2014 Technology Entrepreneurship Boot Camp Sponsored by Jackson Walker

1. 2014 Technology Entrepreneurship Boot CampSponsored by Jackson Walker CITE BootCamp January 2013

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. Choose the Right Entity When Should You Formalize Structure? • Initiation of Business Operations • Asset Protection • Capital Raising • Succession Planning • Multiple other factors ….

4. Choose the Right Entity • Sole Proprietorship • General Partnership (GP) • Corporation • C-Corp • S-Corp • Limited Partnership (LP) • Limited Liability Company (LLC)

5. 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.

6. Corporation Shareholders Ownership Strategy/Direction Board of Directors Officers: President, Vice President, CEO, CFO, Secretary, Treasurer Implementation/ Signing Authority Employees/Operations/Contracts Liabilities

7. 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 Corporation

8. Limited Liability Company Shareholders Members Ownership Strategy/Direction Board of Directors Managers Officers: President, Vice President, CEO, CFO, Secretary, Treasurer Officers: President, Vice President, CEO, CFO, Secretary, Treasurer Implementation/ Signing Authority Employees/Operations/Contracts Employees/Operations/Contracts Liabilities

9. 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 Limited Liability Company (LLC)

10. 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

11. 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

12. 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

13. 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

14. 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.

15. 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)

16. “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

17. 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

18. 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”

19. 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

20. 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

21. 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.

22. 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.

23. 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.

24. 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 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.

25. 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.

26. 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.

27. 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

28. 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

29. 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

30. 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

31. Strategic Partnering Strategic Private Investors/Partners • Large corporations • Potential Acquirors • Potential Customers

32. 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

33. Capitalization * Consider role of bridge notes

34. 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

35. 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

36. 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.

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