Diversifying Capital Raising Strategies for Startups

Navigating the VC Winter: Diversifying Capital Raising Strategies for Startups

In the face of a VC winter, startups find themselves at a crucial juncture, requiring innovative approaches to secure funding. We will embark on an exploration of the myriad avenues available for raising capital beyond the traditional venture capital (VC) sphere. We dive into anecdotes of how private companies have creatively accessed funds, emphasizing the importance of not being tethered to a single source of capital. The focus is on the JOBS Act and its provisions, which offer startups a variety of options with potentially more favorable terms than VC funding. We’ll tackle the challenges companies face in this endeavor, from navigating regulatory landscapes to attracting investors. Additionally, we outline seven strategic steps to diversify funding sources, reinforcing the necessity of a well-rounded understanding of all available options. By the end, startups and established companies alike will be equipped with the knowledge to navigate the capital raising process effectively, leveraging regulations to their advantage and working with trusted advisors to ensure success.

The Landscape of Raising Capital

Raising capital for private companies is an art form, with various avenues from VC and angel investments to friends and family, bank loans, government grants, and the provisions under the JOBS Act. Each source has its narrative, shaping the journey of a startup in unique ways. These stories reveal a broader landscape of funding opportunities, illustrating that the path to securing capital is not linear but a web of interconnected routes.

Beyond VC: The JOBS Act and Other Avenues

Entrepreneurs must look beyond VC to fuel their growth, especially in times when VC funding becomes scarce. The JOBS Act emerges as a beacon of hope in such times, offering three distinct regulations (RegCF, RegD 506c, RegA+) that provide startups with options for funding. These options often come with better terms than traditional VC deals, underscoring the importance of a strategic approach that blends various funding sources. This strategy not only mitigates the risk associated with relying on a single source but also broadens the potential investor base.

Navigating Capital-Raising Challenges

The journey of raising capital is fraught with challenges, from understanding the regulatory framework to choosing the right partners for issuance and attracting potential investors. A significant hurdle is the lack of awareness about the diversity of funding sources. Many companies do not realize the breadth of options available to them, limiting their potential to secure the necessary capital. Familiarity with each source’s regulatory roadmap, working with trusted FINRA Broker-Dealers, and leveraging technology partners for issuance are crucial steps in this process.

Understanding Sources of Capital

A comprehensive understanding of all sources of capital is essential. Each source, from VC and bank funding to government grants, friends and family, and the JOBS Act, comes with its own set of advantages and disadvantages. For instance, while VC funding can offer significant capital and mentorship, it often requires giving up a portion of equity and control. On the other hand, JOBS Act funding may provide more favorable terms but requires navigating a regulatory landscape and a totally different approach in attracting investors to your company.

Seven Steps to Raising Capital

  1. Educate Yourself on Regulations: Understanding the legal framework is paramount. This knowledge will guide which investors you can target and how.
  2. Build a Diverse Funding Strategy: Combine different sources of funding to minimize reliance on any single avenue.
  3. Select the Right Partners: Work with trusted advisors, such as FINRA Broker-Dealers and technology partners, who understand your business and the regulatory environment.
  4. Prepare a Compelling Pitch: Your pitch should resonate with the specific investors you’re targeting, whether they’re angel investors, VC firms, or the public through a crowdfunding campaign.
  5. Leverage Government Grants and Loans: Explore and apply for grants and loans that may be available for your industry or for innovation.
  6. Engage Your Network: Friends and family can be an initial source of capital, often willing to invest in your success.
  7. Utilize JOBS Act Provisions: Understand and leverage the specific regulations under the JOBS Act that best suit your company’s stage and needs.

In the challenging terrain of capital raising, knowledge and strategy are your best allies. The regulatory landscape, embodied by the JOBS Act, provides a roadmap for startups and established companies alike to navigate their way to successful funding. Educating oneself on the myriad sources of capital, understanding the pros and cons of each, and crafting a diversified funding strategy are essential steps. By working with trusted advisors and carefully selecting funding sources, companies can weather the VC winter and emerge with the capital necessary for growth. Remember, the journey of raising capital is complex and multifaceted, but with the right approach and resources, it is navigable. There are no shortcuts, but the path is rich with opportunities for those willing to explore beyond the traditional routes.

 

 

What is a Burn Rate?

Recently, we received a question from an issuer, asking what a burn rate is. We believe that education is an essential part of the capital raising process, so don’t hesitate to reach out to our team with any questions that could help you along your capital raising journey.

 

The word “burn rate” gets thrown around a lot in the realm of startups and early-stage businesses. But what exactly does it mean, and why is it so important? In this blog post, we’ll explore the ins and outs of burn rate, including what it is, why it matters, and how you can keep it under control.

 

Simply put, the burn rate is the rate at which a company is losing money. It takes into account the company’s operating expenses and revenue, measuring it monthly. This metric shows how much cash a company needs to continue operating for a certain period of time. For example, if a company has monthly expenses of $100,000 and revenue of $50,000, its burn rate is $50,000 per month. This means that the company is losing $50,000 each month, and if nothing changes, it will run out of cash in two months. It’s important to note that the burn rate can fluctuate based on several factors, including:

 

  • Investments in development
  • Advertising and marketing costs
  • Research and development costs
  • Operating expenses (e.g., wages, rent, etc.)

 

By monitoring the burn rate, businesses can make informed decisions about how to use their resources and budget.

 

Why is Burn Rate Important?

