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Scott Orn

Scott Orn, CFA

Kelsey Chase of Aumni Discusses the CARES Act PPP Loans and how SBA Affiliate Rules Affect Startups

Posted on: 04/02/2020

Kelsey Chase

Kelsey Chase

Founder & President - Aumni

Kelsey Chase of Aumni - Podcast Summary

Kelsey Chase of Aumni Discusses the CARES Act PPP Loans and how SBA Affiliate Rules Affect Startups.

Kelsey Chase of Aumni - Podcast Transcript

Singer: So, when your troubles are mounting, in the tax or accounting, you go to Cruise, from founders and friends. It’s Cruise Consulting. Founders and friends with your host, Scotty Orn.
Scott: Welcome to founders and friends podcast with Scott Orn of Cruise Consulting. And, before we get to a phenomenal data centric podcast with Kelsey Chase of Aumni, quick shout out to our friends at Rippling. Rippling is amazing for payroll. Amazing for benefits. They’ve got a great integrated tech solution that allows you to spin up or spin down, unfortunately, if your company needs to do that. New employees. But, just connect all your web services super quick. Saves a ton of time. Probably like three hours per new hire. So, we love Rippling, it’s amazing. Also, shout out to the cruise tax team. They’re working super hard. And, special shout out to the cruise P-P-P loans, the CARES Act task force, they are kicking butt. Right now, I think we’re pulling data for something like 85 or 90 companies. Like, right this second, when I’m recording it. So, Cruise team doing phenomenal work. Very proud. All right, now let’s introduce Kelsey Chase of Aumni. Welcome, Kelsey.
Kelsey: Yeah. Thanks, Scott. Thanks for having me. It’s a pleasure being back here. I know we did a podcast a few months ago. But, I’m excited to dive into the subject at hand, today.
Scott: You got to do something right to the second time guest. Let’s just say the list is not that long and it’s distinguished. So, congrats to you and it’s awesome to have you on now. For those who don’t know, well, why don’t you tell people what Aumni does. Because, it’s phenomenal.
Kelsey: Sure. So, Aumni is an automated investment analytics platform for venture capital. So, my relevant, for the discussion today, but, just generally, my background was I came to the startup world as a prior corporate lawyer. So, worked at some large law firms including Wilson Sonsini and D-L-A Piper. And, from that experience, working with investors and entrepreneurs, became aware of a pain point in the industry. And, so, what Aumni does today is we focus in the underlying legal agreements that document all of these private investments in the startup and venture ecosystem. So, kind of relevant, just of recent, even with the subject today talking about CARES. But, just generally, when the market dynamics shift as abruptly as they did, you know what starts to matter? Contracts. And, the truth is anyone that’s anyone that’s negotiated these deals knows that these contracts are very long, complicated, lots of legal horsepower goes into negotiating these deals. And, so, what Aumni does is we bring those documents to life and we’re tracking tons of legal, financial, and economic data out of these deals. Including some items that we can talk about today.
Scott: It’s like the analytics view I always wish I had when I was at Lighthouse helping as chief compliance officer. I know our finance team really wanted it. But, the most amazing they, and by the way, you guys have this like super sleek interface. It’s pretty cool. You sent, I think, a new webpage out to me or something like that the other day. It was really cool. But, here’s the thing. The single most important thing for venture capital backed startups and whether they apply, they can apply for the CARES Act paycheck protection program loans is whether they have, basically, crossed the affiliate rules for S-B-A. And, I’ve answered this question, I think, 200 times. I’m quoted in C-N-B-C today. This is like the topic that is on every single person’s mind in the venture capital ecosystem. And, guess what? Aumni knows the answer. This is like a watershed moment, I think. It’s phenomenal. I’m just like, I couldn’t believe it. I think Tony emailed me the other day. I was like, “Hey, we know the answers to this stuff.” And, I was like, “Holy shit. Let’s get on a podcast with me.” So, Kelsey, can you tell people what the affiliation rules are? By the way, we’re recording this on Friday morning. So, it’s very possible the S-B-A may waive some of these rules, we don’t know. But as of right now, this is the critical thing. Can you tell people what the S-B-A affiliation rules are and then how Aumni knows this data?
Kelsey: Yeah, I mean, it’s such a fluid situation. Could even a change as we’re speaking. But, yeah, I think, credit to some of our partners in groups that we’re close with. Very close with the national venture capital association. That, just so your listeners understand, I mean, they are doing tremendous work trying to have Congress hear the voice of the startup and venture community. So, just credit the N-B-C-A for all the work they’re doing. And, it’s through learnings and discussions with that organization that we really, I think, refined and focused on some key data points that Aumni can track and bring to light through this conversation. So, at its core, and I’m not holding myself out as an S-B-A expert, but at its core, and I’ll give you my synopsis of this, affiliation really comes down to elements of control. Now, for those in the venture community, control is not a novel concept in investing in a startup company. In fact, I believe venture transactions are founded and reside completely on economics and control. So, control is just a natural element of doing venture deals. So, outside of the circumstances, not necessarily a problem. And, I’m sure as these deals were negotiated previously, no one was negotiating these transactions with a view towards this information getting scrutinized for an S-B-A loan. But, in any event, here we are.
