Photo by Michael Tipton
The SEC’s crowdfunding rules (under Regulation Crowdfunding) became effective earlier this week. From the legal and legislative perspectives this was a big day since it marked the effective date of
one of the most heavily anticipated and promoted components of the JOBS Act. It is also the last provision of the JOBS Act to be put into practice. Reward-based crowdfunding has been operational for a long time and has had some pretty positive results, but the SEC’s equity crowdfunding rules were going to be a way for small investors to make equity investments in small companies and help foster the growth of the tech and innovation economies.
Unfortunately, as reported in my prior blog post and just about everywhere else, the execution of the final crowdfunding rules has resulted in a system that is probably not viable for most situations. While the new rules may work in some cases, they create barriers that I believe will prevent widespread use of equity crowdfunding as a financing vehicle. One of the best summaries of Regulation Crowdfunding problems and deficiencies can be found in this post which quotes Jeff Lynn, the CEO of Seedrs (a prominent crowdfunding platform). He is certainly a guy who believes in the crowdfunding concept, but he says that the crowdfunding regulations in their current form are not workable. Lynn also advises US regulatory authorities to study the UK crowdfunding model, which he believes allows companies to raise funds while still providing investor protection.
The main problems with the new crowdfunding regulations are practical ones. First, the funding limit of $1 million each year is just too low for most companies. This is similar to the problem that we saw with Regulation A for a long time – essentially no one used it because the limit was too low in relation to the costs (although the old Regulation A limit was $5 million, substantially higher than the current crowdfunding limit). Regulation A+ has fixed this problem for Regulation A offerings, but the low limit remains a huge challenge for crowdfunding offerings. This low limit problem is made worse by the costs associated with a crowdfunding offering, which will be substantial for a small company. Legal and accounting work will be required. Companies must also use a registered funding portal in connection with the offering, and this will add to the cost burden. Finally, companies cannot “test the waters” before beginning an offering to see if the offering is even viable for them. The combination of all of these factors creates significant practical roadblocks for crowdfunding that cannot be overcome without some adjustments (as discussed below). Continue Reading
Photo by Jan Tik
In business, we’ve all seen the traditional nondisclosure agreement (also known, more simply, as the “NDA”) between two parties wishing to discuss a potential business transaction. While NDAs are good tools to protect a party’s confidential information during such discussions, businesses must take care to ensure that an NDA does not jeopardize the strong protections traditionally available to them under state laws.
State trade secret laws can provide substantial protection to certain confidential information, including trade secrets. These protections generally apply to information or materials that (1) have independent economic value; and (2) are kept “secret” by the owner. Importantly for purposes of meeting the secrecy requirement, most state laws provide that, so long as the owner takes measures to protect the secrecy of the information or materials that are reasonable under the circumstances, the requirement will be deemed met. Entering into an NDA sure sounds like at least one reasonable measure to protect the secrecy of a business’ confidential information, including its trade secrets. But business must beware: certain provisions of NDAs, if not properly addressed, could endanger state law protections regarding trade secrets. These provisions generally fall into one of two categories:
1. The term of the NDA. In many cases, the term of the NDA is limited to a one, two or three year period. The issue with NDAs of limited duration stems from the fact that, once expired, the recipient of trade secrets under the NDA might have no duty to keep such information or materials confidential. Under these circumstances, once the NDA has expired, some courts may find that the owner of a trade secret is no longer taking reasonable measures to keep its trade secret a “secret.” As a result, the relevant information or materials may lose trade secret protections under state law.
On its face, the obvious solution to this problem Continue Reading
Photo by David Fulmer
Over the past couple of months, the FASB has been busy. I wanted to point out one recent change and my thoughts on its impact.
FASB has “simplified” share-based compensation accounting. I will always have a special place in my heart for old FAS123 since it was on my CPA exam a couple of decades ago. Nevertheless, much has changed since then (APB No. 25 anyone?), including most recently:
- No more APIC pools. Currently, tax benefits in excess of compensation cost are recorded in equity (specifically, Additional Paid In Capital or APIC). The accumulation of excess benefits has been known as an APIC pool. Tax deficiencies decrease the APIC pool. Under the new accounting rules, excess benefits and deficiencies are recognized in the period in which they occur.
My Take – Expect more income tax expense volatility from period to period. If the changes impact tax expense significantly, we could see more non-GAAP financial measures develop. Just be careful of the renewed focus on non-GAAP financial measures from the SEC.
