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Bob White is a business, corporate and technology lawyer. He is a member of Gunster’s Corporate and Securities and Corporate Governance Practice Groups, and he is the Co-Chair of the Technology and Emerging Companies Practice Group. He works with innovative companies, entrepreneurs and in-house lawyers on a wide variety of topics including mergers and acquisitions, venture capital and private equity investments, corporate structuring, corporate contracts and technology matters.

SAFE and KISSEarly stage and startup companies often face difficulty in obtaining initial financing.  These companies normally do not have access to traditional venture capital, angel, or bank financing.  Even when a startup finds an investor, the company may not have the time or the funds to pursue the long and complicated negotiation and documentation process required for a convertible debt or preferred stock investment.

Y Combinator (a Silicon Valley technology accelerator) developed a possible solution for this situation:  the SAFE (Simple Agreement for Future Equity). This is a short document that contains the basic terms of an investment in an early stage company. Y Combinator’s goal was to create a standard set of terms and conditions that the investor and the startup can agree upon without protracted negotiations so that the startup can obtain its initial funding relatively quickly and cheaply. Y Combinator offers both a summary of SAFE concepts and sample SAFE documents on its site.  Y Combinator first proposed this instrument in December 2013, but it is just now beginning to be used outside of Silicon Valley.

While the SAFE has appeared in a number of forms, the basic concept is that the investor provides funding to the company in exchange for the right to receive equity upon some future event.  The standard SAFE contains no term or repayment date, and no interest accrues.  The investor gets the right to receive the company’s equity when a future event occurs (normally a future equity financing). There is no need to spend time or money negotiating the company’s valuation, the terms of the conversion to equity or any similar items (which can often be tough and protracted negotiation items) – all of those decisions can be deferred into the future. The investor will receive shares in the subsequent offering, often at a discount to the price that other investors pay in that offering. The parties can also negotiate a cap on the valuation used in connection with the SAFE, and this may provide additional protection to the investor.

The beauty of the SAFE concept (from the company’s standpoint) is that it
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On September 19, Chinese e-commerce giant Alibaba completed the initial public offering of its stock. The underwriters for the offering subsequently exercised their option to buy additional shares, making this the largest IPO in history at $25 billion. The stock’s price immediately jumped by a huge amount, finishing its first day of trading at $93.89, a 38% increase over its $68.00 IPO price. The stock has since lost some ground, closing at $87.17 on Tuesday.

What does this massive IPO mean for U.S. technology companies? I see four possible areas of impact:

  1. U.S. technology companies may delay their IPOs until they see how the Alibaba stock performs. This could be a short delay if the stock price holds up or does well. Right now U.S. technology companies Hubspot, Lendingclub.com, GoDaddy.com and Box, among others, are expected to conduct IPOs this fall.
  2. If the substantial demand for Alibaba stock holds up, fund managers may reduce their
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Waiting for the results of the JOBS Act?
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President Obama signed the JOBS Act into law on April 5, 2012 amid much fanfare and optimism. Small and medium sized fast-growing technology companies and their executives were especially sanguine about this new act as it appeared that it would provide access to much-needed additional expansion capital. These companies were still reeling from the recession and the substantial reduction in available venture capital financing, and they saw the JOBS Act as a potentially positive event. A little more than two years later, has this initial optimism proved to be warranted? Let’s take a look at some of the provisions of the Act.

A new regulatory structure for crowdfunding was initially the most anticipated provision of the JOBS Act. I never believed that crowdfunding would be as beneficial as some people did, but I hoped that it could provide some additional access to capital for smaller companies which were starved for funds. Unfortunately we are still waiting for the SEC’s final crowdfunding regulations. The SEC appears to be caught between two complaining factions here – one which thinks the proposed rules are too restrictive and won’t work, and one which thinks
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SEC may change identity of angels
Illustration by Royce Bair

Potential Changes.

Accredited investors have long been critical participants in private financing transactions, and the success of most private financings is largely determined by the participation of these investors and the availability of their capital. State and Federal securities laws have been written or amended to foster and facilitate investment by these accredited investors. Based on recent developments, the standards for qualification as an accredited investor may be changing, and these changes could pose problems for companies seeking financing.

The current requirements for accredited investor status are contained in Rule 501(a) of the 1933 Act. The most commonly used standards for individual investors are a $200,000 annual income (or $300,000 combined income with a spouse) or a $1,000,000 net worth (excluding the value of the investor’s primary residence). Other than the exclusion of the investor’s primary residence (which became effective in 2012), these standards have been in place since 1982 without any changes to reflect the effects of inflation during that period.  

