Crowdfunding after ICOBox

Crowdfunding after ICOBox

SEC Complaint: ICOBox and Nikolay Evdokimov

I have been a huge fan of the potential of investment crowdfunding since the SEC’s first experiments in the late 1990’s allowing issuers to use the internet to sell their securities directly to investors.  There was a lot of discussion among issuers, regulators, and the traditional Wall Street firms at the time. However, very few investors were included in those discussions.  There was a clear consensus that investors were entitled to the same “full disclosure” that the purchasers of any new issue would receive. 

The JOBS Act in 2012 codified the use of the internet as a way of offering new issues of securities to the public. Nothing in the Act, or the subsequent regulations suggested that investors who purchased securities on a crowdfunding platform would not be entitled to the same disclosures.  The SEC’s very first enforcement action against an offering done on a crowdfunding platform, SEC. v. Ascenergy, confirmed this. 

The SEC has been doling out sanctions against people associated with the Woodbridge Group of Companies, a high end real estate developer and apparent Ponzi scheme. Woodbridge claimed to have a wealth management company in its group that raised money for mortgages and bridge loans.  The wealth management company hired dozens of highly commissioned salespeople.  Many of these salespeople claimed to operate “financial” firms that looked like legitimate financial firms.  The salespeople were telling investors on their websites that these investments were “safe” and “secure”. 

SEC Complaint: ICOBox and Nikolay Evdokimov

In all, Woodbridge raised more than $1 billion from several thousand individual investors. The SEC noted that one of the salespeople they sanctioned was a self-described “media influencer” who made frequent guest appearances on radio, television and podcasts nationwide touting the safety, security and earning potential of Woodbridge securities to unsuspecting investors. He also touted Woodbridge’s securities on the internet through his own website.

Crowdfunding After ICoBox

The JOBS Act clearly anticipates that securities offerings will be posted on

SEC Complaint: ICOBox and Nikolay Evdokimov

The JOBS Act clearly anticipates that securities offerings will be posted on platforms and websites and investors will be solicited by e-mails. What those postings and e-mails say is regulated. There are things that you can and cannot say to potential investors. There are also things that you must say.

Regulators understand the difference between “posting” and “touting”.  Unfortunately, not everyone in the crowdfunding industry understands this.  Regulators are beginning to take action against the crowdfunding platforms that do not follow the rules. 

This month the securities regulator in Kentucky entered a Cease and Desist Order against a company called Kelcas Corporation which was making false claims about oil wells it was drilling. The Kentucky Order calls out a specific string of e-mails with a representative of the company selling the investment to a potential investor. 

The Order repeatedly notes that the company was using LinkedIn to identify and connect with potential investors. It refers to a post on LinkedIn, specifically seeking investors for an “oil well investment opportunity”. Posts like these are common on LinkedIn and other social media platforms.  No one is suggesting that LinkedIn has any liability for allowing this post or others like it, at least not yet.

Crowdfunding after ICOBox

A day or two after the action in Kentucky against Kelcas, the SEC brought an enforcement action against a crowdfunding platform called ICOBox.  According to the SEC’s complaint, ICOBox raised funds in 2017 to develop a platform for initial coin offerings by selling, in an unregistered offering, roughly $14.6 million of “ICOS” tokens to over 2,000 investors.

The complaint further alleges that ICOBox failed to register as a broker but acted as one by “facilitating” initial coin offerings that raised more than $650 million for about 35 companies that listed their offerings on its platform.

The investors who put up their funds to invest with Woodbridge, Kelcas and ICOBox and the 35 companies listed on ICOBox were sold unregistered securities issued under the same SEC rules. In each case the internet was the primary vehicle by which investors were solicited and the primary vehicle used to provide the fraudulent information to the investors.

What separates LinkedIn from ICOBox or any other website or crowdfunding platform that connects private placements with potential investors? In reality, and as a matter of law, not very much.

It comes down to the SEC’s use of the word “facilitate”.  It does not mean that the facilitator actually sells the securities. Both federal and state statutes govern not just the sale of securities, but specifically how they are offered and to whom they are offered.

In the case of ICOBox the allegations are that the platform was actively involved in marketing of the offerings that they listed.  ICOBox promised to pitch the offerings to their media contacts, develop content for promotional materials and promote the listed companies at conferences.  The SEC included this in the complaint because the SEC thinks these acts constitute “facilitation”.

