The Latest on Equity Crowdfunding

We’re excited to share that Lathrop GPM lawyers have again worked with an entrepreneurial client to successfully launch a crowdfunding offering. This time with a company specializing in products and related services for producing non-alcoholic offerings in the craft beverage industry. As always, we are constantly amazed at the level of originality, energy, effort, and, to state the obvious, entrepreneurship that infuses these endeavors at every level!

Our latest crowdfunding client success made us realize that it’s been a while since we’ve written about Equity Crowdfunding; so I think we’re well overdue for an update! As we have written before, prior to the 2021 SEC rule changes (the “2021 Rule Changes”), crowdfunding was limited to offerings of up to only $1.07 million, and investment by the “crowd” through “special purpose vehicles” (which has the practical effect of listing potentially hundreds of “crowd” investors as a single shareholder on your cap table) was not permitted. As a result, crowdfunding at that time did not present a very attractive capital-raising mechanism for most entrepreneurs; few such offerings had been initiated and most of them had not been unsuccessful. The 2021 Rule Changes, among other things, increased the maximum raise to $5 million, and permitted the use of a special purpose vehicle, organized and operating for the sole purpose of acquiring, holding and disposing of securities issued pursuant to a crowdfunding offering, and into which all “crowd” members made their investment. Three years on, how have the 2021 Rule Changes affected the use of crowdfunding as a productive means of raising capital?

Let’s roll the tape! *

Open AI Raises Record Capital

Venture capital is an industry fed by ambition and optimism. There is no better example than Open AI’s recent investment round which raised a record $6.6 billion, while also reportedly turning down billions in potential oversubscriptions.

To provide some context, $150 billion is approximately what the entire U.S. venture capital industry had under management in 1999 to fuel the internet bubble. Just ten years ago, the states of New York, Texas and Florida raised about $6.5 billion—combined.

Women Who Mean Business

In previous posts, we’ve talked about the unpleasant but inescapable reality that an entrepreneur needs money to get a new business up and running, and to keep it running. Friends and family, crowdfunding, Shark Tank—all good possibilities.

Today, though, I’d like to remind all the women entrepreneurs out there of the numerous resources available to women-owned businesses. And out there you are! The 2023 Annual Report of the National Women’s Business Council estimates that women own more than 14 million companies, around 39% of privately held businesses, representing an increase of 13.6% from 2019 to 2023. Check out these:

Updated Resource for Entrepreneurs and their Lawyers

The National Venture Capital Association (NVCA) sets the standards, quite literally, on the forms used by most emerging businesses looking to raise capital. Founded in 1973, the NVCA is a research, advocacy, and professional development network—a non-profit organization supporting the venture capital industry and the various players that make up the community.

Can You Use Someone Who Isn’t a Registered Broker to Help Me Raise Capital?

Tackling a question that so often entices entrepreneurs – can I pay someone to help me find investors? When funding a new enterprise, how can a scrappy small business owner break into those upper echelons and c-suites where high-dollar investors are presumably just looking for the right start-up to fund – folks who would recognize the brilliance of your vision and gladly sink capital into your enterprise…if only they were aware of it!

It’s about at this point that many an entrepreneur remembers they have a rich relative, or a deep pocketed friend or business connection, or maybe just know a high roller that knows a bunch of other high rollers that can be convinced to invest. And this high roller – let’s call him Rich Uncle Pennybags – not only knows all the Sharks (see this post and this post by fellow entreVIEW authors if you’re interested in more about the “Tank”), he will be happy to find investors for you in exchange a fee that’s based on the amount of capital he successfully raises for you, so you’re not out of pocket one dollar! Brilliant, right?

And now we’re reached the point where the buzzkilling entrepreneur’s attorney weighs in – in most cases you can’t do this (well, at least legally anyway…). Unfortunately, Uncle Pennybags’ efforts would likely be deemed “broker-dealer activity”, which is subject to regulation and requires licensure.

Both federal (SEC) and state rules prohibit a person from acting as a “broker” unless that person is registered with the SEC and the state in which the person conducts business. A “broker” is defined as “any person engaged in the business of effecting transactions in securities for the account of others.” Unfortunately, the rules do not define what constitutes “effecting transactions in securities for the account of others,” but the SEC has identified certain activities that will generally be deemed to “effect” securities transactions, including:

• assisting in structuring a transaction,
• identifying potential purchasers,
• soliciting transactions,
• participating in taking orders for purchase of the subject securities,
• advising investors on the merits of the investment, or
• receiving commission or other transaction-based compensation in exchange for their services.

