134 posts categorized "Angels"

Secondary Sales and An Investor Covenant You Don’t Want To Miss

Dear Readers: This is a post I co-wrote with Joe Wallin, who has published the almost identical post here.

If you are investing in early stage companies, there are certain deal terms you want.

Most you probably know already: if it’s a round of convertible notes, you want a discount and a cap; if it’s a priced round, you want a liquidation preference. Etc.

But there is a new thing you need to add to your list of “must haves.”

You now want your investment documents to include a Section 4(a)(7) covenant.

What the heck is Section 4(a)(7)?

Section 4(a)(7) is a new federal securities law that basically says, it’s OK for you to sell your investment in a private company, as long as you don’t generally advertise the securities for sale, sell to another accredited investor, and the company cooperates with certain information requirements.

The new federal law trumps state law. So state law won’t hold you up.

Unlike the existing resale exemption most commonly used, there is no holding period required under this new law.

What is a Section 4(a)(7) covenant?

This new law is great—but you need the company’s assistance to access it, because the law requires the company to provide certain information to the purchaser.

So, get this covenant in your investment documents, and it may be easier for you to later sell your shares.

You can find draft covenants to include in your securities purchase agreements here.

And if you’re a founder or exec, don’t despair: Section 4(a)(7) will work for you, too. For a longer, in depth discussion of the new law, see this article in TechCrunch.

A Gift from Congress to Angels

The picture here was taken by Joe Wallin, who was on a panel with me, Gary Kocher of K&L Gates, Tom Alberg of Madrona Ventures, and Dan Rosen of the Alliance of Angels, talking to the Angel Capital Association's NW Regional Meeting about all the new laws and regulations and SEC guidance recently hatched or in the works that impact angel investing. Really great spirit and energy among the angels who assembled.

CdOv0FCW4AAJ1lgOne thing we talked about was a new law that should make it easier for angels to sell private company stock, provided they find an(other) accredited investor interested in buying, and provided that the company cooperates and provides certain information.

You can read about this more in a TechCrunch article that Joe, Josh Maher and John Myer wrote which ran yesterday. Go here to see a model pair of covenants that Joe, Gary and I prepared to share with the attendees of the ACA NW Regional Meeting. When negotiating with a company on including such covenants in your angel investment, no doubt the company is going to have its own thoughts and priorities, and in every case you will need to customize any model covenants to fit your own circumstances (in other words, the models are not legal advice; consult your lawyer).

$20k Soon to Be the New Standard Minimum Angel Investment?

$25,000 is a common minimum investment in startup financings, at least for those conducted offline (not through an accredited crowdfunding platform).

I wonder if that will change, if new SEC staff recommendations for the accredited investor definition are adopted. 
CaptureThe SEC staff recommendations are broad and potentially positive for the startup financing ecosystem: they call for expansion of the means by which an investor may qualify as accredited, which may mean more individuals may eventually be eligible to participate as angels.
However, on preserving the existing financial thresholds for natural persons to qualify as accredited, the recommendations are muddy. Granted, the staff state that the existing thresholds should stay in place; but they also recommend that the current standards should be indexed to inflation, going forward, and that investors be limited in how much they can invest, unless they meet significantly higher financial qualification thresholds.
Here's a quote from the report on the concept for limiting how much the typical angel may invest:
"The Commission could consider leaving the current income and net worth thresholds in the accredited investor definition in place, but limiting investments for individuals who qualify as accredited investors solely based on those thresholds to a percentage of their income or net worth (e.g., 10% of prior year income or 10% of net worth, as applicable, per issuer, in any 12-month period)."
If the investment cap for the majority of angels ends up being 10% per issuer per year, then I'd predict we'll see downward pressure on the $25,000 minimum rule of thumb, and possibly find $20,000 will become a new de facto standard minimum.
I derive that figure from the $200,000 income threshold. Ten percent of that minimum threshold is $20,000. Though if you go with the $1M net worth standard (as refined by Dodd-Frank), you get $10,000.
What will happen is, the issuer will ask the angel, "unless you are super accredited, what is the maximum you can invest, under either the income or net worth tests?" And the investor will say, "none of your business; I meet the standard, that's all you need to know, here's $20k (or $10k) accordingly - don't ask what my income (net worth) is." This reaction hurts startups insofar as it lowers the average investment, but helps in terms of transaction costs insofar as it bypasses (presumably?) any verification requirement that new rules might impose to enforce individual angel investing limits.

