2014 Technology Entrepreneurship Boot Camp Sponsored by Jackson Walker

UTSA Colleges of Business and Engineering

TAKE YOUR TECHNOLOGY TO THE LIMIT!

Slide 1CITE BootCamp January 2013

2014 Technology Entrepreneurship Boot Camp

Sponsored by Jackson Walker

http://www.jw.com/


TAKE YOUR TECHNOLOGY TO THE LIMIT! Stephanie L. Chandler

• Partner: Business Transactions (Corporate/Securities/M&A)

• Firm-wide Section Head: Technology Section

University of Nebraska B.S.B.A. in Finance

University of VirginiaJuris Doctorate

http://www.jw.com/



When Should You Formalize Structure?

Initiation of Business OperationsAsset ProtectionCapital RaisingSuccession PlanningMultiple other factors ….

Choose the Right Entity


TAKE YOUR TECHNOLOGY TO THE LIMIT! Choose the Right Entity

• Sole Proprietorship• General Partnership (GP)• Corporation

– C-Corp– S-Corp

• Limited Partnership (LP) • Limited Liability Company (LLC)



Sole ProprietorshipGeneral Partnership (GP)

Default Entity No liability protection, partners are jointly and severally liable for all partnership liabilities*The fallacy of a DBA filing …. county DBAs and State of Texas DBAs

* Even in Texas your homestead protection may be limited depending on the specific facts so your home may still be at risk.



Corporation

Officers: President, Vice President,

CEO, CFO, Secretary, Treasurer

Employees/Operations/Contracts

Board of Directors

Shareholders Ownership

Strategy/Direction

Implementation/ Signing Authority

Liabilities


TAKE YOUR TECHNOLOGY TO THE LIMIT! Corporation

Pros• Liability limited• Ease of creation• Most common – easily

understood• Growth oriented• Centralized

Management • Equity Compensation

Easily Implemented

Cons• Federal income tax

and Texas Margin tax • S-election restrictions


TAKE YOUR TECHNOLOGY TO THE LIMIT! Limited Liability Company




Board of Directors

Shareholders Ownership

Strategy/Direction

Implementation/ Signing Authority

Liabilities




Managers

Members


TAKE YOUR TECHNOLOGY TO THE LIMIT! Limited Liability Company (LLC)

Pros• Can have tax flow

through • Limited liability

Cons• Federal income tax and

Texas margin tax• Different terminology

(i.e. Managers and Members instead of Board and Shareholders)

• Not as accepted by institutional investors

• Difficult if option compensation is part of your growth strategy



Traditional and Non-Traditional Lenders

Most major traditional banks do not lend to startups/do so only rarely

Silicon Valley Bank, Square 1 Bank lend to entrepreneurial companies (positive c/f)

Accts Receivable, Inventory, Fixed Assets

Terms may include: company’s stock, fees, collateral, agreement to pay for AR audits, monthly reporting, audited financial statements, compliance reporting, financial covenants plus all banking relationships – checking, credit cards, investments, etc. must be with lender



Angel Investors

Friends and Family Angel Funding – wealthy private

individuals, with background in business, usually smaller than VC’s ($25K - $250K). They prefer to deal directly with the entrepreneur, like local deals, often want to develop a relationship with owners, they are limited in the number of investments they will do concurrently. Usually easier to deal with than VC’s. Invaluable to start-ups.

Must Still Comply with Applicable Securities Laws:• Exemption (“accredited investors”)• Notice Filings



Starting Place: Registration Required

• All offerings must be registered with the SEC• Unless, that offering is exempt from

Registration• Doesn’t matter if small private sale or an

offering which is immediately listed on the NYSE

RULES FOR RAISING FUNDS



Private Offerings = Exempt

• Privately negotiated sales

• Must not involve any general solicitation or general advertising

• Section 4(2)* - the private-offering exemption - “transactions by an issuer not involving any public offering”

* Securities Act of 1933(the “Securities Act”)



Reg D

• Rule 504 provides an exemption for the offer and sale of up to $1 million of securities in a 12-month period

• Rule 505 provides an exemption for offers and sales of securities totaling up to $5 million in any 12-month period.

• Rule 506 provides another exemption for sales of securities under Section 4(2) with no dollar limit.



Rule 506

• Unlimited number of “accredited investors” and 35 “sophisticated” nonaccredited investors

• Popular if Integration is a concern• Popular to comply with Blue Sky

(National Securities Markets Improvement Act of 1996 (NSMIA) removed offerings under Rule 506 from state regulation)


TAKE YOUR TECHNOLOGY TO THE LIMIT! “Accredited Investor”

• a bank, insurance company, registered investment company, etc.

