Month: May 2016

A Closer Look at Title III Equity Crowdfunding

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With Title III equity crowdfunding finally taking effect this month it’s worthwhile to take a peek into what a startup may face in costs to execute a successful raise. One important thing to keep in mind is that this analysis is based on my exposure to only a limited number of portals. The numbers and… Read More

With Title III equity crowdfunding finally taking effect this month it’s worthwhile to take a peek into what a startup may face in costs to execute a successful raise. One important thing to keep in mind is that this analysis is based on my exposure to only a limited number of portals. The numbers and opinions expressed below should be digested through an upfront admission that my analysis may change as time goes on.

As many analysts surmised, the funding portal will handle the bulk of the legal compliance. A Title III funding portal must be registered with the SEC, and the portal must become a member of the national securities association. Thus, the SEC has effectively made the portal the gate-keeper to the public. This means a lot of the compliance work will be handled by the portal, instead of your company’s attorney and CPA.

Areas where an outside attorney can still be helpful include: corporate cleanup in preparation for the raise, organizing the necessary documents and information to complete the Form C disclosure schedule, educating the client on the communication standards that can be used offline when discussing the deal with a potential investor, and the initial application process to use your chosen portal. Therefore, there is still plenty of opportunity to take advantage of an outside counsel’s knowledge and experience, but many of the compliance matters that would be handled by your attorney will instead be handled by the funding portal.

Speaking of a funding portal, it’s helpful to consider the budget you’ll need to engage with one. Generally, the upfront cost should be around $15,000 to $20,000 and it is broken down with $4-7k for the portals legal compliance team, $4-7k for preparing reviewed financials with the portal’s CPA, and $4-7k to setup escrow and the transfer agent to close the deal. However, it’s important to note that those are just the upfront out of pocket costs. In addition to those fees the funding portal will take anywhere from 3-7% of the cash raised, and 3-7% in equity that mirrors what you’re selling through the Title III raise.

We’re still months, and maybe years, away from understanding how this will all shake out, but as you consider different strategies for raising money, please don’t hesitate to reach out to discuss costs, and other implications by contacting us at info@bendlawoffice.com or (415) 633-6841.

If you’re thinking about raising funds in 2016, I encourage you to check out these posts on our website

Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.

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Private Placement Roadmap

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Private placements are the nation’s most frequently used method for startups and small businesses to raise capital. For smaller businesses, public offerings are not a viable option due to the high expenses and disclosure requirements associated with registration. While the Securities Act of 1933 (Securities Act) generally requires that companies register with the SEC whenever a… Read More

Private placements are the nation’s most frequently used method for startups and small businesses to raise capital. For smaller businesses, public offerings are not a viable option due to the high expenses and disclosure requirements associated with registration. While the Securities Act of 1933 (Securities Act) generally requires that companies register with the SEC whenever a security is sold, some businesses can sell securities under certain exemptions without registering. Securities sold under one or more exemptions are referred to as “private offerings.”

In general, in order to qualify for an exemption, companies must adhere to several restrictions, such as the manner in which the offering is made, who can participate in the offering, verification of investors, and the maximum amount of capital that can be raised. Traditionally, only public offerings allowed the use of general advertising and solicitation to attract investors. However the recent adoption of Rule 506(c) has extended this ability to private offerings as well, so long as specific requirements are met.

This post will broadly explore a roadmap for conducting a private offering with the following steps:

  1. Choosing an exemption,
  2. Finding investors,
  3. Qualifying investors,
  4. Negotiating the terms of the offering,
  5. Preparing private placement and offering documents, and
  6. Closing the deal.

1. Choosing an Exemption

Section 5 of the Securities Act mandates that every time a security is sold (and for avoidance of doubt, a convertible note is considered a security), it must either be registered with the SEC or exempt from registration. In a private offering, a company can obtain its capital needs while avoiding complex registrations and associated costs.

The following descriptions of exemptions are only meant to highlight some key characteristics and not meant to serve as an in-depth overview. Please work with an attorney to consider what exemption is right for you.

i. Regulation D

Regulation D is a “safe harbor” private offering exemption that allows for a limited offer and sale of a company’s securities without registration with the SEC. There are several different types of exemptions under Regulation D that are briefly discussed below.

ii. Rule 504

Rule 504 allows for an unlimited number of investors and a maximum aggregate offering price of $1 million in a 12-month period. Companies are not required to provide disclosure materials about the offering to investors, but it is frequently done as best practice over considerations of fraud and misrepresentation. General advertising and general solicitation may be permitted only if state registration requirements are met. Overall, Rule 504 is used less frequently because of its $1 million cap on the amount of possible capital raised.

