Post Category → Funding

Crowdfunding: Boom or Bust?

Over the past few weeks, I’ve read opinions on crowdfunding covering the entire spectrum.  The most pessimistic ones tends to be written by lawyers (surprise, surprise) and sound something like: “This is the worst idea ever.  Regular people are going to get screwed.”  The most optimistic ones have obviously come from people who either own or are affiliated with crowdfunding platforms, sounding something like: “This is going to revolutionize startups.  Venture capital and Angel financing are going to get disrupted.”

In my own characteristic fashion, I’m somewhere in the middle. I’d summarize the pros and cons of crowdfunding as follows:

Pros:

  • I’ve seen a lot of dumb accredited investors, so might as well level the playing field a bit.  The investment amount limits are reasonable.
  • This really could be a viable alternative to straight bootstrapping or conventional bank-rolled debt financing.
  • Might open up funding to the “long tail” (sort of) of business types that don’t fit the hockey-stick trajectory required for venture capital, but are still too capital intensive for a typical entrepreneur to bootstrap.

Cons:

  • Disclosure obligations are likely to make it expensive, or at least certainly more expensive than a typical seed round.
  • Liability exposure to civil suits will make follow-on funding from institutional capital much less likely.
  • Could limit future exit opportunities if acquirers can’t find a viable exemption through which to offer their own securities to the crowdfunded investors.

In a nutshell, I’m of the opinion that (1) nobody who can raise angel or vc money will crowdfund, and (2) most professional angels and institutional investors won’t touch a crowdfunded company with a ten-foot pole unless it’s somehow gone from being unfundable (which is why it crowdfunded to begin with) to Pinterest-esque hotness after its seed round.  Of course, an argument could be made that the SEC might soften some of the disclosure/liability issues, but do you really want to argue that the SEC is going to soften restrictions?

But that doesn’t mean crowdfunding won’t be revolutionary.  There’s a whole spectrum of business types out there that could really use another source of capital.  Not just restaurants and salons, but perhaps niche hardware plays like the ones that are getting a lot of attention on Kickstarter, or maybe specialized apps.  Also, keep in mind that these are thoughts about where crowdfunding will be out of the gate.  Where it goes as the concept matures and expands is a completely different story. I’m really excited to see what happens, even if I likely won’t get much exposure to it inside my practice area for the foreseeable future.

Closing Time: Sealing the Deal

I’m quite surprised that I can’t find a decent blog post or article explaining the closing process in a typical Angel/VC financing transaction. Given that a lot of the entrepreneurs that we work with have never done this dance before, I’m often asked to walk them through it.  This process is what you’ll usually see in a VC deal, or an Angel deal in which equity is issued.  Signature mechanics would be virtually the same in a convertible debt round, although stock certificates would obviously not be issued.

Outline:

  • Finalize docs
  • Create signature packets
  • Obtain requisite signatures
  • File documents with Secretary of State (DE, TX, etc.)
  • Release signatures
  • Close the deal, and show me the money
Vocab:
Signing: When the main parties to the transaction authorize the “release” of their signatures, often days after they actually signed the docs.  This creates a binding contract.
Closing: When money is transferred and shares are officially issued, though certificates typically won’t be printed until later.  Closing is usually simultaneous with Signing in a typical Angel/VC deal, but not always.

1. Finalize the Docs

Before anything gets done, lawyers and clients have to agree on the docs.  Hopefully this doesn’t take too long, but it depends on the attorneys involved and the nature of the deal.  Choose your attorneys wisely, and don’t let the tail wag the dog.

2. Create Signature Packets

First-timers are often fascinated with the concept of “counterpart” signatures.  While your whole deal may involve hundreds of pages of documents, an experienced firm will usually create a PDF “signature packet” containing only the pages that you need to sign, which they’ll send along with the full documents.  Each party signs his or her own counterparts contained in the appropriate signature packet, scans and e-mails them back to the attorneys, and when “Signing” time comes, everything is compiled together, dated, and deemed to be fully executed.  Much better than flipping through hundreds of pages to figure out where to sign.

Some firms (including yours truly) will go a step further.  They’ll run your signature packets through Docusign, or a similar electronic signature process, which will allow you to electronically execute the documents without having to print or scan a single thing.  Makes things easier for everyone.

3. Obtain Requisite Signatures

At the most basic level, a transaction will usually require approval from both the Board of Directors and the Stockholders of the Company before it can move forward.  The state of incorporation of the Company will usually have default thresholds that need to be met for those two groups, or the Company’s governing documents may have designated thresholds.  If any agreements, such as a Stockholders Agreement or Voting Agreement, are being amended in the deal, those documents will have their own thresholds that need to be met as well.  Usually a junior associate will be tracking the signatures received so that everyone can know when to pull the trigger.

When the main parties send their signatures to each other by e-mail, they’ll typically include language like “hold these in escrow until their authorized release.”  This is basically saying that they’re handing the signatures over to prepare for closing, but that the docs aren’t to be treated as executed until they give the signal.  You’ll also notice that signature pages (other than Board/Stockholder consents) usually don’t have date lines on them, or that you may be instructed to leave the dates blank. That’s because the documents won’t be dated until “Signing” occurs, which can be days after the docs are physically signed.

4. File documents with the Secretary of State (DE, TX, etc.)

Once the requisite signatures have been received, attorneys will work on compiling them together to have nice and neat documents with signatures and all.  In a typical financing, an amended Certificate of Incorporation (Delaware) or Certificate of Formation (Texas) will need to be filed, authorizing the new class of stock, along with certain rights associated with that class.

Delaware typically takes a day or two to confirm the filing of the new Certificate, unless you’re willing to pay a few extra hundred dollars for faster service.  Nothing happens until a file-stamped copy of the Certificate is returned.

5. Release Signatures

With the appropriate signature thresholds met and filed Certificate in hand, attorneys will typically send e-mails to each other authorizing the “release” of their clients’ signatures.  This release means that the deal is considered executed, and the documents will be dated on whichever day this release occurs.

6. “Close” the deal and show me the money

In a smooth, traditional Angel/VC financing, Signing and Closing will occur simultaneously.  Once signatures are released, the funding parties will execute wire transfers, and the Company will confirm receipt of those transfers.  Then the deal is “Closed.”

Sometimes special Closing Conditions will be listed in the Purchase Agreement that have to be met in-between Signing and Closing.  Once all parties are in agreement that those conditions are met, Closing will occur and wire transfers will be initiated.  It’s not uncommon for a financing to have an Initial Closing and multiple Subsequent Closings, each involving their own transfer of funds and issuance of shares for those funds.

7. Wrapping it up

Everything else is details.  Usually a paralegal of the Company’s firm prints physical certificates, has the Company sign them, and then they’re mailed to the investors.  A Form D (SEC filing for private issuances) is filed, and over the next few weeks someone orders bound books of the deal docs so that attorneys can put them on their shelves to show off the deal they worked on.  I prefer a well-bookmarked, searchable PDF and save my shelves for family photos, but I don’t judge.