Crowdfunding for Small Business: Maximizing Capital Structure and Finding the Right Investors

1. Crowdfundingfor Small Business February 21, 2013 Rassul Zarinfar, Founder of Buffalo Bayou Brewing Company www.buffbrew.com Travis Crabtree Looper Reed & McGraw, P.C. www.lrmlaw.com www.emedialaw.com

2. Outline • Capital Structure is like a Car • What options make sense for you? • When does crowd-funding add value, and how? • Investors are Business Partners You Can’t Divorce • Who should you be looking for? • How will you find them? • & What do you say when you do? • Tactics: Structuring the Deal • What laws should I be worried about? • How much should you ask for? • How many people & how much each? • The JOBS Act: How Crowd-Funding Will Change

3. Capital Structure is Vehicle • What vehicle should I buy for my company? • Capital Structure is the vehicle for your strategy • It Can Add Value • Business partners know things you don’t! • The right structure can help add more capital as you grow • It Can Destroy Value • Lawsuits over who deserves what • Short-term decisions to pay debts or buy out partners Every decision depends on the business model, especially financing

4. A Refresher on Debt vs. Equity Debt Equity They own nothing They own assets & rights to future cash flows You control everything, banks can’t vote, only repossess Democracy: shareholders vote on certain decisions You pay a fixed amount back, no matter how you do You more you make, the more you pay So then… which one of these is: ?

5. How Many Investors Should I Have? A few put in a lot A lot put in a little Vs. Questions to consider: What’s the product/service? How complex is the deal? Will you need more funding later? What value will each investor bring?

6. How Many Investors Should I Have?

7. Crowd-Funding Has Worked for Me • Positives • Experts I can call on • Extensive Social Networks for a Social Product • Connections throughout the community • Easy Access to Capital: “Dry Powder” • Negative • Herding Cats • Simplistic equity for semi-sophisticated investors • Lots of feedback over minutiae • Lots & lots of phone calls • Herding Cats • Fiduciary Responsibility My Situation: Social Networks Sell Beer Simple Deal Terms Simple Business to Understand Highly-Skilled Friends

8. Fiduciary • Corporate officers and agents owe a fiduciary obligation to the corporation. See, e.g., Poe v. Hutchins, 737 S.W.2d 574, 579 (Tex. App. – Dallas 1987, writ ref. n.r.e.). • The officers and directors are individually liable for fraudulent or tortious acts committed while in the service of their corporations. See Hyman Farm Service v. Earth Oil and Gas, 920 S.W.2d 452, 455 (Tex.App.–Amarillo 1996, no writ).

9. Fiduciary - the jury question Did Don Davis comply with his fiduciary duty to Paul Payne? To prove he complied with his duty, Don Davis must show— 1. the transaction[s] in question [was/were] fair and equitable to Paul Payne; and 2. Don Davis made reasonable use of the confidence that Paul Payne placed in him; and 3. Don Davis acted in the utmost good faith and exercised the most scrupulous honesty toward Paul Payne; and 4. Don Davis placed the interests of Paul Payne before his own, did not use the advantage of his position to gain any benefit for himself at the expense of Paul Payne, and did not place himself in any position where his self-interest might conflict with his obligations as a fiduciary; and 5. Don Davis fully and fairly disclosed all important information to Paul Payne concerning the transaction[s]. Answer “Yes” or “No.” Answer: _________

10. Equity Investors are business partners you can’t divorce Don’t take money carelessly II.

11. Who Should You Be Looking For? • Sophistication level matters • Don’t ever take money from people who don’t understand startup investing. Period. • Wealth Matters • Avoid people risking more than they can lose comfortably • You need more than just cash • The best Investors bring skills & networks that you don’t have • Entrepreneurs think “all I need is money and I can make this work if they just leave me alone”. You’re wrong. You can’t do this alone. • Choose investors that challenge you intellectually • Be wary investors that micro-manage • Prefer Pre-Existing Relationships

12. How Will You Find Them? • Personal, Social Network • Personal, Social Network • Coffee Chats, Meetups, professional organizations • Personal, Social Network • Anywhere else humanly possible • Online Forums & Tools • Kickstarter, etc. Don’t be that person who’s just looking for a buck I never set out looking for investors anywhere. I sought people who would give insight on my business idea & entrepreneurship in general. I shared my business plan with anyone and built real relationships. Soon enough, people started asking to invest.

