34 posts categorized "Startup Law 101"

Bad actors, general solicitors, and other troublemakers

Big, big changes to Reg D filing requirements are potentially in the works, ranging from dire penalties for failure to file, to prefiling requirements to crimp the efficiency of Rule 506(c) offerings.

But these changes to Reg D filing requirements are in the works. They may not happen. Or, if they happen, they may be other than the changes first proposed.

8287466073_590433fbab_oMeantime, however, other changes have been implemented under Dodd-Frank and the JOBS Act, taking the form of final rules that impact day-to-day financings claiming exemption under Rule 506(b).

I'm thinking here primarily of the bad actor rule, now a part of Rule 506, and the renewed attention to general solicitation, which you want to track for purposes of reassuring yourself that you really are inside Rule 506(b) (which continues to prohibit general solicitation).

I thought it would be interesting to drive by how these changes to the law are being reflected in stock or convertible note purchase agreements.

Here's a bad actor rep and warranty from Bo Sartain - the party giving the rep here is the purchaser:

No Disqualification Events. Neither the Investor nor, to the extent it has them, any of its shareholders, members, managers, general or limited partners, directors, affiliates or executive officers (collectively with the Investor, the “Investor Covered Persons”), are subject to any Disqualification Event, except for a Disqualification Event covered by Rule 506(d)(2) or (d)(3). The Investor has exercised reasonable care to determine whether any Investor Covered Person is subject to a Disqualification Event. The purchase of the Shares by the Investor will not subject the Company to any Disqualification Event.

Pretty straightforward. A company asking an investor for such a rep may need to do more to look into whether the person is indeed a bad actor or not; but the rep doesn't hurt.

Investors, of course, may want a similar rep from the company - that the company's insiders don't include a bad actor.

And investors concerned with the risks of a 506(c) financing will ask the company for reassurance that it did not engage in general solicitation in connection with the offering (or any prior offering).

Here's an interesting rep from the model stock purchase agreement promulgated by the National Venture Capital Association. What makes it interesting is that purchaser, not the company, is giving assurances as to general solicitation:

No General Solicitation.  Neither the Purchaser, nor any of its officers, directors, employees, agents, stockholders or partners has either directly or indirectly, including, through a broker or finder (a) engaged in any general solicitation, or (b) published any advertisement in connection with the offer and sale of the Shares.

Implicit here for companies is the suggestion that, not only do you have to take care to not generally solicit, but you may also need to worry about whatever tweeting or blogging your investors might engage in during the course of the offering.

Typesetting photo: Eva-Lotta Lamm / 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.)

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?

Liveblogging SEC Webcast - Tweeting for Investors (of the "Verified Accredited" Variety)

William Carleton and Joe Wallin live blog the SEC Open Meeting webcast on Wednesday, July 10.

Update 12:22 Pacific: here are links to the various rules, now posted:

This meeting is about:

  • lifting the ban on general solicitation in Rule 506 offerings limited to accredited investors (angels);
  • "verification" of accredited investor status;
  • changes to Form D (the filing that is made in connection with most startup offerings); and
  • "bad actor" rules for startup investing.

Recent posts on this blog, anticipating today's meeting:

Reg D's "Super Wednesday?"

Joe Wallin left a comment to Friday's post. It was a reminder – discrete and diplomatic – that Wednesday's SEC meeting isn't only about lifting the ban on general solicitation and possibly setting standards on accredited investor "verification."

According to the Sunshine Act notice, the meeting is also to consider "bad actor" disqualification rules, and possibly also changes to Form D.

The "bad actor" rules have never seemed like a big deal to me. Adding such rules to Rule 506 was part of the compromise of rolling back the changes in the Dodd bill that would have utterly decimated angel investing. (A second element of the compromise, removing the principal residence from the calculation of net worth, is already in place.)

But Joe has always been worried about the imposition of a "bad actor" paradigm on Rule 506. He wrote about it years ago. He may be right. We'll see.