ICOBox is not the only crowdfunding platform that has helped to promote the offerings it lists. I get e-mails all the time from platforms inviting me to look at specific listings.  A lot of those e-mails and a lot of the offerings they promote make outrageous claims and promises.

The SEC also complained that ICOBox claimed it was “ ensuring the soundness of the business model” of the listed companies. Other crowdfunding platforms claim to “vet” or “investigate” the companies they list.  Many of those platforms have no idea what they are talking about. These platforms are lending their reputation to each offering. That also facilitates the offerings.  

Where does that leave LinkedIn? LinkedIn does not claim to investigate any offerings posted on their site.  It does however sell paid advertising.  Does LinkedIn have a duty to refuse to carry ads for securities offerings that it thinks are fraudulent?  What if LinkedIn ads generated the most sales leads for an offering or if the ads were specifically targeted at people LinkedIn identified as “real estate investors”? 

LinkedIn joined the ban on ICO ads by the major social media platforms in 2018, not because ICO ads caused cancer, but because they were largely fraudulent.  Would LinkedIn refuse to accept an ad from a small real estate syndicator if they had a reasonable belief that the sponsor did not own the property they were selling? 

What would a jury tell the “little old lady” investor who handed a few hundred thousand dollars to a scam like Woodbridge if the investor was introduced to the company on LinkedIn and testified that the company was brought to her attention by a LinkedIn “influencer” whom she followed? 

I read the ICOBox case as a clear warning from the SEC to the crowdfunding platforms to get their act together.  If the platform stays within the regulatory white lines, then regulators should leave it alone.

Unfortunately, it is apparent that many crowdfunding platforms have no idea what the rules require. They are setting themselves up to be defendants in enforcement actions by regulators or civil actions by disgruntled investors. Platforms that do not have a securities lawyer on staff or on retainer will be easy targets.

If you would like to discuss any of this article further with me then please contact me directly here

Crowdfunding After ICOBox

Investment Crowdfunding Can Offer Better Investments Than Stockbrokers

Someone in the crowdfunding industry should put that sentence on a coffee mug and send me one.

I have been writing about and working in investment crowdfunding for more than 3 years.  I find it interesting to watch this fledgling industry mature.  It is certainly attracting more and more new money every year and is past the point where it can be ignored by any company in search of investors.

I have looked at a great many offerings on a great many crowdfunding platforms.  I read a lot to keep abreast of new offerings and industry developments. I take the time for conversations with platform owners and their lawyers and several of the better investment crowdfunding marketing executives.

I also speak with a lot of companies who are considering investment crowdfunding to raise capital.  Any company that would raise capital in this new DIY crowdfunding marketplace wants to know if it spends the money to list its offering on a crowdfunding platform will enough investors show up and invest?  From the company’s perspective, little else really matters.

The JOBS Act was intended to be a different approach for corporate finance using the internet instead of a stockbroker to reach potential investors. The internet allows companies to reach a lot of prospective investors, very cheaply. Success or failure in investment crowdfunding is more about what you have to say to those potential investors than anything else.  

Selling securities issued by your company to investors is not the same as selling your product or service to potential customers. Investors will have different expectations and will respond to different things.  

People who sell securities for a living will tell you that any new issue of a stock or bond needs two things: good numbers and a good story. Investors want a return on their investment. 

So the best stories are always about how much money the investors will make and what the company will do to provide that return.   

There are two distinct branches of investment crowdfunding. First, there are the private placements sold under Reg. D to institutions and other larger, accredited investors.  This marketplace is healthy and growing rapidly.  Professional money-raisers have caught on that they can use investment crowdfunding, to substantially reduce the cost of capital and use that savings to enhance investor returns.

Reg. D offerings have been sold through stockbrokerage firms since the 1980s.  Most are sold to institutional investors.  Some are sold to individual, accredited investors. Minimum investments of $50-$100K or more per retail investor are common. 

Many of the retail Reg. D offerings will fund some type of real estate (construction or purchase), energy (oil, gas and alternative energy) or entertainment (films, music, and games) project. There are professional sponsors; people who package and syndicate these projects, often being paid to manage the business on behalf of the investors after the funding.

