KingsCrowd- selling ratings for fun and profit

kingscrowd

The thing about crowdfunding is that it attracts people who are paid to introduce investors to companies that have little to offer. The worst, of course, are those who know that the companies have little chance of success and hype the hell out of them anyway.

So I was particularly interested in a Reg. A+ offering filed by KingsCrowd, a publication that covers the Reg. CF marketplace and companies that are seeking funds.  KingsCrowd has a “patent-pending AI-driven startup rating algorithm” from which it intends to rate the various offerings on the Reg. CF funding portals.  

In its own words, KingsCrowd will “empower individual investors to make intelligent startup investment decisions on platforms like Republic, Wefunder, SeedInvest, Netcapital, etc., by providing institutional-grade research tools for assessing the thousands of investment opportunities available to investors at any one time.”

Given that 90% of start-ups will inevitably fail, any algorithm that can sort likely winners from likely losers would be welcome.  Even if unable to identify the 10% that will succeed, eliminating the bottom 10% or more that have no chance at success would benefit investors as well. 

KingsCrowd already tracks and rates “every Reg. CF investment opportunity in the United States.” It has a system to research and rate Reg. CF issuers. The only question is does their algorithm work?  How good is their research? What constitutes “institutional-grade” research anyway?

CalPERS, the largest public employee’s pension fund manages a multi-billion dollar portfolio.  It employs several hundred research analysts to oversee that portfolio and to make specific buy/sell recommendations. Other funds and money managers around the globe use much the same data and much the same methods to analyze that data.  Generally accepted methods of securities analysis are taught in business schools and have been for decades.

If that is “institutional-grade” research and analysis then I needed no more proof that KingsCrowd does not provide it than the fact that it gave itself a “pre-money” valuation of $45 million.  There is no way that analysis that produced that valuation can be called “institutional-grade”. The numbers just do not add up.

KingsCrowd says that it collects “more than 150 data points on each issuer, including information relating to its team, its market, financial statements, traction with consumers, and competitors. Our investment research team collects data from multiple sources such as the issuers’ pitch decks, capital raise pages on all of the funding portals (including all Reg CF funding portals such as Wefunder, Republic, Netcapital, SeedInvest), news articles and announcements, social media, founder profiles and resumes, recruitment websites, the SEC filings, growth data provided by the companies and information derived from alternative data sources.” 

I do not think that I need tell you that data in “pitch decks” and “growth data provided by companies” is often exaggerated. Information on the funding portals is often unverified.  What I was hoping for was for KingsCrowd to bring some amount of real financial analysis to this marketplace.  To even begin the process it would be necessary for the data used on Reg. CF funding portals to be accurate.  It isn’t.

KingCrowds’ “algorithm uses a comparative modeling approach to rank and score all companies actively raising capital from the markets across the various key dimensions deemed notable in the rating algorithm and traditionally utilized by venture investors to make informed investment decisions.” 

Forget for a minute that the phrase that ties “venture investors” with “informed investment decisions” is itself an oxymoron.  I worked for VC funds and I have dealt with them as a representative of a company being funded, repeatedly, beginning in the 1970s. Funding has always been more about who you know than what you were selling. The days of an MBA as a requirement to be a “venture capitalist” are a receding memory.

I would think that if KingsCrowd’s algorithm really identified better investments, one of the VC funds would have scooped it up.  When you break down what they do, you can see that it is more smoke and mirrors than mathematics.

At the end of the day, KingsCrowd’s patent-pending AI-driven startup rating algorithm yields a rating that is a number between 1 (lowest score) and 5 (highest score) for every aspect of the issuer, including price, market, differentiation, performance, team, and risk, as well as an overall score for the issuer at a specific funding round.

Given that many of the start-ups being funded have neither income nor profits, the metrics of “performance” may be more subjective than one might expect. KingsCrowd seems to intimate that what they are identifying are companies that had a successful capital raise, not successful companies.  If that is true, they are on a fool’s errand. And, while I always help clients structure their offering to present an investment that will be attractive to investors, success in crowdfunding is often about how you market the offering and how much money you put into your marketing campaign.

Giving a numerical score to a “team” also seems quite subjective. KingsCrowd itself has only 3 employees and a “team” of outside advisors. Christopher Lustrino is a founder of the Company, Chief Executive Officer, President, Chief Financial Officer, Treasurer, and also a member of the Board of Directors. If these positions had been filled with qualified people would the “pre-revenue” valuation have been $60 million? More?

Some VCs and angel investors like a founder to have some skin in the game and invest their own money. Lustrino is selling $1 million worth of his stock in KingsCrowd as is one of the early investors. The fact Lustrino needed to sell his shares costs the company an equal amount.

KingsCrowd is also concurrently offering the same shares to investors in a private placement offering under Regulation D. They are raising a total of $15 million which, if the company had something to offer, would have been cheaper and easier to accomplish using only the private placement.

Under current law, however, Lustrino cannot sell his shares or those of the early investor, using Regulation D. To sell his shares, Lustrino needed to have the company prepare and file the offering using Regulation A+.

In the normal course, the shares being sold under Reg. A+ would be the subject of a commission, here 7%.  Shares sold on a crowdfunding platform using Reg. D do not pay a commission unless the platform is a licensed broker/dealer.

Lustrino arranged to have this offering placed with a broker/dealer affiliated with one of the Reg. CF funding portals, Republic. He has agreed to pay that broker/dealer 7% of the entire $15 million or more than $1 million. That is the fee the company will pay to liberate 2,000,000 shares being sold by Lustrino and his partner.     

The issue is more than the fact that KingsCrowd is spending money that it did not need to spend. The funds would certainly be better spent hiring a CFO to watch over the investors’ money.

KingsCrowd is essentially giving $1 million to a company whose offerings it will rate. This kind of conflict of interest would, in my opinion, negate any rating KingsCrowd issues on a company listed on Republic and likely its competitors as well. As importantly, by selling his shares, Lustrino gives the impression that he has one foot out the door, ready to ditch the algorithm with little utility and ready to fund his next company.

If you’d like to discuss this or anything related, then please book a time to talk with me HERE

Start-ups, are you buying investors online?

Start-ups, are you buying investors

I have been writing a lot about crowdfunding lately and speaking with other people in the crowdfunding industry.  From our conversations, it is obvious that most do not share my perspective on the entire business.  I see crowdfunding as continuing an evolution of the capital markets already in progress when I started on Wall Street in 1975.

In 1975 the stockbroker was king. People did not buy investments, I was told early on, stockbrokers sell investments.  Good stockbrokers, especially those on their way up, aggressively sold stocks. The sales pitch was often about one particular stock, frequently supported by a report prepared by research analysts.  Analysts were “ranked” every year and firms paid the “1st, 2nd and 3rd All-American teams”, handsomely.

While there were certainly stockbrokers who met their clients for lunch or at the club for golf who came back to the office with orders in hand, much of the “selling” was done over the telephone.  Young brokers were encouraged to stay into the evening and engage in a ritual known as cold calling.

During my training, I spent an evening with a single page from the NYC phone directory, script in hand, dialing for dollars. Most people had those old, heavy rotary phones.  I swear, I could hear the receiver sucking in air as it was being slammed down onto its cradle.

What cold calling teaches us is that some percentage of the calls you make will respond favorably, and buy what you are selling.  If you want to make more sales, you need to make more calls.

I mention this only as a backdrop.  This “sell-side” focus has shifted, significantly. Today, a great many retail stockbrokerage customers, make their own decisions about what to buy and what to sell in their stock or retirement accounts.  These customers are enticed by lower costs. They respond to advertising, and they will rely upon information delivered to them online.  Without these investors, crowdfunding could not exist. 