- No longer need to estimate forfeitures. GAAP currently requires you to estimate the number of awards that will be forfeited to calculate a more accurate amount of compensation cost each period. Under the new rules, you can continue to estimate or you can just reverse the compensation previously expensed when the forfeiture occurs. If you choose the new route, then you will have to hit retained earnings for the cumulative-effect adjustment incurred as a result of the change as of the beginning of the year the change is applied.
My Take – Again, there could be potentially more volatility if you elect to apply the new “actual” forfeiture approach. A good example of volatility would be if a company had a significant layoff of employees. The increase in forfeitures during the layoff period would significantly Continue Reading
On April 13, the SEC authorized the issuance of a major concept release. Concept releases are trial balloons that the SEC publishes to elicit input on possible rulemaking, including whether rulemaking is needed and what form it should take if it happens. The April 13 concept release is entitled “Business and Financial Disclosure Required by Regulation S-K”. Given that Regulation S-K spells out many of the disclosure requirements applicable to all sorts of Exchange Act filings, it’s bound to be significant.
The concept release is a very large trial balloon indeed – it runs to nearly 350 pages – and I have yet to crack it open. However, I do intend to read it. And I urge you to do the same, as it’s likely to impact disclosure requirements for the next generation.
Some preliminary thoughts about the concept release, based upon press reports and the opening statements made by the Commissioners during the meeting at which the release was approved for publication: Continue Reading
One of the hottest topics in governance today is director refreshment. (No, that doesn’t refer to what your board members have for lunch.) Boards comprised of long-serving directors do, in fact, tend to be “pale, male and stale” – i.e., comprised of old white men. Self-perpetuating boards are less likely to be diverse, and there is increasing evidence that companies with diverse boards tend to perform better (the evidence demonstrates correlation rather than causation, but it’s still evidence). There is also a plausible argument that self-perpetuating boards are less likely to challenge long-standing assumptions and practices, leading to board (and corporate) stagnation.
Perhaps it’s a poorly kept secret, but companies and boards have been concerned about this for years if not decades. Even boards that don’t engage in much introspection are often aware that some directors do not contribute much. As a result, companies and boards have tried all sorts of devices to force board refreshment – term limits and/or age limits having been the most common. Unfortunately, these devices have not worked very well, perhaps because they may be inherently ineffective, and no doubt also because companies often move the goalposts – age limits are waived (because keeping director X is deemed to be “in the best interests of the company”, whatever that means) or creep upward, term limits force good directors to retire, etc. And so, corporate America continues to search for the right approach. Some companies have adopted extremely long term limits (15 years), and others have said that average tenure may not exceed X years, but it’s too soon to tell whether these or other newer approaches will succeed.
Two news items from the front lines:
First, you may recall my mentioning that the Council of Institutional Investors was considering adopting a new policy that would limit newly public companies’ ability to include “shareholder-unfriendly” provisions in their organizational documents (see “Caveat Issuer“, posted on February 13). I just came back from Washington, DC, where I attended the Council’s Spring Meeting, and the new policy appears to have been adopted as proposed. While the text of the new policy was not made available at the meeting, and has yet to be posted on the Council’s website, it appears to provide that while some of these provisions can be in place when a company goes public, others — such as plurality voting for directors in uncontested elections — should be absent from the get-go.
By the way, my hotel room had a lovely view of the Jefferson Memorial, and the cherry blossoms were about to pop.
In other news, the SEC has announced, by way of a Sunshine Act Notice, that at an open meeting to be held on March 30 it “will consider whether to issue a concept release seeking comment on modernizing certain business and financial disclosure requirements in Regulation S-K”. Looks like the disclosure effectiveness program may be moving forward. Watch this space for details.
According to SEC Chair White, regulators are looking – and not happily – at companies’ increasing use of customized financial disclosures. In fact, her recent remarks suggest that additional regulation is not being ruled out to curb the use of such “bespoke” data.
For some of us it may seem like only yesterday – though it was actually in 2003 – that the SEC adopted Regulation G to address the then-growing concern that companies were developing odd ways of communicating financial information to make their numbers look better. In general, Reg G says that companies
- cannot make non-GAAP disclosures more prominent than GAAP disclosures;
- need to explain why they use non-GAAP disclosures; and
- must provide a reconciliation showing how each non-GAAP measure derives from the GAAP financial statements.
