Capital Raising & Fund Formation (Securities Law)

Is your company looking to borrow money or raise investment capital? The reality is, few deals are made on a handshake alone — and of those, even fewer actually work. But beyond making a deal with a good friend or close relative, loan documentation can be tricky. With institutional lenders, documentation can be extensive and complex. When you’re negotiating the terms of financing, it’s important that you come to the table armed with a solid understanding of the market — what’s typical, and what’s not.

You don’t have to go it alone.

As an experienced venture capitalist, I have personal experience borrowing, lending and investing money in/to businesses. On the legal side, I’ve drafted and negotiated hundreds of early-stage equity financing deals, convertible notes, promissory notes, unsecured and secured credit facilities and other financial arrangements.

If you’re forming a hedge fund (including cryptocurrency hedge funds), private equity fund, angel/venture capital fund, real estate investment fund, or other fund that involves raising money from investors, I can help. Fund formation usually entails three distinct projects within the overall project – fund and founder formation, fund investor offering, and fund advisor compliance.

The first project – fund and founder formation – is the creation of the fund entity and the fund manager (it’s rare that we don’t have two entities in a fund formation). Years ago, this was almost always a limited partnership with a general partner (often an LLC even back then) that managed the fund (and the investors were limited partners, or LPs). Today, many securities lawyers (including me) have moved to using limited liability companies (LLCs), although still using two of them to give the managers a little distance personally from the fund. Also, where there are multiple founders/promoters, the second LLC (the fund manager) is the vehicle where we iron out their deal together. We often use Delaware entities, although that isn’t always the default option. Part of that decision depends on your vision for the fund (e.g., how large will you grow it)?

The fund investor offering is a regular ol’ securities offering. This is where the fund issues interest in it to investors (in an LLC, the fund issues limited liability company membership interests). We use Regulation D Rule 506(b) often, although depending on how much you’re raising, who you’re raising it from, and other factors, there are other available securities law exemptions. It’s fairly rare that we don’t produce a private placement (confidential offering) memorandum – fund raising usually calls for a PPM, although, again, that’s not always the only approach. And, PPMs aren’t cheap. For quality, custom work (and be very careful of something spit out of a software program or “PPM mill” – you need to spend some time getting the risk factors specific and candid and covering the right risk factors), you’ll pay a minimum of $10,000. Big law may hit you for $50,000+ on a PPM. I’m usually in there around $12,500. They’re a lot of work, although on even a small fund raise, it’s relatively nominal and wise insurance. If someone quotes you less than $5,000 for a PPM, you are almost certainly better off without that PPM – this is an area where you really can get hurt if you don’t meet a minimum standard (i.e., it hurts more than it helps).

The compliance piece depends on what the fund will invest in. if you’re investing in securities, you’ll be acting as an investment advisor and need to deal with state or SEC registration under the Investments Advisors Act. I will help guide you on this, although often we’ll dial-in an RIA compliance company, which can help you with creating all the policies you need more cost-effectively than I can. A lot of cryptocurrencies and digital assets are commodities. I set up a couple cryptocurrency hedge funds and, at least as of late 2017/early 2018, the regulation (there’s also a commodity pool operator piece to navigate) on these is relatively light if you do it right.

I enjoy this work – lots of moving parts in an exciting context. My sweet spot for this work in my current law practice involves a fund size of $1,000,000 to $100,000,000. If you’re raising a much larger fund than that right out of the gate, I may not be the perfect choice for you, although I’m happy to explore if I am. If you want to talk more about what you’re doing – whether a hedge fund, private equity/venture capital fund, real estate fund, or some other type of fund, give me a call.

I do quite a bit of seed and Series A equity financing work with startups. Typically, I represent companies (founders) raising financing rounds. At times, I will represent investors. I bring to the table my experience raising capital for my own startups, as well as the time I spent working as a Silicon Valley venture capitalist for a publicly-traded media company during dotcom 1.0. This part of my practice is exciting – it’s all about growth!

During the seed stage, a startup is generally raising money from angel investors. Angel investors may be wealthy individuals who put their own money into deals from time to time. Or, angel investors may be “institutional” angels, meaning they make a lot of investments and know their way around the early-stage investment arena. Angel investors generally invest in return for common stock or preferred stock. They usually price their rounds (a round is a distinct financing event, which may include multiple investors), although occasionally they will invest with convertible notes. This is more common with the one-off angel investors than the institutional ones.