 

Understanding and managing burn rate is crucial for any startup or early-stage business. A high burn rate suggests that a company is depleting its cash supply at a rapid pace, which puts it at a higher risk of entering a state of financial distress. This can have serious consequences for investors, who may need to set more aggressive deadlines for the company to realize revenue, or inject more cash into the business to provide more time to reach profitability.

 

Conversely, a low burn rate can indicate that a company has a stronger financial position and are in a better position to become profitable. Low burn rates are also more attractive to investors since their investments can go further.

 

Keeping Burn Rate Under Control

 

Now that we understand the importance of burn rate, let’s look at some strategies for managing it effectively.

 

Layoffs and Pay Cuts: If a company is experiencing a high burn rate, investors may seek to reduce expenses on employee compensation. While layoffs and pay cuts are never easy, they can help a company achieve a leaner strategy and reduce operating expenses.

 

Growth: One way to reduce the burn rate is to project an increase in growth that will improve economies of scale. For example, some startups are currently in a loss-generating scenario, but investors continue to fund them to achieve future profitability.

 

Marketing: Investing in marketing can help a company grow and expand its user base or product use. However, startups are often constrained by limited resources and budgets, making paid advertising a challenge. Instead, they can use low-cost or no-cost tactics to achieve growth, such as email marketing or social media.

 

Burn rate is a crucial metric for any startup or early-stage business. By understanding and managing it effectively, companies can improve their financial health and position themselves for long-term success. Whether it’s reducing staff or compensation, investing in growth, or using low-cost marketing tactics, there are a variety of strategies for keeping the burn rate in check. And for investors, keeping a close eye on the burn rate can help you make informed decisions about funding and supporting startups.

The Growth of Online Startup Investments

Investments in online startups have been growing rapidly in recent years, and the trend is expected to continue well into the future, with the number of online startup deals growing nearly 10% in 2022, according to KingsCrowd. This growth can be attributed to several factors, including the increasing popularity of crowdfunding platforms and the decline in venture capital funding.

 

Why the Popularity Surge?

 

Online startup investing offers many advantages over traditional venture capital funding. For one, it’s much easier to get involved. Platforms like Wefunder and SeedInvest make it simple for anyone to invest in private companies. And because these platforms are online-only, there’s no need to travel or attend tedious meetings. Additionally, online startup investing is much more democratic than traditional venture capital funding. Anyone with a computer or smartphone can participate, which opens up investment opportunities to a much wider audience. With startups being able to grow online instead of requiring a physical presence, this migration to digital-only investing was inevitable.

 

Online startup investing is much less risky than traditional venture capital funding. In most cases, startups that raise money through crowdfunding are already well on their way to becoming successful businesses. This means that investors are far more likely to see a return on their investment. Overall, online startup investing is a great way for retail investors to get exposure to high-quality investment opportunities. With the right platform, getting started is easy, and there’s no need to be a financial expert. So if you’re looking for a way to get involved in the tech industry, online startup investing is definitely worth considering. 

 

Growth in Online Startups

 

With the occurrence of the pandemic and the rise of social distancing, there was a dramatic increase in the number of people working from home. This migration to digital-only workforces has been a boon for online startups. With more people working remotely, there’s been a surge in demand for products and services that can be delivered digitally. And as more and more of these startups pop up, it’s no surprise that online startup investments have been on the rise.

 

Interestingly, this trend appears to be here to stay. Even as some companies are beginning to allow employees to return to the office, many are opting to continue working from home permanently. This is good news for online startups, as they can continue to count on strong demand for their products and services. So if you’re thinking about investing in online startups, now is a great time to get started.

 

What’s Next?

 

With crowdfunding platforms reporting an increase in the amount of fundraising done, sometimes as much as double in the first four months of 2022, this method of startup funding is likely here to stay. This rise in online investing has given everyday Americans the chance to get in on the action and invest in some of the most innovative companies in the world. And as the overall economy continues to struggle, it is expected we’ll see even more companies turning to online crowdfunding platforms to raise money. So if you’re looking for a way to invest in the future, online startup investing is definitely something you should consider. With the right platform, it’s easy to get started, and there’s the potential to see significant returns on your investment. And for startups, this is a great way to raise money and show your company to a larger audience online.

 

Investing in Startups 101

This article was originally written by our KorePartners at StartEngine. You can view the post here

The high-speed world of startups, and the risks of investing in them, are well documented, but startup investing can be complicated and there is a lot of information you should know before making your first investment.

This article will try to answer the question “why should you invest in a startup?” by giving you information about the process and what to expect from investing in an early-stage business.

Why invest in startups?

Through equity crowdfunding, you can support and invest in startups that you are passionate about. This is different than helping a company raise capital via Kickstarter. You aren’t just buying their product or merch. You are buying a piece of that company. When you invest on StartEngine, you own part of that company, whether it’s one you are a loyal customer of, a local business you want to support, or an idea you believe in.

Investing in startups means that you get to support entrepreneurs and be a part of the entrepreneurial community, which can provide its own level of excitement. You also support the economy and job creation: in fact, startups and small businesses account for 64% of new job creation in the US.

In other words, you are funding the future. And by doing so, you may make money on your investment.

But here’s the bad news: 90% of startups fail. With those odds, you’re more than likely to lose the money you invest in a startup.

However, the 10% of startups that do succeed can provide an outsized return on the initial investment. In fact, when VCs invest, they are looking for only a few “home run” investments to make up for the losses that will compose the majority of their portfolio. Even the pros expect a low batting average when investing in startups.

