53 posts categorized "Seed Financings"

Cracking open the SAFE

I see Antone Johnson and Joe Wallin are tweeting about the "SAFE," or "simple agreement for future equity") being promoted by Y Combinator as a seed-financing alternative to convertible notes.

6901756969_dcb05eac80_zThe animating idea appears to be to take the pressure off a startup to close on a priced equity round before a slew of seed fin ancing convertible notes mature.

What does a purchaser of a SAFE get? A promise that future shares will be issued on triggering events that the SAFE agreement defines.

There are four varieties of the instrument indexed on the Y Combinator site. I've had a quick look at this one, a version that imposes a valuation cap and gives the SAFE purchaser a conversion discount. A few things stand out:

  • The size of the SAFE round is not scoped; I suppose this simply reflects a Y Combinator and perhaps Silicon Valley philosophy of open ended rounds, with notes (or SAFEs) being issued with different discounts at different times. (A byproduct of this approach is that you have to get each investor to individually agree to any change in terms; maybe this is not so bad here, as the investor really has no downside protection to give up.)
  • Unless I missed it, I don't think the SAFEs convert into convertible note rounds, if the company later determines to issue convertible notes before a conversion-triggering equity round. Nor is there a covenant restricting the company from issuing convertible notes without consent.
  • Investors do get the benefit of a few key company reps, but there is no capitalization rep, no rep as to founder reverse vesting, and no rep that everyone has signed an inventions agreement (though there is a rep that the company has the IP it needs).
  • There seems to be an appetite to put off corporate approvals to authorize offerings, make reservations of shares, and make appropriate Reg D filings; I think a sophisticated investor is not going to be comfortable with that (even assuming she is willing to get past the threshold problem of not having any priority over the common stock).

The above from a quick read just after seeing Joe's and Antone's tweets. LMK if you see anything I missed.

Photo: Dennis van Zuijlekom / Flickr.

Weekend Read: WSJ Accelerators Post on Pitch Events and General Solicitation

This weekend please read an article I wrote for The Accelerators blog of the Wall Street Journal, The Trojan Horse of Accredited-Investor Verification.

6960882500_cc7fccd4d4_oThe piece gets into how some angel groups, pitch event promoters, and demo day organizers are dealing with new Rule 506(c). Basically, the days of a de facto industry practice of ignoring the Rule 506 prohibition on general solicitation and general advertising are over.

Now that it is okay to generally solicit, it's also time to come to terms with what came part-and-parcel with such over permission: the need to take reasonable steps to verify the accredited status of all purchasers.

It's going to take some time for the ecosystem to sort things out.

Check out this Pando Daily post that Doug Cornelius quoted from in his weekly roundup post. Do you think the newly conservative steps demo days promoters are taking, as recounted by the Pando Daily reporter, Erin Griffith, cut the mustard?

Please do read the piece for the WSJ Accelerators!

Photo: D Services / Flickr.

Three longer reads for where we are after General Solicitation Day

We are now living in the second day after General Solicitation Day. All trying to take stock of what has happened, and how the landscape is different.

And there is no shortage of media coverage! (Here, from a news angle, is a good overview from the Wall Street Journal: General Solicitation Brings Startups Capital, Risks. I was interviewed for this article and love the quote they got from me: "The government is doubling down on the idea that accredited investors can fend for themselves.")

PhotoBut today I wanted to call out three different, longer-form pieces of writing, each published within the last week. Each, in a different way, lends a deeper perspective on where we in the startup financing ecosystem are now.

Each will be a reference piece in the weeks and months to come.

1. Paul Spinrad's take on where we are, how we got here, and how all the different pieces fit together.

Here is an article that Paul Spinrad published on a PBS website: Online Platforms Give the First Public Look at Private Equity. As I said on Twitter yesterday, Paul's is the best written, broadest article yet on general solicitation and the changes to private financing rules.

