Financing

Keep More of the Sales Proceeds

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Sellers: Three simple tips for keeping more of the sales proceeds!

Last year, GA was counsel in more than 40 transactions, representing sellers in a significant number of them.  For sellers that want to maximize sales proceeds at closing, we urge them to keep three things in mind:

Spend time on the LOI.  The letter of intent is crucial and should spell out details of the purchase price and how the seller might have to give it back.  All too often, the parties will sign an LOI stating that the transaction will be on “customary terms and conditions” without specifics.  Sellers can press the buyer to define which representations and warranties are most “fundamental,” how long they will survive, and what dollar holdback escrows will be established.  Sellers have the most leverage before an LOI is signed and the process kicks off—and they should use it. For buyers, more specificity can avoid deal risk and fundamental misunderstandings before documents are drafted.

Consider Structure Upfront.  Typically and for a variety of tax and corporate reasons, buyers like to buy assets and sellers like to sell equity. Sellers should consult their accounting and legal advisors in advance to assess the impact of transaction structure before an LOI is signed.  Can a seller take advantage of 1202 of the Internal Revenue Code providing for the exclusion of capital gains on the sale of small business stock?  What are the tax implications if a buyer agrees to a stock purchase but wants to make a “338(h)(10) election? Whether key contracts, licenses, and relationships can be transferred without consent also will factor into the overall decisions on structure.

 Think about R&W Insurance.  Depending on the size of the transaction, sellers can ask the buyer to purchase an insurance policy to be the source of recovery for the breach of any seller representations and warranties. That can allow the parties to eliminate haggling over indemnity escrows and survival periods and also give the seller more certainty over the amount to be paid at closing. This too should be considered and included as appropriate at the LOI stage.

More time spent at the LOI stage can reduce friction and conflict as the deal process moves forward.

 

New SEC Rules: Impact on financing strategy

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Did you know…

New SEC rules may expand private capital formation?

by Zachary Fountas

New SEC rules touch on a variety of private offerings and certain changes could have significant impacts on entrepreneurs and their financing strategies.[1]

Finding investors!: Mostly, federal private offering exemptions either outright prohibit or painstakingly regulate the use of general solicitation of investors. One situation that has been problematic for early-stage companies are demo days, when the company displays its product or vision to interested attendees hoping to attract interest. However, the details included in the demo, the statements made the day of, and the type of offering pursued after such an event, all impacted whether such a demo day presentation would fall under general solicitation and bar certain exemptions or require such burdensome disclosures to make other exemptions impractical.

Changes: One change is the new Rule 148 which deems demo days that are sponsored by colleges and universities, other higher learning institutions, state/local governments, nonprofits, incubators, accelerators and angel investor groups, would not constitute general solicitation.

This should be a welcome relief to most as the number of startups that pass through an accelerator or incubator has skyrocketed in the past few years.

Federal exemptions for offerings done close in time: Integration is the idea that an issuer’s multiple securities offerings should in fact be considered one larger securities offering. If multiple offerings are “integrated” each such offering must comply with the securities regulations and exemption rules that the other offerings were relying upon, otherwise the issuer will NOT have the necessary legal exemptions and investors may have the right to sue the issuer for rescission (the right to recoup their investment and often penalties). Prior to the new framework the SEC used a 5-factor balancing test to determine if offerings were subject to integration.

Changes: To provide issuers with bright line rules on when offerings will not be integrated, the SEC has established four non-exclusive safe harbors under Rule 152(b). Offerings will not be integrated under the following circumstances:

  1. If the first offering is made 30 days prior to commencing a subsequent offering, or if the prior offering has terminated at least 30 days prior to the subsequent offering; or
  2. If one of the offerings is made in compliance with Rule 701 (the most relied upon exemption for the issuance of restricted stock and options to employees, consultants, and advisors), Regulation S, or pursuant to an issuer’s employee benefit plan; or
  3. If an offer or sale made subsequent to any terminated or completed offering is made and it relies on an exemption that allows for the issuer to use general solicitation ; or
  4. If an offering pursuant to which a registration statement will be filed is made after: (a) a completed or terminated offering that does not permit general solicitation, (b) a completed or terminated offering that does allow general solicitation and such offering was made only to qualified institutional buyers and institutional accredited investors, or (c) a completed or terminated offering that permitted general solicitation ended at least 30 days prior to beginning the offering that will utilize a registration statement.

