What founders and reps can do to limit liability when raising capital

Macro Tech Titan on March 25, 2024

Founders need capital to grow, and registered reps often help them get there – but it’s not only about the capital.  If you search “Issuer Liability” most of the results will talk about the regulations.  When you raise money from someone else (not friends and family) you are selling a security, which is a regulated activity.  When you take an investors money there is liability, they are expecting something in return.  Many founders ask what they can do to protect themselves from investor lawsuits, so we wanted to provide a short guide.  We are not lawyers and this is not legal advice, this is information about the market in general for education purposes.  Founders should always seek guidance from a lawyer and if you are planning on raising capital with or without a broker-dealer you should probably have an attorney who you feel comfortable with on retainer.

  1. Follow the rules

This is pretty straightforward, and if you are working with a registered rep of a broker-dealer they will ensure your offering ticks all the right boxes.  Broker dealers are regulated by FINRA and their job is to understand and implement the rules.

  1. Get a lawyer

Lawyers are like Doctors, you don’t need them when you’re healthy, you need them when you’re sick or if you just got run over by a bus (in that example you’ll need both).  If you’re raising capital as your business grows you’ll need a lawyer to create documents and to provide legal advice for a range of issues well beyond your offering.

  1. Disclose, disclose, disclose

One of the biggest drivers of investor lawsuits is the failure to disclose material facts.  If you disclose everything, it will greatly reduce the risk of getting sued.  Investors understand that there are risks with private investing, they are taking the risk and will be rewarded if it pays off and the project works.  For example, if the company has a loan that needs to be paid off and you fail to disclose that, investors would be very unhappy about that (and so would the regulators).  Most of the regulations center around disclosure, they don’t evaluate the quality of an individual offering or sector – when you file an SEC registration statement, the SEC will verify the format, and that you have addressed all the required points, they will never evaluate the quality of the offering or tell you if it’s a good idea or not.  What they do require is that all material facts are disclosed, including the backgrounds of the principals, financials of the company (if any), audits, reports, articles, business plans, patents or other intellectual property, etc.  The reason for this is simple, investors can only make informed decisions when they have all the facts.

  1. Target sophisticated investors

This is more about strategy; if you target investors who have experience in early stage companies, they are going to be in a better position to make a decision, and may even provide valuable feedback based on their experiences in other deals.  If you are dealing with someone who has never invested in a private offering before, that’s probably not your best investor.

  1. Explain to investors the Use of Proceeds well

This is actually the most important requirement when doing a raise with a FINRA BD; the reason is simple.  Investors want to know where their money is going.  Things don’t always work out, and investors may be receptive to that – where they get angry is if you do something outside the scope of your plan, or something they believe to be reckless.  If you explain that with $500,000 you’re going to do A,B,C, – and then you do it, and it doesn’t work out as anticipated, there’s a much lower chance of having a problem with investors vs. a situation where you went far off the business plan and invested in something not on the Use of Proceeds list.  Founders have multiple roles with investors, they are fiduciaries of the shareholders, and managers of the business.  They have an obligation to the shareholders to maximize their value.  As an executive of the business, their job is to ensure that they execute the business plan to the best of their ability.

  1. Get an Umbrella insurance policy

If you have a house, a ranch, or other family assets, you should probably get an Umbrella insurance policy which covers those assets if you get sued.  The umbrella insurance is not specifically for people raising funds, it’s for general situations like if a stranger trespasses on your property and breaks their leg and sues.  The insurance agent can explain the benefits of it, but the idea is to provide some protection to your core assets in the case of lawsuits.

  1. The LLC or Corp provides basic protection

Incorporation when starting a company is key, it means that any lawsuit would be against the entity, not the individuals.  Having said that, a founder is in a unique position because they typically are the main shareholder, the executive, and the person responsible for the entity.  However, this is the most basic protection and the reason that entities are formed, the group of shareholders are stakeholders who share in the profits or the losses of the business together.

