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EARLY-STAGE INVESTMENT INSTRUMENTS

Venture Center – University of Minnesota

January 23, 2023

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Jen Randolph Reise

Managing Attorney, Reise Law

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www.ReiseLaw.com

Linkedin.com/in/jenniferreise/

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Agenda

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Debt and Convertible Debt

Equity

    • Legal Compliance
    • Understanding Dilution
    • Reg D Offerings
    • Investors and Rounds
    • Due Diligence

Q&A

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Financing: Big Picture Options

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Debt

    • Loan, usually from bank (term loan or line of credit)
    • Repayment over time of principal + interest (“debt service”)
    • Operating covenants
    • Secured and/or guaranteed

Equity

    • Sell shares of ownership of the company
    • Dilution
    • Control
    • Securities laws apply

Internally generated funds

    • Reinvested profits from the business

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Debt: Investment Documentation

A sophisticated lender will have their preferred forms. Main docs:

  • Loan Agreement
    • Terms
    • Reps and warranties by borrower
  • Promissory Note
    • Promise to repay loan on stated terms
  • Often: Security Agreement (loan is secured by property) or Personal Guarantee by founder(s)

Another option: Loan from a large investor or insider. Negotiate:

    • Interest rate
    • Maturity date
    • Interim payments, if any
    • Is it convertible into equity? When? At what price?

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Caution: Convertible debt is subject to equity standards

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Equity Overview

  • Investors buy equity as a bet on the future prospects of the company
  • There are many types of investors, with different goals and preferences
    • May be active or passive investors
  • Equity may be divided into classes with different rights, EG preferred and common stock
  • Issuing equity causes dilution to current equityholders
  • Issuing equity implicates securities laws (even for private companies)

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Dilution

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ABC Corp.

    • A: 500 shares
    • B: 500 shares
    • C: 500 shares
    • NEW Investors: 1,000 shares

500 / 2,500 outstanding

20%

When a company issues more equity, the percentage interest of the existing equityholders decreases (and therefore the amount of the company they own)

  • For example: ABC Corp was founded by A, B, and C as equal partners.
    • Founder A originally owned 500 / 1,500 shares or 33% of the outstanding stock
  • Consider if ABC Corp then sold a total of 1,000 shares to new investors for $1M
  • How much of the company does A own now?

Dilution is the cost of equity

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Securities Law Basics

Securities must be registered or exempt from registration in order to be offered and sold.

  • at federal AND at state level

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Though there are many exemptions, the primary way private placements are conducted in the U.S. is under the safe harbor of Regulation D.

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Reg D Offerings

  • Rule 506(b) offering: No dollar limit, unlimited number of accredited investors and up to 35 unaccredited, no advertising or general solicitation
  • Rule 506(c) offering: no dollar limit, unlimited number of accredited investors only, general solicitation is OK
  • + for both:
    • File Form D with SEC and states within 15 days of first sale
    • Disclosure of material information about the company and terms and conditions of investment

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1,000 Units of Amazing Startup, LLC (a Minnesota limited liability company)

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$5,000 Per Unit

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Accredited Investors Only

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January 23, 2023

Example offer

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Reg D Offerings: Key Investment Documents

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Private Placement Memorandum (PPM)

Business Plan, Management Team, and other information about what the company has done and plans to do with the money

Terms of investment being offered

Material Risks to the Company’s plans

Subscription Agreement

Investors are accredited and understand the risks of investment

Dollar amount of investment

Operating Agreement /

Limited Partnership Agreement /

Shareholder Agreement

Who makes decisions for the company and the control investors have

How investors can transfer their equity & what happens on sale of company

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Rounds and Types of Equity Investors you may see

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Friends and Family

    • Founders
    • Their network

Seed

    • Angel investors
    • Accelerators

Series A

    • Venture capital
    • Private equity

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Legal Due Diligence Savvy Investors Ask For

  • Filed Articles
  • Fully signed Operating Agreement (or Bylaws and Shareholder Agreement)
  • Cap table (all outstanding equity and how held)
  • Any agreements giving equity potentially in future (options, warrants, convertible debt), etc.

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Clean DD starts at formation

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Other Fundraising Options

Equity Approaches

  • SAFE (Simple Agreement for Future Equity)
  • Crowdfunding using Reg CF
  • Equity stake by partner company

Non-Equity Approaches

  • Non-equity crowdfunding (EG Kickstarter)
  • Pre-fund distribution agreements, etc.
  • Sale-leaseback 
  • Bootstrapping
  • Re-invested profits

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Q & A

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www.ReiseLaw.com

Linkedin.com/in/jenniferreise/

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