We expect that the SEC will have much more to say on small business capital formation issues in the days and months ahead.  For now, the new guidance from the SEC provides some important clarity for entrepreneurs on mapping out a financing strategy—for which investors and when—in 2021!

[1] The above should not be considered legal advice and readers are encouraged to consult legal and accounting advisors of their own choosing for more information on the above topic.

 

Minimum Viable Products

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Did you know…

that Lean Startups and Minimum Viable Products (“MVPs”) may be the way startups navigate the pandemic?

by Zachary Fountas

The ongoing pandemic has changed the way most of us work, shop, dine out, and interact with others. For early stage companies hoping to launch, connecting with investors, advisors and potential strategic partners has been challenging. So what’s an early stage company to do to move forward?

Well, maybe a look into the past makes sense. Shortly after the dot com bubble burst, startups around the country ran into an enormous impediment: capital was scarce and investments were lean. Adapting to survive, “Lean Startups” (coined by Steve Blank) pursued MVPs, streamlining product conception to assembly line, scrapping business plans, and pivoted away from what a company “thought” customers needed and focused on what customers said they wanted. Speed was important, since without a product on the market (even one full of bugs), you couldn’t keep the lights on.

Now, more than ever, new companies will need to “show” not just “tell” and more will be returning to the important framework of MVPs. So how are companies going to fund their MVPs? Maybe with one of the following:

  • Convertible Notes
    • Pros: Traditional instrument. Simple and straightforward. Avoids placing a valuation on the Company, especially important to those without enough operating history.
    • Cons: Notes are debt on the Company balance sheet that must be repaid or converted to equity. Notes come with accruing interest. Notes generally convert with a discount or other investor friendly provisions.
  • SAFEs
    • Pros: Generally a short agreement. Does not require interest, and no requirement that the Company repay the investment or guarantee that the investor receive equity. No deadlines for conversion.
    • Cons: As a newer investment vehicle, SAFEs may trigger extensive review and negotiation with sophisticated investors. The more Company friendly terms and limited investor upside may deter some investors.
  • Small Business Innovation Research (SBIR) Grants
    • Pros: Non-dilutive to capital structure of Company and no transfer of IP rights. If terms are adhered to, the Company does not need to pay back the funds. Winning an SBIR grant can also be seen by post-SBIR investors as a “stamp of approval” that your product is viable and has potential.
    • Cons: Application proposals are time consuming and difficult. The timeframe from submission of the application to grant funding can be long. SBIR grants are highly competitive and maintaining reporting and regulatory compliance under the terms can be burdensome on the Company.

Every company’s financing strategy will be different and conferring with legal and accounting advisors is critical. When done right, developing an MVP now could be the key to a successful launch during these challenging times.

 

Accredited Investor

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Did you know…

The definition of Accredited Investor has been expanded by the SEC?

by Zachary Fountas

On August 26, 2020 the SEC announced that it was making changes to the definition of “Accredited Investor” which could impact private placements under Regulation D. Over the years startups and emerging businesses have relied on Rule 506(b) securities offerings in order to take advantage of federal preemption and exempt the offering from regulation by various state regulators. However, under Rule 506(b), securities could only be sold to high net-worth or high-earning individuals, or certain qualified entities.

Emerging growth companies now will be able to reach out to an expanded category of “accredited” investors in financing rounds.

The following are general descriptions of individuals/entities that qualify as Accredited Investors, but it remains imperative to consult with legal counsel to ensure investors meet the requirements of the category:

Individuals

  • Regardless of net-worth or income, individuals with Series 7, Series 65, or Series 82 certifications are considered financially sophisticated enough to qualify as Accredited Investors
  • Individuals who are “knowledgeable employees” of a private fund (if such investment is in the aforementioned fund)
  • Inclusion of “spousal equivalents” in the individual test. Previously an individual could only pool net worth and income with a spouse. “Spousal equivalent” as defined in the “family office rule” is a cohabitant occupying a relationship generally equivalent to that of a spouse. (See 17 CFR Section 275.202(d)(9))

Entities

  • Limited Liability Companies with $5 million in assets are expressly designated as Accredited Investors
  • State-registered investment advisers, exempt reporting advisers, and rural business investment companies
  • Indian tribes, governmental bodies, funds, and entities of foreign countries, that own “investments” (specifically requires investment test not an asset test) under the Investment Company Act in excess of $5 million
  • Family Offices with at least $5 million assets under management and their “family clients”

Love It or List It!

