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You are here: Home / 2009 / Archives for April 2009

Archives for April 2009

What is Class F common stock?

April 23, 2009 By Yokum 19 Comments

Adeo Ressi, the founding member of The Funded, recently announced the establishment of The Funded Founder Institute.

The Founder Institute helps founders launch innovative companies by providing training, services, and company-building assignments, such as incorporating the business, filing provision patents, and setting up books and records. The Institute offers a four month program, called a Semester, hosted initially in the Bay Area and then expanding to locations around the world. The program participants, the Founders, receive extensive training in weekly sessions overseen by three Mentors – two seasoned CEOs and one domain expert for each topic.

The driving beliefs behind the Institute are that (1) great founders are often overlooked by the current entrepreneurial ecosystem, and that (2) innovative startups have a dramatic positive effect on the global economy. Startup companies consume resources intelligently, put people to work in efficient ways, and produce market driven products at lower costs. Helping smart people start new companies should, in fact, help the global economy.

The Founder Institute recently published a sample certificate of incorporation that Adeo used when incorporating the Founder Institute, Incorporated.  Adeo was focused on creating mechanisms to protect founders who may lose control of the companies they created after raising financing from investors.  The current customary form of venture financing documents has not changed much since with mid-1970s when they first became widely adopted in Silicon Valley.

Therefore, Adeo wanted to include a number of extremely founder-friendly provisions in the certificate of incorporation for companies formed in connection with the Founder Institute.  These provisions include a special class of super-voting common stock, called “Class F” common stock, which is named for “Founders.”

  • Voting.  The COI includes Class A common stock, which has one vote per share, and Class F common stock, which has 10 votes per share.  Companies such as Google, Martha Stewart Living Omnimedia, Broadcom and others have super-voting common stock.  Super-voting common stock is sometimes seen in companies where founders or a family wish to maintain control of a company after obtaining outside investment.
  • Protective provisions.  Similar to protective provisions in a Series A preferred stock financing, there are certain fundamental actions that cannot be taken without the consent of holders of more than 50% of the Class F common stock.  The Class F common stock protective provision basically provides:

As long as any of the Class F common stock is outstanding, consent of the holders of at least 50% of the Class F common stock will be required for any action that (i) alters any provision of the certificate of incorporation or the bylaws if it would adversely alter the rights, preferences, privileges or powers of or restrictions on the Class F common stock; (ii) changes the authorized number of shares of Class F common stock; (iii) authorizes or creates any new class or series of shares having rights, preferences or privileges with respect to dividends or liquidation senior to or common stock on a parity with the Class F common stock or having voting rights other than those granted to the Class F common stock generally; (iv) approves any merger, sale of assets or other corporate reorganization or acquisition, or the liquidation or dissolution of the Company; (v) increase the size of the board; or (vi) declares or pays any dividend or distribution.

  • Directors.  Holders of Class F common stock are allowed to elect one director.  The Class F director has 2 votes per director, as opposed other directors, who have one vote. Section 141(d) of the Delaware General Corporation Law permits a company to have directors with more than one vote per director. This may address a situation where there is a desire to keep the size of a board small, but ensure that board “control” is maintained by a particular group of stockholders.

The Class F common stock and the Class A common stock otherwise participate equally with respect to dividends and distributions and other economic rights.  The Class F common stock can be converted into Class A at any time at the option of the holder, and will automatically convert if the holder dies or if the Class F common stock is transferred to someone other than another Class F holder or an entity for the benefit of a Class F holder.

Whether any of these provisions will survive after a typical Series A venture financing depends on the negotiating position of the parties.  At a minimum, people like Adeo and blogs like Venture Hacks are educating founders about financing terms that may be detrimental to founders.

[Update:  Class F common stock is discussed in Techcrunch, VentureBeat, PE Hub and the WSJ.  In addition, Marc Andreessen has a blog post strongly supporting dual class stock structures in certain circumstances.]

Filed Under: Founders

WSGR online venture financing term sheet generator

April 22, 2009 By Yokum 3 Comments

[Below is the text of a WSGR email update.]

Always looking for ways to better serve the entrepreneurial community, Wilson Sonsini Goodrich & Rosati is pleased to announce the release of the WSGR Term Sheet Generator, a publicly available online tool that allows entrepreneurs and investors to generate an initial draft of a term sheet for a preferred stock financing. By answering a series of questions, users are guided through the principal variables contained in a venture financing term sheet. Brief explanations of the questions and typical deal terms are included. After answering as many questions as desired, users can generate, print, and save a Word version of the term sheet, which is intended to be useful in deal discussions between entrepreneurs and investors and in crafting a final, customized term sheet with the help of attorneys.

