In case you haven’t had the chance to attend Crowdnetic’s recent Crowd-Financing conference in New York, or haven’t been keeping on top the webinars hosted by SecondMarket or CFIRA, fear not, as we’ve done your homework for you. We’ve created full transcripts, and highlighted some of the most interesting parts.
These conferences and webinars are really the best source for deep insights into the investment crowdfunding industry, as the people that truly understand what’s going on, have a good perspective on the industry as a whole, and have experience working the the SEC on the nitty gritty details, are the platform founders and CEOs, attorneys, and members of industry groups. These are not usually the same people that have a lot of time to pump out blog articles every day, but they do participate in these panel discussions online or at industry events, and tend to get into the meaty technicalities with each other that are usually left out of standard media coverage of crowdfunding.
According to Luan Cox of Crowdnetic:
* As of Oct 1st. 2014 Crowdnetic has tracked tracked 4,800 companies who
checked the box to take advantage of general solicitation [506(c)], and $375
million raised online through the crowdfunding platforms they are partnered
* The LendingClub IPO is a big deal for the investment crowdfunding /
marketplace lending / alternative finance industry. [Lending Club is the
largest peer-to-peer lending platform. Lending Club’s IPO was Dec 4th 2014 on
the NYSE, raising $870 million at a $8.5 billion valuation.]
According to Jason Best of Crowdfunding Capital Advisors:
* The first equity crowdfunded company to IPO is Rewalk, originally funded on
the Our Crowd platform [based in Israel]. [Rewalk makes robotics wearable
exoskeletons for parapalegics. Rewalk raised $36 million in their IPO on the
NASDAQ on Sept 12th 2014, earning its crowd investors 400-500% return.]
* Some themes to look at in crowdfunding portals in 2015: platform
differentiation via availible features, more investor education, competition
over investors and deal-flow, hybridization of funding sources (Participation
by Angels, VCs, and other institutions investing alongside smaller investors.),
increased specialization, or increased globalization.
According to Tim Baker of Thomson Reuters
* Another very exiting offering we saw in 2014 in the “marketplace lending”
part of the investment crowdfunding space is between CircleBackLending, a
peer-to-peer lending platform, and Jefferies, an investment banking firm, in
which Jefferies invested $500 million in CircleBack generated consumer loan
backed assets, which they will securitize and sell on to large institutional
According to Zack Miller of OurCrowd
* OurCrowd has raised $70million
* Biggest challange is not finding investors, but new good deals. Lots of
effort is spent qualifying offerings.
* Investors should expect to lose their money in 40% of equity crowdfunding
* Also seeing more institutional investors investing along side individuals,
including Battery Ventures, the Sequioas, GE Ventures.
* Crowdfunding and Peer-to-Peer lending are capitalizing on banks lower
willingness to lend as they are squeezed by regulation after the crisis.
According to Sohin Shah of iFunding
* iFunding so far has cunded about 25 different projects for a total of roughly
$26 million dollars. The focus is on real estate single and multi-family units
as debt and equity offerings.
* Sees Investment Crowdfuning as a sister industry to “alternative financing”
including peer-to-peer/marketplace lending platforms LendingClub and Prosper.
According to Ryan Feit, CEO of SeedInvest
* Average investment on SeedInvest is $31,000
* There is a shift in value capture from public markets to private markets. As
more investment and growth is happening in private markets pre-IPO, companies
are IPOing later, at higher valuations, leaving less upside for public
* Secondary Markets [where investors can buy and sell shares] are necessary to
for the equity crowdfunding space to grow. Peer-to-peer lending has the
advantage that you start to get feedback and see financial return pretty
quickly. [While with an equity crowdfunding invstment, you might have to wait
many years for a startup to get acquired or IPO beforeyou see a return.]
According to Michael Soloman, CEO of CircleBack Lending
* Also seeing a lot more institutional investors entering the peer-to-peer
* P2P lending platforms are specializing and differentiating their products. An
example is LendingClub extending their product line to small business loans.
* Newer platforms are seeking to make riskier loans at higher yields, but the
quality of these loans won’t be apparent until 3 to 5 years from now. Even with
high FICO loans, you really can’t know what your returns are going to be until
your vintage [bundle of loans made at the same time] is fully matured.
According to Daniel Gorfine, Director of Financial Market Policy at the Milken Institute.
* The majority of prviate offerings are below $5 million dollars raised. It’s
lower for offerings on crowdfunding portals as they’re able to use the
technology to raise smaller amounts of money. Total amount raised by startups
and smaller companies doing private offerings through rule 506 since is $324
billion since 2009.
* One of the powerful potentials of general solicitation is actually letting
accredited investors know that they’re actually accredited.
According to Sarah Hanks, CEO of CrowdCheck
* The market for private offerings relying on rule 506 is $1 trillion annually.
This includes some big hedge funds which causes the [mean] average raise to be
much higher than the median raise.
* The SEC & IRS estimate there are 8.7 million people in the US that would
qualify as accredited investors, but of them only 500,000 participate in
* A lot of people are registering as 506(c) offerings just in case their online and offline selling has stumbled into general solicitation territory.
According to DJ Paul. Chief Strategy Officer for Gate Global Impact, Co-Chair @ CIFRA
* The total amount raised in private offerings is probably closer to two
trillion dollars, larger than the US IPO market. Those investments are only
technical eligible to some 7 million Americans because you have to be
accredited. Of that 7 million, it’s really something like 80% of the activity
is generated by QIBs [Qualified Institutional Buyers] and about half a million
individuals, that’s it.
* It’s not uncommon that under the old 506(b) rules, investors that self-
certified as accredited may have falsified their income or net worth.
* There is talk from the SEC of raising the threshold definition of an
accredited investor. It is unclear if this will effect private investing, as it
will reduce the pool of potential investors, but most investing is currently
not done by those on the threshold of accredited investor status. On the other
hand there is also pressure to expand the definition to include sophisticated
investors that might not meet the income or net worth thresholds.
Sherwood Neiss of Crowdfunding Captial Advisors:
* Average investment crowdfunding raise according to their research is $117,000
Full Transcripts below:
Crowdnetic Keynote w. Jason Best of Crowdfunding Capital Advisors.
Oct 16th 2014
Luan Cox (Crowdnetic): For those of you who are joining us for the first time, welcome. For those of you who were here last year thank you for coming back. It’s been, needless to say, an exciting year of exponential growth for our industry. We define our industry obviously as peer to peer lending, which by the way got a new name this year: marketplace lending and crowdfunded equities under Title II. On the marketplace lending side of the house when we look at the growth from January, we held our last event in December of 13. In January of 2013, Prosper recorded $9 million in loan originations, and John, I believe last month $170 million?
John (Prosper): $172,000,000.
Luan: There you go. Incredible. Lending Club is on deck to go, no pun intended, to go public. SoFi just announced that as well. Congratulations to them and SoFi can lead into the mortgage world and securitization world and thanks to them for sponsoring the event. New players like Circle Back Lending partnering with Jeffries and doing a $500 million securitizaton with them, which we’ll talk about later today. Brand new players which are being announced today for the first time like our platinum sponsor, Real Partner, who for the first time in history is giving access to existing performing loans to accredited investors. To our partners also at LendZone. Thank you also for sponsoring, who for the first time are marrying social networking. Think LinkedIn meets peer to peer real estate announcing and launching today. Congratulations to you guys.
On the crowd finance equity side of the house it’s been an amazing year. Obviously September 23rd last year marked the date when Title II was implemented, allowing companies to generally solicit. On the Crowdnetic platform where we track all of the data in the U.S. in real time and make it available out to partners, we’ve tracked 4,800 companies who checked the box to take advantage of general solicitation, and as of October 1st, $375 million was raised online through the platforms that we’re partnered with. An amazing year. This year I think is going to be even bigger. I commend all of you for being here because if anyone tells you that our world is changing, they’re wrong. It changed. For those of you in the room you saw it already and you’re innovating and you’re on the forefront and that’s what we need. If you look at the roster, and we’ll provide some statistics on the attendees today, but 80% of the attendees come from Wall Street mainstram financial services, asset managers, hedge funds, financial advisors.
Without spending too much more time on giving kudos to our sponsors, I’m very proud to present and introduce my friend, Jason Best, who in my mind is a big celebrity, in lots of peoples’ minds, who’s traveled the world needless to say, so it’s amazing we’ve caught him here to be able to deliver the keynote. If you don’t know Jason, he and his business partner Sherwood Neiss are legends. They’re pioneers. Without them the equity side of our industry wouldn’t live for sure. Jason Best is co-author of Crowdfunding for Dummies, which we have none of in here, co-author with Sherwood of the World Bank Research Report on Crowd Finance. That was released last November. Then also co-author of what’s the third one you wanted me to mention here? One more. That was it? No. The biggest one! Co-author of the crowdfunding framework in the Jobs Act. See? I almost did it. Without further ado, Jason Best.
Jason Best: Thanks everybody. So you’ve got the lapel mic. Is that working? Can you guys hear me OK? Just to echo what Luan said that this has really been an incredible year. I think a year ago a lot of people were saying things like will it work? I think now we can say that it has worked and it is working, that crowd finance, whether it be equity or debt, has become a very successful new industry, new asset class. What’s fascinating is to see how that will develop over time. One other data point that gets significant in this is the fact that just recently we had our first IPO, our first company that was crowdfunded a few months ago that now has had a successful IPO in NASDAQ, called Rewalk. It was initially funded through the Our Crowd platform, and now is public on NASDAQ.
I think at the top line really what I want to talk about is to global themes for next year, for 2015, and to sort of talk about them in the domestic market thinking about platforms, and then also kind of broadening them out to talk about what we’re seeing globally and the work that we’re doing in other countries. First of all, from a platform perspective we’re seeing greater diversification over time next year. Not only will you see platforms begin to specialize, but I think the most important thing are features matter. Features will matter more next year than they have this year, because this year was about do you have a platform, does it complete transactions effectively, can we be on par with the competition. I think next year you’re going to see a lot more interest in what can you do more me. What can you do for me during the raise and what can you do for me after the raise? Things like investment relations, the ability to do syndication, the ability to get better visibility for those deals, and also how are you going to make it easier for investors to more easily find interesting opportunities by a different mechanisms than just your site?
Another theme really is if you build it they will probably not come. I think one of the big interesting things this year has been the evolution in thinking about what’s important. A lot of people started out a year ago by saying “if we just have the right technologies and the right platform, we’re going to get the best deals and everyone’s going to come to our platform and it’s going to be great.” I think what we found is that obviously it’s all about the investor and how are you going to attract quality investors, and how are you going to keep them and wanting to come back and reinvest in your platform over and over again? Increasingly when Title III comes into play, but also even now in Title II, it’s about education. What kind of educational tools can you offer so that new accredited investors can understand this space, and even existing angel investors who have a way of thinking and a way of considering this space also can learn about this crowd finance space.
Another theme we’re seeing is hybridization of funding sources. Two years ago I was speaking at the angel capital association in San Francisco and there were people coming at me with pitchforks and knives and torches. Charlie was there. I think now what we’re seeing is what we’ve already seen in the UK for a couple of years, is angel groups are looking at this as deal flow. Angel groups are looking at crowd finance as just another part of this ecosystem. We’re certainly seeing that. We’re also seeing now a lot of venture capital firms who are looking at this as 2 years ago a company that was crowd-funded was toxic. Now looking at companies that are crowdfunding, whether it be on rewards or equity or debt, as deal flow. As an opportunity to have access to deal flow in different geographies you may have never had access to before in things that you care about. I was talking with a friend of mine who works at a VC firm in the Bay area where I live. He does hardware tech and every morning he stops at a couple different crowdfunding platforms. That’s how he starts his day by looking for companies raising money on those platforms.
I think a couple of other examples of this are recently the Seed Invest Announcement. You’re having this large angel network come together with an equity platform to share technology and share opportunities. Another is the CrowdCube minibond. The fact that there’s now a mini bond capability in the UK to raise over a million pounds to provide that kind of fixed return that hasn’t been available before. They’ve done three of them now. I think that also what we’re seeing are new entrance in the U.S. but more importantly entrance outside of the U.S. when you’re looking into home markets, who are looking at this as an integrated market, as a crowd finance market, and how are they going to create kind of a full stack crowd finance platform that can also include equity, debt, and rewards or some combination of the two. They’re really not looking at it as either or, but really as combinations and what’s right for those spaces.
Then finally, I think as we move into looking at this in a more global perspective, one of the things that we spent a lot of time doing as we traveled was kind of creating this ecosystem map and creating a model for how to think about this space, because it’s changing rapidly, it’s moving very quickly, it’s growing exponentially not just in the U.S. but in other countries. What we’ve tried to do is put in place a four sector model that we think helps us understand it and helps our clients understand it, really thinking about first infrastructure, so platforms, secondary markets, those sorts of things. Second, category, really our trust and transparency tools because right now most in the equity and debt side, a lot of that is happening among people that you know or people that the business knows or knows of. How do we create these trust and transparency tools to allow those things to scale over time? Third, metrics analytics. Just like with the online advertising world as that was formed, you had to have metrics analytics to make that process and that market more effective, more transparent, and to be able to scale. The same thing will be true in crowd finance. Finally, the white space, which is sort of all the other things we don’t know what they are yet. Three years ago I didn’t know I needed a service like Uber and now it’s hard to imagine life without it.
