SEC Greenlights One Style Of Equity Crowdfunding For Startups

http://techcrunch.com/2013/03/28/equity-crowdfunding-sec/

by mittal • 13 years ago

129 36 13 years ago

techcrunch.com

jpdoctor3• 13 years ago

I love the idea, but what is the plan to keep fraudulent fundraisers away?

thetrumanshow• 13 years ago

Due diligence.

rattray2• 13 years ago

FundersClub carefully vets all their companies; unlike platforms like IndieGoGo (which serves a different purpose), it's a very "hands-on" process with FundersClub ultimately creating an investment vehicle (LLC) for each company they feature. More: https://thefundersclub.com/site/vetting/

jpdoctor3• 13 years ago

That only makes it more confusing. Look at the list of big names: When a big name gets a hold of a company they believe in, they usually take every share they can get for themselves.

Put another way: If someone thinks a company is going to provide a great return, why would they want to share that return with you?

mittal4• 13 years ago

Extensive due diligence.

InclinedPlane2• 13 years ago

What keeps the fraudsters out of ordinary investing? I'll give you a hint, they're there. Hopefully there will be enough visibility and due diligence to keep them in check.

niggler2• 13 years ago

Based on the verbiage, FundersClub is allowed to slide because "FundersClub and FC Management are advisers solely to venture capital funds", which has a very specific meaning that doesn't apply to crowdfunding.

It's pretty clear that WeFunder will need to be registered broker-dealers. I'm surprised they didn't do it already -- it's not a particularly expensive or time consuming process (and here in NY at least people set up BDs all the time because investment banks and most funds won't pay finder's or other fees to entities that aren't broker-dealers)

mittal4• 13 years ago

Correct, FundersClub is a venture capital advisor (ie, a VC), and is not relying on JOBS Act exemptions or a broker-dealer registration. The TechCrunch article title is not technically accurate, though in their defense, people do seem to want to group online VC in with crowdfunding at a high level. There are important distinctions, however.

joshconstine• 13 years ago

I'm Josh, the author of the TechCrunch article. I've updated the post to reflect the differences between equity crowdfunding and the online venture capital model FundersClub uses. I've also noted that WeFunder takes the broker-dealer route.

gbelote4• 13 years ago

Yep - we (Wefunder) already have a broker dealer partnership and one of my cofounders has taken the Series 7.

niggler2• 13 years ago

Out of curiosity, who are you using for finop (or is someone taking the 27)?

rattray2• 13 years ago

I'm personally tremendously excited about FundersClub. It seems like they have the right mix of a hands-on, closed system (for fundraisers) and self-serve, open system (for accredited investors, more or less). I am curious how much each startup has raised through the platform, though. They claim over $26m in total, split over (at least?) 8 companies: https://thefundersclub.com/site/pastinvestments/

mittal4• 13 years ago

Thanks! Right now, our seed investments per startup have ranged from ~$100k to over $500k. We have publicly announced about $4M of FundersClub investments. The $26M figure is the total capital going to our portfolio companies--other VCs frequently lead, co-invest, or follow-on to our investments, leveraging our own capital. We have invested in more than 8 startups but have not yet announced them publicly.

gbelote4• 13 years ago

It's great to see progress with the SEC and crowdinvesting. Even though we (Wefunder) aren't dependent on the JOBS act and the SEC, it's great for everyone that they're making this grey territory lighter!

ChuckMcM2• 13 years ago

I hope this turns out well. As a dot-bomb survivor I recognized that a big chunk of that bubble was gullible 'retail' investors and unscrupulous people happy to separate them from their money. One CEO at the time remarked "these folks have more enthusiasm for the company than I do, that seems backwards."

My worry is that we'll get a race of people who have only seen (or read about) startups that when from a hundred thousand dollar investment into billions, dumping money they cannot afford to lose into these things. That would trigger a bunch of excess capital seeking outlet and result it being used inefficiently, and when these folks learned about the "9 out of 10 start-ups don't make money for their investors" truism, they will be angry and litigious. The latter because it was shown in the previous bubble that someone who invests 25,000 in a company with a sock puppet spokespuppet, loses most of that investment while the CEO gets a nice golden parachute package, is an easy mark for a plaintiff attorney looking to drum up business. Its a circle of pain.

So knowing it can go wrong and be painful, lets be smart about avoiding that ok?

mittal4• 13 years ago

You're absolutely right to call out these concerns ChuckMcM. FundersClub is a curated VC platform that carries out vetting and due diligence; fewer than 5% of inbound startups end up even making it to our vetting panel.

Even in spite of the above process, startup investing is risky, as we disclose in our FAQ. No one should invest money they cannot afford to lose in the startup asset category.