The costs of selling a Reg. D offering through a stockbrokerage firm, including commissions, run 12%-15% of the funds raised. That would be up to $1.5 million for each $10 million raised.. Most Reg. D offerings sold through brokerage firms just raise an additional $1.5 million and dilute the investors’ return.  Using investment crowdfunding a company can raise that same $10 million and not spend more than $100,000 in legal and marketing costs and frequently a lot less. 

The Reg. D crowdfunding platforms compete with stock brokerage firms for projects to fund and for investors to fund them.  The same institutions and accredited investors who have been purchasing Reg. D offerings from their stockbrokerage firm for years are catching on to the fact that they can get good offerings and better yields without the need to pay the very high commission.

The other branch of investment crowdfunding is the Reg. CF or regulation crowdfunding. This allows offerings which can help a company raise up to $1 million from smaller, less experienced investors. Reg. CF allows smaller businesses to sell small amounts of debt or equity to small investors.

The Reg. CF market was the SEC’s gift to Main Street American small businesses. There are always a great many small companies that could benefit from a capital infusion of a lot less than $1 million, the Reg. CF upper limit.

To put down a layer of investor protection the SEC required that these portals that are dealing with small investors become members of FINRA. FINRA dutifully set up a crowdfunding portal registration system and has audit and enforcement mechanisms in place.

As a reward for joining FINRA, the SEC allows Reg. CF portals to be compensated by taking a percentage of the amount the company raises which the Reg. D platforms cannot. Several of the portals also take a carried interest in every company in case the company is eventually re-financed or sold.

The SEC looks at Reg. CF as a tool of corporate finance for small business. It provides a mechanism where a great many small businesses should have access to a pool of capital every year, potentially a very large pool. It provides for a market structure for these small offerings and incentivizes the portals help raise that capital. All in all, not too bad for a a government regulation.

Sadly, the Reg. CF industry is still foundering. There are still fewer than 40 registered portals operating and several have closed up shop.  So why are these portals not successful? Because the people who operate them are not listing better investments than stockbrokerage firms.

When I first looked at investment crowdfunding there were a lot of people proclaiming that it would “democratize” capital raising.  They believed that the crowd of investors could discern good investments from bad ones and that the crowd would educate each other as to the pros and cons of each.  That was never true.

The Reg. CF portal websites are full of bad information and consequently, bad investments.   Comments about any offering that lists on a portal, if any, are always overwhelmingly positive.  Investors will not do any due diligence or other investigation of the company because they do not know how.

The Reg. CF portals compete with banks, which are the primary source of funding for small business.  Here too, a Reg. CF portal can have a competitive edge.  When you borrow from a bank you do so on the bank’s terms. On a Reg. CF platform you can set the terms of your financing.  Done correctly, you can get the capital infusion you want for your company without giving up too much equity or pledging your first-born child to the lender.

What the portals should be offering investors are bank-like products that stress the ROI that investors reasonably might expect to receive.  The portals should be telling investors how each company mitigated the risks that the investors might face. Instead, too many portals and too many people in the Reg. CF marketplace are still selling fairy tales and lies.

The big lie, of course, is that by buying equity in any of these companies an investor might hit the proverbial home run.  Suggesting that investors can or should think of themselves as VCs is patently absurd for any company that I have seen on a Reg.CF portal.  I always tell people who ask that if even one valuation on a Reg. CF portal seems very outlandish, then they likely cannot trust that the portal operator knows what they are doing. I would question anything told to investors by any company that lists on that portal.

If a company wants to raise $1 million on a Reg. CF portal, it might end up with 2000 distinct investors each investing an average of $500.  To secure subscriptions from 2000 people, the company might need to put on a marketing campaign that will put its offering in front of hundreds of thousands of investors if not more.  Success or failure of your fundraising campaign will depend on what you say to these people. 

The cost of the marketing campaign is the major upfront cost of the offering. The good news is that marketing seems to be more data- driven and more efficient as time has gone by reducing the cost of the marketing.

Sooner or later these  Reg. CF portals will wise up to the idea that they cannot succeed unless the investors can make money. They, too, could offer better investments than stockbrokers, but do not seem to have bought int the idea.    

Until that happens, I expect more portals to fail and close up shop and the SEC’s “gift” to small business to remain largely unwrapped.