One of the really exciting things when we travel is we typically meet not only with entrepreneurs and regulators, government folks, but also angel groups that exist in different countries. A lot of times one of the problems with angel groups in many other countries is first it’s hard to find deal flow, second the process itself of angel investing is incredibly high friction. What we’re seeing is a strong interest in the technology that’s been created for crowdfunding to be utilized in a close way with angel groups, as a way to increase deal flow, as a way for them to actually be able to do deals as opposed to one or two deals a year, to be able to move that to one or two deals a month. That would be massive in many, many countries around the world. We’re also seeing this in creating a lot of interest for Vcs because the VC market, frankly in most countries outside of the United States is small to nascent. Again, the same problems of how do I find investors for high risk assets and also how do I find deal flow that makes sense? Variable through these tools, they’re able to find both of those much more quickly, so increasing deal flow, increasing a market that hasn’t existed before. Being able to help those VC firms understand this space and be able to utilize those tools has been really interesting.
We’re seeing new countries that are moving forward in both public and private ways with crowdfunding. We just got back through a swing through Asia. Malaysia will be launching equity crowdfunding nationally by March of next year. They’ll be the first country in Asia to do it and the first Muslim majority nation to do it, so that’s very, very interesting. Thailand will be next up. They will be launching I think sometime later 2015. Been working with their securities commission quite closely, headed back there next month. I think that’s really, really interesting. Singapore, Korea, Japan, Hong Kong, all considering crowdfunding, crowd finance, really. It will either be equity or debt. Singapore just licensed their first peer to peer lending site, so Asia is really kind of moving forward pretty quickly in pretty interesting ways. I think also you look at Latin America, we’re headed down to Chile in a couple of weeks to work with the Ministry of Finance there on structuring their crowdfunding regulation. Also we’ll be working with Mexico next year on their regulation and legislation. There are a couple other countries in Latin America that I think towards the end of next year will also be moving quickly to catch up just from a competitive standpoint and a desire to have this sort of movement take place.
The MENA region is also really interesting. We spent a fair amount of time there. Lebanon actually has crowdfunding regulation in place. I think Dubai is obviously kind of like the first place that it would actually have some traction. The challenge there is that when you build a infrastructure for funding that is focused on large corporates, it takes a while for those sort of environments many times to see the value of funding SMEs and see those things as two separate things. We’ve been working on helping them understand that. I don’t know if that will happen in 2015 or not. I think 2016 is probably more likely. Turkey also very interested. Their securities commission has said that they are going to move forward with equity and debt crowdfunding, so I think that that will be an interesting market to see. We’ll be headed there in December. Also there’s a couple of countries in southern Europe that are also looking at ways to sort of step ahead and trying to do something innovative and new.
We’re also starting to see a couple of things that are really new just in the last few months, which are kind of a combination of things. It’s large corporates beginning to get involved in this space, and also large corporates thinking about this from a regional perspective. How these companies are thinking about who are involved, whether it be consumer brands, whether it be financial institutions, other type of large corporates who have operations in one or more countries, how can I use this with the other existing infrastructure and efforts and strategies that I have to accelerate those? That’s looking at it from a debt, equity, rewards, and even crowd sourcing perspective. There’s a lot of integrated thinking happening there about how to scale this.
What’s really cool is Woody and I are entrepreneurs. We’re not lawyers, we’re not accountants, we’re not regulators. We spend a fair amount of time with those folks. What’s exciting is that now we’re getting a change to spend more time with large corporates, with entrepreneurs, with other folks in these countries who are really making these things happen. It’s increasingly not just thinking about the regulation and the superstructure for these things to take place, but it’s also people coming and saying what are the solutions, how do we do these sorts of things, which demonstrates that these are programs that these countries are really serious about. These are not press release opportunities for these countries. They look at them as core, central opportunities for job creation. That’s what it all comes down to. That’s what this was about in the U.S., that’s what it’s about in every country. Having large numbers of people in their 20s with no jobs is a bad idea. How do we create opportunities for people to build a business which everyone sort of says is the way that you build an economy is through small business and entrepreneurship.
The only way to do that really is this new infrastructure that we have called crowd finance. It’s a really exciting opportunity for us to be a part of it. I’m going to thank Tom for hosting this today, and certainly thank Crowdnetic and Luan for the invitation to be here, so thank you all and look forward to a great day today.
Crowdnetic 2014: The CrowdFinance Marketplace
Oct 16th 2014
Tim: We have an incredible panel. I have spoken to all of these gentleman over the last couple of weeks and was really blown away by the quality of the presenters, the quality of the companies. Although the title of this section is the Crowdfunding Marketplace, of course there are many, many marketplaces and Jason was touching on that. He mentioned actually a number of the companies, a number of the deals. It is amazing to see the pace of change that is going on in this marketplace.
It seems almost that crowdfunding is becoming the solution to everyone’s problems. We saw that F1 is looking at funding itself now – Formula One – with crowdfunding. It is going to solve ebola.
Classic economic theory tells us that as long as supply and demand grow in concert with each other or are relatively in balance, then the market overall will continue to expand. I think we are starting to see that really play out across many, many markets. But of course, there are headwinds. Regulators across the globe are weighing in. We hear that again from Jason. Some of them – perhaps clumsily – are helping to slow the market in some cases.
What else could change the dynamic of the marketplace? We have heard about the entrance of institutional investors. Can institutions and investors co-exist in these various marketplaces? Will we see more deals such as the CircleBack-Jefferies deal? Will the lack of a secondary market, a slowly evolving secondary market, eventually take it’s toll?
Growth is a key question when we think about the marketplace, but growth always comes at someone else’s expense. Who might the losers be in the next five or ten years? My team is spending a lot of time thinking about that, because we currently supply the potential losers. Is it the investment banks, the VCs, the high street and regional banks, the mortgage lenders, the credit card issuers, the exchanges? I am sure we will get into that in a moment.
OK, so enough from me. Let’s hear from the experts. I have three broad questions which will apply across the team. I hope that we will hear somewhat different answers, especially given the fact that the representatives occupy somewhat different spaces or operate in different markets.
To kick off, I would like each of the panelists to introduce themselves, to provide their background and their role in the firm and what their firm does in the marketplace they occupy. Please talk about the specific dynamics driving both the supply and demand for your marketplace. How has that changed over the last 18 months? We have heard a lot about change. Where are the imbalances coming out and how are you expecting the market or your firm to start to address these imbalances?
Why don’t we start with John on this side and we will move across.
John Higgens: You want us to answer the question as well as give our background?
Tim: Yes. The background and then question. Then we will do the next one.
John Higgens: So my name is John Higgens. I’m a director in the Strategic Partnership Group of Prosper Marketplace. Prior to my current role at Prosper, I helped build out the institutional funding platform at Prosper. Prior to that, I spent six years in the alternative investment industry. Prosper is the nations second-largest peer-to-peer lender. We match borrowers and lenders through an online marketplace.
Peer-to-peer is kind of a misnomer today. It is just more of a marketplace. If you look at the way the business has developed and our growth … As Tim said, we are growing very, very rapidly. We went from $9 million in monthly originations in January of last year to $172 million last month. With this growth, I think a big driver for this – and this gets to your question – is the supply and demand imbalance.
You have seen a tremendous amount of demand from institutional and individual investors to fund assets in these marketplaces. Once the marketplace has credibility in it’s underwriting model and confidence from the investor community, there is essentially … Not unlimited, but close to unlimited capital to fund these loans.
Zack: We started two years ago. We were founded and are based in Israel. We are focused on equity crowdfunding, which means we invest in typically young technology-based start-ups in Israel, but we have expanded over this past year internationally. Eight of our last 12 investments – we have made 55 – have been based in the U.S.
We have raised $70 million, which puts us at the forefront of the equity crowdfunding. Obviously much smaller than the peer-to-peer marketplace lenders, I should say, but we are one of the most active. We did have the first IPO in the equity crowdfunding industry. A company called Rewalk Robotics, which listed last month on the NASDAQ, market cap closed at $300 million dollars, so investors that came to our crowd a little less than two years ago saw a 4-5X return on their money in two years. Liquidity, if they were to sell today, there is a six-month lock-up period.
I would disagree a little bit with what Jason said in his remarks in that at least our struggle is not finding new investors. It is in finding new good deals. They are sort of connected, obviously. In the equity crowdfunding space, it is very hard just to put up a pure marketplace and just let any deal in. The quality of the marketplace, because it is such a risky asset class, is very important. We spend most of our time … We have a deal float team that looks and scrubs deals. We only put up 2% of the deals that meet our criteria. We invest our own capital in it, so we ensure that we sit on the same side of the table as investors and then open it up to the crowd.
In our way, we acknowledge and signal to our investor base that yes, this is a risky asset class. You are going to lose your money in 40% of the deals, probably. Which doesn’t sound like a great pitch, but that is the truth. To be successful doing that, you need diversification.
If there is a limiting factor in our growth, it is being able to scale internationally our ability to attract good deals to the platform. We are now seeing deals where we are co-investing alongside some of the best VC companies in the world. The Battery Ventures, the Sequioas, we are now investing alongside them. That took about two years to get to that point. They definitely saw us as competitors initially.
There is one other piece that we see as growth, which hasn’t necessarily been mentioned. We did have GE Ventures make their first investment on our platform. They came and invested in an Israeli med-tech company called MedAware. We also see interest from corporate investors.
Tim: Thanks, Zack.
Sahin Shah: Thanks, Tim. My name is Sahin Shah. I am the co-founder and COO of iFunding. iFunding is a crowdfunding platform for real estate. We went live about a year back and since then we have crowdfunded about 25 different projects for a total of roughly $26 million dollars. We started off focusing purely on equity, but over the past two months we started offering debt as well. Single-family fix and flips was the bread-and-butter of what we did. We also moved on to new construction and multi-family units now.
Just to speak about demand and supply, I think a lot of the attention that the industry receives is thanks to sister industries like the alternative financing industry where Prosper and LendingClub have done such a good job of getting credibility to unsecured loans. People are sort of interested now in looking at how crowdfunding would shape out to be. With LendingClub going for it’s IPO, I think it is just going to be a lot better for new companies like ourselves to be able to grow in this industry.
Just to speak a little more about iFunding, we did launch the first mobile app for crowdfunding in real estate a couple of months ago. Most recently, we also opened an office in Singapore to be able to source Asian capital in the U.S. and expand internationally.
Ryan Feit: Hi. I am Ryan Feit. I am the CEO and co-founder of SeedInvest. SeedInvest is a leading equity crowdfunding platform that is based here in New York. In terms of a couple differences about SeedInvest, one is we are highly vetted. We have historically accepted about 2% of the companies that have applied to our platform. In addition, our business model is different than most folks out there. We are free for investors, so we don’t charge carried interest or anything like that. We charge companies commission on whatever is successfully raised, so more similar to the Kickstarter model.
In terms of this supply and demand imbalance is we see … I would echo what was said earlier. It is not always getting more deals on a platform in the equity space. It is getting more high-quality deals. Then certainly on the other side, I would say getting capital is always important in terms of growing both sides of the marketplace.
I think what we see is probably not that dissimilar to what Prosper probably saw back in ’06 and ’07, where getting capital onto the platform was probably one of the challenges in growth, but what we have been seeing in the past nine months is more family offices and institutional guys that are funding deals on our platform, bridging out to get to larger institutional checks.
Just in terms of metrics, the average investment on our platform is about $31,000. We have had people invest as little as $5,000 this year. We have had family offices in the past few months invest $550K, $750K. Someone invested $1.8 million this morning before I got here. We are seeing bigger check sizes, which is certainly interesting.
It is a balancing act in terms of continuing to scale but making sure you keep quality high, which is always a challenge as you are growing a marketplace. One thing in terms of how we are addressing growing both sides of the market … Jason alluded to it earlier, which is we recently a few weeks ago partnered with Gust. Gust has been around for about 10 years.
They work with the vast majority of all of the angel networks in the world and they have about 8 to 10,000 start-ups that apply every month on their platform and about 50,000 angel investors on their platform as well. So that partnership with Gust enables us to A) get access to a lot more deal flow and see which deal flow is bubbling to the top and getting led by angel groups on their platform, and then on the flip side allows us to kind of combine our 5,000 angel investors with their 50,000 so that there is a lot more potential liquidity on the platform, as well. That is how we are addressing things as we scale.
Tim: All right, Michael.
Michael Soloman: Michael Soloman, CEO of CircleBack Lending. My background is in legal and financial technology companies. CircleBack is very similar to Prosper and LendingClub in which we work with investors on the one hand and borrowers on the other hand. One of the things that we did when we came into the marketplace … And by way of background, I started the third peer-to-peer lender in the United States called Loanioback in 2007.
It wasn’t the best time to launch in 2008 for a number of reasons. But one of the things I have learned along the way and what we have seen in terms of trends and certainly over the last 18 months this has really heated up, is that on the investor side of the equation it has really gone and shifted from a retail marketplace to more of an institutional marketplace.
One of the things that we did when we launched was we deliberately decided that for our business model it didn’t make sense at this stage of development in the evolution of P2P lending or marketplace lending to really get involved with retail, so we are focusing on institutional investors.
On the borrower side, when you are talking about supply/demand issues, we are seeing now that because there seems to be a lot of new players being introduced to the marketplace every day in addition to all of the traditional players that are now also trying to figure out how to shift gears and use some of the customer acquisition strategies that are now being used by the Fin-Tech companies that are in the game, you are finding that there is more price competition, more price sensitivity in the marketplace.
