CROWDFUNDING FOR SMALL BUSINESS

February 21, 2013

Rassul Zarinfar, Founder of Buffalo Bayou Brewing Companywww.buffbrew.com

Travis CrabtreeLooper Reed & McGraw, P.C.

www.lrmlaw.comwww.emedialaw.com

OutlineI. Capital Structure is like a Car

– What options make sense for you?– When does crowd-funding add value, and how?

II. Investors are Business Partners You Can’t Divorce– Who should you be looking for?– How will you find them?– & What do you say when you do?

III. Tactics: Structuring the Deal– What laws should I be worried about?– How much should you ask for?– How many people & how much each?

IV. The JOBS Act: How Crowd-Funding Will Change

Capital Structure is Vehicle

• What vehicle should I buy for my company?

• Capital Structure is the vehicle for your strategy

It Can Add Value

• Business partners know things you don’t!

• The right structure can help add more capital as you grow

It Can Destroy Value

• Lawsuits over who deserves what

• Short-term decisions to pay debts or buy out partners

Every decision depends on the business model,

especially financing

A Refresher on Debt vs. Equity

Debt Equity

They own nothing

You control everything, banks can’t vote, only

repossessYou pay a fixed amount

back, no matter how you do

So then… which one of these is: ?

They own assets & rights to future cash flows

Democracy: shareholders vote on certain decisions

You more you make, the more you pay

How Many Investors Should I Have?

A few put in a lot A lot put in a little

Vs.

How complex is the deal?

What’s the product/service?

Will you need more funding later?

What value will each investor bring?

Questions to consider:

How Many Investors Should I Have?

Personal Funds Bank Loans Angel / VC Crowd-FundedWhat does the deal

look like?You use your

savings You get a loan A lot of $ from a few people

A little $ from a lot of people

Cash Considerations You get all $$$ After you pay debt,

you get all $$You split $ with a

few peopleYou split $ with a lot

of people

Control You = 100% You = 100% (if current)

Split, and they might control

Decentralized democracy

Skill Set Lone Wolf Lone Wolf Board of Advisors Community

The cynical take You’ve gambled everything

You’re drowning in debt

One person controls your life

You’re a professional cat

herder

Crowd-Funding Has Worked for Me• Positives

– Experts I can call on– Extensive Social Networks for

a Social Product– Connections throughout the

community– Easy Access to Capital: “Dry

Powder”

• Negative– Herding Cats– Simplistic equity for semi-

sophisticated investors– Lots of feedback over

minutiae– Lots & lots of phone calls– Herding Cats– Fiduciary Responsibility

Social Networks Sell Beer

Simple Deal Terms

Simple Business to Understand

My Situation:

Highly-Skilled Friends

© Looper Reed & McGraw, P.C.

Fiduciary Corporate officers and agents owe a fiduciary

obligation to the corporation. See, e.g., Poe v. Hutchins, 737 S.W.2d 574, 579 (Tex. App. – Dallas 1987, writ ref. n.r.e.).

The officers and directors are individually liable for fraudulent or tortious acts committed while in the service of their corporations. See Hyman Farm Service v. Earth Oil and Gas, 920 S.W.2d 452, 455 (Tex.App.–Amarillo 1996, no writ).

© Looper Reed & McGraw, P.C.

Fiduciary - the jury questionDid Don Davis comply with his fiduciary duty to Paul Payne?

To prove he complied with his duty, Don Davis must show—1. the transaction[s] in question [was/were] fair and equitable to Paul Payne;

and

2. Don Davis made reasonable use of the confidence that Paul Payne placed in him; and

3. Don Davis acted in the utmost good faith and exercised the most scrupulous honesty toward Paul Payne; and

4. Don Davis placed the interests of Paul Payne before his own, did not use the advantage of his position to gain any benefit for himself at the expense of Paul Payne, and did not place himself in any position where his self-interest might conflict with his obligations as a fiduciary; and

5. Don Davis fully and fairly disclosed all important information to Paul Payne concerning the transaction[s].

Answer “Yes” or “No.” Answer: _________

Equity Investors are business partners you can’t divorce

Don’t take money carelesslyII.

Who Should You Be Looking For?• Sophistication level matters

– Don’t ever take money from people who don’t understand startup investing. Period.