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We enjoyed hosting this timely dialogue!  Check out this bite-sized, 25 minute conversation loaded with great thoughts and ideas pertaining to this key question:

Given these unprecedented times, should you pursue a financing round and invest in further growth or explore the M&A market and a strategic sale now?

Thanks to our panelists Debbie Gustafson – CEO, Energetiq Technology, Bob Emmert – Partner, McCarthy Capital, Scott Glaid – Managing Director, Needham & Company,  and Meredith McPherron – Venture Partner, Glasswing Ventures.
We enjoyed our virtual time together.

 

Financial relief resources

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Did you know?

That right now several private companies and organizations are offering cash grants and low-interest loans to COVID-impacted small businesses and entrepreneurs?

Below are a few financial relief programs currently accepting applications from small businesses and start-ups:

by Shilpa Iyyer

  1. Facebook’s Small Business Grants Program
  • Facebook has reserved $100M to distribute in cash grants and ad credits to up to 30,000 eligible businesses across the world. Businesses in most major cities in the U.S. are now able to apply. Eligible businesses must: (1) have between 2-50 employees, (2) have been in business for over a year, (3) have experienced challenges from COVID-19, and (4) be near a location where Facebook operates. Learn more about the fund and how to apply here.

 

  1. Grow with Google Small Business Fund
  • Google has partnered with the Opportunity Finance Network to launch a small business fund of $125M. Eligible small businesses will receive these funds in the form of low-interest loans through local lenders. The fund is open for applications until 11:59 EST on June 1, 2020. Learn more about this program and how to apply here.

 

  1. Hello Alice – COVID-19 Business for All Grants
  • Hello Alice, an AI-driven platform that connects business owners to personalized growth opportunities, is offering $10,000 emergency grants to small business owners impacted by COVID-19. Grant awards are determined based on demonstrated need and proposed use of funds. Applications are being considered on a rolling basis from March 26, 2020 to July 16, 2020. Please visit Hello Alice’s grant website for general information about the program. The terms and conditions of the grant program are available here.

 

  1. The Red Backpack Fund
  • The Red Backpack Fund is offering at least 1,000 grants of $5,000 each to eligible female entrepreneurs in the U.S. Eligible businesses must: (1) be at least 51% majority women-owned; (2) have fewer than 50 employees total; (3) be registered in the U.S; and (4) have annual revenues not exceeding $5M in any of the past three years. Applications will open in monthly rounds from now until August, and 200 recipients will be selected from each round. The next round of applications will open on June 1, 2020, and will run until June 8, 2020. Learn more about the fund and how to apply here.

 

Additional funding can help protect and move your business forward through these unprecedented times. We encourage you to consult with your trusted advisors to determine whether a specific funding opportunity is right for you.

3 Simple Things with Meredith McPherron

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Meredith McPherron is a Venture Partner at Glasswing Ventures

Glasswing has so many promising technology companies in its existing portfolio, what advice are you giving them these days?

Our Glasswing portfolio is well positioned having a focus on AI-enabled enterprise software and cybersecurity companies which are seeing growth amid the pandemic.  We are advising our portfolio companies to stay focused on their fundamentals.  This includes 1) assuming a more conservative posture on their overall burn, 2) exploring appropriate sources of capital to weather the storm and maintain their market position, and 3) carefully examining and re-examining their product/market fit, making adjustments where and when necessary as the environment dictates. We recommend companies dig deeper into their customer’s world and even further downstream into the world of their customer’s customer to understand their underlying health and stability. This analysis allows them to anticipate potential challenges and opportunities that may not be readily apparent. There are exciting opportunities for entrepreneurs to think differently and push their thinking about how technology can help insulate, mitigate, and even accelerate their growth when faced with supply and demand shocks that force behavioral change.  It requires financial stability at the outset and strong leadership and organizational agility throughout when markets are in turmoil. At Glasswing, we encourage our companies to think about the offense even when playing defense. We support our portfolio by leveraging the Glasswing Platform, bringing them customers and revenue, helping them connect with the highest caliber talent, and championing our founders from funding through to exits.

