UTSA Colleges of Business and Engineering TAKE YOUR TECHNOLOGY TO THE LIMIT! 1CITE BootCamp January Technology Entrepreneurship Boot Camp Sponsored by Jackson Walker

UTSA Colleges of Business and Engineering TAKE YOUR TECHNOLOGY TO THE LIMIT! Stephanie L. Chandler Partner: Business Transactions (Corporate/Securities/M&A) Firm-wide Section Head: Technology Section University of Nebraska B.S.B.A. in Finance University of Virginia Juris Doctorate

UTSA Colleges of Business and Engineering TAKE YOUR TECHNOLOGY TO THE LIMIT! When Should You Formalize Structure? Initiation of Business Operations Asset Protection Capital Raising Succession Planning Multiple other factors …. Choose the Right Entity

UTSA Colleges of Business and Engineering TAKE YOUR TECHNOLOGY TO THE LIMIT! Choose the Right Entity Sole Proprietorship General Partnership (GP) Corporation –C-Corp –S-Corp Limited Partnership (LP) Limited Liability Company (LLC)

UTSA Colleges of Business and Engineering TAKE YOUR TECHNOLOGY TO THE LIMIT! Sole Proprietorship General Partnership (GP) Default Entity No liability protection, partners are jointly and severally liable for all partnership liabilities* The fallacy of a DBA filing …. county DBAs and State of Texas DBAs * Even in Texas your homestead protection may be limited depending on the specific facts so your home may still be at risk.

UTSA Colleges of Business and Engineering TAKE YOUR TECHNOLOGY TO THE LIMIT! Corporation Officers: President, Vice President, CEO, CFO, Secretary, Treasurer Employees/Operations/ Contracts Board of Directors ShareholdersOwnership Strategy/Direction Implementation/ Signing Authority Liabilities

UTSA Colleges of Business and Engineering TAKE YOUR TECHNOLOGY TO THE LIMIT! Corporation Pros Liability limited Ease of creation Most common – easily understood Growth oriented Centralized Management Equity Compensation Easily ImplementedCons Federal income tax and Texas Margin tax S-election restrictions

UTSA Colleges of Business and Engineering TAKE YOUR TECHNOLOGY TO THE LIMIT! Limited Liability Company Officers: President, Vice President, CEO, CFO, Secretary, Treasurer Employees/Operations/ Contracts Board of Directors ShareholdersOwnership Strategy/ Direction Implementation/ Signing Authority Liabilities Officers: President, Vice President, CEO, CFO, Secretary, Treasurer Employees/Operations/ Contracts Managers Members

UTSA Colleges of Business and Engineering TAKE YOUR TECHNOLOGY TO THE LIMIT! Limited Liability Company (LLC) Pros Can have tax flow through Limited liabilityCons 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

UTSA Colleges of Business and Engineering TAKE YOUR TECHNOLOGY TO THE LIMIT! Traditional and Non-Traditional Lenders  Most major traditional banks do not lend to startups/ do so only rarely  Silicon Valley Bank, Square 1 Bank lend to entrepreneurial companies (positive c/f)  Accts Receivable, Inventory, Fixed Assets  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

UTSA Colleges of Business and Engineering TAKE YOUR TECHNOLOGY TO THE LIMIT! 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

UTSA Colleges of Business and Engineering TAKE YOUR TECHNOLOGY TO THE LIMIT! 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 RULES FOR RAISING FUNDS

UTSA Colleges of Business and Engineering TAKE YOUR TECHNOLOGY TO THE LIMIT! 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”)

UTSA Colleges of Business and Engineering TAKE YOUR TECHNOLOGY TO THE LIMIT! 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.

