BILL ANALYSIS Ó
-----------------------------------------------------------------
|SENATE RULES COMMITTEE | SB 1181|
|Office of Senate Floor Analyses | |
|1020 N Street, Suite 524 | |
|(916) 651-1520 Fax: (916) | |
|327-4478 | |
-----------------------------------------------------------------
THIRD READING
Bill No: SB 1181
Author: Correa (D)
Amended: As introduced
Vote: 21
SENATE BANKING & FINANCIAL INSTITUTIONS COMM : 8-0, 4/9/14
AYES: Evans, Block, Correa, Hill, Hueso, Roth, Torres, Vidak
NO VOTE RECORDED: Berryhill
SUBJECT : Finance lenders
SOURCE : Gunderson Dettmer Stough Villeneuve Franklin &
Hachigian, LLP
DIGEST : This bill exempts specified loans made by venture
capital (VC) companies to operating companies and specified
investments made by VC companies in operating companies from the
California Finance Lenders Law (CFLL).
ANALYSIS :
Existing law:
1. Provides that the CFLL does not apply to a commercial bridge
loan made by a VC company to an operating company, as
follows:
A. "VC company" is a person other than an individual or a
sole proprietorship that meets all of the following
requirements:
CONTINUED
SB 1181
Page
2
(1) Engages primarily in the business of promoting
economic, business, or industrial development through
VC investments or the provision of financial or
management assistance to operating companies;
(2) At all times maintains at least 50% of its
assets in VC investments or commitments to make VC
investments, and maintains or will maintain a material
equity interest in the operating company;
(3) Approves each loan made to an operating company
through the VC's board of directors or similar
governing body, based on a reasonable belief that the
loan is appropriate for the operating company; and
(4) Complies with all applicable federal and state
laws and rules or orders governing securities
transactions when making the loan.
A. "Operating company" is a person other than an
individual or a sole proprietorship that meets all of the
following:
(1) Primarily engages in the production or sale, or
the research or development, of a product or service
other than the management or investment of capital;
(2) Uses all of the proceeds of the commercial
bridge loan for the operations of its business; and
(3) Approves each commercial bridge loan through its
board of directors or similar governing body, based on
a reasonable belief that the loan is appropriate for
the operating company.
A. "Commercial bridge loan" is a loan that meets all of
the following:
(1) Has a principal amount of $5,000 or more, or any
loan under an open-end credit program, whether secured
or unsecured, the proceeds of which are intended by the
operating company for other than personal, family, or
household purposes;
CONTINUED
SB 1181
Page
3
(2) Has a maturity date not to exceed one year and
is made in connection with or in bona fide
contemplation of an equity investment in the operating
company;
(3) Is secured, if at all, solely by the operating
company's business assets, exclusive of any real
property; and
(4) Is subject to the implied covenant of good faith
and fair dealing under Civil Code Section 1655.
A. "VC investment" is an acquisition of securities in an
operating company to which a person, that person's
investment advisor, or an affiliated person of either has
or obtains management rights.
1. Provides that a VC company may rely on any written statement
of intended purposes signed by the operating company for
purposes of determining whether a loan is a commercial bridge
loan.
This bill:
1. Increases, from one year to three years, the length of a
commercial bridge loan to which the CFLL does not apply, when
that loan is made by a VC company, as defined, to an
operating company, as defined.
2. Provides that the CFLL does not apply to a VC investment
that is made by a VC company in an equity security issued by
an operating company.
3. Defines equity security, for purposes of #2 above, by
reference to federal securities law (Section 3(a)(11) of the
Securities Exchange Act of 1934).
Background
The VC industry provides a significant source of funding for a
considerable number of innovative small businesses within
California. According to the National Venture Capital
Association 2013 Yearbook, VC firms invested over $14 billion in
CONTINUED
SB 1181
Page
4
1,280 California companies during 2012.
Despite VC's importance to California, California law is vague
regarding the extent to which firms that provide VC funding to
businesses require lending licenses. The only provision in
California's lending laws that speaks directly to VC provides an
exemption for VC bridge loans, which are defined as loans of up
to one year in length that are made by VC companies, as defined,
to operating companies, as defined. That provision was added by
AB 169 (Chavez, Chapter 163, Statutes of 2003).