ACA Webinar on Accredited Investor Definition and Established Angel Group Certification

I've just listened to an archived recording of an excellent webinar presented by the Angel Capital Association last week (I had intended to listen in real time, but got pulled away): ACA Webinar on Accredited Investor Definition and Established Angel Group Certification.

Presented by ACA Executive Director Marianne Hudson and ACA Chair David Verrill, the hour long webcast covers how the accredited investor definition might change (and how that might impact the startup investing ecosystem) and what the Angel Capital Association is doing to facilitate the transition to the brave new world of general solicitation.

The chief initiative of the ACA is the "Established Angel Group" certification program, which is designed to help issuers implement the "principles based method" in satisfying the heightened accredited investor verification burden under new Reg D Rule 506(c) (which allows general solicitation). The Established Angel Group (or "EAG") certification program has potentially broader implications as well - for instance, if the accredited investor definition changes to put more weight on, or define an alternative path to accreditation based on, investor sophistication, the EAG could be important for purposes of both Rule 506(b) and Rule 506(c).

Inside baseball stuff, I know, but if you're interested in the history of how it came to be that only high net worth people were allowed to invest in startups, how that situation was seemingly democratized (somewhat) by the 2012 JOBS Act, and the rearguard action of state securities administrators and others to put a lid on the reforms, giving an hour of your time to this webinar will help fill you in.

David Rose's new book on angel investing

Just got David Rose's new book in the mail, on angel investing.

Definitely looks like it's worth checking out.

Those of us who hang out a fair bit on blogs and online will be familiar with many of David's precepts, from his long, detailed and popular answers on the topic on Quora.

But this book looks like a great way to organize his philosophy on angel investing in one place.

The angel lawyer in me is first drawn - naturally - to a deal form bank at the back, where there is what looks like a term sheet for a light preferred stock offering that combines the NVCA model forms with Ted Wang's Series Seed.

But, bigger picture, the book should be valuable for insights into David's practices as an angel. Chapter titles include "why everyone with six figures to invest should consider angel investing" and"why every angel needs to invest in at least 20 companies."

The first time I encountered how opinionated and direct David could be was when serving on a panel with him at a talk at an accelerator in DUMBO a couple years ago. The topic was crowdfunding, and David was confident that the right structure for non-accredited crowdfunding deals was revenue loans.

And sure enough, there is a revenue loan term sheet in this book! (But I'm swinging back again to being a lawyer.)

David Rose's new book on angel investing

SEC official to angel community: go ahead, develop your own verification methods!

Keith Higgins, the relatively new Director of the Division of Corporation Finance, delivered a speech at the closing session of the 2014 Angel Capital Association Summit - and was it a doozy!

A huge issue for angel investors is the "reasonable steps to verify" accredited status that is part of new Rule 506(c), which permits issuers to engage in "general solicitation." The issue was a focus of at least two breakout sessions at the Summit, including one Thursday moderated by ACA policy chair Mike Eckert that I participated in with the gifted lawyers Peter Rosenblum and Rob Rosenblum (not related), and an excellent breakfast briefing Friday from K&L Gates lawyers Gary Kocher and Kevin Gruben.

1842308438_83cb923365_oThe reason for such attention is the anxiety caused by the non-exclusive verification "safe harbors" set out in Rule 506(c). These verification methods contemplate that, going forward, an issuer is going to have to demand personal financial information from investors, or engage third party verification services to do so. To many readers of the new rule, including a majority of securities lawyers, the safe harbors - in spite of the "non-exclusive" label - feel destined to prove de facto requirement.

But Higgins said that needn't be the case.