Well, so what if Uncle Pennybags just introduces you to potential investors? Unlike a broker, someone just acting as a “finder” does not need to be registered, although the line between “broker” activities and “finder” activities is at least a little blurry. In general, a “finder” is someone who merely provides a prospective investor’s contact information to the company that’s raising capital. But remember, by far the biggest red flag for securities regulators is the payment of commission-based compensation; that is, paying a fee based on the number of investors or a percentage of the amount of money invested. We here at entreVIEW urge caution if you want to go down the “finder” road – there’s a possibility it can be done, but only if you really pay close attention to the structure and compensatory arrangements.

Why should you care? You, the entrepreneur, are not the one engaging in unlicensed activity – isn’t that just a problem for Rich Uncle Pennybags? Unfortunately, no – the entrepreneur’s association with an unregistered broker in prohibited by state and federal law, violation of which can lead to fines, penalties, and sanctions. Worse, an investor whose investment was solicited by an unregistered broker may be able to force you to return any money invested. In addition, it could negatively impact your ability to raise future capital and or sell your Company in the future!!

If you still believe Uncle Pennybags and his rolodex can be really helpful, the safest thing to do is to try and work out a compensation arrangement that is not commission-based, such as a flat fee, and limiting his activities to only providing introductory information. And don’t forget other sources of funding that may be available to you—family, friends, and your own connections, small business loans or grants, angel investors, and crowdfunding platforms as discussed in this post.

Next Up in the Tank – Lessons from Watching the “Sharks”

Acknowledging up front that “Shark Tank” is not exactly breaking news (the show premiered in 2009 and one of the other authors of entreVIEW wrote a post about it back in 2014), I still like to point out how helpful it can be to entrepreneurs, even those who don’t make it into the “Tank”. In initial consultations with start-ups and early-stage companies looking to raise capital, I often bring up Shark Tank and the lessons that can be learned from watching it (I generally recommend casual viewing – my husband can watch for hours, which drives me crazy).

Seriously – learn from watching often-hapless people pitch often-ridiculous products and concepts to a bunch of millionaire/billionaires, frequently subject to brutal ridicule? Actually, entrepreneurs can incorporate many lessons from the show when making their own pitches to potential real-life investors.

The Minnesota Angel Tax Credit Program – good news for startups; good investment in Minnesota.

The Minnesota startup community received good news to begin 2023 as Gov. Tim Walz proposed $20 million in funding for the Angel Tax Credit Program in his biannual budget.

The Minnesota Angel Tax Credit Program, started in 2010, provides a refundable 25% tax credit to investors and angel investment funds that make equity investments in emerging—primarily high-tech—Minnesota businesses. The tax credit, worth up to $125,000 per individual or $250,000 for taxpayers filing jointly, incentivizes a rather low risk investment in capital-needy businesses, fueling their growth, and, in turn, creating more jobs, tax revenue, and vibrant Minnesota communities.

I’m From the SEC, and I’m Here to Help!

Most entrepreneurs (okay, actually pretty much most people) don’t typically think of industry regulators as their friends, but the Securities and Exchange Commission’s Office of the Advocate for Small Business Capital Formation is here to change that!

Let’s take a moment to conceptualize the SEC for most entrepreneurs and start-ups: they’re the ones that burden you with those complex (and pricey!) registration requirements for offerings of your securities, and those pesky licensure requirements for anyone who wants to help you sell them. Yeah, yeah, there are a number of exceptions, but if you miss a step or try to get too creative, the SEC may be waiting with sanctions, penalties, or hefty fines (just ask Kim Kardashian what Section 17(b) of the Securities Act has to say about undisclosed payments for touting a security). And trying to do everything by the book generally requires filing of multiple notices and sometimes ongoing reports, all of which can get complicated and run up expenses and legal fees. So yeah…entrepreneurs might not think of the SEC as their best friend.

