32 posts categorized "July 2013"

The 506(b)/506(c) distinction ain't binary

No shortage of "client alerts" from law firms, famous and obscure, summarizing the massive changes coming to the federal exempt offering rules.

These rules have incredibly broad application. If you work in East Coast finance, you're likely to say they have to do with private equity and advertising hedge funds to retail clients. If you work in the tech sector on the West Coast, you are more likely to fuss over the Impact of the new rules on startup and emerging growth company financing.

Mackenzie (1)As we get more perspective, now a few weeks out from the announcement of final rules lifting the ban on general solicitation, the headlines are both getting pithier and now straddling the two worlds. Case in point, the title of this alert from lawyers at the Day Pitney firm: "SEC Makes Fundamental Changes to Private Capital-Raising Rules."

Securities lawyers I know tend to go one of two ways when asked whether their clients will utilize 506(c) or 506(b) (for purposes of the hypothetical, assume that the SEC's proposed rules, loading up 506(c) with a ton of information posting and pre-filing requirements, are approved as proposed): some say they will tell their clients to only do 506(b) deals; others, that they should automatically pre-file and assume 506(c) will apply, just in case.

Here's how the Day Pitney lawyers express, diplomatically, their view that the higher quality deals will stay within 506(b) (506(c) having some of the taint of non-accredited crowdfunding, you might say):

"Although the impact of these rules is difficult to predict, we believe that many issuers will choose not to rely on Rule 506(c). This will be particularly true if the Regulation D Proposals are adopted and issuers relying on Rule 506(c) are required to file general solicitation materials with the SEC and place legends on such documents. Two of the SEC commissioners expressed concern that the Regulation D Proposals, if adopted, would subject private offerings to considerable burdens and undermine the goals of the JOBS Act. Although certain issuers with limited access to capital will undoubtedly be willing to accept these requirements, those issuers that are experienced in accessing the private capital markets may choose to rely on the traditional Rule 506(b) offering and forgo general solicitation."

Not a particularly controversial view, but it elides over a messier reality. In today's Rule 506 landscape, many offerings ostensibly under 506(b) are going to look a heck of a lot like they now belong in 506(c). The ambit of 506(b) will shrink because 506(c) better describes much of what has already become industry practice.

So the startup issuer may be stuck on a jack-stay between the 506(b) and 506(c) ships o'exemption!

Photo: "HMCS MACKENZIE (left) conducts a jack-stay personnel transfer with Canadian Improved Restigouche Class Destroyer," ReadyAyeReady.com.

Crowdfunding and the consumer protection conundrum

For today's post, I am reproducing the prepared remarks I gave yesterday in Georgetown, Seattle, at a hearing of a Washington State legislative committee considering "Access to Capital for Washington Start-Ups." My given topic was crowdfunding. Check out the crowdfuding bill introduced by Representative Cyrus Habib, that Joe Wallin has played such a key role in.


Prepared remarks of William Carleton
Member, McNaul Ebel Nawrot & Helgren PLLC
for the
Washington State House Committee on Technology & Economic Development
Georgetown, Seattle
July 19, 2013

Chair Morris, Vice-Chair Habib, other members of the Committee: Thank you for inviting me to speak.

My name is William Carleton and I practice at the law firm of McNaul Ebel Nawrot & Helgren in Seattle.

For 22 years I have worked with startups and emerging companies in Washington. It’s hard to say just what stage of the private financing cycle is the most critical, but the seed financing stage is certainly not the easiest. By “seed” I mean that initial round of outside capital, these days anywhere from $200,000 to $1 million, usually supplied by angel investors. that a small new company typically needs to launch and support a product or service and to hire talent.

When these companies get seed funding it is yet anyone’s guess whether or not they will be successful in the marketplace. It is the riskiest investment space that there is. Most fail to generate returns for investors. Even when a company manages to stay alive and in the game and succeed on a second, third or fourth pivot, by that time it is not uncommon for the earliest investors to have been substantially diluted. Sometimes, the last money invested in a company takes a disproportionate amount of the investment reward. For these and other reasons, many experienced angel investors I know think average citizens should steer clear of investing in startups.

