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SEC Adopts Amendments to the JOBS Act to help Entrepreneurs and Investors

Crowdfunding

By Peter V. Hogan, Esq.

On April 5, 2017, the Securities and Exchange Commission (the “SEC”) announced that it adopted amendments to increase the amount of money companies can raise through crowdfunding to adjust for inflation from $1,000,000 to $1,070,000. On April 5th, the SEC also approved amendments for inflation adjustments the annual gross revenue threshold used to determine eligibility for benefits offered to “emerging growth companies” (“EGCs”) under the Jumpstart Our Business Startups (“JOBS”) Act. The SEC is revising the EGC definition under Rule 12b-2 to mean an issuer that had total annul gross revenues of less than $1,070,000 (adjusted from $1,000,000).

The SEC is required to make inflation adjustments to certain JOBS Act rules at least once every five years after it was enacted on April 5, 2012. The SEC approved the new thresholds on March 31, 2017 and they will become effective when published in the Federal Register.

BACKGROUND

Section 101 of the JOBS Act added Section 2(a)(19) to the Securities Act of 1933 (the “Securities Act”) and Section 3(a)(80) to the Securities Exchange Act of 1934 (the “Exchange Act”) to define the term “emerging growth company.” Under those sections, the SEC is directed every five years to adjust the annual gross revenue amount used to determine EGC status for inflation by reflecting the change in the Consumer Price Index for All Urban Consumers (“CPI-U”) published by the Bureau of Labor Statistics (“BLS”) over said five year period. In order to do this, the SEC adopted amendments to the Securities Act Rule 405 and Exchange Act Rule 12b-2 to include a definition for EGC that reflects an inflation-adjusted annual gross revenue threshold. The JOBS Act also provided an exemption from the registration requirements of Section 5 under the Securities Act for certain crowdfunding transactions which helps reduce the cost of raising money for entrepreneurs. The SEC adopted amendments to Rule 100 and 201(t) of Regulation Crowdfunding and Securities Act Form C to reflect the required inflation adjustments.

Additionally, the SEC adopted Sections 102 and 103 of the JOBS Act to amend the Securities Act and the Exchange Act to provide several exemptions from certain disclosure, shareholder voting, and other regulatory requirements for any issuer that qualifies as a EGC. The exemptions reduce the financial disclosures an EGC is required to make in a public offering registration statement and relieve an EGC from conducting advisory votes on executive compensation, as well as provide relief from a number of accounting and disclosure requirements.

Below please find the tables demonstrating the inflation-adjustments made by the SEC which increase certain maximum amounts raised and invested under Regulation Crowdfunding.

Table 1:  Inflation-Adjusted Amounts in Rule 100 of Regulation Crowdfunding (Offering Maximum and Investment Limits)

Regulation Crowdfunding Rule Original Amount Rounded Inflation-Adjusted Amount
Maximum aggregate amount an issuer can sell under Regulation Crowdfunding in a 12-month period (Rule 100(a)(1)) $1,000,000 $1,070,000
Threshold for assessing investor’s annual income or net worth to determine investment limits (Rule 100(a)(2)(i) and (ii)) $100,000 $107,000
Lower threshold of Regulation Crowdfunding securities permitted to be sold to an investor if annual income or net worth is less than $107,000 (Rule 100(a)(2)(i)) $2,000 $2,200
Maximum amount that can be sold to an investor under Regulation Crowdfunding in a 12-month period (Rule 100(a)(2)(ii)) $100,000 $107,000

Table 2:  Inflation-Adjusted Amounts in Rule 201(t) of Regulation Crowdfunding (Financial Statement Requirements)

Regulation Crowdfunding Rule Original Offering Threshold Amount Rounded Inflation-Adjusted Amount
Rule 201(t)(1) $100,000 $107,000
Rule 201(t)(2) $500,000 $535,000
Rule 201(t)(3) $1,000,000 $1,070,000

While these adjustments may seem small, they may make a big difference to a company raising money to expand its business or an investor looking to qualify to invest in a crowdfunding transaction.


Thank you for joining us on ClarkTalk!  We look forward to seeing you again on this forum.  Please note that the views expressed in the above blog post do not constitute legal advice and are not intended to substitute the need for an attorney to represent your interests relating to the subject matter covered by the blog. If you have any questions, please feel free to contact the author, Peter Hogan, by email at phogan@clarktrev.com or telephonically at (213) 629-5700.

