and things of that nature. And you can use Google Drive too, it's a great way but just having like a organized file, that way you know, put together our data room

32:06 and I dumped in our legal documents, our cap table, our financial model and you can just pull all of that stuff and they're pretty quickly. Yeah and you know, make sure that whatever daddy room

32:17 you're using is gonna, it's secure I think they fixed it, but a lot of them. There was, I won't name it in case I get the wrong one, but there was a well-known sort of data freeware database

32:27 freemium and in their terms of service, it basically said, look, if we get subpoenaed to release your information, we're gonna do it. And that's not great, but at the end of the day, look,

32:39 again, be practical. You don't wanna spend 25, 000 a year in a data room if you're a series-seater or series-aid company, but down the line, you may want a data room that has that many bells and

32:51 whistles if you're going through an MA process or an IPA. Yeah, that's what I mean. Yeah, I always gotta take it with a grand assault of where you're at and what resources you have and the early

32:59 stages when there is no money in a company. I mean, you use what you have and do what you have to do. And so, you know, it's even like for us as a company, like we just dropped, you know, like

33:10 eight grand on carda like two years ago, I'd be like, dude, hell no. We don't have eight grand to drop on carda. And so it's just always kind of evolves with the company. I think one of the big

33:22 challenges that we haven't faced this lately, but in the early stages is the big question, like how do you pay yourself, right? Are you a W-2 as a founder, are you K-1? 'Cause I remember a thing

33:33 back in the early days, like we weren't W-2 for years, and then you go to like buy a house or a car, and then you can't finance anything, and it's like you're kind of just screwed as a founder.

33:44 So I'm kind of curious how like what y'all's advice on, what's, I mean, maybe that evolves as like, you know, maybe you're pre-revenue, but then you have a little bit of money. How do you guys

33:53 think about that? Well, we'll stick with Delaware corporations 'cause LLCs are much more complicated. So no K ones with Delaware corporations. But, you know, as a technical matter, you should

34:02 be paying yourselves the minimum exempt salary, which in Texas is like 36, 000 a year or something right now. Again, it's totally impractical for a company with no money to pay themselves. So

34:14 there's usually, like, it's usually kind of, you know, I'll never give this advice to do this, we just understand that. are gonna work for free for a while. But the inflection point is really

34:25 when you start hiring those first people that are real employees, not contractors, you gotta start paying them and that means you probably should start paying yourself. And so that's, again,

34:36 that's always tough 'cause where's the money gonna come from. And that all being said, you know, as long as you understand that and as soon as you're able to get some money, there's ways to

34:40 remediate, honestly, sometimes it never, there is no remediation. It's just, okay, we've got the

34:46 money now,

34:52 now we're

34:54 gonna start doing it, right? Yeah. It's, you know, it's nickels and dimes. The founders, they will, there's this presumption that, like, you guys know what the deal is. But at the end of

35:04 the day, if you start hiring employees and you're not paying them, that's a problem. Yeah, for sure. So, you know, you get series A, you go out, you raise an institutional round from some VCs,

35:18 some things change in the business, Maybe before that, you raised through a safe note,

35:23 which if you're not familiar with safe note, it's just a simple agreement for future equity. So it's not an actual equity investment until it converts at a series A or an

35:35 acquisition. But now your investors maybe have a board seat, you know, they have voting rights, they have all of these different rights that come along with the term sheet So there's some

35:47 fundamental changes and the way that the business operates now. Let's talk about that a little bit and, you know, the, like the board meeting processes and things that change from that C to stage

35:59 to now. Yeah. I mean, having from a, from a operational perspective, hopefully, you know, you, you don't have a real draconian investor that needs to be all up in the business, like all the

36:13 time I mean, we don't usually see that series A. Yeah, occasionally it happens, depending on who the investor is, but, you know, Generally speaking, what you've agreed to is you've agreed that

36:24 their equity position is going to be protected through both through their right to block future equity rounds under certain circumstances. And

36:32 they've got anti-dolution of the ability to keep up all of that stuff. Then from a board perspective, they have a board member. And that means that they've got to vote on fundamental issues for the

36:44 company So usually at the Series A round, the founder appointed board members will still outnumber the preferred director. But sometimes in the docs, they'll be certain things. So you can't do

36:56 this without the preferred director also agreeing, or you can't do this without the Series A, vote also agreeing to it. So it just depends on how much controls that investor wanted in the company

37:07 when you did the round. And as far as preparing for the board meetings, I think early on when you just have one investor, they're pretty straightforward. I mean, I think what I would tell people

