Texas Advanced Paralegal Seminar (TAPS) Wednesday, September 17th San Antonio, Texas

1. Raising Capital: Securities Law Compliance Related to Private and Public Offerings and Resales of SharesStephanie L. Chandler, Esq. Texas Advanced Paralegal Seminar (TAPS) Wednesday, September 17th San Antonio, Texas

2. 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 Virginia Juris Doctorate

3. Starting Place: Registration Required • All offerings must be registered with the SEC • Unless, that offering is exempt from Registration

4. Advantages • Complete exit of ownership • Provides liquidity • Diversification of wealth • Avoid family succession issues • Disadvantages • Difficult transition for long-term owner • Tax issues • Continued involvement in management • Potential need to accept note or stock as part of consideration received Sale of Company Partial Sales Transfers to Family/ Estate Planning • Partial sale • IPO (Initial Public Offering) • ESOP (Employee Ownership) • Family limited partnerships • Estate freezes through recapitalizations • Gifting • Advantages • Liquidity and diversification • Higher valuation multiples (IPO) • Retain some ownership • Capital for growth • Upside potential • Disadvantages • Retained interest/ limited exit • Regulatory/market oversight (IPO) • Expensive process (IPO) • Subject to veto power on major decisions • Accountability to a partner

5. Offer vs. Sale • Offer triggers compliance requirements • Compliance must happen before selling process starts

6. 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”) Private Offerings = Exempt

7. Requirements under 4(2) The purchasers of the securities must: • have sufficient knowledge and experience in finance and business matters to evaluate the risks and merits of the investment (“sophisticated investor”), or be able to bear the economic risk of investment; • have access to the type of information normally provided in a prospectus; and • agree not to resell or distribute the securities to the public.

8. Regulation A Exempts public offerings not exceeding $5 million in any 12-month period must file an offering statement (called a “Form 1-A) with the SEC for review Regulation D Safe harbor promulgated by the SEC under Section 4(2) Most common and today’s focus Desire Definition

9. 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).

10. “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 • 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

11. “Integration” • Whether the sales are part of a single plan of financing. • Whether the sales involve issuance of the same class of securities. • Whether the sales were made at or about the same time. • Whether the same type of consideration was received. • Whether the sales were made for the same general purpose

12. Rule 504 • Up to $1 million of securities in a 12-month period • Rule 504 is the typical means to accomplish a “friends and family” or “seed capital” offering

13. Rule 505 • Up to $5 million in any 12-month period • Unlimited number of “accredited investors” and 35 other persons • Do not need to satisfy the sophistication or wealth standards

14. 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)

15. 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 • 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.

16. Amendments to Reg D • New exemption from the registration requirements of the Securities Act for offers and sales to “large accredited investors” where a limited form of written announcement would be permitted (Rule 507) • Updated definition of “accredited investor” (Rules 505 and 506) • Shortens integration safe harbor from six months to 90 days

17. Definitional Changes

18. Paralegal’s Role • Blue Sky Analysis • Requirements for each state if not a 506 • Form D Filing Fees and Filing Office • Preparation of Form D Filings • Form U-2

19. Board of director resolutions Shareholders resolutions if stock not authorized Stock purchase agreement or subscription agreement Accredited investor questionnaire Certificate of Designations/ Amended and Restated Articles of Incorporation or Certificate of Formation Paralegal’s Role:Other Documents

20. Paralegal’s Role:Other Documents • Investors’ rights agreement - registration rights and rights of first refusal • Co-sale agreement - rights of investors to share in any premium and participate in sales of the company’s stock by founders and other major stockholders • Voting agreement - agreements among investors and other major stockholders as to the rights to vote for certain transactions or the right to elect a certain number of members of the Board of Directors. Note: Back of Presentation is Overview of Deal Terms

21. Other Exemptions • Section 4(6) – exempts offers and sales of securities to accredited investors when the total offering price is less than $5 million and for which a Form D has been filed. • Rule 701 - exempts sales of securities if made to compensate employees according to a written plan of compensation.

22. Take Aways … • All Shares issued in Private Offerings are Restricted • Registration or Exemption applies to Transaction not piece of paper

23. Initial Public Offering • Registered with the SEC • Underwritten • i.e. Google, Rackspace... $$ Invest in Growing Operations and Revenue

24. Documents • Registration Statement • filed with the SEC • Part I: Prospectus • Part II: Additional information • Expenses • Director indemnifications • Exhibits (including employment agreements for key employees and other material contracts) • Take away – www.sec.gov great place for forms • Several types of registration statements • Form S-1: The form for an IPO of a U.S. company • Less detailed forms: • Form S-3: Most simplified securities registration • Form S-4: Business combination or exchange offer • Form S-8: Shares offered to employees under employee benefit plans

25. Documents • Prospectus: describes: • The securities being offered • The company’s business • Financial statements • Biographies of officers and directors and compensation • Any other material information. • Must be declared effective by the SEC (appears to comply on its face with the various rules governing disclosure)

26. Documents • Underwriting Agreement • Firm Commitment Offering - underwriter buys all of the shares and bears the risk that the investors will not follow through on their orders • Best Efforts Offering - here the underwriter, acting as an agent, agrees to do its best to sell the offering to the public, but does not buy the securities outright and does not guarantee that the issuing company will receive any set amount of money • Listing application: the application to become listed on a national exchange such as the NYSE, AMEX or NASDAQ.