Two Years of Crypto Market Memories

I first looked at bitcoins in the Spring of 2017 because a friend asked me for my thoughts.  The price of a single bitcoin had run up sharply and the ICO craze was proceeding at full speed.   Up until that point I knew very little about either blockchain or cryptocurrency. 

I spoke with people who were actually developing blockchain projects for the big tech companies. I read a lot of articles which they thought would help me and a lot of other articles that I found through my own research. I spoke with traders, regulators, and with a lot of people who thought that they had cryptocurrency all sorted out.  There seemed to be a wide spectrum of thought about cryptocurrency, how it might be regulated (if at all) and whether it would augment or supplant the established financial order.  

I concluded that the bitcoin market was in a classic bubble, the price rising only because of hype, and the new money that hype always attracts. I was not alone in that opinion.  Still some intelligent sounding people were making an argument for continued price appreciation to ridiculous levels.  And that was what a lot of people wanted to hear. 

I wrote an article about my research, my thoughts and predictions for bitcoins.   http://laweconomicscapital.com/2017/06/the-bitcoin-bubble/   The article got the attention of a lot of people who were also trying to understand cryptocurrency and ICOs.

The article ends with an invitation to the securities lawyers who were writing the disclosure documents for ICOs to contact me for a professional conversation.  I would have had difficulty preparing those documents.  I confessed my professional curiosity to any and all that might satisfy it. 

A lot of lawyers and other professionals did contact me.  Many of the lawyers were doing what lawyers are supposed to do, marshaling the facts and applying the law as they saw it.  But it was clear that there was not a unified position as to what the facts regarding any cryptocurrency actually were. 

Some lawyers approached ICOs as if they were issuing securities and some as if they were issuing anything but securities.  Before the SEC issued its DAO Report, (July 2017) I was of the mind that a token offering might be structured so as not to be a security. Once the DAO Report was issued, it was clear to me that the SEC saw tokens as securities and would look at an ICO as the sale of securities with all that entailed.

The DAO Report led to a robust discussion, on line and off, with those same lawyers and professionals and more.  The discussion became somewhat convoluted as many non-lawyers often in other countries felt comfortable discussing the finer points of US securities law. A great many of those commentators had interesting takes on the Howey decision that no competent US lawyer would ever present to a judge.  Many of those “experts” just ignored the dozens of other cases cited by the SEC in the DAO Report and many other cases that should have been germane to the discussion. 

There was an interesting undercurrent of lawlessness in the cryptocurrency world.  It was impossible to search for articles about cryptocurrency without coming across many quoting regulators around the world who were reporting cases of money laundering and fraud.  That has not changed.  Fans of cryptocurrency were often happy to ignore these transgressions even though it was obvious that regulators would not.

By now I have read several hundred white papers for ICOs. Some were written by lawyers; other white papers were written by either monkeys or idiots. Some of the latter were using templates because the thought of actually hiring a lawyer to prepare documents for a multi-million dollar financing did not make sense to them.

These white papers are supposed to tell potential investors what they needed to know so they could make an informed decision whether or not to send their money.  That was rarely the case. I recall one white paper where the principals of the firm refused to disclose their last names. 

People were claiming to have advanced degrees they never completed and to have worked at firms where they were never employed.   Quite often, outrageous claims were made about the size of the market to be served and the profits to be made.  If these same founders had been sued by investors in a prior company for fraud, investors in this new company would never hear about it. 

I had my bio and picture hijacked and included in a white paper. So did many other people.  There was no way for any investors to know if what they were being told was true.  Very often, it wasn’t.

These ICOs were being sold by networks of unregulated, self-validating crypto “experts and advisors”.  They traveled in packs to frequent crypto conferences around the world.  They cross-validated each other in articles on websites that had popped up and which reached many thousands of people around the world. Some crypto “experts” developed 6 and 7 figure lists of social media followers.

An issuer could engage any number of these crypto gurus and just pay them in the tokens to be issued.   The “advisors” would notify their followers about the token sale and urge those followers to cough up real fiat money to buy them.  Along the way the advisors were selling tokens that they had gotten for nothing in exchange for their sales efforts.  