This is why the concept of diversifying your portfolio is important in the context of startup investing. Statistically, the more startup investments you make, the more likely you are to see better returns through your portfolio. Data collected across 10,000 Angellist portfolios supports this idea. In other words, the old piece of advice “don’t put all your eggs in one basket” holds true when investing in startups.

Who can invest in startups?

Traditionally, startup investing was not available to the general public. Only accredited investors had access to startup investment opportunities. Accredited investors are those who:

  • Have made over $200,000 in annual salary for the past two years ($300,000 if combined with a spouse), or
  • Have over $1M in net worth, excluding their primary residence

That meant only an estimated 10% of US households had access to these opportunities. Equity crowdfunding changes all of that and levels the playing field. On platforms like StartEngine, anyone over the age of 18 can invest in early-stage companies.

What are you buying?

The Breakdown of Securities Offered via Reg CF as of December 31, 2020

When you invest in startups, you can invest through different types of securities. Those include:

  • Common stock, the simplest form of equity. Common stock, or shares, give you ownership in a company. The more you buy, the greater the percentage of the company you own. If the company grows in value, what you own is worth more, and if it shrinks, what you own is worth less.
  • Debt, essentially a loan. You, the investor, purchase promissory notes and become the lender. The company then has to pay back your loan within a predetermined time window with interest.
  • Convertible notes, debt that converts into equity. You buy debt from the company and earn interest on that debt until an established maturity date, at which point the debt either converts into equity or is paid back to you in cash.
  • SAFEs, a variation of convertible note. SAFEs offer less protection for investors (in fact, we don’t allow them on StartEngine) and include no provisions about cash payout, so you as an investor are dependent upon the SAFE converting into equity, which may or may not occur at some point in the future.

Most of the companies on StartEngine sell a form of equity, so the rest of this article will largely focus on equity investments.

How can a company become successful if they only raise $X?

Startup funding generally works in funding rounds, meaning that a company raises capital several times over the course of their life span. A company just starting out won’t raise $10M because there’s no indication that it would be a good investment. Why would someone invest $10M in something totally unproven?

Instead, that new company may raise a few hundred thousand dollars in order to develop proof-of-concept, make a few initial hires, acquire their first users, or reach any other significant business developments in order to “unlock” the next round of capital.

In essence, with each growth benchmark a company is able to clear, they are able to raise more money to sustain their growth trajectory. In general, each funding round is bigger than the previous round to meet those goals.

When do companies stop raising money? When their revenue reaches a point where the company becomes profitable enough that they no longer need to raise capital to grow at the speed they want to.

What happens to my equity investment if a company raises more money later?

If you invest in an early funding round of a startup and a year or two later that same company is raising more money, what happens to your investment? If things are going well, you will experience what is known as “dilution.” This is a normal process as long as the company is growing.

The shares you own are still yours, but new shares are issued to new buyers in the next funding round. This means that the number of shares you own is now a smaller percentage of the whole, and this is true for everyone who already holds shares, including the company’s founders.

However, this isn’t a problem in itself. If the company is doing well, in the next funding round, the company will have a higher valuation and possibly a different price per share. This means that while you now own a smaller slice of the total pie, the pie is bigger than what it was before, so your shares are worth more than they were previously too. Everybody wins.

If the company isn’t growing though, it leads to what is known as a down round. A down round is when a company raises more capital but at a lower valuation, which can increase the rate of dilution as well as reduce the value of investors’ holdings

How can I make money off a startup investment?

Traditionally, there are two ways investors can “exit” their investment. The first is through a merger/acquisition. If another company acquires the one you invested in, they will often offer a premium to buy your shares and so secure a controlling ownership percentage in the company. Sometimes your shares will be exchanged at dollar value for shares in the acquiring company.

The other traditional form of an exit is if a company does an initial public offering and becomes one of the ~4,000 publicly trading companies in the US. Then an investor can sell their shares on a national exchange.

Those events can take anywhere from 5-10 years to occur. This creates an important difference between startup investing and investing in companies on the public market: the time horizon is different.

When investing in a public company, you can choose to sell that investment at any time. However, startup investments are illiquid, and you may not be able to exit that investment for years.

However, equity crowdfunding can provide an alternative to both of these options: the shares sold through equity crowdfunding are tradable immediately (for Regulation A+) and after one year (for Regulation Crowdfunding) on alternative trading systems (ATS), if the company chooses to quote its shares on an ATS. This theoretically reduces the risk of that investment as well because the longer an investment is locked up, the greater the chance something unpredictable can happen.

Conclusion

Investing in startups is risky, but it is an exciting way to diversify your portfolio and join an entrepreneur’s journey.

How to be Ready for Raising Capital

Whether you’ve raised capital in the past or are preparing for your first round, being properly prepared will help your company secure the funding it needs. Proper preparation will make investors confident that you are ready for their investments and have a foundation in place for the growth and development of your company. So if you’re looking to raise money, what must you do to be ready for raising capital?

 

From the start, any company should keep track of shareholders in its capitalization table (commonly referred to as the cap table). Even if you have not yet raised any funds, equity distributed amongst founders and key team members should be accurately recorded. With this information kept up-to-date and readily available, negotiations with investors will be smoother, as it will be clear how much equity can be given to potential shareholders. If this information is unclear, deals will likely come with frustrations and delays. 

 

Researching and having knowledge of each investor type will also help prepare your company to raise money. Will an angel investor, venture capital firm, crowdfunding, or other investment method be suited best for the money that is being raised? Having a clear answer to this question will help you better understand the investors you’re trying to reach and will help you prepare a backup option if needed. 

