The Latest on Equity Crowdfunding

We’re excited to share that Lathrop GPM lawyers have again worked with an entrepreneurial client to successfully launch a crowdfunding offering. This time with a company specializing in products and related services for producing non-alcoholic offerings in the craft beverage industry. As always, we are constantly amazed at the level of originality, energy, effort, and, to state the obvious, entrepreneurship that infuses these endeavors at every level!

Our latest crowdfunding client success made us realize that it’s been a while since we’ve written about Equity Crowdfunding; so I think we’re well overdue for an update! As we have written before, prior to the 2021 SEC rule changes (the “2021 Rule Changes”), crowdfunding was limited to offerings of up to only $1.07 million, and investment by the “crowd” through “special purpose vehicles” (which has the practical effect of listing potentially hundreds of “crowd” investors as a single shareholder on your cap table) was not permitted. As a result, crowdfunding at that time did not present a very attractive capital-raising mechanism for most entrepreneurs; few such offerings had been initiated and most of them had not been unsuccessful. The 2021 Rule Changes, among other things, increased the maximum raise to $5 million, and permitted the use of a special purpose vehicle, organized and operating for the sole purpose of acquiring, holding and disposing of securities issued pursuant to a crowdfunding offering, and into which all “crowd” members made their investment. Three years on, how have the 2021 Rule Changes affected the use of crowdfunding as a productive means of raising capital?

Let’s roll the tape! *

Woodstock for Capitalists

Each May, thousands of people flock to Omaha for this event, more prosaically known as the Berkshire Hathaway annual shareholders meeting. All it takes to attend the party is to be considered a stockholder. A share of the company’s Class A shares (currently trading at about $525,000) might be a little bit beyond the reach of many, but a share of its Class B stock (about $350) will also do the trick.

The event is a true spectacle, offering a 5K run, comedy skits, disco balls, music, celebrities, and even visits by characters from the Berkshire Hathaway portfolio of companies (such as the GEICO gecko).

Can You Use Someone Who Isn’t a Registered Broker to Help Me Raise Capital?

Tackling a question that so often entices entrepreneurs – can I pay someone to help me find investors? When funding a new enterprise, how can a scrappy small business owner break into those upper echelons and c-suites where high-dollar investors are presumably just looking for the right start-up to fund – folks who would recognize the brilliance of your vision and gladly sink capital into your enterprise…if only they were aware of it!

It’s about at this point that many an entrepreneur remembers they have a rich relative, or a deep pocketed friend or business connection, or maybe just know a high roller that knows a bunch of other high rollers that can be convinced to invest. And this high roller – let’s call him Rich Uncle Pennybags – not only knows all the Sharks (see this post and this post by fellow entreVIEW authors if you’re interested in more about the “Tank”), he will be happy to find investors for you in exchange a fee that’s based on the amount of capital he successfully raises for you, so you’re not out of pocket one dollar! Brilliant, right?

And now we’re reached the point where the buzzkilling entrepreneur’s attorney weighs in – in most cases you can’t do this (well, at least legally anyway…). Unfortunately, Uncle Pennybags’ efforts would likely be deemed “broker-dealer activity”, which is subject to regulation and requires licensure.

Both federal (SEC) and state rules prohibit a person from acting as a “broker” unless that person is registered with the SEC and the state in which the person conducts business. A “broker” is defined as “any person engaged in the business of effecting transactions in securities for the account of others.” Unfortunately, the rules do not define what constitutes “effecting transactions in securities for the account of others,” but the SEC has identified certain activities that will generally be deemed to “effect” securities transactions, including:

• assisting in structuring a transaction,
• identifying potential purchasers,
• soliciting transactions,
• participating in taking orders for purchase of the subject securities,
• advising investors on the merits of the investment, or
• receiving commission or other transaction-based compensation in exchange for their services.

Well, so what if Uncle Pennybags just introduces you to potential investors? Unlike a broker, someone just acting as a “finder” does not need to be registered, although the line between “broker” activities and “finder” activities is at least a little blurry. In general, a “finder” is someone who merely provides a prospective investor’s contact information to the company that’s raising capital. But remember, by far the biggest red flag for securities regulators is the payment of commission-based compensation; that is, paying a fee based on the number of investors or a percentage of the amount of money invested. We here at entreVIEW urge caution if you want to go down the “finder” road – there’s a possibility it can be done, but only if you really pay close attention to the structure and compensatory arrangements.

Why should you care? You, the entrepreneur, are not the one engaging in unlicensed activity – isn’t that just a problem for Rich Uncle Pennybags? Unfortunately, no – the entrepreneur’s association with an unregistered broker in prohibited by state and federal law, violation of which can lead to fines, penalties, and sanctions. Worse, an investor whose investment was solicited by an unregistered broker may be able to force you to return any money invested. In addition, it could negatively impact your ability to raise future capital and or sell your Company in the future!!

