In my last post, I made a comment about startups not needing 45-page LLC agreements. I guess there’s even worse being perpetrated out there. A friend, who also represents startups, reports the following:
Apropos of your point, I am in the process of negotiating a 2-member, early stage operating agreement which spans 70 pages
I love Fred Wilson’s blog. Sure, he’s a smart VC, but he also writes well and believes in sharing his knowledge. I always learn something from his posts.
A little more than a year ago, Fred issued a challenge to startup lawyers: to keep legal fees down for startup investment transactions. Way down. In his view, when an entrepreneur sets up and raises $500K to $1MM, legal fees should be $5,000 or less. I completely agree with that. The fifteen or twenty thousand dollars that companies are paying for stuff like this? It’s nuts. Read the rest of this entry »
Here’s a lawyer secret: we recycle our documents. Over and over and over. We even have a fancy word for it – “precedent.” For the most part, the use of precedent is efficient and benefits the client. Few would want to pay for their agreements to be drafted from scratch, when a document from a similar transaction could be adapted. Read the rest of this entry »
UPDATED: The JOBS Act passed Congress and was signed into law by President Obama. Final bill text here.
I’ve previously posted (here and here) about the crowdfunding measures that have been working their way through Congress. The House has now passed the JOBS Act (text here, for the truly wonky), which contains these measures, and the Senate is debating the bill and some amendments as I write this.
If/when a final bill passes, I will review the final details and what they mean for entrepreneurs.
I certainly agree that it would be great to make it easier for startups to raise limited amounts of capital, and to allow non-“accredited” investors to participate in these investments to a reasonable extent. I am not so sure about the other provisions, which may loosen some appropriate rules put in place in the wake of Enron and Wall Street conflicts of interest. The relaxing of those rules may help a few of the larger “small” companies, but if it comes at the cost of significantly increased fraud, that would not be a good thing for anyone. I’m just not convinced that the regulatory burden is really a significant cause of a reduced level of IPO activity.
I strongly suspect that a broken and abused patent system is a far greater headwind to innovation and drag on the economy than the IPO rules are. But I digress…
Portfolio.com has an update on today’s action, and a good round-up of some of the critics’ views.
By tomorrow, we may have a final bill and then it’s in the President’s hands.
A great many founders that come to me for representation want to split ownership 50-50 with their co-founders. I’ve been thinking about 50-50 issues a lot lately. These situations present interesting challenges for the attorney, in terms of how to construct reasonable, practical mechanisms for dealing with disputes that can take place between the founders, which otherwise can result in deadlock.
Before sharing some thought on that issue, I first want to explore the question, should founders even do this at all? This is a question that has always aroused significant debate in entrepreneurial circles, and I am sure it always will. Read the rest of this entry »
Here’s something that I’ve heard a lot over the years: “Most jobs are created by small businesses.” As a founder of a small business, who now represents them in my law practice, I’d like to believe that this is true. When I hear the same thing over and over again, though, I wonder. And then I research.
It was not hard to find an article taking the contrarian view of small business job creation. A recent Business Week piece questions the quality of the jobs created by small businesses. It notes, for example, that larger companies have more stable, better-paying jobs with benefits. The article points out that many small businesses are neighborhood stores and professional services companies – the kinds that are not trying to grow.
For the small business perspective, I visited the Small Business Administration website. On the SBA website, we learn that small businesses (the SBA defines a small business as one having fewer than 500 employees), though representing 99.7 percent of all employers, employ about half of all private sector employees. That’s not exactly a compelling stat for the dominance of small business in our economy.
Put the static numbers aside and ask, where does job growth come from? The SBA headline is that small businesses “generated 65 percent of net new jobs over the past 17 years.” A recent research study, cited in a Wall Street Journal article, supports the claim that small businesses create more net new jobs, per employee, than do larger businesses. However, the study concludes that the effect vanishes if you control for the age of the enterprise. It is young businesses, not small ones, that drive job creation. In other words: entrepreneurship.
The SBA data seems roughly consistent with this finding. The SBA overview concludes that much of the job growth is from “fast-growing high-impact firms, which represent about 5-6 percent of all firms.” So, who are these companies?