 

Once your target investors have been decided and you have a firm grasp on the equity you’re able to offer, preparing to pitch your company to them will be a key step. Having a pitch deck containing information relevant to your company and its industry will allow you to convince investors why your business is worth investing in. Additionally, preparing for any questions that they may ask will ensure investors that you are knowledgeable and have done the research to tackle difficult problems. 

 

Before committing to raising capital, you should make sure that your company has an established business model. Investors want to see that you have a market for your product and are progressing. If investors are not confident that the product you’re marketing has a demand, it will be less likely they will invest. Investors will also want proof that the company is heading in the right direction and the money they invest will help it get there faster. 

 

Once you have determined that your company is ready for investors, managing the investments and issuing securities will be essential. To streamline the process and keep all necessary documents in one location, KoreConX’s all-in-one platform allows companies to manage the investment process and give investors access to their securities and a secondary market after the funding is completed. With cap table management, the all-in-one platform will help companies keep track of shareholders and is updated in real-time, ensuring accuracy as securities are sold. 

 

Ensuring that your company has prepared before raising capital will help the process go smoothly, with fewer headaches and frustrations than if you went into it unprepared. Investors want to know that their money is going to the right place, so allowing them to be confident in their investments will ensure your company gets the funding that it needs to be a success. 

409A – A Guide for Startups

We “Get It”

We understand that the last thing any start-up wants to worry about is tax compliance, especially when you have so many other things to worry about. Like product development, sales, recruiting, etc.… But it is wise for a start-up to think about compliance early on to avoid potential penalties and distracting complications from lack of compliance later down the road. If you don’t know about an issue ask a professional like your lawyer, accountant, etc.…here is a little background on 409A valuations and choosing the right 409A provider.

 

What is 409A

What is 409A?

409A refers to Section 409A of the Internal Revenue Code for the Internal Revenue Service (IRS) of the United States of America. This code governs the taxation of non-qualified deferred compensation. Section 409A was added to the Internal Revenue Code in January of 2005 and issued final regulations in 2009.

Stock options give employees, consultants, etc. (any grantee) the right to buy stock at a predetermined price (the strike price). But you first need to determine what the strike price should be. The IRS 409A regulation stipulates the strike price must be equal to the Fair Market Value (FMV) of your company’s common stock.

But how do you value the company stock, especially if the company has a complex capital structure (i.e. has raised money via equity or debt)? Third party valuation firms with experience in these valuations are your best bet for staying compliant. But be careful. Not all firms are created equal.

There are three “safe harbor” methodologies provided by the IRS regarding setting the fair market value (FMV) of common stock for privately held companies. Almost all VC or angel-backed startups follow will use a third-party firm and follow the Independent Appraisal Presumption: A valuation performed by a qualified third-party appraiser. The valuation is presumed reasonable if the valuation date is set no more than 12 months prior to an applicable stock option grant date and there is no material change from the valuation date to the grant date. If these requirements are met, the burden is on the IRS to prove the valuation was “grossly unreasonable.” If the valuation does not fall under “safe harbor” then the burden of truth falls on the taxpayer.

 

There are severe penalties for Section 409A violations which include, immediate tax on vesting, additional 20% tax penalty, and penalty interest.

So why is safe harbor important and how you can get it?

Ideally, safe harbor insulates you from persecution. Luckily, IRS has provided avenues for companies to safely offer deferred compensations. If you have a safe harbor, IRS will only reject the valuation if they can prove that it is grossly unreasonable. The burden of proof is with IRS to prove that you are in error. However, this burden of proof is shifted to the company and BOD if don’t have safe harbor. In this case, you are treated as having granted cheap stock unless you can prove otherwise and defend your strike price.

For the valuation to be treated as safe harbor valuation, it must be done in any of the following ways, but we will focus on the first two.

 

Valuation be done internally by a qualified staff

Valuation be done by a qualified third-party valuation company

Stock be offered through a generally acceptable repurchasing formula


Using Internal Value

In this option, the company will appoint a qualified individual from the internal team to conduct the valuation. This can be one of the easiest and cheapest options, but it has several other conditions attached to it. The individual doing the valuation and the company must meet set standards.

The individual appointed to do the valuation must have at least five years’ experience in a field related to valuation. This includes business valuation, private equity, investment banking, secured lending, or financial accounting. This can be tricky because there is room for subjectivity. IRS, upon its discretion, may determine that the individual who did the valuation did not meet the required standards. Further, what we have seen too often is the internal valuation results in values way to high or just plain wrong. Experience matters.

Moreover, a company can only use this option if it can meet the following requirements:

  • It is a private company
  • Has no publicly traded stock
  • Is less than ten years old
  • Has no stock that is considered as a call, put, or similar derivative

Appointing a Third-Party Firm

While this may be the most expensive option, it is also the safest. The only condition is that the firm should follow consistent methodologies in the valuation. So, it is important to supply the firm with all the necessary information to carry out the valuation. The information includes the following.

With the requested information, a qualified firm can do a reasonable valuation. In some instance, a third-party firm may arrive at a favorable fair market value without going too low to raise alarm. The advantage of working with a third-party firm is that you get double protection. Most firms will be interested in saving their reputation, so they are more likely to protect you. Moreover, the burden of proof lies with IRS.