I think that many of us have to try to carve out exclusive niches now when dealing with distribution channels and acquiring new borrowers and also differentiating product. John also pointed out that LendingClub has now moved their product or extended their product line into small business. I think you will continue to see that. There is a lot of activity in a lot of other sectors that you will see here as well as the other marketplace conferences I have been attending this fall.
Tim: This market is evolving fast. The fact that you are all engaging in different types of partnerships, you are mixing it up with some of the incumbents. The next question is all about what happens next. Technology-enablement legislation and the emergence of the so-called Millenials, are often cited as the important catalyst for further growth in the crowdfunding market. The winners seem to be on both sides of that trade, and they are people like you and me. They are investors or people raising capital.
For each of the markets, could you project forward who are the big potential losers and how – if at all – will they respond? I think we started to see some of the response come in some of those answers already. What early signs are you seeing that the incumbents are responding, and where do you think we will be in 5-10 years?
John Higgens: I think the biggest potential losers in this space, at least the marketplace lending industry for unsecured consumer credit, would be the financial institutions. The community banks, regional banks, national banks, and even credit card issuers that do not adopt to the new trends of marketplace lending and are not adopting to meet borrower needs and desires.
Borrowers are seeking a frictionless, fast, very enjoyable experience borrowing money online on convenient terms. On their terms, when they like. Late at night, early in the morning. Whenever. And they are not subject to branch-based hours or brick-and-mortar locations. I think those groups that adapt to that new environment and the changes in consumer behavior, especially with the new Millennial generation coming up and coming of age, those will be the ones that … The ones that do adopt will be the ones that benefit.
Those that do not adopt I think bear the biggest risk of loss of their best customers. I think you are already seeing a trend of the banks partnering with the Prospers and LendingClubs of the world. They are both referring borrowers and originating assets for their own balance sheets. I think you will see that trend continue and I think you are seeing larger and larger financial institutions partner with the Prospers and the LendingClubs of the world in order to meet their objectives and really benefit from this new technology and these new trends.
Frank: I think in the equity crowdfunding space, the first losers are the venture capitalists. That is not to say we don’t work together. We can partner, and I think that there is room. It is not a zero sum game. There is room to partner. A lot of these deals are entrepreneurs who have sort of soured on traditional funding sources and come to our crowd particularly because our model is not just a crowdfunding model, but we actually – I don’t know if there is a better term, but it is like the equivalent of online venture capital where we do diligence, we do support companies after we invest in them and have a portfolio management function just like a regular venture capital firm would.
The other thing which may be surprising, I think actually stock markets lose out. I think a lot of the capital we are seeing from the retail investor base, this is money that would have been earmarked to the stock markets, to mutual funds, to pension plans. This money is instead coming out of the market or not entering the market at all and coming towards a new form of investing, which is equity crowdfunding. I think, at least on the retail side we are going to … I think the losers are the brokers or the actual stock markets themselves.
Sahin Shah: I think it is the funding sources which do not adapt to transparency. If you look at marketplaces like ourselves and others on this panel, what they truly promote is also transparency in some form for investors to be able to look at all the detailed information online and discuss it with like-minded individuals. Also for – in our case – property developers who can come to a platform like ours, get all the information they need, and also get a service beyond just money, where we deal with the investors and the reporting, keeping it transparent for investors, just in terms of providing the source.
Ryan Feit: I was going to talk about the banks, but I think we did a good job of that already. I think aside from financial institutions, I think the other group of people that stand to really lose is the public market participants, so one interesting trend that we have seen over the last fifteen years and which is accelerating now because of the advent of platforms, is that private companies are staying private a lot longer before they IPO. Today, basically companies are staying private about twice as long as they did ten to 15 years ago.
If you looked at 15-plus years ago, you have companies like Microsoft, Amazon, Cisco, they all IPO’d for just around $500 million. While they were in the public markets over the next 15 years, those companies appreciated by an average of about 470 times what they IPO’d at. Hundreds of billions of dollars were created … A value is created in the public markets.
Now you look at today, and you recently had AliBaba IPO for over $150 billion, yet Facebook IPO’d for $100 billion. For those companies to appreciate by 470 times in the public markets, one of those companies alone would have to be worth more than the entire global stock exchange.
It really shows you that because of more capital being available in the private markets – and platforms are a big part of that – and because of some of the regulation which is changing that, allows merging growth companies to stay private longer, so the increase in the number of shareholders and some other things, you are seeing the shift in value capture from public markets to private markets.
In terms of, are we already starting to see some signs that people are paying attention? Absolutely. Absolutely. If you look at a lot of hedge funds, if you look at mutual funds, and you look at the capital inflows to private deals versus last year, it is up over 50%. Same thing with if you look at the corporate VCs. It is pretty incredible to see the year-over-year growth and venture funds getting started by corporations that are trying to get access to private markets.
Then we talked a little bit about if the exchanges themselves are ready, but you are seeing the New York Stock Exchange start to get a lot more aggressive on getting access to IPO’s. You saw Duncan a month ago leave as the head of the New York Stock Exchange to join a company that is actually helping with private placement, so we are absolutely starting to see a lot of these trends. I definitely expect that to accelerate.
Michael Soloman: In the online lending market, we are seeing a lot of new players entering the market. It seems like every week you are hearing about some new platform that is launching. Some of the things that concern me at least is that I’m seeing that there is a lot of also very demanding investment groups out there that are really seeking and chasing yield, right?
I think what is going to happen is, as these new players start to try to differentiate themselves, one of the ways in which they think they are going to be able to do this … And time will tell, right? Is that they are kind of swimming downstream from FICOs and making riskier loans which in turn at least appear to be driving higher yields. I think there is a lot of risk there because you won’t know until three years, five years out when these portfolios fully mature that that could be very problematic for some of the newcomers getting into the space.
There is also a lot of regulatory risk. There is operational risk. There is fraud risk. There is technology risk. I think that a lot of these newer players maybe at this point maybe they haven’t figured out exactly how to create a stable and scalable model, so there are also a lot of risks involved with that.
I think that you could see some losers coming out from all ends of the spectrum, but it concerns everybody on a larger scale because if one goes down, obviously it doesn’t fare well for everybody else who may be more thoughtful and deliberate in handling their underwriting processes at least from our perspective on online lending and underwriting. I think there could be some real problems occurring in that area.
Tim: Does anyone have a view on what the smaller local or regional banks, that kind of 5 to 10 branch banks might do? It feels that as this goes closer to small business lending, they could be at risk as well.
Michael Soloman: Well, it does seem like – and you will see it already – a lot of the community banks are now coming around and they are saying, “Hey, look. These online lenders are getting it right. Why don’t we team up with them?” I just ran into a regional bank last week at a conference and the discussion with the CEO was, “Hey, we are willing to even put up marketing dollars. We get it. We like the idea of being able to plug right into your system. It is automated. You know what you are doing, and you are good at it. We could leverage that and maybe replicate that in other areas.”
You’re seeing that with the other players right now. The banks are starting to come together. I think the big problem with that, like any new financial market, is that everybody wants to sort of wait. When you are dealing with a regional bank, you have board members who have probably been there for 20 or 30 years. They are fine the way things are, and it takes time to convert them into believers and into understanding that the world is changing and you have to change with the world if you want to still serve your community in a meaningful way, right?
Tim: We offer a similar conference to this … I think it is in the first or second quarter of the year. It starred our large wealth and online clients. I asked the audience – I was on a panel talking about crowdfunding – I asked the audience how many of you have used one of the platforms such as LendingClub or Prosper, and I think one out of maybe 130 people. These are senior executives who are really aware of what was going on, and I think there is a sense of maybe it will go away.
There is also the innovators dilemma, right? It is very hard to take a step forward when you might be cannibalizing your own business. The big banks make a lot of money out of the credit card underwriting, for example.
Let’s go into my final question. I think we might have some time for audience questions, as well. What further enablers are required to make this a really big thing? I think we all see the potential. It is a bit like the ETF market. It took quite a long time to really get going. The formation of secondary markets … Is that part of it? Is it further groundbreaking legislation? I think we are still waiting on Title III. Is it further … Is it a strategic shift that comes perhaps through a new entrant? We saw Google last year starting to dip their toes in it, so there is a new, big, disruptive player about to enter the market. Any thoughts on that, gentlemen?
John Higgens: I think what could really make things change the market environment and really grow it significantly would be broader awareness by the borrower community. I think the thing really constraining at least Prosper and LendingClub, and it sounds like some of the equity crowdfunding platforms as well, is quality deals.
For us at Prosper and LendingClub it would be quality borrowers to underwrite, and for the crowdfunding sites, it is quality deal flow. I think if there is a larger awareness by the borrower community at large that you could go online and get your money very quickly, our rates are generally better than other forms of unsecured borrowing, and have a great experience, it’s very quick and easy … I think everyone would borrow money in that way.
As you see a LendingClub IPO and additional efforts made by the platforms to educate the borrower community, you will see tremendous growth. I think awareness is the one thing that is necessary to really propel this to the next level. That, and continued transparency.
As a marketplace, you are built on trust from both your borrowers and your lenders, your borrowers are saying, “Can we get the loan as promised, at the rate promised, and the speed promised?” The investors are saying, “Can we actually invest in this paper or this loan and get the return that we are promised at the rates that we are told we are going to expect. I think those are the two biggest things for us.
Tim: Thanks, John.
Frank: I kind of echo that. We are not looking towards Title III. I am speaking from OurCrowd’s perspective in the business that we are in. We are not looking towards Title III as a sort of Panacea for the industry. I don’t think we are even going to go after that business. I think you could debate whether for the end investor Title III is even a very productive thing. I think it is more brand equity.
I have consulted to many large financial firms in the world, and they have spent billions and hundreds of billions of dollars building their brands over time. If we are taking share away from them, just having walked through the crowd nobody heard who OurCrowd was, and you guys are in the industry. It is just going to take time, energy, and money. More fundraising, essentially, to get the awareness out.
The other piece I would highlight are better tools to be able to assess for the end investor and to compare investments. It is interesting that Ryan has a lot of the same metrics I think we see as a similar business. I don’t think that we want to expand more than 2% of the deals that we see getting onto our platform, but how does the end investor compare an early stage deal versus a mid-stage deal. What is the risk implied? Why are terms better for one and worse for another? How do I build a portfolio of all these things that shows best practices?
Sahin Shah: From a capital-raising perspective definitely when an institution enters the space that will be a big positive for us, but just from an issuer perspective, I think it’s when the bigger developers start using technologies like ourselves or the other crowdfunding platforms to source their deals, too. I think that is when the industry will get a lot more credibility.
Also, in terms of their reporting. Deals are going to go bad. It is up to the platforms like ourselves to make sure we are in constant communication with our clients, which is primarily the investors, to follow-up with them and to send the end-of-project reports if needed or keep them updated on a timely basis to make sure we build on the investor confidence. With that being consistent, I think in time the industry will get a lot more credibility.
Ryan Feit: I will argue that the secondary market is probably what is the most necessary as I look out five to ten years in the equity space. I will give you two reasons. One is, I am an avid peer-to-peer lender myself. I’m a big fan of what Prosper is doing. One of the huge benefits in peer-to-peer lending and I think one of there reasons it has been able to take off so quickly versus equities is that you get a quick feedback loop. You know what your adjusted rate of return is pretty quickly, and you are getting dividends. You are getting coupons very quickly month to month, so you get that quick feedback loop.
In the equity space, it is a different asset and it can take five to seven years to figure out whether you are actually making good investments or not. Same thing in the debt space with the iFunding and companies like Patch of Land. You know pretty quickly what your actual return is, and that is a challenge with equity.
If there were a secondary market, there would be a quicker mark-to-market on your investments, and you have the opportunity to ultimately sell if you wanted to, but at least you know if things are appreciating. It is easier said than done, but I think it is absolutely necessary.
I guess reason number two is just the psychology of investors. Today there are only 370,000 angel investors in the U.S., so a big part of it is, there is a brand new asset class that people are going to have to learn to understand. It is different than the public markets.
By the way, if I’m thinking about jumping in for the first time, it really is jumping in, because even if it is a smaller investment than a typical angel investment, I’m in it for 5 to 7 years potentially. If I know that, I can change my mind a few weeks later and punch out even at a discount. Like the public markets, that kind of makes that leap of faith into a new asset class a lot easier for me. I do think a secondary market is something that in the longer term is very necessary to really accelerate the marketplace in the equity space.
Tim: I agree with that, Ryan. Michael.
Michael Soloman: I am going to echo the education. That is all in capital letters. There are so many people that really still don’t know about a lot of these online lending platforms where they can generally get better rates in a quicker manner. I think that these IPOs, more infusion into the operating capital of the companies will help to propel the message much further. You will see a lot more mass marketing as we enter the next 12 to 24 months.
I also think that performance over time – I stress over time – because a lot of people … Generally, consumer installment loans … Just because you’re getting paid back in the first six months of your loan, you know you are not home free, right? You have economic stresses. You have other things going on in a portfolio that change over time. Typically, that is going to start decreasing over time, so it is hard to say really what your rate of return is going to be in a vintage until that vintage is really fully matured.
I think some folks looks at this marketplace and they go in and you see a lot of the blogging going on and you have a lot of people saying, “Yeah, I’m getting 12%. This is the best thing since sliced bread.” Come back to me in 3-5 years when your vintages are fully matured, and then let’s talk, right? We don’t really know what that is going to look like. We only know historically what it looks like if you’re really following the FICO numbers and you are following the historical date for FICO, but that isn’t always a good indicator of what the future is going to bring, particularly in an economic downturn.