You might think that they would be Internet-age, entrepreneurial companies – Google, Facebook and the like. While these kinds of companies are certainly represented in this cohort, the SBA tells us that the fast-growing companies are older on average somewhat older than startups – 25 years old, in fact. Though definitely on the front side of the curve, they are not brand new.
Digging further, into a research paper called “High-Impact Firms: Gazelles Revisited,” I learned that of “high-impact firms” – those whose sales doubled over a four-year period and have high “employment growth quantifiers” – 94% of them were companies with fewer than 20 employees (based on 1994 – 2006 data). Score one for small business? Not so fast. Here again, as with the static employment numbers, small high-impact firms – though by far the most numerous – account for about half of net job creation, with large high-impact businesses accounting for the other half.
The Gazelles paper is interesting reading. What stands out is how hard it is to identify any distinguishing features of fast-growing businesses. The proportion of high-impact firms does not vary much by region, industry or city/rural density. (One metric that grabbed me, though, was the high proportion of high-impact firms located within 20 miles of a central business district: 44 percent. The peak seems to be within the 6 to 10 mile band, and it declines moving out from there.) Moreover, there seem to be no reliable signals of companies that are about to become Gazelles.
As a non-expert trying to make sense of this information, my conclusion is that small businesses are quite important – not necessarily to the extent that their boosters claim, but much more than their detractors admit. I get that new businesses – regardless of size – account for most job creation, but didn’t nearly every new business start out as a small one?
What this means to me is that entrepreneurship is critical. The drive to innovate and grow that I observe among the cross-section entrepreneurs that I represent tells me, in my gut, that these are the Gazelles of the future.
In my last post, I reviewed the “crowdfunding” legislation that’s before Congress. Since that legislation may be stalled, I’d outline how a company might orchestrate a crowdfunding round in the absence of legislation.
For this discussion, a general familiarity with the laws and regulations governing private offerings is helpful. (You can read goodcounsel’s GoodGuide here.) The important thing to know is that you can’t offer securities to the public without registration (=time-consuming, expensive), unless you fall within a valid exemption.
The primary exemptions are for “private” offerings. What is “private” can be a bit subjective, which is why most companies and entrepreneurs try to stay within one of the “safe harbors” set out in Regulation D (“Reg. D”) of federal securities law. These safe harbors are not mandatory, but they offer clear standards and therefore a high degree of certainty that by meeting them, you’ll stay on friendly terms with the SEC (Securities & Exchange Commission).
So is there a way to crowdfund under current securities laws? Before answering that, we should define terms. Crowdfunding, in my view, is:
An early-stage financing round of a limited dollar amount
in which a large number of investors,
including people the company has reached through general solicitations, such as social media (i.e., those with no preexisting relationship to the company),
invest small amounts of money.
From a legal perspective, the major problem with crowdfunding is item 3. It’s hard to claim that your offering is not public when you are publicizing it to people you don’t even know. Most of the Regulation D safe harbors explicitly prohibit general advertising and solicitation. (That’s Rule 502.)
Rule 504, however, allows general solicitation under limited circumstances: where the offering takes place under a state securities law exemption (did I mention that you have to worry about state as well as federal securities laws?) that permits general solicitation, and then, only to accredited investors (i.e., people with lot of money). How many state securities laws allow general solicitation without registration? Darn few. Illinois doesn’t. Oh well.
But wait. Another section of Rule 504 permits general solicitations if the securities are registered in at least one state. Yes, we were trying mightily to avoid registration, but there is a simplified registration procedure for small companies, the Small Company Offering Registration, or “SCOR,” that has been adopted in most states. Simple, relatively speaking. SCOR registrations still have pages of requirements to understand and significant paperwork to file, state approval is required before you can proceed, and compliance obligations continue even after approval. (For example, Illinois rules can be found here.)
So to sum up, the answer is this:
You may be able to crowdfund a raise of up to $1,000,000, relying on federal Rule 504 and a SCOR filing in at least one state where the offering is taking place. Not a walk in the park, but certainly doable.