UTSA Colleges of Business and Engineering TAKE YOUR TECHNOLOGY TO THE 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)

UTSA Colleges of Business and Engineering TAKE YOUR TECHNOLOGY TO THE LIMIT! “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 (not including house) 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

UTSA Colleges of Business and Engineering TAKE YOUR TECHNOLOGY TO THE LIMIT! 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 NOTE: 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. NEWSFLASH: May now also allow to do broader solicitation with the changes resulting from JOBS Act

UTSA Colleges of Business and Engineering TAKE YOUR TECHNOLOGY TO THE LIMIT! New Rule 506(c)—General solicitation and advertising permitted –Sales only to accredited investors –Reasonable steps to verify AI status 506(d): Bad Actor disqualification –506 Unavailable if a Covered Person has had a Disqualifying Event 506(e): Reporting of prior “bad actor events” JOBS Act

UTSA Colleges of Business and Engineering TAKE YOUR TECHNOLOGY TO THE LIMIT! A Few Warnings Once you go 506(c), you can’t turn back. Extra requirements and complications may scare off some investors Does the issuer have a legitimate business justification for using 506(c)? Securities Fraud Rules still very much apply

UTSA Colleges of Business and Engineering TAKE YOUR TECHNOLOGY TO THE LIMIT! Angel Investors (continued) Advantages  Provides needed capital for start-ups, usually seek smaller deals, like early stage enterprises, higher risk levels, less formal investment criteria, often very enthusiastic, can attract additional investors, requires little control, often brings vast amount of knowledge & experience, often look beyond monetary gain, they are located everywhere Disadvantages  Rarely make follow-on investments, tend to be less patient than VC’s, may require some form of control (board seat), may lack industry knowledge, do not have national recognition so they are hard to find, they chose to be “hidden” to avoid being pestered with business plans and telephone calls

UTSA Colleges of Business and Engineering TAKE YOUR TECHNOLOGY TO THE LIMIT! Crowdfunding Basics Must be conducted through a registered BD or “funding portal” Issuers can raise up to $1,000,000 a year Investors can invest, in any 12-month period, across all 4(a)(6) offerings: –Greater of $2,000 or 5% of income or net worth, if both income and net worth are < $100,000 –10% of income or net worth, if either income or net worth is ≥ $100,000, up to a max of $100,000.

UTSA Colleges of Business and Engineering TAKE YOUR TECHNOLOGY TO THE LIMIT! Highlights of the Crowdfunding Rules Issuers can’t conduct an offering (or concurrent offerings) through more than one intermediary Exemption not available to private funds (or funds that are excluded from the definition of investment company by Section 3(b) or Section 3(c) of that Act). Exemption not available to shells—entities with “no specific business plan” other than to engage in a merger or acquisition with unidentified company or companies. For purposes of the dollar limits, “issuer” includes any entity controlled by or under common control with the issuer. It also includes any predecessor.

UTSA Colleges of Business and Engineering TAKE YOUR TECHNOLOGY TO THE LIMIT! Form C, which has to be filed on EDGAR and provided to the intermediary and investors, includes, among other things: Description of business, capitalization, management and ownership Risk factor disclosures Detailed description of any exempt offerings conducted within the last three years; A financial description including discussion of results of operations, liquidity, and capital resources Financial statements, which need to be (taking into account the targeted amount for the offering): i. Certified by the PEO for issuers with $100,000 or less in 4(a)(6) offerings in the last year; ii. Reviewed by an independent public accountant (and include the review report) for $100,000 to $500,000; and iii. Audited by an independent public accountant (and include audit report) for over $500,000. Highlights of the Crowdfunding Rules

UTSA Colleges of Business and Engineering TAKE YOUR TECHNOLOGY TO THE LIMIT! If the offering doesn’t raise its target amount, offering cancelled and funds returned. Amendment to Form C has to to report any material change. Any investor that does not reaffirm their commitment within 5 business days will have their investment cancelled. 4(a)(6) issuers have to file an annual report on EDGAR (Form C-AR) that includes most of the items from Form C, including financials. Funding portals are prohibited from handling investor funds or securities. Form C needs to be made available for at least 21 days before securities can be sold (but commitments can be accepted during that time). Funding portals have their own registration statement they need to file—Form Funding Portal. Securities purchased in 4(a)(6) offerings are still somewhat restricted. Highlights of the Crowdfunding Rules

UTSA Colleges of Business and Engineering TAKE YOUR TECHNOLOGY TO THE LIMIT! 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.