Also, something that might get lost in the noise around this article: "Technically, it’s not crowdfunding, but rather a venture capital advisor that raises funds online through a streamlined process rather than offline with traditional paperwork."

orangethirty3• 13 years ago

Hmm... So I go and buy a lottery ticket. Then go around selling people a piece of the ticket for 1/10 of what it cost me ($1, so 10 cents). I sell it to 100 people, and manage to make $9. Cool. I made money. But what happened to the lottery ticket? Did I win? No. The aim was never to have the winning ticket, but to sell a piece of the ticket and profit. What happened to those that bought a share of the ticket? They stopped playing the lottery.

Even in spite of the above process, startup investing is risky, as we disclose in our FAQ. No one should invest money they cannot afford to lose in the startup asset category.

Stop calling it an investment. What you do is pure speculation. It is not an investment fund per se. But a speculation fund. But you can't call it that due to how people do not like the word "speculation" (for a reason).

I just think this "startup" is going to set off a lot of copycats and thus mark the beginning of the end.

Anyhow, I'm not against it. God knows I want this model to happen, so I can buy more cheap stocks.

jpdoctor3• 13 years ago

> Technically, it’s not crowdfunding, but rather a venture capital advisor that raises funds online through a streamlined process rather than offline with traditional paperwork.

Nice. So the VCs won't have to answer to big limiteds, who would make demands like lowering fees (as in the dot-bomb).

It brings up the more general question: Since the avg retail guy is clueless, what prevents them from getting severely taken advantage of? So far, this looks a whole lot like CMGI.

gbelote4• 13 years ago

These are good concerns. There's a whole bunch of companies trying to move into the crowdinvesting / online VC space, and there's going to be a whole spectrum of platforms and startups trying to get some action.

Sites like Wefunder (disclosure: I'm a cofounder) and FundersClub put a lot of emphasis on vetting, for obvious reasons. You need "A player" startups to draw other "A player" startups, and if your selection of companies for investors to invest in are duds your ecosystem will collapse and everyone will lose money. Vetting helps keep the ecosystem healthy, but note: it's really hard to pick winners, startups are very risky investments, and at the end of the day never invest more than you can afford to lose.

While the JOBS act isn't in effect yet, there are a few protection mechanisms that are meant to avoid the situation you describe. Namely: unaccredited investors can only invest 5% of their income (10% if you make over $100k/yr). This protects you from losing your life savings. Also: unaccredited investors must invest through a crowdinvesting portal, and there are regulations around how those operate (e.g. the funding round must "tip" by hitting a target amount). There's a bit of "wisdom of crowds" that might help protect investors, but it depends on the crowd, how vulnerable crowd investors are to hype, and how good the fundraising platform is at helping crowds discuss/vet startups.

It's my personal belief, however, that simple startup failure will dominate fraud. Startups are hard! Even smart, motivated, well-connected founders fail. The best protection is to diversify your portfolio (e.g. make 25 $1k bets instead of one $25k bet).

ChuckMcM2• 13 years ago

"Sites like Wefunder (disclosure: I'm a cofounder) and FundersClub put a lot of emphasis on vetting, for obvious reasons."

Yup, and this is essential.

The failure mechanic is that if you're successful, there will be a number of people who don't pass the 'vetting' but they want to participate. That demand will be met by people who don't do vetting, or choose to interpret vetting in a way that allows this person to participate.

A lot of the bad mortgages that were written in the real estate bubble were fraudulent, the "good" mortgage companies took care to insure that their customers could afford a mortgage and would be reasonably able to pay it back. The people who didn't qualify weren't served by them. Instead they were served by people who were less scrupulous.

This is the conversation we need to be on the look out for;

"Those guys turned you down because the rich folks don't want people like you getting in on this sort of deal and suddenly becoming rich like them, they are trying to keep you out by setting bars that says, 'Hey, if you aren't already rich you can't play here.' but that's not fair, is it? We are on your side, we're here to make you rich not to make rich people richer. Sure you can invest your 401k in so called 'index' funds, but with our clients will put it in a dozen different startups, anyone one could make you a millionaire and if two or more make it big, well lets just say I hope you remember the guy that made it possible for you. So are you in or not?"

Wefunder, FundersClub, the initial round of crowdfunding will all (hopefully) be great success stories. And if they are successful someone is going to create the "Countrywide" equivalent to them and fleece a ton of people. That is my fear and I don't know how to prevent it.

michaelochurch2• 13 years ago

Personally, I'd like to see a way for investors to put money into some kind of broad-based startup index fund. I agree that people shouldn't be putting their life savings into a single startup. We don't like taking on that kind of personal risk (that's why we raise money) and they shouldn't have to, either. They should be able to take, say, $10,000 and put it into startups, plural.