Circular 230 Disclaimer: To comply with IRS requirements, please be advised that, any tax advice contained in this blog is not intended or written to be used, and cannot be used, by the recipient to avoid any federal tax penalty that may be imposed on the recipient, or to promote, market or recommend to another any referenced entity, investment plan or arrangement. For more information, please go to www.Clarktrev.com.

 

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Relief for the Dissolution of a California LLC

Limited Liability Company

By Peter V. Hogan, Esq.

Effective January 1, 2017, California Assembly Bill 1722 will amend California’s Revised Uniform Limited Liability Company Act to provide potential relief to members of limited liability companies (“LLC”).

The Act previously provided that a LLC is dissolved, and its activities are required to be wound up, if, among other things, a majority of the members of the LLC vote to dissolve. For an LLC with two members who each own a 50% membership interest, both members would have to agree to dissolve the Company since a “majority” would require 51% or more. If the two members can’t agree to dissolve the LLC, the member who wants to dissolve would need to go to court and seek judicial dissolution which can be costly and time consuming. Assembly Bill 1722 now requires the vote of 50% or more of the voting interests of the members of the LLC to dissolve. The bill is designed to help small, two member LLCs locked in a voting dissolution deadlock to avoid unnecessary litigation and expense.

The amendment does, however, allow for the members to require a higher voting percentage approval to initiate dissolution in the LLC’s articles of organization or the operating agreement. Thus, in the case where it doesn’t make business sense for one member to be able to decide the dissolution issue, the members of the LLC can agree to revert back to a simple majority rule on such decisions.

You can read the bill and the amended law in its entirety here.


Thank you for joining us on ClarkTalk!  We look forward to seeing you again on this forum.  Please note that the views expressed in the above blog post do not constitute legal advice and are not intended to substitute the need for an attorney to represent your interests relating to the subject matter covered by the blog. If you have any questions, please feel free to contact the author, Peter Hogan, by email at phogan@clarktrev.com or telephonically at (213) 629-5700.

Circular 230 Disclaimer: To comply with IRS requirements, please be advised that, any tax advice contained in this blog is not intended or written to be used, and cannot be used, by the recipient to avoid any federal tax penalty that may be imposed on the recipient, or to promote, market or recommend to another any referenced entity, investment plan or arrangement. For more information, please go to www.Clarktrev.com.

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DO NON-VOTING SHARES IN CALIFORNIA CORPORATIONS HAVE VOTING RIGHTS?

By Rajnish Puri

Small business owners – new and established – often inquire about the pros and cons of creating voting and non-voting forms of equity. Naturally, the primary motivation behind the inquiry is to limit the number of persons who can influence business decisions.  This article examines the relevant issues to consider when issuing non-voting shares in the context of California corporations.

New businesses, when deciding on the form of legal entity for their existence – a corporation, limited liability company, partnership or other – consider a variety of factors. The analysis typically includes an examination of issues pertaining to tax implications, the ability to attract investors, simplicity of corporate documents, effective governance models, and the flexibility of establishing employee incentive plans.  Management and control of business affairs is a theme that connects most issues and, therefore, gets a strong consideration in the decision making process.  Interestingly, having the ability to control a business is not just confined to new enterprises; it comes up regularly throughout the life cycle of any organization and most certainly at moments of transition such as recapitalization (raising new capital or rearranging the deck of existing investors), succession planning (transferring ownership to the next generation that would include actively and passively involved family members), and the sale of a business (who decides whether or not to sell), to name a few. This issue, when examined in the context of a corporation, often raises the idea of establishing voting and non-voting shares.  Having the two categories of shares, in many instances, makes sense – the premise being that the ability to vote on company affairs be restricted to a select few who have primary responsibility for growing the business compared to those who remain passive investors or hold a minority position. But, just because a category of shares is labeled non-voting, does it take away all of the voting rights of a shareholder owning such shares? Not in the case of shareholders of corporations organized in California. Therefore, if one is not aware of the rules dealing with this subject, granting non-voting shares might inadvertently create the very rights that were intended to be prevented.

The Rule. California law, specifically Section 400(a) of California General Corporations Code (CGCL), allows corporations to issue one or more classes or series of shares that can have “full, limited or no voting rights.”  However, as a condition to issuing shares with limited or no voting rights, corporations must ensure that there exists a class or series of shares that has full voting rights.  Based on existing law, holders of non-voting shares are precluded from voting on routine corporate matters like the election of directors or other material transactions requiring shareholder approval, thereby eliminating their voice from management and control.