  1. Setup a Trust

If you have children, having a Trust is a great idea to pass assets however modest without dealing with Probate.  A Trust can provide other advantages of asset protection, but it does cost money to set it up.  This varies from state to state, but you should talk to a local attorney near where your primary residence is located.  A Trust should be local, it shouldn’t be in Delaware where most Corporations are registered.

  1. Keep in touch with investors

There’s a reason why publicly traded companies have quarterly investor calls.  Imagine the following scenario-  you have an investor who gave you a decent amount of money to start your company and you don’t hear from him for years.  Time goes by and your business grows, and then you face a huge problem from a competitor, and there is a loss.  You call to tell him that, he’s not going to be happy to listen to this.  But it’s always about the lack of info and attention, if you were calling them or if you write an investor letter at least quarterly, you probably wouldn’t be in such an awkward position.  Regular updates are a great way to keep investors informed, and if they are displeased with anything they’ll tell you that then.

  1. Under promise and over deliver

Getting caught in litigation is usually because an investor feels they were abused, lied to, tricked, or that they got an unfair deal.  If you under promise, and then over deliver – this vastly reduces the chance of someone feeling bad about the investment.  Investors don’t expect miracles and founders are not magicians, things happen, everyone knows that.  But if you provide great results, defined as better than what you originally told them, how could anyone have a problem with that?

This goes to the core of writing great terms, be conservative, be reasonable, explain the risks.  Many will say, that it will be ‘harder’ to raise money if your projections are conservative – exactly!  It’s a filtering process, you don’t want someone to EXPECT a huge return because then if you don’t do it, it will be a problem.  There was a FINRA case where a REIT promised 8%, delivered 5%, and got sued (we’re paraphrasing the terms for the sake of the example).  Or in other words, the 5% return was actually very good, but they hard sold and promised 8%, so it left some to feel that it was misleading.

11. When Speaking, Speak Honestly

According to one lawyer, what can prevent lawsuits is simple honesty.  Don’t exaggerate claims or speculate about the future, and certainly don’t speak about future potential as if it’s fact.  Avoid superlatives such as “Will” and instead use language like “May” because you really don’t know what will happen in the future.

Conclusion

This is not an exhaustive list, but it should provide the idea of how to risk mitigate the potential for getting sued, which is a real liability for founders, issuers, and reps.  There isn’t any language you can add to an investment contract that prevents an investor from suing (which is logical, if you think about it, because real scammers could use that language to shield themselves).

So consider taking the high ground, the ethical approach, disclose more than necessary, be above regulatory standards, don’t just meet the minimum requirements.

Announcing the 2024 Human Health 100

Macro Tech Titan on March 22, 2024

From SOSV: https://sosv.com/announcing-the-2024-human-health-100/

Welcome to the third annual SOSV Human Health 100. The list features SOSV’s 100 most exciting companies in the health category, which for SOSV ranges very widely, from assistive robotics and remote care to therapeutics and diagnostics.

In the past two years (see the 2023 and 2022 lists), venture rounds and company valuations grew strongly, but in the past year funding has become much harder to secure and valuations are fragile at best. We asked founders in our recently concluded and very well attended VC-Founder Health Matchup (more on that below) what they thought of the funding environment: 71% reported that it was worse than prior years; no respondent reported it was better.

We see that trend in our Health 100. As in past years, about 2/3 of the companies are at the seed stage, 1/3 at Series A or more, and 2 have reached ‘Late stage’ (unicorns Opentrons and Formlabs). Compared to the strong numbers the Health 100 posted in the past two years, growth was modest. The Health 100’s aggregate valuation is $6.67 billion (+3% from $5.47B in 2023), and all told the Health 100 have raised $1.43 billion (+1% from $1.42B in 2023).

SOSV, which invests starting at pre-seed and continues through later stages, has invested $99 million (+3% from $96M in 2023) in the 100. Due to the slowdown in follow-on investing last year, SOSV’s investments were mostly in new companies entering our programs or raising seed rounds.