Changes to the Form D that must needs be filed, if those include tightening up the requirement that it be filed, and deadlines for when it should be filed - especially if "noisy" 506 filings need to be made prior to any sale - those will be a big deal.

Reg D's "Super Wednesday?"

Liveblogging Supreme Court same-sex marriage cases: What today's rulings mean for angel investing and the startup financing ecosystem

Go to Scotusblog and elsewhere for discussion of the broader societal ramifications of the US Supreme Court's decisions this morning on same-sex marriage. The picture is from an @Scotusblog tweet.

BNryXjpCEAMbLs7On this blog, we want to focus on what the decision regarding DOMA likely means for the accredited investor definition under Rule 501 of Regulation D.

The decision is in. Amy Howe on the Scotusblog live blog reports, "DOMA is unconstitutional as a deprivation of the equal liberty of persons that is protected by the Fifth Amendment."

Click here for the opinion.

More from Howe: "In determining whether a law is motivated by improper animus or purpose, discriminations of an unusual character especially require careful consideration. DOMA cannot survive under these principles." I think she is paraphrasing from page 20 of the opinion of the Court.

Here is the section of DOMA (the Defense of Marriage Act) that is being struck down:

“In determining the meaning of any Act of Congress, or of any ruling, regulation, or interpretation of the various administrative bureaus and agencies of the United States, the word ‘marriage’ means only a legal union between one man and one woman as husband and wife, and the word ‘spouse’ refers only to a person of the opposite sex who is a husband or a wife.” 1 U. S. C. §7.

 Here's how Justice Kennedy's opinion for the 5-4 majority describes the impact of the above quoted section of DOMA:

"The definitional provision does not by its terms forbid States from enacting laws permitting same-sex marriages or civil unions or providing state benefits to residents in that status. The enactment’s comprehensive definition of marriage for purposes of all federal statutes and other regulations or directives covered by its terms, however, does control over 1,000 federal laws in which marital or spousal status is addressed as a matter of federal law."

And here's more from Kennedy's opinion (pages 15-16) on the impact DOMA had:

"it enacts a directive applicable to over 1,000 federal statutes and the whole realm of federal regulations. And its operation is directed to a class of persons that the laws of New York, and of 11 other States, have sought to protect."

Scotusblog is reporting that references in dissenting opinions on DOMA indicate that the Court will dismiss the California Proposition 8 case on standing. To be clear, the opinion on the Prop 8 case has NOT been released yet, but that would appear to be coming next, after dissent(s) are read aloud from the bench, apparently, in the DOMA case.

It is now 7:23 AM Pacific. I guess the proper reference, since the Court is on the east coast, should be 10:23 AM Eastern.

Here's how Howe of Scotusblog summarizes, for non-lawyers, the upshot of the case: "What this means, in plain terms, is that same-sex couples who are legally married will be entitled to equal treatment under federal law-- with regard to, for example, income taxes and Social Security benefits."

My friend and former law firm colleague David Ziff has tweeted, "The federal govt will have to re-work all their regulations to make benefits available to same sex couples." I'm sure that must be the case but I don't think that is true with regard to Rule 501 of Regulation D.

Rule 501 reads in pertinent part,

"(a) Accredited investor. Accredited investor shall mean any person who comes within any of the following categories, or who the issuer reasonably believes comes within any of the following categories, at the time of the sale of the securities to that person:

. . .

"(5) Any natural person whose individual net worth, or joint net worth with that person's spouse, exceeds $1,000,000 [excluding the person's primary residence]. . . .

"(6) Any natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person's spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year[.]"

Emphasis added.

So I think the implications of the Court's ruling on DOMA is self-executing with respect to who is and isn't allowed to participate in angel investing. "Spouse" now means any person with whom the potential accredited investor is married, regardless of gender. The attenuated, discriminatory meaning imposed by DOMA is now gone.

Not so clear, however, that couples in civil unions are "spouses" to one another. For someone who is part of a couple who wish to be married, but state law doesn't permit them to be, he or she may yet be shut out of the ability to combine income or net worth to meet what is effectively a lower accredited investor standard for married (now, regardless of gender) couples.

