TAKE YOUR
TECHNOLOGY
TO THE
LIMIT!
Center for Innovation and
Technology Entrepreneurship
T e c h n o l o g y
E n t r e p r e n e u r s h i p
f r o m
I n n o v a t i o n
t o
B u s i n e s s
V e n t u r e
The Foundation:
Structuring Your New Venture
and Raising the Cash
Stephanie L. Chandler and George Karutz
January 29, 2011
Center for Innovation
and Technology
Entrepreneurship
UTSA Colleges of
Business and Engineering
Jackson Walker L.L.P.
www.jw.com
Karutz Flavin Wells Investment Banking
www.kfwib.com
CITE BootCamp September 2010
1
Stephanie
Chandler
George
Karutz, Jr., CFA
Partner – Jackson Walker L.L.P.
Partner – Karutz Flavin Wells
Firmwide Head of JW’s Technology
Section, Startech Board,
Emerging Technology Fund Local
Selection Committee
Regional Investment Bank
advising technology start-up
ventures on financial, strategic
and operational matters
Choose the Right Entity
• Sole Proprietorship
• General Partnership (GP)
• Corporation
– C-Corp
– S-Corp
Tax Designation
• Limited Partnership (LP)
• Limited Liability Company (LLC)
Corporation
Shareholders
Ownership
Board of Directors
Strategy/Direction
Officers:
Implementation/
Signing Authority
President, Vice President,
CEO, CFO, Secretary, Treasurer
Employees/Operations/
Contracts
Liabilities
Corporation
Pros
• Liability limited
• Ease of creation
• Most common –
easily understood
• Growth oriented
• Centralized
Management
Cons
• Federal income tax
and Texas Margin
tax
• S-election
restrictions
Limited Liability Company
Shareholders
Members
Ownership
Board of Directors
Managers
Strategy/
Direction
Officers:
Officers:
President, Vice President,
CEO, CFO, Secretary, Treasurer
President, Vice President,
CEO, CFO, Secretary, Treasurer
Employees/Operations/
Contracts
Employees/Operations/
Contracts
Implementation/
Signing Authority
Liabilities
Limited Liability Company (LLC)
Pros
• Can have tax flow
through
• Limited liability
•
•
•
•
Cons
Federal income tax and
Texas margin tax
Different terminology
(i.e. Managers and
Members instead of
Board and Shareholders)
Not as accepted by
institutional investors
Difficult if option
compensation is part of
your growth strategy
Entity Type
Fees and Other
Costs
Timing
Corporation
Filing Fee: $300
Legal Fees: $700$1200
• SOSDirect
•Basic documents (may
also do shareholders
agreement which
results in addl fees)
LLC
Filing Fee: $200
Legal Fee: $1000$5000
•SOSDirect
•Documents can be
complex
Annual Maintenance
• Annual Minutes
– Shareholders Elect Directors
– Directors Elect Officers
• Special Meeting Minutes
• State Filings
– Public Information Report (PIR)
– Tax Return
RULES FOR RAISING FUNDS
Starting Place:
Registration Required
• All offerings must be registered with the SEC
• Unless, that offering is exempt from Registration
• Doesn’t matter if small private sale or an offering
which is immediately listed on the NYSE
Offer vs. Sale
• Offer triggers compliance requirements
• Compliance must happen before selling
process starts
Private Offerings = Exempt
• Privately negotiated
sales
• Must not involve any
general solicitation
or general
advertising
• Section 4(2)* - the
private-offering
exemption “transactions by an
issuer not involving
any public offering”
* Securities Act of 1933
(the “Securities Act”)
Requirements under Section 4(2)
The purchasers of the securities must:
• have sufficient knowledge and experience in
finance and business matters to evaluate the
risks and merits of the investment
(“sophisticated investor”), or be able to bear
the economic risk of investment;
• have access to the type of information
normally provided in a prospectus; and
• agree not to resell or distribute the securities
to the public.
Desire Definition
Regulation A
• Exempts public
offerings not
exceeding $5 million
in any 12-month
period
• must file an offering
statement (called a
“Form 1-A) with the
SEC for review
Regulation D
• Safe harbor
promulgated by the
SEC under Section
4(2)
• Most common and
today’s focus
Reg D
• Rule 504 provides an exemption for the offer
and sale of up to $1 million of securities in a
12-month period
• Rule 505 provides an exemption for offers
and sales of securities totaling up to $5
million in any 12-month period.
• Rule 506 provides another exemption for
sales of securities under Section 4(2) with no
dollar limit.