Among the delights of Paul's well written survey are: an explanation of how public offerings came to be squeezed into a private exemption framework; the balance or contrast of considerations when approaching policy for accredited and non-accredited crowdfunding; and how private equity platforms are rolling out new features to facilitate the new rule set.

On Monday in GeekWire, I tried, not very effectively, to point out some of the new features on some of the leading online platforms. Paul's take on the same topic is far more accomplished. And that topic is only one facet of his survey.

2. Trent Dykes', Megan Muir's and Kiran Lingam's whitepaper on do's and do not's at demo days and pitch events.

This one, Demo Days, Pitch Events and the New Reg D, is controversial. I've had an earful from several people already on how this whitepaper may get one or another thing wrong.

But I greatly admire the ambition and timeliness of it. The question that the rest of us hem and haw about – am I automatically generally soliciting if I show up at a demo day or pitch event? - they tackle.

Whether or not you agree with the protocols and checklists they lay out, Dykes, Muir and Lingam are calling out the right factors to consider and giving laypeople the means to educate themselves about general solicitation.

3. The Gunderson law firm's comment letter to the SEC on the proposed Reg D rules.

This is a letter published on the SEC's received comments page, signed by a Gunderson partner, Sean Caplice.

There are a ton of comment letters on the proposed rules, none too few from big law firms.

What's remarkable about the Gunderson letter is that it provides answers to all 101 "requests for comment" posed by the SEC in its proposing release.

Most commentators either cherry pick which of the SEC's questions they want to answer, or skip the agency's questions altogether and comment from the perspective of the commentators' own agenda or frames of reference. For tackling all 101 requests for comment, and for that reason alone, I think the Gunderson comment letter is a touchstone. (Kudos to Joe Wallin for pointing the letter out to me.)

The 506(c) Seed Financing Blues

I know I can't just take from any Joe
Investment in my fledgling startup co.

But come the 23rd this month, I hear,
It's dope to advertise with brazen cheer

My need for funds. The only legal catch:
My purchasers must be accreds. (Well, natch.)

But wait, a second catch I now recall.
Accred! I have to verify them all.

The legal bloggers tell me I must hire
Someone like them to get me through the mire

Of 506(c), final and proposed,
And all the Form D notice filing woes.

One might have thought that Congress, when it passed
An Act to make it easier to gas

Small businesses to drive more growth in jobs,
It would have fended off last-minute lobs

To compromise by complicating law.
Oh well - democracy's systemic flaw.

The 23rd, I'll take my chances on that day
And verify by asking NSA

What it can tell me 'bout my purchasers.
Yes, that's my plan. It could be worse. And yours?

The general solicitation quandary: can you shoehorn today's pitch events into yesterday's rules?

Lots and lots of questions about the new and final general solicitation rule, as well as proposed rules that would add additional conditions - beyond the accredited investor verification required by Congress - for exempt offerings that make use of general solicitation.

As we sort through the questions and ambiguities, however, one point couldn't be clearer: the old rule used for most startup and emerging company financings, old Rule 506 (hereinafter to be known as 506)b)), was expressly preserved.

9417926220_c54429ce2f_zTrue, if the proposed Reg D rules are finalized as proposed, new Form D filing requirements will impact Rule 506(b), as well as the new, final, general solicitation-friendly rule 506(c).

But 506(b) has no heightened verification requirement, and no pre-filing or information requirements have been proposed for 506(b) deals. It may well be that Form D filing obligations will soon have more teeth, regardless of whether you choose 506(b) or 506(c), but it's fair to say that the new Reg D rule set goes out of its way to preserve the old way of doing things, as long as you do not generally solicit or generally advertise, and as long as you otherwise comply with the conditions that have always been in place for Rule 506.

It didn't have to be thus and the SEC deserves credit and praise for thinking this through.