ii. Rule 505

Rule 505 provides a $5 million ceiling on the amount of capital that can be raised, but it limits the number of possible accredited investors and only allows up to 35 non-accredited investors. Companies must provide these investors with substantive disclosure documents that include financial statements. Whether an investor is considered an accredited investor will be discussed below.

iii. Rule 506(b)

Rule 506(b) has no limit on the amount of capital that can be raised, but issuers cannot engage in general advertising or general solicitation. The rule allows for an unlimited number of accredited investors, but only up to 35 non-accredited investors, and investors must receive detailed disclosure documents including financial statements. Additionally, companies relying on 506(b) are required to take “reasonable steps” to verify the accredited investor status of investors.

iv. Rule 506(c)

Rule 506(c) for the most part is the same as 506(b) in that it allows for an unlimited amount of capital to be raised and requires certain investors to receive disclosure documents. The key difference is that under Rule 506(c), companies can use general advertising and general solicitation if specific conditions are met, including the issuer taking “reasonable steps” to verify that each person is an accredited investor.

v. Section 4(5)

Section 4(5) differs from Regulation D in that securities can only be offered to accredited investors. Section 4(5) has a maximum aggregate offering price of $5 million. Under this section, companies cannot rely on general advertising or general solicitation to market their securities. This exemption is not used often because it is similar to Rule 505, but lacks Rule 505’s flexibility of being able to offer securities to non-accredited investors.

vi. Rule 147: The Intra-State Offering Exemption


Rule 147 grants an exemption from registration to issuers through an intra-state offering provided the following conditions are met:

  • The company must be organized and doing business within the state
  • Advertising and solicitation methods are allowed only within the state
  • Resales are permitted beginning nine-months after the last sale of securities to in-state residents only.

There is no limit to the amount of securities sold, provided you meet the criteria above.

2. Finding Investors

After choosing a type of offering, companies must obtain investors. Depending on the type of offering, general advertising and general solicitation may be permitted. In order for the marketing of a security to not be considered “general” advertising, there must be a substantive and pre-existing relationship between the company and potential investors. In addition, an unsolicited investor can express interest in buying the security.

If general advertising and general solicitation is not permitted, issuers can establish a pre-existing relationship with investors through intermediaries. One type of intermediary is associated persons, including the companies’ officers, directors, and employees. Further, unregistered finders and registered broker-dealers are third parties that help issuers find investors. Issuers shall require finders and brokers to sign compliance certificates, mandating that they comply with the offering’s conditions and regulations. They should also make sure that finders and brokers have the proper experience and a successful track record.

III. Qualifying Investors

For the exemptions discussed above, some or all of the investors need to be “accredited investors.” An accredited investor is a person who meets one of eight different enumerated definitions. Under these definitions, an accredited investor may be a certain type of business, including a business with assets over a certain amount, or it can be a natural person. Generally, a natural person is an accredited investor if he or she has a net or joint net worth of at least $1 million, or if he or she has income exceeding $200,000 ($300,000 including spousal income) in the past two years, and expects to have the same income in the current year.

For a closer look at whether your prospective investors are accredited, please consult an attorney as there are numerous and nuanced characteristics that meet the definition of accredited investor (including trusts and other small businesses). To help document the company’s attempt to vet investors, it’s advisable to request that prospective investors complete a purchaser suitability questionnaire, which will allow the placement agent and counsel determine whether the investor meets the suitability requirements of a specific exemption.

IV. Negotiating the Terms of the Offer

Negotiating the terms of the offering should include a discussion of various important terms. An experienced attorney can help walk you through the important details.

Generally, terms to discuss include type of security, price of security, voting rights, registration rights, right to designate board members, protective provisions which include a vote on key business decisions, information rights, conversion rights, anti-dilution protections, and liquidation preference.

Furthermore, you should consider tax implications when it comes to debt to equity ratios, how the current round will impact your common stock price, your anticipated burn rate, and when you forecast additional capital needs.

V. Preparing Private Placement and Offering Documents

Issuers offering securities to non-accredited investors must provide them with full, fair, and complete disclosure of material facts about the issuer, its board of directors and officers, and its finances, including audited financials. Even when not required, to meet investors expectations and to protect against anti-fraud provisions of the SEC, it’s advisable to provide some form of a disclosure document. Completing a Private Placement Memorandum (PPM) is aimed at fulfilling these requirements. You’ll likely work with your CPA and attorney to complete the PPM to ensure the proper narrative format and that information is presented to comply with Rule 502(b)(2).

Only after the prospective investors have been qualified, as discussed above, should the issuer provide the PPM and deal terms to the prospective investor. A subscription or investment agreement can be provided to the investor with detailed representations and supporting documents showing that reasonable steps have been taken to verify the accredited investor status.