The Traps. Despite the obvious non-voting label, CGCL creates two exceptions, which, if overlooked and left unaddressed, could potentially give the non-voting shareholders a veto right in certain critical situations. Section 903(a), which describes the procedures of amending a corporation’s articles of incorporation, requires that certain amendments must be approved by holders of outstanding shares of a class, “whether or not such class is entitled to vote” as per the articles.  This exception could pose a problem when a corporation seeks to raise new capital and create new classes of shares that often trigger the need to amend the articles, and the terms are not favorable to the holders of non-voting shares.

A similar situation arises in the context of corporate reorganizations – a term defined under Section 181 to include a variety of merger transactions – which call for shareholder approvals. Section 1201(a) states that the principal terms of a reorganization must be approved by holders of “each class” of shares.  While the rules provide some comfort by noting that different series within the same class do not constitute different classes for purposes of the required approval – thereby allowing the (majority) voting stock to control the approval process notwithstanding the (minority) non-voting position – there could be situations, particularly in closely held businesses, where the voting and non-voting shares represent equal ownership of the business.  Effectively, under certain circumstances, the holders of non-voting shares might have the ability to block an amendment to the articles or a reorganization.

The Solution. What is otherwise expressly prohibited under CGCL can be mitigated by having contractual commitments between shareholders.   As a condition to granting non-voting shares to shareholders, the holders of voting shares can require the holders of non-voting shares to agree in advance to vote along with the holders of voting shares in reorganization transactions and other specified situations involving the corporation.  The agreement among shareholders could also provide for serious consequences of a breach by a party of its obligations under the agreement, which, if structured carefully, would serve as a  strong deterrent.  Such agreements can be set forth in voting agreements among shareholders, which are permitted under CGCL Section 706.

In conclusion, it is important to consider the limitations of non-voting shares and address them to ensure there are no surprises at critical moments of an organization’s life cycle.

Hope you found the above discussion helpful. In my upcoming posts, I plan to share with the readers practical knowledge and trends on a variety of corporate finance topics applicable to early stage and established businesses.  Stay tuned for another conversation on ClarkTalk!!

Thank you for joining us on ClarkTalk!  We look forward to seeing you again on this forum.  Please note that the views expressed in the above blog post do not constitute legal advice and are not intended to substitute the need for an attorney to represent your interests relating to the subject matter covered by the blog.   If you wish to consult with the author of this post or another attorney at Clark & Trevithick, please contact Raj Puri by email at rpuri@clarktrev.com or telephonically by calling the author at (213) 341-1322.

 

 

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REGULATION A+ AND PREPARING THE MINI-IPO

By Peter V. Hogan

Business is booming but do you find yourself in need of additional capital to expand operations? Private companies that need capital should evaluate whether Regulation A+ is a viable option to raise money and if the compliance associated with utilizing Regulation A+ is worth the time and effort. Regulation A+ went into effect in June of 2015, spurred by the JOBS Act, and private companies are hoping to utilize the new rules to raise capital from small investors within the general public, not just from accredited and institutional investors. Regulation A+ attempts to make it easier for these smaller companies to raise capital by increasing the potential pool of investors and limiting the amount of disclosure requirements. Under Regulation A+, small companies can raise up to $50 million in a 12-month period in new capital through what’s being called a “Mini-IPO”. In evaluating the pros and cons of doing a “Mini-IPO”, a company must look at the key features of a Regulation A+ offering.

1. Determining Eligibility

Regulation A+ is available only to companies organized in and with their principal place of business in the United States or Canada. Generally, Regulation A+ is not available to companies that are already public reporting companies or “shell” companies with no specific business plan. Additionally, companies that issue fractional undivided interests in oil or gas rights or similar interests in other mineral rights are not eligible to utilize Regulation A+. Companies that are subject to “bad actor” disqualifications, where the company or other relevant persons (such as underwriters, placement agents and the officers, directors and significant shareholders of the company) have experienced a disqualifying event, such as being convicted of securities fraud or other violations of law, also are prohibited from raising money under Regulation A+.

2. Preparation of Audited Financial Statements

Companies looking to raise money via Regulation A+ will need to file an offering statement with the Securities and Exchange Commission. A Tier 1 offering consists of securities offerings of up to $20 million in a 12-month period, with no more than $6 million in offers by selling security-holders that are affiliates of the company, whereas a Tier 2 offering consists of offerings of up to $50 million in a 12-month period, with no more than $15 million in offers by selling security-holders that are affiliates of the company. A Tier 2 offering also requires that the company file audited financial statements for the last two years. Hiring  an experienced auditor is imperative, since the SEC has routinely rejected many initial Regulation A+ filings based on incorrect financial statements. Since preparation of Regulation A+ financial statements take a considerable amount of time and effort, working with an experienced accountant and auditor are critical to expedite the process.

