Crowdfunding: An Interim Report

Joseph W. Bartlett, Counsel, Reitler Kailas & Rosenblatt LLC

  1. The Need for Action. An interesting piece of evidence that the startup economy in the United States is accruing increasing support from both the participants on the ground, including just about every academic center, the policy makers … Titles II and IV of the JOBS Act are already in place authorizing forms of crowdfunding Title III is now out of the box as well, and the expansion of Rules 147 (intrastate) and Rule 504 (Rule 147’s cousin) are on their way toward joining the Makeover http://josephbartlettvc.com/2015/01/07/the-makeover/.  This tsunami (likely although, of course, not certain) in financing emerging growth companies follows shortly after June 19th when the Title IV Regulations were finalized, lifting the curtain on so-called mini “IPOs” under Reg A+.

  1. At this stage in the proceedings, it is difficult to forecast with any degree of certainty how much capital will flow into the startup economy from online investors but, if “accredited crowdfunding” under Title II, which has been around for a while, is any indicator, it is likely that quite a bit of investor cash will follow the channels which have been set up by the Congress and the SEC.[1] The rationale for this process, as recognized by academia, the political policy makers, regulators, and investors and entrepreneurs running at flank speed is summarized in the following language from the New Yorkers’ profile of Reid Hoffman, the founder of Linked in:

“Hoffman likes to cite a statistic from a United Nations paper on sustainable development goals: the global economy will need six hundred million new jobs over the next twenty years, and existing business can provide only ten to twenty million of them. The rest, he claims, will have to come from startups, so societies everywhere will have to reorient themselves significantly in order to make entrepreneurship easier.”[2]

  1. Platforms. In addition to the officially recognized methodologies of crowdfunding, there is a steep J curve in the creation of online speed dating platforms, which I am following with great interest and analyzing; a pre-publication paper is attached.

Given this new ecosystem in U.S. capital markets, interest is increasingly captured by the multiplication of speed dating “platforms” which are bringing together … in the same room so to speak, i.e., an online web site … investors and emerging growth companies seeking capital (“EGCs”). The word “platform” in fact crops up in every third sentence one hears in the course of discussions on the entrepreneurial/innovation economy in the U.S., assuming the subject matter has something to do with raising capital.[3] Both the virtue and vice of “platform” is that, like “metric,” the word can mean just about anything the speaker wants it to mean (“it means just what I choose it to mean” in the immortal words of Humpty Dumpty).[4] A long winded introduction to a listing of the enterprises which I have in mind and forecast (speculation) on what all this may mean.

Let me illustrate by running two lists;

List One:

Players which have a Recognized Profile and a Tested Method of Doing Business

  • Secondary Exchanges …SharesPost; Second Market
  • Venture Exchanges ….OTCQB
  • Accelerators …Y Combinator; TechStars; Start Engine; Accelerprise Ventures
  • Alternative Trading Systems; SEC approved in 1998; Regulation ATS
  • Business Development Companies launched in 1980 to “democratize” venture investing
  • Rewards based platforms… Indiegogo; Kickstarter
  • Rule 506(b) curators like AngelList; FundersClub; Circle Up
  • Rule 506(c) platforms … EarlyShares; Crowdcube.
  • Physical incubators … office space; ping pong tables; co-locating entrepreneurs with investors
  • Spin outs from academic laboratories licensing technology and sourcing capital from the university’s bank account
  • Demo Days. The issuers tell their story from the podium to a pre-selected audience and/or the issuers say nothing about soliciting capital, deal terms or the like.[5]
  • Title III portals
  • Registered Exchanges …NYSE; NASDAQ; OTCQX, OTCQB, and the Pinks

List Two:

All Others

What has my undivided attention at the moment is List Two, which I am describing as “all others.” In that category I am including the likes of GrowVC; Crowdcube; Microryza. These are ‘platforms’ which do not seem to fit into any of the categories recognized as ‘tried and true.”

They appear to be the equivalent of dating bars or restaurants where the parties, the buy and sell sides, can relax, meet up, dress themselves properly, deliver an attractive story and take the temperature of potential sponsors on the platform … too hot, too cold or just right. The drinks served by the bartender can include: model documents; information on valuations; market deal terms and the like.

It is very likely, of course, that many of these ‘platforms’ has been organized with the help of an experienced law firm. And, attention has been paid to such issues as broker dealer registration; general solicitation outside of Title II and Title III, and State blue sky laws which might be applicable. What I’m trying to do is to understand, and then explain to clients and friends, how and in what way these ‘platforms’ could be categorized, meaning identified in terms of (i) functionality; (ii) observance of (or navigation around) securities law, rules, regulations and like matters; and (iii) importantly, how the platforms finance their costs of doing business and provide a profit for the organizers sufficient to make the exercise worth the trouble. Many platforms are “affiliated” with a broker dealer which can charge success fees and deals are closed. Is that the answer? Is there a way for platform organizers to take a piece of the EGC?

On the other hand, will periodic subscription charges … cash required for an EGC to join the Platform and speed date … be adequate? Separate charges to cover certain expenses (legal? Compliance?). This is not an attempt, of course, to stigmatize any such ‘platforms.’ Rather it is a learning experience so that yours truly is in a position to give advice to existing and prospective clients and to panels in which I participate on the theory I know what I am talking about.

