Business Transactions

Additional Exemption Available to Federal Securities Registration for Selling Equity in Your Company

When you sell equity in your company, you must either (i) register with the Securities and Exchange Commission (“SEC”) and with each state in which investors reside, or (ii) qualify for an exemption to registration.

 

Regulation D Offering Exemptions to Securities Registration

One of the available federal exemptions is Regulation D to the Securities Act of 1933. Regulation D provides three “safe harbors” that give companies some assurance that their capital-seeking activities are in compliance with federal securities laws. Those other Regulation D exemptions include exemptions under Rule 504, Rule 505, and Rule 506 (now Rule 506(b)). I discussed the Rule 504, Rule 505, and Rule 506(b) exemptions in a previous blog posting, “Finding an Exemption to Federal Securities Registration for the Sale of Equity in Your Company”.

 

New Regulation D, Rule 506(c)

As of September 23, 2013, Regulation D, Rule 506(c) offerings became permissible. This new category of offering exemption differs from traditional 506 offerings in a few ways:

Advertising Allowed. Companies offering securities under the Regulation D, Rule 506(c) exemption may use general solicitation and advertising in connection with selling equity in the company.

Accredited Investors Only. The issuing company may sell securities only to accredited investors. There are requirements to verify the accredited investor status of investors.

Bad Boy Provisions Apply. The company cannot rely on a 506 exemption if the company, its officers, directors, 20% or more shareholders have been involved in any acts on the statutory “bad acts” list. Those bad acts include securities-related or fraudulent acts resulting in criminal convictions or administrative/regulatory discipline. As of September 23, 2013, the “bad boy” provision applies to both Rule 506(b) and Rule 506(c) offerings.

 

Some Points to Remember

Regulation D, Rule 506(c) is an additional available exemption. All the Regulation D exemptions that existed prior to September 23, 2013 are still available and work in the same manner.

Relying on Rule 506(c) requires a Form D filing just as all the other Regulation D offerings do. As of the 506(c) launch date, the Form D remains the same except for two additions to accommodate the new 506(c) exemption:

• There is a checkbox which the company selling equity must check if it is relying on the Rule 506(c) exemption.
  
  
• The issuing company must state that it is not disqualified from relying on Rule 506 due to any “bad actor” factors.

Top Legal Issues for App Developers

Today, there is an app for nearly everything - from finding a neighborhood bar to pointing a tv satellite dish to the correct satellite. While the app industry explosion creates tremendous opportunities for developers, it also creates new legal issues. Here are legal pitfalls that can trip the unwary app developer:

Piggy-backing on an Existing Platform

When developers tie their apps to a third-party platform like Twitter, Facebook, or Amazon, they expose the app’s success to the whims of another company. That other company can very easily block your access to their APIs and modify their terms of use. If your app is not clearly allowed by the platform’s terms of use and not firmly inside the spirit of those terms, it’s prudent to have a dialogue with the platform before expending resources and time on building an app and business model that the platform can shut down with a few keystrokes.

Targeting Kids Can Lead to Large Government Fines

The financial consequences of violating the Children’s Online Privacy Protection Act (COPPA) is very real for app developers. To comply with COPPA, any website that engages children under 13 must post a privacy policy and obtain parental consent before collecting personal information from children under 13. The Federal Trade Commission (FTC) takes COPPA very seriously and has levied fines of up to $3,000,000 on websites that were not COPPA compliant. The FTC has also demonstrated its willingness to apply COPPA to app developers. Developer Broken Thumbs Apps paid $50,000 to settle FTC charges it collected email addresses and other personal information from 30,000 children signing up for the developer’s Emily's Girl World and Emily's Dress Up apps.

Incorporating Music into Apps

The commercial use of music typically requires a license and frequently requires multiple licenses from multiple parties. The music industry gives specific names to many licenses according to whether it is the song or sound recording you are using and ac¬cording to how you are using it. If your app requires background music, you will need master use licenses for any specific recordings and synchronization licenses for the underlying songs. Obtaining licenses for popular music can be expensive and administratively frustrating so stock music may be a viable option for those without large music licensing budgets.