You have to make sure that when you are underwriting that you are applying stress to your different credit grades appropriately to withstand that and at least preserve your capital moving forward. I think it is education and performance, but over time.
Tim: Great. Thanks, Micheal. James, do we have time for a couple of questions? Yeah?
Speaker 1: Stand up and talk about it.
Speaker 2: I am a real estate broker here in New York City and I am starting launching a private equity fund to raise money to rally black and Latino investors. My question is, from a social justice aspect, do you think that crowdfunding could be very effective to lobby a niche market? For instance, the African-American and Latino community in New York City which is very angry about the displacement of their communities. I mean communities like Harlem and Fort Green. Do you think crowdfunding would be a great way of setting up a niche to exploit a common goal within a particular group or ethnic group?
Tim: Great question.
Sahin Shah: Absolutely. That is a good question. I think crowdfunding has the potential to redefine communities. We have seen that in the past in real estate with different platforms. It is also something that we are working on right now, where we are going after neighborhoods as opposed to just an asset and allowing individual investors to invest in the entire neighborhood and just be a part of the development there.
Ryan Feit: I would say the answer is absolutely yes, but I don’t think it is going to happen until Title III gets passed because Title III opens up investing to the other 98% for the first time. The beauty of that is it is more akin to Kickstarter or Indiegogo’s model where you can kind of invite anybody to invest really small amounts to support a business. I just don’t think with Title II you are going to see a lot of changes. I think it is really a Title III game which is yet to be seen hopefully in 2015.
Speaker 3: It is kind of interesting that the crowdfunding and peer-to-peer lending space is kind of capitalizing on banks lower willingness to lend as they are squeezed by regulation after the crisis. I am wondering, giving that the scalability of this market depends a lot on the continued and growing involvement of institution investors and scalability methods like securitization, for example … Michael, you kind of eluded to this earlier that there is going to be a temptation maybe with new lenders hitting the market everyday to chase yield, essentially.
I’m wondering whether the originate-to-distribute kind of problems that we saw during the crisis particularly in the securitization market in the U.S. could end up being a bit of a concern for the online lending space as they strive to make their business more scalable.
Michael Soloman: Yeah. I think about it everyday and you are right. It is no surprise that a lot of the economic disaster was the result of just poor underlying assets that were being packaged up, right? At least CircleBack Lending and others we work with and we are aware of that are in the marketplace now are striving to really keep the quality of the underlying assets very high, but as new players get in there is that concern and fear that as institutional investors and other types of investors are chasing yield and pressuring to drive yield up, it is going to present this opportunity for other folks to maybe start going downstream in the riskier stuff.
I think it is inevitable. It will start to get packaged up and most likely securitized. It is just something that everybody has to be aware of and hopefully everybody has their eyes open this time when they start buying bonds and understanding what the differences are between a basket of loans made up of 500 FICOs and a basket of loans made up of 640-plus FICOs, and so on and so forth. It is a real concern. I think it is inevitable that it is going to happen.
John Higgens: Just to add to Michael’s point, I also think that transparency on the platform’s part help maintain the integrity of the platform, the underwriting models. At Prosper, we offer over 500 attributes on each loan if you have an API, so all of our institutional and retail investors can go in and understand exactly what the loan looks like, what that borrower looks like, and they can sort by a number of different fields to choose only the ones that they believe meet their criteria.
I think anyone that is buying a securitized product can also look at the historical data on the Prosper website and look at, OK, I’m buying a securitized portfolio of Prosper loans. I can get all the information, all the vintage information, all the loss curves. Also, because we are an SEC registrar, we file like a public company although we are not public. There is just a wealth of information about our business, our underwriting, et cetera.
I think that level of transparency will prevent they type of issues that you are talking about with people just securitizing anything and eventually crashing.
Tim: I think what is interesting to that point is the fact it kind of scales back it’s activities. It feels like the banks aren’t stepping up. They have not recovered fully or they are being much more conservative. The big question is to what extent will this marketplace be encouraged by that and be able to fill that market or whether you are just going to continue to see a lot of volatility in the markets.
Tim: Can we do one more question? Yep. In the back there.
Speaker 5: Are any of you seeing smaller or regional or more nimble traditional banks or investments banks deciding they want to enter your market directly and compete with you directly? I appreciate maybe the larger ones are a little bit too ingrained in existing business models, but institutions with licenses and technology staff and so forth. Do you see that at all?
John Higgens: We have certainly seen a number of smaller investment banks approach us to use our technology to make their processes more efficient. We are actually regulated, so we can do KYC – know your customer – and anti-money laundering and accreditation verification in under a minute. A lot of these processes just haven’t changed in 20 years, whether it is what people are doing in the P2P space, or the debt space, or real estate, or equity. It is just a lot more efficient.
People were talking about it earlier with angel groups, but it is the same thing with the broker dealers and investment banks. If you look at companies that have gone out of business in the last five years … I think number one is companies that made cassette cases. Number two is like supermarkets. Number three is broker-dealers. Because of a lot of the additional regulation, a lot of them know that they have to make changes to survive, so we have definitely seen a lot of people trying to make things more efficient.
Tim: Thank you so much. That was a fascinating start to the conference.
CIFRA Webinar on General Solicitation:
March 20th 2014
Steve Ferrando: I just want to welcome everyone to the first in a series of CIFRA Educational Webinars. We’re planning on offering these approximately once a month. The first topic today is going to be on General Solicitation 101. My name is Steve Ferrando. I am one of the founders of CrowdClear. We provide broker-dealer services and client services to funding platforms operating under current exemptions as well as with an eye towards operating under Title III. I want to thank a number of people for making today’s event possible. Not the least of which are our four panelists. That’s Daniel Gorfine, Sarah Hanks, Woody Neiss, and DJ Paul. I also want to thank the CIFRA Board for sponsoring this and allowing this to happen. Specifically Ryan from Seed Invest for putting together the curriculum here. Unfortunately, Ryan had to back out at the very last minute and asked me to step in for him as the moderator. I wanted to give each of the panelists an opportunity to introduce themselves. Daniel, if you could introduce yourself please? Then we’ll just move through the list of panelists here.
Daniel Gorfine: Sure, thanks, Steve. Good to be with all of you today. My name is Daniel Gorfine, I’m the Director of Financial Market Policy at the Milken Institute. We are a nonprofit, nonpartisan economic policy think tank. I actually do my policy work out of our Center for Financial Markets which is based in Washington D.C.. One of the policy programs that I’ve led for the last couple of years focuses on new capital assets tools. A lot of that is based off of developments within the JOBS Act. We’ve gone through the JOBS Act in great detail and at the same time as the SEC has been working to implement different pieces of the JOBS Act. It’s about time that we that we cover those different sections. We’ve done a fair amount of work on Titles I, II, III, and now we’re looking at Title IV which is dealing with Reg A+. Yeah, I look forward to being with you all today and hopefully we can share some helpful information.
Steve: ALl right, Sarah?
Sarah Hanks: Yeah. Hi this is Sarah Hanks and thanks for having me. I’m CEO of CrowdCheck, we provide compliance due diligence and disclosure services for online investment platforms. I am a recovering securities and corporate lawyer of three decades.
Steve: Excellent. Woody?
Woody Neiss: Thanks. Hello, everyone, this is Woody. I’m a Partner at Crowdfund Capital Advisers. I’m also one of the three entrepreneurs that wrote the framework to legalize equity crowdfunding in the United States. We were at the White House as the President signed the bill into law. We now work with the governments, multilateral investors, any stakeholder in the industry, in the crowdfunding space to help them understand what crowdfunding is, prepare for it. We do this on a global level. We wrote the World Bank report on crowdfunding’s potential for the developing world.
Steve: Excellent. Last, but certainly not least, DJ?
DJ Paul: I don’t mind being least, that’s fine in this crowd. I’m definitely pulling down the average. I’ve got the least educational degrees of anybody that’s on the panel. My name is DJ Paul. I am the Chief Strategy Officer for Gate Global Impact. I’m also the co-chair of CIFRA and one of the founding members of both CIFRA and formerly CFTA. I was working with Woody and some others, although we didn’t work all that directly in D.C. when we were working to get the JOBS Act passed. My contribution was smaller than theirs by far but I hope it was somewhat meaningful and hopefully I can lend a slightly different perspective than the other panelists on this as well. Thanks for having me.
Steve: Okay. Just in terms of the process, folks, we’ve got a series of slides here which will be available for distribution after the event. We’re not really going to do this as a presentation, this is more of a panel discussion. I’m going to be flipping through the slideshow but basically asking the panel some directed questions about the subject matter on that particular slide. It’s sort of a combination presentation/panel discussion.
The regulatory background around what we’re talking about is very clearly here. Again, I think many people on the call will be aware of the fact that there are platforms and broker-dealers out there issuing securities under Reg D. Sarah, can you give a little insight into what the cap on raising under 506(d) is and what kind of capital people can actually raise using this exemption?
Sarah: The interesting thing, of course, is that there is no cap under Rule 506 which stands in contrast to what’s permitted under crowdfunding. That’s why you’ve got this enormous, at least trillion-dollar market that the SEC knows about. I suspect it’s very, very much bigger than that because there’s a couple of areas of offerings that aren’t included in Reg D filings that they’re making their judgment about. Which is [inaudible 00:05:46] offerings and probably a lot of the angel offerings. You can have some very, very large offerings made under Rule 506. Of course it’s what the big hedge funds are relying on. When we look at the numbers that the SEC analyzed in order to come up with this one trillion market number; you see that the average size of a raise is way, way bigger than the median size of a raise because there are some enormous hedge fund offerings out there. Private companies can do very large offerings too. So no cap, it’s an incredibly flexible tool.
DJ: Okay. I think it’s fun to contextualize this a little bit because one trillion is this massive number. As Sarah correctly points out, I’m sure it’s … Most of us are pretty sure it’s higher than that. That’s roughly equivalent, that’s about the same amount as all of the money that was raised in all the IPO markets last year. This market is equivalent to and it probably exceeds, maybe by not orders of magnitude but by maybe a significant percent. All the money that was raised in the IPO markets last year, this is not a trivial market.
Daniel: When you were talking about the average and the median, I know that we were originally doing some research on this. You’re right that the hedge funds pull up the average but when you really look at the bulk of people that are using it, you’ve got this sub-$5 million mark which is where the majority of the offerings are taking place.
Sarah: Yeah, there’s a sweet spot in the small handful of millions, that’s for sure.
Steve: Anybody else has a view as to what is actually going on there, maybe specifically in the online world? Reg D offerings can be done both online and offline, rational investment banking model. Woody and DJ, anybody want to take a stab at what’s actually, what the average or the norm is in the online world? My personal research would indicate that it’s actually sub where you are, Sarah, and that it’s possibly sub-a-million dollars.
DJ: You mean in the last several months for 506(c)?
DJ: I don’t know, I don’t have access to that.
Daniel: This is Daniel here. Yeah, I think that that’s right. I think if you’re looking at the Title II, the accredited investor kind of crowdfunding type platforms; the size of the offerings are probably smaller. I think that’s because the ability to use technology and use the internet allows for the minimum investment threshold to be a lot lower than what would be typical outside of an internet context. When you look at platforms like AngelList, they’re able to set the minimum investment level quite low. That means that you’re able to use this for slightly smaller raises. I think it’s still early with 506(c), I think that a lot of platforms and a lot of, Sarah mentioned hedge funds and other types of funds, they’re all starting to dip their toe in the water and see how this tool can be used. Meaning the tool of general solicitation. I think it’s still early in the development of this marketplace but if you’re talking about the platforms themselves I think that they’re able to probably go a bit smaller in some respects than what we traditionally see.
Woody: The only thing I would add to that is we … We did research over the last summer, we looked at 1,000 companies campaigns doing crowdfunding. We whittled that down to 87 and had in depth surveys with each of them. The average raise was 117,000. Again, these are way early signals, way early in the beginning of what’s happening in the online part of it. You’ll see that particularly with Title III where you have the all-or-nothing financing component, when that comes into effect, the dollar amounts that people are going to be seeking I believe are going to be smaller because they have to be achievable.
DJ: I want to just keeping this one trillion dollar number because this is obviously without the … This one trillion dollars, which as Sarah points out is probably low. This is a number based without the benefit of general solicitation. How long before this one trillion becomes, I don’t know, two trillion? As we’ll see I think perhaps the next slide, but certainly in a subsequent slide that while that’s one trillion dollars or whatever the actual higher number is; it is only technical eligible to some 7 million Americans because you have to be accredited. Of that 7 million, it’s really something like 80% of this is generated by QIBs and about 500,000 about half a million individuals, that’s it.
Daniel: Steve, before we move on the only other thing I would add to what DJ said is, I think it’s important to note that when we’re looking at this trillion dollar figure that is inclusive of funds. Hedge funds, private equity, those collectively tend to be the largest category. I believe I saw data that since 2009, of these non-financial type of funds you’re seeing what would be essentially smaller companies or startups had raised about 324 billion since ’09. Again, that’s just through 506 and as Sarah mentioned, there are other private offering exemptions that they could be utilizing. It’s still a very large market and I think there’s no question that you opened up the door with general solicitation. You can anticipate that marketplace will grow from where it currently is.
Woody: To DJ’s point. I think the real opportunity comes from the fact that the process of raising capital offline is a very sticky one and it comes with parts and procedures that are manual. The minute this becomes online, it doesn’t matter if we’re talking about accredited or un-accredited, it’s the streamline and how easy this will be to do the ACH transfers and how streamlined everything will be. I believe that’s the main reason why we’re going to see this trillion dollar figure bounce up rapidly. There has to be transparency and efficiency in the marketplace, and trust. Once people get comfortable with it, the pace at which this will happen will quickly increase.