37:17 about board meetings I probably about 12 to 15 a quarter and done some very fun. Sometimes it is, sometimes it's not. I was joking about this the other night, but I've got some clients that can

37:27 run them in two hours and these are unicorns. I've got other ones that I think the normal is three to four. I've got one that every single time, it's an all day thing. Now there's always some

37:37 really cool things going on, but it's all day and

37:41 wouldn't recommend that unless you have the confidence to make that happen But it's always sort of the two to three hours as a sweet spot. So, but one of the things you should do is talk with your

37:54 investor board member. How do you want to see the numbers? What are the key KPIs that you want to see in the board meeting? And you're going to have a couple board meetings where they go, okay, I

38:02 see what you're doing on this slide. Next board meeting, I want you to show me this. And I want you to send this to me the email after the board meeting too. I want you to frame it this way

38:11 instead. And so you'll learn what that board member wants to see As you get more rounds and maybe you have more investor. investors on your board, it gets even more complicated. Yeah. Sometimes

38:22 it gets a little more adversarial, frankly. But ask questions, prepare, don't drop surprises in the board meeting. If you

38:33 do, it's not gonna come

38:36 across very well. And

38:40 I just don't be afraid to ask questions. You're an investor for a VC fund, you sit on a dozen boards, what do you wanna see in a board meeting? And then we'll cater to that with our own color on

38:51 it. And then we'll just work from there. Yeah, I like that, that's really good advice. So let's talk about as companies are scaling and.

39:02 You know, let's kind of say that, you know, maybe you've raised a series B, series C, or maybe you're just growing within cash flow, and there's two options. You know, maybe someone comes in

39:15 and wants to. make an offer for acquisition. Maybe you're going IPO route. Let's talk about the acquisition because I think it's more realistic for a lot of companies, especially if your company's

39:28 in that 30 million, 100 million range. There's a big pool of companies out there that could acquire you. So let's talk about that. It's actually something I'm interested in. So company comes in

39:41 here and wants to acquire digital wall catters. What do we need to start looking for? Well, I'll presume you didn't run a process. You just had unsolicited offer for you guys. Yeah, unsolicited

39:53 offer. Yeah, I mean, look, hopefully, like we talked about your data room, you've got your stuff set up so you can put a data room together really quickly. If it's unsolicited, they're gonna

40:01 be put in a term sheet down. Call your lawyers, don't negotiate the term sheet without the lawyer. Sales side, that's usually kind of obvious. And I do a lot of buy side and we'll get a term

40:10 sheet that's signed and a hand it to us and I'm like, what just happened? Yeah.

40:15 there's a lot of stuff you can do on the sell side in a term sheet stage to prevent getting locked up under exclusivity with this buyer under terms that you would never have agreed to. And so you can

40:26 expect, especially in this context, to if you sign a term sheet to be under exclusivity for 60 to 120 days, I think 90s, well, 45 to 60 is probably the low end and then 90s probably the high end.

40:38 Meaning you can't go out and shop the deal. Can't go and shop the deal, yeah, exactly And

40:45 I think you're gonna wanna make sure you're bored. Obviously, you're not gonna even sign the term sheet unless you're investor, director, and your investor's on board with it. Because almost

40:54 certainly the early stage they have a blocking right on exits.

41:01 Later stage we're able to like to loot that blocking right sometimes as company counsel, but early stage almost always there's a protective provision that you can't sell the company without the

41:10 series A approval You've got to realize what the return profile is for your. venture capital investor.

41:18 They're wanting to make a 50 to one, 75 to one return, maybe not that high, but if 20x minimum, yeah. You've got to understand that if they've only been in the company for a couple of years and

41:31 you get the software, it may not be good enough for them. You guys might be ready to exit as founders, but I mean, you took the venture capital money, you knew what you were getting into and what

41:39 the exit that they saw was. Now, maybe things haven't been going that well and the fund is ready to exit then too, but usually that soon, the funds don't want to see that return profile we talked

41:52 about. So make sure everyone's on the same page.