13. The Pitch: What to Say Honesty, Transparency Knowledge/Expertise • Set clear expectations from the beginning & you’ll avoid fights later • Build trust early with simple, clear deal terms • Admit your failures & fears: people trust you more • If you lie, they’ll figure it out. You’ll get their cash today & meet their lawyers tomorrow. • Know your plan & its industry backwards and forwards • Read up on all industry publications • If someone asks a question you don’t immediately know the answer to, look it up and get back to them • If you miss the same question twice, you’ve failed. Period. In the age of Google, there is no excuse for ignorance Passion Cautious Optimism • You’re going to be doing this 24/7. Show them that you’re committed & excited • “Bet the Jockey not the Horse” • Passion is infectious. Leaders share their vision • Don’t promise what you can’t deliver. • Be realistic, and candid. • Avoid wishy-washy answers, but also avoid being resolute about uncertainty Good deals get funded. Don’t be pushy, and don’t compromise your ethics out of fear.

14. Tactics: Structuring the Deal III.

15. Laws to Navigate Federal: SEC regulates all securities offerings Texas: Texas State Securities Board Texas Securities Act Others States: Each state has “Blue Sky Laws”

16. How Much Should You Ask For? I needed way more than I set out to raise at first Goals change as you gain information Choose a structure flexible enough to raise more later

17. Sequencing the Raise for Growth Round 1: $70k Round 2: $20K I pledge $50,000 I don’t have more Yes, $50,000 No I pledge $40,000 Yes, $20,000 I have another $20k Yes, $20,000 I pledge $30,000 No You said no dude. No

18. Sequencing the Raise for Growth Round 1: $70k Round 2: $50K I pledge $50,000 I have another $20k Yes, $30,000 Yes, $20,000 I pledge $40,000 Yes, $20,000 I have another $20k Yes, $20,000 I have another $10k I pledge $30,000 Yes, $20,000 Yes, $10,000 Accepting less from more people increases your access to capital

19. How Many People is Too Much? Only one A few people A lot of people • A strong team of experts can become your biggest advises • More connections than you otherwise have • Easier access to follow-on capital • Simple business meetings • Your single investor is probably really committed & you’ll get their full focus • More passionate advocates of your brand • Greater social networks, word of mouth advertising & connections • Surrounded by experts who can help • No one “bet the farm” • Easiest access to follow-on capital • Lots of time communicating • Fiduciary responsibility to a lot of people • Tragedies (Death & Divorce) will definitely come up and distract you • Lots of people to answer to if things go wrong • Too many cooks in the kitchen? • Small investments mean they don’t care as much about you • One person has a lot of control over you • Strategic decisions can become “coin-flips” & arm wrestling matches • It better be the right person! • Over-investment happens quickly • Communication becomes a burden • People have a lot invested in you • What if the investors gang up? • More fiduciary responsibilities • Greater risk of alienating someone and earning a lawsuit

20. JOBS Act: How New Laws Will Affect Crowd-Funding IV.

21. Jumpstart Our Business Start-Ups • Problem Addressed The Securities Act of 1933 states that entities cannot offer or sell securities to the public unless: (a) the offering is registered with the SEC, or (b) there is an available exemption from registration

22. Jumpstart Our Business Start-Ups • Problem Addressed - Rule 504 Under Rule 504, no registration, but, • Can only offer and sell up to $1 million of securities in any 12-month period; • May sell to an unlimited number* of investors regardless of whether they are accredited or sophisticated; • Must inform purchasers that they receive restricted securities,* meaning that the securities cannot be sold for six months or longer without registering them; • No PPM required, and • Cannot use general solicitation or advertising to sell the securities.