The term sheet generator is another example of the firm’s commitment to providing services to our clients more quickly and efficiently. Our attorneys use a more extensive version of the tool to generate initial drafts of documents for Series A preferred stock financings, including Certificates of Incorporation, Preferred Stock Purchase Agreements, Investor Rights Agreements, Right of First Refusal and Co-sale Agreements, Voting Agreements, corporate approvals, and closing documents. By using this tool, we believe that we are able to represent clients and complete transactions more efficiently. We also have a similar tool for generating initial drafts of more than 20 start-up company formation documents. In addition to document automation, Wilson Sonsini Goodrich & Rosati has developed other sophisticated knowledge management and related resources that enable our attorneys to better serve clients by tapping the essential expertise and experience of the entire firm.

Users with general comments regarding the WSGR Term Sheet Generator should contact partner Yoichiro (Yokum) Taku at ytaku@wsgr.com or Practice Resources Special Counsel Anthony Kikuta at akikuta@wsgr.com. To learn more about Wilson Sonsini Goodrich & Rosati’s entrepreneurial services, please click here.

[Update:  See below for various mentions of the term sheet generator.]

Altgate:  Law Firm Wilson Sonsini Now Preparing Term Sheets For Free (Furqan Nazeeri provides a review of the tool along with a sample term sheet that he created.)

Mendelson’s Musings: Wilson Sonsini Term Sheet Generator

Legal Blog Watch: Law Firm Replacing Itself With Free Term Sheet Generator

Guy Kawasaki:  Free Online Term Sheet Generator

WSJ Blogs: The Daily Startup: Putting Terms in Entrepreneurs’ Hands

ABA Journal: Wilson Sonsini Offers Free Document Assembly Tool

Adams Drafting:  The WSGR Term Sheet Generator: The Inoxerable Creep of Document Assembly

Prism Legal: New WSGR Term Sheet Generator – an Innovative Online Service

Law Shucks:  WSGR Term-Sheet Generator

Startup CFO:  Automatic Term Sheet Generator

The Startup Lawyer:  WSGR Launches Term Sheet Generator

VC Confidential: Term Sheet Tool

CenterNetworks:  Wilson Sonsini Launches Free Term Sheet Generator

Strategize:  Wilson Sonsini Term Sheet Generator

Sophisticated Finance:  Wilson Sonsini Term Sheet Generator

Kentucky Startup Blog: Term Sheet Generator

Steven Cox: Need a Venture Capital Term Sheet?  Here’s a FREE One

Legal Process Outsourcing:  Have Wilson Sonsini Read “The End of Lawyers?”

Barron’s:  For the Startup with No Money to Pay Pricey Lawyers:  Wilson Sonsini’s Do-It-Yourself Term Sheet Generator

Reuters:  Free financing tool to help startups get legal ball rolling

Reuters:  Hoopla over automated term sheet may be legit

WSJ Law Blogs:  Wilson’s Little Gift to the World

Xbusinessman:  WSGR term sheet generator (in Japanese)

The Lean Marketer: Online Term Sheet Generator for Venture Capital Funding

Filed Under: Series A

What is an accredited investor?

April 3, 2009 By Yokum 9 Comments

Under the Securities Act of 1933, a company that offers or sells its securities must register the securities with the SEC or find an exemption from the registration requirements. In addition, the company must also comply with securities laws in each state where securities are offered.

The Act provides companies with a number of exemptions from federal registration requirements. For some of the exemptions, such as rules 505 and 506 of Regulation D, a company may sell its securities to what are known as “accredited investors” defined in rule 501 of Regulation D.  Offerings to accredited investors are exempt from the registration requirements on the theory that accredited investors are sophisticated enough to protect their own interests.

The following types of individuals are accredited investors:

  • a director, executive officer, or general partner of the company selling the securities;
  • a natural person who has individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase; or
  • 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 for those years and a reasonable expectation of the same income level in the current year.

Net worth includes the value of houses and automobiles.  Thus, many homeowners are accredited investors due to the value of their houses.  The $1 million net worth and $200,000 income standards were established in 1982 and have not increased with inflation.

The following types of entities are accredited investors:

  • a bank, insurance company, registered investment company, business development company, or small business investment company;
  • an employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million;
  • a charitable organization, corporation, or partnership with assets exceeding $5 million;
  • a business in which all the equity owners are accredited investors; or
  • a trust with assets in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes.