As drafted, Title II of the JOBS Act did not actually require that the old 506 be preserved. The notion had been in the air. A version of the JOBS Act that had been introduced in the Senate in March 2012, not the version that made it into law, expressly contemplated that the SEC might bifurcate 506 in the way that the agency ended up doing. And I and others advocated for such an approach in the run up to the SEC's August 2012 proposed rules to implement the lifting of the ban on general solicitation. But there was no Congressional imperative that the agency do so.

And because the Reg D rule set expressly preserves "the old way" of startup and emerging company financing - no general solicitiaton or general advertising - there is actually pretty darn good intuitive appeal to the apparently commonsense reaction, "just stay away from general solicitation."

I'll bet many companies will decide to stay inside the cozy, clubby confines of 506(b). But here's the problem with taking too much comfort from such a reassurance: industry practice today has been bending the old rule - prohibiting general solicitaiton and general advertising - to the point of breaking.

Joe Wallin puts it this way on his blog:

"What about startup weekends? What about business plan competitions? What about incubator demo or graduation days? Will the teams that compete in these events be deemed to have generally solicited an offering? Some of these events, if conducted as they’ve been run in the past, will clearly constitute general solicitation."

If you're going to content yourself (limit yourself? liberate yourself?) with the old way, if you're going to stay within the confines of 506(b), here's the longstanding verbiage from the Reg D rule set you need to get comfortable with:

". . . . neither the issuer nor any person acting on its behalf shall offer or sell the securities by any form of general solicitation or general advertising, including, but not limited to, the following: (1) Any advertisement, article, notice or other communication published in any newspaper, magazine, or similar media or broadcast over television or radio; and (2) Any seminar or meeting whose attendees have been invited by any general solicitation or general advertising . . . ."

Ask yourself: come September 23, will some offerings that formerly looked like 506(b) now look like 506(c)?

Photo: Entrepreneurs Club Berlin / Flickr.

Congress not yet fully awake to the problems with the SEC's proposed overhaul of Reg D

A letter to the SEC from two Republican congresspersons is getting a lot of attention.

The subject is SEC proposed Reg D rules at odds with Congressional intent under the JOBS Act. This is a point I and others previously made in the press so it is good to see some members of Congress waking up. (From TechCrunch: Let’s Have General Solicitation As Congress Intended It.)

8355141_067c162acc_oBut it's disappointing, frankly, that the letter is so strident and partisan. Yet again we have to hear over and over how late the SEC was in adopting 506(c). (Get over it already Rep. McHenry and look forward!)

And it's difficult to credibly speak for Congressional intent when you get core features of your own legislation wrong. Example: the letter speaks of the lifting of the ban on general solicitation "for those Rule 506 offerings that solely target accredited investors." That is exactly the opposite of the policy choice actually made in the legislation. The greatest significance of the lifting of the ban on general solicitation is that you need not target. You can broadcast if you like. The point is to only allow as purchasers those persons for whom you have taken reasonable steps to verify accredited status.

Really, the SEC's proposed re-trading of Title II of the JOBS Act should not be a partisan issue. I would think that moderate Democrats and the White House would be equally interested in seeing 506(c) work and in 506(b) being protected. After all, the JOBS Act was actively supported by the Obama administration, and championed by the President himself.

And I imagine the SEC could probably use the political cover as state regulators will never be at peace with the democratization of angel investing. I am speculating here, but the agency could be more worried about hedge fund advertising then what a little incubated three-person startup raising $200,000 might do. The right policy choice might be to say yes to information requirements for hedge funds, no for operating issuers.

The consensus, non-partisan agenda should include, not just general solicitation, but also the angel platform exemption that Rep. McHenry originally introduced as a floor amendment, with express support from then Rep. Barney Frank. Congressional intent for that provision could not have been clearer. And yet an SEC staff FAQ threatens to compromise its utility.

My call to New Democrats, White House policy staffers, independents worried about depriving startups of a useful federal exemption: get together and own, by consensus, what the JOBS Act was supposed to do for angel investing.

Photo: Diane Hamilton / Flickr.

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?

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