Rule 506
• Unlimited number of “accredited investors”
and 35 “sophisticated” nonaccredited
investors
• Popular if Integration is a concern
• Popular to comply with Blue Sky (National
Securities Markets Improvement Act of 1996
(NSMIA) removed offerings under Rule 506
from state regulation)
“Accredited Investor”
•
•
•
•
•
•
•
•
a bank, insurance company, registered investment company, etc.
an employee benefit plan
a charitable organization, corporation or partnership with assets ≥ $5
million
a director, executive officer or general partner of the company selling
the securities
a business in which all the equity owners are accredited investors
a natural person with a net worth of at least $1 million
a natural person with income exceeding $200,000 in each of the
two most recent years or joint income with a spouse exceeding
$300,000
a trust with assets of at least $5 million
Why Only
Accredited Investors?
Private placement memorandum (“PPM”) that meets Reg D
requirements = $$$$$
If more than $1 million is raised in a 12-month period, Rule 504 is
not available
Under Rule 505 and 506, a PPM would be required to offer
securities to nonaccredited investors
Even if not required, delivering a PPM or at least a detailed business
plan is probably advisable for liability and marketing reasons,
particularly in fulfilling the antifraud requirement.
Initial Public Offering
• Registered with the SEC
• Underwritten
• i.e. Google, Rackspace...
$$
Invest in Growing Operations and Revenue
Traditional and
Non-Traditional Lenders
Most major traditional banks do not lend to
startups/do so only rarely
Comerica, Square 1 Bank, Silicon Valley Bank
lend to entrepreneurial companies (positive c/f)
Accts Receivable, Inventory, Fixed Assets
Very sensitive to market conditions – this last
down turn caused them to become risk adverse
Terms may include: company’s stock, fees, collateral, agreement to pay for AR
audits, monthly reporting, audited financial statements, compliance reporting,
financial covenants plus all banking relationships – checking, credit cards,
investments, etc. must be with lender
Angel Investors


Friends and Family
Angel Funding – wealthy private
individuals, with background in business,
usually smaller than VC’s ($25K - $250K).
They prefer to deal directly with the
entrepreneur, like local deals, often want to
develop a relationship with owners, they are
limited in the number of investments they
will do concurrently. Usually easier to deal
with than VC’s. Invaluable to start-ups.
Must Still Comply with Applicable Securities Laws:
• Exemption (“accredited investors”)
• Notice Filings
Venture Capital ($1 million - $50 million)
Advantages







Excellent source of capital / funding committed to your business
VC’s often are prepared to invest in continued rounds as the
business grows and achieve it’s milestones
Bring valuable skills, contacts, experience and discipline to your
business
VC’s have common goals with the entrepreneur – growth,
profitability and increased value of the business
VC’s time horizon is often 3 – 7 years before exiting.
Looking to have a 3 – 7 times return on their capital
Exiting usually in the form of a Public Offering or Sale to a larger
business after reaching certain milestones.
Venture Capital ($1 million - $50 million)
Disadvantages


Raising Equity Capital – demanding, costly, time consuming. Your
business suffers as you devote your time to answering questions
Due Diligence process can be brutal – background checks,
justification of your business plan, legal review, patent review,
financial forecasts, etc (note: this can be a very useful process to force
management to think through every issue. This is valuable even if funding
doesn’t occur)


Often the entrepreneur will lose control after 2nd round of financing.
VC’s may want to bring in a marquee CEO, CFO, etc. to run the
business.
Management reporting to the VC’s is often onerous, requiring 4 to 6
board meetings per year plus answering questions, providing
updates and monthly reporting. [war story]
Grants
• GRANTS.gov
• STTR (Small Business Technology
Transfer)
– 5 federal departments participate
– 0.3% of the relevant agencies' extramural
research budgets
• CPRIT (Cancer Prevention and
Research Institute of Texas)
Governmental Funds
• Texas Emerging Technology Fund (ETF)
– Apply through Startech (South Texas)
– Emerging scientific or technology fields that have
a reasonable probability of enhancing this state ’s
national and global economic competitiveness.
