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Private Placement Roadmap

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

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

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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Starting a Non-Profit Corporation in California

If you are thinking about starting an organization with socially-conscious goals, you may want to consider forming a non-profit corporation or benefit corporation. Forming a corporation designed to help you achieve your goals will limit the personal liability of the organization’s officers and directors and give legitimacy to the organization that most donors and investors require. To… Read More

If you are thinking about starting an organization with socially-conscious goals, you may want to consider forming a non-profit corporation or benefit corporation. Forming a corporation designed to help you achieve your goals will limit the personal liability of the organization’s officers and directors and give legitimacy to the organization that most donors and investors require.

To help you decide which entity type is best for your new organization, this article discusses non-profit corporations, which cannot keep their proceeds or distribute them to stockholders, but may be able to obtain tax-exempt status. To learn more about benefit corporations, which can make a profit while focusing on their goals, read our previous blog post here.

Types of Non-Profit Corporations in California

California allows for the formation of three types of non-profit corporations: religious corporations, mutual benefit corporations, and public benefit corporations. Religious corporations are organized primarily or exclusively for religious purposes, such as running a community church. Mutual benefit corporations are organized to provide social or economic benefits to their members, such as medical cannabis collectives. Public benefit corporations are organized instead for the benefit of the public generally to promote a social, educational, recreational, or charitable purpose.

Due to the distinct characteristics of each type of corporation, the type of non-profit corporation you organize depends entirely on the purpose of the organization and who the organization seeks to benefit. By forming any of these non-profit corporations, the directors are duty-bound to devote their primary attention to the promotion of the social mission of the corporation rather than to the production of profits, and the non-profit corporation cannot issue capital stock.

“Non-Profit” Does Not Automatically Mean Tax-Exempt

It is important to distinguish the formation of a non-profit corporation from 501(c)(3) or other tax-exempt status, because forming such a corporation does not automatically give the corporation a unique tax status. In fact, unless the corporation applies for or elects to be taxed differently with the IRS, a California non-profit corporation by default will be taxed as a normal c-corporation.

Most commonly, non-profit corporations apply for tax exempt status under IRC Section 501(c)(3) (other sections under which tax exempt status can be applied for are (c)(4) – (c)(7), but these are less common and will not be discussed in this short article). This is the most common section because it allows for tax exempt status for the type of groups one typically thinks of when they think of a non-profit organization: public charities (organizations that receive a substantial part of their income from the general public) and private foundations (organizations that receive most of their income from investments and endowments and distribute this funding as grants to other organizations) organized for “exempt purposes,” which include charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and preventing cruelty to children or animals. Thus, even if a non-profit corporation is formed, it may not be eligible for tax-exempt status if it is not expressly organized for one of these purposes.

Once federal tax exempt status is applied for and granted by the IRS, the non-profit corporation can then avoid federal income taxes on its profits generated from any activities that fall under its exempt purpose. Tax exempt status also allows the corporation’s donors to deduct the amounts of their donations given to the organization, providing additional incentive to contribute.

Other Filing Requirements for a California Non-Profit Corporation

Forming a non-profit corporation in California requires many of the same formation documents as a standard general stock corporation, with some alternative language to reflect the corporation’s non-profit purpose. However, two other filings are required that are unique to California non-profit corporations:

  1. State tax exempt status: even if a non-profit corporation applies for and is granted tax exempt status from the federal government, it must also separately apply for tax-exempt status from the California Franchise Tax Board. Until a tax determination has been made at the state level, the corporation will owe California franchise taxes each year.
  2. Registry of Charitable Trusts: within 30 days of receiving a donation, all non-profit corporations in California, regardless of whether they have tax-exempt status, must register with the California Attorney General’s Office to be on the Registry of Charitable Trusts.

Forming a non-profit corporation in California has many detailed requirements that are especially crucial if the organization plans to apply for tax-exempt status, which is its own complicated application process. We highly recommend that you speak with an attorney before starting the formation process, and Bend Law Group would be happy to assist you with this and the tax-exempt application process. If you would like to talk more about your non-profit organization or have any questions, 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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Essential Elements of the Annual Shareholder Meeting

If you are formed as a corporation, whether you are a small start-up or a larger business, you will almost certainly need to hold an annual meeting of shareholders. An annual meeting of shareholders is a statutorily required meeting to be held once a year subject to the laws of the state of incorporation. Many… Read More

If you are formed as a corporation, whether you are a small start-up or a larger business, you will almost certainly need to hold an annual meeting of shareholders. An annual meeting of shareholders is a statutorily required meeting to be held once a year subject to the laws of the state of incorporation.