 

The Dangers of Working with Non-independent Valuation Firms

For a company to be deemed as independent, in IRS context, it should only provide you with valuation services. Some companies may be tempted to register a separate LLC company to handle valuations, but the conflict of interest is their regardless.

409A independent valuation

To qualify for a safe harbor, valuers must be seen to be independent. They should also employ objective judgment in arriving at their conclusion. In this case, there should not be any conflict of interest, and valuation should be based on merit, free of bias. Therefore, if a valuation company receives other forms of income that are not related to valuation from your company, then that amounts to a conflict of interest. There is even a bigger conflict of interest if the valuation firm offers liquidity to the same shares it is valuing.

Legally, conflict of interest indicates the presence of economic benefit. In that case, IRS requires valuation firms to declare that there have no relations with their clients. On top of this, they should also attest that the compensation is not based on the results they deliver. The bottom line is that you will not achieve safe harbor if is there is a conflict of interest.

 

So, when can you say you have fully achieved safe harbor?

If your valuation has respected all the requirements for achieving a safe harbor, then you are almost guaranteed of protection, but you are not off the hook yet.

The following caveats need to be taken into consideration:

  • If there is material change that might have a direct impact on the value of the company, then the valuation will become invalid
  • The valuation is valid for 1 year, so if you are issuing additional shares after 12 months, then you should do a new valuation
  • IRS still has room to determine if the valuation was grossly unreasonable

It may seem like a daunting task to do 409A valuation the right way, but it is worth the effort because the consequences for violations are severe. Remember that safe harbor is the best way to protect yourself against harsh penalties.

How Do I Get a 409A Valuation?

In order to get a 409A valuation you want to work with a reputable firm that has experience in rendering valuation opinions. We recommend staying away from 409A only shops, firms that are not independent, or are “giving away” in conjunction with a software sale.

How Much Will a 409A Valuation Cost?

409As are relatively new. When they were first introduced in 2005, everyone scrambled to comply. Valuation firms were born into a world where they were desperately needed but without a precedent to set a price for their services. Since then, with more options becoming available, the costs have decreased. The DIY and qualified individual methods are typically more cost-effective, but significantly riskier, so if you want safety and a good deal, keep reading…

It can be difficult to know what market or fair prices for valuation services are if you have not had experience with these services before. Below we are presenting what we feel are middle of the road prices for quality service and reports with technical rigor that would pass a big four auditor. You can find cheaper, but you run all kinds of risk for your company, employees, and board.

409A market prices

No matter what, make sure you choose a valuation firm you trust and that you can see yourself having a good relationship with because that relationship may be a long one. If you’re ready to get your 409A valuation and start issuing stock options to employees.

SEC Proposes Relief for “Finders”

I have long (oh so long) been one of those urging the SEC to give some clarity with respect to the status of “finders.” See here for the latest piece.

Early-stage companies raising funds very often reach out to a guy who knows some guys who have money and have invested in startups in the past. If the first guy wants to be compensated by reference to the amount of money his contacts are able to invest, he may well have violated the broker registration requirements of the Securities Exchange Act of 1934. And it’s not only him who needs to be worried; if a startup raises funds through someone who should have been registered as a broker and wasn’t, their sales of securities may be subject to rescission – buying the securities back, with interest.

Nonetheless, startups are so strapped for money (and often don’t understand the requirements of the law) that they do this all the time.

Industry participants have been asking the SEC for guidance in this area for decades, and now the SEC has come up with some simple proposals that should be of use to the startup community.

The SEC is proposing to exempt two classes of finders, Tier I Finders and Tier II Finders, based on the types of activities in which they are permitted to engage, and with conditions tailored to the scope of their activities. The proposed exemption for Tier I and Tier II Finders would be available only where:

  • The issuer is not a reporting company under the Exchange Act;
  • The issuer is seeking to conduct the securities offering in reliance on an applicable exemption from registration under the Securities Act;
  • The finder does not engage in general solicitation;
  • The potential investor is an “accredited investor” as defined in Rule 501 of Regulation D or the finder has a reasonable belief that the potential investor is an “accredited investor”;
  • The finder provides services pursuant to a written agreement with the issuer that includes a description of the services provided and associated compensation;
  • The finder is not an associated person of a broker-dealer; and
  • The finder is not subject to statutory disqualification at the time of his or her participation.

Tier I Finders. A “Tier I Finder” is defined as a finder who meets the above conditions and whose activity is limited to providing contact information of potential investors in connection with only one capital raising transaction by a single issuer within a 12-month period, provided the Tier I Finder does not have any contact with the potential investors about the issuer. A Tier I Finder that complies with all of the conditions of the exemption may receive transaction-based compensation (in other words, compensation based on the amount raised) for the limited services described above without being required to register as a broker under the Exchange Act.

Tier II Finders. The SEC is also proposing an exemption that would permit a finder, where certain conditions are met, to engage in additional solicitation-related activities beyond those permitted for Tier I Finders. A “Tier II Finder” is defined as a finder who meets the above conditions, and who engages in solicitation-related activities on behalf of an issuer, that are limited to:

  • Identifying, screening, and contacting potential investors;
  • Distributing issuer offering materials to investors;
  • Discussing issuer information included in any offering materials, provided that the Tier II Finder does not provide advice as to the valuation or advisability of the investment; and
  • Arranging or participating in meetings with the issuer and investor.