If I were teaching Law and Economics today, I would look back to 1975 and say that is where it all started.  Changes in the law, a new one enacted and an old one discarded, were the catalysts for enormous changes in the way the capital markets operate. The market responded to those changes by bringing in millions of new people who were affirmatively looking to invest and who brought trillions of new dollars with them.   

ERISA, enacted in 1974 created the tax-deferred Individual retirement account (IRA).  It was intended to incentivize millions of small savers to put their money into a bank or the stock market and to leave it there for the long term. 

In response to this new market of small investors who might start small and add a few thousand dollars every year, John Bogle opened the Vanguard Mutual Funds. Mutual funds provided a simple way for small investors to participate in the market.

Mutual funds had been around for a long time by then.  They were commissioned products sold by many stockbrokers.  And while an IRA account was the perfect vessel for mutual funds, what I would stress to my students would be the shift in the way mutual funds were advertised and sold directly to investors.

Vanguard and the other mutual funds actively advertised for investors seeking to make direct purchases.  Instead of dealing with a stockbroker who would call whenever they had, something that they wanted you to buy or sell, with a mutual fund, an investor could just put their money into a fund and the fund will do it all for you.  Somebody called it “passive investing”. Instead of touting the skill of their analysts to pick winners, these mutual funds sold convenience.

In 1975, both the State of New York and the City of New York were functionally bankrupt. The stock market had tanked and lending had ground to a halt.  The economy was in the midst of abnormal inflation.  People responded to the idea that they take some risk to grow their retirement funds in the stock market rather than save it in a bank so they could keep up with inflation.

Also in 1975, the New York Stock Exchange repealed its long-standing rule that had fixed the commissions that NYSE Members charged for each trade.  Mainframe computers were being installed up and down Wall Street. The costs of everything from executing trades to sending out confirmations and monthly statements were going down.

When commissions were fixed, the customer was charged a commission that reflected both the costs of execution and the “other” services that the brokerage firm provided, most notably, research that would tell the customers what to buy and when to sell. As commission costs became a source of competition, Charles Schwab and others were already talking about “unbundling” the cost of executing a trade from the research component that had always come with it. 

Schwab and its “discount” competitors demonstrated that a great many investors were happy to sit at home and make decisions on what to buy and what to sell, based only on what they read themselves. And while Schwab and other discount brokers now offer research reports, very few customers of discount firms are exposed to the type of research available to institutions. 

The stockbrokers’ response to this unbundling can be encapsulated in their advertising slogans of the time: “Thank you, Paine Webber”; “When EF Hutton talks, people listen” and my personal favorite: “Smith Barney makes its money the old-fashioned way, they earn it”.  The mainstream industry doubleddown; they were selling advice and they were proud of it. 

Without good advertising and a lot of it, the full-service stockbrokers, the discount firms like Schwab, and the entire mutual fund industry would not have grown into the behemoths that they are today.  The result of all of that advertising is a market full of millions of investors who are comfortable making their own investment decisions.  This includes a significant number of baby boomers who still represent a very large pool of capital that is available for investment. 

What does this have to do with crowdfunding in 2021?

If I have learned anything from watching the growth and evolution of this market since 1975, the one thing that stands out is that for companies that are selling investments, good advertising works. There is a cost, certainly, of acquiring investors for any given offering, but if you pay that cost, you will get enough investors to pony up the investment that you seek.

The best people in marketing who are working in crowdfunding understand that it is very much a “numbers game” just like “cold calling”, although now much less expensive and efficient. Modern data mining techniques enable each company that is seeking investors to present its offering to an audience that is more and more specifically targeted. 

I call it “buying investors online”. What do you call it?

I have sat in marketing meetings for various players in the financial services industry many times. Depending upon what these companies are selling and to whom, the marketing and sales strategies differ greatly.

The common denominator of these varied strategies is that they are all measured by the same standard, CAC, the cost of acquiring each customer or investor. The object of any marketing campaign is to attract the most customers (and their ‘orders’) from every dollar spent on any advertising directed at those customers. 

In crowdfunding, while statistics are few, it is obvious that the costs associated with acquiring investors varies greatly, offering to offering. Some offerings fail because investors do not find them attractive, most, I think, because they lacked marketing muscle.  

Personally, I find it painful to watch a company that has hired me to prepare the paperwork for their offering fail to acquire the investors they need.  Often, these company’s campaigns fails because they hire the marketing company that was the lowest bidder.  I try to steer my clients to a marketing company that may not be the least expensive, but gets the job done.   

The Regulation D, private placement market has found enormous success using crowdfunding for investors.  Even now, a sponsor can identify potential investors for the purchase of an office building who can afford to invest, who have an interest in real estate, and who live close enough to the property, to drive by if they want to look at it. And the data mining techniques that created these targeted mailing lists are still in their infancy.

Crowdfunding for capital has become a simple process.

Step one: create an investment that will be attractive to investors

Step two: create advertising copy that can be pre-tested and shown to be effective

Step three: put those ads in front of your pre-targeted lists of prospective investors.

Step four: Repeat step three until you raise the money you need.   

I have written elsewhere that I believe that crowdfunding has reached the point where it will now quickly grow to be a major source of capital for start-ups and small businesses.  A major reason will be that companies seeking funding can now approach crowdfunding with a high degree of certainty that they will get funded. With the proper perspective, those companies can appreciate that they are buying investors online. 

 

If you’d like to discuss this or anything related, then please contact me directly HERE

Or, you can book a time to talk with me HERE

 

Making the New Capitalism Efficient

Making the New Capitalism Efficient

Economic theory teaches us that in a perfect world capital would always be allocated to its best use. The best use is always viewed from the perspective of the person or entity that is deploying the capital. Consequently we normally calculate the best use as the highest rate of return that the capital can reasonably achieve. The object is always to use money to make money.

To further this goal, capital has always been deployed to companies that have had the best chance of success. A due diligence process is employed to separate the best companies from those that the market deems less worthy. While far from perfect, this system has historically worked well enough to create our modern society with few truly innovative ideas left by the wayside, meaning unfunded.

In the last 20 years, some people with capital have been content to deploy it for other, more altruistic reasons. Specifically, they want to make capital available to people who have no access to the mainstream capital markets and others who for a variety of reasons could not get funded.

This new capitalism has taken two innovative forms, micro-lending and crowdfunding. Each has the potential to put capital into the hands of people who otherwise would never have access to it. Both have the potential to be transformative at the lowest tier of the global economic system. Neither is focused on highest rate of return as its primary goal.

In its purest form a micro-loan is very small and will often help a subsistence level individual transform into a capitalist. Micro-loans are frequently used to purchase one sewing machine to create a manufacturer; one shipment of goods at wholesale to create a merchant. Some micro-loans are used by a rural community to purchase one used truck or tractor. The benefits of these loans are obvious.

As originally envisioned, micro-loans were often interest free or loaned at an interest rate low enough to cover only the lender’s overhead and the costs of defaults. Even though no one who gets a micro-loan has a FICO score, statistics show the rate of default worldwide to be very low. As much as 97% of the loans are repaid. As conceived, micro-lending is a model of market efficiency.

Unfortunately, as this industry has developed and matured, there are some places where micro-loan programs are managed by bloated bureaucracies. There are stories of interest rates that would make loan sharks blush, corruption and exploitation in the lending process and misappropriation of funds intended for borrowers.

Crowdfunding

Crowdfunding is a remarkable tool for capital formation. Its successful utilization still eludes too many small businesses who might benefit most from an infusion of capital.

