1.0 Law & Legal CLE Credit – A/V Approval #1114214 Recording Date - March 20, 2019

Meeting Location Date Time Topic

King County Bar Association 1200 Fifth Avenue - Suite 700

Seattle, WA

Wednesday, March 20, 2019

12:00 PM to 1:15 PM

Current Trends in Startup and Small Business Financing

AGENDA 12:00 PM Introduction 12:10 PM Presentation: ‘Current Trends in Startup and Small Business Financing’, by Joe Skocilich,

Foundry Law Group The presentation will look at some of the common financing instruments and standard terms used by startups and small business when raising capital, as well as the available securities law exemptions and practices.

1:15 PM Adjourn

SPEAKER BIOGRAPHY Joe Skocilich, Foundry Law Group - Joe Skocilich is a corporate and securities lawyer at Foundry Law Group, where he focuses on the representation of emerging companies in connection with company formation, capital raising, business transactions, and mergers and acquisitions. Joe is a member of the WSBA Securities Law Committee and the occasional commentator on developments in federal and state securities laws. He is admitted to practice in New York and Washington.

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Current Trends in Startup

Capital Formation

Questions from Clients

How do I raise money?

How do I comply with securities laws?

What is the best type of investment structure?

What terms are people getting?

What do investors want to see?

Lingo: “traction” “PMF”, “MRR,” “beta,” “MVP,” “burn”

How do I limit dilution and make sure I don’t lose control of my company?

Securities Law Offering Exemption Primer

Reg D, Rule 506(b)

● Primary exemption used by startups. Key features are manner of conducting the offering and limitation to

accredited investors

● Filing Form D w/ SEC and notice filings with the applicable states.

Reg D, Rule 506(c)

● Still not too common, used in accredited investor crowdfunding and crypto/blockchain ICO/STO.

Section 4(a)(2) Private Offerings (NO STATE PREEMPTION)

Crowdfunding (REG CF)

Capital Raising Trajectory

Bootstrapping (founders’ stock or debt)

Friends & Family (simple debt, convertibles)

Seed Rounds (convertibles, Series Seed)

● Growth of seed rounds and “pre-seed,” follow-on seed rounds.

● Series Seed Preferred Stock.

● Preserving the Series A for later in the fundraising cycle.

Series Preferred Rounds (Series A, B, C, . . . . )

Convertibles

Two primary types of convertible investment instruments:

Convertible Notes

● Standard debt with principal, interest, and maturity date.

● Conversion terms: when, with what discount and/or capped conversion price.

SAFE (Simple Agreement for Future Equity)

● Essentially a pre-purchase agreement for shares with the price and terms TBD

Convertibles: Key Terms

Discount: 20% is common, but can be 15% to 25%+

Valuation Cap (most important term)

● Pre-Money or Post-Money Cap?

Automatic Conversion: Size of next round that forces conversion.

Discount Shares: Issued in common stock or shadow preferred (e.g. Series A-2).

Maturity: 12-36 months, but more important what happens at maturity if no conversion.

Warrant Coverage: Getting more and more uncommon.

Preferred Stock

Series Seed

Published at: https://www.seriesseed.com/ and Github--https://github.com/seriesseed/equity.

Created by Ted Wang, a Fenwick & West lawyer in 2010.

Idea is to offer a simple, pre-negotiated, early-stage priced equity round that can be led by the company.

Series A

A fully negotiated investment round that should be led by a VC or other fund/lead investor.

NVCA (National Venture Capital Association) Model Series A Docs (updated in 2018).

Preferred Stock: Series Seed

Main Document: Series Seed Preferred Stock Investment Agreement. Structured as a fill-in-the blank.

Key Terms:

● Designed as a “light,” company-friendly agreement--1x, non-participating, no anti-dilution rights, and fairly

limited special “protective provision” investor voting rights.

● Series Seed gets same rights given to investors in the next equity issued (e.g. Series A, but with same carried-

over liquidation preference--i.e. class of shadow preferred stock)

Additions to Series Seed: Trend is to build on the Series Seed terms to incorporate standard Series A

provisions and even agreements. At its worst, the Series Seed is in name only and you have a Series A deal (maybe

a light version) called Series Seed. Some add-ons can be worthwhile though.

Preferred Stock: Series A

What makes a Series A?

Main documents: Stock Purchase Agreement, Investors’ Rights Agreement, Voting

Agreement, Right of First Refusal and Co-Sale Agreement.

Key Economic Terms:

● Liquidation preference: 1x, non-participating, has become the standard.

● Dividends: % rate, pro rata with common, cumulative, or non-cumulative.

● Anti-dilution: broad-based/“typical” weighted average. ○ CP2 = CP1* (A + B) ÷ (A + C)

○ A = fully diluted cap, B = hypothetical # of shares sold at old price, C = actual # of shares sold

○ Exceptions are key, including right of majority of investors to waive.

Preferred Stock: Series A (Cont’d)

Key Legal Terms:

● Board Composition, typically, a 3 or 5 person board (common, investor, and joint seats).

● Protective Provisions, requires a majority of Series A approval to issue senior class of shares (or any), change

board size, sell debt, pay dividends, redeem shares, non-wholly owned subsidiaries, change of control, issue

and blockchain-based “tokens.”

● Drag-Along Rights, forced sale terms and waiver of appraisal rights.

● Participation Rights, limited to “Major Investors.”

● Registration Rights, often not worth negotiating.

● Long list of technical provisions, add-ons, etc.

The State of Crowdfunding

Investment Grade Crowdfunding

● Created by Title III of the JOBS Act of 2012, REG CF went live on May 16, 2016.

● Works as a sort of micro-IPO, with disclosure and reporting obligations. Must be conducted through CF

Portal or broker.

● Biggest CF Portals: Wefunder, SeedInvest, Republic.

● Portals have adopted suggested forms of the SAFEs, convertibles notes, other promissory notes, or other

investment instruments.

● Criticism that SAFEs can be inappropriate when a next round is not expected or realistic. (SEC Bulletin, May

9, 2017).

● Platforms have opened up to allowing token/crypto sales as securities through the platforms.

Initial Coin Offerings

A sale (or pre-sale) of “tokens” to fund a blockchain-based project.

“Utility Tokens” were marketed and sold as not a security. Questionable Howey Test analysis in many

cases.

Now accepted that tokens are securities and sold under standard exemptions, Rule 506(b) or 506(c),

Reg CF, and Reg A+.

Pre-Sale Investment in Tokens:

● SAFT (Simple Agreement for Future Tokens).

● DPA (Debt Payable by Assets) Agreement. Similar to a convertible note, with the price of tokens TBD.

Initial Coin Offerings

A form of crowdfuding for “tokenized” blockchain-based projects.

Token marketed as a “utility token” and believed to be not a security.

Position is not clear that token are securities (mostly).