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Are You Smarter Than A Fifth Grader?

After speaking with hundreds of CEOs, I realized that burn rate isn’t as Startup101 as I had thought. There are still a lot of things that founders understand incorrectly when it comes to being a #BurnRateZombie. But before we get into it…

Let’s take a pop quiz!

Once upon a time, there was a CEO running a very promising startup. The company was all set to join the ultra-exclusive Unicorn club. It was valued at $900M, and this is how their cash inflows and outflows looked:

(FYI, Singapore fifth-graders’ are expected to take one minute to answer that.)

Thinking $62M? Well, your math is as good as the fifth graders, but you should know better.

Jason realized after all this burn that he doesn’t have a business model. His company had become a #BurnRateZombie, so he sold all inventory, cut the staff, and finally offloaded the company for a special clearance price of $15M. Jason hems for a living now.

Burn Rate is very complicated. See if you understand this.

Burn rate = Money that comes in — Money that goes out

No, don’t mock. It’s tougher than it looks. In fact, I’ve had this talk with so many founders that I created this burn rate calculator to better illustrate my examples.

You can run your numbers at this link: BURN RATE CALCULATOR

Don’t know what numbers to fill in? You need to talk to us.


Jason wasn’t paying attention to the red flags. But here is what you should be doing:

  1. Sit regularly with your accountant and deep-dive into your numbers (I hope you have an accountant!). Beyond the bean counting (what’s coming in and what’s going out), you should have an overall sense of your financials. One thing about numbers — they don’t lie. Know your top five buckets of expenses and analyze them for patterns. Look out for unexplained numbers and unusual variations in expense lines. Grill your accountant on and make sure she/he knows the stuff.
  2. Ruthlessly track KPIs. Track your Key Performance Indicators and tweak your strategy based on what they are telling you. Do not forget that B2B and B2C businesses track different KPIs. For example, as a SaaS company, do you track your company’s magic number? A lot of disciplined operating KPI tracking goes into this number. But once you have the systems in place, the resulting insight for your business are priceless.
  3. Keep your eyes and ears open. Keep an eye out on the market indicators for funding. For example, if the market is down, raising funds might take longer than what you’d earlier accounted for. If you are not prepared for it, that could be fatal. Don’t die mid-keystroke. Die trying. But above all, avoid dying at all.

“If you can just avoid dying, you get rich. That sounds like a joke, but it’s actually a pretty good description of what happens in a typical startup.” — Paul Graham, Y Combinator

4. Know your burn, track your burn, control your burn. Question the expenses you’re committed to. Just because you have okayed something in the past, doesn’t mean you don’t track it’s ROI. The money you spend on networking events is a classic example of doubtful ROI. Constantly trim the fat.


Survival stories are boring. Who wants to hear about the company that didn’t die? Only our client founders, their investors, and us.

Avoid being a #BurnRateZombie by tracking your burn rate. Make your story boring again.

The best time to talk is now! Call us today.

 

Busting Startup Myths: Tracking Financial Metrics is NOT Important

Busting Startup Myths: Tracking Financial Metrics is NOT Important

When I was out on lunch with the CEO of an early-stage SaaS startup, I asked him how his company was doing.

Quite well, I was told. The revenue is growing month on month, we have enough money in the bank, and the employees are happy. Life’s good.

Always a data-oriented guy, I asked him if I could take a look at his books. And when I did, I found out that while on the surface things were going well, a deeper look told an entirely different story.

On the aggregate, the company’s revenue was growing, but month on month, a good chunk of small customers kept canceling the service. The aggregate revenue from these customers was small, which is why their cancellation got lost under revenue increase from a few large customers. Were these cancellations driven by lack of features? Lack of good customer service? Or something else? It is generally a combination and you have to decide where to invest to fix the problem.

Mentally, it’s impossible to track too many pieces of information, and most companies at this stage make these decisions more on gut feeling and less on hard data.