Scott: Real fast. The reason why is because you would never take an S-B-A loan. Because, they used to require personal guarantees. But, the CARES Act, the P-P-P loans, don’t have a personal guarantee. They strip that out as part of the act for this specific kind of loan. So, all of a sudden it became interesting to venture capital backed companies. But, the affiliation rules, which is right where you’re going right now, are what’s tripping everybody up.
Kelsey: Sure. So, there’s a few primary prongs of the test and the analysis based on S-B-A guidance and prior case law. And, it really comes down to control at the board level, control at the stockholder level, and then specifically around operational covenants and restrictions that are imposed on the company. So, effectively, giving investors the waiver right or consent rights for companies to take on certain operational activities. So, at the board level, I think we should just, what we can dive into, Scott, is just some of the data. And, can add some of our own anecdotes around venture. But, in essence, companies are of course controlled and comprise sort of at two major corporate levels, the board of directors level and the stockholders level. And, there are different elements of approval and consent that both of those parties have. I mean, the board is generally in charge of the business direction of the company and stockholders are primarily have control over major corporate activities. But, tying back to this affiliation test. So, one thing that we understand to be a key in point of analysis is, does a particular investor basically control the majority of the board? So, in absence of everything happening right now, that type of leverage and right, it would be very abnormal for one V-C fund to control the board. I mean, that’s kind of one of the tenements of V-C is minority investments and they typically do not take majority control of the company like that.
Scott: Yeah. Yeah. They’re usually like at 20, 25% each. And, they usually have one board seat, sometimes two if they’re a major amount of money. But, no, it’s very rare for one V-C firm to have, for example, two board seats out of three totals. Like you’d always… The entrepreneur would always balance that out. They’d always have another independent or two independence or something like that. So, it’s very rare, like what you’re saying, I’m confirming what you’re saying. So, keep going.
Kelsey: Sure. And, some of the other data points we can talk about today I think are relevant just in the broader market scheme right now. I mean, there are significant changes happening to the economy right now that will impact venture and startups. So, some of the other data points I can reference, we can really tie to the bigger picture. But, back to the affiliation test. So, what our data tells us is less than 0.1% of venture backed companies have a board of directors where a single fund controls the board. So, kind of to our gut check. It’s just something that never happens. So, I think most companies are not at risk of tripping that up. Although, we do have some, but it’s such a significantly low percentage that I’m sure those are such edge case transactions that it wouldn’t look like the typical startup profile. So, our data’s saying less than 0.1% of companies have that.
Scott: Yeah. That’s amazing. So, everyone’s been super worried about this. And, what you’re saying is Aumni’s data says that pretty much everyone’s fine on this test. Because, I think there’s a couple of other tests, aren’t they? Some of the negative protective provisions. But, on this test, probably, almost every startup we see in this is going to be fine. Obviously, check with your lawyer. Don’t take our word for it. We don’t know your cap table. But, Aumni has the data on most of this stuff.
Kelsey: Right. So, I guess tying into one of the other prongs of this analysis is the ownership thresholds. And, there’s a couple of different lenses that we can look at that through. One is, does a single investor own a majority of the company, right? Which, would typically enable them with special control provisions. And, so, again, what our data shows in venture firms are taking minority interest. It’d be highly irregular for a venture fund to take a 51% ownership stake in a company. And, so, what our data shows is about 0.3% of companies do have a single investor that owns a majority. But, again, those are probably out edge case type scenarios. So, most companies, their cap tables should not have owners that own more than 51% of the company. So, on that prong, too, just on the pure ownership test, I think companies will be okay. It’s where we get into the operational covenants where there’s just, frankly, a lot of gray area. And, I think this is where the most concern is, as I understand it from the venture community and startup community based on the existing proposal for CARES. So, again, I think stepping back, the operational negative covenants that we’re talking about, these are contractual limitations that are imposed on private businesses by the investors that restrict the company from doing certain activities, or, require the company to do certain activities without a certain consent or approval rate that can go out to a single investor, can go out to a group of investors, can go out to a class of stock. But, basically there’s these covenants that apply to companies that give the investors control over the business. And, outside of this context, again, nothing crazy or new in venture. This is a typical, industry standard part of the investor rights that V-Cs get when they make investments. But, now, we’re in the situation where this is going to be scrutinized and actually matter.
