For the first time since 2015, the SEC has its full complement of five commissioners.  That’s a good thing.  And at least one new Commissioner – Robert Jackson – seems to have hit the ground running.  For example, he made a speech in San Francisco just the other day in which he expressed his disfavor of dual-class stock, suggesting that it would create “corporate royalty”. Specifically, because shareholders in at least some dual-class companies have no voting rights, leadership of the company could be passed down through the generations in perpetuity.

Commissioner Jackson is a smart man – I’ve seen him speak at a number of programs, and he’s demonstrated his intelligence as well as his telegenic appearance.  His use of the “corporate royalty” meme also shows that he’s witty, though don’t think we need to worry too much about CEO titles becoming hereditary.

What I do think we may need to worry about is where he goes with his concerns.  Specifically, the point of his speech is to suggest that exchanges adopt mandatory sunset provisions so that their dual-class structures would fade away over time.

Continue Reading Dual-class shares: marching toward merit regulation?

Photo by hamad M

Initial Coin Offerings, or ICOs, have generated a lot of buzz recently as a new method by which companies can raise capital to fund their businesses. At the same time, the SEC has been cracking down on ICOs that involved the offer or sale of a security that was not registered or structured to comply with an exemption from registration. For example, the SEC announced last week that it halted a $600 million ICO by AriseBank, which allegedly involved the offering of a coin that was a security without properly registering the transaction. Despite the apparent scrutiny of ICO transactions by the SEC, there’s much uncertainty in the space as to when securities laws may or may not apply to a specific ICO transaction.

Currently, we are seeing two primary types of ICOs – those that involve the sale of a “security token” and that are intended to be offerings of a security and those that involve the sale of a so-called “utility token,” which do not involve the offer or sale of a security. The primary difference between these two types of tokens is that a utility token is designed such that it has some intrinsic value that is not based upon prospective price appreciation. For example, a cloud computing company might sell utility tokens that are redeemable with the issuer for storage space on the issuer’s servers. In this sense utility tokens are not unlike gift cards where a purchaser is acquiring something that can be redeemed for products or services from the issuer in the future. Like gift cards, an incentive to purchase a utility token could be that the token offers a discount to the normal price for the issuer’s goods and services. While a secondary market for the utility token might develop, just like there are secondary markets for the purchase and sale gift cards, issuers usually intend for these tokens to fail the Howey test, which is the test that is used to determine whether something constitutes an “investment contract” (which would be a security) for federal securities law purposes. Continue Reading Is your Initial Coin Offering a securities offering?

Initial coin offerings have taken off in 2017.

The SEC took two strong steps this week toward increased regulation of the cryptocurrency markets and specifically regulation of Initial Coin Offerings (“ICOs”). These steps included the halting of an ongoing ICO and a strong statement by the SEC’s chairman regarding ICOs and their status under the Federal securities laws. These steps were the SEC’s strongest actions to date regarding ICOs, but what is the probable long-term result here? This is getting very interesting as you pit the regulators and their application of traditional securities law concepts against an increasing strong demand in the investment community to invest in these cryptocurrency vehicles.

An ICO involves the offering of a token, “coin” or other digital product. In exchange for their investment, investors receive these tokens or coins. The company then uses the proceeds of the ICO for various corporate purposes similar to a regular offering of securities. ICOs have generally not been registered with the SEC.

On December 11, 2017, the SEC halted the ICO that was being conducted by Munchee Inc., a company that developed a restaurant review app. This action was based on the fact that the company had not registered this offering with the SEC. This ICO involved the issuance of MUN Tokens by Munchee, which the company said might increase in value. Munchee planned to raise about $15 million in this ICO. The SEC said that an investor could reasonably expect to earn a return on these Tokens, and accordingly the Tokens issued in the ICO were “securities” and should have been registered under the Federal securities laws. Munchee accepted the SEC’s findings without admitting or denying anything. The company agreed to halt the offering and to return all proceeds that it had received from investors in the offering.

The investigation of this matter was conducted in part by the SEC’s new Cyber Unit (a division of its Enforcement Section). The SEC had also issued other materials regarding concerns with cryptocurrencies and ICOs, including an Investor Bulletin issued on July 25, 2017 and a Report of Investigation issued on the same date. Continue Reading Cryptocurrency crackdown

The still relatively new SEC Chair, Jay Clayton, has let it be known that one of his missions is to improve the health of our IPO market and, thereby, to improve our capital markets generally.  His minions – including a senior SEC Staff member I recently heard in Washington – have been spreading this gospel according to Jay.