You have helped a number of companies with their launches, what would you advise company decisionmakers about scaling in challenging times?

Scaling in challenging times requires greater organizational discipline and prioritization around a roadmap for expansion.  Focusing on high priority, profitable and well-vetted customers and customer segments, for instance, makes more sense than funding experimental pilots into new channels and segments.  New customer acquisition is always expensive but during challenging times, it can rise considerably as spending stalls on new contracts and services. For B2B models, focus instead on a “land and expand” strategy. If expansion is out of the question, lean into a “land and love” strategy to ensure the needs of those with whom you already have relationships and contracts are fully satisfied. When the economy recovers, these customers will serve as important ambassadors for future growth.

For CEOs, this is the time to engage in visible leadership, even if that must happen over Zoom or other UCaaS providers. In times of uncertainty, conveying a sense of confidence around your mission, compassion that times are challenging, and conviction that you can and will get to the other side is vital. It can engender a powerful “take the hill” mentality necessary for rapid innovation, pivots or scaling.

Avoid the natural impulse when “sheltering in place” to put your head in the sand and simply weather the storm.  Instead find ways to learn more and use the forcing mechanism of a tougher environment to drive innovation and creativity from your teams into your products and services.  Use the opportunity to connect with your customers to understand their needs, find new ways to serve them and build stronger loyalty and partnerships. Challenging times can often bring people together in deeper, more lasting ways than the more transient tidings of gold and glory.

In this tumultuous period, what should new innovative product companies do now to attract funding and maintain morale?

Learn from the unicorns which were founded during the 2008 financial crisis (e.g. Credit Karma, Slack, Uber, Venmo, WhatsApp). Their ability to see and leverage important behavioral changes resulting from the crisis and deliver innovative new products in response, was essential to their ensuing inflection and scale. The challenge is that capital markets funding innovation are most difficult to access in times of uncertainty. New venture funding outside of existing investments can quickly freeze up as caution and capital preservation become a greater priority. Start-ups seeking follow-on rounds are often met with suppressed valuations and requirements for stronger adoption proof points and higher level growth rates over longer periods of time.  If existing startups require additional capital to hit stretch milestones, they might consider bridge rounds with current investors to extend their runway, in addition to focusing on high quality execution with current customers and finding new and relevant ways to win as the market evolves.

To maintain or even boost morale, I recommend entrepreneurs remind their teams of their mission and vision for the future. Anchor them in realistic roadmaps and resources they can access to deliver against that vision. Set shorter term targets and goals for individual and collective work to provide a sense of traction, accomplishment, and psychic reward. This is the time to double down on culture, find opportunities to acknowledge how people are stepping up to “take the hill” together.  Great leaders will make lemonade out of lemons and provide their teams with the drink all start-ups thirst for: passion and purpose.

3 Simple Things: Peter Blacklow of Boston Seed Capital

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3 Simple Things with Peter Blacklow, General Partner at Boston Seed Capital, a venture fund investing alongside founders who are striving to improve life, work, and play, through building innovative tech companies. www.BostonSeed.com

Boston Seed has a broad portfolio of companies in its existing portfolio, what advice are you giving them these days?

No earthshaking news here, but we have to ensure Boston Seed’s portfolio companies’ ongoing operations with cash in the bank, and we emphasize to them that raising new capital in a very uncertain market may be difficult or impossible.  As a result, it’s critical for teams to make excruciating decisions in reducing expenses with the ultimate goal of extending the runway for new capital into the business or achieving a break-even model.

Also, it’s a fascinating insight into the DNA of entrepreneurs — I have observed that many founders believe our new social/economic reality could actually be accretive to their business.  I would even say that most founders I speak with see a silver lining or a unique opportunity in today’s challenges as it relates to their business.  I believe entrepreneurs are positive opportunists, which is what makes them special, but nobody has a clue what the short and long-term impact will be for our  customers and their ability to do business with us.  So, even those portfolio companies that are demonstrating short-term gains or no negative effect on their business need to plan for a deeper impact in Q2 and beyond.

You’re a marketing veteran with deep industry experience prior to joining Boston Seed—what would you advise company decision makers about marketing their products in challenging times?