But to emphasize the riskiness of startup investing, and that alone, is to miss a larger point about freedom and liberty and self-determination. Startups are part of how our nation reinvigorates itself. Along with the arts and other fields of human striving, it's how individuals push themselves and learn new things about leadership, connecting with community, and developing new skills. People who found startups never to go back to 9 to 5 jobs. If their startup is bought out by Microsoft or Google, sure, they may "do time" for a couple years at the big company, but they are eager to get back out into the field to do another startup. To paraphrase Yoda from Star Wars, once you join the startup side of the innovation economy, forever will it control your destiny.

And if you put even a modest amount of your personal capital to back an entrepreneurial neighbor you know, a niece you want to support, a colleague whose dreams you want to play a part in, or a company you are a part of, it can change the way you see yourself and your role in your community.

Right now the law says only the affluent can be owners. We tell average citizens, in effect, you have no power or efficacy to participate in startups, in the wellspring of the state’s economy, in the business lives and dreams of your friends, family and neighbors. Pack up your money and send it 3,000 miles across the country to Wall Street. You know your money will be safe in the hands of Wall Street. (That last remark was meant to be sarcastic.)

That’s not right and it underestimates the citizens of Washington State. We know aerospace and communications and productivity software and cloud computing because we live in the epicenter of all of it. While most Americans think technology is cool, Washingtonians further appreciate it’s hard work, because we see family, friend and neighbors working in technology, or are involved in it ourselves.

I applaud Representative Habib and Represenative Morris for the crowdfunding bill introduced last session in the Washington legislature.

But I do have a critique and a caution. The experiment, if braved at all, should be given a fair chance. Investment crowdfunding so far, once it gets written out in a bill or a regulation, tends to get weighted down with legal liabilities, conditions, reporting obligations - the kind of restrictions that are not imposed when deals are restricted to angels. The challenge is not how to protect investors. If we’re honest, we already know investors are likely to lose all their money anyway, and not because of fraud, but because of competition, or failure to execute, or a thousand factors not foreseen when the startup starts spending captial. The challenge with crowdfunding is how to not prematurely burden entrepreneurs with reporting, accounting, privacy and record retention obligations that make sense only if the company has revenues. If entrepreneurs have to spend $50,000 in legal fees to comply with crowdfunding regulations in order to raise $200,000, they will skip it, they will stick with accredited investors, angels only.

Investor protection in crowdfunding should consist of two things and two things only: (a) mandatory disclaimers that an investor is likely to lose all of her or his money; and (b) a strict limit in how much the investor can put at risk.

What's the right limit for investors? I don't know, but I would encourage you to ask, what is an amount that it should be okay for citizens to spend on lottery tickets, on charity, on raffle tickets at a fair, gambling at a casino? What is an amount we are okay with letting people lose, if they want to? $2,000? $500? A dollar?

I have circulated copies of investment crowdfunding regulations and bills pending in other states and would be happy to answer questions about them and how they compare.

These remarks are personal and do not reflect the views of my law firm or organizations I represent in private practice.

Investment crowdfunding at the state level

Writing you in real time from Georgetown, Seattle.

No, I am not lifting pints at Machine House Brewery (that was a good guess!), but am attending a public meeting of the House Technology & Economic Development Committee of the Washington State Legislature. The Committee is meeting today at the South Seattle Community College Georgetown Campus. (Not in Olympia, the state's capital, some sixty miles south of here.)

The morning session is about international trade.

The afternoon session is to be about "Access to Capital for Washington Start-Ups." That, and attracting private equity to the state.

I am scheduled to be part of a panel that starts at 1pm. I have some prepared remarks to make about investment crowdfunding, and hope to get a chance to say that such an experiment, if braved, should be given a fair shot at succeeding. It won't be useful if it shares even 20% of the features of the federal crowdfunding legislation (Title III of the JOBS Act).

Okay, it's now 12:42 pm. I had better sign off and figure out where I am supposed to be.

Investment crowdfunding at the state level

Whole pay-stub

Stepping away from national policy on startup investing for today, Sunday, to consider some very local, Seattle-specific news.