The fundamental question: Where is the startup world going if the online platforms display pitch materials and investors can (i) hit the “buy” button and own securities, paid for with, let’s assume, bitcoins (ii) service providers … e.g., Wealth Forge (http://www.wealthforge.com/) … sanctify the process by handling back office and compliance issues (“reasonable steps to verify” if Title II is the window); (iii) “equity research providers” follow the companies so presenting; (iv) venture exchanges provide liquidity … the OTCQB, for example; (v) due diligence is performed by automated systems, a/k/a Watsons, including a trolling of the web for, e.g., bankruptcies, criminal convictions, lurid civil cases and the like; (vi) valuation data is provided by VC Experts www.vcexperts.com (disclosure, I am the chair); (vii) survey data on the market standard in deal terms is also provided by VC Experts, in league with Fenwick & West; and (viii) deal terms are translated into economics through Solium Capital’s Scenarios (https://solium.com/product/scenarios/) .

The objection, of course, is that the odds are that x% (50 +/-) of early stage companies will tank; how will Joe the Plumber have a shot at a bargain? See the following riposte:

First, the remarks from this explorer about the powers of the Internet and the efficacy of dating services. The analogy is driven from John McPhee’s book on The Control of Nature, commenting on the Mississippi River. It finds its own way to the Gulf regardless in the Mississippi’s case, of the Corps of Engineers’ multiple attempts to influence the river bed with dikes, dams, channels, etc. So also, I daresay, is the Internet. It will enable deal flow up, down and sideways regardless of the dicta laid down by a bureaucrat in D.C. or some State capitol. If the political hacks pipe up about fraud protection, we dust off the favor the Massachusetts State securities regulator did the residents of the State by banning, as too speculative, the IPO of … Apple! Think of the money we Bay Staters saved.

O.K., you say, the Internet is powerful but what does that mean to an investor looking at a FinTech play 3000 miles away? Equity research, you say? Won’t happen, say the critics? The institutions won’t find it dignified (my word) to troll for deal flow on the web. When I recently advanced that theorem to a crowd of younger players, they howled, “Dignified?”, said one. “Fifteen years ago,” he remarked, “it was undignified to look for a spouse on the internet. Now,” he said, “everyone does it.”

Well, how about social media? Encourage Joe the Plumber to troll the web, find the plaudits and/or stink bombs? Do the research the modern way … electronically. Encourage the establishment of online bulletin boards which solicit information from the web on each startup seeking capital and, with the appropriate caveats in the Terms of Use, make the same available to subscribers.

What if the platforms worth their salt band together and hire a curator (I have one in mind) to build a system which tracks each EGC raising capital on the responsible platforms … from start to finish … and forwards the information to a central repository. The data translates into track records … the good, the bad and the ugly. The EGC is dressed up for the electronic senior prom by the likes of Wealth Forge. The confident founders limit the audience by minimum investment levels … at least $50,000 to play. Can Joe the Plumber play alongside an institutional lead?

The short of the matter is that investing in Newco may well become as simple and easy as buying a lottery ticket and, once a few winners have been posted in the news, players now spending cash on lottery tickets, plus Fantasy Football and other “no chance” online gaming, may well lean in that direction. And what if the 99% (or some significant percentage thereof) wind up enlarging their assets by playing in Fantasy Startup, thereby satisfying Jeff Feldman’s theory that asset (vs. income) enlargement is the way to go. For Jeff Feldman’s learned paper on the subject see, Feldman, “Wealth Inequality in the US – The Result of Unintended Consequences and How This Time Can be Different,” Jun, 2015/VC Experts (www.vcexperts.com).

[1] A tip from this corner is for interested parties to log on to the website of Crowdnetic (www.crowdnetic.com) to get the scorecard for Title II, Rule 506(c) from that well known scorekeeper and then keep one’s nose to the wind to see what is happening around and about for the benefit of clients (of which there is no shortage) looking for money on the web these days to get to be the next Google or Facebook.

[2] Leman, “The Network Man,” The New Yorker, October 12, 2015.

[3] Terms of art include “curators” and “chaperones.” Curators are generally labels attached to the parties which select the issuers for presentation on the platform and chaperones have the function of leading the EGCs, or in some cases the investors who have joined the platform, from step one to the final series of steps in closing the deal.

[4] “When I use a word,” Humpty Dumpty said in rather a scornful tone, “it means just what I choose it to mean — neither more nor less.”
“The question is,” said Alice, “whether you can make words mean so many different things.”
“The question is,” said Humpty Dumpty, “which is to be master — that’s all.”

[5] The SEC’s latest take on Demo Days is summarized in Breheny, DeCapo, Deitz, Duggel, Fernicola & Gao, “Corporate Finance Alert SEC Staff Issues Interpretations on General Solicitation Prohibition,” Skadden Arps Meagher & Flom LLP, Aug. 13, 2015.

“Demo Days or Venture Fairs. The Staff stated that demo days or venture fairs do not necessarily constitute a means of general solicitation. If an issuer’s presentation at a demo days and venture fair constitutes an offer of securities, the presentation may not be a general solicitation if audience is limited to persons with pre-existing substantive relationships with the issuers or the event organizer; or persons who have been contacted by members of angel investors networks or similar informal, personal networks of experienced investors.”


Joe Bartlett,  jbartlett@reitlerlaw.com

Reitler Kailas & Rosenblatt LLC

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