27. Alternative Public Offering (APO) which is the combination of a reverse merger with a simultaneous Private Investment of Public Equity (PIPE). It allows companies an alternative to the IPO as a means of going public while raising capital. In the reverse merger, the private company becomes public by merging with or being acquired by a public “shell” company. IPO vs. APO

28. Securities Exchange Act of 1934 • Regular Reports • Proxy filings • Beneficial ownership reports • Transaction reporting by officers, directors and ten percent shareholders (Section 16)

29. Sale of Restricted Shares • Rule 144 • Allows public resale of restricted and control securities if a number of conditions are met • Rule change effective February 15, 2008

30. Recent Changes • Shortened the holding period requirement • Relaxed Rule 144 filing requirements • Eliminated the manner of resale restrictions applicable to non-affiliates

31. Rule Changes

32. Rule Changes

33. Paralegal’s Role • Shareholders Representation Letters • Broker’s Representation Letters • Preparation of Form 144 Filings

34. Stephanie L. Chandler, Esq. Jackson Walker L.L.P. 210.978.7704 schandler@jw.com 112 E. Pecan Street, Ste. 2400 San Antonio, Texas 78205 www.jw.com

35. 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

36. Investors • Investor No. 1: Gringotts VC: 5,000,000 shares at $1.00 per share • Investor No. 2: Ollivanders VC: 1,000,000 shares at $1.00 per share

37. Amount Raised • $6,000,000, including $500,000 from the conversion of Subordinated Convertible Promissory Notes of Gringotts VC • $1,000,000 to be invested at the Closing • $2,000,000 to be invested upon completion of a prototype of the Firebolt • $2,000,000 to be invested upon achieving actual manufacturing of the Firebolt • $1,000,000 to be invested upon achieving initial sales of $250,000

38. Price Per Share • $1.00 per share (based on the capitalization of the Company set forth below) (the “Original Purchase Price”).

39. Pre-Money Valuation • The Original Purchase Price is based upon a fully-diluted pre-money valuation of $4,000,000 and a fully-diluted post-money valuation of $10,000,000 (including an employee pool representing 10% of the fully-diluted post-money capitalization).

40. Capitalization

41. Charter • Dividends • Liquidation Preference • Voting Rights • Protective Provisions • Optional Conversion • Anti-Dilution Provisions • Mandatory Conversion • Pay-to-Play • Redemption Rights

42. Dividends • Example: The Series A Preferred will carry an annual 10% cumulative dividend compounded annually, payable upon a liquidation or redemption. For any other dividends or distributions, participation with Common Stock on an as-converted basis.

43. Liquidation Preference • In the event of any liquidation, dissolution or winding up of the Company, the proceeds shall be paid as follows: Alternative 1 (non-participating Preferred Stock): First pay [one] times the Original Purchase Price [plus accrued dividends] [plus declared and unpaid dividends] on each share of Series A Preferred. The balance of any proceeds shall be distributed to holders of Common Stock.

44. Liquidation Preference (cont.) • Alternative 1 (non-participating Preferred Stock) – the Math: • Assume Hogwarts sold for $100,000,000 • If no conversion, Series A would receive $6,000,000 (money back only) • If Series A converts, it would receive $60,000,000 ($100,000,000 SP times 60% ownership percentage)

45. Liquidation Preference (cont.) • In the event of any liquidation, dissolution or winding up of the Company, the proceeds shall be paid as follows: Alternative 2 (full participating Preferred Stock): First pay [one] times the Original Purchase Price [plus accrued dividends] [plus declared and unpaid dividends] on each share of Series A Preferred. Thereafter, the Series A Preferred participates with the Common Stock on an as-converted basis.

46. Liquidation Preference (cont.) • Alternative 2 (full participating Preferred Stock) – the Math: • Assume Hogwarts sold for $100,000,000 • If no conversion, Series A would receive $6,000,000 (money back) plus 60% of the $94,000,000 balance, or $56,400,000 – total of $62,400,000 • If Series A converts, it would receive $60,000,000 ($100,000,000 SP times 60% ownership percentage)

47. Liquidation Preference (cont.) • In the event of any liquidation, dissolution or winding up of the Company, the proceeds shall be paid as follows: Alternative 3 (cap on Preferred Stock participation rights): First pay one times the Original Purchase Price plus accrued dividends and unpaid dividends on each share of Series A Preferred. Thereafter, Series A Preferred participates with Common Stock on an as-converted basis until the holders of Series A Preferred receive an aggregate of 5 times the Original Purchase Price.

48. Liquidation Preference (cont.) • Alternative 3 (cap on Preferred Stock participation) – the Math: • Assume Hogwarts sold for $100,000,000 • If no cap, Series A would receive $6,000,000 (money back) plus 60% of the $94,000,000 balance, or $56,400,000 – total of $62,400,000 • Assuming a 5x cap, Series A would receive $6,000,000 (money back) plus 60% of the $94,000,000 balance, but limited to 5x $6,000,000, or $30,000,000 – total of $36,000,000

49. Liquidation Preference (cont.)

50. Voting Rights • The Series A Preferred Stock shall vote together with the Common Stock on an as-converted basis, and not as a separate class, except (i) the Series A Preferred as a class shall be entitled to elect two (2) members of the Board (the “Series A Directors”), one of whom shall be designated by Gringotts VC and one of whom shall be designated by a majority of the Series A Preferred Stock, (ii) as provided under “Protective Provisions” below or (iii) as required by law.