Based on these current standards, observers estimate that there are approximately 8.5 million accredited investors in the United States. Some critics have asserted that this number is far higher than it should be, and that many of these people only qualify as accredited investors because
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States creating own exemptions for crowd funding
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The JOBS Act’s crowdfunding provisions were once one of the most eagerly anticipated items contained in that Act. Many companies and their advisors had high hopes that these crowdfunding provisions would open up new arenas for financing smaller companies while easing the costs and challenges associated with securities regulatory compliance. These hopes and dreams have been substantially curtailed as the SEC’s proposed crowdfunding rules (issued in 2013) did not provide the anticipated relief. The SEC received a significant number of comments on these proposed crowdfunding rules, and these comments were predominantly critical due to the perceived regulatory and cost burdens that the proposed Rules seemed to contain.

Hope springs eternal, however, and many people are still eagerly awaiting the SEC’s final crowdfunding regulations to determine if the SEC will adopt a more reasonable position that may be useful to small companies seeking financing. The Federal crowdfunding exemption from registration will not be effective until the SEC issues these final regulations. Many people just want to know what they are actually dealing with here and whether crowdfunding will offer any viable opportunities for small company financing. Somewhat surprisingly given the significant amount of attention and publicity that crowdfunding has generated, the SEC still has not issued those final regulations despite the JOBS Act’s deadline. This situation has caused a significant amount of frustration in the corporate finance community.

Given the uncertainty regarding the status of Federal crowdfunding regulation, some states have seen an opportunity and have taken somewhat bold steps in establishing crowdfunding exemptions on the state level. The states moving ahead of the SEC is somewhat unusual, but it appears that the initial impact of these state crowdfunding initiatives may be economically beneficial to these states.

The predominant model for these state crowdfunding structures is the creation of an intrastate crowdfunding exemption from registration. The states have been very creative in their efforts, as they appear to have used the strong desire for a useful crowdfunding regulatory structure to create state structures that will help to provide economic growth in the states. This is also very compatible with the nature of crowdfunding – since many crowdfunding projects are smaller and localized, they may not be affected by being required to be contained in any one state.

The participating states have mainly modeled their crowdfunding regulations to be
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Cybersecurity in the cross hairs of the SEC
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The SEC continues to increase its focus on cybersecurity preparedness. As we have reported in prior blogs here and here, we believe that cybersecurity will become an increasingly important element of the SEC’s disclosure and enforcement efforts. Recent events show that the SEC is ramping up its efforts in the cybersecurity area, and we believe that all companies who are potentially affected by these SEC activities should pay special attention to their cybersecurity preparedness and should anticipate possible SEC action in this area.

The SEC’s most recent activity in the cybersecurity area involves registered broker-dealers and registered investment advisers. These entities are logical choices for a cybersecurity focus because of the large volume of confidential and very sensitive customer information that they hold. The SEC’s Office of Compliance Inspections and Examinations (“OCIE”) announced this cybersecurity focus in an April 15, 2014 Risk Alert which stated that the SEC plans to mount an initiative to assess cybersecurity preparedness in the securities industry. The SEC had previously laid the groundwork for this initiative during a March 26, 2014 Cybersecurity Roundtable when Chair White stressed the vital importance of cybersecurity to our market system and consumer data protection. She also called for more public/private cooperation in strengthening cybersecurity preparedness. Other SEC participants at this Roundtable stressed the importance of gathering data and information regarding cybersecurity preparedness so that the SEC could determine what additional steps it should take in this area.

The OCIE’s cybersecurity initiative will assess cybersecurity preparedness in the securities industry and obtain data and information about the securities industry’s recent experiences with cyber threats and cybersecurity breaches. As part of this initiative, the OCIE announced that it will conduct examinations of more than 50 registered broker-dealers and registered investment advisers to obtain cybersecurity data and information and to assess the preparedness of these entities to defend against cyber threats. According to the Risk Alert, this investigation will focus on such things as
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Last shot for JOBS Act?
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The Jumpstart Our Business Startups (JOBS) Act was enacted on April 5, 2012 with much fanfare and high expectations. The JOBS Act was designed, in part, to help “Emerging Growth Companies” (annual revenues less than $1 billion) gain greater access to growth capital while reducing regulatory restrictions, compliance requirements, and costs. The JOBS Act was welcomed by a business community which was just emerging from a brutal recession and starved for growth capital. The general reaction to the JOBS Act has been disappointment and a feeling that the JOBS Act has failed to live up to its advance billing. With the proposed Regulation A+ still to come, however, the JOBS Act may at last provide some real financing opportunities for private companies seeking growth capital. For background on the JOBS Act see our Emerging Growth Companies Task Force page.