Is this worth it to crowdfund $1,000,000? It depends on your circumstances.
If you have a strong network or live in an active entrepreneurial community, you may be able to raise $1,000,000 from a small group of accredited investors – relying on Reg D safe harbors that don’t require any registration. (Not to minimize the challenges of that – even in a world more comfortable with startup risk.)
For true crowdfunding to be practical, it seems that we just have to hold our breath and see what Congress does.
Crowdfunding – the aggregation of small payments from a broad base of funders – has been enabled by the technologies of the Internet, particularly social media and easy electronic payments. Filmmakers have been bootstrapping movies with crowdfunding for some time. It has been widely used in the non-profit arena. Kickstarter operates a popular crowdfunding platform for creative endeavors. Kiva is well-known in the microfinance arena. Benevolent.net, a new Chicago non-profit on whose board I serve, is using crowdfunding to channel aid directly to individuals in need.
Why not, then, use crowdfunding to start your for-profit venture? Well, there’s one very big reason, and it has three letters – S, E, and C. The cardinal principle of federal securities law, as enforced by the Securities and Exchange Commission, is this: any investment offering to the public requires registration of the securities, a complex process beyond the means of nearly every startup – that is, unless there is a valid exemption.
The promising news (if you are an entrepreneur with a good idea and an extensive social network) is that Congress is moving to create a just such an exemption for crowdfunding offerings. The “Entrepreneur Access to Capital Act” (H.R. 2930) passed the House of Representatives with nearly unanimous support, 407-17. A similar bill, the “Democratizing Access to Capital Act of 2011” (S. 1791), has been introduced in the Senate.
The bills are similar, but not identical. Most significantly, the House bill allows companies to crowdfund up to $1,000,000 in any 12-month period – and up to $2,000,000 if the company provides potential investors with audited financial statements. The limit in the Senate bill is a flat $1,000,000. Moreover, the House bill allows a maximum investment by any individual of $10,000, dwarfing the Senate cap of $1,000. (Wrap your mind around the prospect of crowdfunding $1,000,000 in capital, a thousand dollars at a time!) Finally, while the House bill permits the use of “intermediaries” to provide a platform for the administration of crowdfunded offerings, the Senate bill mandates their use. Differences between the House bill and any ultimate Senate version would be worked out in committee before a final bill is sent to the President.
Where does it go from here? The bill is awaiting action in the Senate. Some influential groups, such as the North American Securities Administrators Association (NASAA) and the SEC’s Advisory Committee on Small and Emerging Companies, have expressed concerns about the potential for fraud and abuse. Because President Obama is a supporter, I predict that some kind of crowdfunding bill will reach his desk. However, its simplicity and utility still hangs in the balance. Even after final passage, it’s not quite over until the SEC weighs in with rules to flesh out in some of the details that the legislation leaves out.
Take a look at this recent NYTimes piece, reporting that many attorneys are leaving big law firms and opening up practices of their own. Not sure this really qualifies as news at this point, but okay…
To me, the more interesting issue is how many of these newly self-employed attorneys will perpetuate the standard hourly-billing models of the typical law firm and how many will opt instead for more client-friendly, risk-sharing business models, and adopt the lean business processes that support them. While many attorneys are becoming more entrepreneurial by necessity, the truth is that most lawyers are not terribly entrepreneurial or risk-tolerant by nature.
An entrepreneurial person at heart, I also had the good fortune to spend my 1995 summer at Bartlit, Beck, Herman, Palenchar & Scott — a Chicago spinoff from Kirkland & Ellis made up of attorneys who are not only some of the best trial lawyers in the country, but also, innovators in the use of alternative fee structures. Bartlett Beck was fervent about the advantages of non-hourly billing for attorneys and clients alike. It was an eye-opening experience for a young attorney, and it has helped shape the way that I view client service.
GoodCounsel handles a significant portion of its matters on a fixed-fee basis, and while a one-price-fits-all approach can be challenging in a legal practice, stay tuned for much greater price transparency in the weeks ahead.