Personally, I have always followed the pithy saying that my an ex-boss would repeat to me weekly:

In God we trust, rest everybody please bring data.

As on-demand CFO service providers, this is the discipline we bring to startups: diligently gathering data and deriving conclusions that will make or break the company at this young stage.

A case in point would be measuring the efficiency of a company’s investment in sales and marketing. An excellent example of this is the “magic number” metric defined by a veteran Silicon Valley investor Rory O’ Driscoll of Scale Venture Partners. A lot of disciplined operating KPI tracking goes into coming up with this number. But once you have the systems in place, the resulting insight for a SaaS company is priceless.

In Rory’s words:

“An investment is made in Q1 in sales and marketing (S&M). The revenue starts going up in the books, usually in the next quarter (Q2). The correct ratio to look at, is not the relationship between S&M expense to revenue, but the ratio of S&M expense in that quarter to the change in revenue for the following quarter.”

Let me simplify it. Take the change in subscription revenue between two quarters, annualize it (multiply by four), and divide the result by the S&M expense for the earlier of the two quarters.

(Quarterly Increase in MRR x 4) / (Sales and Marketing spend of previous quarter)

The idea is that if your magic number is > 1, the company is growing efficiently, and your S&M expense is in the right direction. You can consider increasing it. If it’s <0.5x, the company is still figuring out its model, and you need to take a step back and re-strategize. Anything in between could eventually be successful but in a relatively capital inefficient manner.

This is the magic number that SaaS enterprises often get wrong. And this is one of the many myths we at myStartUpCFO help our CEOs bust. We have done it for dozens of companies, and would be happy to help you. Feel free to reach out through a comment below or directly at sshroff@mystartupcfo.com

There is NOTHING more expensive than a cheap accountant!

There is NOTHING more expensive than a cheap accountant!

There is one thing that I tell every client and employee I work with.

Bad information can kill you.

Think I’m exaggerating? Ask the guys who blindly followed Apple Maps in Australia and landed in death traps – stranded in the middle of nowhere for up to 24 hours.

And when bad information comes from the person handling the finances in your startup, it can and will kill your company. CEOs are often complacent in the confidence that everything is okay because their CFO says so. They’re on a hiring spree, until they wake up one morning and learn that there’s no money to fund the next paycheck of their 400-something employees, and there’s no recourse but to declare bankruptcy. And fire them via email and quietly delete all their social media accounts. (Zirtual, I’m looking at you).

The accountant says your bank balance is $200,000, which is all good, it’s enough runway for a couple months. But he forgot to account for this big AmEx bill that has been building up, or forgot that the San Francisco payroll tax of 1.162% on 2015 payroll is due on Feb 29th.

Oops.

As a CEO, how do you make sure this situation does not arise? What are the red flags you need to look out for? It’s vital to make sure your accountant is capable and adroit, but while a QA might work with an engineer, how do you test your accountant?

One, make sure you always ask a few detailed questions when you review with your accountant. He tells you your burn rate is $100,000, you grill him for a high level breakup. What part of it is variable? What is fixed? Any change in spending pattern? While these questions will get you some relevant info, but more importantly, they increase your confidence in your accountant and his / her own diligence with numbers before they present the numbers to you.

Two, look out for unexplained numbers and unusual variations in expense lines. If in a 10 person company, your food amounts to $20,000…pause. Analyze.

Make sure your accountant knows the five big buckets that account for 80% or more of your burn.

If you have a budget, compare it with actuals, and analyze the deviations with your accountant. If he stammers and stutters or says “I will get back to you,”, you’ve been warned.

The conclusion is simple: trust but verify, and be careful with your hiring. A cheap accountant can prove very expensive!

If you have any doubts or questions, feel free to reach out to me via LinkedIn or email at sshroff@mystartupcfo.com. I’ll be happy to provide an audit of your books to warn you about any red flags. Our website is www.mystartupcfo.com if you’re interested in knowing more about what we do.

Looking forward to hearing your thoughts.