A Tier II Finder wishing to rely on the proposed exemption would need to satisfy certain disclosure requirements and other conditions: First, the Tier II Finder would need to provide a potential investor, prior to or at the time of the solicitation, disclosures that include: (1) the name of the Tier II Finder; (2) the name of the issuer; (3) the description of the relationship between the Tier II Finder and the issuer, including any affiliation; (4) a statement that the Tier II Finder will be compensated for his or her solicitation activities by the issuer and a description of the terms of such compensation arrangement; (5) any material conflicts of interest resulting from the arrangement or relationship between the Tier II Finder and the issuer; and (6) an affirmative statement that the Tier II Finder is acting as an agent of the issuer, is not acting as an associated person of a broker-dealer, and is not undertaking a role to act in the investor’s best interest. The Commission is proposing to allow a Tier II Finder to provide such disclosure orally, provided that the oral disclosure is supplemented by written disclosure and satisfies all of the disclosure requirements listed above no later than the time of any related investment in the issuer’s securities.

The Tier II Finder must obtain from the investor, prior to or at the time of any investment in the issuer’s securities, a dated written acknowledgment of receipt of the Tier II Finder’s required disclosure.

A Tier II Finder that complies with all of the conditions of the proposed exemption may receive transaction-based compensation for services provided in connection with the activities described above without being required to register as a broker under the Exchange Act.

A finder could not be involved in structuring the transaction or negotiating the terms of the offering. A finder also could not handle customer funds or securities or bind the issuer or investor; participate in the preparation of any sales materials; perform any independent analysis of the sale; engage in any “due diligence” activities; assist or provide financing for such purchases; or provide advice as to the valuation or financial advisability of the investment.

This exemption would not affect a finder’s obligation to continue to comply with all other applicable laws, including the antifraud provisions of federal and state law. Additionally, regardless of whether or not a finder complies with this exemption, it may need to consider whether it is acting as another regulated entity, such as an investment adviser.

The exemption is really aimed at the guy at the golf club who has accredited buddies he can introduce the startup to. It would be available to natural persons only (not companies) and the finder couldn’t undertake general solicitation (he should know the people he is introducing to the startup; if he has to go searching for them, he’s essentially acting as a broker. The “no general solicitation” and “natural person” conditions means that the proposed exemption doesn’t help clarify the regulatory status of non-broker online platforms.

We are a little disappointed that so many of the comment letters on the proposal have been negative. We do understand that there is a great deal of clarification needed with respect to what it means to be in the business of a broker. And the SEC needs to work closely with the states in this area. But we at CrowdCheck are pleased that the SEC has provided some clarity in this area.

Meet the KorePartners: David Benizri, Rivver

This post is part of a series of short interviews about the companies and faces that are part of the KorePartners Ecosystem*.

We believe that behind every great company there are people, and behind every person, there is a story to tell.

KorePartner: David Benizri, CEO & Co-Founder at Rivver

Born in: Montreal, Canada
Based in: Tel Aviv, Israel

What was your first job?
Ice hockey referee

How and when did you get involved in the tech industry?

July 2016, I was hired as a sales associate in an e-commerce startup in Montreal. I then fell in love with the dynamic nature of the Hi-Tech field and began launching my own ventures in both Canada and Israel.

How do you see the Tech industry today, especially when it comes to the new Digital securities wave? In that aspect, is it possible to have an idea of what the next five years will bring?

To me what is beautiful about the tech industry as a whole is the fact that there are always new technologies being discovered, which by association ensures that there is always room for startups to build applications on top of that new technology and monetize. The last big innovation which we knew was technologically unprecedented was Blockchain, so we decided to apply it to securities. Within 5 years time, we see a securities industry where the use of distributed ledger technology is a given.

What does your company bring to the KorePartners Ecosystem?

Rivver brings the first blockchain-based fund issuance and administration platform, specialized for Private Equity funds. By building the first fund administration platform for the digitized fund ecosystem, Rivver’s goal is to ensure that KorConX Private Equity clients and the entire Digitized Fund ecosystem can scale.

What is it about the partnership with KoreConX that most aligns with your company strategy?

For Digital Securities to achieve adoption, industry leaders will have to provide a solution which is adoptable for legacy players today and not just in 10 years. By us both building on top Hyplerledger Fabric, we at Rivver saw obvious synergies and are certain that our partnership with KorConX will help materialize this mission.

*The KorePartners Ecosystem is a group of organizations that follows our governance standards and share with us the same goal: to provide entrepreneurs with the tools they need to grow their business.

Reg A+ Webinar: The Highlights

In our last webinar, we’ve talked about a very complex topic in the startup industry: The Regulation A+.

For those of you who have never heard of it (no shame in learning, folks), Regulation A+, or Reg A, is a section of the JOBS Act that allows private companies to raise up to $ 50 Million while offering shares to the general public.

This can have a profound impact on how startups work. Unfortunately, there’s still a great deal of confusion surrounding the topic.

That’s why we brought in Sara Hanks, a top attorney with over 30 years experience in the corporate and securities field and Founder of CrowdCheck, and Darren Marble, Co-Founder and CEO of Issuance, with extensive experience in the capital raising process.

Here are some highlights of the discussion:

Sara Hanks: Regulation A+ is a popular name for a series of amendments to existing laws there were made in 2015. The Regulation A was an exemption for full regulation with the SEC, that permits a company to make a public offering, without the restrictions on the security being sold, but not to go through the full SEC process. So it’s an exemption for a public offering.

And that’s important because it’s public, the securities that are sold are not restricted, they can be free traded, if you can find a place for them to trade, you can trade them immediately, after the qualification of the offering. The companies who can use Reg A are U.S. or Canadian companies.

