Andrew Abramowitz

Series Seed Preferred Stock Documents

Scott Sutherland Great Ideas, Inc.
Licensed under CC BY 2.0.

As a general matter, the complexity of the documentation used for private company capital raising transactions is correlated with the amount raised. If a company is raising, say, $5 million or more from an institutional investor like a venture capital fund, the deal documents will often be based on the model legal documents prepared by the National Venture Capital Association (NVCA). While the standardization, easy availability and wide acceptance of these forms have been helpful in reducing legal costs and negotiation time, they are still over 100 pages spread over several agreements with many negotiable provisions. But in the context of the amount being raised, the associated costs are relatively small.

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Small Firms: Don’t Use Your Smallness as an Excuse

Small Firms: Don't Use Your Smallness as an ExcuseCarolyn Elefant, writing in Above the Law, takes to task those solo lawyers who, to use her phrase, “play the solo card” by using their firm’s smallness as an excuse for sub-standard service. I don’t know enough to weigh in on the specific case that triggered her piece, a solo attorney who tried to excuse a late filing by citing Microsoft Word technical issues. There certainly have been large firms that have tried to make excuses as a result of their network crashing or the like. However, I completely agree with Elefant’s overarching point that small firms should not assume that their clients and others will accept second-class service just because of the size of the firm.

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The Development of “SAFE” Instruments

In early 2015, I wrote about SAFE instruments, which I then had heard about but not yet seen in my practice, with a gently mocking but grudgingly intrigued tone, which likely resulted from the trend having originated on the West Coast. (As a native New Yorker, I have been trained to roll my eyes at each new development from California and then promptly forget about that when I incorporate it into my life.) With over three years of experience with SAFEs in my practice, I thought it appropriate to update my post, less the cynicism, since they have become pretty common and accepted in the world of early stage corporate finance.

A SAFE instrument (Simple Agreement for Future Equity) is an alternative to convertible notes for startups seeking bridge financing to keep the lights on until they can raise substantial funds in a true equity round.  Y Combinator offers open source SAFE equity forms with some background information.  With a convertible note, the seed investor acts temporarily as a lender, with the note being converted to equity if and when the company completes a qualifying equity financing.  With SAFE equity, the investor simply receives the right to receive preferred equity when the qualified financing is completed, without the need to temporarily treat it as a loan.  There is no interest, maturity date, repayment terms or any other provisions that you’d associate with a debt instrument.

SAFE promoters correctly point out that these seed investors are not ultimately seeking a debt-like steady return on their investment.  As early-stage equity investors, they have more of a high risk/high reward orientation. Convertible notes are usually not repaid in cash. The more likely scenarios are that (1) they are converted into equity, or (2) the company fails to complete a financing and realistically is not able to pay back the note. In the first scenario, the accrued interest adds to the amount of shares issued upon conversion, giving the investors a windfall that they would not have expected by making a simple equity investment. With SAFEs, the investment is treated like an equity instrument, which reflects the intent of both parties.

The SAFE folks also tout the relative simplicity of the SAFE documentation.  There is only one five-page document to be executed, and there aren’t a lot of moving parts requiring much customization.  Essentially, the parties need to only agree on whether there is a cap on the valuation of the later financing for purposes of determining the number of shares to be issued to the investor, and whether the investor receives a discount on the conversion price when the later financing is completed.  In fairness, convertible notes are themselves fairly simple and are used because they are themselves much simpler than VC equity documents, but SAFE equity appropriately combines simplicity with avoiding introducing debt concepts where not intended.

Finally, the absence of a maturity date with SAFEs takes the time pressure off of the company to complete the equity offering within a particular timeline, though investors may prefer having such a deadline in place to incentivize a quick completion of an offering.

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Does It Matter that Few Investors Read SEC Disclosure?

Jason Zweig, writing in the Wall Street Journal, discusses efforts to make securities disclosure more understandable to the typical investor. He quotes the Nobel-laureate behavioral economist Richard Thaler as saying that “nobody reads” the dense disclosure mandated by the SEC. This is clearly a bit of hyperbole, but I think we can all agree that a majority of investors don’t read a prospectus cover to cover before making their investment decision. The question is what to do about it.