– Additional preference is given to proposals that:
• May result in a medical or scientific breakthrough;
• Have previous equity investment into the company;
• Have a demonstrable economic development benefit to
this state; or
• Guarantee commercialization or manufacturing in
Texas if successful
– Must have partnership with Texas State institution
Strategic Partnering
• Strategic Private
Investors/Partners
– Large corporations
• Potential Acquirors
• Potential Customers
Getting Comfortable with
Investor Terminology
• NVCA Model Legal Documents
– www.nvca.org - Model Legal Docs Button
• Know Offering Terminology
Investors
• Investor No. 1: Gringotts VC: 5,000,000
shares at $1.00 per share
• Investor No. 2: Olivanders VC: 1,000,000
shares at $1.00 per share
Amount Raised
• $6,000,000, including $500,000 from the
conversion of Subordinated Convertible
Promissory Notes of Gringotts VC
• $1,000,000 to be invested at the Closing
• $2,000,000 to be invested upon completion of a
prototype of the Firebolt
• $2,000,000 to be invested upon achieving
actual manufacturing of the Firebolt
• $1,000,000 to be invested upon achieving initial
sales of $250,000
Pre-Money Valuation
• The Original Purchase Price is based upon
a fully-diluted pre-money valuation of
$4,000,000 and a fully-diluted post-money
valuation of $10,000,000 (including an
employee pool representing 10% of the
fully-diluted post-money capitalization).
Capitalization
Pre-Financing
Security
Post-Financing
# of Shares
%
# of Shares
%
Common –
Founders
3,000,000
100%
3,000,000
30%
Common –
ESOP
Series A
Preferred
0
0%
1,000,000
10%
0
0%
6,000,000
60%
3,000,000
100%
10,000,000
100%
Total
Terms to Negotiate
• Dividends: The Series A Preferred will carry
an annual 10% cumulative dividend
compounded annually, payable upon a
liquidation or redemption. For any other
dividends or distributions, participation with
Common Stock on an as-converted basis.
• Liquidation Preference: In the event of any
liquidation, dissolution or winding up of the
Company, the proceeds shall be paid as
follows… non-participating Preferred
Stock… full participating Preferred Stock
Liquidation Preference (cont.)
Liquidation Preference
Alternative
Conversion to Common
Total Amount
Received on Sale of
Hogwarts
$60,000,000
Non-Participating
$6,000,000
Full Participating
$62,400,000
Full Participating with Cap
$36,000,000
Terms to Negotiate:
Right of First Refusal/
Co-Sale Agreement and Voting Agreement
•
•
•
•
Right of First Refusal
Right of Co-Sale
Board of Directors
Drag Along
Corporate Board & Advisory Board
• Corporate Board –
elected by shareholders
to set direction for
Company
• Advisory Board –
Company’s resources
(scientific, experience,
connections)
Joint Ownership Issues
Not only your partner, but …
Buy-sell/Shareholders
agreements
What if I don’t
want to keep doing this?
What if my partner
dies? Gets divorced?
Files for bankruptcy?
Issues are always easier to
resolve before money is a factor
READ EVERYTHING …
• “Boilerplate” = Most
important provisions, do
NOT ignore
• Don’t assume a provision
can’t be changed
• Don’t sign contracts until
reviewed by a lawyer
Use of Forms
The parties hereto agree that any
disputes or questions arising hereunder,
including the construction or application
for this agreement, shall be settled by
arbitration, in accordance with the Code
of Civil Procedure 1280. Said arbitration
to be accomplished by a single arbitrator
appointed by the presiding judge of the
Superior Court of Dallas County Texas.
Use of Forms
13. Venue. This Agreement and all amendments or
modifications hereof shall be governed by and interpreted in
accordance with the laws of the State of Confusion
governing contracts wholly executed and performed therein,
and shall be binding upon and inure to the benefit of the
parties, their respective heirs, executors, administrators and
successors. Jurisdiction for any suit filed to enforce the
provisions of this Agreement by either party shall be filed in the
federal or state courts of Mostfavorable District of
Confusion in Hitsville, Confusion or Miracle County,
Confusion.
Stephanie
Chandler
Jackson Walker L.L.P.
210.978.7704
schandler@jw.com
112 E. Pecan Street, Ste. 2400
San Antonio, Texas 78205
www.jw.com
George
Karutz
Karutz Flavin
210. 804.4240
karutz@kwfib.com
7373 Broadway, Suite 503
San Antonio, Texas 78209
www.kfwib.com
TAKE YOUR
TECHNOLOGY
TO THE
LIMIT!
Center for Innovation and
Technology Entrepreneurship
T e c h n o l o g y
E n t r e p r e n e u r s h i p
f r o m
I n n o v a t i o n
t o
B u s i n e s s
V e n t u r e
The Foundation:
Structuring Your New Venture
and Raising the Cash
Stephanie L. Chandler and George Karutz
January 29, 2011
Center for Innovation
and Technology
Entrepreneurship
UTSA Colleges of
Business and Engineering
Jackson Walker L.L.P.
www.jw.com
Karutz Flavin Wells Investment Banking
www.kfwib.com
CITE BootCamp September 2010
41