Steve: Yeah, absolutely agreed. Also in the interest of time, let’s move onto to Slide 2. Fifteen minutes in, so let’s move on to the next slide and we’ll circle back if there are additional comments. Again, as we say here, there have been some very notable changes in Rule 506 recently. September 23, yeah, general solicitation went into effect? Yeah, I think we’re finally settled on the actual date. There was some debate when it actually happened amongst the group. Sarah, again starting with you just on this one. In an old style 506(b) offering where we’ve not using general solicitation there is a provision to include up to 35 non-accredited investors in the offering. That obviously as we say here involves additional disclosure but also I’m interested in your thoughts on what it does to the raise from the perspective of investor suitability.
Sarah: Yeah. The problem with the including the non-accrediteds, you’ve got … All of these offerings, of course, have to be done by broker-dealers, and broker-dealers always have obligations with respect to suitability of the transaction both under CC and FINRA 10-22 Rules. Once you step into the non-accredited field, you are really stepping into a field that’s full of land mines because it’s expensive, it’s burdensome, and the whole thing about the accredited is they don’t have a lot money anyway. We did traditionally see people doing 506, old style 506(b) offerings and not including accredited investors because of suitability questions, because of disclosure questions, because of getting financial statements. Unless it was somebody who had to be included at all costs in an offering, there’s not a lot of upside and there is a whole load of downside to including the non-accrediteds. Even when it was possible, or even in the offerings where it’s possible, not a particularly popular option I’ve got to say.
Steve: That would line up with our opinion as well. We agree that it takes, it’s more downside than up. I was wondering if anybody had a contrary opinion or saw anybody in the marketplace who was actively bringing non-accreds into these deals?
DJ: I would say anecdotally, if we’re talking about the old rules, it’s pretty much the worst secret in this process is that under the old rules because the ability to certify or self-certify was so easy. It was literally checking a box. I think it was generally understood that there were a lot of non-accredited investors who checked the box and perhaps were encouraged to do that in order to get them in the deal and to avoid having the additional … I think they’re mostly state oriented filings for having non-accrediteds in those older deals. Now that’s gone away, for 506(c) one is no longer enticed to perhaps have 35 non-accredited investors, that’s gone.
Sarah: Steve, I’m shocked. I’m just shocked.
DJ: I know, I know.
Steve: That people would lie when self-certifying?
DJ: Lie is a such a strong word.
Steve: Such a strong word. We’re actually going to get, we’re going to actually speak a little bit more at length about the processes around verifying somebody’s status a little later in the presentations. Let’s get back to that. I think everybody is of the same opinion that even though the exemption supports it not a whole lot of people that are using it. Accredited investors; again, hopefully this is information most people are aware of in terms of the definition of an accredited investor. We’ve had some interesting discussions amongst this group as to what might happen in terms of the definition of an accredited investor. That’s such a key component of 506(c), right, only accrediteds can participate. I was just curious if, to get some thoughts on what those changes might be and what the impact on the industry in general is? DJ, I was hoping you could start us off there.
DJ: From a political or a legislative standpoint and a regulatory standpoint, there’s a move now to raise these numbers. These numbers have effectively been in place, I think it’s since 1982. They haven’t been adjusted for inflation or anything. The 200, 300, and one million have been in place for a long time. With the proviso that fairly recently the exclusion of the value of the principle residence was really the only modification that I’m aware of in the last several decades. What’s being discussed is perhaps raising those. That may or may not actually fly, but if it does there’s another part that may expand it in the other. Whereas that is restrictive, there’s some discussion, quite a bit and I think several of the people on this call, including myself, are pushing to expand the definition of accredited investors pretty much to what it was for a brief period of time prior to 1982. In that it included what was known as sophisticated investors.
The test was not just limited to what it is now which is whether one can take the hit. That’s all these numbers that are on the slide do, except it doesn’t’ demonstrate that you’re smart. It doesn’t demonstrate that you understand the investment. It just demonstrates to some extent, in a broad sense, that you have enough money that if it goes sideways that you can take the hit. That however, again, is much more restrictive than … I think it was, I think Sarah will probably be able to help me with this. I think it was the Rossland Corina case versus the SEC. Where the Supreme Court established the text that this is vaguely based on, which was whether or not someone could and I quote “fend for themselves” and that they needed to be a sophisticated investor. The SEC took it upon itself to define fend for themselves as someone who could take the hit. This does not necessarily, this does restrict people who might be otherwise … Who might not qualify under these financial terms but might be smart enough to actually understand the investments.
For example, just a couple of anecdotal examples. One would be, let’s say somebody who actually passed the Series 7, or Series 82, or 79; these are FINRA tests that enable somebody to actually structure and sell these types of offerings. If they weren’t worth a million dollars right now or they don’t make over 200,000, they can sell them but they can’t buy them for their own account. That’s kind of nuts! If someone has the expertise to actually push these things to customers, then surely they have enough expertise to decide on their own whether or not they can participate in them. That’s just one example, I could give others that obviously it’s anecdotal. I don’t think that anyone is thinking that expanding the market to allow brokers to participate is really that big a deal but there are other examples as well. Rather than take up any more time on this, I’ll turn it over to someone else’s comments on this topic.
Steve: Yeah, DJ just sort of echoing the general sentiment of your point. We’ve talked about this before, rich doesn’t necessarily mean smart or sophisticated.
DJ: I could say with some degree of authority that it doesn’t. I’m positive that that’s true.
Daniel: The only thing I would add here too is there’s the Angel Capital Association submitted a comment letter to the SEC which I suggest people take a look at, commenting on definition changes to accredited investor. It made the point that if you index these income thresholds to inflation, it would result in a significant number and I believe it was between 40 to 60% or so of those who currently qualify as accredited investors would no longer qualify. Even just indexing to inflation would have a dramatic impact on the overall pool of accredited investors.
DJ: On the overall pool, but I think that there was some discussion about whether or not that would have a meaningful impact because the majority … Or at least my understanding is that the vast majority of the investors who actually participate aren’t on the line, they aren’t people that are making $250,000. They tend to be people who are worth considerably more.
Steve: That’s interesting. I would ask the rest of you guys, what do we think those, the impact of that would be on those angels or accredited investors who are utilizing platforms? I just wonder if the whole purpose of Title II and a lot of the online platforms is to attract the broader pool of accredited investors. I just wonder where they would fall on that spectrum.
Sarah: That’s a really difficult question to answer because now we’re talking about the absent 8.2 million here. The estimate that the SEC comes from the IRS, it’s like 8.7 million. It’s probably not a very accurate number but that’s the estimate of how many accredited investor households there are. As DJ mentioned, it’s something like 400,000 or less than that who invest. How many of the people who would otherwise have been brought in would get thrown out again? You’ve got two moving parts there, that’s a very difficult thing to estimate.
Daniel: Yeah, fair enough. I guess I’m just thinking that one of the powerful potentials of general solicitation is it’s actually letting accredited investors know that they’re actually accredited. That they can participate in these markets because I suspect that the 8.7 million that we’re talking about, I would suspect the vast majority do not know what it means to be an accredited investor. I think it’s a very interesting question but I suspect that the ultimate definition here will have an impact on some of the developments we’re seeing in the 506(c) marketplace.
Steve: I would agree with that as well but I also think that the point that Sarah made is a very good one. Of the available accredited investors, a very small number of them are participating in these deals. It’s very difficult to gauge what the impact on the deal-friendly group would be. Okay, let’s move on. Again, I think that this is self explanatory. I’m interested here in peoples’ experience in working with the various platform providers in terms of the channels that folks are actually using to generally solicit. I know I for one haven’t seen a TV ad as yet or an ad in the Post, or any of the other vehicles that are possible. I’m just wondering if folks had some thoughts as to what channels are actually being utilized to solicit folks generally. Danny, do you have any specific thoughts on that?
Daniel: Yeah. As I mentioned before, I think everything is developing slowly. You’re seeing some testing I think of some different approaches. I don’t know about seeing an television ad. I know that there have been a couple of funds that have done some web videos, so ads on YouTube. Actually I know there’s been a couple of newspaper placed ads, and again for funds. I know AngelList is doing some 506(c) offerings and they’re using their syndicate model there to promote certain offerings. I know that they’re also filing some of their form Ds with the SEC, so that’s a place that you can go look to see what’s taking place.
I think you’re seeing some experimentation, there’s been some news, print media, some web, web video … I certainly don’t think it’s been the deluge that some people thought you might see come September 23rd. I think that’s really a result of participants seeing what others do, seeing where the boundaries are and how impactful it can be to utilize these new tools. I would actually just add though, the last piece here is that I suspect that one of the biggest impact it’s having is preventing issuers from having this overarching fear of a foot fault. In the past, everyone was very, very cautious about any kind of communications surrounding private offerings for fear that they would inadvertently trip general solicitation. Now they may not want to trip it but if you do, it’s not necessarily the end of the world. You do have to go through the investor verification process, which many probably do not want to necessarily or they’re not intending to have to go down that path. I think that’s probably also having an impact on the markets for just general practices surrounding offerings.
Sarah: It’s the one area where I was totally surprised that is being used for general solicitation is LinkedIn. LinkedIn is a morass of half baked, idiotic ideas put together by people who have no idea what they’re doing and who can’t spell.
Steve: Don’t sugarcoat it, Sarah, let us know exactly how you feel.
Sarah: Yeah, I’m the grammar police. I was amazed how much was being used on LinkedIn. That one surprised me, I expected a bit of Twittering and …
Steve: Sarah, are these intentional do you think, or are you seeing some, as you said kind of half baked like…
Sarah: It’s kind of both. Prior to September 23rd, you did occasionally see stuff on LinkedIn where people (bless them) would say, “Hey guy, you might not want to say that in the open media.” Now there are deliberate offerings and I think that’s one of the places where you see some of the worst offerings, to be honest.
Woody: Yeah. I would have to agree with Sarah. I think the, like Daniel was saying, a lot of the big firms are proceeding with caution and rightfully so. I think everyone’s trying to see what the first mess-up is going to look like. I think the people that are doing this on LinkedIn are foolish, and are not, they probably are not doing what they’re doing with counsel. I would encourage everyone to make sure that you retain counsel before you start sending messages haphazardly out there.
DJ: It’s going to be interesting to see how this evolves because so far what we’re talking about is that everyone … The examples that everyone is pointing to are basically broadly under the rubric of social media but it’s not limited to that. I can tell you that anecdotally that I, it was a year ago really, I met with several rather large advertising agencies in New York City to make them aware of this. If you think that there are a bunch of accredited investors who don’t even know that they’re accredited, the advertising industry was pretty much and remains for the most part unaware of the fact that they can now participate in securities offerings. Someone is going to figure that out. I don’t know which one it’s going to be, but one of these advertising agencies is going to figure out how to do this in a way that doesn’t feel like ambulance chasing lawyers on public access at 2:00 in the morning so it doesn’t feel slimy.
It’s going to be figured out and it’s not just going to be the things we’ve always talked about with respect to the JOBS Act generally and more specifically Title III but still Title II, Wall Street meets Main Street. It’s also going to be Wall Street meets Madison Avenue in a way that has never happened before. It may take a while because that industry simply hasn’t been permitted to participate in securities sales. They’ll figure it out because there’s a lot of money here and there’s nothing that advertising agencies like more than money.
Sarah: The one thing that they do need to do is figure it out in conjunction with their counsel. We’ve had a couple of conversations with people who say, “Hey, we’re going to do X, Y, and Z.” We say, “You know what, that’s actually a brokerage activity you’re planning to do. Go talk to your lawyer.” We are the destroyer of dreams, the blower up of business models. It’s not just like advertising iced tea.
Daniel: Right, Sarah, that’s a great point. I actually was, as I was listening to this, I know that’s one of the legal questions out there. What’s different today is that in the past, you were talking about a very passive medium for advertisement if it’s a newspaper or television. What you’re describing is, especially through social media is the advertising entity has a much more active role in promoting an offering. It starts to look like a broker-dealer type activity as opposed to a promoter activity, as opposed to just passive advertising. Which is an interesting question.
Sarah: Yeah, exactly. Advertisers are, really, they’re going to end up talking to more securities lawyers than they ever wanted to. Which I think in most people’s experiences, they want to talk to zero securities lawyers.
DJ: I only like to talk to you, Sarah, that’s pretty much it.
Steve: Yeah, and we’re actually going to talk a little bit more about some of that hybrid online-offline model a little later. Sarah, let’s circle back on that one for now. Moving on, we spoke already about the statistics of 8.7 million accredited investors but very narrow penetration there. Again, interested in thoughts on what kind of companies are being successful or what types of companies it makes the most sense for them to use general solicitation. I think we’re all familiar with the AngelList high tech startup model but there are some other industries/asset classes that are being somewhat successful with this model. DJ, you want to talk to us a little bit about your experience with real estate?
DJ: I can just say that I have, my background is not in tech, and whatever, Silicon Valley, and those kinds of startups although I have some exposure to it. When I first got into this because I’ve spent more time in the real estate vertical than perhaps any other with the possible exception of filmmaking, which we’re not going to talk about today. I thought that this was going to be incredibly valuable for … That that was going to be an asset class that would be incredibly valuable to promulgate among people who didn’t realize that they can participate in it. Inarguably, more wealth has been created through real estate in this country and probably on the planet than through any other vertical including financial services. Or in Los Angeles, more money has been made in real estate than the entertainment business. By and large those types of investments have not been not widely available to all but a very small few and not just accredited but a smaller group than that, a smaller field than even that.