The (Ir)relevance of Unit Economics

The (Ir)relevance of Unit Economics

How’s your new business coming along? Good? Why do you say that?

Probably because as rational human beings, we intuitively use ratios to measure things. Businesses tend to operate the same way.

You look at your numbers and see that your company is adding 2x new clients every month. Would you think your company is doing well? Your first thought would probably be: yes. But the truth is that while it might look good at first glance, you won’t have the right answer until you look deeper. Your unit economics matter, and if they are adverse, it might just kill your company.

At this stage, what’s more important than the total revenue is your unit economics, which is essentially the revenue and costs associated with each unit you sell.

When you are selling one more thing of what you make – are you making money on it?

In this post, I will be discussing the importance of unit economics, especially for seed-funded companies, both B2B and B2C.

Case Study of a B2C Mobile Gaming Company

Let’s pick up the case study of a B2C mobile gaming company I worked with. A company in that industry will calculate its revenue in the following manner:

It will have X number of Daily Average Users (DAUs), out of which only a few will pay. The company now needs to look at the total money collected over this period.

In this situation, let’s say the company has a total of 1,000 users, and collected $100. So the unit revenue (average revenue per daily average user — ARPDAU) is 10 cents per user per day.

The company, as a service provider, now computes its costs, which are generally divided into two parts: fixed and variable. Variable costs are typically: server cost (partially fixed but some variable), bandwidth, and advertising costs to acquire users.

Assume the advertising cost is $2 per thousand impressions (CPM). On an average, how many impressions does the company pay for before it gets a customer? Let’s assume it to be 1,000 impressions.

Thus, its cost per install (CPI, i.e. the cost of customer acquisition) is $2.

To be profitable to the company, an average user has to last at least 20 days. (20 days * 10 cents / day = $2 revenue) If an average user goes away in LESS than 20 days, the company will never make money.

What happens in B2B?

The situation is completely different in the case of seed-funded B2B companies, because their fundamentals are different. How?

  1. To get any accurate statistical average of a data set, the data set needs to be big (“n” has to be large), and at the seed stage, that is near impossible for a B2B company. At the seed stage, a seed-funded B2B company that has good “traction” will have 4-5 customers, even if that!
  2. A B2B company also has much longer sales cycles – i.e. prospects today become clients next year, which means the costs of acquisition are higher and add up for a longer period of time, for each client. This makes averaging costs over a data set really difficult.

So for B2B entrepreneurs, any unit economics figures derived would have serious validation issues.

Moments like these have made me realize that a lot of startup advice dispensed about is implicitly aimed for consumer startups. While hundreds of people are talking about unit economics for startups, nowhere did I find a distinction between B2B and B2C companies. This is perhaps explained by the sheer volume of consumer startups – AngelList actually shows over four startups tagged “consumer” for every one startup tagged “B2B” or “enterprise.”

However, where unit economics is concerned, I’d like to dispense this myth for B2B startups. Don’t waste precious resources getting those figures right. At this stage, even your investor is more concerned whether you’ve built something that people will pay for. Unit economics gain importance after a Series A round.

If you’d like me to deep-dive into your numbers, I’d be happy to provide a free consultation. Please reach out to me via email at sshroff@mystartupcfo.com or even an inMail works.

Source for cover image here. I have talked more about the “magic number” that startups need to get right in an earlier article here.

Funding Downturn And What It Means For Entrepreneurs

Last night, I was sifting through my inbox, when I noticed a pattern.

Mail 5: CEO of a $1m seed funded company informing me that they’re shutting down shop since neither the Series A nor the bridge loan came through.

Mail 67: Another seed-funded company planning to wrap up operations at the end of the month.

Mail 96: A B2C startup with 1M active users but with no clear path to monetization. Unsuccessful in raising any money. Hoping for an aquihire, but planning for a shutdown.

Mail 128: CEO of a well-funded seed-stage company (high single digit, in millions) had to sell because they’d run out of money. It was an acquihire – so the team stayed intact, the product wasn’t shut down. They consider themselves lucky.