If you still believe Uncle Pennybags and his rolodex can be really helpful, the safest thing to do is to try and work out a compensation arrangement that is not commission-based, such as a flat fee, and limiting his activities to only providing introductory information. And don’t forget other sources of funding that may be available to you—family, friends, and your own connections, small business loans or grants, angel investors, and crowdfunding platforms as discussed in this post.

The Minnesota Angel Tax Credit Program – good news for startups; good investment in Minnesota.

The Minnesota startup community received good news to begin 2023 as Gov. Tim Walz proposed $20 million in funding for the Angel Tax Credit Program in his biannual budget.

The Minnesota Angel Tax Credit Program, started in 2010, provides a refundable 25% tax credit to investors and angel investment funds that make equity investments in emerging—primarily high-tech—Minnesota businesses. The tax credit, worth up to $125,000 per individual or $250,000 for taxpayers filing jointly, incentivizes a rather low risk investment in capital-needy businesses, fueling their growth, and, in turn, creating more jobs, tax revenue, and vibrant Minnesota communities.

Crowdfunding the Entrepreneurial Spirit!

Author: Patricia Garrigner-Strickland

We had a bit of a snowy winter here in Kansas City and after every storm, I had at least one teenage boy ring my doorbell and ask to shovel off my driveway (for a price). On a recent trip to the grocery store, I encountered a group of Girl Scouts selling cookies (I bought three boxes of Thin Mints and ate an entire sleeve on my way home). A new client, a photographer and graphic designer, is looking to expand her business to include art shows and more event bookings. Another client is looking to develop an interactive video game based on martial arts instruction.

Meredith Willson, “‘But He Doesn’t Know the Territory’: The Making of Meredith Willson’s The Music Man” (University of Minnesota Press, 2009)

With this book review, I risk stepping on the toes of another entreView blogger whose efforts tend to circle back frequently to topics relating to musical theatre, so it’s a good thing that he was the one who suggested that I read Meredith Willson’s “‘But He Doesn’t Know the Territory.’”

Let’s be clear from the start: I am no aficionado of musicals, certainly not on the scale exhibited by my co-blogger (who is known to maintain a database of the over 600 unique musicals he has seen), but I do enjoy a few. Chief among these is the show that is the subject of this book. Chalk it up to my Irish imagination and library full of books (though, alas, no Iowa stubbornness). 

The salient point I drew from this book was how much work went into writing, financing, and producing this show, most of it done on the side while Mr. Willson was pursuing a livelihood elsewhere, although you would be hard-pressed to say how he earned his living during this period. His regular employment does not figure prominently in this narrative. In fact, little is said about his day job, which is entirely appropriate for a book about his personal passion for developing a musical harkening back to his Iowa upbringing during the early years of the 20th century. 

Welcome to gener8tor

Twin Cities Startup Week, which was held for the third time early last month, has evolved into a one-week showcase of the creators, innovators, hackers, investors and others who are driving the Twin Cities startup scene. There were events from early in the morning to late at night, and all hours in between.  There were intimate gatherings of people focusing on specific topics (healthcare, AI, IoT, etc.), and other larger general purpose events, including the Minnesota Cup’s final awards event, a Beta.MN showcase event, Techstars Demo Day and MinneDemo. As in years past, there was plenty of enthusiasm and energy on display by the Twin Cities startup community.

One new event on the Twin Cities Startup Week calendar was gener8tor’s premiere night launch event. Held on October 10th at the Minneapolis Event Center, it was the coming out party for the 5 cohort companies that participated in gener8tor’s accelerator program beginning this past summer. For those of you who don’t know, gener8tor is an accelerator program that was started in Milwaukee and Madison, Wisconsin in 2012. The program graduates one cohort group from each of their Wisconsin locations annually (Madison in the spring and Milwaukee in the fall).  gener8tor launched its Minneapolis program this past year and has been a welcome addition to the Twin Cities startup community.

Hot Off the Yule Log: Latest Seed Capital reVIEW Report Just Published

There are plenty of traditions this time of year—lighting candles and eating potato latkes, hanging lights and wrapping gifts, readying confetti and champagne to welcome in the new year, and of course the arrival of the new edition of our Seed Capital reVIEW report, this time analyzing seed and angel capital raised by early-stage companies in Minnesota during the first half of 2015.

Since it has been on the “bestseller” list of reports regarding seed and angel capital raised in Minnesota for two years now (of course, it’s a short list, since there aren’t any other reports like it), I’m sure you know that Seed Capital reVIEW is our compilation of data regarding what types of companies are raising early-stage capital in Minnesota (typically between $100,000 and $2,000,000) and the terms relating to that fundraising activity during the period surveyed.