There is no doubt that some good things have come out of the JOBS Act as its various rules have become effective. The elimination of the ban on general solicitation and advertising for some private offerings may prove very helpful to companies trying to find potential investors. The confidential filing of initial public offering documents (which allows a company to file IPO documents and work with the SEC on a confidential basis to resolve problems before the documents become public) has been extremely popular. The maximum number of shareholders that a private company can have before it must register and report as a public company has increased. This allows large private companies to stay private longer, avoiding the dilemma that Facebook and other companies faced. Finally, issuers of securities are now allowed to “test the waters” in some circumstances to determine potential investor interest in an offering before undertaking it. All of these are positive items, but they have not caused a significant increase in successful financing activity.

So what is Regulation A+ and why do we care? This proposed Regulation is one of the last major rulemaking proposals available under the JOBS Act. The SEC voted on December 18, 2013 to propose new rules under the existing Regulation A that would substantially increase the potential for substantial financing transactions conducted under Regulation A. While we haven’t seen the final rules and likely won’t see them for some time, these proposals have been much anticipated in the corporate finance community because of the
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Where to list NYSE or Nasdaq?These are interesting times for technology companies that are contemplating initial public offerings. For companies of sufficient size, the exchange for the listing of their securities generally comes down to the New York Stock Exchange and the Nasdaq Stock Market. The NYSE has historical prestige and a long track record, while the Nasdaq has cultivated a progressive, tech-friendly reputation. If you are a high visibility technology company, you will probably find these exchanges actively competing for your listing. Such benefits as free advertising have been used, and business deals involving a company’s services may influence a company’s decision as to which exchange to list its securities. For example, Oracle’s switch to the NYSE from Nasdaq was reportedly in part due to an agreement by the NYSE to continue to use Oracle software in its operations.

Nasdaq has long been the favorite exchange for the listing of technology company offerings. This was probably due to the initial progressive use of automation and electronics in this exchange’s early operations which resonated with technology company executives. Rather than traders waving pieces of paper (the historical process at the NYSE), Nasdaq pioneered the use of electronic quotation boards and other advanced methods in its operations. Nasdaq was willing to list the offerings of smaller companies and was also cheaper than the NYSE. All of these factors allowed Nasdaq to build a reputation as the technology companies’ preferred exchange. This reputation was fostered and supported by the listing of a large number of technology companies, including big hitters like Apple and Microsoft.

Nasdaq’s role as the preeminent exchange for technology companies has been diminished. One of the major blows for this exchange was
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The next big tech IPO is in the works. Twitter, the hugely popular short message social media site, announced last week that it has filed a Form S-1 registration statement with the SEC in connection with the company’s proposed initial public offering. This IPO has been rumored and anticipated for some time, and it will generate substantial interest among members of the tech and investment communities. This offering may not have the impact of last year’s Facebook IPO, but it will be close.

Twitter appropriately announced its planned IPO in a tweet on September 12:

Twitter announces IPO in tweet

(followed by a “get back to work” tweet):

Twitter IPO

This offering should proceed more smoothly and productively than the ill-fated Facebook IPO. The various participants in the IPO process learned a lot from the significant problems that the Facebook IPO encountered, and in some cases these lessons were driven home by significant monetary penalties (See my prior blog post regarding the Facebook IPO and its problems). No one wants a repeat of that situation, especially with such a high profile IPO. Twitter has also always impressed me as a more thoughtful and rational company than some in the tech space, and this should carry through in their IPO.

In its IPO filing process Twitter took advantage of one of the key available provisions of the JOBS Act. Section 6(e) of the Securities Act allows an “emerging growth company” to file an IPO registration statement on a confidential basis. This provision is designed to give the company and the SEC time to identify and work through potential problem areas or issues before investors see any information. It also allows companies to keep material nonpublic information confidential until late in the SEC review process. If the company decides not to proceed with its IPO, it has avoided the public disclosure of this information. If the company and the SEC can work out these problems and issues satisfactorily, the registration statement (amended as necessary) eventually becomes available to the public and the IPO process goes forward. This should make the registration process very quick and efficient after it emerges from the initial SEC review.

This confidential filing opportunity has been popular with emerging growth companies. According to an Ernst & Young JOBS Act study, approximately 63% of eligible companies used this process during the first year of its availability under the JOBS Act. The SEC has published a set of helpful FAQ’s which clarify many components of this confidential filing process.

Twitter added one interesting change to this
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