VI. Closing the Offering

If the issuer accepts the investor’s subscription/investment documents, an agreement is formed and the offer is closed. If relying on a private offering under Regulation D, once the offering is closed a Form D must be filed with the SEC and at the state level within 15 days. When subscription funds are accepted into escrow, the 15 days filing requirement is triggered even though the security hasn’t technically been sold. Additional state and federal registration may be required depending on the type of exemption you are relying on, and preparing a strategy with an experienced attorney is crucial to maintaining the validity of your private placement.

As this roadmap reveals, the process of providing a private offering is still extensive and detailed, but with the help of an experienced attorney, small businesses can take advantage of its less stringent requirements than those required by public offerings. To set up a consultation to discuss your fundraising efforts in greater detail, please contact us at info@bendlawoffice.com, or at (415) 633-6841.

Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.

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Incorporating Socially-Conscious Purposes Into a New Business

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Increasingly, new business owners and entrepreneurs are envisioning companies that value social and environmental issues and want to make these values part of the company culture, brand, and purpose. Yet while a corporation can make efforts to create products, market itself, and accept funding in ways that are aligned with certain values, the directors in… Read More

Increasingly, new business owners and entrepreneurs are envisioning companies that value social and environmental issues and want to make these values part of the company culture, brand, and purpose. Yet while a corporation can make efforts to create products, market itself, and accept funding in ways that are aligned with certain values, the directors in any corporation have a fiduciary duty to act in the best interests of the corporation. Traditionally “the best interests of the corporation” have been to generate profits for the shareholders, and decisions made for any other reason could subject the directors to a shareholder lawsuit.

Luckily, different types of entities exist in California that give directors the ability to consider other interests. More than just sounding good, choosing a company type with a socially-conscious purpose gives directors more flexibility in how they structure, run, and even sell the company, as traditionally without such a purpose the board must approve a sale to the highest bidder without consideration of other factors.

The entities listed below provide a survey of the various types of California corporations. The General Stock Corporation is the most well-known entity and provided for comparison, and the other entities are for founders who would like to incorporate a social, charitable, environmental, or other non-monetary purpose into their company activities.

General Stock Corporation:

A for-profit entity with this as its only purpose.

  • Articles of Incorporation: purpose of the corporation is “any lawful activity”;
  • Interests that the directors must consider when making decisions: the interests of shareholders (paying dividends) take top and sole priority;
  • Reporting requirements: annual Board and shareholder meetings are required but do not need to be reported anywhere;
  • Best used: when a company wants to take on investors and not be required to consider any objectives besides profit generation.

Benefit Corporation:

A for-profit entity that allows founders to pursue social and environmental goals alongside the traditional objective of maximizing profits (see a more detailed description of benefit corporations here).

  • Articles of Incorporation: one of the purposes of the corporation must be creating a general public benefit, plus it may also have a specific public benefit stated;
  • Interests that the directors must consider: the interests of shareholders are considered along with the interests of other stakeholders, such as employees, customers, the community, the environment, and the ability to accomplish the corporation’s public benefit purposes, and all must be considered;
  • Reporting requirements: required to produce and distribute an annual “Benefit Report” that outlines the corporation’s performance and includes an assessment of the company’s overall environmental and social performance using an independent third-party standard;
  • Best used: when a company wants social and environmental goals to play a role in its business strategy, while also taking on investment money.

Bonus: Become a certified B-Corp

“B Corp is to business what Fair Trade certification is to coffee or USDA Organic certification is to milk.” – B Labs

Corporations that include the necessary provisions in their Articles, recruit directors who are motivated to fulfill their fiduciary duties, and follow the reporting requirements can be successful benefit corporations. If you are interested in taking the commitment one step further and becoming part of a global network of like-minded businesses, a benefit corporation can become a certified B Corp by meeting performance requirements monitored by B Lab, “a nonprofit organization dedicated to using the power of business to solve social and environmental problems.” Hundreds of companies are B Corp certified, including household names such as Patagonia, Ben & Jerrys, Etsy, Dansko, and Fetzer Vineyards (and Bend Law Group!).

Social Purpose Corporation (formerly known as a “flexible purpose corporation”):

A for-profit entity in which directors are required to consider specific socially responsible purposes, in addition to shareholder interests

  • Articles of Incorporation: must set out a special purpose(s) that can be a charitable or public purpose activity, or promoting positive effects, or minimizing adverse effects, of the corporation’s activities upon the corporation’s employees, suppliers, customers, and creditors, the community and society, and/or the environment, provided that the corporation considers these purposes in addition to the financial interests of the shareholders;
  • Interests that the directors must consider: the interests of the shareholders and the special purposes of the corporation;
  • Reporting requirements: an annual report sent to shareholders containing a management discussion and analysis related to the corporation’s special purpose and corporate financial statements, plus a “current report” must be sent to shareholders when certain financial decisions are made related to the special purpose;
  • Best used: when a company wants to take on investment and work for shareholder profits in addition to a specific purpose, but in a more limited way than the many interests considered in a benefit corporation.

