Exemptions

Securities laws are complex. Each state - as well as the SEC - highly regulates the manner in which equity or debt may be sold. To avoid the incredibly expensive regulations public companies comply with, startups must qualify under one of several federal exemptions from securities registration. Startups on Wefunder use one of the following federal exemptions:

Regulation D, Rule 506(b) - Private Fundraising

Companies using the Rule 506(b) exemption can raise an unlimited amount of money from and a maximum of 35 unaccredited investors. Almost all startup investing occured this way until late 2013.

There's one catch. Companies using Rule 506(b) cannot advertise their fundraising. On Wefunder, only our community of pre-vetted accredited investors may see these deals after they are logged in.

Regulation D, Rule 506(c) - Public Fundraising

This is a new exemption released by the SEC on September 23rd, 2013. Like Rule 506(c), startups using this exemption can raise an unlimited amount of capital from . But unlike 506(b) these startups can advertise their fundraising to the public.

There's a downside. Startups using 506(c) must verify that all their investors actually are accredited. This may require the investor to provide a letter from their lawyer, or it can be as burdensome as requiring tax returns or bank statements.

Learn more about 506(c)

Regulation Crowdfunding

Created by the JOBS Act, Regulation Crowdfunding allows startups to raise up to $1,070,000 per year from an unlimited number of investors, no matter how wealthy they are. This law gets rolled out May 16th, 2016.

Investors are also limited in the amount of capital they may invest in Regulation Crowdfunding startups per year. To calculate your investment limit, first choose either your net income or net worth - whichever is lower. If the lower number is over $107,000, you are allowed to invest 10% of it each year. Otherwise, only 5%. For instance, if your income is $96,000 and your net worth $200,000, you'd be legally allowed to invest $4,800 per year in startups.

To find out your annual investment limits, open an investor account.

Regulation A

Also known as Title IV of the JOBS Act, Regulation A+ allows startups to raise up to $50 million per year from an unlimited number of investors, no matter how wealthy they are. Companies can think of Regulation A+ as a mini-IPO, allowing them to gauge public interest without the strenuous fees and reporting requirements of actually going public before they're ready.

Investors are also limited in the amount of capital they may invest in Regulation A+ startups per year. Non-accredited investors may legally invest no more than 10% of their income or net worth—whichever is greater. Accredited investors (those who have an income of $200K+ or have a net worth of over $1 million) have no investing limit.

To find out your investment limits, open an investor account.

Deal Terms

Valuation Cap

The valuation cap is a term in a Convertible Note or SAFE that puts a ceiling on the conversion price. It rewards the first investors more appropriately for the extra risk they took by investing early.

For example, let's say you invest in a startup with a convertible note that has an $8 million dollar valuation cap, and, one year later, the startup raises their Series A at a $20 million Pre-Money Valuation

Without the valuation cap, your note would convert into equity at the $20 million valuation. But with the cap, your note would convert as if the valuation was $8 million, giving you more equity at a much better price per share than the venture capitalists that just invested.

Discount Rate

The discount rate is a term in a Convertible Note or SAFE that gives investors a reduced price to that paid by the Series A investors.

Let's say you hold a convertible note with a 20% discount rate. If a venture capitalist invests in that company at $20 million valuation paying $3 per share, your note converts to equity at $2.40 per share. Note that discount rates usually are only applied when the valuation is below the Valuation Cap.

Interest Rate

An interest rate is often expressed as an annual percentage of the principal. It is calculated by dividing the amount of interest by the amount of principal.

In a Promissory Note, interest plus principle is often repaid in monthly, quarterly, or annual dispursements.

However, while Convertible Note have an interest rate, the interest and principal are rarely repaid in cash; rather, the accumulated interest entitles the investor to receive more stock if and when the note converts to equity.

Pre-Money Valuation

The pre-money valuation is the valuation of the company before an investment has been made. It does not include the value of the cash a venture capital firm is about to invest.

Pre-money valuations are determined by supply and demand. 'Hot' startups often have multiple venture capitalists chasing after them, and therefore command a higher valuation.

Post-Money Valuation

The post-money valuation is the valuation of the company after the investment has been made. It is equal to the pre-money valuation plus the amount of the investment.

For instance, a venture capitalist might determine a company has a pre-money valuation of $15 million. The VC then invests $5 million in exchange for a third of the company. The post-money valuation is $20 million.

Other Jargon

Accredited Investor

An Accredited Investor - with a few exceptions for entities - either has over $1 million in net worth (minus their home) or earned over $200,000 for the past two years and expects the same this year ($300,000 if joint with spouse).

Seed Round

A seed round is the first significant money a startup receives, typically from many angel investors. While there are exceptions, most seed rounds raise between $500,000 and $2 million.

Series A

The Series A is the first investment by a venture capitalist. In the past, startups raised between $2 and $5 million for their Series A. In recent years, some of the best startups have been receiving well over $10 million from their first venture capital investment. It's been getting cheaper for startups to make more progress with their seed funding, increasing their price when venture capitalists finally invest.

Carried Interest

Carried Interest is a share of the profits from an investment.

It's paid by backers to Club Members, typically when a startup is acquired or after an IPO.

Example: Backers invest $1M at a $10M valuation. In five years the initial $1M of equity is sold for $300M. If carried interest is 20%, Backers would pay the Club $59.8M [($300M - $1M) * 20%]. Less carry, Backers earn a profit of $239.2M.