Progress of the Health 100 – 2022-2024

Total Valuation Total Raised SOSV Funding Countries Female Founders PhD Founders
2022 $5.65B $1.0B $73M 19 30% 62%
2023 $6.47B $1.42B $96M 17 30% 67%
2024 $6.67B $1.43B $99M 16 35% 70%

Note: this table is based on actual funding amounts.

This year’s list welcomes 16 newcomers, who are listed below. Individual companies on the Health 100 experience ups and downs due to new fundings, regulatory breakthroughs and commercial partnerships. Joining or leaving this list is not a reliable indicator of future outcomes!

The Health 100 Founders

As with the SOSV Climate Tech 100, the diversity and sophistication of our health companies and founders is striking.

  • 35% of the companies have at least one woman co-founder.
  • 16 countries are represented; topping the list are the US (64), the UK (9) and Canada (6), followed by France, Ireland and Singapore (3).
  • 70% of the startups have at least one PhD co-founder.

A total of 52 companies graduated from the bio-focused IndieBio while another 38 hail from hard-tech focused HAX, and five came from the SOSV Consortium.

SOSV is continually expanding its health portfolio by accepting pre-seed health startups into our HAX and IndieBio startup development programs with checks ranging from $250,000 to $500,000. As the companies progress, SOSV also participates in their series seed, A and later rounds. That helps account for our strong showing in PitchBook leaderboards for active investors in categories such as healthcare devices & supplies, women’s health, pharma and biotech.

The 16 New Health 100

All the new companies in the Health 100 are at the seed stage; 9 of them were founded in 2020 or later.

  • Afynia (Canada): The first diagnostic blood test for Endometriosis
  • Cell Bioengines (US): ‘Off-the-Shelf’ Cell Therapies to Cure Cancer.
  • DropGenie (Canada): Accelerating the pace of drug discovery through automated gene editing workflows
  • HelEx (US): Re-shaping gene editing drug design by leveraging nature’s own operating system- the epigenome,
  • Kinexcs (Singapore): AI-driven digital therapy platform & wearables empowering recovery and mobility
  • LightHearted AI (UK): AI-based diagnostics device offering faster, accurate, and affordable solutions for the detection of heart conditions.
  • MedIQ (Pakistan): Integrated virtual care platform providing on-demand healthcare at the point of need.
  • Neuroqore (US): Developing neuromodulation treatments for various neurobehavioral conditions using rTMS (Repetitive Transcranial Magnetic Stimulation)
  • Oli Technologies (US): Helping kidney disease patients see better outcomes at lower costs via portable dialysis devices.
  • OpenShelf (US): Provides flexible “vending machine”-like robots that manage inventory for thousands of unique contact lenses.
  • Portable Diagnostic Systems (US): Microfluidics-based drug testing platform for law enforcement.
  • Rizlab Health Diagnostics (US): A handheld device that allows clinicians to test patient white-blood cell counts in minutes.
  • TippingPoint (US): Attacking cancer with a platform that makes genome packaging states druggable.
  • Unlocked Labs (US): Probiotics with an enhanced ability to biodegrade toxins that are the root causes of serious chronic conditions.
  • ViAn Therapeutics (US): Ophthalmology pharma startup combating microvascular retinal diseases (AMD and DME) with a simple eye drop.
  • Vitarka Therapeutics (UK): Developing RNAi therapies and a non-viral delivery platform technology to activate the immune system and normalize tumor vasculature

The VC-Founder Health Tech Matchup

The health category may be little better than flat year-on-year, but SOSV’s second annual VC-Founder Health Tech Matchup, produced results consistent with a very vibrant category. There were 1092 participants (416 investors and 676 founders) for the free, online event, which took place over the past two weeks, and those folks took approximately 1,500 founder-investor meetings. Year-on-year, matchup registrations were up 52% and meetings up 134%. Some of that energy may derive from the wave of AI-based technologies moving through the health sector: 63% of founders reported that AI was now playing a significant role in their work.