The crowdfunding industry still suffers from “experts’ who have no idea how to raise capital. Fraud remains a problem because no one really vets the companies that seek funding. The process itself can be expensive and is often hit or miss even though it does not need to be.

Investors who buy into the equity of a small company on a crowdfunding platform must understand they may take a total loss. Even if the company is initially successful, there is no liquidity for the equity that investors purchase.

There is, I would think, a way to combine the micro-loans with crowdfunding in a way that would remove much of the inefficiency. I think it would be welcomed in the developing world.

In most developing countries there are universities whose students are themselves often making the transition to the middle class. They should appreciate that strengthening the underclass will provide a greater market for the products and services that they themselves will eventually make and/or sell.

What I would propose is that each university in developing countries create a crowdfunding program to enable students to fund micro-loan programs in their own communities.

Most peer-to peer lending platforms allow companies in need of loans to borrow from multiple individuals, essentially syndicating each loan. I envision the university students creating a single fund from which to make micro-loans to many borrowers.

I would ask the students to fund the program by purchasing shares in the fund with a small yearly tithe for the 4 years that they are students and for a few years after they graduate. Call it a 10 year voluntary commitment to purchase shares.

Additional funds would come from sale of shares to faculty, alumni, local banks, businesses and importantly, each country’s expatriate community. University students in western countries could partner with university students in developing countries. All anyone need do to participate is buy one share.

I have intentionally left out any local government involvement or participation. Direct government participation rarely adds efficiency to anything.

Business students and volunteer faculty at each university would administer the fund. This would remove much of the costs and corruption. It would give these students valuable experience evaluating business proposals and detailed knowledge about the local economy that will not be found in their textbooks.

Borrowers would pay a fixed interest rate. A rate of 6% might be sufficient to cover the risk of defaults and provide some amount of internal growth. Real growth for the fund will come from new students who will join the program each year as they enter college.

At some point each fund would reach a predetermined principal amount and be closed. In the US and elsewhere a closed-end mutual fund can become registered and be listed and traded in the regulated securities markets. This would provide liquidity to these crowdfunded investments where none exists.

Even after it is closed, a fund can continue to collect payments on existing loans and make new loans year after year. There would be no reason or requirement for it to liquidate.

As the fund grows after it is closed the per-share value will continue to appreciate. Providing for growth and a liquid market would mean that shareholders could expect to make a profit from their investment.

The closing of one fund will be followed by the opening of a new fund to replicate the process. Over time, multiple funds will exist in every country that wants them, sponsored and funded by university students and others who will see both the benefits of the program and the potential for their own modest profit.

Replicated university to university and country to country a program like this would have a demonstrable effect within a decade. On a continuing basis it has the ability to transform communities and economies in the developing world from the bottom up.

It is an opportunity to demonstrate that altruism and capitalism are not mutually exclusive.

If you’d like to discuss this or anything related, then please contact me directly HERE

Or you can book a time to talk with me HERE

Remembering the “customer’s man”

customer's man

The 1970’s

Several weeks back I had lunch with a colleague who, like me, had started in the brokerage business in the 1970s. At one point he referred to himself as a “customer’s man”. It was a term used to describe a registered representative that I had not heard in years. It evoked a way of doing business that has largely been lost.

At that time, commissions and costs were fixed across the industry. Today, we see these costs as an impediment to our ability to maximize investment returns. We have lost sight of the value that a good customer’s man brought to the process.

A good customer’s man got to know you.

The brokerage firms encouraged every customer’s man to get to know every one of his customers and to get to know them well. You would meet in person to share lunch, drinks, dinner or to play squash, tennis or golf. Over time and many conversations you would get to know quite a bit about each others’ lives and families. Your customer’s man would become one of your trusted advisers.

A good customer’s man was a good stock picker.

Customers’ men were always on the look-out for the next stock that was about to make a move. They were selling their ability to pick stocks and to buy them for you at the right price.

Your customer’s man would always tell you which stocks he was following and why he was following them. He would call to tell you when the price had dipped and to recommend that you give him an order to buy a few hundred shares for you. You would not hesitate.

A good customer’s man made money for you.

Customer’s men were judged by how much the stocks that they recommended went up. It was a simple metric that everyone understood. Very few built their book of customers by advertising or seminars. The best built their books by word of mouth. They asked existing customers for referrals. Customers who made money following their broker’s recommendations gave the best referrals.

From the 1970s forward if the firms wanted more customers, it meant having more brokers with bigger and bigger books of customer accounts. The big action was moving established producers around from firm to firm. Front-end bonuses for really big producers became really big. Just about every broker wanted to be a bigger producer.

That attitude was good for the firms and they encouraged it. Brokers became almost exclusively focused on bringing in more customers. No longer were they judged for the stocks that they picked or how much money their customers made. Producers were now judged on how many “assets under management” they have.

The actual management and investing of the customers’ funds was increasingly handled elsewhere. Enticing new customers meant selling the investing and management skills of others.

The 1987 Crash

This was logical as so many of the customers’ men had not seen the 1987 crash coming. If they had, logic suggested that they would have pulled their customers out before it happened.

customer's man

It was time to let the experts manage your investments. Customers were sold many different kinds of managed funds, annuities and other “packaged” financial products. All of these products were expensive from the customers’ standpoint. The firms had built in significant underwriting costs and management fees.

Many of these fund managers drank from the Kool-aid that said that price/earnings ratios of 50 or more were sustainable and likely to go higher. Individual brokers who questioned the wisdom of the high paid fund managers and research analysts were brought into line or shown the door.

When the tech market inevitably crashed, many in the industry argued that “no one had seen it coming.” They said the same when the market crashed again in 2008. It was a phrase that was repeated so often that people started to believe it.

It re-enforced the idea that the average financial adviser can do no better than average. Everyone just started buying the index, certain that no human being who actually works in the markets every day could actually have awareness of what was going on or to help customers profit from it.

The index was much cheaper than a human adviser in any event. Lower costs were more efficient and would increase returns, provided, of course, the market goes up.

A good customer’s man always put the interests of his customers first. It was an era when almost every business adhered to the idea that “the customer was always right.” When is the last time that you heard that phrase or saw it posted in a business or an office?

Today, the industry staunchly opposes any regulation that would require individual brokers to put their customers’ interests first. That should tell you everything that you need to know about the financial services industry today.

The individual registered representative, the back-bone and the public face of the brokerage industry will likely not survive another generation. Their jobs are already foolishly being replaced by computer driven robo-advisers.

The industry will survive and prosper without the customer’s men. It is already oblivious to what it has lost.

If you’d like to discuss this or anything related, then please contact me directly HERE

Or you can book a time to talk with me HERE

What is a dream worth?

What is a dream worth

A long time ago, when I was a young lawyer fresh out of school, I was walking with a friend along a side street in Manhattan, probably in the West 30s. There were brownstones on both sides of the street. We stopped in front of one that had a small shop on the street level.

In the window were two shelves on which were displayed a series of antique dolls, doll clothes and doll carriages and furniture. Many seemed to be from the early 20th Century, if not earlier. The shop was dark and the sign on the door said: Hours by Appt. Only.

“Interesting business” I remarked. My friend responded: “That isn’t a business, it is someone’s dream”.

In some ways, every entrepreneur and small business owner is a dreamer. They try to turn the intangible, an idea, into something tangible, a business. Assigning a value to any business is not an easy task. While the business is still a dream it is virtually impossible.

Valuations

Of all the things that we teach business school students, corporate valuation is given very little time or attention. When a business needs to be valued because it is being bought or sold the task is relegated to accountants. Accountants plug data about earnings and assets into established formulas and come up with a value. 