UTSA Colleges of Business and Engineering TAKE YOUR TECHNOLOGY TO THE LIMIT! 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 2 nd 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.

UTSA Colleges of Business and Engineering TAKE YOUR TECHNOLOGY TO THE LIMIT! Grants GRANTS.gov SBIR (Small Business Innovation Research)  11 federal departments participate  2.5% of the total extramural research budgets agencies Advantages  Funds are non-dilutive – don’t have to give up any ownership  Great way to fund your initial invention Disadvantages  Takes tremendous amount of time, drawn out process – 8 to 14 months  No guarantee of having your application approved  Costs money to prepare the grant application properly  Significant reporting, follow on audits, strict rules,  SBIR grant may not be perfectly aligned or you may have trouble finding a grant solicitation that matches your needs

UTSA Colleges of Business and Engineering TAKE YOUR TECHNOLOGY TO THE LIMIT! Other Alternatives Private Foundations The Robert Wood Johnson Foundation The Kresge Foundation Otto Bremer Foundation The Kate B. Reynolds Charitable Trust Private Foundations American Heart Foundation Juvenile Diabetes National Burn Repository of the American Burn Association American Cancer Society

UTSA Colleges of Business and Engineering TAKE YOUR TECHNOLOGY TO THE LIMIT! Governmental Programs Federal R&D Contracts –National Institute of Health –Department of Energy

UTSA Colleges of Business and Engineering TAKE YOUR TECHNOLOGY TO THE LIMIT! Governmental Funds Texas Emerging Technology Fund (ETF) –Apply through T3DC (South Texas) –emerging scientific or technology fields that have a reasonable probability of enhancing this state ’s national and global economic competitiveness. –Must have partnership with Texas State institution

UTSA Colleges of Business and Engineering TAKE YOUR TECHNOLOGY TO THE LIMIT! Strategic Partnering Strategic Private Investors/Partners –Large corporations Potential Acquirors Potential Customers

UTSA Colleges of Business and Engineering TAKE YOUR TECHNOLOGY TO THE LIMIT! Getting Comfortable with Investor Terminology NVCA Model Legal Documents – - Model Legal Docs Button Offering Terms –Closing Date –Investors –Amount Raised –Price Per Share –Pre-Money Valuation –Capitalization

UTSA Colleges of Business and Engineering TAKE YOUR TECHNOLOGY TO THE LIMIT! Capitalization Pre- Financing Post- Financing Security# of Shares% % Common – Founders 3,000,000100%3,000,00030% Option Plan 00%1,000,00010% Series A Preferred 00%6,000,00060% Total 3,000,000100%10,000,000100% * Consider role of bridge notes

UTSA Colleges of Business and Engineering TAKE YOUR TECHNOLOGY TO THE LIMIT! 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

UTSA Colleges of Business and Engineering TAKE YOUR TECHNOLOGY TO THE LIMIT! READ EVERYTHING … “Boilerplate” = Most important provisions, do NOT ignore“Boilerplate” = Most important provisions, do NOT ignore Don’t assume a provision can’t be changedDon’t assume a provision can’t be changed Don’t sign contracts until reviewed by a lawyerDon’t sign contracts until reviewed by a lawyer

UTSA Colleges of Business and Engineering TAKE YOUR TECHNOLOGY TO THE LIMIT! 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.

UTSA Colleges of Business and Engineering TAKE YOUR TECHNOLOGY TO THE LIMIT! Stephanie L. Chandler, Esq E. Pecan Street, Ste San Antonio, Texas