3. The Offering Statement

Companies will also need to work with experienced securities counsel to draft and prepare the offering statement that will be filed with the SEC and comply with ongoing reporting requirements under Tier 2 offerings. The offering statement has three parts: Part I requires basic issuer information such as the securities being offered, the jurisdiction where the securities will be offered, and the recent sale of securities by the issuer. Part II of the offering statement requires financial statements as well as business, management, and other substantive disclosures. Part III contains exhibits and related documents to be filed based on the company’s determination of pertinent documentation including exhibits that should be filed on a confidential basis with the SEC in order to protect the company’s trade secrets, pricing, etc. Utilizing a team approach, the chief financial officer, auditor and securities counsel can work together to draft the offering statement without interrupting the day-to-day business of the company. The same approach should be used to complete any ongoing reporting obligations under Tier 2.

A private company that is looking to raise capital through a Regulation A+ offering needs to understand the timing and expense associated with such an offering. The earlier you obtain experienced securities counsel and an experienced auditor to help you prepare the offering statement, the quicker you can get your offering statement into the hands of the SEC to be qualified and raising funds. Please contact me by e-mail at phogan@clarktrev.com or call me direct at 213-341-1385 if you would like further information on Regulation A+ as well as the timing and costs associated with such a transaction.

Thank you for joining us on ClarkTalk! We look forward to seeing you again on this forum. Please note that the views expressed in the above blog post do not constitute legal advice and are not intended to substitute the need for an attorney to represent your interests relating to the subject matter covered above.

 

 

 

 

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DON’T WANT DISPUTES WITH YOUR BUSINESS PARTNER? FOLLOW THE MONEY!

By Rajnish Puri

Generally, it is friends or family members who jointly create a new business and in doing so, become business partners. So, why is it that, only in a matter of time, the once-friendly relationships turn sour and, as business partners, the same friends and family have disputes and, in many cases, litigate against each other?  Primarily, money matters . . . I believe.  How can such disputes be prevented?  The famous motion picture in the late 1970s – All the President’s Men – offers a clue.  Remember Deep Throat’s advice to Bob Woodward –  “Follow the Money”? Agreed that those three words led Woodward to reach only the source of the problem in the famous thriller about the Watergate scandal.  However, the advice, if followed when creating agreements among business owners, can bring clarity to expectations in the relationships, avoid fallouts and, most importantly, retain the original friendships –  the primary idea being about keeping an eye on the money from the time of investing in, to the moment of exiting, the business.  In that context, this article offers key ideas to consider for agreements among shareholders of corporations, members of LLCs, and partners in partnerships. For convenience, in the discussion below, the term “owner(s)” includes shareholders, members and partners and, similarly, “company(ies)” means privately-owned corporations, LLCs and partnerships.

Capital Contributions.  Businesses need capital, certainly at the launch and frequently at later stages.  An agreement among the owners should specify the initial capital contributions they are expected to make to the company in exchange for their ownership interest.  That’s the easy part.  But, what happens when the company needs more money? The owners must identify the decision making process to make calls for additional capital and establish the timing and other limitations.  It is just as important to agree on the consequences when one or more owner fails to satisfy the request for new capital.  These may include automatic dilution of ownership percentages in the company or, if other owners step in to make up for the shortfall, whether to treat the shortfall as a temporary loan.  Just like the inflow of money, its outflow, too, requires attention.  In addressing the distribution provisions, owners must describe the criteria for making the distributions and other considerations, like mandatory tax-related payments and repayment of the invested capital before the sharing of profits.

Management and Control. Although the concepts of managing and controlling the business do not directly involve money issues, they indirectly impact such issues. Owners should clearly define the role each would play in the operations of the company and set the voting thresholds required for approving major decisions.  Often, the responsibility to operate the business rests with a few.  A sensitive item is whether or not the operating owners should be entitled to any compensation, which is an expense that reduces the profits.  Without clarity on the issue there’s the risk of some owners feeling they are receiving less benefits than the others.  Similarly, when dealing with the important subjects – typically involving significant money matters such as borrowing, adding new owners, disposition of major assets, real property agreements, and material business agreements – the stakes are high and so is the need for an understanding among the owners as to who among them is/are best suited to authorize decisions on such crucial matters.  Arguably, everyone would like to have a say, but the unanimous voting requirement would give everyone a veto, which might lead to more problems than solutions.