UPDATE

SEC Proposes Amendments to the Net Worth Standard for Accredited Investor Status

On January 25, 2011, the Securities and Exchange Commission (SEC) voted to propose certain amendments to the net worth standard for determining accredited investor status under the rules promulgated by the Securities Act of 1933. These amendments reflect the requirements of Section 413(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). Although Section 413 was effective on July 21, 2010, upon enactment by operation of the Dodd-Frank Act, the SEC is still required to revise the Securities Act rules to reflect the new standard. In addition, the SEC is proposing technical amendments to Form D and a number of rules to conform them to the language of Section 413(a) and to correct cross-references to former Section 4(6) of the Securities Act, which was renumbered Section 4(5) by the Dodd-Frank Act. The proposed rules are available here.

New Net Worth Test

Under proposed Securities Act Rules 215 and 501, the value of a person’s primary residence would be excluded for purposes of determining whether the person qualifies as an “accredited investor” on the basis of having a net worth in excess of $1 million. Previously, the net worth standards required a minimum net worth of more than $1,000,000, but permitted the primary residence to be included in calculating net worth.

The proposed amendments would define an accredited investor, among other things, as:

“Any natural person whose individual net worth, or joint net worth with that person’s spouse, at the time of purchase, exceeds $1,000,000, excluding the value of the primary residence of such natural person, calculated by subtracting from the estimated fair market value of the property the amount of debt secured by the property, up to the estimated fair market value of the property.”

Neither the Securities Act nor the Securities Act rules define the term “net worth,” so the proposing release states that the purpose of adding the phrase introduced by the words “calculated by” is to clarify that net worth is calculated by excluding only the investor’s net equity in the primary residence. The SEC believes this approach is consistent with and advances the regulatory purposes of Section 413(a) because it reduces the net worth measure by the amount or “value” that the primary residence contributed to the investor’s net worth before enactment of Section 413(a). The SEC also notes that some of its existing rules are similar in approach to the proposed rules. For example, Rule 701 under Regulation R provides for the exclusion of the value of a person’s primary residence in applying a net worth standard and also provides for the exclusion of “associated liabilities,” such as mortgages.

The proposed rules do not define “primary residence,” although they provide that issuers and investors should be able to use the commonly understood meaning of the term—the home where a person lives most of the time.

Effectiveness of the Proposed Rules

There is no transition period for the new accredited investor net worth standards, since these new standards were effective upon enactment of the Dodd-Frank Act. Under the current rules, a company or fund is not permitted to treat an investor as accredited if the investor subsequently loses that status, even if the investor has previously invested in the company or fund at a time when it satisfied the accredited investor standard. Investors must satisfy the applicable accredited investor income or net worth standard in effect at the time of every exempt sale of securities to the investor that is made in reliance upon the investor’s status as such. The proposed amendments would not change this situation. Nevertheless, the SEC is seeking comment on whether some transition and other rules might be appropriate to facilitate subsequent investments by an investor who previously qualified as accredited but was disqualified by the change effected by the Dodd-Frank Act.

Section 413(b) specifically authorizes the SEC to undertake a review of the definition of the term “accredited investor” as it applies to natural persons, and requires the SEC to undertake a review of the definition “in its entirety” every four years, beginning in 2014.

Effect of the New Net Worth Test

Among other things, the changes required by Section 413 of the Dodd-Frank Act impact the legal requirements governing unregistered offers and sales of securities, i.e., “private placement” exemptions from the registration requirements of the Securities Act relied on by companies in raising private capital from individuals. One of the requirements of certain private placement exemptions is for capital to be raised from accredited investors. By excluding the value of an investor’s primary residence in calculating net worth, indebtedness secured by the primary residence would be netted against the value of the primary residence up to the fair market value of the property. This may cause fewer individuals to qualify as accredited investors, thereby reducing available private capital.

Notwithstanding the foregoing, it is still possible for individuals to qualify as accredited investors on other grounds. For example, Rule 501 of the Securities Act provides that an accredited investor shall also mean any person who comes within, or who the issuer reasonably believes comes within, any of the following categories:

  • any director, executive officer, or general partner of the issuer of the securities being sold, or
  • any natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person’s spouse in excess of $300,000 in each of those years, and has a reasonable expectation of reaching the same income level in the current year.

As a result, while the net worth test promulgated pursuant to the requirements of the Dodd-Frank Act may be more restrictive, natural persons may still qualify as accredited investors under one of the other definitions provided in Rule 501.

What You Should Do Now

Because Section 413(a) became effective upon the enactment of the Dodd-Frank Act and it requires the exclusion of the value of a person’s primary residence for purposes of determining whether such person qualifies as an “accredited investor,” all companies that have not already done so should revise their standard forms of accredited investor questionnaire and investor representations and warranties in their standard forms of financing documents to ensure that an individual’s net worth is properly calculated.

Filed Under: General

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