Real estate investments as a vertical are a pretty significant percentage, it might even be higher than … I know that for example Daniel referenced, I think we’re all referencing the SEC report that came out last July about this market, about the Reg D market. Real estate is listed there as one of the verticals that’s pretty significant. I think it’s like 12 or 16%, I can’t remember. However I think it’s actually higher than that. I think it’s higher than that because I think that a lot of the funds and a lot of the things that aren’t specifically allocated to industries are in fact real estate investments. What I’m seeing now and I’ve been talking about it for a while, that there seems to be, of all of the verticals real estate seems to be the one where there’s the most amount of would-be platforms that are specifically targeted to different aspects of real estate which in itself can be broken down into different verticals. Of course, there’s commercial, there’s residential, there’s all kinds of different ways to slice and dice it.
There’s certainly debt and there’s also equity and there are blends of the two. I’m seeing a lot of platforms that are focused on real estate and I think that that’s kind of interesting. I’m not seeing a lot of platforms, not as many where they’re specifically focused on a vertical. There might be something that’s focused on tech but that’s rather broad compared to real estate which is much more specific. Is that the kind of thing you were looking for, Steve?
Steve: Yeah, exactly and interested in others’ opinions as well. From our perspective, it’s also something that people can get their arms around. It’s pretty easy to understand fractional ownership in a building, or a house, or any other type of real estate. It’s a little harder for people to really understand what owning a very small percentage of a very private company, what that really means. I just wonder if anybody else has thoughts.
Daniel: Yeah, Steve. This is Daniel. I would just add to that. I think one of the things that’s compelling about real estate so far is that it’s tangible and people can know it. They know either the specific property and as you guys mentioned there are a fair number of platforms. There’s one here in D.C. called Fundrise that has done a couple of well known projects in the city, so would-be investors can actually go take a look and see the property itself. I think that’s compelling.
That’s the same reason things like consumer products have also made good sense. You’ve got CircleUp that’s been doing that for a while within the consumer product vertical. Again, it’s because people can know the brand. I think, ideally investors will invest in what they know. Especially since you don’t want to be chasing after offerings that you have very little information, so things that are more tangible seem to make good sense to me. A lot of brick and mortar make sense or brands that people actually follow.
Woody: Yeah. This is Woody. I spent a good bit of time this morning on the phone with an oil and gas company that is looking at using a combination of Title II and Title III crowdfunding. According to the rules, you can do a concurring offering if you’re doing a Title III, so you could do something for under a million dollars to gauge interest. Then actually do a parallel offering under a Title II. They’re trying to figure out how to leverage their successes to date with oil and gas exploration and to pull in un-accredited investors through Title III offerings. You’re going to see people that you wouldn’t expect to be entering this space. That’s usually bigger dollar denomination deals but are trying to be creative on how do we leverage not just the crowd for their money but the crowd for their ability to talk about what is going on and bring more awareness to these deals. I think verticals in those type of industries are going to be popping. Every industry, I do believe will either have its own vertical or will have portals that are of course looking at deals across multiple sectors.
Speaker: The oil and gas thing is actually really interesting. Most wildcat drills for oil and gas, particularly in the Louisiana area and I only know this because I did some research on it about a year and a half ago. The cost to throw one up, usually between 700 and $1.2 million. That falls pretty squarely within the, we’re just about within the caps of Title III. We’ll see how that goes. I’ve talked to a couple of people that are looking forward to trying to do that so that people can have a fractional ownership of a wildcat gas exploration in rural Louisiana.
Steve: Great, yeah. That’s interesting and I’m going to make a mental note to follow up with you offline. I think we may be talking to the same oil and gas company, it would be interesting to compare notes.
Speaker: Moving on. Just talking about success. Again, I think it’s been noted a number of times that this is a brand new industry for everyone and it’s going to take time in traction. One of the things that we wanted to talk a little bit about with regards to the slide is the concept of securities being sold. Form D filing needs to be made once securities are sold. Sarah again, turning to you as the lead on this, can you give a quick definition of selling a security in this context?
Sarah: Okay. It’s about, there’s no magic to it. In most Reg D type offerings, or in many Reg D offerings, there’s kind of rolling closing. When you have a binding commitment for somebody to put up the money and buy securities, that’s when you’re really supposed to, you’ve got 15 days to file a Form D. What we’ve seen is you’ve got the opportunity of filing a Form D which says we’ve started making sales in effect. You’ve got the opportunity of checking the box for 506(c) or 506(b), if you’ve done any kind of combination, which many of the offerings are at the moment. In many cases it’s 90% offline and 10% online.
Then I think we’re probably seeing more people checking the 506(c) box just in case. It’s a very difficult thing to analyze right now as you just said, six months. Who knows what’s going to happen. What we can say is there have been well over a 1,000 offerings where somebody is confident enough that they’ve actually gotten money from a selling asset, which included some element of online selling that they felt they had to file a Form D. So, yeah, it’s not a lot, there’s 20,000 offerings a year under Form D but 12,000 in the first six months for the brand new initiative. That indicates something, I’m just not sure what it is.
Steve: Just to clarify for everyone. When you talk about a binding commitment, I just want to make sure that what you’re talking about there is possibly the signing of a subscription agreement or some other document that binds…
Sarah: Yeah, there’s a number of different ways that you can commit. It means that the money will end up with the company at some point and it may not have yet. The funds could be in escrow or it could just be a rolling closing and everybody pays at the end. It is an indication that the company is going to get that money.
Steve: Okay. In the interest of trying to have a little bit of time for questions, I’m going to move on to get through the covered material and see if we can open it to the other guests for questions. We’ve talked a bit about compliance with 506(c), that you can only sell to only accredited investors. One of the things that I wanted to get opinions on and open this to everyone is; from a verification perspective, the rule mandates now that platforms must verify that someone is in fact accredited. Just interested in starting a discussion around the challenges of both income and asset verification. I can either be making so much money or I can have liquid net worth of over a million dollars. Just wanted to get some thoughts on challenges around doing both of those types of verification. If anyone has any …
Woody: Woody. I’ll jump in with everyone … We heard a lot of people saying this is going to deter people from investing because no one wants to turn over their private information. I’ll be the first to tell you that on my, on Fidelity’s website I can actually print a form now that just looks at the assets and allows you to take that, I’m sure it’s just self-populating if you have assets that are over a certain amount, you can print this letter. It’s a certification letter for accreditation. People are going to realize if we just need to go into their assets and make sure that they’ve got what they need there, there’s ways of having these firms and I think technology will enable it, make it easier. Granted, a lot of this doesn’t take into the debt side of things but it does certify that you have assets over a certain amount.
Steve: That’s actually a great intro to what I was trying to get at. There are definitely several different ways that I could prove to you that I have assets in one place totaling more than a million dollars but there’s no way to guarantee that I don’t have liabilities larger than that in some other place.
Woody: Well, there may not be a way to guarantee but there’s something called a credit report. You pull a credit report, which is pretty standardized, and that tends to list your debt. That is what banks and financial service companies that will seek to lend you money are reliant on in order to determine what your liabilities were. That’s pretty precedented. I never did understand the resistance to providing this information, which I think and I know Sarah and I have spoken of it briefly. The resistance seems to have dissipated to some extent because it seems this is, the process is certainly no more onerous and indeed might be less onerous than applying for a credit card, opening a brokerage account, opening a bank account really. It’s really not, it’s just not that invasive or at least it doesn’t do … My perception has never been that it’s all that big a deal.
Sarah: There are certainly ways to make it less invasive and some of the easiest ones are just a letter from the broker kind of thing. One of the things to just circle back. Steve, you used the word guarantee. Nobody is asking for a guarantee, it’s just reasonable steps to verify. The industry will drive the definition of reasonable-ness.
Daniel: The only thing I would add to this is, I think the biggest issue that existing angels have with it is just the change to the status quo. That’s a fair point, they’re used to things working in a certain way and self-certification worked for a long time. When someone says to you, “Now you’ve got to prove it,” I think that changes the game a little bit for them. I think that was, just connecting to something we talked about earlier, that’s why I do suspect a lot of the 506(c) especially online angels may be newer angel investors, or first time accredited investors who are entering the marketplace because of that they don’t have that historical experience of self-certification. It made it seem less problematic to go through the verification process.
DJ: That’s actually a really good point there. I hadn’t really made that historical resistance connection in my head.
Steve: Okay. Then last slide here and then we’ll try and see if we can get a couple of questions in. Now that 506(c) is possible and available it doesn’t mean that 506(b) is an old style non-general solicitation offerings have gone away. It’s still possible to issue securities under these exemptions but there needs to be a lot of care in terms of making sure that you’re not in any way, shape, or form generally soliciting.
Sarah: I would add don’t start getting clever with the general solicitation definition. As we pointed out, one of the earlier slides there’s been a fair amount of speculation as to what general solicitation. General solicitation was defined in a whole series of no-action letters from 1982 right up to today’s date and the SEC says that hasn’t changed. I had a conversation with an SEC staffer yesterday on this very topic. For example on the demo days argument and her answer was, “You guys said that, we didn’t.” They’re the ones who are going to decide if there’s a problem or not. So don’t get clever.
DJ: Yeah. I think that let’s put a finer, I would put a finer point on it. I’m certainly not seeking to offer anybody legal advice. First because that would be inappropriate because I’m not an attorney. Second because people aren’t paying me anything. I would say that when I talk to people about this, and they’re like, “Well, we’re more comfortable with (b).” I say, “Well first of all, there are some activities that you did under (b) for example demo days that now that the SEC hasn’t been very aggressive in pursuing or enforcing. Now that there’s an alternative, where you can really make it legitimate, the SEC may no longer look the other way so you might as well file under (c).” The other thing that I’ve also said is, “Forget about the demo days. Whether someone says they’re not doing them. You have no idea whether or not somebody is going to say something that they might not want to say.”
I think the term was, I think it was Daniel used was great, foot fault. Why risk foot fault? Why not just file under (c)? This gives you some degree of protection.” While I certainly agree that there will be some unique situations where 506(d) will continue to be used. At this point, it’s awfully hard for me to make the argument to someone who comes to me, a potential issuer, and says “Should I do (b) or (c)?” It’s very hard for me say, “Let’s talk about this at length. You really should consider it, maybe you should do a (b).” My default device is usually you might as well go with (c). It just gives you more optionality and a measure of protection in case you do happen to say the wrong thing inadvertently.
Sarah: Hey, DJ, I’m giving you an honorary J.D..
DJ: Thank you. That’s clever.
Steve: DJ, just one quick point. The only compelling reason we’ve heard to date around going (b) is that situation we talked earlier about where someone has just got to bring a couple of non-accrediteds in.
DJ: Yeah, that’s right. Then there’s this thing called simultaneous offerings and hopefully Title III coming up so that might be a more appropriate place for them. Of course, I get your point. That’s a fair one. Sarah, can you do me a favor and can you call my mom and just tell her you just gave me an honorary J.D., that’d take a lot of pressure off me.
Steve: All right, so we’ve got about five minutes left. I want to try and see if we can get a question or two from the people out there not on the panel. Everybody should have a go to webinar little toolbar there that would allow you type questions that I can see and tee up to the panel. If anybody has a question, taht would be the way to post it to the group. Okay, so I’ve got a couple here. I’ve got a question from Adam Whitaker asking if we could discuss the condition of the market aspect of general solicitation. Interested to hear about advertising past capital raises, so throw that out to the group.
DJ: I’m sorry, do you mean closed raises? Raises that are done?
Steve: Yeah, it’s hard for me. I’m just reading the questions as I have them, DJ. Let me see if I can un-mute Adam.
DJ: If it is that, like are you allowed to advertise your past raises to demonstrate your track record. That kind of is known as a tombstone. Which is to say once it’s closed and there no possibility of new money going into a raise once it’s done, you can talk about it. I don’t think there’s a lot of restrictions with respect to that. I defer to the attorneys on the phone on that one but I’m pretty sure that that’s fine. It can’t be soliciting if there’s nothing for them to buy.
Sarah: That’s true but there are circumstances in which you might want to use the success of a past raise in order to create market interest in a current raise. That would be problematic.
Steve: Yeah, new technology. Just going through a couple of other questions. I’ve got a question here from Donovan Johnson; what do we think in terms of how saturated the market for crowdfunding platforms is for tech versus real estate. I’ll take a first stab at that, I don’t think any of this is saturated unless someone wants to disagree with that.
Woody: Not at all. This is Woody. I think they’re at such an early stage that even the players that are in right now are going to come up to competition with people that see the true opportunity of this, that have deeper pockets, and stronger hands. That are probably out there institutionally already, that have decided to venture into this space. I think we’re at the very beginning stages.
DJ: Of course, I would agree. I don’t think there’s no danger of saturation. I would say that the question does point out something that many of us have talked about, which is that because so many of the people running platforms come from the tech space themselves, indeed they perceive the setting up of a platform as a tech venture. It’s where they’re comfortable. There may be, maybe a better way to put it is that for the time being there does seem to be perhaps a disproportionate number of sites or would-be platforms that are focused on tech because that’s what the platforms themselves are used to and are comfortable with. I think over time you’re going to see, I think Woody mentioned this, you’re going to see platforms that do agricultural business raises, and of course real estate has been mentioned, and others that might do equipment leasing, and some that do some sort of pooled consumer loans and things. You might be hearing about tech just because that’s the first one out of the box, they’re the early adopters for this new methodology. I think that’ll even out over time.