Scott: I can think of like the dividend test is one that I’ve been pointing people to. Which is like, if an investor can keep your company from issuing a dividend, then the S-B-A thinks that’s minority control. But, it’s the kind of thing that every investor would always have in the investor rights agreement. Because, you can’t put a bunch of money into a company and then let the founder dividend the money out to themselves. Right? Or, everyone else. It defies logic. So, to me, it’s like, yes, I guess that maybe what S-B-A thinks. But, it just seems like a basic part of governance. You need that in investor rights agreement.
Kelsey: Yeah, totally. Yeah. I would emphasize that, in a vacuum, these are control elements. But, in normal course venture deal making these types of rights are totally commonplace. And, I think something that hopefully S-B-A and Congress is getting educated on. That this is just how the entire venture industry runs. I mean, this is not abnormal. So, I think what helps is to throw in some more data that we’re tracking. The typical construct around these rights is typically a simple majority. So, a simple majority of the applicable stockholder base or investor base can approve or waive these covenants.
Scott: That’s super helpful to know. Okay. Yeah. Cool.
Kelsey: How that ties back to affiliation is, if a single investor has that majority, I mean, they defacto have a right to control the business if some of these operational covenants are triggered. So, that’s, I think, where we’re just focusing in on the data. If you take for granted that most of the constructs for these rights do rely on a simple majority, there could be problems. And, companies are going to have to work with council to really analyze their protective provisions. But, what our data is showing, so transactions where there are… There are multiple classes of stock. So, series A-B-C. Instances where a single investor owns more than 50% of that individual class. So, 51% of the series A, for example, it’s about half of companies. So, many companies have this construct, right? Like a lead investor leads this series A. Not crazy that that lead investor would own 51% of the class. If it’s a $10 million deal, they might invest seven million of the series A. So, our data is telling us that about 51% of companies have this existing in their cap table, right? They’ve got a single investor that controls a preferred class. So, what that means is, analysis, I think, scrutiny will be placed on how these protective provisions are constructed. But, in my series A, B, C example, if the C investor is a major investor in that round took the major allocation of the series C investment and they also have these specific protective provisions that prohibit the company from doing certain activities, I mean, I think you really have an affiliation issue. And, so, our data’s just saying there are, and it’s not uncommon, but investors do take a majority position of the existing class.
Scott: Yep. Yep. That seems to be the test. The Cruise lawyer, he’s awesome, Ryan Chaining at S-P-Z. We were talking about that yesterday. So, I just want to make sure I got it right. If a institutional investor has the majority of a single round, like a single share class, like series C or series B, does that mean that you’re failing the affiliation test? Because, I thought if the company had just taken like seed or series A, they might be okay. But, is it progressively get harder as you go through the rounds? Or, is it just any round that institutional investor controls?
Kelsey: So, it really ties into the actual covenants themselves. So, let’s just look, let’s look at an example of a covenant that is a very common covenant existing in most venture backed companies that will cause an affiliation issue if a single fund has the right to control that covenant. And, so, one to just zero in on is, you already mentioned it, making, declaring, or paying distributions or dividends other than tax distributions.
Scott: Yep. Yep.
Kelsey: Highly standardized right that investors get. And, so, if you have, for example, let’s just take a series A company. If you’ve got a series A company and there’s a primary series A investor, also not uncommon, there’s just a single lead investor. So, the series A investor owns 100% of the class. So, I think, by extension, that investor has control over that provision. So, it’s those types of covenants that are going to be scrutinized. And, I think the more that we look at this, if you have instances where single funds really have a de facto right over these provisions, we’re going to have a problem.
Scott: I think the same thing. I mean, first of all, the advice everyone should take away from this is talk to your lawyer and make sure your lawyer signs off that you are not… You’re either okay or not okay. Because, as a founder, you don’t want to certify. The S-B-A and the banks are asking you to certify that you’re compliant. And, so, if you certify and you know you’re not compliant, there’s a false claims act that could really get you in trouble. You just don’t want to take money from the government if you’re not certain. And, I laugh, but it’s really true that you comply. So, your lawyer’s your best friend. Aumni is probably your second-best friend on this. Or, your V-C firm is using Aumni. That’s actually the best. Because, the V-C firm can look in their dashboard and see what the control provisions are and they can also see the ownership levels and things like that. It’s kind of that easy. But, someone needs to give you the clear go ahead or the clear, this isn’t going to work.
Kelsey: Yeah. And, I appreciate that, Scott. And, I do want to leave you, I know we’re keeping this podcast short, but I want to leave you with two other data points that are relevant for the affiliate test. So, we talked about ownership of an individual preferred class. You know, another lens that I think is relevant that really just zeroes in on how much control a single fund has over a company is of the preferred investors, the venture investors, how many companies have an investor that owns 50% of all the classes? So, if you add up the A-B-C shares, are there investors that own 50… A majority of that group of stock. Which, undoubtedly, will have approval rights over these protective revisions. And, our data’s showing-