Many corporations decide to incorporate in Delaware due to the various regulatory advantages. For more information on some of practical advantages of Delaware incorporation, please read our previous post: The Convenient and Practical Features of a Delaware Corporation. This article focuses solely on the Delaware General Corporations Law, but it is still a great starting point for any corporation because many states have analogous provisions.

When setting up your annual meeting of shareholders, planning will be essential. Setting up a successful annual meeting requires a firm understanding of the purpose of the meeting, an understanding of what options your state law and company bylaws allow, a proper navigation of voting rights, and a balanced approach to cost considerations.

What is an annual shareholder meeting?

An annual shareholder meeting is a meeting held for the primary purpose of electing a new board of directors. When setting up the meeting, the sources of authority that corporations need to consider are (1) the law of the state of incorporation, (2) the certificate of incorporation, and (3) the company bylaws.

Delaware General Corporation Law (hereafter referred to as DGCL) states that each corporation incorporated in Delaware shall hold an annual shareholder meeting. While the primary purpose of the meeting is to have a shareholder vote, the annual meeting of the shareholders is also a great time to review the success of the past year and to present the general vision for the upcoming year. For many corporations, this meeting will also serve as the only face-to-face interaction between shareholders, corporate officials, and investors.

The Nuts and Bolts of a Notice of Meeting

Each shareholder must be informed that the meeting is taking place. Corporations must provide this notice to shareholders so they can make an informed decision about whether or not they wish to exercise their right to appear and vote. DGCL has five key elements that each notice must include to ensure that shareholders are fully informed.

The DGCL states that, (1) a written notice of the meeting shall be given, (2) the notice shall state the place of the meeting, if any, (3) the date and hour of the meeting, (4) the means of remote communications, if any, and (5) the record date for determining the stockholders entitled to vote at the meeting. Each of the aforementioned items must be included in the notice, however, it’s important to remember that these are the minimum requirements and the company’s bylaws can provide additional notice requirements.

1. Written Notice

DGCL states that a written notice must be given to shareholders to notify them of the meeting. Traditionally, this meant that a paper version had to be mailed to each shareholder to provide proper notice. Many shareholders and corporations now prefer notice by email, therefore, the DGCL was amended to allow notice by electronic transmission. While Delaware acknowledged the need for this new option, they also did not want to force shareholders to receive notice by electronic transmission if they preferred paper copies. In order to properly send notice by email, corporations must obtain an electronic transmission consent form from a shareholder.

While sending the electronic consent waiver to each shareholder may sound like a burden, the effort invested will make subsequent notices more efficient because the waiver can be applied to future notices beyond the immediate shareholder meeting.

2. Place

Some considerations of choosing a location for the meeting include: convenience to the shareholders, cost of the location, and the amount of shareholders that will be participating. Keep in mind that if you hold an election for the board of directors during your annual shareholder meeting, the Delaware default rule for voting is voting by written ballot. Many states allow you to opt-out of voting by written ballots, so check the laws of your state of incorporation. Delaware allows for corporations to opt-out of the default written ballot rule so long as language allowing electronic voting is included in the company’s certificate of incorporation.

Delaware also allows corporations to take advantage of evolving technology by allowing meetings to be held solely through means of electronic transmission such as conference calls or Skype. These options can be used to hold your meeting thereby allowing shareholders a convenient way to participate in the meeting.

3. Date and Hour

The date and hour of the annual shareholder’s meeting shall be designated by or in the manner provided in the bylaws. When setting the date and hour of the meeting, it is best to consider a time that will allow the most participation as there is a minimum amount of shareholders that need to be present for a valid meeting. (See Quorum below).

4. Remote Communication

In the sole discretion of the current board of directors, shareholders and proxy holders not physically present at a meeting of shareholders may be deemed present in person and vote by means of remote communication in accordance with DGCL. Remote communication gives corporations the ability to conduct a hybrid meeting with some shareholders participating in person and others present by means of remote communication such as conference call, Skype, or any other service.