Pushing the Privacy Envelope

There are currently no federal laws that explicitly prohibit app developers from collecting and even selling information about the online conduct of their customers (with the exception of personal information about children under 13 which is regulated by COPPA). Nevertheless, consumers, advocacy groups, regulatory agencies, and Congress tend not to like online business models that track and commercially use detailed information about consumers. Such activities create a potential risk of an FTC investigation or a consumer lawsuit when the app developer (i) does not disclose to consumers the fact that such data is being collected and/or sold and (ii) does not offer a mechanism by which consumers can opt out of having their information collected and sold.

Developing Apps for Other Companies

When developers produce apps for customers on a contractor basis, ownership is always a tricky question. App developers that want to protect their future rights to produce similar apps for other clients must clearly define in their contracts which rights the developer reserves in the background technology and source code and which exclusive rights, if any, the developer grants to the client.

Insight on COPPA Compliance for Plug-Ins, Ad Networks, Apps, & Third-Party Providers

TechFreedom, a Washington, DC-based think tank, offered a panel discussion shortly after the July 2013 effective date for new COPPA regulations. A recording of the panel, “COPPA: The Past, Present & Future of Children’s Privacy & Media”, is available online. The discussion highlighted the ambiguity still existing in application of the new COPPA rules to third-party providers.

What Is COPPA?

The Children’s Online Privacy Protection Act (COPPA) prohibits commercial websites and online services from collecting, using, or disclosing the personal information of children under thirteen without parental notice and consent. The Federal Trade Commission (FTC) issued regulations for COPPA in April 2000 and subsequently issued amended COPPA regulations which became effective on July 1, 2013.

How 2013 Regulations Impact Plug-Ins, Ad Networks, Apps and Other Third-Party Providers?

Among other things, the 2013 regulations clarify that COPPA applies to operators of commercial websites and online services with actual knowledge that they are collecting personal information directly from users of a child-directed website. This includes plug-in and app services providing services to and collecting user information from child-directed websites.

When Does a Third-Party Provider Have Actual Knowledge Its Customer Is a Child-Directed Website?

One of the panels’ most useful take-aways for plug-in and mobile app services involved FTC staff interpretations of what constitutes actual knowledge. Kandi Parsons, an attorney with the FTC Consumers Protection Bureau, indicated that third party websites have no general obligation to investigate whether their customers are child-directed websites or online services. (Note that as the verbal interpretation of an FTC staff person, this is informal insight. Hence, the FTC is not absolutely bound by what Ms. Parsons said. Here’s a transcript of a relevant portion of Ms. Parsons comments (starting at approximately 1:12 of the recording). . .:

If I can speak briefly to actual knowledge. . . . if you get a list of urls from somebody that says these are child-directed sites or services. As a third party, that is not sufficient to provide you actual knowledge. We don’t believe this gives you independent evidence of the child-directed nature of the site or service because the Commission was very clear that there’s not a duty to investigate. That would turn the obligation from an actual knowledge standard into a reason to know or should have known standard and we’re not interested in [making that conversion]. It’s an actual knowledge standard.

There is some ambiguity in Ms. Parsons’ later comments where she implies that a third party website would have a duty to investigate if it found a “red-flag” that it was serving a child-directed website (e.g., a website customer with the url “games-for-7-year-olds.com).

Can Third-Party Providers Comply with COPPA by Having Customers Sign Contracts Stating the Customer Is Not a Child-Directed Website?

The FTC addresses this question in its FAQs on Complying with COPPA. FTC staff persons also addressed the issue during the TechFreedom panel (at approximately 2:27 of the recording).

Here is what I distilled from those resources. In order for a third party provider to rely on such a customer representation, the customer would need to make an affirmative statement that the website was not a child-directed website. A third party provider could not rely on a “Not-a-Child-Directed-Website” response that was the default response in an online form. The analysis might be different (i) for a negotiated contract and (ii) for a checkbox in an online form where the customer had to self-identify itself as “child-directed website” or “not-child-directed-website”.

The customer contract will not shield the third party provider from COPPA liability if the third party provider has actual knowledge that the customer’s representation is untrue and the customer is actually a child-directed website.