Darren Marble: The most interesting question to me is what companies are ideal candidates to use the Reg A Securities exemption as a capital raising tool. And just because you might be eligible to do a Reg A offer doesn’t mean you should. You know, if there’s a cliff that’s 50 feet above the ocean and you’re on that cliff, and you can see the ocean, doesn’t mean you should dive in. You probably need to be a professional diver.

I say that you don’t choose Reg A, Reg A chooses you. And what I mean by that is I think the Reg A exemption discriminates in that aspect. They will save a very particular type of issuer and it will punish or harm another type of issuer.

We also talked about:
– Marketing strategies that need to be considered for a Reg A+
– Who qualifies for it?
– What are the benefits?
– What does the Due Diligence look like?
– What liability is there for the issuer?
– What liability is there for any who promotes the offering?

To watch the full webinar, click here.

You can also watch the full version of our previous webinars:

Digital Securities Webinar

Marketing Your Raise Webinar

 

Meet the KorePartners: Adrian Alvarez, InvestReady

This post is part of a series of short interviews about the companies and faces that are part of the KorePartners Ecosystem*.

We believe that behind every great company there are people, and behind every person, there is a story to tell.

KorePartner: Adrian Alvarez, Co-Founder & CEO at InvestReady

Born in: Miami, USA
Based in: Los Angeles, USA.

What was your first job?

I was a clerk for a mortgage service company. Very exciting =)

How and when did you get involved in the startup industry?

In college, I was the first employee of a tutoring company for standardized tests. That led me to go off on my own with my own tutoring service a few years later. During grad school where I did a JD/MBA, I became involved with the University’s startup incubator and after graduating, I worked there for 4 years as the assistant director and program manager. We helped advise thousands of startups and helped a lot of students with their projects. I also met my co-founders for InvestReady in that job as well.

How do you see the startup scene today?

I’m seeing a lot of work behind the scenes preparing for 2019 in the crypto and private investment scene. I believe 2019 is going to be huge for security tokens and we’re preparing ourselves for it. It’s an exciting time.

 

What does your company bring to the KorePartners Ecosystem?

InvestReady provides accredited investor verification services under the US and international law. Our API allows issuers, brokers, exchanges, portals, service providers and more verify that their users are eligible to participate in the investment in a secure and scalable manner.


What is it about the partnership with KoreConX that most aligns with your company strategy

I believe our shared focus on providing exceptional service at scale is a huge factor. We’re also both constantly re-tooling and thinking about how we can improve our service which also helps.


*The KorePartners Ecosystem is a group of organizations that follows our governance standards and share with us the same goal: to provide entrepreneurs with the tools they need to grow their business.

The Right Technology – The Case of Mercury Cash

Nothing proves the wisdom of choosing the right technology for the right job than the case of Mercury Cash, a hosted-wallet solution for real-time liquidation and transfer of cryptocurrency and fiat assets. Recognizing the importance of being prepared for a new cryptoworld, Mercury Cash set out to explore various blockchain protocols to find the one that can stand the test of the real world.

The real world is full of messy complexities. We may think the mess is unnecessary and we should sweep it all away and usher in a new world order, but we do have to recognize that regulation and corporate law make it possible to protect investors and shareholders.

As someone pointed out regarding the tragic debacle of QuadrigaCX, Canada’s own Mt. Gox, “When was the last time your banker died and you lost access to your money?”

I’d add, “When was the last time you forgot your bank account password and your money became irretrievable?”

Can regulation and corporate legal processes be more efficient? Yes.

Are some of the regulatory requirements onerous or unnecessary? Yes.

But pretending that all regulation is unnecessary is like pretending that protections are unnecessary. Disruption with technology is good, as long as it doesn’t lead to destruction!

Click here to download Mercury Cash Case Study.

Many issuers are finding out the hard way two fundamental truths about how the real world works:

One, transactions don’t exist in atomic silos, least of all in securities; every transaction is connected with others and impacts multiple entities at various points in time in an ever-expanding ripple effect. One buy/sell securities trade requires validation of participants, ensuring protection for all parties, recording changes to captables, distribution of dividends, exercise of rights, filing reports, getting notifications of corporate events, voting, etc., all of it over a long time cycle.

Two, choosing a technology based on hype, popularity, and promise is not the way to go; instead, understand the characteristics of the problem and then identify the technology to solve it effectively.

In the case study, Mercury Cash describes the capabilities that will keep their business processes humming in a fully compliant manner. Most importantly, they found that ERC20-based protocols are inadequate for full lifecycle management of securities. This is not a knock against Ethereum, which is a fine platform for many types of DApps; much of the technology work is praiseworthy. But a Ferrari, no matter how shiny or powerful, cannot sail the high seas.

Many of our clients are coming to the same realization. Interestingly enough, a company could conduct its main business using public blockchain, while managing its security tokens on KoreChain. There is nothing wrong with that – it’s just like transporting a car on a ship. In many conversations with some of these technologists, I point out that the issue is not that ERC is inadequate for securities, just that it’s not the right tool. The same can be said if someone tries to use KoreChain for building cryptokitties.

When many companies are coming to us abandoning ERC20 protocols for various reasons, it validates our own approach to technology: first understand the problem you are trying to solve, then carefully pick the technology stack to solve it. In doing so, some of us have to leave our technology egos behind to move forward.

Click here to download Mercury Cash Case Study.