5. Record Date

A record date represents the cutoff date for the eligibility of voting. Shareholders who have purchased after the record date will be precluded from voting at the annual shareholder meeting. The record date may be fixed at the Board of Directors discretion, but it shall not be less than 10 days nor more than 60 days before the date of the annual shareholder meeting.

Timing of the Annual Meeting

Similar to the record date timing, the notice of the annual meeting shall be given not less than 10 days nor more than 60 days before the date of the meeting. This allows shareholders enough time to make plans should they decide to attend, but not so much time that they forget about the meeting, resulting in low attendance.

Voting Rights and Requirements

Now that each shareholder has proper notice of the meeting, they will want to exercise their right to vote their shares for each board of director seat. We’ve put together a list of five factors to consider regarding shareholder rights and requirements.

1. How Many Votes Do Shareholders Have?

Unless otherwise provided in the certificate of incorporation and subject to DGCL Section 213 (record date shareholders), each shareholder shall be entitled to 1 vote for each share of capital stock held by such shareholder. In other words, one share, one vote.

2. Written ballot

All elections of directors shall be by written ballot unless otherwise provided in the certificate of incorporation. If it is authorized by the board of directors, such a requirement shall be satisfied by a ballot submitted by electronic transmission in compliance with the DGCL Section 211(e).

3. Proxy

Each shareholder entitled to vote at a meeting of shareholders may authorize another person or persons to act for such shareholder by an instrument in writing or by an electronic transmission permitted by DGCL and your company bylaws.

4. Quorum

In order for an election of the board of directors to take place, there must be a minimum number of shareholders entitled to vote present at the election. This is called a Quorum. The articles of incorporation or bylaws of a corporation may specify the number of members having voting power required to be present, or represented by proxy, at any meeting in order to constitute a quorum in accordance with DGCL. Note that in most instances no quorum may consist of less than 1/3 of the shares entitled to vote at the meeting, except where a separate vote by a class or series or classes or series is required. Generally, a majority of voting shares are needed to be present at a meeting to constitute a quorum, and subsequently a valid meeting and vote.

If a quorum is not present, the corporation will have to adjourn the meeting and reset it, conforming with all applicable restrictions mentioned in this post. This adds undue delay and cost to the meeting, which can affect your relationship with your shareholders.

5. Plurality

Once a quorum is present at the annual shareholder meeting, a plurality vote is required for a nominee to be elected to the board of directors. Directors shall be elected by a plurality of the votes of the shares present in person or represented by proxy at the meeting and entitled to vote on the election of directions according to DGCL. Note that this does not mean that the nominee has to receive a majority of the votes (i.e. 51 percent), it means that the nominee has to receive more votes than other nominees. For example, if there are three nominees for one seat of the board of directors, two of the candidates could receive 30 percent each of all votes cast, while the remaining candidate receives 40 percent of all votes cast. While the candidate that receives 40 percent did not receive a majority of all the votes cast, this nominee would prevail as they received more votes than the other nominees.

Cost Considerations

Navigating the laws of your state and the bylaws of your corporation will allow you to reduce the cost of the annual meeting of shareholders. To ensure that your meeting is effective and efficient, consider options that are convenient to your shareholders. For instance, if your shareholders are located throughout the state, you may want to consider holding the meeting through electronic communication or allowing certain shareholders to participate through remote communication.

Additionally, if your shareholder base is small, DGCL allows the shareholders to elect the board of directors, and complete other corporate actions through unanimous written consent. The key here is having unanimous consent, which gets much harder to accomplish as your company grows.

Conclusion

Setting up your corporation’s annual meeting of shareholders is a technical task that, when done correctly, can be advantageous to both the corporation and the shareholders. Make sure to check your corporate bylaws to see if there are efficient options that allow for the best meeting for you and your shareholders. If you begin planning your annual meeting of shareholders early, the corporation will be able to host a cost effective performance of official business while building strong relations with key shareholders.