The 2024 Human Health 100

Checkout Sensill @ VCCross.com at the following page:

https://vccross.com/primary/sensill 

Google-backed Anthropic debuts its most powerful chatbot yet, as generative AI battle heats up

Macro Tech Titan on March 4, 2024

From CNBC:

  • Anthropic on Monday debuted Claude 3, a chatbot and suite of AI models that it calls its fastest and most powerful yet.
  • The company, founded by ex-OpenAI research executives, has backers including Google, Salesforce and Amazon, and closed five different funding deals over the past year, totaling about $7.3 billion.
  • The new chatbot has the ability to summarize up to about 200,000 words, or a lengthy book, compared to ChatGPT’s ability to summarize about 3,000. Anthropic is also allowing image and document uploads for the first time.

Anthropic on Monday debuted Claude 3, a suite of artificial intelligence models that it says are its fastest and most powerful yet. The new tools are called Claude 3 Opus, Sonnet and Haiku.

The company said the most capable of the new models, Claude 3 Opus, outperformed OpenAI’s GPT-4 and Google’s Gemini Ultra on industry benchmark tests, such as undergraduate level knowledge, graduate level reasoning and basic mathematics.

This is the first time Anthropic has offered multimodal support. Users can upload photos, charts, documents and other types of unstructured data for analysis and answers.

The other models, Sonnet and Haiku, are more compact and less expensive than Opus. Sonnet and Opus are available in 159 countries starting Monday, while Haiku will be coming soon, according to Anthropic. The company declined to specify how long it took to train Claude 3 or how much it cost, but it said companies like Airtable and Asana helped A/B test the models.

This time last year, Anthropic was seen as a promising generative AI startup founded by ex-OpenAI research executives. It had completed Series A and B funding rounds, but it had only rolled out the first version of its chatbot without any consumer access or major fanfare.

Twelve months later, it’s one of the hottest AI startups, with backers including Google, Salesforce and Amazon, and a product that directly competes with ChatGPT in both the enterprise and consumer worlds. Over the past year, the startup closed five different funding deals, totaling about $7.3 billion.

The generative AI field has exploded over the past year, with a record $29.1 billion invested across nearly 700 deals in 2023, a more than 260% increase in deal value from a year earlier, according to PitchBook. It’s become the buzziest phrase on corporate earnings calls quarter after quarter. Academics and ethicists have voiced significant concerns about the technology’s tendency to propagate bias, but even so, it’s quickly made its way into schools, online travel, the medical industry, online advertising and more.

Between 60 and 80 people worked on the core AI model, while between 120 and 150 people worked on its technical aspects, Anthropic co-founder Daniela Amodei told CNBC in an interview. For the AI model’s last iteration, a team of 30 to 35 people worked directly on it, with about 150 people total supporting it, Amodei told CNBC in July.

Anthropic said Claude 3 can summarize up to about 150,00 words, or a sizeable book (think: around the length range of “Moby Dick” or “Harry Potter and the Deathly Hallows”). Its previous version could only summarize 75,000 words. Users can input large data sets, and ask for summaries in the form of a memo, letter or story. ChatGPT, by contrast, can handle about 3,000 words.

Amodei also said Claude 3 has a better understanding of risk in responses than its previous version.

“In our quest to have a highly harmless model, Claude 2 would sometimes over-refuse,” Amodei told CNBC. “When somebody would kind of bump up against some of the spicier topics or the trust and safety guardrails, sometimes Claude 2 would trend a little bit conservative in responding to those questions.”

Claude 3 has a more nuanced understanding of prompts, according to Anthropic.

Multimodality, or adding options like photo and video capabilities to generative AI, whether uploading them yourself or creating them using an AI model, has quickly become one of the industry’s hottest use cases.