A Conversation with Eddie Brown about Beating the Odds

I recently had the pleasure of interviewing Eddie Brown, founder of Brown Capital Management. My interview with Eddie was part of this year’s The Twelve-In-Twelve Book Club Meet the Author Forum in Columbia, Maryland. Eddie, who last year published his memoirs entitled Beating the Odds: Eddie Brown’s Investing and Life Strategies (John Wiley & Sons), was the invited author.

Beating the Odds has a potential dual meaning. First, Brown Capital Management, founded by Eddie Brown in 1983, has a history of slightly outperforming and sometimes significantly outperforming the market. A deeper meaning arises from the fact that Eddie was born in 1940 Jim-Crow-era Apopka, Florida to a teen-age mother and into poverty. He beat the odds of those less-than advantageous circumstances to become a Howard University-educated electrical engineer; a valued worker at IBM; the first African-American portfolio manager at T. Rowe Price; a regular financial commentator on national television show, Wall St. Week; the founder and president of a financial services firm with $6 billion under management; and a philanthropist.

During our interview, Eddie and I discussed his childhood in Apopka, Florida; what it means to have an entrepreneurial gene and how he has exercised that gene throughout his life; the role and importance of family in his life; his attitude towards and approach to handling racism; his approach to investing; and the impact of his philanthropy.

All those topics are of course covered in Beating the Odds, written by Eddie Brown with co-author Blair S. Walker. I highly recommend you pick up a copy.

A Lesson for App Developers: Why Amazon’s Smack-Down of Ebook Lending Sites Is No Surprise

Update: March 23, 2011. After some email communications, Amazon did restore Lendle’s access to the Amazon API. Amazon agreed to the action if Lendle would disable the functionality of the Lendle Book Sync tool which syncs a user’s Kindle books with their Lendle account. In this Lendle blog posting, Lendle discusses the reinstatement as well as its new-found realization that it needs to be less reliant on third-party APIs.

Lendle co-founder Jeff Croft may have been surprised by today’s revocation of Lendle’s access to Amazon’s API– but I wasn’t surprised. I was only surprised that Amazon allowed Lendle and other book lending sites to operate for the few months they were in existence.

Some Background on the Book Swapping Sites

Ebook lending sites like Lendle.me and Booklending.com take advantage of the lending functionality offered by Kindle and Nook. Instead of being restricted to lending your ebook for two weeks to your friends and family, these book-swapping sites bring together strangers with ebooks to lend and give you thousands of potential ebook lenders and borrowers. Lendle and other book-sharing sites rely heavily on Amazon’s API (application programming interface)

What’s the Lesson

When your business model piggy-backs on another company’s business, your business is significantly exposed to the whims of that other company. Companies can very easily block your access to their APIs and modify their terms of use. If your app is not clearly allowed by the platform’s terms of use and not firmly inside the spirit of those terms, it’s prudent to have a dialogue with the platform before expending resources and time on building an app and business model that the platform can shut down with a few keystrokes. To my knowledge, none of the ebook lending sites ever had a discussion with Amazon.

A Hard Lesson for Lendle to Grasp

On the Lendle blog, co-founder Croft talked about how the Lendle site could be re-formatted and go back into business by eliminating reliance on the Amazon APIs. Croft later expanded in comments to msnbc.com that Lendle could rely instead on information submitted by users (i.e., a user would have to type in the book title rather than Lendle importing that information from Amazon).

What Lendle doesn’t seem to be processing is that third party app developers need some cooperation from the platforms for which they build and Amazon dislikes Lendle’s business model. I doubt Lendle will successfully circumvent Amazon. I can certainly visualize a few changes to the Kindle user agreement or technical changes to the Kindle user interface that could effectively kill a Lendle re-formatted for reliance on customer data input.

And need I mention the breadth of Amazon’s resources in the event this turns into a legal fight?

The Accountant’s Role in the Sale or Purchase of a Business. Audio Interview with Jina Etienne,CPA.

Previous posts have covered the role of attorneys as well as the role of business brokers (here and here) in the sale or purchase of a business. Recently, I talked with Certified Public Accountant,  Jina Etienne, about the role of accountants in the business sales process.

Jina shared advice concerning

• the tax implications of purchasing/selling a business via a stock sale versus an asset sale;
• what a buyer/seller should consider when allocating the company purchase price among real property, tangible and intangible assets, and goodwill; and
• how a company’s long-term strategic objectives should impact tax decisions during the sale.