The one-year bridge loan exemption was intended to remove
confusion over the treatment of bridge financing under the CFLL
and ensure that VC companies are not subject to the CFLL when
making short-term commercial bridge loans which are not secured
by real property. VC companies provide investment capital to
start-up companies in exchange for a percentage ownership
interest in the company's equity. Equity financing is typically
provided by VC firms in stages, based on the start-up company's
progress in meeting its stated business plan milestones. In
some instances, interim financing in the form of a commercial
bridge loan is necessary, as the company moves from product
development to product sales. AB 169 was intended to ensure
that these bridge loans did not subject the VC firms which made
them to licensing under the CFLL.
In a letter of support it wrote for the 2003 bill, the National
Venture Capital Association stated that "VC and entrepreneurial
activity thrive in a clearly defined regulatory environment."
FISCAL EFFECT : Appropriation: No Fiscal Com.: No Local:
No
SUPPORT : (Verified 4/15/14)
Gunderson Dettmer Stough Villeneuve Franklin & Hachigian, LLP
(source)
500 Startups
August Capital
Battery Ventures
Charles River Ventures
DCM
Felicis Ventures
Illuminate Ventures
CONTINUED
SB 1181
Page
5
Relay Ventures
Sofinnova Ventures
SoftTech VC
VantagePoint Capital Partners
ARGUMENTS IN SUPPORT : According to Gunderson Dettmer Stough
Villeneuve Franklin & Hachigian, LLP (Gunderson Dettmer), they
are sponsoring this bill to modernize the CFLL as it applies to
the VC community. In support of the commercial bridge loan
provision of the bill, Gunderson Dettmer writes, "today's
entrepreneurs in California can do more, for a longer period of
time, with less capital. When venture capital firms invest in a
start-up company via a cost-effective commercial bridge loan,
this further assists the small business in keeping its expenses
under control. Unfortunately, the CFLL imposes a 1-year
maturity date on such loans under the 2003 safe harbor, which is
at odds with the extended time that today's small businesses can
operate on such capital. We believe that SB 1181 (Correa)
solves this issue by extending the permitted maturity date for a
commercial bridge loan under the safe harbor from one year to
three years. Requiring that a commercial bridge loan under the
safe harbor have a maturity date not to exceed one year is an
antiquated, and damaging, limitation."
In support of the provision which clarifies that equity
investments should be treated as investments rather than loans,
the sponsor explains that VC firms may invest in portfolio
companies through preferred stock financings or through issuance
of a streamlined, convertible promissory note. "In such cases,
the principal and interest of the promissory note are
convertible into equity of the company. Because these
convertible promissory notes represent equity investments rather
than loans, we believe that they should be regulated as equity
securities subject to applicable state and federal securities
laws, rather than as loans subject to the CFLL. SB 1181
provides that clarification. The bill makes clear that standard
loans are subject to the CFLL, while instruments that are
considered equity securities are subject to existing state and
federal securities laws and not to the CFLL. Given California's
well-established securities laws and enforcement resources, we
believe that this clarification will result in overall greater
protections to industry participants."
Several VC firms, including Charles River Ventures, Felicis
CONTINUED
SB 1181
Page
6
Ventures, August Capital, Sofinnova Ventures, VantagePoint
Capital Partners, SoftTech VC, and others, believe that "SB 1181
will greatly assist in restoring efficiency for both
entrepreneurs and venture capital funds that use bridge
financings as a means to capitalize small businesses. The
California Finance Lenders Law imposes unwarranted restrictions
on the ability of venture capital firms to finance entrepreneurs
and small businesses in a manner consistent with the practical
needs of venture-backed companies. SB 1181 is instrumental in
removing some of these unnecessary inefficiencies that currently
inhibit the making of commercial bridge loans by venture capital
funds and the issuance of convertible promissory notes by small
businesses."
MW:nk 4/15/14 Senate Floor Analyses
SUPPORT/OPPOSITION: SEE ABOVE
**** END ****
CONTINUED