“The world is multimodal,” OpenAI COO Brad Lightcap told CNBC in November. “If you think about the way we as humans process the world and engage with the world, we see things, we hear things, we say things — the world is much bigger than text. So to us, it always felt incomplete for text and code to be the single modalities, the single interfaces that we could have to how powerful these models are and what they can do.”

But multimodality, and increasingly complex AI models, also lead to more potential risks. Google recently took its AI image generator, part of its Gemini chatbot, offline after users discovered historical inaccuracies and questionable responses, which have circulated widely on social media.

Anthropic’s Claude 3 does not generate images; instead, it only allows users to upload images and other documents for analysis.

“Of course no model is perfect, and I think that’s a very important thing to say upfront,” Amodei told CNBC. “We’ve tried very diligently to make these models the intersection of as capable and as safe as possible. Of course there are going to be places where the model still makes something up from time to time.”

Clarification: Anthropic clarified with CNBC that Claude 3 can summarize about 150,000 words, not 200,000.

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Comparison of Equity Crowdfunding and Venture Capital Funding For Startups

Macro Tech Titan on March 2, 2024

From Colonial Stock:

Choosing the right funding source is pivotal for startups, impacting their growth, control, and future success. While venture capital (VC) has been a coveted source of startup financing for a long time, equity crowdfunding, especially under Regulation Crowdfunding (Reg CF), has quickly risen in popularity. It is crucial to explore the complexities and nuances of both options so that startups can make informed decisions.

Startup financing is the fuel that powers the generation of new ideas into tangible products and services. Venture capital and equity crowdfunding are distinct options, each with its own set of rules, expectations, and ecosystems. VC funding offers significant capital injection but at a cost of equity and, often, operational control.

On the other hand, equity crowdfunding democratizes the investment process, allowing a broader base of investors to participate in a startup’s growth journey. The right choice for one startup is not necessarily the right choice for another, and it is crucial for each startup to consider its current financial situation and long-term goals.

Startup Funding: What are the New Trends?

Equity crowdfunding under Regulation Crowdfunding (Reg CF) allows startups to raise capital directly from the public, with individuals investing small to medium amounts of money. This regulation, part of the JOBS Act, was designed to ease securities laws, making it more straightforward for startups to access funding while providing investors with a share in potential success. Reg CF has democratized investing and opened up a new vein of capital for startups, bypassing traditional gatekeepers like banks and venture capitalists.

Venture capital funding is a form of private equity investment provided by venture capital firms or individual investors to startups and small businesses with strong growth potential. This financing is about both the investment and a partnership where venture capitalists often provide strategic guidance, networking opportunities, and operational expertise. In exchange for their investment, VCs receive equity in the company, betting on the company’s future success to earn a substantial return.

The allure of equity crowdfunding lies in its ability to leverage the power of countless smaller investors, offering startups a platform to connect with potential supporters, customers, and advocates simultaneously. It’s a pathway that fosters community engagement, broadens the investor base, and enhances brand visibility. In addition, Reg CF caps the amount a startup can raise in a 12-month period at $5 million, ensuring a level of protection for new investors while allowing startups to validate their business model.

The rise of equity crowdfunding is underscored by compelling statistics that demonstrate its growing acceptance and success among startups. According to statistics published by Yahoo Finance, equity crowdfunding doubled from Q4 2022 to Q1 2023. The Q4 2022 data released shows Reg CF raising more than $80 million. In addition, an article published by Fundera showed that funds raised through crowdfunding jumped by more than 33 percent from 2022 to 2023. While there are numerous crowdfunding platforms out there, the top platform generated close to $172.8 million from more than 140,000 investors.

These numbers clearly show that equity crowdfunding is growing in popularity. Therefore thousands of investors looking to back companies, and it presents an attractive option for startups looking to raise more capital.