Accountants can determine the “book value” of a business by subtracting the company’s liabilities from its assets. That rarely tells the whole story. What if there is little or no data? What if the business has no earnings or assets?

Assets are placed on a balance sheet at cost and are then depreciated over time. The true value of the asset is not always represented in the financial reports. Some assets, especially real estate can often appreciate over time to greatly exceed their cost.

We teach that real estate should ultimately be valued at its highest and best use. A developer may see a dilapidated old farm as the site of a shopping mall or residential development. Still, the current owner carries the farm on its books at cost minus depreciation. The value of any parcel of real estate can change dramatically in the time it takes to hold a press conference announcing a new development.

Accountants will often add a line item for the company’s “good will” which is more often than not the accountant’s way of capturing the value of the business as a going concern, including the value of its brand and customer base. This, too, is far from perfect.

I have helped many clients buy or sell a business over the years. If they use a business broker to facilitate the transaction, they are likely to hear that a business is “worth” 3 times next year’s projected earnings.

This may not be a proper method of valuing a small business either. It is modeled after the way that many research analysts predict the future price of publicly traded securities. But with privately held companies, the risk is often higher so the price for which it sells, logically should be lower. 

Yes, I know that this is the antithesis of the view practiced by venture capital firms who are often dealing with companies that have little more than an idea that they want to bring to market. These companies do not have earnings or assets. The values assigned to portfolio companies by venture capital firms have no basis in reality nor are they entitled to be included in any serious discussion of finance.

IP

Intellectual property like patents, copyrights and trademarks are very hard to value at the time they are first obtained. No author knows that they have a best seller on the day their book is published. Few know that their book will be made into a movie or that anyone will pay to see it. So, what is the “value” of any book on the day before the manuscript goes to the publisher?

As an example, I have a friend who is a noted cartoonist. Her characters were originally published in the US for an American audience but have found a huge following in Japan. Was that in her business plan when she sat down to draw those characters for the first time? Hardly.

One of the interesting things about intellectual property such as copyrighted material, is that it can be segmented in myriad ways. A novelist can sell the right to have his book published in the US to one publisher and the rights to publish the book in a dozen other countries, or a dozen other languages to a dozen other publishers. The theatrical rights and film rights to the same novel can also be segmented and sold. In the right circumstances, the rights to produce and sell merchandise that derives from the novel may be the most valuable rights of all.

The value of intellectual property can vary greatly based upon how it is used and how it is sold. Young Bill Gates might have sold the operating system he purchased from a third party to IBM for a nice profit and gone on to do something else. Instead, he licensed the software and received a royalty every time IBM sold a PC with the operating system in it. The result was the Microsoft Corporation which made Gates the world’s richest man. We use a lot of royalty or revenue sharing arrangements in crowdfunding because they are clean and simple.

1990’s

Back in the 1990s when there was a new and disruptive technology introduced every day, I would ask my students if they could identify the most valuable intellectual property that was in use in the 20th Century. It had been a century of tremendous innovation, much of which had been superseded by even better innovation. Many very valuable patents and other IP had become worthless.

The object of the exercise was for them to identify a simple idea that had been patented, trademarked or copyrighted, that had become very valuable even though no one could have predicted the magnitude of its success on day one. I wanted to demonstrate just how difficult it was to value things that had never been done before. Two pieces of IP stood out.

The first was the copyrighted image that is Mickey Mouse. The media giant that is Disney today started with an animated short film of a mouse whistling.  Maybe the most recognizable face on the planet, I do not believe that even Walt Disney would have valued the ownership of the copyright at anything close to its true value.

The second was the patented formula for Coca Cola. I have been in a Jeep in the middle of a jungle where the guide said that there was a village up ahead where we could stop and get a Coke. Pour yourself one and try to imagine how many cans and bottles they have sold. How would you have valued that patent on the day it was filed?

I think that I have made the point that placing a value on any business, especially a start-up, is a waste of time and effort. I will encourage any small business owner to dream big, but you just cannot put a number on it. 

If you’d like to discuss this or anything related, then please contact me directly HERE

Or you can book a time to talk with me HERE

Fidelity’s Folly: Bitcoins for All?

Fidelity

Fidelity Investments

People keep asking me what I think about Fidelity Investment’s announcement that it will act as a custodian for bitcoins and other cryptocurrencies. As anyone who follows me knows, I don’t think very much of it at all. 

Fidelity has made it clear that it is “all in” on cryptocurrency. Its website notes that: Fidelity Investments “operates a brokerage firm, manages a large family of mutual funds, provides fund distribution and investment advice, retirement services, Index funds, wealth management, cryptocurrency, securities execution and clearance, and life insurance.” 

Fidelity would certainly wish to expand each of those profit centers. With bitcoins and cryptocurrency there is the potential for enormous growth if Fidelity can turn them into just another “investment”. It can’t, even though it is trying very hard. 

Just last week, Fidelity’ Director of Research published a report that suggested that bitcoin is a “potentially useful” asset for “uncorrelated return-seeking investors”. The report said that “in a world where benchmark interest rates globally are near, at, or below zero, the opportunity cost of not allocating to bitcoin is higher.” 

Please do not be impressed with that gooblygook. There is no real data about bitcoins for the Director of Research to research. You cannot analyze bitcoins in any traditional way. They are merely a few lines of computer code. This report is reminiscent of the type of justification that analysts gave in the dotcom era for supporting stocks, with no income, trading above $100 per share. 

The report further suggests that bitcoin’s current market capitalization “is a drop in the bucket compared with markets bitcoin could disrupt.” That certainly sounds like a “buy” recommendation to me.

The primary markets that bitcoins might disrupt are banks. In truth, bitcoins, when used as payment in commercial transactions, disrupt nothing. Banks and banking are not going away.   

If you consider how many payroll and Social Security payments are already deposited directly to recipients’ accounts and how many of those recipients pay their electric power or insurance company “on-line” it is fairly easy to see that converting the deposit to bitcoins before you make the payments is an extra step not likely to find favor.  

The one thing that will cause the current price of bitcoins to appreciate is a lot more investors willing to buy them and hold on. That is the strategy being pushed by Fidelity with the blessings of “pseudo” market professionals. 

Last month, Fidelity stated that it had polled a number of the “professional” fund managers and investment advisors who are currently its customers.  Apparently enough advisors would consider bitcoins for their advisory clients to warrant Fidelity acting as a bitcoin custodian. 

Some number of advisors who already use a Fidelity platform will certainly purchase some amount of crypto currency for their clients’ accounts.  That “professionals” are buying bitcoins is likely to be used by Fidelity as a reason to advertise them to average, small investors as “what the Pros” are buying. 

In 2 years, Fidelity may have many billions of dollars’ worth of bitcoins held in accounts on its platform. That will not make it the right thing to do.

Law and Economics, which I taught back in the 1990s, studies how our interwoven markets interact with the laws that regulate them. Judges interpret those regulations, often influenced by what they perceive the regulators intended to accomplish.

The regulations that govern our financial markets (equity, debt, currencies and insurance) have evolved over the centuries with the markets that they regulate. The introduction of something as novel as crypto currencies into the financial markets should be expected to suffer some adverse legal consequences. 

As a matter of law, every Registered Investment Advisor (RIA) and anyone investing other people’s money is held to a fiduciary’s standard of care.  Fiduciaries are usually required by law to: 1) act in the best interests of their clients, 2) preserve and protect the assets entrusted to them and, 3) when investing to act as a “prudent” investor would act.