Digital Assets: Lathrop GPM Takes on Consensus

Author: Julian Sansano 

I recently attended the largest cryptocurrency, non-fungible token (“NFT”), and digital asset conference in the world. Consensus by Coindesk attracts tens of thousands of people from around the world, in a variety of fields and sectors, who either participate in the world of digital assets or are looking to build their knowledge and network in the digital asset world. Incredible buzz and excitement—think trade show meets rock concert, but the rockstars were the largest players and influencers in the digital asset game. For example, the founder of Cardano, a cryptocurrency, presented in jeans and a tee-shirt about his optimistic views on the future of cryptocurrency and their utility in the modern world, while the Chairman of the U.S. Commodity Futures Trading Commission presented in a suit about incoming crypto regulation.

Crowdfunding the Entrepreneurial Spirit!

Author: Patricia Garrigner-Strickland

We had a bit of a snowy winter here in Kansas City and after every storm, I had at least one teenage boy ring my doorbell and ask to shovel off my driveway (for a price). On a recent trip to the grocery store, I encountered a group of Girl Scouts selling cookies (I bought three boxes of Thin Mints and ate an entire sleeve on my way home). A new client, a photographer and graphic designer, is looking to expand her business to include art shows and more event bookings. Another client is looking to develop an interactive video game based on martial arts instruction.

Can’t Afford a New Robot for Christmas? How about the SEC Navigator?

I recently came across this article from earlier this year regarding the “Coolest Robots in 2021.” This isn’t just about robots that can vacuum your carpeting, although I understand that Roomba now has built in Artificial Intelligence to avoid having a pooptastrophe when it smears your dog’s feces all over the place. These robots can help do laundry, unload your dishwasher, eliminate germs (something that remains top of mind almost two years into a global pandemic), or replace your companion animal.

Yuval Noah Harari, Sapiens: A Brief History of Humankind (Harvill Secker, 2014)

Is it really possible to fit the history of mankind into a mere 500 pages? Yuval Harari gives it a shot and, while understandably a little light on a granular level, it’s a pretty enlightening journey, even to a history buff like me.

Take, for instance, money — a topic near and dear to every entrepreneur’s heart. Most of us think we know what it is, but really, as Harari tells us, money is an illusion, a social artifact that we all have agreed, consciously or not, will have a certain meaning. Money has no value except that which we give it. It’s all based on trust. 

Harari traces the development of money from ancient times, when bags of grain were used as a means of exchange, to the silver coins used during the biblical era. The silver itself had no inherent value. Unlike the grain, you couldn’t eat it, nor did this soft metal serve any other useful purpose, but it was a great deal easier to carry around and store. Fast forward to today, when most money is actually in the form of electronic data (not just credit cards, but Bitcoin!). Even easier to use!

The amazing thing is that this system based on trust is, and always has been, a global phenomenon. Harari says it all: “Money is the only trust system created by humans that can bridge almost any cultural gap, and that does not discriminate on the basis of religion, gender, race, age, or sexual orientation. Thanks to money, even people who don’t know each other and don’t trust each other can nevertheless cooperate effectively.”

Hot off the Press: SEC Proposes Conditional Exemption for Finders

It has been over three years since the SEC’s Advisory Committee on Small and Emerging Companies recommended (by a split vote) that the SEC should propose a conditional exemption for finders from the broker registration requirements of Section 15(a) of the Exchange Act for certain capital raising activities involving accredited investors. Last week, the SEC finally issued such a proposal. 

This is potentially big news! I’ve spent countless hours advising emerging companies about issues related to the retention of “finders” to assist with fundraising. For almost 30 years, these “finders” have been pointing to the Paul Anka no action letter* (from 1991) as evidence that they can be compensated for helping raise capital without being registered as brokers. 

The problem with the Paul Anka precedent is twofold. First, it is based on a very narrow situation that rarely matches the actual circumstances faced by people who regularly work to help emerging companies find capital. Mr. Anka only did it once in his life, and he never had any contact with the potential accredited investors about the investment. Second, given the SEC’s stance on the need for broker registration for anyone receiving transaction-based compensation in these situations, the SEC had essentially stated in recent times that, if it had a “do over,” even on the limited Anka facts, it likely wouldn’t have provided no action relief in the current regulatory climate. 

Twin Cities Startup “Week” in a Pandemic

Last week marked the beginning of Twin Cities Startup Week 2020, our annual celebration of local startups, founders and everyone who supports the Twin Cities entrepreneurial ecosystem. Usually, attendees can expect a jam-packed week of lunches, happy hours and networking events, interspersed with panel discussions, workshops and other events. This year, of course, is proceeding somewhat differently, with events spread out between September 7 and September 25, and being hosted all online. I guess it’s appropriate that in our COVID-19 universe a week lasts 18 days (at least many weeks feel like they last 18 days).  Get your tickets here!