The process of securing venture capital is highly competitive, requiring startups to have a compelling business model, a strong team, and a clear path to significant growth. VCs are looking for the potential for high returns, which means they often take a substantial stake in the company. This infusion of capital can propel rapid growth, but it also means founders may have to cede a significant portion of their company and sometimes control over business decisions.

Equity Crowdfunding vs. Venture Capital

Several key differences appear when comparing equity crowdfunding and venture capital. Venture capital typically involves larger sums of money and requires giving up a more substantial stake in the company, often with specific expectations regarding control and decision-making.

Equity crowdfunding, however, allows for a broader base of investors to contribute smaller amounts of capital, potentially reducing the need to relinquish large portions of equity or control.

Feature Equity Crowdfunding Venture Capital
Investment Size Generally smaller amounts from a wide investor base Large sums from a select group of investors
Equity Required Lower (investors are willing to pay a higher share price); allows for a wider distribution of shares Higher (VCs require a low share price); often requires giving up a larger percentage of your company
Investor Profile Broad, including non-professional investors Professional, experienced investors or firms
Involvement in Operations Typically minimal High; often involves board representation
Timeline for Funding Can be quicker, depending on campaign success Longer, due to due diligence processes
Access to Additional Resources Limited compared to VC Extensive, including networks and expertise
Regulatory Requirements Subject to Reg CF limits and disclosures Less regulated, but involves complex negotiations; Reg D offering applies

Pros and Cons of Equity Crowdfunding

Equity crowdfunding provides access to a wide pool of investors, potentially increasing the startup’s visibility and customer base. This mode of funding is also more inclusive, allowing startups to raise capital without having to fit the stringent criteria often required by venture capitalists. However, it has the potential for dilution of ownership if not managed carefully with a cap on the amount that can be raised. This might limit growth potential for startups with larger capital needs.

Pros:

  • Broader Access to Capital: Opens up funding to a wider audience, not limited to traditional investors.
  • Market Validation and Community Building: Allows startups to gauge market interest and build a community of supporters and customers through your crowdfunding campaign.
  • Increased Visibility: Campaigns can double as marketing, increasing brand awareness.
  • Flexibility: Offers startups more control over the amount of equity they offer.

Cons:

  • More Investor Relations: With more investors, comes more support required to help them.  Colonial Stock specializes in Crowdfunding Transfer Agent Services to provide such support.
  • Funding Cap: Reg CF limits the amount that can be raised to $5mm, potentially restricting funding.
  • Regulatory Hurdles: Requires navigating SEC regulations and compliance requirements, but the process isn’t that bad according to Colonial. Request Information on your Reg CF Offering.

Pros and Cons of Venture Capital Funding

Venture capital funding is renowned for the significant resources it can bring to a startup, not just in terms of capital but also strategic guidance and networks. The mentorship from experienced investors can be invaluable, and the large sums of money can fuel rapid growth. However, this comes with the cost of potentially losing a significant portion of equity and control.

Pros:

  • Large Amounts of Capital: Enables significant growth and scaling.
  • Mentorship and Expertise: Access to the investor’s knowledge, network, and resources.
  • Credibility: Association with known VCs can enhance a startup’s market position.
  • Strategic Assistance: Beyond capital, VCs often provide operational, strategic, and networking support.

Cons:

  • Equity and Control Loss: Founders often have to give up a significant portion of their company.
  • High Expectations: Pressure to perform and deliver rapid growth can be intense.
  • Selective Process: Very competitive, with a focus on high-growth potential businesses.
  • Risk: VCs have been known to take controlling stakes including moving founders out.

Why Equity Crowdfunding Wins

In the end, equity crowdfunding’s advantages extend beyond the capital raised, fostering a community of investors who are genuinely interested in the startup’s success. Equity crowdfunding embodies the future of startup financing, bridging the gap between innovative ideas and the capital necessary to bring them to life. Its rise signals a shift towards more equitable, transparent, and accessible funding mechanisms, heralding a new era of entrepreneurship fueled not by the few but by the many.