Twin Cities Startup Week

That noticeable chill you’ve felt in the air recently signals that summertime is sadly and quickly coming to a close.  It will soon be time for the State Fair, Labor Day, kids returning to school, football, and of course, Twin Cities Startup Week.  For those who don’t know, Twin Cities Startup Week (running from Tuesday September 8th through Sunday, September 13th) is a series of informative, fun and networking based events focused on the Twin Cities startup community.

Events include Beta.MN, which is a showcase of local startups identified by the Beta.MN team. There are no formal pitches at Beta.MN, just startups exhibiting their products and services, kind of like the exhibitors at the State Fair.  At the end of the evening, the audience votes on their favorite startup, and the winner receives the famed “Golden Ipod.”  This event is being held from 5:00 to 8:00 pm on Tuesday night of Startup Week (the 8th) at Target Commons on Nicollet Mall.

The MN Cup final awards reception is being held on Wednesday night (the 9th) at the McNamara Alumni Center on the University of Minnesota campus.  We’ve posted about MN Cup many times on this blog (including, most recently, here), so not much else needs to be said.  However, if you haven’t attended the final awards reception before, it’s a great event for Minnesota entrepreneurs and supporters of the entrepreneurial community.  The event is well-attended and is a good opportunity to meet and network with leaders of the entrepreneurial community and learn about some exciting new companies.

MinneDemo, which is a demonstration showcase for seven companies, is on Thursday night (the 10th).  Each of the seven companies will have seven minutes to show their work.  These are real demos, not powerpoint presentations.

The week’s events culminate in Startup Weekend, which begins Friday night (the 11th) and continues through Sunday afternoon (the 13th).  On Friday night, any participant can pitch their idea for a startup.  Teams then organically form around the ideas they find most interesting.  The teams then spend the rest of the weekend creating a business plan and developing a product.  On Sunday evening, the teams give demos and pitches to a live audience.  Real companies have come out of Startup Weekend, including hidrate and QONQR.

There are several other events throughout the week, which can be seen on the schedule listed here.  I’ll give a quick pitch for my colleagues Doug Ramler and Kate Nilan, who will be hosting the first in a series of quarterly presentations on legal issues for tech companies.  This event will be from 8:00 to 9:30 Friday morning (the 11th) at our office in downtown Minneapolis.  At this event, Doug and Kate will be discussing how to launch a new tech venture, terms of use/privacy policies, and the top five tech law developments you should be aware of.  There will be lots of good information, checklists and sample documents, and an opportunity to connect with others in the tech community. 

It will be a great week for the entrepreneurial community in Minnesota.  I hope to see you at some of these events.

Seed Capital reVIEW—It’s Survey Time (again)!

Having our Seed Capital reVIEW report for the second half of 2014 (which analyzes seed and angel capital raised by early-stage companies in Minnesota) in the rear view mirror can only mean one thing—it’s time for us to start collecting data on deals completed during the first half of this year.

As you may recall, Seed Capital reVIEW is our compilation of data regarding what types of companies are raising early-stage capital in Minnesota (typically between $100,000 and $2,000,000) and the terms relating to that fundraising activity. I know, it isn’t quite as fun as taking a survey to find out which character from the movie Inside Out you are (easily the best movie of the summer, if you ask me). For the record: according to the survey, I’m Joy and I’m living with Anger and Disgust.

We did add a few new questions to the survey to try to gauge emerging trends like crowdfunding
(including equity crowdfunding, which is almost legal in Minnesota). Of course, the key to making the data meaningful is to have broad-based participation to ensure the data provides an accurate reflection of seed capital activity. 

With that in mind, please CLICK HERE NOW to help us out. Please also send this link to others who you know were involved in seed and angel capital raising in the first half of the year. 

As added incentive to respond to our survey, the Gray Plant Mooty Foundation has pledged to make a $10 donation to MEDA, the Minnesota Economic Development Association, for each survey completed. MEDA is an organization that provides business development services, business financing, and access to market opportunities to support entrepreneurs of color.

Thanks for helping us collect some data of interest to entrepreneurs and investors.

Hot Off The Press—Seed Capital reVIEW for 2nd half of 2014

We just released our Seed Capital reVIEW report analyzing seed and angel capital raised by early-stage companies in Minnesota during the second half of 2014.

I know, the first half of 2015 is already over—what took us so long? You may or may not be surprised to learn that, for a bunch of lawyers trying to get information about financings from a bunch of busy CEOs and CFOs, it takes some time.

As you may recall, Seed Capital reVIEW is our attempt to compile data regarding what types of companies are raising early-stage capital in Minnesota (typically between $100,000 and $2,000,000) and the terms relating to that fundraising activity.