• Wealth Matters– Avoid people risking more than they can lose comfortably

• You need more than just cash– The best Investors bring skills & networks that you don’t

have• Entrepreneurs think “all I need is money and I can make this work

if they just leave me alone”. You’re wrong. You can’t do this alone.

– Choose investors that challenge you intellectually– Be wary investors that micro-manage

• Prefer Pre-Existing Relationships

How Will You Find Them?

1. Personal, Social Network2. Personal, Social Network3. Coffee Chats, Meetups,

professional organizations4. Personal, Social Network5. Anywhere else humanly possible6. Online Forums & Tools

– Kickstarter, etc.

Don’t be that person who’s just looking for a buck

I never set out looking for investors anywhere.

I sought people who would give insight on my business idea & entrepreneurship in general. I shared my business plan with

anyone and built real relationships.

Soon enough, people started asking to invest.

The Pitch: What to Say

Passion

Honesty, Transparency

Cautious Optimism• You’re going to be doing this 24/7. Show them that you’re committed & excited• “Bet the Jockey not the Horse”• Passion is infectious. Leaders share their vision

• Set clear expectations from the beginning & you’ll avoid fights later• Build trust early with simple, clear deal terms• Admit your failures & fears: people trust you more• If you lie, they’ll figure it out. You’ll get their cash today & meet their lawyers tomorrow.

• Don’t promise what you can’t deliver.• Be realistic, and candid.• Avoid wishy-washy answers, but also avoid being resolute about uncertainty

Knowledge/Expertise

• Know your plan & its industry backwards and forwards• Read up on all industry publications• If someone asks a question you don’t immediately know the answer to, look it up and get back to them• If you miss the same question twice, you’ve failed. Period. In the age of Google, there is no excuse for ignorance

Good deals get funded. Don’t be pushy, and don’t compromise your ethics out of fear.

Tactics: Structuring the Deal

III.

Laws to Navigate

Federal: SEC regulates all

securities offerings

Others States: Each state has

“Blue Sky Laws”

Texas: Texas State Securities

Board Texas Securities Act

How Much Should You Ask For?

First Plan Second Plan Incorporated Finished Raise First Board Meeting

Now

What I thought I needed

Capital Pledged

Goals change as you gain information

Choose a structure flexible

enough to raise more

later

I needed way more than I set out to raise at first

Sequencing the Raise for Growth

I pledge $50,000

I pledge $40,000

I pledge $30,000

Round 1: $70kYes,

$50,000

Yes,$20,000

No

Round 2: $20KI don’t

have more

I have another $20k

You said no dude. No

No

Yes,$20,000

Sequencing the Raise for Growth

I pledge $50,000

I pledge $40,000

I pledge $30,000

Round 1: $70kYes,

$30,000

Yes,$20,000

Round 2: $50K

I have another $20k

Yes,$20,000

Yes,$20,000

I have another $10k

I have another $20k

Yes,$10,000

Yes,$20,000

Accepting less from more people increases your access to capital

How Many People is Too Much?

• Simple business meetings• Your single investor is probably really

committed & you’ll get their full focus

• One person has a lot of control over you

• Strategic decisions can become “coin-flips” & arm wrestling matches

• It better be the right person!• Over-investment happens quickly

Only one A few people A lot of people

• Lots of time communicating• Fiduciary responsibility to a lot of

people• Tragedies (Death & Divorce) will

definitely come up and distract you• Lots of people to answer to if things

go wrong• Too many cooks in the kitchen?• Small investments mean they don’t

care as much about you

• More passionate advocates of your brand

• Greater social networks, word of mouth advertising & connections

• Surrounded by experts who can help• No one “bet the farm”• Easiest access to follow-on capital

• Communication becomes a burden• People have a lot invested in you• What if the investors gang up?• More fiduciary responsibilities• Greater risk of alienating someone

and earning a lawsuit

• A strong team of experts can become your biggest advises

• More connections than you otherwise have

• Easier access to follow-on capital

JOBS Act: How New Laws Will Affect

Crowd-Funding

IV.

© Looper Reed & McGraw, P.C.

Jumpstart Our Business Start-Ups Problem Addressed

The Securities Act of 1933 states that entities cannot offer or sell securities to the public unless:

(a) the offering is registered with the SEC, or

(b) there is an available exemption from registration

© Looper Reed & McGraw, P.C.