As always, however, there are far too many events for even the most dedicated scheduler to possibly attend, even on an expanded timeline. Below, I’ve curated events that I’d recommend to one of my clients. Note: I’ve stayed away from specific technology areas — if you are working in AI, Edtech, Food & Ag, Healthcare or VR, take a look at the TCSW schedule here, where there are plenty of exciting opportunities. Instead, I’ve tried to focus on areas where any entrepreneur has the chance to get something valuable.

Allen Kurzweil, Whipping Boy: The Forty-Year Search for my Twelve-Year-Old Bully (Harper Books, 2015).

Sometimes you pick up a book out of mild curiosity and discover that it’s a whole lot more interesting than you thought it would be.

I expected this book would be a middle-aged man’s reflections about his childhood, perhaps an exploration of how painful experiences had laid the foundation for the wisdom that comes with age. There is this angle, sure, but even more interesting is the story within the story. The bully with whom the author tries to reconnect turns out in later life to have become the shill for a fraudulent international financing scheme that preyed on entrepreneurs who could not find financing to underwrite their dreams. And thereby hangs a cautionary tale for all of us.

The book focuses on the activities of the Badische Trust Consortium, which held itself out to be a 150-year-old private bank based in Switzerland and run by a committee composed of “European aristocrats capable of underwriting loans from $10 million to $500 million.” The author’s nemesis, who did business as a representative of “Barclay Global Investments” (confusingly close to Barclays Global Investors, a legitimate investment banking firm), would lure victims into the scheme. Preliminary meetings would be arranged at the New York offices of a premier Park Avenue law firm, which was duped into lending credibility to the Trust’s operations.

MN DEED Now Accepting Applicants for Minnesota Angel Tax Credit Program

Summer is in full swing and as you prepare to head to the cabin for the fourth of July, now is a good time to review exciting news for Minnesota entrepreneurs! After a several year hiatus, as of July 1, 2019, the Minnesota Department of Employment and Economic Development (DEED) once again accepts applications from businesses, investors, and funds to participate in the Minnesota Angel Tax Credit program. If you are an avid follower of this blog (and you should be), you probably are already aware of the historical popularity of the Minnesota Angel Tax Credit and some of its limitations. If you are not a frequent reader or are new to the entrepreneurial scene in Minnesota, below are some highlights of the 2019 Angel Tax Credit program.

• Minnesota’s Angel Tax Credit provides a 25% credit to investors, or investment funds, that make equity investments in early stage companies (with a particular focus on high technology, new technology, or new proprietary products, processes, or services in select fields). 
• The maximum credit is $125,000 per person, per year ($250,000 if filing jointly) and the credit is both refundable and available to residents of other states and foreign countries. 
• For 2019, the Minnesota legislature allocated $10 million of tax credits for eligible investments. Until September 30, 2019, $5 million of that $10 million is reserved for businesses owned by women or minorities, or for businesses located outside of the seven county metro area. Beginning on September 30, 2019, any portion of that $5 million that has not been allocated will be made available for all other eligible investments.
• If you are planning to use the Minnesota Angel Tax Credit for an investment in 2019, you should plan on becoming qualified as soon as possible. Many companies are submitting applications now, and some have even delayed financings that would have been otherwise completed at this point in the year.

As a reminder, the process requires that the company be certified as a qualified business and that the investor also be certified as a qualified angel. Both of these steps require filings with DEED. Once the company and investor are both certified, they must jointly submit a credit allocation application. 

SELF-REPORTING OF UNREGISTERED INITIAL COIN OFFERINGS: PERHAPS A FRAMEWORK FOR AVOIDING HEFTY CIVIL PENALTIES

Keeping with the theme of my prior post covering recent oversight and enforcement action by the Securities and Exchange Commission (SEC) of the cryptocurrency industry/exchanges, Gladius Network (an issuer of unregistered cryptocurrency tokens) recently reached a settlement with the SEC which avoided civil penalties entirely.

Gladius, a Washington D.C. firm dedicated to using the Ethereum Blockchain as a means of mitigating Distributed Denial of Serve attacks, raised over $12 million USD in an initial coin offering (ICO) in 2017 – the peak of the cryptocurrency investor craze. 