So far, so good. However, some companies give little more than lip service to these requirements. For example, it’s not unusual to see Item 2 addressed by a statement along the lines of “investors who follow the company use this measure to assess its performance.” And, more recently, companies seem to be developing more peculiar ways of showing performance, such as excluding the effects of some taxes but not others. This creativity may not be as arch as excluding recurring items or turning losses into gains, but it still makes regulators uneasy.
We are pleased to provide a posting from our colleagues, William K. Hill, a shareholder in Gunster’s Business Litigation practice group, and Joshua A. Levine, an associate in that practice group.
On January 22, 2016, as part of the Delaware Court of Chancery’s decision concerning the stockholder class action challenging Zillow’s acquisition of Trulia, see In re Trulia, Inc. Stockholder Litig., CV 10020-CB, 2016 WL 325008 (Del. Ch. 2016), the Delaware Court extensively discussed the phenomenon of “disclosure settlements” and the Court’s attitude and approach to them.
The Court wrote that, in today’s environment, a public announcement of virtually every transaction involving the acquisition of a public corporation provokes a “flurry” of class action lawsuits alleging that the target’s directors breached their fiduciary duties by agreeing to sell the corporation for an unfair price. The Court explained that the percentage of transactions of $100 million or more that have triggered stockholder litigation in the United States has gone from 39.3% in 2005 to a peak of 94.9% in 2014.
Far too often, the Court explained, such litigation serves no useful purpose for shareholders and only generates fees for “certain lawyers who are regular players in the enterprise of routinely filing hastily drafted complaints on behalf of stockholders.” The plaintiff leverages its threat of an injunction to prevent a transaction from closing, and defendants are incentivized to quickly settle in order to avoid the expense and distraction of litigation and to obtain comprehensive releases as a form of “deal insurance.” Defendants procure settlements by issuing supplemental disclosures to the target’s stockholders before they are asked to vote on the proposed transaction, under the theory that, by having this additional information, stockholders will be better informed when exercising their franchise rights. Once an agreement in principle is reached to settle for supplemental disclosures, the Court must evaluate the fairness of the proposed settlement.
Despite the wave of corporate governance reform that began after the enactment of Sarbanes-Oxley in 2002 – and that continues pretty much unabated today – companies going public have gotten a pass. Whether the process of going public takes the form of a spin-off or a conventional IPO, newly public companies have been able to emerge into the world with a full (or nearly full) arsenal of defensive weapons that can help them stave off an unwanted acquisition.
The rationale for this leniency is that newly public companies are like tadpoles that need to be given time to turn into frogs (or princes) before they are gobbled up.
That seems to be changing.
Photo by Saulo Cruz
Corporate venture capital has quickly developed into a major funding source for startup companies. This type of startup funding is available to some innovative startups and early stage companies, and the dollars involved are significant. This all sounds great, but is this type of funding right for your startup?
According to the National Venture Capital Association and PWC’s Money Tree survey, 905 corporate venture capital deals were closed during 2015 with $7.5 billion invested (primarily in high growth startup companies). These transactions comprised 21% of the total number of venture capital deals closed in 2015 and represented 13% of the total venture capital funds invested in that year. Not surprisingly, the biggest chunk of these investments went to software companies ($2.5 billion in 389 deals, which represented 33% of all corporate venture deals in 2015), while biotech deals were second ($1.2 billion in 133 deals, which represented 16% of all corporate venture deals that year).
Many large and familiar companies have implemented venture capital programs. Some of the most well-known corporate venture funds are Alphabet’s GV (formerly Google Ventures), Microsoft Ventures, and Salesforce Ventures. Most of these corporate venture funds are sponsored by large technology companies, but Airbus Group Ventures is an example of a fund established by a non-technology company in a specific industry space. While each of these programs has some independent characteristics, the commonalities are a strong desire to foster innovation (either generally or in specific industry segments) and an ability to step out of the normal corporate mold and commit funds to situations with higher risk profiles when compared to normal corporate investments like real estate and straightforward corporate industry acquisitions.
There are a number of significant potential advantages associated with corporate venture capital. For me, two of the biggest potential advantages are the broader investment scope and the more long-range expectations which may result in a corporate venture investment as compared to a normal external venture investment. A corporate venture capital investor can Continue Reading