

SEC Greenlights One Style Of Equity Crowdfunding For Startups - mittal
http://techcrunch.com/2013/03/28/equity-crowdfunding-sec/

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

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

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

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

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

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

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

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

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

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

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

~~~
jmharvey
I don't really follow your math. In your scenario, you're over-selling shares
in the lottery ticket (a la "The Producers"), meaning you (as the
intermediary) profit if the underlying investment fails, but you lose if the
investment succeeds.

As for whether this is investment or speculation, as I understand the Funders
Club model, every extra dollar that comes out of an investor's pocket results
in one extra dollar going to a startup company. If providing a company with
additional capital to pay for up-front costs before they're profitable isn't
investing, what is?

~~~
orangethirty
Still speculation because these are startups. Had these been stable companies
this fund would not have such high ROI potential. Calling it investments has
people think there is some sort of security here. There is none. Well, only
for the "market makers".

~~~
Ankaios
Since when has "investment" implied "security?" This is a _textbook_ , bog-
standard example of investment.

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

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

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

Quoting their letter to the SEC:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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michaelochurch
This is a huge win.

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

Here's an exposition of how that would be structured to make it fair to
everyone: [http://michaelochurch.wordpress.com/2013/03/26/gervais-
macle...](http://michaelochurch.wordpress.com/2013/03/26/gervais-
macleod-17-building-the-future-and-financing-lifestyle-businesses/)

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

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

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

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

~~~
arbuge
Maybe because it will only provide that great return if it raises sufficient
capital, and they can't provide it all themselves, or want to diversify (as
you should too).

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