• an employee benefit plan• a charitable organization, corporation or partnership with

assets ≥ $5 million• a director, executive officer or general partner of the company

selling the securities• a business in which all the equity owners are accredited

investors• a natural person with a net worth of at least $1 million (not

including house)• a natural person with income exceeding $200,000 in each

of the two most recent years or joint income with a spouse exceeding $300,000

• a trust with assets of at least $5 million


TAKE YOUR TECHNOLOGY TO THE LIMIT! Why Only Accredited Investors?

Private placement memorandum (“PPM”) that meets Reg D requirements = $$$$$

If more than $1 million is raised in a 12-month period, Rule 504 is not available

Under Rule 505 and 506, a PPM would be required to offer securities to nonaccredited investors

NOTE: Even if not required, delivering a PPM or at least a detailed business plan is probably advisable for liability and marketing reasons, particularly in fulfilling the antifraud requirement.

NEWSFLASH: May now also allow to do broader solicitation with the changes resulting from JOBS Act



• New Rule 506(c)—General solicitation and advertising permitted– Sales only to accredited investors– Reasonable steps to verify AI status

• 506(d): Bad Actor disqualification– 506 Unavailable if a Covered Person has had a Disqualifying Event

• 506(e): Reporting of prior “bad actor events”

JOBS Act



A Few Warnings

• Once you go 506(c), you can’t turn back.• Extra requirements and complications may

scare off some investors• Does the issuer have a legitimate business

justification for using 506(c)?• Securities Fraud Rules still very much apply



Angel Investors (continued)

Advantages Provides needed capital for start-ups, usually seek smaller

deals, like early stage enterprises, higher risk levels, less formal investment criteria, often very enthusiastic, can attract additional investors, requires little control, often brings vast amount of knowledge & experience, often look beyond monetary gain, they are located everywhere

Disadvantages Rarely make follow-on investments, tend to be less patient

than VC’s, may require some form of control (board seat), may lack industry knowledge, do not have national recognition so they are hard to find, they chose to be “hidden” to avoid being pestered with business plans and telephone calls



Crowdfunding Basics

• Must be conducted through a registered BD or “funding portal”

• Issuers can raise up to $1,000,000 a year• Investors can invest, in any 12-month

period, across all 4(a)(6) offerings:– Greater of $2,000 or 5% of income or net

worth, if both income and net worth are < $100,000

– 10% of income or net worth, if either income or net worth is ≥ $100,000, up to a max of $100,000.



Highlights of the Crowdfunding Rules

• Issuers can’t conduct an offering (or concurrent offerings) through more than one intermediary

• Exemption not available to private funds (or funds that are excluded from the definition of investment company by Section 3(b) or Section 3(c) of that Act).

• Exemption not available to shells—entities with “no specific business plan” other than to engage in a merger or acquisition with unidentified company or companies.

• For purposes of the dollar limits, “issuer” includes any entity controlled by or under common control with the issuer. It also includes any predecessor.



Form C, which has to be filed on EDGAR and provided to the intermediary and investors, includes, among other things:

• Description of business, capitalization, management and ownership • Risk factor disclosures• Detailed description of any exempt offerings conducted within the last

three years;• A financial description including discussion of results of operations,

liquidity, and capital resources• Financial statements, which need to be (taking into account the targeted

amount for the offering):i. Certified by the PEO for issuers with $100,000 or less in 4(a)(6) offerings

in the last year; ii. Reviewed by an independent public accountant (and include the review

report) for $100,000 to $500,000; andiii. Audited by an independent public accountant (and include audit report)

for over $500,000.




• If the offering doesn’t raise its target amount, offering cancelled and funds returned.

• Amendment to Form C has to to report any material change. Any investor that does not reaffirm their commitment within 5 business days will have their investment cancelled.

• 4(a)(6) issuers have to file an annual report on EDGAR (Form C-AR) that includes most of the items from Form C, including financials.

• Funding portals are prohibited from handling investor funds or securities.

• Form C needs to be made available for at least 21 days before securities can be sold (but commitments can be accepted during that time).

• Funding portals have their own registration statement they need to file—Form Funding Portal.

• Securities purchased in 4(a)(6) offerings are still somewhat restricted.




Venture Capital ($1 million - $50 million)

Advantages Excellent source of capital / funding committed to your

business VC’s often are prepared to invest in continued rounds as

the business grows and achieve it’s milestones Bring valuable skills, contacts, experience and discipline to

your business VC’s have common goals with the entrepreneur – growth,

profitability and increased value of the business VC’s time horizon is often 3 – 7 years before exiting. Looking to have a 3 – 7 times return on their capital Exiting usually in the form of a Public Offering or Sale to a

larger business after reaching certain milestones.