Jumpstart Our Business Start-Ups Problem Addressed - Rule 504

Under Rule 504, no registration, but, Can only offer and sell up to $1 million of securities in any 12-month period; May sell to an unlimited number* of investors regardless of whether they are

accredited or sophisticated; Must inform purchasers that they receive restricted securities,* meaning that

the securities cannot be sold for six months or longer without registering them;

No PPM required, and Cannot use general solicitation or advertising to sell the securities.

© Looper Reed & McGraw, P.C.

Jumpstart Our Business Start-Ups Problem Addressed - Rule 505

Under Rule 505, no registration, but, Can only offer and sell up to $5 million of securities in any 12-month period; May sell to an unlimited number of “accredited investors and up to 35 other

persons who do not need to satisfy the sophistication or wealth standards associated with other exemptions;

Must inform purchasers that they receive restricted securities, meaning that the securities cannot be sold for six months or longer without registering them;

Cannot use general solicitation or advertising to sell the securities; and If you use unaccredited investors, you must disclose information.

© Looper Reed & McGraw, P.C.

Jumpstart Our Business Start-Ups Problem Addressed - Rule 506

Under Rule 506, unlimited amount of raise; no registration, but,

May sell to an unlimited number of “accredited investors” and up to 35 other persons who must be “sophisticated investors” -- that is, they must have sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment;

Cannot use general solicitation or advertising to sell the securities; and

If you use unaccredited investors, you must disclose information.

© Looper Reed & McGraw, P.C.

Jumpstart Our Business Start-Ups Problem Addressed - the Sophisticated Investor they must have sufficient knowledge and experience in

financial and business matters to make them capable of evaluating the merits and risks of the prospective investmentQUESTIONNAIRE

Employment and Business History

Education

Income

Objectives

Investment History

Representation that you have read and understood the PPM, for your own account, not registered, not liquid and not borrowed money invested.

© Looper Reed & McGraw, P.C.

Jumpstart Our Business Start-Ups Problem Addressed - the Accredited Investors

1. a bank, insurance company, registered investment company, business development company, or small business investment company;

2. 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;

3. a charitable organization, corporation, or partnership with assets exceeding $5 million;

4. a director, executive officer, or general partner of the company selling the securities;

5. a business in which all the equity owners are accredited investors;

6. a trust with assets in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes.

© Looper Reed & McGraw, P.C.

Jumpstart Our Business Start-Ups Problem Addressed - the Accredited Investors

7. 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, excluding the value of the primary residence of such person; or

8. 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.

© Looper Reed & McGraw, P.C.

Jumpstart Our Business Start-Ups Problem Addressed - the PPM

“AN INVESTMENT IN UNITS IS SPECULATIVE AND INVOLVES A HIGH DEGREE OF RISK. See “Risk Factors” beginning on page 3. THERE IS NO PUBLIC MARKET FOR THE UNITS AND NO PUBLIC MARKET IS EXPECTED TO DEVELOP AS A RESULT OF THIS OFFERING OR AT ALL. AN INVESTMENT IN UNITS IS SUITABLE ONLY FOR OFFEREES WHO HAVE NO NEED OF LIQUIDITY IN THEIR INVESTMENT. UNIT HOLDERS MUST BE PREPARED TO BEAR THE ECONOMIC RISK OF THE INVESTMENT FOR AN INDEFINITE PERIOD AND BE ABLE TO WITHSTAND A TOTAL LOSS OF THEIR INVESTMENT.”

© Looper Reed & McGraw, P.C.

Jumpstart Our Business Start-Ups Problem Addressed - the PPMRISK FACTORS

Exploration for shipwrecks is speculative by its very nature, and involves a high risk of loss. A large number of expeditions do not find a submerged vessel, and even when a vessel is found, there is a high likelihood that the expedition will not find artifacts and other items of value in an amount necessary to offset costs to conduct operations. If the Dive Operations are not successful, then Unit Holders might receive no return of (or from) their investment. Therefore, Unit Holders must be prepared to lose all of their contribution, whether in cash or services provided, and there can be no assurance that even if any items of value are found, that the value will be sufficient to cover operating expenses.

Distributions to Unit Holders could be adversely affected if the Dive Operations cause any environmental damage. Company does not intend to maintain environmental hazards insurance, so any liability due to environmental damages will directly reduce profits otherwise available to the Unit Holders.

© Looper Reed & McGraw, P.C.