Transferring Ownership.  Unlike publicly-held companies, investments by owners of private businesses are generally not liquid.  There may arise situations in the future when one or more owners wish to cash out from the business for different reasons.  Once again, money plays a role.  Equally compelling is the need to ensure that the entire ownership of the company remains among friendly parties.  The two objectives, sometimes inherently conflicting, are addressed through provisions that require the selling owners to offer their equity interests first to the company or the other owners before selling them to third parties – referred to as the right of first refusal.  A similar situation exists when a significant number of owners wish to sell their interests but others do not.  The majority achieves its goal by providing in the agreement a right to compel the minority to join the sale – referred to as the drag along right.  Both scenarios require the owners to deal with the selling price.  Incidentally, under both situations, third parties play a role in influencing the sale price.

Exits – Forced and Unforced.  Finally there are circumstances – some forced and others unforced – that compel an owner’s exit from the company.  Death, disability, retirement, termination of employment (where owners also are employees), marital dissolution and personal bankruptcy are some such situations.  To address these exigencies, owners should ask themselves the following three questions: first, who has the right or obligation to acquire the interests of the affected owner; second, how is the affected owner’s interest valued; and third, what are the terms of payment?  Absent answers to these questions in the agreements, owners may find themselves in undesired and costly disputes among each other.

Hope you found the above discussion helpful. In my upcoming posts, I plan to share with the readers practical knowledge and trends on a variety of corporate finance topics applicable to early stage and established businesses.  Stay tuned for another conversation on ClarkTalk!! If you have questions, feel free to contact the author by email at rpuri@clarktrev.com, or telephonically at 213-629-5700.

 

 

 

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START-UP CAPITAL: WHEN CONVERTIBLE DEBT MAKES SENSE!

By Rajnish Puri

Often, entrepreneurs are too eager to seek funds from relatives, friends and other investors in the hope of converting their business ideas into operating businesses in exchange for equity – an ownership interest – in the enterprise, without considering the consequences presented by this form of capital raise.  Start-ups rarely expand their business without selling equity in the company, but should this be the primary method of raising capital when attempting to get out of the gate?  Does borrowing, with certain limitations, make more sense?  This article examines some disadvantages of raising capital in exchange for equity during the early stages of a start-up and discusses the benefits of pursuing convertible debt as an alternative.

Valuation and Control of Business.  When considering sale of equity in a start-up, the primary question is one of valuation because, without having a firm idea of what the business is worth, founders might risk giving up too much for very little in return.  (Investors, too, especially those with little or no familiarity with assigning a value on businesses, face the risk of overpaying for the percentage and type of equity they would receive in exchange for their investment.)  Naturally, given the limited resources available to entrepreneurs at the early stages, obtaining an independent appraisal for the business is impractical and, therefore, not common. Such inequities are avoidable in a borrowing (see later) and diminish with time, as the business grows and brings a greater degree of certainty to the value and, thus, a fairness to the parties involved.  Another concept frequently overlooked by entrepreneurs is the loss of control associated with selling equity, which comes in the form of granting board seats and other contractual commitments to investors.  Under certain situations, the lack of control or a violation of such commitments may lead to the removal of the founders from the business – an outcome neither anticipated nor desired by an entrepreneur.

Debt versus Equity.  At the risk of oversimplifying, debt needs to be returned to a lender whereas equity typically stays with the business.  Actually, there’s a lot more to the distinction between the two forms of financing.  Debt does not appreciate in value (apart from the earnings through interest); equity increases with business growth and offers the potential of lucrative returns to the investor.  On the other hand, debt, like equity, may not be recoverable when a business fails.  For a business, the costs of borrowing money include the payment of interest, the limitation of time within which the loan is to be paid off or risk bankruptcy or foreclosure and the inability to borrow again – consequences generally not experienced when raising money through the sale of an ownership interest in the business.