Non-Profit Corporation: 

A not-for-profit corporation organized for a charitable or public purpose that is designed to benefit the public and typically will apply for tax-exempt status (see a more detailed post, including the differences between non-profit corporation and tax-exempt status, here)

  • Articles of Incorporation: must include the specific purpose(s) of the corporation using language that complies with the IRS’s definition of tax-exempt purposes, plus language related to how funds will be distributed if the corporation dissolves;
  • Interests that the directors must consider: the specific purposes of the corporation and ensuring that the corporation is not engaging in any non-exempt activities or benefiting any private individuals;
  • Reporting requirements: IRS Form 990 or its equivalent and an Annual Report at least sent to the corporation’s directors, plus detailed records of all meetings, compensation, and decisions must be kept in case of an audit, which are more common for tax-exempt organizations;
  • Best used: when the company is relying on donors and grants that require tax-exempt status.

Bonus: Fiscal Sponsorship

Fiscal sponsorships are not an entity type, but rather a legal arrangement that allows groups or companies that do not have IRS tax-exempt status to indirectly receive donations from foundations or others who will only donate to 501(c)(3) organization. There are two types of fiscal sponsorships: 1) Comprehensive, wherein the outside group’s project becomes an internal program of the sponsor, such that the sponsor takes on all liability and legal requirements while the outside group may volunteer or become employees of the sponsor; and 2) Pre-Approved Grants, through which the outside group remains a separate entity running the project, and then receives all funds from the project as grants from the sponsor.

Fiscal sponsors can be an organization that does similar work and therefore can easily integrate an outside group’s project into its operations, or there are organizations that operate largely to provide fiscal sponsorship services, such as Netroots Foundation. Regardless of the type of fiscal sponsor, it is critical that a well-drafted fiscal sponsorship contract is in place before the project begins for the benefit of the sponsor and the outside group.

If you are interested in running a company that has socially conscious goals, it is important to consider the many options available to ensure that your goals and capacity are in line with the abilities and requirements of your entity. Bend Law Group can assist with deciding which entity type is best for your new business, forming your desired entity, applying for federal tax-exempt status, drafting and reviewing fiscal sponsorship contracts, and advising you on annual reporting requirements. If you would like to talk more about any of these issues, please give us a call at (415) 633-6841 or send us an e-mail at info@bendlawoffice.com.

Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.

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Updating the Government When You Buy or Sell a Business in CA

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When buying or selling a business in California, you need to update all relevant governments agencies. You should consult with your attorney as each business has different requirements, but here is a list of agencies that most often need to be updated. 1. The California Employment Development Office If the business runs payroll in California, you… Read More

When buying or selling a business in California, you need to update all relevant governments agencies. You should consult with your attorney as each business has different requirements, but here is a list of agencies that most often need to be updated.

1. The California Employment Development Office

If the business runs payroll in California, you will need to update the Employment Development Office (EDD).

You can do so by submitting the Notification of Change of Employer Account Information (Form DE 24).

2.  Seller’s Permit

If the business collects sales tax, you will need to close out the current seller’s permit account and open up a new account.

To close out the current permit, you will need to file Form CDTFA-65.

To open up a new account, you will go to the Board Of Equalization’s website, which you can access here.

If you have any trouble, you can call the Board Of Equalization at 1-800-400-7115 and they will walk you through the process step-by-step.

3. IRS

If you are selling the equity in a legal entity, to update the IRS of the responsible party you will need to write a letter. The letter must include: (i) the name and social security number of the person that will be the new responsible party, (ii) the business name, (iii) the company’s federal employer identification number (EIN), and (iv) the company’s the mailing address.

If the entity’s principal business is located in California, you can mail the letter to:

Internal Revenue Service
M/S 6273
Ogden, UT 84201

Or you can fax it to (801) 620-7116.

4.  California Secretary Of State’s Office

You will need to file an updated Statement Of Information with the California Secretary Of State’s Office. You can do so here.

5. City Business Registration Certificate

You will have to update the business registration with the city.

Buying or selling a company has many steps and we highly recommend that you speak with an attorney before starting the process.  If you would like to talk more about selling or buying a business, please give us a call at (415) 633-6841 or send us an e-mail at info@bendlawoffice.com.

Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.

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