In his speech (the full text of which you can access on the SEC's website), Higgins emphasized that if any verification standard might be core under Rule 506(c), it is the flexible, "principles-based" approach laid out in the inital release proposing the new rule:

"These [applications of the principles-based method] are all part of a deliberate effort by the Commission to provide issuers with an alternative to the clear but highly prescriptive list of verification methods included in the rule. In fact, it is ironic that this list of verification methods is being viewed by some as the primary way to verify a purchaser’s accredited investor status when, in fact, the Commission originally proposed the principles-based approach as the way issuers would comply with the rule’s verification requirement and added the list of specific verification methods only in response to address the concerns of commenters who wanted more certainty."

As Gary Kocher explained plainly in his breakfast briefing earlier in the day, lawyers are a conservative bunch, and naturally are going to navigate to the safe harbors. But, Gary stated he believed that the staff meant what they said in the rule and in the release, that the principles-based approach was viable. I think Higgins' speech completely validates Gary's view.

All of this portends well for verification methods based on the Angel Capital Association's Established Angel Group guidance, which would not require the turning over of sensitive financial information to issuers or their vendors.

As for seeking express SEC staff blessing of particular applications of the principles-based method of verification? Higgins seemed to say that was both not likely to be forthcoming anytime soon, and also beside the point:

"On that note, we have had recent inquiries asking whether the staff would provide guidance – presumably on a case-by-case basis – confirming that a specified principles-based verification method constitutes 'reasonable steps' for purposes of the rule’s requirement.  The notion of the staff reviewing and approving specific verification methods seems somewhat contrary to the very purpose of a principles-based rule and I am not yet convinced of the need for this type of staff involvement. Rather, this is an area where issuers and other market participants have the flexibility to think about innovative approaches for complying with the verification requirement of the rule and use the methods that best suit their needs. While the staff may not be in a position at this point to provide guidance on what constitutes 'reasonable steps' under particular circumstances, I also believe the staff will not be quick to second guess decisions that issuers and their advisers make in good faith that appear to be reasonable under the circumstances."

I should note that the angels I spoke to at the Summit, and the questions they posed in the breakout sessions, were more precisely focused on the definition of general solicitation and the activities at pitch events and the like that might push a company from 506(b) territory into 506(c) territory. But let's step back a second and look at the problem from just a story or two higher: to the extent that verification under 506(c) becomes more manageable, then the general solicitation issue becomes somewhat less of an existential distinction. (There may yet be reasons to avoid publicly soliciting investors - but that is another topic.)

Success for principles-based verification approaches will not be self-executing. Angels and their entrepreneurs will have to insist on them, and will have to make sure they have enough rigor to acquire respect. In the right circumstances, lawyers for a given deal might, just might, go along.

Drawing: "Principles Mound" by Paul Downey / Flickr.

2014 ACA Summit Coming Up!

Next week, I will be joining more than 700 of my colleagues at the largest gathering of angel investors in the world. I have been invited to present at this conference session: The New SEC Regulations - Practical Interpretation and Guidance for Angel Group Management Activities.

2014 Summit MastheadThe session I'm participating in will be chaired by Mike Eckert, ACA Policy Chair and of the NO/LA Angel Network, and my fellow panelists will be Peter Rosenblum of Foley Hoag, and Robert Rosenblum of K&L Gates.

Here's a description, from the conference agenda, of what Mike, Peter, Rob and I will cover;

'Leaders of angel groups continue to deal with confusion, uncertainty and misunderstanding as related to the recently passed SEC regulations about General Solicitation. The questions ”what should my group be doing or not be doing?”, “which rule is effective and when did it become effective?”, “which is not effective?”, “what kind of guidance should my group be providing to entrepreneurs, startups, accelerators/incubators, colleges and universities about General Solicitation and Reg D/Form D?”, “what is and what is not General Solicitation?”, “has anything really changed?”, and “how do I protect my group, its members and the companies presenting to it?” are pervasive. The objective of this session is to provide further guidance and where possible clarity such that ACA members and member groups can make continued informed decisions about these issues in their day-to-day real-world activities, and be key sources of knowledge about these in their respective markets.'

If you’re not already attending the ACA Summit March 26-28th in Washington DC, I invite you to learn more about it at www.angelcapitalassociation.org/2014summit.

Related Posts with Thumbnails