The link to Rule 501 above is to the offical language of the rules. This summary of the accredited investor definition on the SEC website is friendlier.

Turning back to Kennedy's opinion striking down DOMA, there as a lot of discussion and citation on pages 16-18 about how marriage is the province of state law, not federal law, and how DOMA abrogated that precept.

From pages 20-21 of the opinion:

"DOMA’s unusual deviation from the usual tradition of recognizing and accepting state definitions of marriage here operates to deprive same-sex couples of the benefits and responsibilities that come with the federal recognition of their marriages. This is strong evidence of a law having the purpose and effect of disapproval of that class. The avowed purpose and practical effect of the law here in question are to impose a disadvantage, a separate status, and so a stigma upon all who enter into same-sex marriages made lawful by the unquestioned authority of the States."

The argument here I think could be applied or adapted in reasoning that persons in civil unions, designated beneficiary arrangments, and other state law relationships designed to afford couples the economic benefits of marriage, should also be treated as "spouses" for purposes of the accredited investor standard. But no question Kennedy uses the word "marriage."

Here's another quote from Kennedy's opinion, one that helps put the implications of the prior DOMA-discrimination in an angel group context, I think:

"By creating two contradictory marriage regimes within the same State, DOMA forces same-sex couples to live as married for the purpose of state law but unmarried for the purpose of federal law, thus diminishing the stability and predictability of basic personal relations the State has found it proper to acknowledge and protect."

In other words, under DOMA, before it was struck down, an angel in a given state who was married might well think she or he would be able to meet the same standard to be qualified as an angel, as would any other married person in the angel group. But, because of DOMA, before it was struck down, she or he might in fact had to have met a higher standard than other members of the angel group who were in marriages that the federal government called out as not legitimate.

So DOMA is unconstitutional, the Court holds, "as a deprivation of the liberty of the person protected by the Fifth Amendment." 

Getting back to the limits of the ruling, the word marriage, the penultimate sentence of the Court's opinion probably settles it: "This opinion and its holding are confined to . . . lawful marriages."

That's probably enough for this morning. Signing off at 11:15 AM, Eastern!

Light reading

Last night I participated in a "legal best practices" panel at the new WIN Reactor space (near the Seattle Art Museum Sculpture Park).

I'm just getting to know about the Reactor program. Its head, Chip Hallett, described it as a "launch incubator" for startups in the game industry.

WIN reactor legal best practices panelThe panel was a mix of lawyers and game company founders/CEOs. As anyone would expect going in, the founders/CEOs were more interesting to hear. (That said, Seattle attorney Scott Warner did an uncommonly good job of moderating the discussion; he'd be a good moderator even when the topic isn't legal).

I think the whole show (long – 2 1/2 hours?) is preserved for posterity on video - I can actually see it being a good resource for first time game startup entrepreneurs, because Scott was so careful to cover all the basic topics - so I sure as heck won't attempt anything like a recap here.

What I do want to remark on briefly: the answers the CEOs/founders gave to one of Scott's questions, to the effect of, do you read all the legal contracts that affect your business?

Bob Berry of Uber Entertainment, Matt Wilson of Detonator Games, and Randy Chung of Zhurosoft, each said, yes, of course, every line, you have to.

I knew this is the answer Bob would give, as I and my firm represent Uber and know his style. But I was impressed to hear Matt and Randy equally adamant.

Sensing that he had hit an especially rich vein in the silver mine, Scott pressed everyone for examples of where contracts go wrong, issues presented or sections and legal contracts to be especially wary of. Everyone had great examples. We got into not just legal drafting "gotchas" but also the nitty-gritty of payment terms and how important it is to spell out unspoken assumptions.

If I come across a link to the video archive, I'll try to remember to post it here.

I'll leave you with a link to a video calling card that Bob kindly created for me in the span of about 90 seconds, using a fun app created by a startup which is part of the current WIN/Reactor class, Freak'n Genius. It had me in stitches.

Photo courtesy of Julian Allen, REACTOR community manager.

Related Posts with Thumbnails