Fascinating reporting and editorial commentary in the Seattle Times today about incumbent Seattle Mayor Mike McGinn facing down Whole Foods, as a way of shaking up and reinvigorating his prospects for re-election.

CaptureApparently, when a developer proposes a project that would have the City vacate a street or alleyway, that gives the City leverage, or additional leverage, to, in return, exact public benefits from the project. And the controversy McGinn has started is in saying, if Whole Foods wants to claim an alleyway in West Seattle to build a new grocery store, it needs to pay its non-unionized workers a fairer wage.

What draws me most to the story is the angle, threaded throughout the Times' coverage, that the Mayor or the City did not make similar wage or wage information demands on Amazon when that company was pursuing development that would also have the City vacate a street.

This from the main news story about the controversy in today's Seattle Times:

"[Other candidates for mayor] labeled as hypocritical McGinn singling out Whole Foods while not raising the same issue when granting recent street vacations to nonunion Amazon.com in South Lake Union."

I have to say, that is an absurdly out of touch comparison for other candidates to draw. I don't know what Amazon pays its food service workers, but the people I know who work there, they make very good salaries. And the boon to Seattle of having these knowledge workers in town, inside the city limits, rather than a godforsaken office park on the eastside . . . 

Don't get me started.

I say be liberal in giving Amazon alleyways. 

Feeling helpless about the new proposed rules for startup financing?

This morning, the leader of a Seattle group active in the seed financing / startup contest space emailed me to ask that I outline three to five things people in the startup ecosystem can do, to impact the rulemaking the SEC has started to change Reg D. (If the changes are made final in the form proposed, they would completely overhaul Reg D and probably at least quadruple legal compliance costs for seed financings.)

Below is an adaptation of the email reply I sent him a few minutes ago.

* * *

Here are the top four things people can do:

1. Get a basic grounding in the topic.

I can think of three or four independent ways to go about this:

(a) For some people, just taking the hour or two required to read through the actual text of the SEC release with the proposed rules, that might be the best. Let me see if I can identify which particular section of the release might be the most pertinent.

(b) Every few days on his blog, Joe Wallin writes about this topic. Joe's posts are both passionate and absolutely authoritative as to what the proposed rules say. http://www.startuplawblog.com/

(c) People can read my posts on the topic under the category tag "general solicitation." http://www.wac6.com/wac6/general-solicitation/

(d) People can refer to and follow the links found on http://saveregd.org

2. After getting some familiarity with the topic, people can and should leave comments on the official SEC comment webpage. THIS IS THE MOST IMPORTANT STEP. The SEC staff read the comments. Usually, entrepreneurs and individual angels do not leave comments. Comments are usually left by banks, big financial institutions, institutional investors, etc. You get the picture.

3. Spread the word.

4. Tell your representatives in Congress you are concerned that the agency is undermining the very goal of the JOBS Act, which was, as the acronym suggests, to jumpstart America's business startups.

Feeling helpless about the new proposed rules for startup financing?

Secret post for @vbalasubramani and @anthonyrstevens

Another absolutely gorgeous summer day in Seattle.

Today is Friday, and sunny, and summer, and the taproom of the Machine House Brewery opens for the weekend at 3pm.

As it is a well known fact that bitter pulled manually from a cask (no Co2 or nitrogen) lubricates the legal, writerly, artistic and pleasure lobes of the brain, I will be removing my office to a picnic bench in the parking lot outside the taproom in Georgetown.

Meet me there!

Secret post for @vbalasubramani and @anthonyrstevens

Clipped wings

Really important opinion piece in the Wall Street Journal this morning by David Verrill, chairman of the Angel Capital Association and co-founder of Hub Angels in Boston: SEC Rules Will Clip the Wings of Angel Investors.

Everyone interested in the impact new rules will have on startup and emerging company financing, they should read this opinion piece.


The subtext of Verrill's piece, as I read it, is an important one: angels should not be put into the position of telling entrepreneurs that entrepreneurs should not be using Rule 506(c).

Here's a key quote from the piece:

"Angel groups know their members well, and focus on the education and skill needed to do this type of investing. They could and should be considered safe harbors unto themselves."

Photo: Sean Fraga / Flickr.

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