Venture Capital ($1 million - $50 million)

Disadvantages Raising Equity Capital – demanding, costly, time consuming.

Your business suffers as you devote your time to answering questions

Due Diligence process can be brutal – background checks, justification of your business plan, legal review, patent review, financial forecasts, etc (note: this can be a very useful process to force management to think through every issue. This is valuable even if funding doesn’t occur)

Often the entrepreneur will lose control after 2nd round of financing. VC’s may want to bring in a marquee CEO, CFO, etc. to run the business.

Management reporting to the VC’s is often onerous, requiring 4 to 6 board meetings per year plus answering questions, providing updates and monthly reporting.



Grants

GRANTS.gov

SBIR (Small Business Innovation Research) www.sbir.gov 11 federal departments participate 2.5% of the total extramural research budgets agencies

Advantages Funds are non-dilutive – don’t have to give up any ownership Great way to fund your initial invention

Disadvantages Takes tremendous amount of time, drawn out process – 8 to 14

months No guarantee of having your application approved Costs money to prepare the grant application properly Significant reporting, follow on audits, strict rules, SBIR grant may not be perfectly aligned or you may have trouble

finding a grant solicitation that matches your needs

http://www.sbir.gov/



Other Alternatives

• Private Foundations• The Robert Wood Johnson Foundation • The Kresge Foundation • Otto Bremer Foundation • The Kate B. Reynolds Charitable Trust

• Private Foundations• American Heart Foundation• Juvenile Diabetes• National Burn Repository of the American

Burn Association• American Cancer Society

http://www.rwjf.org/index.jsp

http://www.kresge.org/



http://fdncenter.org/grantmaker/bremer/

http://www.kbr.org/



Governmental Programs

• Federal R&D Contracts– National Institute of Health

http://oamp.od.nih.gov/contracts/contract.htm– Department of Energy

http://www.energy.gov

http://oamp.od.nih.gov/contracts/contract.htm

http://www.energy.gov/sciencetech/grants.htm



Governmental Funds

• Texas Emerging Technology Fund (ETF)– Apply through T3DC (South Texas)– emerging scientific or technology fields that

have a reasonable probability of enhancing this state ’s national and global economic competitiveness.

– Must have partnership with Texas State institution


TAKE YOUR TECHNOLOGY TO THE LIMIT! Strategic Partnering

Strategic Private Investors/Partners

– Large corporations• Potential Acquirors• Potential Customers



Getting Comfortable with Investor Terminology

• NVCA Model Legal Documents– www.nvca.org - Model Legal Docs Button

• Offering Terms– Closing Date– Investors– Amount Raised– Price Per Share– Pre-Money Valuation– Capitalization


TAKE YOUR TECHNOLOGY TO THE LIMIT! Capitalization

Pre-Financing

Post-Financing

Security # of Shares

% # of Shares

%

Common –Founders

3,000,000

100% 3,000,000 30%

Option Plan

0 0% 1,000,000 10%

Series A Preferred

0 0% 6,000,000 60%

Total 3,000,000

100% 10,000,000

100%

* Consider role of bridge notes


TAKE YOUR TECHNOLOGY TO THE LIMIT! Joint Ownership Issues

Not only your partner, but … Buy-sell/Shareholders agreements

What if I don’t want to keep doing this?What if my partnerdies? Gets divorced?Files for bankruptcy?

Issues are always easier to resolve before money is a factor


TAKE YOUR TECHNOLOGY TO THE LIMIT! READ EVERYTHING …

• “Boilerplate” = Most important provisions, do NOT ignore

• Don’t assume a provision can’t be changed

• Don’t sign contracts until reviewed by a lawyer


TAKE YOUR TECHNOLOGY TO THE LIMIT! Use of Forms

13. Venue. This Agreement and all amendments or modifications hereof shall be governed by and interpreted in accordance with the laws of the State of Confusion governing contracts wholly executed and performed therein, and shall be binding upon and inure to the benefit of the parties, their respective heirs, executors, administrators and successors. Jurisdiction for any suit filed to enforce the provisions of this Agreement by either party shall be filed in the federal or state courts of Mostfavorable District of Confusion in Hitsville, Confusion or Miracle County, Confusion.



Stephanie L. Chandler, Esq.

[email protected]

112 E. Pecan Street, Ste. 2400San Antonio, Texas 78205

www.jw.com

http://www.jw.com/