Financing Transactions/Securities Offerings

When startups are seeking to obtain seed capital through a friends and family financing, most of the time, those friends and family members make a direct cash investment either in their individual capacity or through a business entity that acts as an investment vehicle.  Another option that is not widely known is for the investor to use tax-deferred retirement funds for the investment, via what’s known as a self-directed IRA.  Essentially, IRA funds can be used for many investments other than the familiar publicly-traded stocks, bonds, mutual funds, ETFs, etc., and among the other permitted investments are private company securities.  However, the investment must be made through a custodian who administers the process, executing transaction documents on behalf of the investor, etc.  The custodians are not the familiar brokerages like Fidelity and Schwab, but others you probably haven’t heard of that specialize in this area. …

Using Self-Directed IRAs for Friends and Family FinancingsRead More »

As much as I am always inclined to mock West Coast trends, there is a recent one that I grudgingly find intriguing:  so-called “safe” equity (simple agreement for future equity), which is an alternative to convertible notes for startups seeking bridge financing to keep the lights on until they can raise substantial funds in a “real” 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 has a qualifying equity financing.  With safe equity, the investor simply receives the right to receive preferred equity when the 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.

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“SAFE” Equity as an Alternative to Convertible NotesRead More »

Back in the day, by which I mean the mid-2000s, I worked on a few reverse mergers.  The term is kind of a misnomer, because it sounds like the unwinding of a merger, but it actually refers to an alternative way for private companies to go public by merging with a public “shell” company.  The shell has little or no current operations and files its 10-Ks and 10-Qs, waiting to complete the reverse merger and acquire the private company.  A private company would go this route, rather than doing a traditional IPO, mainly because it is not large enough to attract the interest of first-tier investment banks, and because completing the reverse merger can be done relatively quickly, without the SEC review process associated with a traditional IPO.  However, there are a number of caveats and restrictions that should be considered by any private company before proceeding down this route:

• Several SEC rules limit the activities of issuers and stockholders of former shell companies, including issuers’ ability to conduct certain types of offerings and stockholders’ ability to sell their shares.  Basically, the SEC hates reverse mergers, in part because they historically attracted unsavory promoter-types, and in part because the transaction is viewed as an end run around the SEC’s usual procedures, even if it’s technically permitted.
• The cost of being a public company is significant, especially with Sarbanes-Oxley internal control and other requirements, and such costs may be too much for the former private company to bear.
• The major stock exchanges will no longer list a former shell’s shares immediately after the reverse merger, meaning that at least for some time, the shares will be quoted on the OTC Bulletin Board or Pink Sheets, which are shunned by most institutional investors.
• Perhaps because of these factors, companies that have completed a reverse merger tend not to be successful long-term, though surprisingly, a recent study found that reverse mergers of Chinese companies (which have attracted particularly bad press in recent years) performed fairly well on average.

Reverse mergers are not as common as they were, and they may become less so following the enactment of Regulation A+, which will permit mini-public offerings of up to $50 million, which will presumably be attractive to those companies that currently would consider the reverse merger route.

Keith F. Higgins, the Director of the Division of Corporation Finance at the SEC, recently spoke at the 2014 Angel Capital Association Summit.  His speech came in the midst of much JOBS Act rulemaking that I’ve blogged about frequently, and his remarks provide some useful insight into what the SEC is thinking about these days, although he includes the standard disclaimer that he’s speaking for himself and not the whole agency.  In particular, I thought the following topics that he covered were worthy of note: …

The Latest from the SEC on Private Offering RegulationRead More »

I’ve noted in past posts that the SEC tends to take a paternalistic attitude toward the notion of non-accredited investors participating in private offerings, with income and net worth enshrined in the applicable rules as a rough proxy for sophistication and ability to take investment risk.  However, the risk to non-wealthy investors of being wiped out is real.  Needless to say, placing one’s entire nest egg in one basket, particularly a high-risk/high-reward-type of an investment, is a recipe for disaster.  The JOBS Act provisions on crowdfunding, and the SEC’s proposed rules enacting those provisions, seek to address this issue through limitations on the amount that can be invested in any one offering and all crowdfunded investments together by those with modest income and net worth. …

Limiting Investment Risk for Non-Accredited InvestorsRead More »

The Private Placement Memorandum (PPM) is the disclosure document used in private securities offerings, providing to prospective investors detailed information about the company’s business plan, terms of the offering, risk factors, management, financial history and/or projections, etc., to enable the investors to make an informed decision on whether to participate in the offering.  For Regulation D offerings, Rule 502 requires that a PPM be provided to any non-accredited investor and goes on to recommend that the same PPM also be provided to the accredited investors.  Therefore, in an offering that is made solely to accredited investors, as is often the case, a PPM is not required.  So the question is whether, in such cases, a PPM should nevertheless be prepared and provided.

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When to Use PPMsRead More »