I wish him (and them) luck, but I wonder if the mission is impossible.  I’m thinking of some recent articles, including one by the inimitable Andrew Ross Sorkin entitled “Fixing the ‘Brain Damage’ Caused by the I.P.O. Process”, that makes the resuscitation of IPOs seem unlikely.  As if the title weren’t off-putting enough, one of the executives quoted in the article described his company’s IPO process as “a way of living in hell without dying”.  Not a good start.

Continue Reading Can the US IPO market be brought back from the dead?

In late July, S&P Dow Jones and FTSE Russell announced that they were changing or proposing to change the standards that govern whether a company is included in their indices.  Although their approaches differ, the changes would effectively bar most companies with differential voting rights from their indices, as follows:

  • In its July 31 announcement, S&P Dow Jones said that companies with multiple share classes will no longer be included in the indices comprising the S&P Composite 1500 – which includes the S&P 500, S&P MidCap 400 and S&P SmallCap 600. There are some exceptions; companies currently in these indices will be grandfathered, as will any newly public company spun off from a company currently included in any of the indices.
  • Five days earlier, FTSE Russell proposed to require more than 5% of a company’s voting rights – across all equity securities, whether or not listed or traded – to be held by “free float” holders to be eligible for inclusion in the FTSE Russell indices.

Continue Reading Class Acts: Stock Indices Bar Differential Voting Rights

waldryano
waldryano

I don’t know when Congress decided that every piece of legislation had to have a nifty acronym, but the House Financial Services Committee recently passed (on a partisan basis) what old-fashioned TV ads might have called the new, improved version of the “Financial CHOICE Act”.  The word “choice” is in solid caps because it stands for “Creating Hope and Opportunity for Investors, Consumers and Entrepreneurs”.

Whether and for whom it creates hope, opportunity or something else entirely may depend upon your perspective, but whatever else can be said of the Act, it is long (though at 589 pages, it is slightly more than half as long as Dodd-Frank), and it addresses a very broad swath of issues.  Here’s what it has to say about some key issues in disclosure, governance and capital formation, along with some commentary. Continue Reading The Financial CHOICE Act – everything you’ve ever wanted, and more?

SMU Central
SMU Central

Things are looking pretty good for the venture capital industry. Potential VC investors have a lot of money available, and industry and geographical trends show a positive outlook for VC investing in the near term. There are numerous factors that could negatively affect the outlook for VC investments, but it certainly appears that substantial VC investment activity could occur over the next twelve months.

The most significant positive factor for VC activity in the near term is the supply of available cash. According to a recent report, VC funds currently have approximately $120 billion available for investment. Even though this is a composite number that is applied across the whole VC industry, it is a huge amount of available investment funds.

Another positive factor is the increase in corporate VC investment. In a relatively short time (aided by large amounts of cash on corporate balance sheets), corporate investors have begun to play a key role in the VC industry, especially in larger deals. Last year corporate VC deals comprised 25% of total VC deals, and this percentage will continue to increase. See my prior blog post on the rise of corporate VC investors (Corporate Venture Capital Investments – Good for Startups?).

Continue Reading It’s a good time to be a VC fund

Photo by Chad Cooper
Photo by Chad Cooper

Good, but not surprising, news for issuers considering a Regulation A+ offering. Back in May 2015, Massachusetts and Montana sued the SEC in an attempt to invalidate the Regulation A+ rules.  Montana had attempted to obtain an injunction to prevent the Regulation A+ rules from going into effect last June, but was denied.  Now, the DC Circuit has officially rejected the lawsuit brought by the two states.

As we have discussed, Regulation A+ is a vast improvement over the previous version of Regulation A.  The biggest improvement, state pre-emption, was the most controversial (from the states’ perspectives).  Because Regulation A is already a more burdensome exemption than Regulation D (private offerings) due to the need for SEC review and qualification, pre-empting state securities laws for Tier II offerings was a welcome improvement.  The North American Securities Administrators Association (NASAA), which represents the state securities regulators, was strongly against pre-emption.  NASAA is largely seen as the force behind the lawsuits by Montana and Massachusetts.

I will boil down the details of the lawsuit into a sound bite. The states argued that the SEC acted beyond its authority in enacting rules that pre-empted state securities laws.  The court disagreed and said that Congress, in passing the JOBS Act, pre-empted the state laws.

Massachusetts and Montana could appeal, but I doubt that they will. The validity of the states’ argument was not well grounded because the JOBS Act clearly states that the new Regulation A+ exemption would be a “covered security” – which means state law is pre-empted by federal law.

In any event, the conclusion of the lawsuit provides additional clarity for Regulation A+ offerings. We expect that Regulation A+ will become more widely used as bankers and issuers become more comfortable with the exemption.

Photo by Michael Tipton
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 What’s up with Crowdfunding? So far, not much (but a fix may be coming)

Corporate Venture Capital
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 Corporate venture capital investments – Good for startups?