It used to be that if you wanted to start a corporation and the end goal was not to maximize shareholder value (or other typical corporate goals), you’d start a not-for-profit corporation. That’s no longer the case. Now in New York (and at least six other states) you can form a Benefit Corporation (a “B-corp”) which has other purposes besides making money. There are also other strategies you can use in a for-profit company to give it more of an egalitarian feel. We’ll discuss below. Read more
Tag: startup
The Marketplace Fairness Act of 2013 a/k/a the Internet Sales Tax Act
As you may have heard, the Senate is working on a bill which looks like it may be passed on May 6th called the Marketplace Fairness Act of 2013. If passed into law (it looks like the House will also approve it, but we’ll see) it would allow state governments to force Internet retailers to collect sales tax from their customers and remit the proceeds to the state and local governments where the purchaser lives. The States would have to provide free software to Internet retailers which would allow them to do the calculations, and Internet retailers with revenues under $1M would be exempt. That’s some small relief.
There are seemingly two goals of the legislation. The first is to fund state and local governments which are, for the most part, starved for cash and seeking any new revenue sources (ie tax moneys) they can find. Second, brick and mortar retailers claim that they are at a disadvantage because customers can come in and look at items in their stores, check the price of the item on their smart phone and then order the same item online and not have to pay any sales tax on it.
My thought is that the effect of the legislation, if passed into law, would be more economically stifling (from a nationwide perspective) than it would actually serve the goals it presumes to address. Read more
Hack-a-thon Agreements
I hit on the Hack-a-thon craze in an earlier post. The IP that is created by the hackers in these programs has to be owned by someone, although there are still times where everyone walks away not knowing what everyone’s rights are. If nothing is ever signed by all participants and the hackathon sponsor, its unclear who owns what.
There are a couple different options. The sponsor may want to own everything, or may want to at least have a perpetual paid up license to use the IP created. The hackers should get some rights as well, but its been hard to delineate what and how it should be handled.
A friend of mine and a fellow startup lawyer, Dave Capuccilli of The Capucilli Firm has been working on a solution to this dilemma. Check out his latest iteration to a Hack-a-thon Collaboration Agreement, courtesy of Docracy. Its a great way to ensure all hackers and the sponsor get a fair shot at using the IP created.
I currently represent a few companies that were born at Hack-a-thons and Startup Labs (a similar idea but slightly different format/program), and if they had an agreement like this signed before they came to me it would have made things much smoother.
IRS’s “Check the Box” Regulations for LLCs
There are many reasons why LLCs can be great for business owners. For those types of businesses that have revenue and don’t need outside investors or to issue stock options (although LLC profits interests can work), LLCs are a good choice.
For a lot of startup companies, a corporation may be the right choice, especially if it will be seeking investors, plans to be acquired by a larger player in the industry at some point, or would like to have an IPO or other offering. The choice for a lot of companies especially in the high tech sector is the corporation. But if those aren’t your goals, if you have a business plan, target market, product and are ready to sell and make revenue then an LLC may be the right choice for you. Whatever industry you are in, an LLC can be a beneficial entity to use. LLCs can do complex and sophisticated things with respect to splitting profits, can have interesting classes and structures, require less paperwork than would a corporation, and are by far more flexible. (I’ve kind of beat the LLC v. Corp. horse to death earlier so will get to the point now). One of the other great advantages of the LLC form is that it can elect (i.e. choose) to be taxed as either disregarded entity (if one member then a sole proprietorship, and if multiple members than a partnership), an S-corporation or a C-corporation.
Stock Appreciation Rights
Another way to compensate employees of a corporation is to issue them Stock Appreciation Rights (“SARs” – not “sars – severe acute respiratory syndrome”, that’s something else). SARs grant employees, usually higher level executives, the right to receive stock and/or cash at a future date in an amount pegged to the increase in value of the corporation’s shares of stock over a certain time period. If the company’s share value increases, so to does the value of the SARs. SARs often are offered along with traditional stock options, although they are granted seperately (if done with stock options, sometimes you will see them called “Tandem SARs”). Read more
To Register or Not to Register?: Broker-Dealers and Finders
If you are involved in a startup you undoubtedly have heard about the company’s need to raise money. If you’ve gone the regular route you may be funded by institutional investors, like an angel or VC fund. The company may also have raised money through a private placement by selling equity to investors directly or through brokers.
You may have heard of another type of person involved in the capital raising process called a “finder”. Everyone has heard of the term a “finder’s fee” which is known to be about 10% of the overall transaction. The concept is the same with startup financing or M&A activities, although who can qualify as a finder and how they can be compensated has been a big deal with the SEC in the last couple years. The real issue is when anyone can act as a finder, and if they really should be registered with the SEC as a broker-dealer. Read more
SEC proposed regulations would allow general solicitation and advertising in a Rule 506 financing
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.
Using “Convertible Equity” instead of Convertible Debt
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.
Crowdfunding – Prepare your Company to Crowdfund
As I’ve discussed earlier, the SEC is now preparing regulations to allow for Crowdfunding pursuant to the recently passed JOBS Act. These should be done by 2013 (emphasis on should be done by then – we’ll see when they actually come out). As you may have heard, it will allow for true equity sales over the World Wide Web. Companies will soon be able to sell shares of their corporation (or LLC) through online portals to regular persons that are not accredited investors (i.e. not millionaires or otherwise sophisticated).
There are a couple of things to discuss, the first is whether this is something your company actually would want to do. The second item is, if it is something you want to do, then what can you do to prepare your company to do a Crowdfunding raise in 2013 (or whenever the SEC finishes the regulations).
How do I Value my Company?: Startup Valuation
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.