Scott: Is that like on an as converted basis? Is that how I should think about that? Or, you’re saying own 50% of a 50% of B, 50% of C.
Kelsey: Yeah. I’m saying you add up the A shares, B shares, C shares. And, you’ve got an investor that either participated in one or all of those rounds. But, combine all the shares and they hold a 51% ownership-
Scott: Of preferred?
Kelsey: … Of all the preferred. Yeah. And, so, our data is showing that 15% of companies have this composition in their cap table. So, I think, one just quick interpretation of the data is that, if really 51% of companies have a single investor that controls an individual class, and 15% of companies have a single investor that controls 51% of all preferred classes, we’re going to have some real issues with these affiliation tests and I think a lot of startups are going to be disqualified and not able to take advantage of these S-B-A loans. So, that is why there’s so many folks lobbying and trying to get clarity in interpretations on these rules. But just the nature of how venture is composed, it’s going to be problematic.
Scott: Yeah, and, I was interviewed by Ari Levia at C-N-B-C yesterday, ran this morning. And, don’t say that tooting my own horn, but, C-N-B-C’s top financial reporter in the valley is asking these same exact questions. And, the dude’s super dialed in and super knowledgeable. And, I had kind of the same answer as you, is like, it’s unfortunate. And, I think the other takeaway is like, look, the government’s essentially buying jobs here. That’s what they’re doing. I 100% agree with it. They’re effectively doing an equity injection into these companies. They’re giving them money, they’re forgiving the loan, they’re not taking equity ownership. So, it’s effectively like they’re giving equity in these companies without the ownership, which is super positive. More debt wouldn’t help. But, this helps. And, so, sometimes people are like, well why should venture capital companies be able to participate? But, to me, I’m like, these jobs are just as valuable as other jobs. We’re trying to preserve jobs here. And, so, I’m super pro this. And, I actually really like how the administration got the stuff out quickly. I wish the dates on that sample application would have said April 10th instead of April 3rd. Because, I think they put way too much pressure on basically the entire country to get this in and four days. And, the banks are feeling it right now. And, it was unfair to the banks. But, this is something that I do think venture capital backed companies should be able to participate in this. Because, we’re really just saving jobs here. That’s what it’s all about.
Kelsey: Yeah, totally. I mean, Aumni employees, we’ve got to have an amazing workforce. And, I know there are many other companies and, frankly, ecosystems that rely on the startup community. So, I certainly would like to see clarity around this. And, I think giving some attention to the startup community would be extremely valuable during these tough times.
Scott: Yeah, I totally agree. And, a quick plug for Aumni. If you’re the G-C at a venture fund or the C-F-O or C-O-O or even just like a partner, this is a pretty awesome service. I would just go to the website and just look at the dashboard. Because, to me, if you have a lot of experience in venture, you’re going to connect with this very quickly. This is giving you the database and the analytics to know exactly what’s happening in your portfolio and know exactly what the terms are in each deal. And, it’s moments like this where, it’s not even very expensive, and it’s moments like this where you could be telling all your clients, all your portfolio companies, giving them perfect guidance. So, I just think this is a service that every venture capital fund should be signing up for. It really works.
Kelsey: Yeah. To that point, I mean, our inboxes started lighting up this week from all of our venture C-F-Os and general counsels. And, so, our awesome engineering team responded and we generated this awesome report that gives… Has all of these data points responsive to the affiliation tests and they can view it all in one lens.
Scott: I love it. I love it. All right, man, thank you for coming on at short notice. I’m sorry I pulled you off probably those sales calls. But, I just felt like this was the moment in time for Aumni, it’s like the ultimate validation of what you guys are doing. And, let’s hope we don’t have another pandemic next year. But, you should have visibility in your portfolio. And, it’s awesome that you could also define some of these provisions and how they interplay. Because, I think a lot of startup people, I know a lot of founders listen to this podcast. So, this can be really helpful for them, too.
Kelsey: Yeah. Awesome, Scott. Well, wishing you and your family and your team the best. And, I’m sure I’ll talk to you soon.
Scott: We’re good. We’re safe. Cruise is kicking ass. I’m super proud of our team, so that’s all good.
Kelsey: Awesome.
Scott: All right, man, I’ll catch you.
Kelsey: Thanks, Scott. Bye, bye.
Singer: So, when your troubles are in tax or accounting, you go to Cruise, from founders and friends. It’s Cruise Consulting. Founders and friends with your host, Scotty Orn.

Kruze Cares More - We take our clients’ success - and happiness - seriously. Kruze has worked with hundreds of early-stage companies, many of which have gone on to raise tens to hundreds of millions in venture financing - and a number of which have been successfully acquired by major public companies.

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