Tag: investors

SEC proposed regulations would allow general solicitation and advertising in a Rule 506 financing

Accredited Investors, Angel Investors, Crowdfunding, Financing Your Business, Investors, Private Placements, Securities, Stock, Venture Capital

Last week the SEC issued its proposed regulations to allow for public advertising and general solicitation in Rule 506 offerings.

As way of background, at this point when companies are trying to raise funds in a private offering, they typically rely on Rule 506 of Regulation D of the Securities Act of 1933, which allows for an unlimited amount of funds to be raised and minimal disclosure requirements if the securities are sold to accredited investors.  Offering undertaken pursuant to Rule 506 also preempt state securities laws, except those relating to fraud and notice filing (and notice filing fee) requirements.  While all of the above makes Rule 506 the “go to” securities law exemption, the main reason it was originally allowed is because it has historically only been able to be used in private offerings, where the issuer (or the broker acting for the issuer) had a pre-existing relationship with the investor.

The JOBS Act, which I’ve discussed, contained a provision which would require the SEC to promulgate regulations to allow general solicitation and advertising in Rule 506 offerings, provided that all purchasers in such offering are accredited investors.

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Using “Convertible Equity” instead of Convertible Debt

Angel Investors, Financing Your Business, Investors, Securities, Stock, Tax, Venture Capital

As I’ve discussed, an option for startups to raise money is to do a convertible debt financing.   In this sort of a transaction, the investor gives the company a loan evidenced by a convertible promissory note.  The note is convertible upon a later financing round into the same type of securities that the financing round’s investors receive, and the note holder gets a discount on the per share purchase price.   The benefits of this are that it is generally much quicker and straightforward than a typical seed/angel round and the company and investor do not have to have the awkward and difficult conversation regarding valuation of the company.  The detriment to this type of transaction is that the company’s balance sheet is saddled with debt, and if the company does not raise another round of investment before the term of the convertible promissory note comes due, then the investor can essentially bankrupt the company if the investor does not want to extend the due date.  Also, there are a good amount of investors that do not like investing through a convertible note, as one of the important terms – how much of the company the investor will own – is up in the air.

Recently, TheFunded.com and the Founder Institute annouced the introduction of a new concept called “Convertible Equity”.  The concept and draft documents, were put together by Yokum Taku or Wilson Sonsini and a top accounting firm. TechCrunch has a good write up on it.

The form documents are available for free download here.

From a quick review of the documents it seems to be a great compromise.  There would be no more maturity date or interest due.  The startup will not have any debt on its books, and the investors would have the opportunity to qualify for the exclusion available on gains for holding “qualified small business stock”.  It will still leave open how much of the company the investor actually owns, however, but that can probably be resolved using a valuation cap or some similar mechanism that can be drafted into the convertible equity documents.

The documents appear to automatically convert into shares of the company stock upon a change in control or qualified investment.  There doesn’t appear to be an option for the investors to decide to convert at will or in any other circumstance, although certain provisions can be added for different situations.

This would be great if it gets adopted in the startup community, but like anything, it may take awhile.  I know I will be recommending it as an alternative to convertible debt.

How do I Value my Company?: Startup Valuation

Angel Investors, Financing Your Business, Investors, Private Placements, Securities, Stock, Uncategorized, Venture Capital

One of the most important issues when raising money from investors is the valuation of the company. This will drive all of the other financial terms of the deal: how many shares will be sold, at what price per share, and how much equity the investor will own in the company after the transaction.

In essence, for early stage (pre-revenue) startups, the company’s valuation is whatever the market deems it to be.  I’m not being glib, that’s actually how it works.  For example, say that I have a flat screen TV that I want to sell, if someone offers me $800, and then someone else offers me $900.  I’m selling it for the $900 and that’s the TV’s market value.  If an investor values you at $1M, then that’s your market value.  Now he could be undervaluing you, but probably not by a large amount, and if the investment goes forward at that valuation then it’s the de facto market price.  Now that doesn’t mean that there is no room to negotiate.  That’s why it’s always said that early stage company valuation is an art and not a science.

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Convertible Debt Financing 101

Angel Investors, Financing Your Business, Investors, Securities, Stock, Uncategorized, Venture Capital

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.

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The basics of Startup Funding

Accredited Investors, Angel Investors, Crowdfunding, Financing Your Business, Investors, Private Placements, Securities, Stock, Venture Capital

So you’ve got a great business idea, and a team ready to bring it to market (or at least a plan to begin getting it there), but the one thing you don’t have, like a lot of new companies is the capital to begin.  This post will walk through the traditional process for a startup to seek and receive funding. Read more

JOBS Act Breakdown – What the New Crowdfunding Law Actually Means for Startups

Crowdfunding, Financing Your Business, Investors, LLCs, Private Placements, Securities, Stock

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.

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Crowdfunding – A Potential New Wave of Startup Financing

Crowdfunding, Financing Your Business, Investors, Securities, Stock

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.

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Startup Financing – Private Placements 101

Financing Your Business, Investors, Private Placements, Securities, Stock

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.

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Choice of Business Entity – LLC v. Corporation

Business Entity Formation, Choice of Entity, Financing Your Business, Investors, Shareholders Agreements, Startup Formation, Stock

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.