While it is riveting reading (think “50 Shades of Grey,” but actually well written) and you’ll undoubtedly want to read the whole thing here, a few highlights from the survey include:

• Not surprisingly, as in past survey responses, most of the companies raising capital identified themselves as being in the Medical/Healthcare (with 30% of respondents indicating they are involved in the sub-category of healthcare IT), Cleantech/Biotech, or Technology spaces.

• Only 24% of respondents utilized MN Angel Tax Credit, likely a reflection of the limited available credits during the second half of last year.

• Two-thirds of respondents reported offerings structured using equity (60% common equity and 40% preferred equity), with debt securities comprising the remaining third.

• Consistent with prior surveys, the most frequent rights received by equity investors were:

• Participation rights in future investment rounds.
• In preferred equity deals, 80 percent reported a 1x liquidation preference.
• A board seat or board observation right.

• Debt offerings:

• Almost all respondents again reported debt with an initial term of at least one year.
• A majority of respondents reported receiving rights to participate in future financings.
• Almost 82% of debt-structured offerings were convertible to company equity.

Please look for our call for survey responses for capital raised during the first half of 2015 soon.  If we can get our act together (no promises) and get quicker responses, we may even be able to publish the next report before Santa hitches up his sleigh this winter!

Seed Capital reVIEW—it’s Survey Time!

It’s Survey time again and we need your help!

Our Seed Capital reVIEW survey for the second half of 2014 is now open! 

Click here for the survey.

In case you haven’t already seen the announcement, Gray Plant Mooty’s Entrepreneurial Services Practice Group has launched its third semi-annual survey regarding seed and angel capital being raised by Minnesota’s start-up and early-stage companies (typically financings between $100,000 and $2 million). Investors and entrepreneurs are being asked to complete this survey regarding deal terms of seed/angel investments during the second half of 2014. Past surveys have revealed relevant and useful information regarding trends in the angel capital community. 

The most recent release of the Seed Capital reVIEW report analyzed seed and angel capital raised by 84 early-stage companies in Minnesota during the first six months of 2014. Please complete the survey by February 28, 2015 to help make sure the data is meaningful. The survey will only take a few minutes per deal to complete! Click here to respond to the survey. 

The next edition of Seed Capital reVIEW report is due sometime late in the second quarter of this year.

“Private Equity and Angel Investment”

As a new author to entreVIEW, I wanted to write about a topic near and dear to the hearts (and pocketbooks) of entrepreneurs—money! While private capital raising remains tough, there has been a shift to alternative asset classes and the “private equity” landscape has been robust.  

Depending on the type of business and on the amount of money needed to begin or continue operations, equity financing may be the only capital available for your start-up. However, it doesn’t hurt to know and understand a little about private equity funds, which could be a source of later stage capital or an exit. What follows is a summary of what we mean by private equity. 

Simply put, a private equity fund is a collective investment vehicle used for making equity or debt investments. Some common attributes: 

• Usually structured as Delaware limited partnerships. Under this framework, the fund is not subject to taxation on its income or gains but limited partners (“LPs”) are taxed based upon their share of the fund’s profits or losses.

• Managed by a general partner (“GP”) with capital raised from institutional investors, universities, insurance companies, foundations, endowments or high net-worth individuals. 

• Key economic incentives for the GP are the management fees and the carried interest, which is a share of the profits of the fund’s investments (typically 20%), usually with some minimum rate of return (typically 8-12%) before the GP shares in the success.  

• The key economic incentive for an LP is the opportunity to earn a high rate of return on their invested capital through access to a diverse portfolio of investments that are made by experts. 

As with so many things, there are a host of regulations that apply to these funds, including the Investment Company Act of 1940 and possible registration under the Securities Act of 1933, if there isn’t an available exemption like Regulation D, which is often available in offerings to accredited investors.

Investing in private equity funds allows groups of sophisticated investors to pool their resources to mitigate the customary risks associated with investing while attempting to maximize the synergy created by the collective “thought equity” of the LPs. These investors are known as “angel investors.” Angel investors are accredited investors who invest in businesses in exchange for convertible debt or an ownership stake in the business. These individuals or institutional investors conduct their own due diligence and make their own determinations about individual investments (like the “Sharks” on “Shark Tank,” without millions of people watching).  Like “Shark Tank,” angel investors will often make investment decisions based upon a personal interest in the business or the entrepreneur. 

Of course, nobody should take money from angel investors without their eyes wide open about the potential perils. Alignment of interests between the entrepreneur and the angel is critical (e.g., what type of exit in what timeframe?). For this reason, remember that raising angel capital can be like getting married. Make sure that each side has done their due diligence so their eyes are wide open to problems (like whether to leave the toilet seat up) and defined their rights and obligations (sort of like a pre-nuptial agreement) to ensure that everyone is on the same page. At the risk of sounding self-serving, getting your lawyer involved early in the dialogue is a good idea.