It’s not easy.  In our consumer businesses, many of our companies have significantly slowed or completely shut off marketing as a result of these uncertain times.  In our B2B businesses, our customers are making similar cuts to marketing budgets, and SAAS implementations are much more difficult with a remote workforce.  But, that doesn’t mean we can give up on marketing.  However, companies have to be thoughtful around 1) finding an approach that will work with their customers and 2) speaking in a way that is sensitive to the upheaval in our daily lives.  Alyce is one of our portfolio companies that has reacted quickly and thoughtfully to their customers’ needs.  As a B2B AI gifting business that helps companies acquire and enhance communication with customers, Alyce understood that smart physical gifts delivered to business contacts via direct mail would be irrelevant today.  So, they emphasized their digital and charitable gifting offerings and customer response was amazing.  In this sense, Alyce listened to their customers, developed a product that worked given the confines of remote workforces, and provided a charitable component which resonates even more strongly in today’s world.

In this tumultuous period, what should new innovative product companies do now to attract funding, get launched and gain traction?  

Many entrepreneurs talk about building businesses during bleak economic times, like in 2002 or 2008.  This feels different for a couple of reasons.  First of all, we don’t know how long or to what extent an economic downturn will last.  Second, even an innovative product may have new challenges in terms of go-to-market given the massive social/economic changes their customers are facing.

We clearly need to continue to develop and launch innovative products.  But, those companies also need to understand the current needs of potential customers and how to build a loyal customer base in times of social/economic turmoil.  Bootstrapping a business and demonstrating proficiency in connecting with customers will continue to unlock capital, but not just because they are clever ideas – you’ll need to show customer traction.

Farmwise closes funding round

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Congratulations to our client, Farmwise, on the closing of their financing round.  Great work, great products, great team!

For Immediate Release                                                                                                     

FARMWISE® (MAKERS OF VEGGIE FRIES®, VEGGIE TOTS®& VEGGIE RINGS™ CLOSES FUNDRAISING ROUND LED BY CLEVELAND AVENUE, LLC INVESTMENT FIRM

BOSTON, M.A. – April 2018 – Farmwise LLC based in Boston, Massachusetts—makers of Veggie Fries®, Veggie Tots® and Veggie Rings™announces closing a $4.5 million financing round led by Cleveland Avenue LLC*, the venture capital firm founded by Don Thompson, former President and CEO of McDonald’s Corporation.

For more information, visit us at www.eatveggiefries.com.

Farmwise®has been providing a fresh take on America’s favorite frozen foods since 2014, when, with families and fries in mind, Boston-based couple Dave and Cristina Peters and their three children created the first batches of Veggie Fries® in their home kitchen.  Using a blend of farm-grown vegetables and beans, the Peters developed a patent-pending process to provide consumers a healthier alternative to America’s beloved fry. Farmwise continues to deliver break-through innovation with the launch of three varieties of Veggie Tots® (Broccoli, Cauliflower and Beets) and two varieties of Veggie Rings™ (Cauliflower and Butternut Squash).

“Our Cleveland Avenue investment philosophy is to search for emerging companies that have potential for mainstream success across multiple channels,” said Thompson.  “What Dave and Cristina have achieved in just four short years is impressive, and we look forward to helping Farmwise further accelerate their growth.”

“As parents of three daughters, we’re focused on creating healthy products that we’re proud to serve our own family.  Veggie Fries, Tots and Rings are a parent’s dream – crispy, fluffy and delicious with an exceptional nutritional profile,” said Cristina Peters.

“We’re so excited to be partnering with the Cleveland Avenue team to bring our products to every family in America.  Don and his wife Liz are also strong believers in “family first” and giving back to the community, and we are proud to be a part of their extended Cleveland Avenue family,” said Dave Peters.

Joining Cleveland Avenue is Home Market Foods, Inc., a leading protein company with the number one brand of frozen meatballs (Cooked Perfect) and one of the fastest growing brands in the frozen chicken category (Fire Grilled).

ABOUT FARMWISE LLC

Based in Boston, Massachusetts, Farmwise LLC is a privately held company with a mission of developing healthier alternatives to some of America’s favorite foods without compromising on taste. All Farmwise products are made from real, farm-grown vegetables and beans, are Non-GMO Project Verified, Free of the Top 8 Allergens, Vegan Friendly, provide a Good Source of Fiber, 3+ grams of Protein and an Excellent or Good Source of Vitamin A, C and/or K.   Farmwise products are found in over 8,000 supermarkets in the USA.