Should entrepreneurs be worried?

According to CB Insights’ annual report, the first quarter of 2016 saw the lowest number of deals worldwide in nearly three years, down by 15% from Q4 2015. Interestingly,  according to another report, Series A deals made up 48% of Q1 transactions, a level not seen in over a year. However, total dollars invested were the lowest since Q3 of 2014 for the U.S.. Even Asian markets have taken a hit, with funding down 32% (in dollars).

Yes, entrepreneurs should be worried.

VCs have less funds available. (No exits lately!) If they have a portfolio of ten companies, they’re analyzing them, and backing the winners, instead of equitably distributing the available funds between all of them. Think of a mother picking favorites when there are five kids to feed, and food only enough for two of them.

What can entrepreneurs do?

Raising funds is going to get even more difficult. Call it a correction or a normalization, the bottom line is that there are going to be more unicorpses than unicorns this year.

Here are some tips for early stage startups:

  1. If you are raising funds: Aspire to raise a larger amount than planned, since the next opportunity for fundraising may not come soon. This strategy is different than the past strategy of raising a very small pre-seed or seed round, getting traction, and then going for larger rounds.

Because, well, you will probably not be around for that round.

  1. If you are not or cannot raise funds: Cut down your expenses.Ruthlessly prioritize.

If you are still building your MVP, don’t invest in a sales and marketing team just yet, because they don’t have anything to sell.

If your product is ready, see where you can scale back on the R&D spend, and put all that you have in your sales team. Lean in. You are guaranteed to NOT get traction if you don’t invest in sales, so why not risk it?

  1. Track your KPIs. If they are looking good, you’ll survive. Focus on customer validation and your monetization path. Your metrics should prove two things:
  1. You’re actually solving a problem
  2. The problem is so significant that users spend a good chunk of time on your product, and not just two minutes a day.

Sad fact: If you are running out of money in 2016, and KPIs don’t look good – you’re in trouble.

  1. Approach your current investors, have a heart-to-heart. Figure out if you’re the favorite child, or the one who’s going to be left to die. If you think you might need money, discuss the possibility of bridge financing before you go for the next round.

I know the situation is difficult, but in the long run, this is a good change. Evolution is at work. The strong will survive. This will make companies more resilient, and will make sure the more deserving ideas get funded, and competition gets thinned. The capital to go around is limited, and with less startups clamouring for their attention, the money would be spent more judiciously.

However, if you’re the ones left in the cold…stop worrying.

Welcome to the graduation ceremony of the School of Hard Knocks. Learn from your mistakes, prepare for the next cycle, and come back with better ideas.

And if you need a sounding board for those ideas, I’m available on LinkedIn or email at sshroff@mystartupcfo.com.

Good luck!

Health Benefit Expenses: Get the Best of Both Worlds

Health Benefit Expenses: Get the Best of Both Worlds

A lot of CEOs I work with on a daily basis struggle with designing their employee health benefit plans. For most companies, after salaries, this is the company’s biggest expense. Not surprising, given that over the last 50 years, the cost of consumer goods and services have gone up eight-fold with one exception — healthcare.

Healthcare costs have increased 274-fold.

Splitting the healthcare cost between the employer and employee is a sensitive employee morale issue – if the employer takes on a major share, it’s good for the employees and recruitment, but can end up being expensive. It can also lead to economically irrational decisions on part of the employees, who would always choose the most expensive health plan if the company is paying for it. On the other hand, simply shifting a greater burden to employees just adds financial stress that indirectly costs the company down the road.

So how do you tread this fine line?

I often advise clients to look at insurance as a trade-off between peace of mind and guaranteed fixed expense. The premium is the guaranteed fixed cost that I to bear while the doctor’s bills are variable. The peace of mind I tend to buy is that a catastrophic medical incident will drive me bankrupt. So I tend to buy lower premium plans that come with higher deductibles and out-of-pocket expenses. The savings on the premium I put in a health savings account (HSA) for that inevitable day when I will hit a wall! This works out well as long as I am generally in good health. (The avoided doctor visits also give me added flexibility to contribute more to my HSA.) Of course, for someone with a chronic condition requiring on-going doctor care and medication, the math might work out better if they go with a high premium and low deductible plan.