Features of Convertible Debt; Things to Avoid.  Broadly speaking, a convertible debt is a promissory note accompanied with a special feature that allows conversion of the amount outstanding under the note into equity of the borrowing entity upon the occurrence of certain events. Similar to a promissory note, a convertible debt instrument describes the amount borrowed, term of the loan, interest rate and consequences of non-payment.  The convertibility aspect describes (1) the timing for conversion, which is typically a time in the foreseeable future when the business raises new capital, (2) the valuation to be used when computing the conversion of debt into equity, which is linked to the valuation deployed for the new capital raise, and (3) the conditions of conversion, which generally require a mutual agreement between borrower and lender and, occasionally, include a discount feature favoring the lender.  (Note that the discount feature, which allows the lender to convert debt into equity using a price lower than the price at which the business sells equity in the new financing round, raises tax issues that are not within the scope of this article.)  Borrowers should be careful and avoid giving assurances of repayment of debt (by issuing individual guarantees) or agreeing to controls imposed in the form of negative covenants that require lender’s permission for certain business activities.  Obviously, the size of the borrowing will impact the final terms, but, for capital raised through debt at early stages by start-ups, guarantees and the use of negative covenants are uncommon.  Using a convertible note to raise capital at an early stage avoids the perils associated with an unknown valuation of the start-up’s business (for both parties) and prevents giving up control (by founders) until the later stages of the business when the extent to which control might be conceded can be carefully measured.  In times when investors are looking to invest in businesses with promise and entrepreneurs are routinely conceiving promising ideas, raising capital through convertible debt provides a balanced alternative.

Hope you found the above discussion helpful.  In my upcoming posts, I plan to share with the readers practical knowledge and trends on a variety of corporate finance topics applicable to early stage and established businesses.  Stay tuned for another conversation on ClarkTalk!!

Thank you for joining us on ClarkTalk!  We look forward to seeing you again on this forum.  Please note that the views expressed in the above blog post do not constitute legal advice and are not intended to substitute the need for an attorney to represent your interests relating to the subject matter covered by the blog.   If you wish to consult with the author of this post or another attorney at Clark & Trevithick, please contact Raj Puri by email at rpuri@clarktrev.com or telephonically by calling the author at (213) 341-1322.

 

 

 

 

 

 

 

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Crowdfunding: Is it for Everyone?

By Rajnish Puri |

Regulation Crowdfunding issued under the Securities Act of 1933 (Securities Act), became effective on May 16, 2016, six months after the Securities and Exchange Commission (SEC) published the final rules relating to Section 4(a)(6) of the Securities Act.  The regulation provides guidance to startups and small businesses on how to raise money from smaller investors via the Internet.  But, is raising capital through a crowdfunding mechanism for everyone?  This article briefly examines the background for the regulation, provides an overview of the key rules, and makes certain practical observations about the effectiveness of the crowdfunding process.

The term “crowdfunding” is designed to allow (and encourage) “crowds” to “fund” businesses with relatively low dollar investments.  Broadly speaking, federal and state securities laws, make it unlawful for persons to sell securities unless sold pursuant to a registration statement effective under the Securities Act or under one of the several exemptions authorized under the Securities Act.  To facilitate raising capital for startups and small businesses using the Internet and social media platforms, and to provide individual (including non-accredited) investors an opportunity to invest in those entities, Congress established a regulatory framework for crowdfunding by enacting the Jumpstart Our Business Act (JOBS Act) on April 5, 2012.  The legislation was codified in Section 4(a)(6) of the Securities Act, with Regulation Crowdfunding providing guidance on the finer aspects.  When sold in compliance with Section 4(a)(6) and Regulation Crowdfunding, the securities qualify as an exempt transaction (Crowdfunding Exemption) obviating the need for a registration statement.

Who Is Eligible?  Only companies organized under the laws of a state or territory of United States are permitted to raise capital using the Crowdfunding Exemption, so long as they are not subject to the reporting requirements of the Securities Exchange Act of 1934.  Foreign companies, investment companies, companies with no specific business plans and companies that have failed to comply with the reporting requirements of Regulation Crowdfunding during the two-year period immediately prior to the crowdfunding offering, are not authorized to avail themselves of the Crowdfunding Exemption.

Rules for the Issuer. The Crowdfunding Exemption caps the amount an issuer may raise in a 12-month period to $1 million using crowdfunding offerings.  (Note: Crowdfunding offerings are not integrated with other types of offerings – for example, a Regulation D offering – and an issuer is free to raise capital independent of the Crowdfunding Exemption so long as it complies with the requirements of the other exemption.)  The offering must be transacted using only one intermediary online-platform that must be registered with the SEC.  For each offering, issuers must file Form C with the SEC using EDGAR, the SEC’s electronic filing system.  The disclosures accompanying Form C include, among other things, the filing of the company’s reviewed or audited financial statements (depending on the size of the offering), a description and discussion of the business, information about officers, directors and owners of 20% or more of the company, and related party transactions.  If there are any material changes or updates to the information included in the original Form C, issuers are required to file amendments using appropriate forms prescribed for such purposes.  The rules also require that, after a crowdfunding offering has been completed, issuers file financial statements with the SEC and post the statements and other disclosures on the issuer’s website on an annual basis.