A fiduciary’s duty to its client or beneficiary is a much higher standard of care than in any ordinary commercial transaction. To satisfy that standard often means taking “extra” care to mitigate obvious risks.

Fiduciaries become fiduciaries when people trust them to hold their property or to act on their behalf.  People most often trust fiduciaries because they have specific expertise in the matter at hand. Both fund managers and RIAs fit that description. Both are held to a fiduciary’s standard of care and their conduct is most often judged against that of other experts in their field. Most investment professionals will never purchase any crypto currency for their clients.

Fidelity, the fund managers and RIAs who do purchase bitcoins and store them at Fidelity obviously believe that the price of bitcoins (currently in the range of $10,000 a piece) will appreciate and perhaps double or more.  It is certainly possible this could happen.  Two years from now the price of a bitcoin might have risen to $20,000 each and possibly higher. Many of the bitcoins held at Fidelity will have been purchased at close to that amount.   

Let’s assume that for some reason or another, in a 90-day period, the price drops back to $10,000 each.  That could result in several billion dollars in actualized losses as some will “hold” all the way down in hope of a rebound.  Does Fidelity shoulder any liability for these actualized losses?

The Fund Managers and RIAs certainly do. Unlike most litigation, where the burden of proof is on the plaintiff, in many states, fiduciaries are required to demonstrate the reasons that they made the offending investments.  Much of the case will be dependent upon what the advisors can show were their reasons for buying bitcoins in general and also specifically on the day and at the price that they did. They will also have to demonstrate why they held on as the price deteriorated.

Given that there are no fundamental reasons for purchasing bitcoins I suspect that most will try to defend themselves arguing that bitcoins are a hedge against adverse results in the rest of the portfolio. That argument is likely to fail. 

Bitcoins are, after all, a commodity, and putting aside the fact that most RIAs are not trained or licensed to sell commodities, gold would be a more accepted hedge if that is what the RIA wanted to do. If nothing else gold is unlikely to lose 1/2 its value in a short period of time, which bitcoins have already demonstrated they can do. 

Litigation

Fidelity’s role as a platform or clearing firm might save it in Court but these customer claims are more likely to be heard by arbitrators appointed by FINRA, especially if Fidelity is named as a respondent. I have been an arbitrator and argued many cases in front of others. They are more likely to be older and their view of bitcoins will probably be closer to Beanie Babies, than as a new form of currency that trades in a very opaque market. 

Fidelity

Two recent cases brought by the SEC will not help Fidelity’s defense either. The first is SEC v. ICO Box, where the SEC alleged that the platform “facilitated” the sales of more than 30 different crypto currencies. “Facilitated” is a word that will make defense lawyers crazy. 

By the time that these claims get to a hearing I suspect that complaining customers will be able to present a banker’s box or two of “reports” written by Fidelity that suggest that RIAs purchase bitcoins for their customers. That should certainly be viewed as a “facilitation”.

The other case is called SEC v. Lorenzo.  Lorenzo was charged with copy and pasting an e-mail written by someone else and sending it to prospective investors. The SEC alleged that Lorenzo “disseminated” misleading information in order to make the sale. Given the outrageous claims made by many in the bitcoin world, some Fidelity employee is more likely than not to resend a report or article that Fidelity cannot defend.

The mutual fund industry, Fidelity’s core business, is under great stress to lower the fees it charges investors.  For all the BS that you may hear about how Fidelity’s actions in embracing crypto is “cutting edge” or “visionary”, it makes more sense that Fidelity is touting crypto to make up for revenue lost elsewhere.

If you’d like to discuss this or anything related, then please contact me directly HERE

Or you can book a time to talk with me HERE

Reg. CF – Will Fools Rush In?

Reg. CF – Will Fools Rush In?

I have written a lot of articles about crowdfunding in general and specifically about crowdfunding to accredited investors under Regulation D.  I have largely ignored the much smaller financings that are accomplished under Regulation Crowdfunding (Reg. CF) that accept investments from all comers. The time has come to fill that void.

REG CF

Reg. CF was the last of the regulations issued by the SEC under the JOBS Act.  It embodied much of what proponents of the Act had wanted….a sanctioned method for community funding for start-ups and small businesses. 

The first Reg. CF offerings began in May 2016. Despite a few success stories, the Reg. CF marketplace has yet to mature.  I do not see that coming at any time soon, despite the out-sized need for small business capital.

Reg. CF created a new class of financial intermediary called “portals” which are essentially websites where companies seeking investors are displayed.  But the portals are more than just websites.

The SEC wanted this market to be regulated, in part to protect investors from fraudulent offerings and in part to provide the companies seeking capital with a way to interact with investors in a regulated environment. The SEC required the portals to register with FINRA, the stock brokerage industry’s regulator, and to adhere to FINRA’s regulations.     

Until recently only about 50 portals had been registered with FINRA, a number that had been fairly static for a while. A small handful of the portals handle the bulk of the transactions.  Some of the earlier portals have quietly gone out of business. The rest quietly grind out only a few offerings at a time. 

Top Ten REG CF Portals Ranked By Capital Raised 2020

Reg. CF required that investors be given specified disclosures about each company.  It set baselines for the presentation of financial information and set limits on how much any small investor could invest every year in these very risky ventures.  A required filing gives the SEC specific information about each offering. 

Reg. CF allows companies to raise no more than $1,070,000 in a single year. For reference, the average loan guaranteed by the SBA is closer to $600,000. The SBA guarantees about 40,000 loans per year and rejects a similar amount. There are many thousands of small companies that do not come up to SBA standards.

A great many companies would have their capital needs satisfied with much less than $1,000,000.  These companies should be looking to Reg. CF portals but are not. The portals have not demonstrated that every listing will get funded which is what any company should want.   

A very large percentage of the offerings that list on Reg. CF portals raise very little money.  Still, a great many start-ups and small businesses ask for very little.  Many of the offerings seek less than $100,000. 

Many of those small offerings do not employ a specialized marketing company or even an organized crowdfunding advertising campaign.  Too many of the campaigns rely solely upon the company’s existing social media contacts which are rarely enough to get the company funded. 

Portals

Very, very few of the portals are wildly profitable, if at all, even though the compensation structure is patterned after the wildly profitable mainstream stock brokerage industry.  Most portals charge close to 7% of the funds every company raises. The very best portals raise a total of less than $1 million every week.  This against a backdrop of so many companies in need of capital.

Five new portals were registered this month and the scuttlebutt around the industry is that another dozen portals more or less are in various stages of the registration process. Many anticipate that the SEC will raise the limit to $5 million. That may or may not happen and it will have little import since most of the portals have no idea how to raise even $100,000.

Just in the last few months, I have spoken with several people planning new Reg. CF portals. With one exception, none of these new portal owners knew anything about selling securities which is the business of any portal. None seemed particularly interested or focused on helping the listing companies raise the funds that they seek, even though the portals get paid a percentage of the funds that are raised.

FINRA

FINRA has always been a fairly lax regulator.  Notwithstanding, like many regulators, FINRA can get their teeth into you. They especially like to tangle with smaller firms that would rather settle than fight. 

Reg. CF – Will Fools Rush In?

I expect FINRA to get more involved as it is aware that the investors themselves have little recourse. If an investor invests in a Reg. CF offering that is a total scam no lawyer is going to file a suit against the portal if the loss is only $500.  Even a $1 million Reg. CF offering is likely too small for a class action.

FINRA has its own set of portal rules and an established set of standards and practices.  FINRA views the portals as being in the business of selling securities to public customers and should be expected to act accordingly.