 Most of the startup equity (sale of stock) legal work that I do is in Austin, although I have two technology company clients in Dallas and a few energy and other industry startup clients in Houston. Both Dallas and Houston are growing technology sectors and all of Texas has a come a long way in competing to take some of the startup activity from Silicon Valley.

 I do most of my work for startups raising early-stage capital on a flat fee basis. You can read more about this at flat-fee billing.

The difference between a venture capitalist and an angel investor is simply that venture capitalists generally work with larger pools of other people’s money. A venture capital fund may easily be a few hundred million dollars.

Given that venture capitalists still only have so much bandwidth to review, make and manage stock investments in startup portfolio companies, they must make larger investments. Larger investment sizes mean that venture capitalists usually invest in growing companies doing Series B and Series C (and so on) rounds. These later financing rounds can easily be in the tens of millions of dollars, whereas as Seed and Series A stage deals tend to be much smaller.

 Raising venture capital isn’t always very different from raising angel investment, although as the deal sizes get larger, there tends to be a heavier emphasis on deal terms such as anti-dilution (full-ratchet and weighted average), board and information rights, liquidation preferences and registration rights. These deals tend to take a little more time and it’s very rare to see a venture capitalist invest using a convertible note or SAFE agreement.

Whenever you sell stock, you have to comply with the securities laws, both federal and state. There are plenty of exemptions available to assure you don’t have to file expensive registration documents with the SEC, although it’s important to navigate these waters carefully.

Another thing that often comes up in the context of raising capital are founder agreements. And, I do quite a bit of this work when founders are just forming and launching their startups.

Simply forming a corporation or limited liability is very simple. It’s easy to file a Certificate of Formation or Articles of Incorporation with the Secretary of State and services like LegalZoom and Clerky get the job done. However, when there are multiple founders or management with equity, it’s important that they work their deal out together, preferably when they launch, although certainly before they raise capital. In a corporation this is generally done with a Shareholders Agreement. In that document, we talk about making decisions (voting), how to handle disputes, buy-sell provisions in case the founders want to get their separate ways, etc.

As a quick aside, if you are just launching a startup and intend to raise venture capital, you want to form your company as a Delaware corporation. We can talk more about why, although, trust me, that is the only “right” decision. If you do it otherwise, it’s not the end of the world (you can convert a Texas or other state limited liability company to a Delaware corporation), just not the preferable path.

The JOBS Act may not have been absolutely everything startups, startup lawyers, angel investors and venture capitalists were hoping for, although it has changed the nature of raising startup capital in the United States. The two main changes are the ability to raise capital through general solicitation under new Regulation D Rule 506(c) and the ability to raise money from non-accredited investors using the exemption provided by Regulation CF.

 Rule 506(c) isn’t about crowd funding. It is an expansion of the most widely-used private securities offering exemption(s) – Regulation D Rule 506 (Rule 506(b) is the specific exemption that gets a lot of private securities activity!). Rule 506(c) allows startups to raise an unlimited amount of capital and identify investors through general solicitation (e.g., email marketing, radio ads, etc.). If a startup uses this exemption, they may only raise money from accredited investors (for a definition of “accredited investors” visit the SEC’s website at  www.ecfr.gov. The ability to raise capital through general solicitation has historically been very difficult for private companies, so this is a game changer.

 And, while securities lawyers (myself included) generally encourage startups to raise money only from accredited investors, sometimes this isn’t the best route (or, it simply isn’t an option) and using the new crowdfunding (crowd investing) exemption, raising equity through approved portals in compliance with the new crowdfunding rules is an interesting option that more startups should consider. Regulation CF allows startups to raise money from the crowd, including non-accredited investors. All deals using this exemption must run through approved portals (websites). Compared to Rule 506(c), there are a lot of specific requirements to fully comply with Regulation CF. There are individual crowd funding investing limits (investors can’t put more than a certain percentage of their annual income or fixed dollar amount into any one crowd funding investment opportunity). To read more about Regulation CF, visit   Regulation CF for Startup Founders and Investors.

These are new rules and, whenever securities law is at play (when a startup is raising capital by issuing securities – stocks, LLC interests, convertible notes, etc.), founders must be careful to carefully comply with all applicable laws to avoid unnecessary risks. This is a lot of what I do with businesses that are raising capital – talk with them about how to source the money they need in compliance with securities law.