Steve: Yeah. Then just the last question and then we’re going to have wrap up with the question round. What is the best educational and training resource for aspiring crowdfunding professionals? I think on some level one answer to that is the series of webinars that we’re holding at CIFRA. I would also open it up to the panel, are there other good places that you know that people should go?
Woody: This is Woody. I’ll put two shameless plugs in there. By all means, if you feel like you need to take the dummies approach, feel free to buy Crowdfunding Methods for Dummies. I took all my experiences of growing businesses and leveraging crowdfunding and put it into that book. It’s on Amazon.com. Actually Wal-Mart has got it for 15 bucks now. Then the second one is we have both a Title II and Title III education for entrepreneurs and investors through our online video education series called “Success with Crowdfunding.” So SuccesswithCrowdfunding.com.
Steve: Anybody else want to throw a shameless plug in before we wrap up?
DJ: Sure, you can hire me, consult me. I’d be happy you to walk you through it, that’s fine.
Steve: All right. We’re at 2:00. I want to thank both the panelists and all of the people who participated in this event for their attendance, their patience. This is new technology for us so hopefully it works pretty well for a first shot. I believe I have recorded this.
DJ: God, I hope so.
Steve: Yeah, hopefully the recording will be made available shortly after the end of this even so that everybody can hear what everyone had to say offline. Thank you all once again. We should be announcing the next session shortly but expect in approximately four to six weeks.
Second Market Webinar: Demystifying General Solicitation
Originally hosted on SecondMarket.com, but the link is now down.
Kevin Laws, Chief Operating Officer @ AngelList
Greg Raiten, General Counsel @ 500 Startups
Bill Siegel, Senior Director @ Second Market
Bill: Hi everybody. Welcome to today’s webinar on Demystifying General Solicitation: Please Think Before You Tweet. Today’s webinar is brought to you by 500 Startups, AngelList and Second Market. With us today are Kevin Laws Chief Operating Officer of AngelList, Greg Raiten General Counsel of 500 Startups and I am Bill Segel Senior Direct at Second Market.
For starters today, we’re going to kick it over to Greg who is going to give us the basics on the laws. We’re going to learn about what is allowed and what is not allowed, so I’ll kick it over to Greg.
Greg: Thanks Bill. Let me just start real quick with a brief overview of the financing landscape for startups who are looking at using the securities markets to raise financing. In the past, there were really only two options for companies that wanted to pursue securities markets for fundraising. They could either conduct a fully registered IPO with SEC and go through all the pains and expenses of registering a company or they could pursue one of these exemptions that the SEC has provided which means that you don’t need to register with the SEC as long as you followed the rules of the exemption.
All of the exemptions the SEC provided in the past contained the same prohibition on what people commonly refer to as general solicitation which means that companies really weren’t allowed to talk publicly about their financing rounds, instead they were forced to speak privately with investors which they had some sort of preexisting relationship with.
Now with the passage of the JOBS Act which went into effect, the new rules that the SEC proposed there-under went into event on September 23rd. The SEC has proposed a middle ground approach here where it’s an exception from registration that also allows companies to speak publicly about their financing so long as they follow these new rules.
Let’s talk about these new rules real quick. There’s two main prongs to the new rule for general solicitation and this can be found in 506C of Regulation D. The first thing is that all investors that you sell securities to must be accredited so the definition of accredited has not changed. For individuals that generally means that they have to make at least two hundred thousand dollars in a year or three hundred thousand with their spouse or they have to have a net worth of at least a million dollars not including their primary residence. For companies that generally means they have to have at least five million dollars in assets so same standard as before for accredited investors.
The core of the new rule however is the second prong which says that companies who use this exemption must take what the SEC calls reasonable steps to verify that each investor who purchases securities is in fact accredited. That means that companies can no longer just rely on an investor certifying to them through something such as a questionnaire that they’re accredited but they’ll actually have to take some sort of reasonable steps to make that verification themselves.
The SEC didn’t really provide any hard line rules as to what reasonable steps would be but instead said that it is an objective determination that companies will make based on the facts and circumstances of the financing so that means the type of investors that you sell to as well as the particular terms of the financing.
They did however provide a couple of examples of what would be deemed reasonable steps and the key one would be for companies to ask their investors to provide certain financial information to the company so the company can review those statements and determine whether the investor meets the accredited threshold. That would mean asking your investors to provide things like tax returns, bank statements, credit reports, information like that.
The other way you can do this and this was set forth by the SEC is that you can rely on certain third parties to review those statements for you and give you a written certification that they have determined those investors are in fact accredited. The types of third parties that you are allowed to rely on are registered broker dealers or licensed attorneys or CPAs, so that again is the core of the new rule.
The third prong here is really not new. This is something that applies to all financings under Regulation D but it means that companies need to file a Form D with the SEC at least fifteen days after the first sell of securities. The reason that’s notable here is that if you do a general solicitation this new exemption under Regulation D is the only exemption that you can rely on without actually registering your securities with the SEC doing an IPO.
In the past, under the Private Placement Regime there were various exemptions you could rely on, one of which being Regulation D but if you chose not to go the Regulation D route you wouldn’t need to file a Form D, here you will always need to file a Form D.
In addition, the last prong here is the SEC passed a new rule that is called the bad actor rule. That actually applies to all offerings under Rule 506 of Regulation D so it’s not just general solicitation offers but any offer that you conduct from now on under Rule 506. This rule is really broad. It really states essentially that any person who is involved with the financing will have to certify that they have not committed any bad acts or else the company would be disqualified from using Rule 506.
What constitutes a bad act and what constitutes being affiliated with the purchaser is quite broad? It essentially means that people can’t have been convicted or had any sort of court ruling or decree about committing some sort of securities crime or bad actions in connection with the securities markets. I encourage you to look at those rules a little more closely if you are doing any offerings under 506.
In addition to the rules, the SEC also put forth a set of proposed rules so these have not yet been enacted. They’re in what’s called a Notice and Comment Period and the SEC is soliciting comments on this to determine which if any of these rules they will actually enact. The proposed rules have really generated a lot of commentary. They’re quite onerous and a lot of people out there have been saying that if any or all of these were enacted it would really make it very difficult for startups to comply with the general solicitation rules.
I just want to talk real quick here about a few of the aspects of the proposed rules that are most notable. The first thing would be the requirement to file a Form D at least fifteen days before actually conducting any offering as opposed to fifteen days after any sell. There’s also a requirement that an amendment to the Form D would have to be filed thirty days after the offering finishes and you have to disclose information about the amount of funds raised in the offering.
The requirement of what information would be disclosed under a Form D has also been greatly expanded in the proposed rules. New companies would be obligated to give information about the number and status of their investors, how they plan on using the proceeds, what types of general solicitation they used as well as which method they used to verify their investors. The proposal also contains a pre-onerous or severe penalty if companies fail to file the Form D as prescribed by the rules. If you did fail to file it, there would be a one year disqualification from using Rule 506 and that’s pretty severe because 506 is really the most common path companies use to avoid registering securities. There is a cure period for one missed filing of thirty days, but in general the one year disqualification would stand.
The proposal also says that if you use written general solicitation materials, you would have to include a legend on those materials. It also imposes a two-year period after the enactment of the rules in which companies would actually be required to submit their written solicitation materials to the SEC before they use them. There’s no requirement that the SEC approves them but they would need to be submitted which could be challenging if your written materials are things like a Tweet or Facebook post or something like that.
Again, these are just the rule proposals. None of these have actually been enacted yet, so none of this is effect and it remains to be seen which if any of them the SEC does take up. That was really a very brief overview of the new rules and the proposals.
I just wanted to give you four quick takeaway points here if you remember nothing else from this presentation. First one, as we said as of September 23rd you can now generally solicit or make public statements about your fundraising so long as you comply with these new rules which was set forth in Rule 506(c). The core of the new rules is this reasonable steps to verify it which means that you will now need to take steps to make sure that all of your investors are accredited.
A third point here which I didn’t really touch on here today but something for you to keep in mind is that if you do raise a round with general solicitation depending on when you do other financings and the types of securities you sell in those other financings, they may be deemed integrated together with this new fundraising such that all of them are considered to be one offering which means that if they were integrated the new general solicitation rules, the more onerous standard would apply to all of the financing rounds.
That really leads me to my last point which is once you make a public statement, you can’t go back, so once the genie is out of the bottle here you really can’t put it back and you’re going to be in this new general solicitation land so you’ll want to think carefully about making this decision and make sure you discuss it with your attorney before deciding to do anything.
Again that was a very brief overview here. There’s a lot of information out there on the web. If you’re interested in exploring this further, 500 Startups has written a blog. You can see the URL here which has some additional information as well as many other resources out there. Just a final note, this isn’t legal advice we’re providing here just saying this for informational purposes only. If you guys do have specific questions about your company and your financing rounds, I encourage you to talk to your lawyers and to walk through that with them.
Bill: Great Greg. A quick question for you, if the company has already done a round of financing which I’m sure a lot of the participants on today’s webinar have what are some of the most immediate factors that they should consider before they Tweet or decide to go forward with the public solicitation? What would you say is exemplary behavior for 500 Startups, but for companies in terms of the decision-making process that you go through before they undertake this?
Greg: Sure, yeah that’s a really good question. I think the main thing for companies to consider is these new verification requirements. That’s the core of the new rule and that may really change what type of investors companies are able to get into their [realms 00:11:19] because obviously you’re asking your investors to provide pretty sensitive information whether that’s to your or to a third party that will be required of every investor that you close on if you decide to take this path of general solicitation.
I think the other thing for companies to consider is what I touched on very briefly is this idea of integration. There’s a rule under Regulation D rule 502 that says if you sell securities in a same or similar class, so maybe notes or some sort of preferred securities, and you sell them in two different rounds [of the curve 00:11:54] within six months of each other they may actually be integrated and treated as the same offering so that really means if you did a private financing in the past, sold some sort of notes and then do a public financing within six months of that if the SEC deems those to be similar securities they could integrate those financings so that all of the new general solicitation rules would apply to both financings.
If you did your old one under the private placement regime something like Rule 506(b), you might not have complied with these heightened standard of taking steps to verify your investors so something to keep in mind is if these offerings will be integrated together that’s something you can talk to your attorney about and try to think about as well as what it means to take steps to actually verify your investors are actually accredited.
Bill: Got you. Then just a simple question just so I’m sure a lot of companies are asking this, if they don’t financing before the rule change are they safe if they solicit after the rule change or is integration still a risk?
Greg: Integration could still be a risk. The SEC hasn’t really talked about that. It remains to be seen. It’s again it’s one of these areas law, it’s a gray area what will be deemed integrated. There’s no bright line rule. It just depends on the facts of the particular round.
Bill: Got you. Cool so Kevin obviously tons of companies raising capital on AngelList, some publicly, some privately, what have you seen in terms of best practices of some of the companies weigh the decision about soliciting and using a tool like AngelList to attract investors?
Kevin: It’s really depends on the type of company. Most of the companies that has chosen to do general solicitation, there’s been two things the ones have done that I think have done it the right way. The first is they have been aware of the consequences of general solicitation meaning they know that they are going to have put their investors through more work to invest in them many of those that have chosen to do so any way.
Second, they have done so because they believe there’s something about their business that will make it easier to raise money using general solicitation. There are plenty of sources of accredited capital that you don’t have to generally solicit to get to via AngelList, via taking tours up and down Sand Hill Road or talking to Angels et cetera, but there’s some companies that believe that because of what they do they think that they can reach the right kind of investor, less so the idea of advertising but more by using Twitter or a blog post or the press or announcing at one of these demo days in a very public manner. Those kind of things can really help an exciting company get fund raised. Those companies have had the best success using general solicitation to find interest in accredited investors to invest in them.
Bill: Excellent, so another question for you Kevin, everybody wants to know what their peers are up to. Can you share some high-level information about variances between money that a company could raise publicly versus privately on AngelList and if there’s a difference between time to close if you solicit broadly or do a private placement?
Kevin: Yes, so there are about three thousand companies that have opted in to use general solicitation on AngelList. Now what it means when you opt-in on AngelList is just that you make your profile available to the public and that means that you can Tweet it or Facebook it and point back to the profile so that everybody can see if even if they’re not already an accredited investor registered on Angel List. Of those that have gone through it, there’s the companies have been able to raise money much faster if their general solicitation has been combined with some sort of publicity.
For example, the first one to go out using general solicitation on AngelList was a company called Shyp and it raised its full round within hours because Tim Ferriss one of the investors happens to write a blog post about Shyp that he put out at the same time as the company was generally soliciting and the company gathered up all of its investors almost immediately because of the publicity that surrounded that. That’s the kind of success that people have had.
One the flip side, I do want to make sure people are aware [inaudible 00:16:51] use those to make money, closing your round is certainly in this first six to nine months when investors themselves aren’t aware of the additional steps they have to go through that can take longer because the investors have not all already pulled together all the information and said, “Yes here’s another investment that needs to see my 1040s and ship them off.” They’re not use to all of that. The actual close process which might have taken several weeks to a month before extend whatever you’re expecting to do by a week or two especially if you’re dealing with investors who aren’t expecting to be asked for these documents that they’ve never been asked for before. I expect it to fade over the next six to nine months as the sophisticated investors get used to being asked for this kind of information.
