Ashoka’s Post

Transcript

We're very pleased to be part of an initiative between Ashoka and the Association of Pro Bono Council Transactional working group to provide legal information presentations to Ashoka Fellows. These presentations will provide Fellows with legal orientation as part of a larger collaboration to provide pro bono counsel to Ashoka Fellows across the globe with respect to their diverse legal needs. Today we're talking about financing mechanisms and vehicles for startups. My name is Patricia Ecker, I go by Trish. I am a partner in Oryx Public Finance Group. I represent a variety of municipal bond issuers, borrowers and underwriters for a variety of public infrastructure, 501C3 nonprofit and enterprise fund, general obligation and other financing structures. This presentation was prepared in collaboration with my associates Christopher C Reynolds, Melinda Cesarec Sakarias and Serena Tibrewal. The agenda today is to talk about broad considerations. Debt and safe financing. Equity financing and other financing that's available for nonprofit organizations. What to consider when taking in capital? Many companies require outside financing in order to grow. The type and terms of the financing will have an impact on the company's governance, ownership and economic outcomes. What do we need to know about the timing? Some investment strategies are much quicker than others. For example, a safe or the equivalent versus a Series A round. We'll talk about safe a little bit later. More cash will often lead to more involvement from a bank or investor. So if a larger financing is needed, that typically requires more involvement with the bank and the investor. You also need to consider the amount of the capital targeted. Depending on the amount to be raised, there might be one method of financing that might be more beneficial than others. So first, let's talk about debt financing and safe financing. Venture Debt. Venture debt is an option that is often available to pre cash flow positive venture capital backed companies. Companies can borrow money and establish lines of credit even though they would not otherwise be creditworthy from a traditional debt standpoint based on cash flow or current assets. Current assets. This type of debt often assumes that a company will be able to raise equity financing down the road as a source of repayment, or will repay the debt via an exit event, such as a sale or an IPO or other similar exit event. The advantages and disadvantages of venture debt include that venture debt is relatively cheap source of capital. It extends your runway of equity financing but will not usually be used as a replacement. It is usually minimally or non dilutive to the company's ownership. And it can be a fairly quick process. It will often come, however, with certain obligations and restraints on operations, and it puts pressure on the company to raise additional capital. It also limits the use of the company's cash. There are usually restrictions on how much cash can be used and how much cash must be on hand. Further, it puts the company's assets at risk if there's a default. It can also be very costly, even if relatively quick. In the US, there is something called a safe or simple agreement for future equity. Many jurisdictions have adopted their own form, such as the BSA AIR in France or the ASA in the UK. What a safe is, is a right to shares of a company's preferred stock. Typically it is not treated as debt as it will not have a maturity date or interest. Key considerations safe are great option to consider as they are very standard and have very few key points that need to be negotiated. This typically results in a lower transaction cost to startups. We will dive into it in the next slides, but equity financings can take time and are expensive. Safes or advantageous over convertible notes as well as foreign investors, they offer more clarity on what percentage of their investment will convert to. And for companies, there's no interest accrual. So let's talk about equity financing. Equity financing is where a company raises capital by selling securities that represent ownership stakes in the company to investors. Depending on the entity type, these might consist of shares of stock, membership interests, percentage interests, or otherwise. The company may sell common equity or preferred equity. Common Equity Common equity is the same class of ownership interest held by all stakeholders. These are also referred to as common stock or ordinary shares. A common equity does not have any special rights, so the financing process is simpler and requires less negotiation with investors. However, the lack of special rights can make common equity less attractive to investors, who generally expect greater rewards for putting their money at risk. Another concern was selling common equity is dilution. Because investors will hold the same class of equity as the founders and will have the same voting rights, founders ownership can be diluted to the point that they lose control of the company. Also a factor is pricing and its impact on the company's valuation. It is generally desirable to sell equity to investors at the highest possible price. However, setting a high price on common equity can make it too expensive to grant equity incentives to employees. For these and other reasons, most most companies choose to sell preferred equity rather than common. Preferred equity is a security representing a separate class of ownership. There are special rights, powers, preferences, or privileges that are negotiated with investors. Because preferred equity comes with these special rights, it is typically sold at a higher price than the company's. Common equity rights