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Why I Need to Rely on Legal Specialists

Corporate Transactional Law Practice | Andrew Abramowitz, PLLCWhen I am assisting a client on a matter, and the help of a legal specialist is needed (tax, above all else, but many other areas as well), the client will often be reluctant to loop in the other attorneys and will urge me to handle it. While I’d like to think that this is a reflection of the client’s respect for my abilities, I’m sure it’s in part based on a fear that bringing on another attorney will drive up legal costs. I don’t think this is necessarily the case, and in any event, scrimping on getting the right advice can create substantive issues that cost far more in the long run.

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The SEC Expands the Pool of Smaller Reporting Companies

The SEC Expands the Pool of Smaller Reporting CompaniesThe SEC has greatly expanded the number of public companies that can take advantage of the “scaled disclosure” provisions of Regulation S-K. Under these rules, smaller reporting companies have less onerous requirements that apply to their periodic filings. For example, smaller reporting companies do not need to include the lengthy Compensation Discussion and Analysis disclosure that larger companies do. Following the SEC’s recent action, the definition of “smaller reporting company” includes registrants with a public float of less than $250 million (up from $75 million), as well as registrants with annual revenues of less than $100 million for the previous year and either no public float or a public float of less than $700 million (previously, less than $50 million of annual revenues with no public float).

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What We Can Learn from Changes in Public SEC Filings

Scott Sutherland Great Ideas, Inc.
Licensed under CC BY 2.0.

Peter R. Orszag, writing in Bloomberg View, highlights a study of public SEC-filed Form 10-K annual reports, which found that companies that make changes to the disclosure in their 10-Ks from one year to the next tend to have lower stock returns than average after publication of those changes. The study found that a significant majority of the changes constituted disclosure of negative information, so the resulting decline in performance is not surprising.

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Charging Fees for Initial Legal Consultations

Start Up Valuations | Andrew Abramowitz, PLLCWhen I start a new client relationship, the referral source introduces me to the potential client, usually by email, and then I have an initial call or meeting with the potential client. I don’t require that a fee be paid before I agree to proceed with this background consultation. It’s only after the meeting where we make engagement arrangements if there is a need to do so. Many attorneys, however, feel strongly that this is a bad policy and insist that even the initial meeting is on the clock. Of course, attorneys can feel free to set whatever ground rules they want, as long as they’re properly communicated in advance. There may be practice areas where immediate charging makes sense, but for what I do, I think this sort of policy reveals a mindset about the attorney that I try to avoid.

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The Presumed Sophistication of Accredited Investors

The Presumed Sophistication of Accredited InvestorsA recent Wall Street Journal article highlighted how sketchy brokers have been marketing problematic private placements to accredited investors. While the article focused on the brokers, I was struck by the identity of one of the investor victims noted in the article as having lost a lot of money: George Stephanopoulos, the ABC News anchor and former Clinton Administration official. I don’t mean to cause Mr. Stephanopoulos any further embarrassment by highlighting this here (though I’m guessing that the readership of my blog is far less than that of the Journal), but the fact that he was scammed is a useful illustration of the misguidedness of the accredited investor definition and associated rules.

The current definition of “accredited investor” under SEC rules essentially uses wealth as a proxy for sophistication, as an individual can qualify by either having an annual income of $200,000 or a net worth of $1 million not including the value of one’s primary residence. An offering made to all accredited investors does not have an information requirement, meaning the investors do not need to be provided with a similar level of disclosure that would be associated with a registered public offering.

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The New York Times on Ownership of Real Estate by LLCs

Preserving Anonymity with LLCs | Andrew Abramowitz, PLLCBack in January, before they truly became household names, I wrote about how the publicity around Michael Cohen’s use of an LLC to pay off Stormy Daniels fell into a larger narrative of how Delaware LLCs were being portrayed (unfairly, in my view) as equivalent to offshore shell companies, i.e., mysterious entities being used for nefarious purposes. Now, The New York Times comes along with a lengthy expose of how LLCs are being used to own real estate and enable bad behavior. …

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