Legal Stuff, Explained

Thanks to everyone who joined us yesterday for our fourth Legal Stuff Explained session of the year. Bill Carleton, Larry Baker, and David Rose took questions from the audience and spoke on a number of issues in equity crowdfunding and the JOBS Act. It was a very dense and in-depth talk, so we definitely recommend watching the whole thing. Recap and highlights from the panel follow below, but if you are interested in the full transcript of the event, consider joining this crowdfunding effort.

Crowdfunding State of the Art:

• Crowdfunding comes in two types: equity and non-equity.
• Equity crowdfunding: putting money into a project in order to make money (i.e., a return on your investment). Public equity crowdfunding doesn’t exist right now outside of regulated stock markets.
• Non-equity crowdfunding: putting money into a project for other reasons, normally as a donation or subsidized support (i.e., a t-shirt or a thank-you note; e.g., Kickstarter).
• The SEC, the entity that regulates public markets, prohibits “general solicitation” and general advertising of sales of securities, meaning that you can’t go online and tell everyone that you’re raising money for your startup and that in exchange for investment you’ll give out equity. This rule applies to both accredited investors (very wealthy people and angels) and non-accredited investors (everyone else).
• Current crowdfunding platforms function as ways to broaden investor networks or to get funding from pre-existing investor networks. There is no public marketplace, and all offerings are private.
• Angels find out about and participate in private offerings through their individual networks and through platforms like Gust or AngelList.  
• BOLSTR provides a platform for selling private securities to both accredited and non-accredited investors, particularly within local communities, but it has to comply with SEC Rule 504 and each state’s “blue sky” rules on non-accredited investors, and again, offerings are private.  

The JOBS Act:

• President Obama signed the JOBS Act into law on April 5th, 2012, and the SEC has been given until 2014 to spell out the specific rules of crowdfunding.
• Its biggest impact will be to change general solicitation rules and allow companies to seek funding from the general public. Based on the guidelines the SEC has issued so far proposing an amendment to rule 506 of Regulation D, companies will be able to generally solicit and generally advertise so long as they only sell securities to accredited investors. If selling to non-accredited investors, companies cannot generally advertise, but can place “notices which direct investors to the funding portal or broker” (JOBS Act Title III; awaiting SEC clarification).
  
• Two notable sections of the JOBS Act involve equity crowdfunding: Title II and Title III.
• Title II applies to accredited investors and allows them to buy equity in generally-solicited private companies.
• If selling to only accredited investors, crowdfunding platforms don’t have to register with the SEC as broker/dealers, as long as they meet certain conditions.
• Platforms have to take reasonable steps to verify that purchasers are accredited investors (details).
• Since the SEC has not given specific factors constituting “reasonable steps” (i.e., examining level of income, tax returns, other investments…), caution remains the general attitude among companies and platforms.
• Additionally, since investor information must remain private, how platforms are to obtain information about investors’ investments for verification is an issue that needs SEC clarification.
• The SEC has yet to propose rules governing the content and manner of advertising and solicitations.
• Title III applies to non-accredited investors and allows them to buy shares in private companies in small amounts, subject to limits that are proportional to investor income. The rules for non-accredited investors are much more extensive (platforms have to register with the SEC as a broker or funding portal; companies cannot generally advertise the terms of the offering, “except for notices which direct investors to the funding portal or broker”) and will place a heavier burden on platforms that sell to non-accredited investors.   
• The SEC has not yet issued its own guidelines for sales of securities to unaccredited investors. How unaccredited investors will be treated and what kind of access they will have (what amounts they will be able to invest, what income requirements will be imposed, and how funding platforms will be able to advertise to them) will play a significant role in how crowdfunding will play out and whether it will become truly democratic.
• In general, increasing access for accredited investors will likely increase the number of angels, simply because investing will take less work.  
• David Rose pointed out that giving equity and accompanying voting rights to unaccredited investors is very unattractive to professional angel investors. An alternative funding instrument for unaccredited investors is the revenue-backed note, which would allow them to invest and obtain a return, while keeping them out of cap tables and allowing angels to buy out unaccredited investors if they want.

We hope we cleared up some confusion! In case you missed it, we have a streaming video of the entire event here!

Thank you to all who were able to join us for yesterday’s Legal Stuff Explained. Arina Shulga presented on a range of legal issues surrounding mobile app development, including corporate, employment, and intellectual property law, as well as government regulations. We’re currently preparing a video of Arina’s presentation and we’ll post that soon! Meanwhile, check out the main takeaways below: 

Corporate Considerations:

• Incorporating is not necessary for selling an app, but it has its advantages, including limiting personal liability, raising your credibility, protecting your business name, and providing easier access to capital.
• A dual corporation structure may be preferable, where one corporation owns the intellectual property and licenses it out to a second that sells apps.
• If you are a team of co-founders, vesting is essential for creating a clear incentive structure and aligning founder interests.

Employment Considerations:

• Be clear about the status of each person working for you, whether they are an employee or independent contractor, and carefully spell out how any intellectual property they create will be treated in their contract or through a Work-for-hire provision or Master Services Agreement.
• Make sure that you keep a repository of all source code anyone creates for you so you easily have it if they leave.
• Someone may be contractually defined as an independent contractor, but if you exhibit a high level of supervision, direction, and control over them, the law may treat them as an employee.  

Intellectual Property Considerations:

• Make sure to secure any trade secrets through security measures, good corporate policies, and Non-Disclosure Agreements.
• File your copyrights with the US Copyright Office to ensure that your ownership of the copyright is clear and easily enforceable.
• If your app uses user content, familiarize yourself with the DMCA and how to stay within the bounds of its safe harbor provision.

Government Regulations:

• FTC Truth-in-Advertising laws require that all information about the
  app be truthful, complete and any objective statements are backed with
  evidence. Once the developer starts selling the app, the developer
  becomes an advertiser.
• Privacy regulations – make sure you follow your privacy policies, keep them up to date to accurately reflect your actual practices, and let users know of any changes.
• Children’s Online Privacy Protection Act of 1998 (COPPA) applies, if
  your app is directed to children or the developer has actual knowledge
  that the app will be used by kids.

The powerpoint Arina used during her presentation is available here.