Limitations for Investors. Individual investors are subject to certain limitations with respect to their investments in a crowdfunding offering.  Securities acquired may not be resold for a one year period.  The amount an individual may invest during a 12-month period in all crowdfunding offerings is limited by the individual’s annual income and net worth (without taking into account the value of the individual’s primary residence).  If either the annual income or the net worth of an individual is less than $100,000, the maximum amount that can be invested is the greater of (a) $2,000, or (b) the lesser of 5% of the individual’s annual income or net worth.  If the annual income and the net worth are equal to or greater that $100,000, the maximum amount that can be invested is 10% of the lesser of the individual’s annual income or net worth, subject to an annual limit of $100,000 for all crowdfunding offerings.

Costs versus Benefits.  Because Regulation Crowdfunding went into effect only about a week ago, there isn’t enough data out there, as yet, to accurately determine its impact on the business community or perform a thorough cost-benefit analysis of the legislation.  As a preliminary observation, however, it appears that the costs and administrative burdens of compliance associated with the regulation seem to outweigh the benefits.  For starters, the SEC estimates the preparation and filing of Form C to take about 100 hours, with about 25% of that time being attributed to outside professionals.  Adding to the preparation and filing costs is the compensation an issuer would pay an intermediary for the listing as well as the accountants’ fee for the preparation of reviewed and audited financials – a practice not prevalent among early stage companies.  Apart from the costs, by posting the  financial statements and other material disclosures about the business on its website, a startup or a small business might be at a disadvantage by making the information available to the competition.  Of course there are protections that can be built to secure the data, but, those, too, carry a cost.  With the ability to invest as little as $2,000,  arguably, the number of shareholders in a crowdfunded business might exceed a manageable figure which could add to the administrative burdens of management dealing with shareholder matters – be it information dissemination or simply seeking shareholder approvals for governance issues.  Depending on the size of the proposed offering, alternative exemptions available under the securities laws might be more attractive to the issuers.  By contrast, businesses less willing to work with, or facing difficulty in successfully raising capital through, traditional channels of funding, utilizing the Crowdfunding Exemption could be desirable, so long as they are willing to comply.

Hope you found the above discussion helpful.  In my upcoming posts, I plan to share with the readers practical knowledge and trends on a variety of corporate finance topics applicable to early stage and established businesses.  Stay tuned for another conversation on ClarkTalk!!

Thank you for joining us on ClarkTalk!  We look forward to seeing you again on this forum.  Please note that the views expressed in the above blog post do not constitute legal advice and are not intended to substitute the need for an attorney to represent your interests relating to the subject matter covered by the blog.   If you wish to consult with the author of this post or another attorney at Clark & Trevithick, please contact Raj Puri by email at rpuri@clarktrev.com or telephonically by calling the author at (213) 341-1322.

 

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Is VC Funding Right for Your Business?

Accepting venture capital funding is one of the biggest decisions many entrepreneurs face during the infancy of their start-ups.  Over the next few weeks, TechInsurance Blog will explore how new tech businesses secure the capital they need to get started.  In  TechInsurance Blog’s most recent post, Clark & Trevithick’s Peter Hogan talks about what VCs are looking for in return for their investment.  Here’s what Peter has to say: http://www.techinsurance.com/blog/business-tips/is-vc-funding-right-for-your-business/

Following your review, if you have any questions for Peter, please feel free to contact him at (310) 629-5700 or via email at phogan@clarktrev.com

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Dangerous Liaisons – Be Careful When Transferring Assets

By Leslie R. Horowitz |

Clients often ask how to protect their assets.  Some refer to this as “asset protection,” a term that connotes the hiding of assets. Sometimes the request is based on a genuine concern for preservation of assets for family and retirement purposes, and sometimes based on a genuine concern that creditors from business transactions will be unrelenting in attempting to recoup potential losses.  Either way, depending upon the purpose and timing of the transfer, any transfer of assets that is not well thought out and carefully planned may be undone by third party creditors, bankruptcy trustees, assignees for the benefit of creditors and State or Federal Court appointed receivers.