For example, a client came to me with a sticky situation. His family of four had a $10,000 out-of-pocket max PPO plan for $928 / month. ($11,136 / year).

When I looked deeper, I saw that he could buy a $5,000 out-of-pocket max PPO plan but the cost goes to $1,546 / month. ($18,552 / year).

So to save $5,000 of expense on the deductible, he was taking on a cost of $7,416.

I skipped over some finer details in this example, but you get the idea!

I encourage companies to make this math transparent to the employees and encourage them to go for the cheaper plan and contribute part of the savings to the employees’ HSA plans. This is like a health 401(k) plan…employees get to take this pre-tax money with them when they leave. It’s a win-win for both you and your employees.

That’s my 2 cents towards making sure your health benefits expense do not become an albatross around your neck. As a CEO, how has your experience been while managing health benefits? What potential risks do you see to a higher deductible health plan for your employees? How do you mitigate it?

Leave a comment, send an inMail or write to me at sshroff@mystartupcfo.com

The 6 Must-Have Skills For A Startup CEO

Chief Executive Officer? Chief Visionary? Chief Cheerleader? Chief Salesman? Chief Funding Officer? Chief Communications Officer? Chief Team TISI -1.07% Builder? Chief Lightbulb Changer? Chief Coffee Maker? Yup, all of these titles apply to the role of a startup CEO. It is perhaps one of the hardest jobs to do in the business world, given the wide range of skills required to excel. This is one of the reasons only 10% of startups actually succeed, as it takes a really special person that has the right combination of skills and startup DNA. In many ways, a much harder job than a CEO of a Fortune 500 company, minus the big salary.

When it comes down to the core skills required, a startup CEO needs: (1) a clear vision of where the ship is sailing; (2) a finger on the pulse of the industry and competitive trends, to navigate the ship over time; (3) solid team management skills to keep all employees sailing in the same direction; (4) impeccable sales and motivational skills, while maintaining credibility with clients, investors and employees; (5) to keep the business on plan and budget; and (6) keep the company liquid. I’ll tackle each of these points below.

1. Set the vision.

The first two points really go hand-in-hand. In order to create the clear vision, you need to have a good sense to what is going on in the industry and with competition. That is really the first step to building a winning business plan. It is not enough to say, “we are building a great travel website”, as there are tons of travel websites out there. You must shape the vision in a way it is more unique and competitive than current solutions in the market. My previous startup, iExplore, positioned itself as a niche killer for adventure travel (compared to the general online travel agencies like Expedia EXPE -2.04%). And, within the adventure travel sector, iExplore marketed “privately-guided, made to order” tours (compared to the traditional packaged group tours with set itineraries) at a price point 25% less than similar tours being offered (leveraging the cost efficiencies of the internet, compared to brick and mortar agents). This vision for the business created a unique product in the market place, which consumers ultimately flocked to with over 1MM unique visitors per month coming to the website.

2. Monitor key trends and pivot accordingly.

But, the CEO’s job is not done setting the initial vision. He or she must stay on top of key trends in their industry or competition to navigate the ship over time. For example, after the economic impact of 9/11/01, iExplore needed to evolve from a travel agent of other tour operators’ trips, into an iExplore branded tour operator of its own, in an effort to get more margin to the bottom line during a difficult economic climate. And, at the same time, iExplore opened up a whole new revenue stream from online advertising, to get the company to profitability while people were not traveling. It is the CEO’s job to constantly watch these kinds of economic, industry or competitive movements over time, and to respond accordingly to keep the ship afloat.