Meet the KorePartners: Luka Gubo, Blocktrade

 

This post is part of a series of short interviews about the companies and faces that are part of the KorePartners Ecosystem*.

We believe that behind every great company there are people, and behind every person, there is a story to tell.

KorePartner: Luka Gubo, CEO at Blocktrade

Born in: Celje, Slovenia
Based in: Ljubljana, Slovenia and Schaan, Liechtenstein

What was your first job?
 High Frequency Trader at a proprietary trading firm.

How and when did you get involved in the Blockchain industry?
I started reading about Bitcoin in 2015 and mostly dismissed it as an alternative for fiat currencies. In 2016 I read about other Blockchain protocols and immediately saw the potential for disrupting the capital markets – both on the primary market (issuance of securities) and also the secondary market (for post-trade processes).

How do you see the Blockchain scene today?
There was a lot of regulatory uncertainty in past years and I think this will change in 2019. Crypto assets have their place in broader financial markets as a unique asset class where more and more institutional investors will seek uncorrelated returns. On the technology side, I think we will see a lot more use cases where several counterparties are involved – we are focused only on the capital markets, while we see a lot of disruption in banking, payments, transportation and other industries.

What does your company bring to the KorePartners Ecosystem?
Blocktrade is a secondary market for crypto assets with a focus to bring institutional clients to this new market. With the MTF license (pending regulatory approval) we will be able to list security tokens issued on KoreConX and bring necessary liquidity.

What is it about the partnership with KoreConX that most aligns with your company strategy?
KoreConX provides a full suite of services that companies that are issuing (or just tokenizing) their shares on blockchain must have in place when admitting securities to trading on a regulated trading venue. Covering the full lifecycle of these securities (from issuance, reporting, trading, etc.) we can together create a seamless experience for companies and investors. I believe that Blocktrade and KoreConX can together disrupt how the capital markets operate.


*The KorePartners Ecosystem is a group of organizations that follows our governance standards and share with us the same goal: to provide entrepreneurs with the tools they need to grow their business.

KoreSummit is honored to have Mr. David Weild IV as its keynote speaker

The first KoreSummit event just got even more interesting. We are thrilled to announce Mr. David Weild IV, the father of the JOBS Act, as our keynote speaker. Weild is currently CEO and Chairman of Weild & Co.

He also gathers the expertise of the most competitive stock markets, as he was a former Vice Chairman and executive committee member of NASDAQ, and spent years running Wall Street investment banking and equity capital markets businesses.

Weild will speak at 1 p.m. at the KoreSummit New York. This is an invite-only event. Seats are limited, but you can still apply to attend here: https://koresummit.io/apply/

StartUp Law 101

Late last year I had the opportunity to collaborate with Catherine Lovrics, B.A., LL.B at Bereskin & Parr LLP, on the inner workings of raising capital for entrepreneurs. Her book, Startup Law 101: A Practical Guide, published last week.

The basis of our conversations surrounded accessing funding at the right time and identifying the the business expenses that are needed most, from capital expenditures to operational costs.

As part of a panel discussion during last Wednesday’s launch event hosted at MaRS Discovery District, I was asked several great questions about funding that I wanted to discuss further.

Q: Securing funding for early-stage companies can be the biggest challenge for founders. What are some of the opportunities that have developed recently in the equity crowdfunding space for early-stage companies?

A: Without crowdfunding, the ability for early stage companies to access capital would not exist in such high numbers.

The emergence of online platforms helping private and public companies access capital from accredited and non accredited investors has literally transformed the investor landscape.Today’s private capital investor can invest as little as $50.00 into a company.  This was not possible five years ago.

Part of this transformation includes the addition of online payments. It has not only increased the speed in which an investor makes a decision to invest, but has changed the perception of how an investor views an investment. All an investor has to do is enter a credit card number using their VISA, MasterCard, American Express, etc.

With this new dynamic, companies need to have a very proactive approach to their new stakeholders.  Your investor relations strategy and tools will be the key to maintaining and growing your company.

Q: What are some of the major changes and challenges we’re seeing in equity crowdfunding?

A: The biggest challenge globally in equity crowdfunding is that companies are not ready.  We see 98 percent of companies stall in their funding process when they engage in online platforms to help startups raise capital.

What companies don’t understand is that nothing has changed from the days of applying to Venture Capital firms, Angel groups, etc.  Sites like like StartEngine, FrontFundr, BankRoll Ventures, MicroVentures, etc., expect you to have your company and critical business documents in order.

The largest barrier and one of the major delays is the lack of up-to-date corporate records. Make a checklist — update your corporate records, capitalization table, signed agreements, legals for the offering, business plan, executive summary, financials, projections, etc.

Q: There has been a lot of buzz this past year with the rise of cryptocurrencies and ICOs. What are we seeing now with the regulation (and potential demise) of ICOs and the rise of token offerings or ITOs?

A: In 2017, we saw the rise of crowdfunding v3.0 with the introduction of Initial Token Offerings (ITO).  For many in crowdfunding, ITOs have proven that people will invest from around the globe if they trust the underlying technology that is managing their investment, i.e. blockchain.  

Out of the gate, many companies took advantage of this type of capital raising and many investors lost billions of dollars. Like any new form of technology, it can be used for good and bad.  

We will see a rise of security token adoption in 2018 as companies begin issuing tokens like selling securities. But, these tokens will also have the capability to trade on secondary exchange.

This just scratches the surface of what we covered and Catherine was generous enough to provide a copy of Chapter 6, “Canadian Startup Funding Sources” for KoreConX followers.