Jumpstart Our Business Start-Ups Problem Addressed - the PPMRISK FACTORS

Exploration for shipwrecks is speculative by its very nature, and involves a high risk of loss. A large number of expeditions do not find a submerged vessel, and even when a vessel is found, there is a high likelihood that the expedition will not find artifacts and other items of value in an amount necessary to offset costs to conduct operations. If the Dive Operations are not successful, then Unit Holders might receive no return of (or from) their investment. Therefore, Unit Holders must be prepared to lose all of their contribution, whether in cash or services provided, and there can be no assurance that even if any items of value are found, that the value will be sufficient to cover operating expenses.

Distributions to Unit Holders could be adversely affected if the Dive Operations cause any environmental damage. Company does not intend to maintain environmental hazards insurance, so any liability due to environmental damages will directly reduce profits otherwise available to the Unit Holders.

© Looper Reed & McGraw, P.C.

Jumpstart Our Business Start-Ups Problem Addressed - the PPMRISK FACTORS

The Partnership is a newly formed entity that has no operating history upon which to base an evaluation of an investment in the Units. The Partnership will be subject to the risks involved with any speculative new venture. There can be no assurance that the Partnership will be able to operate profitably in the future. The Partnership will be subject to fluctuations in the real estate markets. If the Partnership is unable to operate successfully, or its operations fail to produce sufficient revenues to cover operating and other expenses, the Partnership and the investors in the Partnership may suffer a partial or total loss of their investment. Further, the Partnership is only obligated to make distributions to the Partners (including the Preference Amount) to the extent that the Partnership generates income in excess of Partnership expenses. Further, the Partners have no right to receive any distributions from the Partnership, including that no Partner has any right to receive a return of all or any portion of its capital contributions to the Partnership (including funds paid to acquire Units).

© Looper Reed & McGraw, P.C.

Jumpstart Our Business Start-Ups

TABLE OF CONTENTSSUMMARY

RISK FACTORS

INVESTOR SUITABILITY

PLAN OF DISTRIBUTION

OPERATIONS

COMPENSATION AND REIMBURSEMENT

MANAGEMENT

SUMMARY OF PRINCIPAL TERMS OF COMPANY AGREEMENT 10

TAX ASPECTS

REPORTS AND RECORDS

RESTRICTIONS ON TRANSFERABILITY 

FURTHER INFORMATION

© Looper Reed & McGraw, P.C.

Jumpstart Our Business Start-Ups

CROWDFUNDING FINRA and SEC to promulgate rules - originally expected by Jan. 2013 Funding Portals must register as either a broker-dealer or a funding

portal with FINRA Will have to include investor education, mitigation of fraud and privacy

protection Limited investments up to 5 percent for individuals with annual income

of less than $100,000 and 10 percent for those who make over $100,000 Audited financials if trying to raise more than $500,000 Lift the ban on general solicitation/advertising

© Looper Reed & McGraw, P.C.

Jumpstart Our Business Start-Ups CROWDFUNDING – “Suggest” filing . . . Registration and incorporation documents. Name of directors, officer and stockholders. Description of the business. Financial statements. Prior year tax returns Intended use of proceeds, target amount and deadline. Share price. Description of the ownership. Outstanding securities of the company

© Looper Reed & McGraw, P.C.

Jumpstart Our Business Start-Ups CROWDFUNDING – FINRA Interim Application

1. General Information about the Site2. Ownership Information3. Contributions of equity or debt financing made

available to portal4. Management disclosure including “bad boys”5. Business Model

© Looper Reed & McGraw, P.C.

Jumpstart Our Business Start-Ups Other provisions

Streamlined IPO’s for Emerging Growth Companies with less than $1 Billion in revenues

1. Confidential Submissions

2. Reduced Financial Statements

3. Testing-the-Waters Communications

4. Publication and Distribution of Research Reports

5. Limited Executive Compensation Disclosures

6. Exempt from SOX Auditor Attestation

7. Extended Transition to New GAAP

© Looper Reed & McGraw, P.C.

CROWDFUNDING FOR SMALL BUSINESSFebruary 21, 2013

Rassul Zarinfar, Founder of Buffalo Bayou Brewing Companywww.buffbrew.com

Travis CrabtreeLooper Reed & McGraw, P.C.

www.lrmlaw.comwww.emedialaw.com