23. Jumpstart Our Business Start-Ups • Problem Addressed - Rule 505 Under Rule 505, no registration, but, • Can only offer and sell up to $5 million of securities in any 12-month period; • May sell to an unlimited number of “accredited investors and up to 35 other persons who do not need to satisfy the sophistication or wealth standards associated with other exemptions; • Must inform purchasers that they receive restricted securities, meaning that the securities cannot be sold for six months or longer without registering them; • Cannot use general solicitation or advertising to sell the securities; and • If you use unaccredited investors, you must disclose information.

24. Jumpstart Our Business Start-Ups • Problem Addressed - Rule 506 Under Rule 506, unlimited amount of raise; no registration, but, • May sell to an unlimited number of “accredited investors” and up to 35 other persons who must be “sophisticated investors” -- that is, they must have sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment; • Cannot use general solicitation or advertising to sell the securities; and • If you use unaccredited investors, you must disclose information.

25. Jumpstart Our Business Start-Ups • Problem Addressed - the Sophisticated Investor • they must have sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment QUESTIONNAIRE Employment and Business History Education Income Objectives Investment History Representation that you have read and understood the PPM, for your own account, not registered, not liquid and not borrowed money invested.

26. Jumpstart Our Business Start-Ups • Problem Addressed - the Accredited Investors 1. a bank, insurance company, registered investment company, business development company, or small business investment company; 2. an employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million; 3. a charitable organization, corporation, or partnership with assets exceeding $5 million; 4. a director, executive officer, or general partner of the company selling the securities; 5. a business in which all the equity owners are accredited investors; 6. a trust with assets in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes.

27. Jumpstart Our Business Start-Ups • Problem Addressed - the Accredited Investors 7. a natural person who has individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase, excluding the value of the primary residence of such person; or 8. 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 for those years and a reasonable expectation of the same income level in the current year.

28. Jumpstart Our Business Start-Ups • Problem Addressed - the PPM “AN INVESTMENT IN UNITS IS SPECULATIVE AND INVOLVES A HIGH DEGREE OF RISK. See “Risk Factors” beginning on page 3. THERE IS NO PUBLIC MARKET FOR THE UNITS AND NO PUBLIC MARKET IS EXPECTED TO DEVELOP AS A RESULT OF THIS OFFERING OR AT ALL. AN INVESTMENT IN UNITS IS SUITABLE ONLY FOR OFFEREES WHO HAVE NO NEED OF LIQUIDITY IN THEIR INVESTMENT. UNIT HOLDERS MUST BE PREPARED TO BEAR THE ECONOMIC RISK OF THE INVESTMENT FOR AN INDEFINITE PERIOD AND BE ABLE TO WITHSTAND A TOTAL LOSS OF THEIR INVESTMENT.”

29. Jumpstart Our Business Start-Ups • Problem Addressed - the PPM RISK FACTORS Exploration for shipwrecks is speculative by its very nature, and involves a high risk of loss. A large number of expeditions do not find a submerged vessel, and even when a vessel is found, there is a high likelihood that the expedition will not find artifacts and other items of value in an amount necessary to offset costs to conduct operations. If the Dive Operations are not successful, then Unit Holders might receive no return of (or from) their investment. Therefore, Unit Holders must be prepared to lose all of their contribution, whether in cash or services provided, and there can be no assurance that even if any items of value are found, that the value will be sufficient to cover operating expenses. Distributions to Unit Holders could be adversely affected if the Dive Operations cause any environmental damage. Company does not intend to maintain environmental hazards insurance, so any liability due to environmental damages will directly reduce profits otherwise available to the Unit Holders.