41:57 Outside of that, I mean, I think obviously get somebody that knows how to do MA on the legal side. It's not

42:06 unsolicited, you probably don't need to hire a banker advisor. So you go do you go get an investment bank and and

42:14 Represent you, I mean, it's like, unsolicited. And, you know, let's just say it's a 100 million acquisition seems kind of, I wanna go pay bankers. Yeah, I think in that context, my banker

42:28 friends will slap my hands here, but like, in that context, I don't think it makes sense. And one of the things you can do, if you've got a good relationship with your VC board member, is use

42:36 them as the bad cop. You know, they're exiting. You might be, especially if it's a strategic, you may be working for this company after this is going on So you want to keep a really good

42:45 relationship. And those negotiations can get tough sometimes. And what we often do is, like, if a company doesn't have a banker, because a banker usually will play this role. If it's a good

42:55 banker, have your VC director. If everyone's on board with the sale, have them play the bad cop. So you guys can be the good cop, the founders. And it helps the negotiations. Because what it

43:07 makes sense to the buyer, too, is like, I've got these founders, I like these guys. I want to work with these guys on a go forward. and all the VC guys worried about is his return. Oh, he

43:17 cares about the money. And return, and so the buyer knows that. And so he knows he's going to have to appease that guy. And not only are they concerned about the return, they're concerned about

43:25 their exposure post-closing. And so that's the other thing. Again, you can make them the bad cop. And I've seen

43:33 a lot of deals go well by kind of having some kind of dynamic like that. Yeah, no, that's great advice. I mean, 'cause you have this essentially buffer that allows you the founders to maintain

43:43 your relationship with the acquirer, especially like you said, if there's burnouts and things. And you had to run the company during that time too. I mean, that's the other thing that's tough.

43:51 And so that's where bankers can really help. But again, unsolicited, maybe not, but obviously if you're running a process, the bankers can take that over while you're - Yeah, so let's solicit

44:02 that. So not unsolicited. US founders are ready to exit. How should we be thinking about investment banks? Well, I similarly don't even start a process without - Um your, your, your, your

44:15 investor on your series A on board with it, but it may be BC, whatever, you're bored, you know, make sure everyone's aligned. If you go into a process and people aren't, aren't into it, then

44:25 it's going to come out and the valuation is going to get lower than you want, all of that stuff.

44:31 The, the bankers, I like the best. They're less transactional and more relationship. So they can get in with companies early. So I think if you're a founder and you get introduced to bankers,

44:40 keep those relations with them. Let them take you out. Like, you know, let them tell, you know, to the extent it's not confidential, keep them up with your company.

44:50 When, when bankers come in to do the deal and to get out,

44:55 it can work. It's fine. I've seen really good deals happen that way. But sometimes it's like, okay, I've got the deal signed up to under exclusivity. They turn it over to the lawyers and

45:02 management to do the rest of the deal. And then sometimes we'll be getting calls for the, you know, it's almost like the bankers representing the buyers at that point because they want their feet.

45:08 Yeah. That's few and far between, but I've run into that before. Usually what happens is they kind of disappear. You want a banker that's going to be willing to kill the deal, if you get a term

45:20 that you don't like, even though they're not going to get their fee. Because they know that they fought for you and that you'll come back to them the next time you want to run a process, if for

45:29 whatever reason the deal blows up. And you have that conversations. Are you going to be with me through the closing and fighting for everything that I want you to fight for? It's kind of funny how

45:39 when you look at it, it's like that, like I was just reminded of when we bought the Domain for Collide and I use that broker. And the seller of the Domain wanted to like 30, 000 and I was like,

45:49 Hey, we'll pay you 10. And the broker's like, They're not going to take that. I'm like, Offer it, you're supposed to be my broker. But then I realized, as I know, this dude wants me to pay

45:56 the higher amount because he's getting a, I'm not paying him a flat fee. I'm playing him a success fee. And so anyways, yeah, it's interesting to look at like incentives like that sometimes. And

46:08 you know, there's, I always really enjoy working with people who are just super honest and like, hey, look. like, yeah, we may not make any money on this, but those types of groups and

46:19 companies and service providers always win my trust because I know that even if they may not benefit from it, they'll always tell us the right thing to do. So I think that just comes down to working

46:31 with good honest groups. Yeah, I mean, I think it's an industry that can do real, real good for a company during a process, just because they know the market, they know the players, they know

46:43 how the process is going to run. They're going to be able to, if they're good at it, they can play buyers against each other. But it can also be, you know, there's some out there that they look,

46:53 they have one lucky deal where they got a massive fee and they're out there chasing fees and they'll maybe get one deal a year. And, you know, it's, you just have to, I really have to vet them,

47:03 you know, make sure they're willing to introduce you to some people that they help to exit prior And, yeah, most of the good ones will. So, real quick. Ending this podcast, let's talk about the

47:15 IPO process when IPO digital walk-outers and take it public. What's that process look like? We're going to have to go through this one process. I know there's a lot of direct listings and SPACs out

47:30 there now, and so

47:34 depending on how we want to get listed on the market, but let's say that we want to go public, whether it's IPO or SPAC.