If you have any questions, or need assistance as you start to plan for your annual meeting of shareholders, 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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The Top Ways to Fund Your Business

Entrepreneurs have more options than ever to raise capital for their new business ventures. However, with an increase in options comes the difficulty of choosing the best way to fund the business. Keep in mind that this is very much a high level overview. Each capital raise has its own unique features that impact what… Read More

Entrepreneurs have more options than ever to raise capital for their new business ventures. However, with an increase in options comes the difficulty of choosing the best way to fund the business.

Keep in mind that this is very much a high level overview. Each capital raise has its own unique features that impact what it means to be compliant under state and federal laws. There are a lot of ways to have a compliant security strategy, but here are a few points to start the conversation.

Convertible Notes

A convertible note is traditionally one of the most common methods used to raise capital for new ventures. When a company funds the business through a convertible note, they are receiving immediate capital in exchange for debt. The debt will convert into equity at a later date after the company has secured a second round of financing, which is typically at a point in which the company feels it is in a better position to value its stock.

Every business raising capital is looking to obtain that capital for a fair and reasonable price. New businesses often offer equity in exchange for capital, but problems can arise when parties cannot agree upon the value of the equity. The convertible note allows both parties to delay the difficult task of business valuation to a date when the business value is more definite. Furthermore, unlike a fixed price round (more on that below), a convertible note round is much easier (read as, less expensive) to execute. When companies are just getting started, every dollar counts.

This is often why you’ll hear people refer to a convertible note round as a “bridge loan.” The company has an opportunity to establish proof-of-concept, data points, and other key metrics to properly value its business. Investors have confidence in their investment because a convertible note is a loan, therefore giving investors security. The loan will have a maturity date and can build interest during the period that both parties are attempting to determine a proper valuation when a second round of financing occurs.

This option is attractive to young businesses looking for fast capital that don’t have the history to establish a proper business valuation and need to raise capital without committing a lot of money to legal or accounting fees. Convertible notes are equally attractive to investors looking for security in their investment (maturity date and interest), while holding the potential for valuable return once the note converts into equity of the successful business.

SAFE Agreement (“Convertible Security”)

The “SAFE” agreement stands for a “simple agreement for future equity.” These agreements are very similar to the aforementioned convertible note in that the money becomes available to the new business immediately, but are distinct in how the investment is converted into equity.

A SAFE agreement (sometimes referred to as “Convertible Equity”) is an investment of capital into a venture; however, they are not debt instruments, meaning that they do not have maturity dates. The lack of a maturity date allows ventures more time to go through a round of funding or more time to accurately establish the valuation of their venture. Additionally, because SAFE agreements are not loans, interest does not accrue on the invested capital, unlike a convertible note where interest can and often does accrue. Furthermore, while a convertible note will select the definition of a “qualified financing round” which triggers conversion (such as the raise of $1,000,000), a SAFE agreement will convert on the first sale of “preferred stock” regardless of the amount raised.

Investors and businesses are attracted to SAFE agreements due to the lower cost of negotiation compared to convertible notes because the parties do not have to establish an interest rate, maturity date, or definition of qualified financing. In turn, this lowers the cost for both parties to invest the capital to get the business moving (hence the inclusion of the word “simple” within the agreement).

SAFE agreements, while primarily business-friendly, can be rejected by investors because of uncertainty. Absent a clear groundwork for when and how a conversion will take place investors may still lean towards a convertible note, as this gives them power due to the note ultimately becoming due.

Fixed Price Financing

Fixed Price Financing, or “Priced Equity Rounds,” are the most well known and most common investment method for an established startup or small business. The key difference between Fixed Price Financing and other options previously mentioned is that there is a valuation of the company and the company will typically sell “preferred shares” to investors. A fixed price round can be completed either through investment crowdfunding (provided you meet the rules of the JOBS Act Title II, and Rule 506 of Regulation D) or as a “private placement” (private=no advertising or generally soliciting of the investment).

Businesses that are willing to set a company valuation often favor Fixed Price Financing. Often, Fixed Price Financing is achieved in multiple rounds, each time adjusting the company’s valuation and equity accordingly. This strategy allows companies to mature, demonstrate proof-of-concept, get in touch with consumers, and evaluate the success of their business at various stages of funding the company.

