Many founders I speak with are concerned about where their startup is incorporated and how this could impact fundraising opportunities in the United States.  In reality, this concern is unfounded.

Any sophisticated investor considers the product/service, team, market potential and other commercialization factors before, if at all, considering where a startup is incorporated.  In some circumstances, an investor may request that the startup alter its jurisdiction of incorporation but whether or not they proceed with the investment is determined 90% by quality of the company over jurisdiction of incorporation.  As relayed to me by Canadian founders, “if an investor passes because you’re a Canadian company, that’s not the real reason for passing“.

Where an investor requires your startup to be incorporated in the U.S. there is a simple process for creating this structure that I discussed in a previous blog post – The Canadian-U.S. Swap: Moving an Early-Stage Startup to the U.S.

Canadian founders should focus on building a compelling product/service and not waste energy worrying about minutia of incorporation.  Sell investors on your company and any issues concerning where your company is incorporated can be worked out between your legal counsel and investors.

Congratulations, you received a term sheet!  While the main terms, such as valuation, are certainly important, there are numerous less noticeable terms that can have just as great an impact.  One such term is “fully-diluted”.

What is a fully-diluted calculation?

A fully-diluted calculation assumes that all options, warrants and other rights to acquire stock have been exercised or converted, regardless of whether they are actually vested or exercisable at the time of the offering.

Let’s illustrate the impact of a fully-diluted calculation compared to a funding round without full dilution.

Startup has issued 1,000,000 shares and 100,000 options.  None of the options are vested.  Investor desires to take 10% interest in the company.

Not fully-diluted:  Startup will use the number of issued shares only to calculate the 10%  and will issue investor 111,100 shares (representing 10%).

Fully-diluted:  Startup will use the total number of issued shares and options to calculate the 10% and issue the investor 122,200 shares.  However, since none of the options are vested, and may never vest, investor actually acquired a present-day interest of 10.89%.

While the above example seems benign given the .89% difference, that percentage could be worth a large sum if the company exits in the future.  What if you are selling an almost controlling interest in the company, perhaps 23.5%?  In that case, a fully-diluted calculation could result in a sale of a 25%+ (and controlling) present-day interest depending on the number of outstanding options etc.  In other situations, an investor may request that the entire option pool (even if no options have been granted) be factored into the fully-diluted calculation – in the case of a 12% option pool, this term would have a substantial impact.

In sum: while you may not be able to avoid a fully-diluted calculation in a term sheet, it’s important to understand its impact and to negotiate with that impact in mind.

Startup accelerator acceptance season is upon us and those lucky startups are now going through the vetting process that follows acceptance into an accelerator.  In order to simplify the lives of founders and lawyers everywhere, I’ve put together a list of key items that often need to be addressed as part of the accelerator vetting process:

1.  IP Ownership.  Make sure all intellectual property developed relating to your startup has been assigned to the company through separate assignment agreements or as part of employment/independent contractor agreements.  Remember, this is where the value in your startup lies.

2.  Clean up the CAP Table.  This is the time to clean up your CAP table and make sure that everyone you’ve “promised” equity is issued their shares and represented on the CAP table.  There’s nothing worse than calculating the number of shares of the company to issue to the accelerator only to realize that you forgot an intended shareholder – your uncle granted 0.5% (undocumented) for doing company taxes a year ago.  Go in with a clear picture, and proper documentation, of company capitalization.

3.  Lock Down Founders.  The accelerator will want to see that the founders and key persons are tied to the company, whether by an employment or contractor agreement.  If your resources are limited, a reverse vesting agreement for founders should suffice.  In addition to IP, founders are a key startup asset.

4.  Canadian Company?  Determine Cross-Border Structure.  If the accelerator is in the U.S., Canadian startups have the extra steps of determining what Visa will allow them to work in the U.S. while at the accelerator and what cross-border company structure will meet company and accelerator needs.  A discussion of company structure can be found HERE.

If you’re not in an accelerator yet, the above are important considerations to keep in mind for running any company and will make future accelerator vetting a seamless process.

New registration and prospectus exemptions adopted in British Columbia, Saskatchewan, Manitoba, Quebec, New Brunswick and Nova Scotia permit startups (and other companies) to crowdfund investment in exchange for equity.  Importantly, investors do not need to be accredited or have a previous relationship with the company.

What are the company requirements?

1.  Have a head office located in one of the above provinces;

2.  Conduct crowdfunding through an online funding portal that meets certain requirements (to be detailed in our next blog post); and

3.  Use, and post on the online funding portal, the required offering document form that details, for example, certain information about your company, the securities being offered, the minimum offering amount and how funds will be used.  The offering document is available at https://www.bcsc.bc.ca/45-535_[F]_Form_1_05142015/.

How much can your company raise?

You can raise up to $250,000.00 per distribution in up to two crowd funding distributions a year.    As such, you can crowdfund a total of $500,00.00 a year (in two separate distributions).

What type of securities can you offer?

Common and preferred shares, convertible securities (that convert into common or preferred shares), non-convertible debt securities (fixed or floating interest rates) and limited partnership units.

Do the investors need to be accredited?

No.  However, each investor is limited to invest up to $1,500.00 per distribution.  As such, one person could invest a total of $3,000.00/year in your company where they invest the total permitted amount in two separate distributions.

You can receive concurrent investments under other securities exemptions, such as from accredited investors, and put these investments toward the minimum offering amount.

Do I need to raise the minimum offering amount?

Yes.  Like a Kickstarter campaign, the crowdfunding exemption requires that you raise the minimum offering amount.  Where you fail to raise the minimum amount, you cannot complete the offering.  Nonetheless, as noted above, concurrent investments under other securities law exemptions can assist with raising the minimum amount.

Are there other requirements?

Of course – this involves law, remember?  Other requirements include, but are not limited to:

1.  The crowdfunding campaign has a maximum duration of 90 days;

2.  Each investor has a right to withdraw their commitment within 48 hours of: (a) their subscription or (b) upon receiving notification that the offering document has been amended; and

3.  A report of exempt distribution and the offering document must be filed with the applicable securities commission no later than 30 days after closing.

The full text of the exemption is available at: https://www.bcsc.bc.ca/Securities_Law/Policies/Policy4/PDF/45-535__BCI___May_14__2015/

In upcoming blog posts, I will discuss funding portals as well as aspects to consider when structuring a crowdfunded investment round.