Several people in the crowdfunding industry have suggested to me that crowdfunding platforms and portals have no real liability if an offering they host uses fraudulent or deceptive means to attract investors.  At least with portals, that is categorically not true.

FINRA’s Rules for Portals specifically forbids the portals from engaging in fraudulent conduct with the same language it prohibits the mainstream stock brokers. As the portals do not have trading desks, the only place the portals might engage in fraudulent conduct is regarding the offerings they host.

FINRA expects each of its Members to have some system in place to verify the information that the listing companies provide to the public investors.  FINRA has warned its members to not accept the self-serving statements of the founders of these companies at face value.  In many ways, this is the antithesis of the approach that many portals take, especially with start-ups. 

I have said before: when a portal lists an offering for a pre-revenue company, with negative or minimal book value, and allows the company to claim a “valuation” of tens of millions of dollars it is a fraud.  What some VC might think or say about the company is not regulated in the same way as a firm registered with FINRA.  The lawyers who allow the portals they represent to make a misrepresentation as to the “value” of a company are not doing anyone any favors. 

There are very few lawyers who work with Reg. CF portals. Every one of the lawyers that I have met or spoken with was a very competent professional.  But not all of them could really see Reg. CF offerings from the investor’s point of view which FINRA is likely to adopt as its own.

I recently spoke with an attorney who represents one Reg. CF portal and who is in the process of helping a client set up another.  His new client writes a blog with a lot of followers. The blog features articles about specific start-ups.  His client frequently appears on podcasts that get a significant amount of viewers. The client hopes to leverage his notoriety to help the companies that list their offerings on his new portal.

Rules Are Rules

FINRA expects portal owners to follow its rules regarding communications with the public.  When you are selling securities much of what you can and cannot say is regulated.  There is also a list of things that you must say when talking about an offering where you expect to collect a fee if the offering is successful.

Reg. CF – Will Fools Rush In?

FINRA has already expelled one portal owner for what he said about an offering in an interview away from his portal. There will be others.

I asked the attorney if the portal he was working on had an in-house compliance officer with experience to check all the scripts and the advertising copy for compliance before it is released.  He told me that his client had not even thought about it.

That is the nub of the problem.  Only one of the new portal owners with whom I spoke had a clear idea of how they would find companies to fund or how to make certain that there were always more investors available than securities to sell.  And that is really crucial to the success of this business.

Adding 20 new portals to a market where most of the portals are not profitable is likely to result in a race to the bottom rather than the top.  Adding more portals whose operators lack essential experience and trained compliance officers is not going to get more small businesses funded correctly.

Ideally, there would already be 50 portals each supplying $1 million per week or more for start-ups and small businesses.  Another 20 would be welcome, especially now when the need for small business capital is great.

With Reg. CF the SEC offered a truly new and relatively simple method of corporate finance for small business.  FINRA offers a roadmap to compliance and respectability. The road to success will come when the portal owners start acting like they are in the business of selling securities and focus on doing exactly that. Sadly, I do not see that happening any time soon.

If there are any portal owners out there who are ready to give up because they cannot run their portal profitably, I have some clients who would be interested in acquiring your registration to help you to salvage something from your efforts.  Serious inquiries only.

If you’d like to discuss this or anything related, then please contact me directly HERE

Or you can book a time to talk with me HERE

Start-ups Don’t Have to Fail

start-ups don't have to fail

I think that it is patently absurd for people to accept the fact that 90% of start-ups will fail in their first year or two.  That number screams that the market for new business formation is not efficient.  Economics teaches that markets hate inefficiency and always strive to do better. But this is one statistic that never seems to change.

I have read quite a few books and a lot of articles written by so-called experts dissecting why start-ups fail and how to make them succeed.  Much of it is nonsense.

There are really only three primary reasons why a new business will fail; 1) the owner lacks basic business acumen; 2) the business is under-capitalized and 3) the business misread the market. All can and should be avoided if the entrepreneur knows what he/she is doing.  Usually lack of experience and the ability to run the business profitably is what leads to the failure.  There are a lot of would-be entrepreneurs who do not know what a successful business looks like or how to run one.

It is hard to find an article that discourages entrepreneurs and entrepreneurship. But some people need to be discouraged because they do not have what it takes.  Fortunately, most of those people could learn what they need to know even though most will not.

Economics

When I was teaching economics I used the example of a restaurant, specifically a small pizza parlor, as a way of demonstrating how profitable a restaurant or any business can be.  Of all start-ups, restaurants often top the list of those that fail most often and more quickly than other businesses. That should not be.

In the example, the restaurant’s owner stops on his way to work to buy the ingredients that he needs, flour, cheese, tomato paste, pepperoni, etc. to make the pizzas.  If he opens his shop at 11AM, he can convert all of those ingredients into pizzas and back into cash, at a healthy mark-up, by the time he closes that evening. That type of rapid inventory turn-over is almost impossible to get in any other business.

Start-ups Don't Have to Fail

Customers at a pizza parlor are not expecting table cloths and fancy décor so overhead can be kept to a minimum. Since the pizzas come out of the oven one or two at a time, the wait staff can handle more tables than the staff at other restaurants. They may use paper plates and paper cups eliminating the cost of a dishwasher. In most cases, advertising can be done cheaply with signage, flyers and coupons.

Couple that with the fact that the other product the restaurant sells, fountain soft drinks, has a huge mark-up and you can see why a small pizza restaurant can make a lot of money.  If he owner is really smart, he will add a soft serve ice cream dispenser as well because it also has a very high mark-up and will substantially increase the total amount of sales and profit per customer.

The further away the restaurant gets from this simple model, the greater the chance that it will fail.  Nothing about this discussion has a lot to do with the pizza or how good it is. It is all about the numbers, especially money in and out; how to maximize the former and minimize the latter.

The problem with most people who start a restaurant is that they plan the menu around what they want to serve or what they think they need to serve to attract customers, not on how much money they will make. Likewise, most start-ups focus on their product. But they also need to keep their eyes on the numbers. That is where start-ups succeed or fail.

The real lesson here for any business and especially start-ups is that what you are doing is a business. To make it work you need to be focused on the bottom line. If you cannot operate the business at a profit, it cannot succeed.  So why do 90% of start-ups fail: because their expenses are greater than their income.

When someone asks me what I consider to be essential for any new business, I always include an adequate bookkeeping system so the business owner can easily keep track of cash flow, inventory turn-over, etc. It is very difficult to find that suggestion on the list of start-up essentials in any of the hundreds of articles on the subject in Inc. or Entrepreneur Magazine.

Start-ups Don't Have to Fail

The best advice for any start-up would be to “work smart and spend your time and your money wisely”.   That is especially true if you are looking for investors. Investors are expecting you to make money and they are expecting that you have what it takes to run a business and that you know what you are doing.

There are still thousands of articles about how to pitch VCs for funding. Over all VCs fund very few companies each year and many thousands of entrepreneurs are trying to get their attention because that is what the articles tell them to do.  Pitching to VCs may be the single biggest waste of time and money that any start-up does, especially so if you have to get on an airplane to make your pitch.

On the other hand, boot strapping can be very hard and the lack of cash can hold you back, delay your progress and cause you to fail just when you were beginning to succeed.  It is a lot easier to focus on your business when there is money in the bank to pay the bills.

Being able to raise seed capital so that you can focus and move forward is also an indication of other people’s evaluation of you and what you are attempting to do.  Feedback from potential investors on your seed round is important. Comments and suggestions, especially negative ones, will help you move forward.