Bill: Got you. It sounds like what I’m hearing is if you’re a company and your plan is just to tell folks that you’re raising money, you don’t actually have a plan and also if you are going to raise money probably certainly plan on investors having a little bit of friction involved with disclosing information but that should hopefully fade over time.
Greg question for you. As a GC of a firm that makes a lot of investments how has your diligence process changed or how has your view of a potential investment changed knowing that the company is probably advertising a round that you would actually be participating in?
Greg: Sure, so we actually haven’t been approached by a company that is doing a public financing and put in more money, but I’m sure that will happen soon. There are really two things that we’re going to be paying attention to on our end and the main one is this reasonable steps to verify it as we’ve been talking about. In order for the exemption to be valid, companies must have taken these steps and that’s really on the company to prove that they have documented the steps they have taken.
We’re going to want to make sure that companies have some sort of process that they’ve gone through whether that be using some sort of platform like AngelList or Second Market or they’ve done the verification procedures themselves making sure that they’ve actually done that adequately and are collecting information.
The second thing that we’re going to be looking for and this is dependent of general solicitation but it’s any company that does offering under Rule 506 moving forward will have to comply with these bad actor rules. This is something that a lot of the NVCA has been talking about and a lot of investors recently have been talking about this is making sure that companies have actually done the diligence on their side and making sure that there are no “bad actors” involved in the offering.
That will be something that companies will probably start seeing from their lawyers as well because depending on the ownership level of the investor they hold twenty percent of the company they’re also going to be required to fill out a bad actor questionnaire so companies might see their attorneys sending these over and investors will probably start seeing these coming their way when they make investments.
Bill: Got you. Kevin, two issues that I think we’ll be interesting to hear your opinion on costs and associated signals got lumped into good reasons to soliciting and potentially bad reasons to solicit. What are some of the good reasons and bad reason to solicit and maybe you could touch on those two issues in particular?
Kevin: I wanted to distinguish using the general solicitation provision which just allows you to talk about in forums where there are unaccredited investors. For example in the pres or on Twitter or wherever else and seriously advertising your offering. Those are two different things. Either way given the costs of general solicitation meaning you have to put your investors through these extra steps and you’ll have [inaudible 00:20:58] to do that or certainly have your lawyer evaluate whether the investors have presented enough information so there are some more costs involved.
You definitely want a plan for what you are going to do if you are opt in to general solicitation. You don’t just want to do it by default, you want to say, “Great if I opt in to general solicitation, then I can turn around and use Twitter or Facebook or announce it to TechCrunch because they’re doing big article on me and I want to put that I’m raising financing in that article. That’s certainly the thing you want to do ahead of time.
In terms of signaling you asked about, that’s where I say it matters whether you’re advertising. That can be an offering to some investors if you’ve just said, “Here I am. Everybody should come invest in me,” as opposed to being able to say to an investor, “I am a really hot deal. You’d better move fast but here’s your opportunity now because other people are going to find out about it later,” rather than, “I found you because I read about you in the newspaper.”
There are some signaling issues with it but that has more to do with whether you are truly out there aggressively promoting the financing of your company as opposed to just using general solicitation to be able to talk about it in certain forums or if you Tweet it to your followers or want to post it on your website to a select set of customers or things like that. That doesn’t necessarily have the same concern about signal that it might if you, to go to an extreme, have a late night infomercial on TV advertising your company. You wouldn’t get any credible investors that way.
It more matters what you specifically do with the ability to generally solicit than it matters whether you opt-in to 506(c) or not.
Bill: Awesome. Let’s pick up one quick piece of advice from both Kevin and Greg before we kick it over to the Q&A. Greg one quick closing piece of advice for all the listeners out there.
Greg: Sure I think the main thing I would say is this general solicitation world is really brand new and I think it’s going to take a while before we see how the market fully absorbs it. There’s still a lot of gray area here. We don’t know how the SEC is going to interpret these rules but maybe more importantly we really don’t know how the states and foreign countries are going to interpret these rules as well.
The SEC federal law is just one aspect that companies need to worry about in the US. There’s also state law and some states have been pretty vocal about saying they’re opposed to this new general solicitation regime and may take some steps to make it more difficult for companies to sell to investors in their states.
Foreign countries also this is brand new for them, most foreign countries [inaudible 00:23:55] general solicitation so it’s a murky area. If you put some sort of blog post up there which can be seen around the world and then someone contacts you from a foreign country because they heard about your financing, it’s not clear how that foreign country will treat.
I think the main thing here is really as Kevin has said as well you really want to think carefully about whether you want to pursue these offerings and if you do you want to make sure that you’re doing it for the right reasons. There’s risks and rewards here. You can certainly get access to other investors and another thing that companies may start pursuing this for is really just a defensive measure in case they actually slip up and say something publicly about a fundraising in the past that would cause problems for companies and they would need to go into some sort of quiet period where they shut down fundraising efforts.
If you’re under this new general solicitation regime and you make that slip up or a reporter asks you a question, you can answer it. I think the main thing here really think about this decision carefully, talk it over with your attorney and just make sure you know what you’re getting yourself into.
Bill: Great. How about from you Kevin?
Kevin: The main piece of advice I’ve been giving people is just because you can find an investor doesn’t mean you should accept their investment. One of the biggest defenses that we in the startup community have had against legal trouble is the fact that we’ve been dealing with investors who know what they are doing and are sophisticated, so they know what they’re getting into and we know what we’re getting into as startups raising money.
As this spreads out and you reach an investor, if you’re doing a news article and somebody random contacts you and says, “I’d like to put money in your company,” you basically need to check them out before taking their money. You want to make sure that they know what they’re getting into, that they have a reputation or that you know them personally, in this case you wouldn’t need to generally solicit, so that rule doesn’t go away just because general solicitation is legal. You still need to watch out for your investors.
Bill: Great. I’ll just add that there are in addition to the [500 Startups blog 00:26:07], there are a lot resources out there for information on this. AngelList is a great resource for this. Every company on here should in addition to talking to Greg utilize [inaudible 00:26:22] like that, reach out to companies that have done public raising to see what their experience has been, get their firsthand knowledge, do your homework, and approach from this an educated position.
With that we will turn it over to a few minutes of Q&A. Okay we’re going to begin the live Q&A now, first question from our participants today is for Kevin. How will the new regulations affect demo days and pitch competitions, Kevin?
Kevin: That’s a very good question and the answer is nobody knows. Up until now demo days and pitch competitions et cetera if you were to ask a securities lawyer in D.C. they would have looked at that and said, “That’s general solicitation,” but the regulators both in D.C. and the state regulators have tended to look the other way because it’s all sophisticated investors, honestly intended companies that nobody was getting heard and they weren’t really sure what to do with this world.
Now they’re sure what to do with it which is it’s general solicitation and the issue is for each of the demo days and pitch competitions to figure out whether out whether they’re going to stay in the old world of 506(b), not general solicitation by now restricting who attends those pitch competitions to previously known accredited investors only or making sure that the companies themselves never hint that they’re raising financing and even beyond that some lawyers would tell you and again this is not legal advice, I’m not even a lawyer, but some lawyers would tell you make sure that it’s not true that every company presenting is taking investment because that itself might be a signal that it’s investors only.
With the demo days and pitch competitions themselves are looking out for whether they want to be 506(b) or 506(c) old world or general solicitation and you as a company if you are going to present at one of these need to check in with the demo day and find out from them what kind of demo day or pitch competition it is, investors only or not investors, make sure that in that case you don’t even breathe a word of your financing.
Bill: Great. Next question to continue on the draconian view here what is the worst thing that can happen to my company if I solicit and I don’t verify my investors? This one over to Greg.
Greg: Sure, I think the most common thing that people worry about in that situation is having what’s called a rescission right so in order to do a general solicitation or really in order to avoid a registration with the SEC you have to go under one of these rules, these exemptions from registration. If you don’t comply with the rules and you don’t have a valid exemption your investors could have what’s called a rescission right meaning that they could say that the entire offering was invalid and they could demand their money back.
That would be obviously a very bad thing to happen for a company if one or all investors started demanding their money back, it could put the company into a situation of bankruptcy, generally they would be raising money to spend it, would not necessarily have the money to give back to the investors and even if investors themselves don’t actually demand money back it would also put the company in a weird position for getting new investors because likely new investors won’t want to come into your company if they know a rescission right is on the table and other investors could start pulling money out.
I’ll also say one other thing that I’ve talked to a number of law firms who have been looking into these rules and one other fear people are thinking about is whether or not the bad actor rules what we were talking about under 506 D would apply for a company that was egregiously breaching these new general solicitation rules of if you’re out there flaunting and publicly talking about your fundraising not making any attempts to follow the new rules and verify the investors if there’s any sort of way the SEC could say, “Hey you know that’s really an egregious violation here. You need to be a bad actor,” in which case you’d be prohibited from raising any financing under rule 506 at all which would be a very onerous penalty for these companies because Rule 506 is really the most common way companies raise money privately.
Bill: Great. Next question. How risky is it to use general solicitation but verify through means other than the stated safe harbors? I’m going to take this one here. We’re all talking about relative risks here by utilizing a safe harbor you are pushing some of that risk to that third party so provided the third party whether that be an attorney, a registered investment advisor, a broker dealer or a CPA whether or not they’re willing to verify on behalf of the investor you are essentially absolving yourself of the liability and putting it on that third party.
From the standpoint of the company, you are de-risking yourself by putting that process on them. Now that being said, you do have to believe that that third party is taking reasonable steps to verify so it doesn’t completely absolve you of the responsibility of ensuring that you’re running an adequate process.
The short answer is it’s easier to use a third party and a little bit less risky but doesn’t completely absolve you of the responsibility to ensure that you’re taking reasonable steps to verify your investors.
Next question here. Let’s see this looks like a product question here. What is the cap table impact of sounds like the invest online or syndicate products that AngelList is currently running that utilize general solicitation, Kevin?
Kevin: Yep, sure I can take that. I will first of all state that this has nothing to do with general solicitation. The cap table impact is exactly the same regardless. If you use invest online or syndicates as a company, you will get a single line item on the cap table. What’s happening at the back end is all of the investors who are putting in smaller dollar amount via that mechanism are being combined into I would say a virtual venture fund, except it’s not virtual at all, a venture fund that becomes the line item on your cap table with a single signatory so it’s not administratively difficult and is a single investor as far as that’s concerned.
Let me qualify that only in one way which is because it is a single security fund the only thing it invests in is your company the number of investors in that fund count towards your total two thousand cap above which you shouldn’t go as a private company, but in terms of normal day-to-day investor management single line item on the cap table.
Bill: Great. One more question for you Kevin. Where the investors that have accredited on AngelList and been verified, can a repeat issuer reuse that accreditation verification for future capital raises on AngelList or off AngelList?
Kevin: Sorry, let me qualify one thing there which is Angel List does not verify an accreditation but we do collect evidence of accredited status so we have this … The concept is consider an investor’s license like a driver’s license. You renew it periodically depending on how you prove it somewhere between three months and a year and we store the proof in a way that protects your privacy and provide that to any company that an investor confirms that they’re interested in investing in.
When an issuer closes their financing, a company closes financing, they will get a packet of information for each investor that says here’s the evidence they provided for their accreditation and then the company can use that letter. It’s often a letter from an accountant or an investment advisor with saying, “Yep I’ve seen official government documents that say they’re north of this income,” or official documents from a regulated financial institution saying, “They’re north of these assets,” so yes. The short answer is yes, the long answer is we’re not verifying but we’re collecting the evidence necessary to verify.
Bill: Great. Question for Greg here. What if a prior investor of mine turns out to not be accredited after inspection of their documents? How would that affect the prior capital raised where the investor was accepted on the [inaudible 00:35:45] self attesting to their accreditation?
Greg: If you took the reasonable steps and you can document the fact that the steps you took were actually reasonable and you had no knowledge that an investor was not accredited so I think it would the goal of that rule is for it to be much harder for investors to slip through the cracks that are not accredited because you actually have to take steps to verify it so they’re giving you documents and somehow those documents are forged or incorrect and you knowledge of that then it would be fine.
The fact that an investor is not actually accredited is not one of the requirements of the rules. I guess to put that differently, the fact that you took reasonable steps, determined an investor to be accredited and it turns out later that they are not, that would be okay as long as the steps you took are reasonable.
The contrary to that is not necessarily true though. If it turns out that an investor is in fact accredited but you did not take reasonable steps to verify, the SEC has actually said that that will not resolve you or it will not absolve you of following the rules here. Regardless of whether or not you know an investor is accredited, you still need to take steps and document those steps.
Bill: All right one last question for Kevin, back on the demo days. Haven’t demo days always been general solicitation? Is it different now that the SEC is just paying more attention to these events?
Kevin: That depends on who you ask, back to my first answer. If you ask an east coast law firm or anybody who is in securities law they would say, “Yes,” straight out to your question. If you ask somebody on the west coast, we would pretty much say, “Huh, we never really thought of it that way. It’s all about sophisticated investors so we would not consider it general solicitation,” but to your point, the regulators never got involved so that never got results one way or the other.
Bill: Great. That’s going to wrap up our Q&A for today. I encourage all of our participants to visit the 500 Startups blog, AngelList FAQs or Second Market Education Center for more information on general solicitation and underlying products are available to companies in this space. A recording of this webinar will be available very shortly. We’ll be emailing it out to all participants and I’m sure the associated parties here will also be tweeting it out and sending it out to their constituents as well. Thank you very much for joining us today and we look forward to being in touch with everybody in the future.
Kevin: I enjoyed it thanks.
Greg: Thank you Bill, Kevin.