30. Jumpstart Our Business Start-Ups • Problem Addressed - the PPM RISK FACTORS Exploration for shipwrecks is speculative by its very nature, and involves a high risk of loss. A large number of expeditions do not find a submerged vessel, and even when a vessel is found, there is a high likelihood that the expedition will not find artifacts and other items of value in an amount necessary to offset costs to conduct operations. If the Dive Operations are not successful, then Unit Holders might receive no return of (or from) their investment. Therefore, Unit Holders must be prepared to lose all of their contribution, whether in cash or services provided, and there can be no assurance that even if any items of value are found, that the value will be sufficient to cover operating expenses. Distributions to Unit Holders could be adversely affected if the Dive Operations cause any environmental damage. Company does not intend to maintain environmental hazards insurance, so any liability due to environmental damages will directly reduce profits otherwise available to the Unit Holders.

31. Jumpstart Our Business Start-Ups • Problem Addressed - the PPM RISK FACTORS The Partnership is a newly formed entity that has no operating history upon which to base an evaluation of an investment in the Units. The Partnership will be subject to the risks involved with any speculative new venture. There can be no assurance that the Partnership will be able to operate profitably in the future. The Partnership will be subject to fluctuations in the real estate markets. If the Partnership is unable to operate successfully, or its operations fail to produce sufficient revenues to cover operating and other expenses, the Partnership and the investors in the Partnership may suffer a partial or total loss of their investment. Further, the Partnership is only obligated to make distributions to the Partners (including the Preference Amount) to the extent that the Partnership generates income in excess of Partnership expenses. Further, the Partners have no right to receive any distributions from the Partnership, including that no Partner has any right to receive a return of all or any portion of its capital contributions to the Partnership (including funds paid to acquire Units).

32. Jumpstart Our Business Start-Ups TABLE OF CONTENTS SUMMARY RISK FACTORS INVESTOR SUITABILITY PLAN OF DISTRIBUTION OPERATIONS COMPENSATION AND REIMBURSEMENT MANAGEMENT SUMMARY OF PRINCIPAL TERMS OF COMPANY AGREEMENT 10 TAX ASPECTS REPORTS AND RECORDS RESTRICTIONS ON TRANSFERABILITY  FURTHER INFORMATION

33. Jumpstart Our Business Start-Ups • CROWDFUNDING • FINRA and SEC to promulgate rules - originally expected by Jan. 2013 • Funding Portals must register as either a broker-dealer or a funding portal with FINRA • Will have to include investor education, mitigation of fraud and privacy protection • Limited investments up to 5 percent for individuals with annual income of less than $100,000 and 10 percent for those who make over $100,000 • Audited financials if trying to raise more than $500,000 • Lift the ban on general solicitation/advertising

34. Jumpstart Our Business Start-Ups • CROWDFUNDING – “Suggest” filing . . . • Registration and incorporation documents. • Name of directors, officer and stockholders. • Description of the business. • Financial statements. • Prior year tax returns • Intended use of proceeds, target amount and deadline. • Share price. • Description of the ownership. • Outstanding securities of the company

35. Jumpstart Our Business Start-Ups • CROWDFUNDING – FINRA Interim Application • General Information about the Site • Ownership Information • Contributions of equity or debt financing made available to portal • Management disclosure including “bad boys” • Business Model

36. Jumpstart Our Business Start-Ups • Other provisions Streamlined IPO’s for Emerging Growth Companies with less than $1 Billion in revenues 1. Confidential Submissions 2. Reduced Financial Statements 3. Testing-the-Waters Communications 4. Publication and Distribution of Research Reports 5. Limited Executive Compensation Disclosures 6. Exempt from SOX Auditor Attestation 7. Extended Transition to New GAAP

37. Crowdfundingfor Small Business February 21, 2013 Rassul Zarinfar, Founder of Buffalo Bayou Brewing Company www.buffbrew.com Travis Crabtree Looper Reed & McGraw, P.C. www.lrmlaw.com www.emedialaw.com