3. Keep the team focused on the same goal.

Another job of the CEO is to make sure all employees are clear on the vision, and that all staff are sailing in the same direction. In the iExplore example for adventure travel, you can’t have your tech guy building a cruise seller, your operating guy building a hotel seller and your finance guy building an airfare seller. Everyone is building an adventure travel seller, and the CEO’s job is to make sure all staff have contributed in building that vision, so all players are on the same page as to what they are building. Therefore, the CEO is not only the communicator of the vision, the CEO is the consensus builder for that vision. You will never be successful if your team does not buy into the vision, or if they feel their good ideas for improving the vision are not being listened to. Then once everyone is firmly on board, keep them clearly focused on the goal.

4. Evangelize and motivate.

Once the vision is set and being maintained over time, now comes execution. And, one of the key execution requirements for any startup CEO is to be its Chief Evangelist. This includes cheerleading the staff, from top to bottom, and getting prospective business clients and investors excited about getting involved with the company. Everyone has been around that infectious personality that lights up the room, and you can’t help but be excited by that person. That is who you need to be. But, and this is a big but, everyone has also been around that person who you feel is trying to sell you the Brooklyn Bridge. So, it is important that your sales and motivational skills, are tempered with equally important business judgment and intellect to come across as credible and backable to all parties involved.

5. Manage to key targets and budgets.

Keeping the business on plan, on budget and liquid is a no brainer requirement for any startup CEO. The CEO needs to set acheivable proof-of-concept points, and put key managers in place for hitting those goals. That means building a management dashboard of the key drivers for your business, that are going to dictate its success or failure. For iExplore, it was all about: (i) driving traffic to the website; (ii) getting those visitors to contact us; and (iii) getting those contacts to convert into a sale. So, all energy went into driving those three datapoints, with one key manager in charge of each datapoint (e.g., head of marketing drove traffic, head of web design drove contacts, head of call center closed transactions). Figure out your key drivers, and get the right team members to manage them accordingly. But, more importantly, you need to be able to quickly identify when things are not going to plan, so you can put new initiatives in place to make up for any shortfall. The longer you let cash-using problems go unfixed, the shorter your liquidity runway, and the higher odds you will run out of money and potentially go out of business. So, plan accordingly.

6. Keep the company liquid and in business.

The worst thing that can happen to any startup is running out of capital mid-launch or prior to full proof-of-concept, that would attract additional capital. So, it is the CEO’s job to make sure those proof-of-concept points are clear to the entire staff, a reasonable timeline has been created to achieve those points and the company has enough cash (including a cushion) to get to those goals. The best people to solicit proof-of-concept input are your prospective investors. Ask them, “what are you looking for before you would be willing to fund our business?”, and firmly focus on hitting those targets. And, when raising money, always raise more than you think you will need, to leave a material cushion for when things go wrong, as they always do with startups. And, if necessary, make the hard decision to cut payroll or overhead, to give the company a long enough runway to live another day.

There is no single right answer for “who makes for the best startup CEO?”, as everyone is different in terms of skills, style and personality, and every business is different in terms of economic, industry and competitive dynamics. But, the above is a good summary of the types of people that have the best odds for success in becoming a successful startup CEO.

Source: www.forbes.com

Private Placements: What happens if you fail to file Form D (or file it late)?

Form D is a document that the SEC requires a company to file when it issues securities in a private placement under Regulation D. It must be filed with the SEC within 15 days of the first sale of a security in a private placement. In addition, for offerings made under Rule 506 (the most frequently used part of Regulation D), an issuer must also file a copy of Form D (along with a filing fee) with the securities administrator of each state in which purchasers of the securities reside within 15 days of the first sale within each state. Overall, Form D is a relatively simple document to complete and file; however, it’s very easy for a small company to overlook filing one, especially if it doesn’t use qualified legal counsel for its securities offering. I frequently get asked about what happens when an issuer fails to file Form D or if the issuer files it late. This post describes what consequences can and cannot occur.