Taking on the right angel investors can actually have many positives in addition to securing capital needed to build your business. The ideal angel investor will be someone who has experienced success before (and has not just been born with a Silver Spoon) and who brings contacts and relevant expertise. With interests aligned between investor and entrepreneur, all parties should have the incentive to see the business succeed.

What Could Be More Fun Than A 585-Page Release on Proposed Crowdfunding Rules?

After about 18 months of eager anticipation, the SEC just published its proposed rules regarding Crowdfunding under the Title III of the JOBS Act. The release is 585 pages long so I’d suggest it may be an ideal time to buy stock in companies that supply paper to law firms across the country!

Unlike the recent changes under Rule 506 detailed in this prior post, which permit raising capital from accredited investors only using general solicitation (if you jump through all the right hoops to verify accredited status), the Crowdfunding rules, once finalized, will permit the raising of small sums of money from a large number of investors (whether accredited or not).

Unless you’ve been living in a cave, you know that companies have been crowdsourcing capital (on sites like Kickstarter and indiegogo ) for a while. Of course, this capital hasn’t come with any equity strings attached (maybe just a T-shirt or beta test promise). Title III of the JOBS Act is supposed to change all of this by permitting up to $1 million in equity capital to be raised in any twelve-month period from all types of investors.

Since these are only proposed rules (it took almost a year to get from proposed rules to final rules on the Rule 506 general solicitation), I haven’t yet dropped everything else on my desk to pour through all the details. A couple of key things to know that haven’t changed since I wrote about the crowdfunding provisions of Title III back when the JOBS Act was originally passed:

·         These are still just proposed rules. You still cannot conduct a crowdfunded securities offering (general solicitation with unaccredited investors) until the final rules are adopted (likely a minimum of months from now). You don’t want to end up like the buy a beer company guys.

·         There are still many requirements in the proposed rules that could limit the usefulness of crowdfunding for most companies. These include certain financial disclosures (depending on the amount of total capital being raised), other mandatory disclosures, the use of a broker or "funding portal,"  along with some ongoing reporting obligations to the SEC. The bottom line may be what I said in my original post:  “You won’t be able to do it without the assistance of a skilled securities lawyer (and, depending on the amount you’re raising, an independent CPA).”

·         There’s still quite a bit unresolved about crowdfunded equity offerings. For example, state securities commissioners (like Ohio) appear openly hostile to equity crowdfunding.

As with every JOBS Act post, stay tuned for updates as the final Title III Crowdfunding rules develop.

Names, Numbers, Dates, and Signatures – Cleaning Up Your Legal Documentation

As most of the entrepreneurial community in Minnesota is well aware, the funding still available under the state’s Angel Tax Credit program, which gives investors in tech start-ups a tax credit on qualified investments, is fast dwindling. I’m sure ours is not the only law firm in town working with clients that are still hoping to take advantage of the remaining allocation of credits, and reaching out to potential investors with their business summaries, financial information, and perfectly-crafted elevator pitches. 

These aren’t the only requirements of the savvy investor, however. Potential business partners also often want to understand the precise equity structure of company in which they are investing, who comprises the company’s board of directors, what the requirements are of the governing documents (articles, bylaws, buy/sell or member control agreements), and other corporate matters. These issues, while often easy to discuss and agree upon in theory, are not technically (or legally) solidified unless they exist in writing, with appropriate names, numbers, dates—and signatures. For some of our entrepreneurial clients, who are often working at break-neck speed, these items exist in spreadsheets, word documents, or emails, but not in legally-binding agreements. And the need to step back and complete this documentation in order to present it accurately to investors seems like a frustrating, stilted, “lawyerly” process that just delays the finalization of key partnerships and funding. 

Despite the seeming insignificance of some of these items, the importance of the technicalities surrounding these types of business decisions cannot be understated. Promising an investor that they will receive 10% equity in your company in exchange for their investment, without clear documentation illustrating who owns the other 90%, when they received it, and for how much, does not instill much confidence in the certainty of that 10% (or in compliance with applicable state and federal securities regulation). And promising an investor a board seat without confirming to them how much power this may yield (will they be one of two, or one of seven board members?) may not add the value to their investment that a company thinks it should. 

According to West’s Encyclopedia of American Law, a signature is “a mark or sign made by an individual on an instrument or document to signify knowledge, approval, acceptance, or obligation,” with the purpose of “authenticat[ing] a writing . . . and bind[ing] the individual signing the writing by the provisions contained in the document.” I recently assisted a client who insisted that his company’s capitalization table reflected three current owners. However, the third owner had continually delayed providing his signature on the subscription documents evidencing his investment and ownership in the company. Ultimately, when push came to shove and the importance of reflecting the company’s ownership accurately was required, it became clear that there was no true meeting of the minds, and the company was left with its two, official founders. Signatures are the talismans that turn mere conversations (or that “hand-shake” deal) into something that companies – and investors – can rely on as permanent and secure.