Several otherwise intelligent people tried to convince me that this was not just a dressed up pump and dump scheme playing out over and over again. The results were certainly the same because most people who bought the tokens in these ICOs were left holding the bag.

A significant number of the ICOs were out and out scams which, sadly, many people refused to see.  Fifty million dollars raised here; one hundred million there, all going down the toilet of financial history.  It got so bad that several of the large social media platforms banned ads for ICOs. Several countries banned the sale of ICOs altogether.

Many of the ICOs claimed that they were not selling securities but “utility” tokens instead.  That died down significantly after the SEC published its Cease and Desist v. Munchee toward the end of 2017.  http://laweconomicscapital.com/2017/12/sec-v-munchee-will-the-crypto-currency-community-listen/

Along the way some really bright lawyers thought that ICO offerings might be structured as SAFTS. I saw it as an attempt to solve a valuation problem by promising to set the value down the road.  They were touted as making the ICO market less risky. To me they looked to be a riskier “derivative” and began to write an article that said so. But I never finished that article. 

In short order one of the NYC laws schools published their research and pulled back the curtain on SAFTS. After that most securities lawyers stopped talking about them.  SAFTS were a financial flash in the pan and not a very good one at that.   

I also had conversations with a number of groups that wanted to develop a realistic scheme to regulate ICOs and cryptocurrency trading across borders.  Each failed because most of the participants had never worked at or had dealt with any market regulator.  I wrote e-mail after e-mail trying to explain that transparency is only useful if everyone in the market was honest and that without significant penalties for dishonesty no regulatory scheme can work.  All that fell on deaf ears and each of those groups disbanded.

I also spoke with several people who wanted to create trading platforms for cryptocurrency but most of whom had no idea what a trading platform does or how it operates.  I would ask questions like: What would be the minimum standards for listing on your trading platform?  It was apparent that they had not even worked out that simple, basic and necessary issue. When I asked about market-makers and liquidity I got a series of blank stares.

Today, at least in the US, most lawyers have accepted the fact that any ICO sold here will be the issuance of a security and that US securities laws will have to be followed.  

To sell securities to investors in the US the securities must be registered with the SEC or specifically exempt from the registration requirement.  Registration is an expensive and often lengthy process. By mid-to-late 2017 a number of lawyers were reporting that they were filing registration statements for ICO offerings with the SEC. Apparently, many never got approved.

Securities offerings in the US do not have to be registered if they comply with regulations which provide guidelines for un-registered offerings. Un-registered offerings are generally sold only to institutions and wealthier investors who have no real interest in owning crypto currency.  These unregistered securities are not intended to be traded.

More than one lawyer has reminded me in the last few months that unregistered securities can be transferred after 12 months if the company is putting financial information into the market or if the tokens are listed on a crypto exchange outside the US.  I am not certain that they have thought that idea through.

Investors in an unregistered offering in the US are usually required to attest to the fact that they are making a long term investment and not intending re-sale.  That is why most companies in the US that sell unregistered securities provide those investors with income from dividends or interest.   So if you are selling unregistered securities with the promise of liquidity and re-sale, you are likely to confuse everyone, except perhaps the judge who will ultimately set you straight.

Companies from around the world have always wanted to tap the US for capital investment.  It is often a difficult process for any company and especially for start-ups and smaller companies.  In the ICO market, it became apparent that political borders and local regulations were not considered to be important by the issuers.

Investors who should have seen the shoddy disclosures as a problem seemed happy to invest, convincing themselves that if the offering “complied” with the laws of the country of origin, then protections afforded to them by US law were unnecessary.   A lot of people who were touting blockchain because it was supposed to promote transparency were willing to invest in crypto offerings that provided none. 

Today, people are spending money to “tokenize” real estate, fine art and many other tangible items as if there was a market for those tokens or if it made any sense to create one.  If I can buy 1/10,000,000 of a Picasso, do I get to hang it over my fireplace for 20 minutes? 

If you are selling shares in a building that you call “tokens” and tell me that you believe that all of the laws pertaining to real estate syndications would not apply, I would suggest that you really need to re-think what you are doing.  There are established rules for selling “asset backed” securities in the US.  Not surprisingly, most of the articles I read about “tokenizing” this or that fail to mention those rules and most of the people with who I am now speaking who are preparing to “tokenize” this or that offerings do not seem to be considering them.

