Discussing the Legal Issues Accelerators face. This includes compliance, liability, and regulations.

1. Legal Issues for
Accelerators
Royse Law Firm
Silicon Valley, San Francisco, Silicon Beach
rroyse@rroyselaw.com
www.rroyselaw.com
Skype: roger.royse
Twitter @rroyse00

2. Lease vs. License
Leases
A lease is an agreement in which the
landlord agrees to give the tenant
the exclusive right to occupy real
property, usually for a specific term
and, in exchange, the tenant agrees
to give the landlord some sort of
consideration. A lease transfers to
the tenant a leasehold interest in the
real property and, unless otherwise
provided in the lease, a lease is
transferable and irrevocable.
Licenses
A license gives the permission of the owner
to an individual or an entity to use real
property for a specific purpose. Unlike a
lease, it does not transfer an interest in the
real property. It is personal to the licensee
and any attempt to transfer the license
terminates it. It is (usually) revocable and
can be either exclusive or non- exclusive.
A facility use agreement (FUA) is a short
form license for very limited use of a facility.

3. Lease vs. License
Lease License
Characterize Bilateral Unilateral
Conveys an interest in real
property?
Yes No
Revocable Usually No Usually Yes
Transferable Yes No
Exclusive Right Yes Optional

4. Regulatory Compliance
There are countless
federal, state, local, and
foreign regulations which
may impact your
business now or in the
future.
Unsuccessful
Precedents:
- Coding House
- Trump University
- ITT Educational
Service

5. Accelerators should consider obtaining insurance to
protect the business from unforeseen and expensive
accidents or natural disasters
Considering Liability
Insurance
Accelerators should protect themselves against tort
liability arising from accelerator licensees and guests
using accelerator property and following accelerator
advice.
Tort Liability
Fraudulent &
Misrepresentation
Breach of Contract
Be careful with advertisement materials and
representations made to participating companies.
Accelerators may be found in breach of contract
just like other businesses.

6. The Core Economics
Equity
(2-8%)
Additional
Investments
Example
Common Stock
Preferred Stock
Stock Options
Convertible Debt
Warrants
SAFE Instruments

7. Ancillary Covenants
» Information Rights
» Anti-Dilution Rights
» Approval Rights
» Pre-emptive Rights
» Investment Rights

8. (Investment)
Convertible Debt v. Warrant

9. Compensatory Options
» Tax of Compensatory Options/Warrants is governed by SEC. 83
» Compensatory: Property received in connection with the performance of services
» “No readily ascertainable value” If the option is not actively traded on an established
market, the option is not considered to have a readily ascertainable Fair Market Value
when granted, unless all of the following conditions exist:
– The option is transferrable by the optionee;
– The option is exercisable immediately by the optionee;
– The option or the property subject to the option is not subject to any restriction
or condition that has a significant effect on the FMV of the option; and
– The FMV of the option privilege is readily ascertainable, considering whether
the value of the property subject to the option can be ascertained, the
probability of any ascertainable value of the property increasing and
decreasing, and the length of the period during which the option can be
exercised Regs. Sec. 1.83-7(b).

10. Google – Time Warner
Dispute
Google was disallowed
$83 million deduction
AOL was issued a $4.6
million IRS notice of
deficiency over the same
deal
Both parties filed petition
against the IRS
If Sec. 83(a) applies,
Compensatory Option is taxed
upon on exercise – the excess
of FMV over the exercise
price.
Sec. 83(h) provides that the
issuer entitled to a deduction
equal to the amount of the
income the optionee realized
in the tax year that included
the year end in which the
optionee realized the income.
Compensatory Options

11. Form Agreements
Standard agreements provided by accelerators may seem like
an easy and cost-effective solution for most startups. But buyer
beware: They may not adequately describe your company
assets or adequately protect your company from liability. For
example, the following provisions will likely need to be modified
according to the particulars of each company:
- Federal vs. State Choice of Law
- 83(b) election
- State-Specific Employment Laws, such as non-competes
- Shareholder Rights and Liabilities

12. Security Laws & Regulation
 Investment Company Act of 1940 (the “40 Act”)
Unlike other federal securities laws, which are designed to protect
investors primarily through disclosure, the 40 Act also imposes substantive
requirements on the operations of investment vehicles known as
Investment companies.
If the incubator is required to register as an investment company, it may
be forced to comply with many regulatory requirements, including:
i. limitations on its ability to borrow;
ii. limitations on its capital structure;
iii. prohibitions on transactions with affiliates;
iv. restrictions on specific investments;
v. limitations on the composition of the board of directors; and
vi. compliance with reporting, record keeping, voting, proxy disclosure
and other rules and regulations.
 Broker/Dealer Registration

13. Security Laws & Regulation
A Typical
Investment Company:
Any issuer (i.e., the
incubator) that is or holds
itself out as being engaged
primarily in the business of
investing, reinvesting or
trading in securities.
An Inadvertent
Investment Company:
The “40% Test”
Exceptions:
(1) Incubators who are not
making and do not presently
propose to make a public
offering and whose
outstanding securities are
beneficially owned by not
more than 100 persons; or
(2) whose outstanding securities
are beneficially owned solely
be “qualified purchasers;” or
(3) Pass the 45% Test