The first consequence an issuer might be concerned about is losing the federal private placement exemption and consequently be in violation of securities laws by improperly selling unregistered securities. Thankfully, a failure to file a Form D does not result in the loss of the federal registration exemption. The SEC has issued guidance on this in Question 257.07 of the Securities Act Rules Questions and Answers of General Applicability. While filing Form D is a requirement for using a registration exemption under Regulation D, it is not a condition to qualifying for the exemption. Instead, the only potential consequence on the federal level is that the SEC could take action against the issuer and seek to have the issuer enjoined from future use of Regulation D under Rule 507. If the violation is willful, it could also constitute a felony.[1] Despite the fact that Form D is not a condition to being exempt under Regulation D, I would caution issuers to not take their responsibility to file Form D lightly. Often when an issuer is sued in court, the plaintiff will accuse the issuer of violating the federal registration requirements of the Securities Act. In such instance, the issuer will bear the burden of proof to prove that the securities offering met an exemption under Regulation D. While courts have explicitly stated that failing to file Form D does not create a private right of action, an issuer may be assisted in meeting its burden of proof that the securities were issued pursuant to an exemption under Regulation D by producing a properly filed Form D.[2] Therefore, while failing to file Form D may not result in the SEC seeking penalties against an issuer for selling unregistered securities, it could put an issuer at a disadvantage in civil litigation by eliminating one piece of evidence that an issuer can use to build their case that they substantially complied with Regulation D. In addition, the SEC may seek substantial penalties against an issuer who has failed to properly file Form D.

The other question an issuer may be concerned about is what are the consequences for failing to file Form D at the state level. Most Regulation D offerings are conducted through Rule 506. When an issuer makes use of Rule 506 to issue securities, those securities are considered “covered securities,” and state registration requirements are preempted. However, states are permitted to require that the issuer file a copy of the Form D (along with a filing fee) with the state securities administrator if the issuer has sold its securities to the state’s residents. Is the preemption of state securities registration requirements in a Rule 506 offering lost if the issuer fails to file with a state? The SEC’s position is that it is not. Under Question 257.08 of the Securities Act Rules Questions and Answers of General Applicability, the preemption is not conditioned on properly making a notice Form D filing with a state. One word of caution: some states take the opposite position. The Wisconsin Department of Financial Institutions for instance takes the position that if a Form D is filed late in Wisconsin, the issuer must find another exemption or register the security.[2] My personal opinion is that if the Wisconsin Department of Financial Institutions ever took the case to court and claimed that a Rule 506 offering needed to be registered because a Form D was late, Wisconsin would lose that case, as courts have repeatedly held that failure to make a notice filing does not strip the offering of the status of a “covered security.”[3] But taking such a case to court would be expensive. In addition, there can still be significant consequences on the state level beyond losing a registration exemption for an issuer who fails to make required notice filings. States can issue fines or even stop orders, preventing further sales of securities by an issuer. Arkansas, for example, is one state that has been particularly aggressive in issuing fines for late Form D filings.

The good news here is that if an issuer accidentally fails to file a required Form D when conducting an offering or files it late, that will not invalidate the private placement registration exemption, which would potentially be a catastrophic event for an issuer. However, the SEC and state securities administrators can still issue fines and prevent an issuer from engaging in future private placements, so issuers still need to be diligent in making all required securities filings when conducting private placements.

Footnotes

[1] See Hamby v. Clearwater Consulting Concepts, Lllp, 428 F.Supp.2d 915, 920 (E.D. Ark., 2006).

[2] In a court trial, the issuer would have to produce additional evidence to show substantial compliance with Regulation D, such as subscription documents that evidenced an inquiry into whether the investors were accredited or sophisticated.

[2] See http://www.wdfi.org/fi/securities/regexemp/exemptions/23_19_506.htm

[3] See for example Chanana’s Corp. v. Gilmore, 539 F.Supp.2d 1299 (W.D. Wash., 2003) for an example of a case where a court concludes that a late filing does not cause a security to lose its status as a “covered security.”

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© 2011 Alexander J. Davie — This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.

Source: Strictly Business