One way that a startup can take seed or angel investments is by doing a convertible debt financing, sometimes called a bridge loan or bridge financing. It is essentially a loan the company receives which allows the investor to later convert the amount due into a certain number of preferred shares upon the company’s next round of equity financing.
Tag: startup
Remember to make your 83 B elections! Here’s why and how to do it
As I’ve written about in the past, founders of a startup should have their equity vested. There are times when you may not want to, but the majority of the time it is beneficial. Some investors may insist upon it, although its one of the things in the negotiations. If the founder’s stock is vested, they should make an 83-b election. To not do so could turn into a lot of tax due to the IRS over the years the stock will vest. We’ll discuss how it works and how to make the election here. Read more
JOBS Act Breakdown – What the New Crowdfunding Law Actually Means for Startups
This is a follow up to my last post regarding the concept of crowdfunding in general and the progress of the JOBS Act through Congress (full name – Jumpstart Our Business Startups Act). Since then, the Senate revised and passed the JOBS Act in a 73 to 26 vote. The House then, voting on the amendments made by the Senate, passed it by a vote of 380 to 41. This is something that both parties agree on, and were eager to work together to implement. Josh Earnest, the White House Deputy Press Secretary, stated that President Obama will sign the JOBS Act into law this Thursday, with a bipartisan public announcement. The President and Eric Cantor, one of the champions of the JOBS Act, will appear together for the signing of the bill into law.
This post will detail the provisions of the JOBS Act and how they will affect companies going forward. The JOBS Act can be found here if you’d like to take a read. After it is signed into law, the SEC has 270 days to promulgate regulations. Expect the SEC to claim that they need more time, as the JOBS Act is a monumental change, and there are various consumer (i.e. the new investor) protections required, especially to prevent fraud which, unfortunately, could run rampant if left unchecked. Hopefully Congress can put enough pressure on the SEC to get the regulations complete in the actual 270 day time period, and the regulations will actually have some teeth with respect to fraud without stifling startup’s ability to raise money.
Crowdfunding – A Potential New Wave of Startup Financing
As you may have heard, Congress is now debating certain bills which would allow startups to raise funds in a new less restrictive manner, i.e. through “crowdfunding”. The lead bill is the Jumpstart Our Business Startups (“JOBS”) Act passed by the House on March 8, 2012. There is fierce opposition from various groups to the House version of the JOBS Act – including most states, the SEC, the New York Times, Bloomberg, accounting groups, AARP (?) and even the the old “Sherriff of Wall Street” himself, Eliot Spitzer. In this post we’ll look at what crowdfunding is, what Congress is proposing and the effects it may have.
Startup Financing – Private Placements 101
Startups need cash, no doubt about it. One of the ways to go about getting it is through a private placement. This post will give an overview of how such a placement works.
For the sale of any stock in a startup corporation, the federal and state securities regulations require registration of such securities prior to the sale, unless there is an exemption from registration that is available to the company. One of the exemptions from the registration requirements is when the securities are sold in a private placement. This is a federal exemption which preempts state regulation, save for certain notification filings and fees to be paid wherever to whatever state the company and investors are located in.
Drag Along v. Tag Along Rights
Both drag along rights and tag along rights can be very beneficial in an LLC Operating Agreement or a corporation’s Shareholder Agreement. They both relate generally to when an owner (or a group of owners) holding a certain percentage of the equity of a company (usually a majority) wish to sell their interests in the company to a third party. Tag along rights are beneficial to minority owners, while drag along rights are beneficial to majority owners.
Granting LLC Profits Interests
In a startup company, its common for certain employees to be compensated with some form of equity. When you incorporate, you would adopt a stock option plan and then issue options to the corporation’s employees to compensate them for their past services and to incentivize them to stay and keep up the hard work – make sure you vest!
With LLCs becoming ever more common, the owners of a startup organized as an LLC want to be able to compensate and motivate their employees and contractors in the same manner. They can do so by granting employees LLC profits interests.
Choice of Business Entity – LLC v. Corporation
This is one of the earliest questions that comes up when an entreprenuer or group of founders want to formalize their company or business relationship. The usual advice is that if you have current income and are not looking for investors and will not have to bring on other owners in the near future, an LLC is usually a good choice. They are flexible, light on required paperwork and are similar to doing business as a sole proprietor, assuming you continue to have the LLC disregarded for tax purposes. Sole member LLC’s are inherently flexible. Multi-member LLC’s are also flexible, but will require a carefully crafted Operating Agreement to cover certain actions each member can take, breakdown of membership interests, profits, and exit options. LLC’s are great vehicles to hold real estate.
Now if your company is seeking investors, especially institutional investors of either angel or VC level, it goes without saying that you will need to be set up as a corporation. Usually the investors will want a Delaware corporation. This will allow the corporation to issue preferred shares with various beneficial provisions in favor of the investors; right to convert to common, liquidation rights, registration rights, anti-dilution provisions, etc. While all of these are technically possible to do in an LLC format, they are not as commonly used. Investors feel more comfortable with the corporation form, notably c-corps, and they are the ones putting up the money so they usually get their way. Also, and more importantly, most investment funds have prohibitions in their organizational documents prohibiting investments in LLC’s to ensure that the fund does not receive any unrelated business income tax (UBIT). While you will hear some buzz around the internet, and maybe directly from some startups that institutional investors invested in their LLC, this is most likely through a “blocker” corporation, which is essentially a sole purpose corporation owned by the fund which holds the interest in the LLC. Most investors do not like this structure as it has its drawbacks, but it is done. Honestly, if you are running a startup, you would rather be negotiating investment terms and trying to get the best deal that you can, so you don’t want to already have one foot in a hole with respect to your entity situation.
Of course, no matter which entity you choose, you can always later either convert (depending on what state your company was formed in) or merge the existing LLC or corporation into another that you have formed. This will of course, require legal assistance, and is not always an easy process, especially if your company has signed certain non-assignable contracts or has other liabilities. But, as with most things, there is a way that it can be done.