Also, given that you're going to have a "power law" distribution of returns where a couple black swans are responsible for a large amount of the return, it's good for most investors to be in the whole spectrum; otherwise you get a St. Petersburg Lottery phenomenon where median returns are much lower than the (presumably quite high) expectancy.

jeffwass3• 13 years ago

FundersClub offered exactly that, the YCS13 fund that invests in about 10 companies in the YCS13 batch, with a $10k minimum investment. It closed about two months ago.

JumpCrisscross• 13 years ago

The best way to do this is probably a VC fund. Unlike public equities, a broad-market benchmark for startups faces low survival rates, limited liquidity, and ambiguous inter-round valuations - the tracking error would probably render the index useless.

PaulHoule• 13 years ago

As long as it is stuck to "accredited" investors it's pretty boring.

I think the SEC is going to forced to give up on this concept after a few more years of conventional investment instruments available to most people struggling to keep up with inflation.

It's definitely true that some accredited investors are smart about investing but plenty of them are just people with a lot of money.

matthewmcg• 13 years ago

That's precisely the intent and effect of the JOBS Act: to open opportunities like these to unaccredited investors.

zaroth• 13 years ago

There are some interesting characteristics of the arrangement between FC and the investors. Obviously it's a free market, and if FC is the best way a VC/accredited investor can get access to a startup they want to invest it, then maybe it's worth the cost, but IMO FC is taking a pretty big cut (from the VC) for their due diligence, making an introduction and pooling money. Personally, I discount the "due dilligence" aspect because a VC that doesn't do their own due diligence isn't a VC, and isn't someone you want investing in your company.

They do make things pretty easy on the startup. Having gone through a Reg D/504, it does take time to deal with the EDGAR and state-specific filing requirements, but it's not exactly rocket science either, and personally I found it fun to learn the system and successfully close a round on my own.

There are some interesting terms attached... In particular: - They vote all the shares on behalf of the investors, - They take up to 30% of the profits as carried interest, - They can resell on secondary markets if they become available, - And they can fully withhold their shares from an offer they don't like. For comparison, YC Series AA term sheet requires consent of 50% of the preferred to sell, and they can participate pro-rata. TechStars Series AA term sheet simply allows the preferred to participate pro-rata. - No mention of if their standard liquidation preference is participating, or anti-dilution clauses, neither of which [a startup] would typically want in a Series AA, but that's irrelevant to the SEC.

Quoting their letter to the SEC:

- FC Management manages the investment funds of which it is the manager. FC Management exercises any management rights negotiated with the start-up company (for example advisory board status, rights to review books and records, access to board materials, and/or access to management).

- FC Management has the ability to vote the investment fund's shares in any matter requiring a vote of the start-up company's shareholders. FC Management has the ability, subject to the terms of its agreement with the start-up company and applicable federal and state securities laws, to offer or sell its securities in the start-up company in the secondary market (if such a market exists or develops), or to offer or sell those securities back to the start-up company or to other existing investors in the start-up company.

- If the start-up company is the subject of a tender offer, FC Management has the right to decide whether or not to tender the shares owned by the investment fund.

Upon the liquidation of such a fund,the proceeds of the fund would be disbursed as follows:

(1)first any remaining out-of-pocket third-party expenses of the investment fund, to the extent not already paid out of the administrative fee, would be paid;

(2) second, the capital contributions of each of the investors in the investment fund would be repaid; and then

(3) third, any remaining profits of the investment fund would be distributed on a pro-rata basis, with a percentage to be paid on a pro-rata basis to the investors who had made capital contributions to the investment fund, and the remaining percentage to be paid to FC Management, Inc. in return for its role in organizing and managing the investment fund. The amount of this "carried interest" to be earned by FC Management would be disclosed to all investors in the fund at the time of the organization of the fund. We anticipate that amount of carried interest in most cases would be 20% or less of the profits of the investment fund, but in no event would the amount of carried interest exceed 30%.

michaelochurch2• 13 years ago

This is a huge win.

FundersClub: have you thought about including profit-sharing (instead of a payoff at "liquidity", which might never happen for a profitable lifestyle or mid-growth business that still manages to kick out profits for 20 years) as a mechanism for returning funds to investors on a more immediate basis? If there's transparency in compensation, you can actually make this very fair to investors, and more fair to employees than the current VC-istan model. It would, even more importantly, provide a template for financing of mid-growth businesses (a "fleet" of thousands of so-called "lifestyle businesses" focused on cultural health and ~20%/year growth instead of VC-istan's 150%) that are currently underfunded.

Here's an exposition of how that would be structured to make it fair to everyone: http://michaelochurch.wordpress.com/2013/03/26/gervais-macle...

InclinedPlane2• 13 years ago

This is a win, but it's still a bit disappointing. The SEC has been directed by law to come up with rules to allow the crowd funding provisions of the JOBS act to come into force and they've blown past the deadline and been dragging their feet. I think there are a lot of people in high positions there who just want to see the whole thing go away.

SEC Greenlights One Style Of Equity Crowdfunding For Startups

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