I have also recently been working with a client that is attempting to raise money, and an investor inquired about composition of the company’s board of directors. The client had multiple notes as to who was supposed to have been on its board at different times throughout the company’s two-year history, but (much to the surprise of its super skilled legal team) had never followed the statutory process required for the election of directors, or properly documented decisions that had been made regarding the structure of the board. While getting these documents in order was not a very large undertaking, it did take additional time, delaying the company’s receipt of its equity capital and adding some undue headache to the process.

Dates are important as well. Providing a snapshot of your company’s capital structure requires that the documentation leading up to that point is dated and executed prior to the date of the snapshot. And as most business owners realize, subsequent investments dilute previous investors, so solidifying the order of who came in first, second, and third, is critical.

With the potential for at least one incentive to invest, the Minnesota Angel Tax Credit, appearing close to running out for the year (unless proposed legislation like this is passed to increase it), companies are realizing that any delay in communicating with an investor is a set-back. Getting your legal “house in order” with accurate and complete documentation can save time and energy down the road – when these attributes will surely be needed to polish that elevator pitch!

A Post by Karen Wenzel, Guest Blogger

Nail Down Your IP So You Can Sleep Soundly

As I was reading this article in The Minneapolis/St. Paul Business Journal, I was reminded again how a failure to button down intellectual property (IP) often leads to later problems. The article describes a lawsuit against My Pillow, Inc. and Steve Lindell, the Company’s CEO and founder, by investors in a predecessor company, Night Moves Minnesota. The plaintiffs claim that they own 42% of My Pillow because that’s what they were promised by Night Moves when they loaned it $70,000 in 2006.

I don’t know much about My Pillow, although I do recall meeting Mr. Lindell several years ago when he was looking for angel investments at a conference put on by RAIN Source Capital.  He seemed like a good guy and it seemed like an interesting product, although I can’t recall whether it seemed like a good investment at the time. I’m guessing some of the angels who turned him down may be wishing they got in on the business, now poised to generate almost $100 million in annual revenue from selling pillows! I haven’t slept on a My Pillow, but I understand it is different from the Sobakawa pillow, which a close friend once told me was so loud that it kept her awake at night. I may just have to get a pet pillow for the newest member of our family (see my recent post for more details).

Before all this talk of pillows puts you to sleep, let me get back to the issue at hand. Why would these investors in the prior company believe they own 42% of My Pillow? The lawsuit claims that they invested in and therefore own the intellectual property behind the pillow. Apparently, the patent was issued in Lindell’s name and never transferred to Night Moves and the trademark was originally registered by Night Moves and later transferred to the new company (allegedly without their consent).

These types of IP issues are common in early-stage ventures. Often, in an attempt to maintain control over technology, founder inventors will want to grant a “worldwide, perpetual, royalty free, transferable” license to the business, rather than assigning the IP outright. In my experience, savvy investors typically will not accept such a scenario and force an outright assignment before writing a check. They reason that any value in the IP, even if the enterprise fails, should be shared by the stakeholders, rather than having the IP revert to the inventor is so that s/he can monetize it.

It appears one key issue in the My Pillow litigation will be whether the investors knew the status of the IP ownership at the time of their investment. If they did, then they may be out of luck on the patent rights because the business didn’t own them. If they didn’t, I’m not sure it means that they own 42% of My Pillow, but they might have a claim relating to inadequate disclosure (something we lawyers call “securities fraud”). At a minimum, it is likely to cost a lot and cause plenty of distraction to figure it all out.

If everyone had focused on and dealt with these issues early, nobody would have to lose any sleep over them today...

Crowdfunding: Legal Eagles Take a Chicken Little Approach

When it comes to crowdfunding, the legal community has taken a “sky is falling” view of the proposed funding mechanism for startup companies. Crowdfunding has created an enormous buzz within the startup finance community. In fact, my fellow authors on entreVIEW blog have written about it enough that it’s among the top 20 most frequent tags since we launched our blog for entrepreneurs a couple of years ago. However, regulators and practitioners have not only thrown cold water on the idea, they have also begun to squawk about its approaching perils. If you’re excitedly expecting that crowdfunding will fundamentally transform the way companies raise capital, the legal community is telling you to think again.

Unlike traditional donation-based Crowdfunding through sites like Kickstarter, equity Crowdfunding involves the sale of ownership interests in a company to a large number of investors via the Internet (or other means of “general solicitation”). Crowdfunding was included in the federal JOBS Act passed more than a year ago to facilitate capital raising of up to $1 million annually by early stage companies. Companies selling shares are currently prohibited from “general solicitation,” which involves the offer of shares to people you don’t know via public means such as offers made via the Internet, advertisements, or cold call. The enormous change proposed by Crowdfunding in the JOBS Act is the removal of the prohibition on general solicitation to unsophisticated potential investors . This means that companies could be permitted to offer shares of their stock on websites, billboards and radio ads, just like kitchen gadgets, life insurance and Viagra. 