ABOUT CLEVELAND AVENUE, LLC
Cleveland Avenue, LLC is a privately-held venture capital firm which accelerates and strategically invests in innovative restaurant, food and beverage concepts and emerging brands including Beyond Meat, Drink Maple, Bhakti, Farmer’s Fridge and SomruS.

*Cleveland Avenue is the General Partner of the Cleveland Avenue Food and Beverage Fund I

Visit us at www.clevelandave.comand @CleveAveLLC on Twitter and Instagram.

 

Five Common Deal Mistakes to Avoid

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By Lawrence Gennari

This has been an historic year for M&A and has many companies and management teams wondering whether an exit next year might be in the offing. As strategic planning for 2017 continues, decision makers planning for an exit should avoid five common mistakes in the process.

  1. Forgetting to do due diligence on your own business. How will your business look to a potential buyer? Every sale or financing starts with due diligence and that means corporate books and records and significant contracts should be in good order. Now is the time to complete stock option or restricted stock grants, estate planning transfers or issuances long promised but not papered. In connection with new grants or stock awards, the Company may want to consider securing or updating a so-called 409A valuation of the business, to establish “fair market value” for tax purposes. Also, consider necessary changes to important contracts, leases or customer agreements. Better to negotiate those now, instead of during the compressed time frame of a contemplated sale.
  2. No Competitive Process. Separate from a tax oriented 409A valuation to set option prices, should the Company pay for an outside enterprise valuation now to get a sense of what’s “market”? Not necessarily. An overall “enterprise” valuation won’t necessarily tell the business owners what a company is worth. For that, you’d need a competitive process, most likely run by an experienced and practical investment banker with experience in your market segment. Many companies make the mistake of talking to only one potential partner or in reacting to an unsolicited term sheet from an interested party. Due diligence commences, negotiations quickly follow, and the team finds itself confronting the often difficult choice of status quo versus sale to one particular buyer. Remember: terms, conditions and equity valuations improve only in the context of a competitive process, with multiple suitors with terms sheets bidding against each other. The executive team should consider how to create such a process or meet with investment bankers who know how to make that happen.
  3. No Plan B. Resist the temptation to put off a needed management shakeup or customer contract price negotiations just to maintain the status quo. Projections for 2017 should include a go-it alone strategy, with realistic plans for personnel, marketing and cash flow, including any necessary equity or debt infusions to increase top line revenues for the longer term. Hope for a game-changing transaction is not a substitute for a real time operational and financing strategy. Chances are, finding and negotiating the right transaction will take months, especially if a competitive process is in play. Any team would want the leverage of continuing the business in the ordinary course while the auction/sale process is ongoing.
  4. Avoiding the hard questions in the letter of intent. The letter of intent will set out expectations for both sides as well as the parameters for continuing negotiation. In many cases, the sellers should spend a lot more time on two basic questions: (i) what is the purchase price and (ii) under what circumstances will I have to give some it back. Is the purchase price at closing satisfactory or is much of it dependent on earnout payments, which provide for contingent purchase price payments over time, the details of which still require negotiation? What are the indemnity obligations for any breach or inaccuracy of the sellers’ representations and warranties and are they capped, limited or do they survive the closing for a very long time? What are the terms of any continuing employment, including non-competes and severance? Sellers will save a lot of time and money if they invest the time hammering out these issues for the letter of intent instead of waiting until the deal is at the documentation stage.
  5. Structure matters. The Company should be engaging its accountants and lawyers about tax and structure planning now. What are the tax implications of the proposed deal structure? Next year’s tax code proposals could bring big changes and thoughtful structural changes now could yield significant efficiencies next year. Also, if the team is not familiar with “installment sale” structures, which provide for deferred tax treatment of sale proceeds, they should consult their legal and tax advisors and get up to speed.

Financial pundits are suggesting an uptick in corporate finance activity in 2017. A proactive exit planning strategy—and avoiding typical mistakes—will best position your company for what lies ahead.

Gennari is a partner at Gennari Aronson LLP and an Adjunct Professor at Boston College Law School where he has taught Mergers and Acquisitions, Corporate Finance and now a separate seminar “Advising the Entrepreneur.” He can be reached at lgennari@galawpartners.com.