Uniform Voidable Transactions Act

The area of law which governs asset transfers is known as the Uniform Voidable Transactions Act (“UVTA”), which was adopted into law by California commencing January 1, 2016.  Previously, the law governing voidable transfers was referred to as the Uniform Fraudulent Transfer Act and, before that, the Uniform Fraudulent Conveyance Act. The name change is relevant, because of the frequent misconception that common law fraud was being committed with regard to the transfer of assets.  Indeed, the elements of fraud are not required under the UVTA or its predecessors to recover transferred assets.

Transfer to Hinder, Delay or Defraud

The UVTA states that a transaction is voidable under two sets of circumstances.  The first circumstance is when the purpose of the transfer is to hinder, delay or defraud creditors.  This is called “actual fraud” and is judged by a subjective standard.  There are eleven “badges of fraud” that determine actual intent which are set forth in the statute as follows:  (1) Whether the transfer or obligation was to an insider; (2) Whether the debtor retained possession or control of the property transferred after the transfer; (3) Whether the transfer or obligation was disclosed or concealed; (4) Whether before the transfer was made or obligation was incurred, the debtor had been sued or threatened with suit; (5) Whether the transfer was of substantially all of the debtor’s assets; (6) Whether the debtor absconded; (7) Whether the debtor removed or concealed assets; (8) Whether the value of the consideration received by the debtor was reasonably equivalent to the value of the asset transferred or the amount of the obligation incurred; (9) Whether the debtor was insolvent or became insolvent shortly after the transfer was made or the obligation was incurred; (10) Whether the transfer occurred shortly before or shortly after a substantial debt was incurred; and (11) Whether the debtor transferred the essential assets of the business to a lienor that transferred the assets to an insider of the debtor.  The more “badges” that a court finds applicable to a transaction, the more likely it is to be determined to be voidable.

If the purpose of the transfer is to hinder, delay or defraud creditors, such a transfer tends to occur in situations such as when a party has a lawsuit against him/her, sets up a new legal entity, such as a corporation or limited liability company and transfers personal or real property into the new legal entity, thus attempting to transfer legal ownership to another party. Some parties attempt to transfer assets directly to their children for similar purposes.  Some parties attempt to transfer assets into a trust, seemingly for estate planning purposes, however many such circumstance may be interpreted to fall within the definition of hinder, delay or defraud creditors. The statute of limitations is generally four years.

Transfer for Less than Reasonable Value

The second kind of voidable transfer occurs when a party makes a transfer without receiving a reasonably equivalent value in exchange for the transfer or obligation, and the debtor either (1) was engaged or was about to engage in a business or a transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction, or (2) intended to incur, or believed or reasonably should have believed that the debtor would incur, debts beyond the debtor’s ability to pay as they became due.  This is generally called “constructive fraud” and is judged on an objective standard.  Similar to “actual fraud,” parties may sell personal or real property to a friend or family member for less than the value of the asset (intending to recover it later), thus preserving value for him or herself.  The statute of limitations is generally four years from the date of the transfer.

Protections are Available

There are methods available to protect a person’s assets.  For business purposes, corporations or limited liability companies may be formed to own assets, such as income producing real property.  If such a legal entity holds assets, generally, neither the shareholder of a corporation nor a member of a limited liability company is liable for the debts of the entity.  If a shareholder or member owns interests in other legal entities, the legal entities are not liable for the debts of the other legal entities.  So, if a bankruptcy is needed for one, it will not affect the assets of the other.

Trusts are a useful and valuable tool for family estate planning purposes, but, in California, a trust does not protect the settlors from their own creditors.  Some trusts may protect assets of from future creditors.

Keep in mind, the new entity, either a trust or a corporation/limited liability company, may be set up to protect assets as long as the “purpose” is not to hinder, delay or defraud creditors and does not render the transferor insolvent at the time of the transfer.  The same rules under the UTVA apply. Again, the statute of limitations is four years, but may be seven years from the transfer if actual fraud can be proven. Should the applicable statute of limitations expire, otherwise voidable transfers of assets may be protected from future creditors.

There are no sure fire ways to protect assets, but consulting with a lawyer for business and family estate planning in advance could avoid future problems.

Thank you for joining us on ClarkTalk!  We look forward to seeing you again on this forum.  Please note that the views expressed in the above blog post do not constitute legal advice and are not intended to substitute the need for an attorney to represent your interests relating to the subject matter covered by the blog.  You should certainly consult legal counsel of your choice when considering this or any other asset protection issue.  If you wish to consult with the author of this post or another attorney at Clark & Trevithick, please contact Leslie R. Horowitz by email  lhorowitz@clarktrev.comat or telephonically by calling the author at (213) 629-5700.