Raising Capital from New Money and Old Money: Crowdfunding and Family Offices in 2014

1. Raising Capital from New Money and Old Money:Crowdfunding and Family Offices in 2014 February 18, 2014

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. Michael Laussade Partner: Corporate & Securities University of Texas at Austin BA, 2002 University of Texas School of Law JD, with honors,2006 Editor in Chief, Texas Law Review

4. 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

5. 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.

6. RULES FOR RAISING FUNDS 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

7. Before 9/23/13: Reg D and 506 • Section 4(a)(2) “transactions by an issuer not involving any public offering” • Regulation D—Safe Harbor • Rule 506—Unlimited accredited $ • No general solicitation or advertising, no more than 35 non-accredited investors

8. JOBS Act • IPO On-Ramp • Raising of thresholds for Regulation A and Exchange Act registration • Allowing general solicitation and general advertising in Rule 506 offerings • Crowdfunding—Not Yet Effective.

9. Effective September 23, 2013 • New Rule 506(c)—General solicitation and advertising permitted • Sales only to accredited investors • Reasonable steps to verify accredited investor 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”

10. “Reasonable Steps” • Focus on natural persons • Income Test: Tax returns • Net Worth Test: Account Statements, Credit Report • “Principles-based” approach • Certifying Professionals • Third-Party Certification

11. Technical Notes • 506(b) still in place • Independent Requirements: Sales and Steps • Treatment of active offerings • Form D Change • Voluntary submission portal up and running

12. 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

13. Additional SEC Proposals • Form D • Initial filing 15 days prior to first general solicitation or advertising • Additional detail • Closing amendment • Submission of solicitation materials to SEC • Amendment to Rule 507: One-year penalty box

14. Implications • More visibility for offering documents • No 4(a)(2) fallback • Bad actor diligence • Legal Opinions • Reps and Warranties in M&A agreements

15. More on Angel Investors 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

16. Crowdfunding Basics • Must be conducted through a registeredBD 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.

17. 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.

18. Highlights of the Crowdfunding Rules 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; and iii.         Audited by an independent public accountant (and include audit report) for over $500,000.

19. Highlights of the Crowdfunding Rules • If the offering doesn’t raise its target amount, offering cancelled and funds returned. • Amendment to Form C has 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.

20. 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 its 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.

21. 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.

22. 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

23. 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

24. Governmental Programs • Texas Emerging Technology Fund – T3DC http://t3dc.org/t3dc/entrepreneurs • Federal R&D Contracts • National Institute of Health http://oamp.od.nih.gov/contracts/contract.htm • Department of Energy http://www.energy.gov

25. Stephanie L. Chandler 210.978.7704 schandler@jw.com Michael Laussade 210.978.7700 mlaussade@jw.com