14. Crowdfunding
Jumpstart Our Business Startups (JOBS) Act
» Title II General Solicitation
o The SEC has extended the exemption for private offerings under Rule
506 to allow for general solicitation providing certain requirements are
satisfied
o Can only issue securities to accredited investors and there are
additional filing requirements
» Title III Crowdfunding
o Allows companies to raise a limited amount of funds from the general
public (Effective as of May 16, 2016)
o Investment must be through an intermediary broker or funding portal
» Title IV Regulation A+
o Preempts state registration, allow for what some call a “mini-IPO”

15. Crowdfunding
Jumpstart Our Business Startups (JOBS) Act
Data of 2016
» As of December 31, 2016, 169 companies had filed a Form C to offer securities
under the Title III exemption.
» The average minimum raise sought is $100,000 and the average maximum raise
is $647,000.
» The average time period has been between four and six months.
» Among the issuers, Delaware entities accounted for nearly half (81) of all filers,
with California (21) and Texas (10) entities a distant second and third,
respectively.
» Compliance rate is very low - 15%.
o By January 9, 2017, only 39 issuers had filed a Form C-U. Among those 39 filings, only 14
were filed within the five business day time period, representing a 15 percent compliance rate.
Source: Drinker Biddle Crowdfunding Report

16. Crowdfunding
Jumpstart Our Business Startups (JOBS) Act
Data of 2016
Source: Drinker Biddle Crowdfunding Report

17. General Solicitation
» Rule 502(c) of Regulation D provides that neither the issuer nor
any person acting on its behalf shall offer or sell the securities by
any form of general solicitation or general advertising, including,
but not limited to, the following:
o Any advertisement, article, notice or other
communication published in any newspaper, magazine,
or similar media or broadcast over television or radio;
and
o Any seminar or meeting whose attendees have been
invited by any general solicitation or general advertising.”
» In general, this means that there will need to be a substantial
pre-existing relationship with those to whom an issuing company
makes an offer of securities under Rule 506 (now 506(b)).

18. General Solicitation
» Rule 506(b) – The “Old Way” Preserved
o If a company is not using general solicitation, they can continue to
conduct offerings as they have done in the past in terms of verification
of accredited investor status
o We may see heightened regulatory scrutiny on the issue of accredited
status even for companies conducting Rule 506(b) offerings
» Rule 506(c) – The “New” Way
Issuers can offer securities through means of general solicitation as long as:
o All purchasers are accredited investors; and
o The issuer takes “reasonable steps” to verify the purchasers’
accredited investor status
» Structuring you event
o Demo Days
o Pitch Events

19. Pitch Competitions
» Potential problems under Reg D for pitch competitions and demo
days
o The pitch could be considered a general solicitation and
therefore any presentation materials would need to be filed
with the SEC
o If the pitch is amended after feedback from judges then the
new presentation would need to be filed with the SEC
before the next pitch
» Issuers that break the rules are subject to a one year penalty
o Very onerous and essentially a death penalty for early
stage companies

20. Demo Days, Pitch Events and General
Solicitation
o Open to Public
o Public Audience
o Financials
o The Ask
o Standard Disclaimers

21. Broker dealer registration
Any person engaged in the business of effecting transactions in securities must
register with Securities Exchange Commission (the “SEC”) as a broker-dealer.
Registration is a timely and costly process and requires the broker-dealer to
become a member of a self-regulatory organization such as the Financial
Industry Regulatory Authority.
California has a similar requirement that any person engaged in effecting
transactions in securities in California must be licensed with the Department of
Corporations.

22. Broker dealer vs finders
» The following activities indicate classification as a broker-
dealer:
» Negotiating the terms of the financing transaction
» Offering or providing advice or recommendations in the
financing transaction
» Receiving success-based fees (i.e., fees contingent on the
success of the financing transaction)
» Providing issuing companies with assistance in drafting
or distributing sales and financial materials
» Soliciting investors
» Handling funds involved in the transaction
» Previous involvement and the frequency of involvement in
the sale of securities

23. Broker Dealer
» In 2013, the SEC released two no-action letters confirming that certain fund-
raising websites did not need to register as broker-dealers:
o AngelList LLC
 Matches investors with companies
 Exclusively available to accredited investors
 No transaction-based compensation
o FundersClub Inc
 Posts details of companies to its website after they pass initial
due diligence
 Exclusively available to accredited investors
 No transaction-based compensation
» In 2012, the SEC charged some companies operating secondary markets
for private stock
o SecondMarket escaped unscathed which it puts down to its
transparency, rigid accreditation process, and strict adherence to
rules on general solicitation

24. Pooled Investment Vehicles: Investment funds that aggregate funds from many
individual investors according to a particular investment strategy. Pooled
investment vehicles include investment clubs, partnerships and trusts. Typical
investments include stocks, bonds and mutual funds.
Typical Fund Accelerator Structure
Portfolio
Company
Pooled Investment Fund
Investment Advisory
Committee
Portfolio
Company
Portfolio
Company
General Partner
Individual
Investors
Individual
Investors
Individual
Investors

25. Royse Law Firm
rroyse@rroyselaw.com
www.rroyselaw.com
Skype: roger.royse
Twitter @rroyse00
Thank you!