As SEC enforcement activity increased over the last several years, and the SEC maintained that most ICOs qualified as the sale of unregistered securities, Gladius decided to proceed with caution and self-reported its unregistered ICO to the SEC during the summer of 2018.  Gladius cooperated with the SEC’s investigation and agreed to take certain remedial actions, including registering its tokens as a security and repaying investors that requested their investments back.

Most significantly, however, is the SEC’s determination not to levy any civil penalties against Gladius. The SEC explained that “the SEC did not impose a penalty because the company [Gladius] self-reported the conduct, agreed to compensate investors and will register the tokens as a class of securities.” Robert Cohen, Chief of the SEC’s Cyber Unit, further commented that the case “shows the benefit of self-report and taking proactive steps to remediate unregistered offerings.”

The Gladius settlement follows similar enforcement actions initiated by the SEC in November 2018 against companies that conducted unregistered ICOs. In those instances, the companies did not self-report and were penalized by the SEC, sometimes to the tune of $250,000.

If nothing else, the Gladius case sends a clear and deliberate message that self-reporting to the SEC can result in meaningful cooperation credit – in particular the avoidance of hefty civil penalties. 

If you or your company are interested in learning more about the SEC’s guidance regarding cryptocurrency or ICOs and the recent regulatory activity, or have questions about how to make sure you are in compliance with securities law, the GPM team is here to help.

Keep Control of Your Venture

Every founder I work with is concerned about control. And rightly so, given that their new venture is their baby and the beneficiary of a lot of sweat and money out of their own pockets.

Usually the discussion gets interesting when the company begins issuing shares to employees or raising funds, but sometimes we dig into it right at formation. There are various creative methods to approach the issue.

Some traditional methods include implementation of voting agreements or the like, but for a startup looking to add and retain employees in a competitive market those methods may not be an ideal approach, plus they can be overly complex and it can become a burden making sure every employee signs an agreement that nobody other than legal counsel understands. Another method is to implement a dual-class of shares to give one or more founders the sole vote or “super” voting rights.

Recent SEC Activity Puts the Cryptocurrency Industry on Notice

For those who have not been following the U.S. Securities and Exchange Commission’s (SEC) oversight of the cryptocurrency industry/exchanges, the SEC recently settled its first-ever enforcement action against an unregistered cryptocurrency exchange.

Earlier this year, the SEC accused the cryptocurrency exchange EtherDelta and its management team of violating federal securities laws by illegally allowing users to trade tokens (a form of cryptocurrency) that the SEC considers securities under federal law, making it an unregistered securities exchange. Without admitting or denying any of the SEC’s allegations, EtherDelta agreed to pay a $75,000 fine and $313,000 in disgorgement and interest. 

This enforcement action comes on the heels of the SEC’s issuance of The DAO Report—a comprehensive investigation by the SEC of The DAO, a now defunct unincorporated organization established with the objective of operating as a for-profit entity that would create and hold assets through the sale of tokens. Among other findings and a lengthy discussion of the fascinating downfall of The DAO, The DAO Report, as well as the SEC’s March 2018 guidance on cryptocurrency, indicated that nonexempt cryptocurrency exchanges must be registered with the SEC and that online platforms that allow the trading of digital cryptocurrency assets could, in fact, be trading securities. 

Welcome to gener8tor

Twin Cities Startup Week, which was held for the third time early last month, has evolved into a one-week showcase of the creators, innovators, hackers, investors and others who are driving the Twin Cities startup scene. There were events from early in the morning to late at night, and all hours in between.  There were intimate gatherings of people focusing on specific topics (healthcare, AI, IoT, etc.), and other larger general purpose events, including the Minnesota Cup’s final awards event, a Beta.MN showcase event, Techstars Demo Day and MinneDemo. As in years past, there was plenty of enthusiasm and energy on display by the Twin Cities startup community.

One new event on the Twin Cities Startup Week calendar was gener8tor’s premiere night launch event. Held on October 10th at the Minneapolis Event Center, it was the coming out party for the 5 cohort companies that participated in gener8tor’s accelerator program beginning this past summer. For those of you who don’t know, gener8tor is an accelerator program that was started in Milwaukee and Madison, Wisconsin in 2012. The program graduates one cohort group from each of their Wisconsin locations annually (Madison in the spring and Milwaukee in the fall).  gener8tor launched its Minneapolis program this past year and has been a welcome addition to the Twin Cities startup community.