(Click the link below to listen to my 12-minute conversation with Jina Etienne, CPA.)

Interview with Jina Etienne

How Much Attorneys Charge to Handle a Company Sale or Purchase?

In a recent posting, I outlined what attorneys do to help business people buy and sell companies. An attorney’s role in a company sale includes helping the parties with getting ready for sale, contract negotiation, financing, due diligence review, and closing.

Of course, one of the initial questions I get from clients seeking a lawyer to help with a company sale is “How much are the legal fees for a company sale?” I’ll talk in terms of number of hours. If your lawyer charges an hourly rate, you can then do the math. Here are some general guidelines on attorney hours required for the phases involved in a relatively straight-forward small or medium-sized company sale:

• Drafting and Negotiating Term Sheet, 5 - 10 hours
• Drafting and Negotiating Purchase Agreement, 10 - 20 hours
• Conducting Due Diligence Review, 10 – 15 hours
• Drafting and Negotiating Ancillary Documents, 20 – 40 hours
• Handling Closing and Post-Closing Matters, 10 hours

Hours required will vary greatly depending upon which party has responsibility for drafting the various agreements and how much negotiation is required to reach agreement. Attorney hours required can increase significantly if a problem is uncovered or develops and must be remedied prior to closing. Sample problems include chain of title in property to be conveyed; difficulty obtaining required third party or governmental consents; and a party’s unwillingness to assume potential liabilities uncovered during due diligence.

Setting a Price for a Company Sale. Audio Interview with Business Broker, Clayton Wendt.

In this posting, I continue the discussion about how attorneys help buy and sell companies as well as how other professionals aid in facilitating a company sale.

If you seek to buy or sell a company, one of your first questions is what’s the value of the business? That’s a question a business broker can help you answer. Clayton Wendt, a business broker with Sunbelt Business Brokers in St Paul, Minnesota, shared with me his thoughts on how to set a price for the sale or purchase of a business.

When valuing a business, Clayton divides companies into separate tiers. A main street business might sell for of up to about $1M and is valued according to a multiple of the seller’s discretionary earnings. A mid-market company might sell for a price of up to $7 - $8 Million and is valued at a multiple of EBITBA (Earnings Before Interest, Taxes, Depreciation and Amortization). Clayton also explained how copyright, trademarks, and patents owned by the company get worked into the valuation.

(Click the link below to listen to my 10-minute conversation with business broker, Clayton Wendt.)

Interview with Clayton Wendt

The Business Broker’s Role in the Sale or Purchase of a Business. Audio Interview with Paul Corrigan.

In my last posting, I outlined what attorneys do to help business people buy and sell companies. Of course, attorneys aren’t the only professionals who work on company sales. Business brokers collect listings of companies available for sale, make those listings available to the public, pre-screen buyers, and facilitate the closing of the deal. (In some ways, they are analogous to a real estate broker helping you buy or sell a home.)

I recently spoke with Paul Corrigan, a business broker at ROI Business Broker. During our conversation, Paul shared how his firm prepares a confidential business memorandum to promote transparency and minimize the chances of the transaction going off-course. Paul also discussed the importance of confidentiality in the company sales process, the positive impact of recent SBA legislation, and how buying and selling businesses stimulates the economy.

(Click below to listen to a 5-minute excerpt of my conversation with Paul.)

 

Interview with Paul Corrigan

 

Your Attorney’s Role in the Sale or Purchase of a Business

I allude to the attorney’s role in the company sales process as part of the blog series, "Steps In a Business Transaction". I thought it would be helpful to outline more specifically what attorneys do to help business people buy and sell companies:

Getting Ready. Small businesses owners sometimes neglect corporate formalities such as annual meetings and resolutions. If the small business is organized as a corporation or LLC, it must make sure that its organizational documents are up-to-date. It will have to represent that they are as part of the sale. Attorneys review your organizational documents and help fill-in anything that’s missing. Reviewing the other party’s (i.e., the buyer or the seller) organizational documents is also part of the due diligence review. When representing the buyer, the attorney’s "getting ready" activities might include organizing the business entity (e.g., a new LLC or corporation) that will make the company purchase.