The startup and fundraising communities are excitedly waiting for Crowdfunding to become effective. However, the legal community is taking an entirely different view. I recently attended a national legal education seminar on private company financings. The expert panel included representatives of the SEC, which is responsible for adopting regulations to give effect to Crowdfunding but has not done so after more than a year of waiting. Also on the panel were state securities law administrators who are responsible for investigating fraudulent capital raising activities.  

Simply put, federal and state regulators are horrified at the prospect of Crowdfunding. One state regulator acknowledged that she and her 49 state counterparts are “freaking out” about the impending rampant investor fraud and the lack of resources to address the problem, which they believe will lead to a decrease in investor confidence and less investment. State regulators view the world as being full of unscrupulous fraudsters waiting to prey upon unsuspecting widows and orphans. They have the right to be concerned as there are certainly a number of these fraudsters separating the elderly and unsophisticated from their retirement funds.  

Representatives of the SEC made it clear that they are not in a hurry to adopt regulations that will commence Crowdfunding. If it were up to them, it seems to me that they would wait forever. Congress, on the other hand, has reportedly been getting impatient.

Whether Crowdfunding will have a significant positive impact on financing will depend on the scope of the regulations adopted by the SEC. Onerous regulations requiring audited financial statements, extensive offering disclosure documents and limits on amounts that can be invested (all telegraphed as possibilities by the JOBS Act legislation) will put Crowdfunding six feet under, similar to the Small Corporate Offering Registration (“SCOR”) adopted ten years ago for similar purposes. Burdensome requirements that eviscerate Crowdfunding seem like counterproductive overkill. Many practitioners believe the Crowdfunding regulations will be “unworkable.” Companies struggling to raise money could use a little help. But help from Crowdfunding does not appear likely. 

Unlike the doomsday view of equity Crowdfunding the regulators and practitioners (much like my colleague, Dan Tenenbaum in this prior post) gave a much warmer response to permitting general solicitation of accredited investors under Rule 506, which was also part of the JOBS Act. Accredited investors are wealthy persons or entities who are viewed as being more sophisticated and able to sustain a loss of investment in risky ventures based on their income or assets. They can also be referred to as “angel” investors. Most companies raising capital in private securities offerings today do so exclusively from accredited angel investors. Permitting general solicitation to reach these persons is a logical extension. What is really important is that investors are actually accredited (and the SEC has proposed regulation for “verification” of  accredited status) and not whether the investor learned about an investment from a web site or an advertisement. Based on the feedback of regulators and practitioners, general solicitation of accredited investors is likely to have a significant impact on startups raising capital in the future. 

The unfortunate truth is that Crowdfunding may be DOA and startup companies will continue to face the challenges of raising capital through more traditional means. However, based on my more than 20 years of experience, unsophisticated investors gained through Crowdfunding will be more numerous, demanding, bothersome and litigious than accredited angel investors anyway. Perhaps the premature death of equity Crowdfunding is a blessing in disguise.

Thoughts on Raising Capital

I was recently going through some old articles and cleaning out my office (it still needs a lot of love), when I found this article in a hard print copy of the Minneapolis/St. Paul Business Journal. I read almost nothing anymore that I can’t access online, but I don’t mind reading the Minneapolis/St. Paul Business Journal in hard copy form. It’s small enough that it’s easy to read on the bus (my preferred mode of commuting), and I usually get through it very quickly (there’s something very satisfying about finishing the paper, recycling it, and then crossing it off of my “to do” list).

Apart from the paper in which it was published, I like this article because it highlights that there is more than one way to raise capital and fund operating costs for startups. As a lawyer for entrepreneurs, I get asked frequently about how to raise capital. The short answer is that it’s hard, and it depends on your circumstances and what you need. Articles like this reinforce that raising capital isn’t always easy, but there are many ways to do it. For example, bootstrapping won’t work for every business, as some businesses are just too capital intensive to fund through founder resources and working capital. But, for the right business, bootstrapping is an ideal way to build value to the enterprise without diluting the founder’s (or founders’) ownership, especially if it doesn’t come at the risk of stifling growth.

I thought a couple of interesting things from this article were worth noting. Luke Shimp, the owner of Red Cow, who obtained SBA funding to help launch his restaurant business, describes the importance of having a business plan. Having a good business plan is certainly important for businesses that intend to obtain debt financing from a sophisticated financial institution. I also think the process of developing a business plan is important for entrepreneurs, whether or not you are seeking debt capital. It forces you to think through issues, such as go-to-market strategy, operating capital requirements, customer acquisition timing and costs, management skills, and other critical business factors in a way that you aren’t required to do if you aren’t trying to articulate them on a piece (or several pieces) of paper. 