Fixed Price Financing is one of the more expensive options to raise capital, as businesses will want to exercise due diligence in selecting the proper valuation for their business as well as carefully structure the rights granted to investors under each new class of preferred shares. Furthermore, because fixed price rounds come into play once a company is established, investors will also want to perform their own due diligence on the company. Preparing the proper disclosure packet that can survive the myriad of representations and warranties a company makes undoubtedly increases costs to complete the deal.

Fixed Price Financing provides the certainty that convertible notes and SAFE agreements do not provide because both the business and the investors have negotiated and determined the company’s valuation prior to investment. In turn, this increases the cost of this capital-raising vehicle in comparison to convertible notes and SAFE agreements. Fixed Price Financing is an option most commonly used for a business that has proven operations and can show a path of scalability with additional funds.

New Kid on the Block: “Investment Crowdfunding”

Until recently, crowdfunding efforts have been associated with donations and “pre-orders” in which people pay a fee in order to receive a product in return. Indigogo and Kickstarter are not structured to sell any securities; rather, they are set up to accept donations and create pre-orders. However, whenever the exchange for capital includes either debt or equity, the SEC gets involved and the rules are governed by Title II and Title III of the Jumpstart Our Business Startups Act (commonly referred to as the “JOBS” Act).

Pre-order crowdfunding offers a great way to test the market before taking your company to the next step. This fundraising vehicle allows you to gauge market interest and gain feedback from potential consumers, enhancing your overall service or product before you look to sell any securities. Many crowdfunding campaigns have gained valuable exposure to their core markets, thereby allowing their businesses to gain momentum that is ordinarily associated with high priced advertising efforts.

Once it becomes time to fund your business, the parameters under which a startup can raise funds for equity through crowdfunding depends heavily on whether they will take money from an unaccredited investor. Under Title II, if you take money from only accredited investors there is no cap on the amount of money you can raise, or the number of investors. However, if you take investments from an unaccredited investor per the rules of Title III, you may only raise up to $1 million dollars within a 12 month period, and investors who make less than $100,000 can only invest the greater of 5% of their annual income or $2,000. Furthermore, the offering under Title III must be made via a Broker-Dealer or Portal Intermediary, and significant disclosures are required for companies to help provide transparency (such as yearly audited financials if you raise over $500,000). The factors just discussed are not an exhaustive list, and for a deeper analysis on the distinction between Title II and Title III we encourage you to read this post: Crowdfunding: Understanding Title II and Title III of the Jobs Act.

The recent passage of Title II and Title III has made the ability to seek capital from a wide audience a reality, but the rules still must be carefully followed. Additionally, downstream implications such as a cluttered cap table could hinder your ability to seek venture capital financing after using crowdfunding for investment, and the yearly requirement for audited financials (roughly $10,000 to $20,000 per year) can be a big long-term burden for only raising between half a million and a million dollars. It’s extremely important to strategize ahead of time with an attorney and an accountant to ensure you’re not harming the long-term financial health of the company by selecting crowdfunding for fundraising.

Conclusion

From Convertible Notes to Fixed Price Financing, there have never been more ways to successfully raise capital for your business venture. We have highlighted some of the differences between your capital raising options, but there are many other variations and options to raise capital that can fit your growing business.

If you have any questions, or need assistance as you decide which type of capital raising option is for you, please give us a call at (415) 633-6841 or send us an e-mail at info@bendlawoffice.com.

This Article was written by Alex King and guest author Paolo Visante.

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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Crowdfunding: Understanding Title II and Title III of the JOBS Act

In recent years, crowdfunding has been a useful tool for small businesses to raise capital because it allows entrepreneurs to solicit from a wider range of investors. In theory, this would also help alleviate funding gaps and regulatory concerns associated with raising smaller capital amounts. Websites like Kickstarter and IndieGoGo have been helping to facilitate… Read More

In recent years, crowdfunding has been a useful tool for small businesses to raise capital because it allows entrepreneurs to solicit from a wider range of investors. In theory, this would also help alleviate funding gaps and regulatory concerns associated with raising smaller capital amounts. Websites like Kickstarter and IndieGoGo have been helping to facilitate these types of investments for years.

This form of alternative financing is regulated by the JOBS (“Jumpstart Our Business Startups”) Act  first passed by Congress in 2012. The term “JOBS Act” is informally used to represent Title II, Title III, and Title IV of the legislation. Title II was officially passed in September of 2013 with the intent to make it easier for startups and small businesses to raise capital. However, unlike Title III (which took effect May 16, 2016), Title II places heavy restrictions on who can purchase the securities being offered. We focus on the key distinctions between Title II and Title III, and what this might mean for your fundraising efforts.