47:41 What is a company to be thinking about when going towards that route, and who should go that route in IPO Is? there

47:52 a right size company that should be doing it? That gets a little beyond me. That's where the bankers and the finance guys, what they'll say tell you, but right now, if you're not a unicorn

48:04 a couple times over, it's pretty hard to go public and have a trading price. It's going to be able to stay above what. What's required? Yeah. And so, I mean, the key is it's not a six month

48:17 process. You don't wake up and decide we're going to go public, hire your bankers and go out. The bankers are going to tell you, man, you've got four people on your board. It's all white males.

48:26 You've got, you know, you've got no audit committee. You haven't done an audit in two years, like, there's no way. So one of the things that most of the companies we work with that are going to

48:37 go public, this has been a two to three year ramp up. And to the point where they're really running the company and they've hired the internal controls to like run the company like a public company

48:48 over the course of several quarters prior to doing even their org meeting, which is the start of the IPO process. And then over that time, you build your board with different expertise. You build

49:00 it, you create your committees, you get socks compliance, Sarbanzak. I mean, there's all these things. It's a massive process. Yeah. And, you know, from my perspective, you know, it's not

49:11 something, I think a lot of these companies had de-spacked over the course of the last three years, weren't ready to go public. And you're seeing that right now. Yeah, another day. They didn't

49:20 have the internal, and so they just scrambled the internal controls together as part of the, you know, when they signed this back and they scrambled the internal controls together, now they're a

49:27 public company and they just weren't ready. Yeah. Yeah. And so that's,

49:32 you know, and I think the de-spack's gonna continue. I think that's one way to go public still and it's gonna be, it's gonna continue to be But I think you're - Yeah, pretty much any company

49:41 that's de-spacked over the last two years just getting crushed, so. Yeah, I mean, it just, it depends. I mean, it was seen as an easier way to go public and then over the course of about a 12

49:51 to 15 month period, it became clear that it wasn't necessarily. Yeah. Yeah. Well, all super fascinating stuff. You know,

50:01 there's a ton of people that was some of this podcasts. Sorry, I've got the hiccups, so I'm trying to - No worries

50:09 people that listen to this podcast that wanna go out and build their own companies. And, you know, there's not a lot of content and resources that are tailored specifically to startups in the

50:20 energy space. And, you know, what's interesting is that even from an investor perspective, this industry has a lot of high network individuals that are quote unquote accredited investors and wanna

50:30 invest in startups, but they don't know what to look for. You know, they don't know what a safe note is and, you know, things of that nature And so this is all super valuable information both

50:41 from an operator's perspective, but from people that wanna invest in companies too. If someone's out there and they're a startup or, you know, just any other company and they wanna use Latham and

50:52 Watkins, where can they find you and the company? Sure. Like website-wise or website-wise. Yeah, website-wise, yeah. Are you on LinkedIn? Are you on LinkedIn? Yeah, on LinkedIn, Scott

51:05 Prager. Yeah, on Google, like what apps can they find you on? I'm on LinkedIn. I've also got a website on lwcom, but if you search Scott Craig late them and walk in, so you can find me, I mean,

51:14 to your point is a Google me. Yeah, kind of a big deal.

51:19 Well, it's also like, I mean, there's like two websites. It'll come up. So don't worry. But yeah, no, you're absolutely right. I mean, what we're finding in energy tech is there's a lot of

51:26 people that want to invest in a profile company that they haven't in the past. And you know, they're dipping their toe into venture and they have not that's not something they're used to. So it's

51:36 not just educating the companies these days, it's educating the investors. And we hope to just create deals and create a really fraught the environment for deals getting done. Yeah. And it doesn't

51:45 need to be traditional venture capital. Yeah. Necessarily. But there's an education process because when you do bump into it, you're going to want to have docs and have it have your be ready for

51:56 it. Be ready and prepared for it. Yeah. Well, dude, I appreciate you taking the time to come on the podcast and drive down here from Austin. Really enjoyed it, man. Absolutely. Appreciate it,

52:04 guys. Thank you. Yeah. If y'all enjoyed this episode, make sure to share it with a friend, share

52:11 it on LinkedIn, send it to anyone that is out there building or thinking about starting a company. This is great information. We will catch y'all on next week's episode.