But, as my colleague and fellow entreVIEW author, Dan Tenenbaum, noted in a prior post, investors (as opposed to lenders) don’t really want to review a full blown business plan anymore. Investors expect that you’ll know the answers to the questions that might otherwise be described in your business plan, but they are not interested in reading through a lengthy plan. For companies looking to raise equity capital, I find that they have much more success using a short pitch deck to help identify potential investors. While the business plan is a useful tool for developing your actual business, it may not be quite as useful for attracting investor capital as it once was.

The story about Interrad, which raised money from several angel investors, offers an insight into a possible problem with raising money from too many investors. If you need to raise capital, and small investors are the only sources that are interested in your opportunity, then that’s who you will likely partner with. It would be silly to set some artificial number of investors that you won’t exceed. If you need the money, then you take it wherever you can get it. 

But having lots of small investors can be a distraction and divert the CEO’s time. While the Interrad CEO doesn’t seem to complain about the quarterly communications he has with his shareholder base, it undoubtedly takes time to prepare those communications (and answer phone calls) that could be used adding other value to the company. The more investors you have, the more people you need to answer to. If your investors don’t have a lot of resources, the investment they made in your business could be very important to them. As noted in this prior post (also by Mr. Tenenbaum), having proactive and frequent shareholder communications, as the Interrad CEO does, is a good way to maintain positive relationships with your investors. Of course, successfully growing your business is an even better way to maintain positive relationships with your investors.

The Code 42 piece highlights the importance of running a lean operation. It also highlights the importance of identifying the right partners to take on as investors. The right investors bring more value than just the checks they write. They also bring connections and industry expertise that can be invaluable to helping your business grow. They should be vested in the success of your business, as they ultimately stand to benefit from that success.

All these stories highlight that there are many ways to raise capital and fund operating capital needs for early stage businesses. However you decide to fund your business, know that it takes hard work, patience and discipline (and a little luck) to get it done. If you are willing to put in the work, and can be patient and disciplined throughout the process, your chances of success will be significantly increased.

“Silicon Prairie”: The Increasing Entrepreneurial Draw of the Midwest

A few months ago, my mother forwarded me a link to an article in our very own Minneapolis Star Tribune entitled “Tech New Frontier: Silicon Prairie.” (Yes, my mom may be overly engaged in what I do for a living, but I do owe her for inspiring this entreVIEW post.) The article described the emerging high-tech startup community in the Midwest, emphasizing the home-grown roots of entrepreneurs in the area and the increasing attention – and money – paid to these businesses over the past few years. 

The moniker “Silicon Prairie” intrigued me, so I decided to dig a little more deeply into the origin of the phrase. It turns out that our nation embraces a few different prairies of silicon nature – an area in Texas north of Dallas, an area in Wyoming, an area surrounding Chicago, and our very own “Midwest,” which loosely encompasses Iowa, Nebraska, Kansas, North Dakota, Minnesota, Missouri, and South Dakota – the states bordering I-29. Each area boasts somewhat of a different start-up focus, with Texas named chiefly for the concentration of information technology companies in the area, Illinois centering on research companies, and Wyoming being mentioned for its Web 2.0 startups. 

But as the Star Tribune article emphasized, the Midwest has historically been known “more for its barns than its bandwidth,” and many of the burgeoning businesses in this space relate to agriculture, biotechnology, and manufacturing. Though the region currently reflects only about 6% of the country’s angel investment transactions, it is one of only two geographic areas that exhibited an increase from 2011 to 2012 based on a report prepared in connection with the Angel Resource Institute, Silicon Valley Bank and CB Insights. Because the history of the area reflects a “like on the farm” work ethic, those paying attention believe the region only has more room to grow. 

There’s even a publication called Silicon Prairie News dedicated to recognizing and supporting the area’s “entrepreneurs, creatives, and investors through an emerging model for grassroots entrepreneurial ecosystem development.” I’m not sure how I missed this one, but will be adding it to my regular reading list, as well as paying heightened attention to how this Silicon Prairie we live in continues to make headlines. 

Post by Karen Wenzel, Guest Blogger

A New Tool for the Elevator Pitch

I’ve written before about the importance of a good elevator pitch in attracting interest in your business.  Looks like the folks at Harvard Business School have created a new interactive tool to try and help entrepreneurs create their two-minute pitch.

I’m sure it isn’t perfect (and it certainly won’t bring the experience of a guy like Nathan Gold to the process), but it might be an interesting way to get started on developing a good pitch.

You can read more about it here.