Fund raising for start-ups has become remarkably easy with the JOBS Act and equity crowdfunding.  There is a lot of money available. It works for most start-ups because they can control the process and make it work.  I started walking companies through the process 3 years ago. Feel free to contact me if you are considering raising capital through crowdfunding or are raising capital and never considered crowdfunding.

A start-up is not a start-up until it starts-up.  Every business begins when it makes its first sale. It is a lot more difficult to raise funds for a pre-revenue company versus one which has a product already being sold. Pre-revenue you need a great business plan and a team to carry out your plan.  A good idea for a new business is important but execution is everything.

Given that financing a pre-revenue company is difficult, no one should plan on doing it twice; once to build your prototype product and again to launch it.  So an article that suggests that should raise money to create a  MVP (minimum viable prototype) and then again to take it to market is not really not helpful.   If you are going to raise seed capital to get your company off the ground, you should raise enough to get your product into the market, sustain your company until it is profitable, cover the costs of raising more money to help it grow and usually a small reserve in case things do not go exactly to plan.

There seems to be another stream of start-up gospel that suggests if you want to succeed you need to disrupt the market or solve a problem that nags the market. It is vitally important that you understand your market but you do not have to disrupt anything.

Nothing about the pizza parlor solves any specific problems that cannot already be solved in the marketplace. There is no new technology; no bells and whistles; no Blockchain.  While in a competitive market like New York City everyone knows a good slice from a not so good slice, I have waited on line at pizza parlors in small college towns around the US for some really mediocre pizza.

I look at a lot of pitch decks and I speak with a lot of entrepreneurs. Sometimes I can tell that the person just does not have what it takes to operate a successful business.  When that happens, I usually ask a lot of questions. How will the business operate post-launch? What are the sales goals month to month and where will the sales come from?  Where is your break-even point?

From day-one, the focus needs to be not on just starting up but staying open. The reason that 90% of start-ups fail is a lack of execution by the founders. If every entrepreneur focused on running the business well, that number would plummet.

If you are thinking about opening your own business, take a moment to have a slice a pizza and consider why that pizza parlor is successful.  Do that for fifty businesses. Look at what they are doing right and what you would do better.  Quantify how much more money the business would make if they did things your way.

Once you can analyze what makes other businesses successful, you will on the road to making your own business successful as well.  Sadly, the vast majority of people who are considering their own start-up would fail at this exercise. That, more than anything is why the 90% failure rate for start-ups is with us year after year.

If you’d like to discuss this or anything related, then please contact me directly HERE

Or you can book a time to talk with me HERE

The “Real” Costs of Crowdfunding for Capital

the real costs of crowdfunding

Most people who consider crowdfunding to raise capital for their business are first-timers. A great many have never even been investors themselves nor considered investing in any of the companies whose offerings are currently on any of the crowdfunding platforms.

Economic downturns always present opportunities for people with the capital to exploit them. I get more calls from CEOs and CFOs interested in crowd finance every week. Many have become interested because the banks they would normally turn to are not lending.

A crowdfunding campaign, if executed correctly can be an excellent source of capital for most businesses. Like any other corporate task, it requires preparation, an adequate budget, and professional execution. Not surprisingly, everyone wants to know what a successful campaign to raise capital from investors will cost.  

The “Real Cost”

Most companies will rely heavily on their CFO or outside financial advisor to execute this financing. The CFO needs to consider how the financing will affect the company’s balance sheet, cash flow, and capital structure. The company will need to decide if it should offer investors debt, equity, or another form of financing instrument.

The question of “what do we offer the investors” necessarily comes up early in the planning stages of every offering. The right terms can save a company a lot of money and make subsequent financing easier. The wrong terms can result in an expensive or failed campaign now or may erupt into a costly mess, years later.

For many CFOs the desire to offer investors as little as possible is at odds with the reality that if you do not offer investors enough, they will put their money elsewhere. This is where the “real cost” of any financing is determined.  

Investors in every Regulation D offering are always advised that the securities they are purchasing are “very high risk” or “speculative” to the point that investors should be prepared, both mentally and financially, to lose their entire investment. When the risk is high, investors expect to receive a high return as well. Some risks can be mitigated and should be. 

The process of deciding the terms investors will be offered usually starts with a series of spreadsheets. How much the company can afford to pay is in the revenue projections. How much the company may need to pay to attract investors requires a good idea of the cost of capital from other sources and a good idea of what other companies are offering in the crowdfunding universe. 

I frequently participate in this process. This is because most of the platforms fail to offer this type of advice which most companies sorely need.

I like to ask the questions that investors are likely to ask. I try to help each company see the investment from the investors’ point of view. Wall Street firms sell billions of dollars worth of these private placements every year. They know what needs to be said to get investors to invest.

Regulation D securities will only be sold to US “accredited” investors, mostly those who have a net worth above $1 million (excluding their primary residence). For years the mainstream stock brokerage industry has conditioned these same investors to look at the return that is being promised to them first, and most do. 

Investors want to know how you will use their money to make the returns you are promising come true. How you price and present your offering tells serious investors a lot about how serious and professional you are. 

What to look for in a lawyer (if you don’t hire me).

Once you have decided on the terms you will offer to investors you will have 3 major out-of-pocket expenditures. The first is a securities lawyer to draft the offering documents. What you say to potential investors in the offering and marketing materials is regulated. A good lawyer will keep you within the regulators’ white lines.

The standard disclosure document for a Regulation D offering is called a private placement memorandum (PPM). The overriding requirement is for full, fair, and accurate disclosure of the information that an investor would need to make an informed decision of whether or not to invest. 

PPMs have been presented as a bound booklet for decades. The bound booklet PPM is the normal format for disclosure that most practitioners still use.  In booklet form, the cost for a PPM is typically $50,000 and upwards.

Crowdfunding websites have begun to change the format and have started to use landing pages to spread out the information about offerings rather than present it as a standard booklet. This format makes the offerings more readable and investor-friendly while still making all of the necessary disclosures.

The landing page will provide investors with the terms of the offering, a description of the business and its principals, and a table showing how the company will use the money it is seeking. Most include links to current financial statements and revenue projections. The same information about the business, its competitors, and the particular risks of the investment that would appear in a bound booklet is all laid out. Key documents can be viewed with a “click”.

It usually takes less drafting and less time for a lawyer to use the landing page to “lay it all out” which is one of the benefits of crowdfunding. I usually bill in the neighborhood of $20,000-$25,000 for a Regulation D offering done in this manner rather than the traditional booklet form.

Paying for the Platform

Many crowdfunding platforms advertise that tens of thousands of investors have invested in at least one offering that they had hosted. Unless the platform can deliver those investors to you, such claims are irrelevant. You are going to need to execute a marketing campaign sufficient to bring in the capital you seek.

Platforms usually charge a “hosting fee” that covers two or three months for you to use their platform to attract investors to your offering and process them.  The processing will include a vendor to verify that your investors are actually “accredited” and an escrow agent to hold the investors’ funds until closing.

Key individuals at each company are required to get a background check to verify that they are not “bad actors” who cannot use the JOBS Act to raise money. Platforms charge for this and the better platforms charge to conduct due diligence on the company as well. 

Most platforms charge more the longer your offering is live.  A well planned and executed marketing campaign should get you the funding you want faster. Expect to spend $10,000 more or less for the platform hosting and the background checks.

Never Take Marketing Advice from Your Lawyer

the real costs of crowdfunding

Working in financial services where so much of what you must say and cannot say is regulated; I came in contact with a lot of advertising and marketing professionals over the years. In the 1980’s, when stockbrokers went searching for accredited investors they would buy subscription lists from “Yachting” magazines.