Title II

Companies looking to raise money through the sale of securities must either register the securities offering with the SEC or rely on an exemption from registration. Most exemptions from registration prohibit general solicitation (such as advertising in the newspaper, on the internet, etc). However, Title II allows a company to employ “general solicitation” to market securities offerings, provided they follow the rules and guidelines of Rule 506 of Regulation D. Under this new exemption, companies can use the Internet or other mediums to advertise their security offerings. This gives the company a chance to attract a large number of new investors in a short period of time, but restricts the type of investor who can purchase those securities.

Under the Title II exemption a company can only make an offering to “accredited” investors. The act defines an accredited investor as anyone who has either a net worth of $1,000,000 (your principal residence cannot be included in this calculation), or who made greater than $200,000/year for the three years leading up to their current securities purchase. Additionally, the company must take “reasonable steps” to verify they are in fact accredited. This does narrow a company’s investment pool slightly, but the potential to reach more investors in a short period of time greatly outweighs the negative. Additionally, there is no cap to the number of investors or to the amount of money that can be raised under this exemption. If you’re a company trying to raise capital for the first time, then you likely don’t have a list of willing investors to draw from, and the ability to use the Internet could change things dramatically.

Title III

Title III, adopted May 16, 2016, gained a lot of attention because it allows a company to make securities offerings to non-accredited investors. In theory, this would allow a company to solicit a virtually infinite number of investors from the general public to meet their fundraising goals. That may be music to the ears of hungry startups eager to disrupt traditional investing, but there is some fine print to consider. If a company is soliciting non-accredited investors, then they can only raise $1,000,000 in a 12-month period. If that amount meets your needs, then this exemption provides a very fast way of crowdfunding your capital. If not, it can still be useful when implemented in conjunction with more traditional fundraising strategies.

There are also some restrictions to consider regarding the purchasers of your offering under this exemption. Investors who make less than $100,000 a year can invest the greater of 5% of their annual income or $2,000. Investors who make greater than $100,000 a year can invest up to 10% of their annual income, but they cannot invest more than $100,000 in one year. Funds, such as venture capital firms, are prohibited from investing in a Title III raise.  Additionally, transactions must be conducted through an intermediary that either is registered as a broker-dealer, or is registered as a new type of entity called a “funding portal”. A funding portal must register with the SEC, and be subject to the SEC’s examination, enforcement and rulemaking authority. Furthermore, for companies that raise over $500,000, significant disclosures in the form of audited financials are required. This can create an annual cost of $10,000+ for years down the line if you use this type of crowdfunding.

Certain companies are ineligible to use Title III. Common disqualifications include non-US companies, companies who failed to comply with the annual reporting requirements during the two years immediately preceding the filing of the offer, and companies with no specific business plan or that have indicated their business plan is to engage in a merger or acquisition with an unidentified company.

Finally, for those issuers who are conducting an offering, in addition to the offering documents, issuers are required to disclose (1) information about the officers, directors and owners of 20% or more of the company, (2) description of the issuer’s business and use of the funds, (3) the price for each security, the target offering amount and if they will accept more than the target amount, (4) any related party transactions, (5) the issuer’s current financial health and (6) either reviewed or audited financials, depending on the offering.

Even with these caps, restrictions and requirements to qualify for the exemption, the Title III exemption still has the potential to be a very powerful crowdfunding tool. However, it’s very important to consider that venture capital firms will be excluded, and a large cap table could hinder downstream investment.

Crowdfunding: Conclusion

Crowdfunding has already disrupted traditional fundraising models for small businesses and it is now set to do the same for securities offerings. Even though there are some restrictions, both the Title II and Title III exemptions greatly widen the investor pool for companies interested in crowdfunding. While the exemptions do have the potential to make raising capital less difficult, venture capitalist and angel investors will still play a role in early stage investments. A comprehensive strategy, and a complete understanding of relevant exemptions, is needed to get the biggest benefit from the JOBS Act.

If you have any questions, or need assistance as you prepare for a round of fundraising 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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