might include a liquidation preference, the right to receive dividends, approval rights over certain matters, the right to participate in future securities offerings by the company, or other similar rights. Investors might also negotiate for additional contractual rights, such as the right to appoint members of the companies board of directors or other governing body, rights of first refusal and Co sale, registration rights and etcetera. Advantages of equity financing include the fact that they are not loans, so there is no obligation to repay. Most cases allow for startups to raise more money selling equity than debt. Equity is generally more attractive to investors because of a greater potential upside. Because investors have an ownership stake, they're also more willing to help the company succeed. Disadvantages include that equity financing is a more time consuming and expensive process, the terms are often heavily negotiated and the transaction requires multiple agreements to document, and investors usually conduct a very extensive due diligence review. Both the company and investors will require legal counsel, which adds cost. Selling new equity. Inevitably dilutes the ownership interests of existing stakeholders. The founders control over the company is often reduced as a result of investors being granted approval rights over certain actions and the right to appoint members of the company's governing body. A misalignment of priorities can occur and that investors expect an eventual return on their investment, which they can only achieve by selling their equity for a premium. This can sometimes lead to investors pushing for an acquisition of the company against the founders interests. Key considerations for equity financing. How much of the company are you willing to give up? Many companies conduct multiple rounds of financing, and each subsequent round further dilutes the interest of the original founders. What rights are you willing to provide? Keep in mind that your first equity round will set a preference precedent for future rounds, and it's difficult to scale back on rights that you have granted to previous investors. What if you're a nonprofit? So nonprofits are different because revenues earned by nonprofit organizations cannot be returned to private investors in the form of equity or dividends. Rather, the return on investment for those contributing to nonprofits is, in seeing out the mission effectively, a social return on capital. Different types of funding include community funding, private donation, donations, and corporate sponsorships. There are a wide range of resources from crowdfunding websites, including some that are all or nothing like Kickstarter, to targeted outreach, to placing a Donate Now button on your own website. Many jurisdictions require charitable registration or licensing before engaging in charitable solicitation. And or reporting requirements after engaging in solicitation. In addition, solicitation materials are required to include certain disclosures that vary by jurisdiction. Broad reaching solicitations can trigger requirements in all jurisdictions where citizens may be reached by your request. These requirements are designed to improve accountability of nonprofits and the accountability to their donors. Certain nonprofits might also choose to file as a 501C3 corporation with the Internal Revenue Service, and many 501C3 corporations can receive tax deductible charitable contributions. If your organization would qualify for tax deductible contributions, filing for federal tax exemption will encourage donors. Grants are also an option for nonprofit organizations. Sources include corporate giving programs, private foundations, donor advised funds, federal grants and endowments, and state and municipal grant programs. The vast majority of nonprofits count government grants and endowments as their primary source of revenues. Grants are available for supporting specific projects or programs of nonprofits or as general operating support. Grant funding usually comes with multi year reporting requirements. That grant requirements maybe one time or multi year periods with funds being dispersed in great amounts annually. For international nonprofits, fund fundraising from grant makers seeking to make a U.S. tax deductible contribution may need to provide the grant maker with detailed information about its operations and finances to enable the grant maker to make an equivalency determination. That's whether the nonprofit is equivalent to a US public charity or to assist the grant maker to comply with the procedure called expenditure. Responsibility that allows the grant maker to make a grant to organizations that are not US public charities nor their foreign equivalents to ensure that funds are only used for charitable purposes. Or the international nonprofit can ask a 501C3 to act as a fiscal sponsor. The third route, finding a fiscal sponsor, is preferred by foundations but likely would entail the fiscal sponsor taking a 5 to 15% cut of the grant funding. Debt financing for nonprofits is also an option that acts a little bit differently from debt financing for for profit organizations. Debt financing or loans require the organization to have the expectation to repay the funds loan. However, when you are a nonprofit, you may have an option to provide for the loan to be converted to a donation in special circumstances. In some in some cases, capital projects can be funded by 501C3 corporations through publicly offered tax exempt securities, which typically results in lower borrowing costs. We hope you've enjoyed this presentation and we really appreciate the work with Ashoka and hope that you have a wonderful day. Thank you.