A modern-day marketing campaign is skillfully targeted at a pre-selected group of prospective investors. Content is pre-tested and the campaign will target more potential investors than you should need. 

The costs of setting up the landing page for an offering can vary greatly. I think that $10,000 is reasonable for setting up the website and preparing the marketing campaign.

Many Regulation D offerings have a minimum investment of $25,000. This equates to a maximum of 40 investors for every $1 million raised. A rule of thumb suggests that for Regulation D offerings, an expenditure of $10,000 on the marketing campaign for every $1 million raised seems reasonable.

So for a crowdfunding raise of $3 million, you might spend $20,000 for a lawyer, $10,000 for the platform and related fees, and $40,000 for the marketing campaign for a total of $70,000 more or less.  I always tell clients to keep a little in reserve as well, just in case the marketing campaign needs to be extended.

If you borrow $3 million from a bank, the bank will charge 2 or 2.5 points (percent of the loan) as well which is roughly the same.  And in truth many of the companies that chose crowdfunding did so because bank financing is not an option for them.  

The crowdfunding world has evolved from “put the offering on the platform and see who invests” to a world populated by legal and marketing professionals who get the job done and the money raised.  If you want your crowdfunding to be successful, be prepared to pay for them.


If you’d like to discuss this or anything related, then please contact me directly HERE

Or you can book a time to talk with me HERE

Creative Crowdfunding

Creative crowdfunding

A mentor of mine used to refer to the process of preparing a securities offering for public investors as a “craft”. He would explain to me:“Before you can sit down and write the offering based on your clients’ specifications, you need to be able to see the offering through the eyes of the prospective investors.”

Crowdfunding is creative finance.  Crowdfunding comes with endless possibilities for creating a variety of unique financing transactions. Each company sets the terms that they will offer to investors. Investors get to say “no thank you” to those terms if other investments are more appealing.   

Many people who work in crowdfunding don’t know the first thing about finance. This limits their creativity and often dooms a crowdfunding campaign that should have been successful.

Crowdfunding Experts

When speaking with a company seeking an infusion of capital, many crowdfunding “experts” give cookie-cutter advice. Some companies use templates to create their offering instead of lawyers. Those companies will never know that there is usually a better way to approach their financing that will be more attractive to investors and at the same time save them a lot of money.  

Creating an attractive investment for an audience of targeted investors on a crowdfunding platform involves a series of tasks. Much of it involves a lot of time looking at spreadsheets.  If you don’t, at the very least, do the following while preparing your crowdfunding campaign, you are likely wasting your time and money. 

Before I structure an offering I expect to review the company’s current financial position. Only then can we decide whether the financing should be debt or equity, whether it should be on or off balance sheet and whether the offering should be for more or less.

You need to be able to demonstrate how you will use the investors’ money and how that money will generate revenues. Your revenue projections need to be supported by real world data and real world assumptions. “We’re going to capture 50% of a billion dollar market in 2 years” is fantasy, not finance.

Every financing transaction has a risk of default or sub-standard performance. You need to understand the specific risks of your business and how to mitigate those risks. You will need to estimate how much of a reward it will take to compensate your target investors so that they will accept those risks. 

Crowdfunding overwhelmingly operates in the Regulation D market selling private placements to accredited investors.  A great many of the accredited investors who you are likely to pitch for your offering have more likely than not, already been pitched to purchase a private placement.

Since the 1980’s the mainstream stock brokerage industry has sold private placements to millions of individual accredited investors. Various types of real estate offerings are the most popular, followed by energy (oil, gas, and solar), films, entertainment and events and equipment financing. 

For over 40 years the mainstream brokers have been selling investors on the idea that private placements provide passive income. Accredited investors are also used to being pitched that private placements come with higher returns. Most crowdfunding is directed at these same accredited investors. You need to give them the information and the pitch they expect to hear. 

The vast majority of accredited investors are baby boomers. They still control the bulk of the money in the Reg. D market. They have grown up with new tech and new companies and they are not afraid to invest in either. But new tech is always risky. You have to offer a return commensurate with the risk.

Crowdfunding as we know it today began with a rewards based model. A company would sell its product on a platform like Kickstarter and use the proceeds from the sales to manufacture the product. Much of the time, the product never got delivered. 

Revenue Sharing

During 2016-2017 there was a lot of discussion among Crowdfunders about a financing model called “revenue sharing”.  In its basic form, a company would raise money from a pool of investors, manufacture the product and then share the revenue with the investors.

Revenue sharing is actually a mainstream tool of modern finance. Many oil drilling programs pool investors’ money to cover drilling costs with the investors and land owners, sharing in the revenue if and when it strikes oil. 

Many franchisers use a revenue sharing model with their franchisees. The parent gets a percentage of the franchisee’s gross revenue structured as a franchise fee, rent, or a royalty on intellectual property. The parent often provides advertising support or promotions to help build sales.

Accredited investors that have purchased Reg. D offerings are familiar with this “slice of the revenue pie” structure. They understand that they will earn less if their oil well pumps 10 barrels a day than they will if it yields 100 barrels a day.  

As I have already mentioned, there was for a while a lot of discussion about revenue sharing.  Several platforms were going to come on line to specifically offer revenue sharing programs. Revenue sharing is a natural for a crowdfunding audience.  Unfortunately it never really took off in the way that I would have expected.  

The crowdfunding industry is still focused on the “buy equity in the business” model, It has gone out of its way to create derivatives like SAFEs to complicate what should be simple capital raising projects.

The crowdfunding industry needs to accept the fact that businesses with no sales or assets are not “valued” at hundreds of millions of dollars in the real world. Insane valuations actually hurt the crowdfunding industry because they drive away serious investors.  Many of those same companies could use creative revenue sharing models instead of trying to sell equity.    

I recently spoke with a business owner willing to sell 10% of his business for $2 million. He wanted to syndicate a Reg. D offering and raise the money on a crowdfunding platform.  He was having a good year and wanted to expand.

The company sells an automated HR suite to businesses with at least 100 employees.  Its customers pay monthly, per employee. The company wants to use the $2 million to open more accounts, each with a large number of employees.    

The company knows the cost of account acquisition and expects at least $10 million in additional revenue in the first year from its $2 million expenditure. Those new accounts are likely to stay customers for many years. 

Instead of selling 10% of the company, I suggested that he share the income stream with investors, pay them back quickly with a generous return and move on. It makes perfect sense.

The company might give the investors 60% of the revenue from these new accounts until the investors get distributions equal to $3 million and then cut them off. They can pay the investors more or less and carry the payments into the future, if they prefer. The company should easily be able to attract $2 million with the promise of paying back $3 million in only a few months.

In this case I would advise the company to take the investors into a separate limited partnership or LLC. Investors like this structure for a number of reasons, not the least of which is that can get paid on the gross sales. They are not concerned about executive pay or management issues. How the company spends its 40% the first year is not the investors’ concern. 

The company does not have to deal with investors on its books and all that entails. This relationship operates and terminates by contract.  If the company wants to sell 10% of its stock later, it will get more if the sales have been increased by $10 million per year.  

I have seen many advertising campaigns funded this way. I have seen companies with multiple products fund one product or even one cargo of its product this way. Most of the crowdfunding “experts” have never recommended this type of revenue sharing arrangement because this type of offering rarely shows up on crowdfunding platforms.

This $2 million gets you $3 million model does not work for every company, but there are other “fund the transactions, not the company” models that may.  These are only one alternative to the traditional equity method. There are others.

As I said, crowdfunding offers opportunities for creative finance, but you need to understand finance, in all its forms, before you can really get creative. 


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