Back in 2017 a lot of regulators told me that the ICO boom came upon them suddenly and that they did not have the staff or budget to deal with them.  They do now and there is every indication that the leniency some regulators have exhibited is about to come to a screaming halt.  

More On Internet Stock Manipulations; SEC v. Lebed (2000), revisited


I was reminded recently of the story of Jonathan Lebed, a 14 year old kid from New Jersey who was investigated by the SEC for stock manipulation using the internet back in 2000.  This case was a big deal at the time, garnishing a segment on 60 Minutes and some interesting discussions in the financial and legal press.

Even though he was underage, with the help of his parents, Lebed had managed to open an account at one or two of the discount brokerage firms. He was apparently trading his accounts in low price stocks when the SEC came knocking on his parents’ door. 

It seems that in the course of trading Lebed liked to post positive comments about what he was buying on various websites, bulletin boards and chat rooms where people who might be interested in purchasing these stocks would see them.  This was in 2000 when the chat rooms were not sophisticated and the web reached a fraction of the people it reaches today. 

Lebed would buy a low priced stock and then say something nice about the company in a message that he posted in a chat room. Using multiple e-mail addresses he might get that same, positive message posted in 200 chat rooms.  Some of the people who saw his posts would re-post them again. 

Lebed knew that his simple postings would create significant interest in these shares and that the price would move up.  He commented that posting the messages with key words in all capital letters would actually get even better responses. 

Bringing a lot of attention to a more obscure, low priced stock can, indeed, lift the price. The SEC called it an intentional market manipulation.  Lebed said that he was only doing what the research analysts at the big firms did, publish their opinions about companies whose share price they wanted to go up. 

Lebed did all this out in the open. Several of his classmates and school teachers followed his leads and invested with him. They were willing to take a chance of doubling their money if the share price of one of these companies went from $.30 to $.60. 

Many of these investing neophytes did understand the positive effect that Lebed’s postings and his quasi investor relations campaigns had on these stocks.  They wanted to buy before he posted and get out as the buyers reacting to his posts pushed up the price.  

Lebed was not the only person or group at that time that was using the internet to enhance the price of shares of small public companies.  But he demonstrated that in the year 2000 the power of the internet to sell investments directly to investors was underrated.  In the almost 20 years since, the use of the internet to sell almost anything, including investments, has become much more powerful and pervasive. 

In the regulated financial markets the dissemination of information is encouraged, but it is also controlled.  Regulations require that information be accurate and complete. Public companies are required to report specific information about their business, to present that information in a specific manner and to release that information on a regulated schedule. 

For a licensed stock broker or investment advisor every e-mail, tweet, posting, comment and utterance about any investment is subject to the scrutiny of his/her employer and by regulators. The SEC depends on the market professionals and market participants to play by the rules. There are significant penalties for non-compliance. 

But Lebed was not a market professional. He was an outlier. He was an independent investor, not a licensed participant in the marketplace.  In the end the SEC let Lebed keep most of the money that he made from his trading as long as he promised to stop.  

At the time, no one really questioned the SEC’s jurisdiction over Lebed or what he was doing. Lebed was a US citizen, operating out of New Jersey. His posts were about US companies whose shares traded in the US markets. Many of his posts were made through a US based internet company (Yahoo Finance). 

In the ensuing 20 years, social media and on line platforms, publications and unregulated “experts” have demonstrated that they can easily sell investments directly on line to millions of investors.  Moreover they have demonstrated that they can disseminate information about public companies and new issues without regard to the truth of the information.  And they can do so without regard for regulations or national borders.

In the “direct to investors” investment world, social media “followers” has replaced “assets under management” as a measure of how many investors’ dollars a person can bring to an investment or new offering.  And you can buy people who have a lot of followers.

If I wanted to hype a stock, either a new issue or one that is already trading, I can make a financial arrangement with any number of independent “experts” who have a lot of social media “followers”.  Some may write articles for financial publications, some write books and blogs and many can be found going from conference to conference and podcast to podcast. 

Any financial “expert” can purchase the right to give the keynote speech at a conference and purchase any number of other speaking slots and sponsorships as well.   Anyone can buy interviews on financial websites, blogs and podcasts or pay for the right to create and distribute positive content on these sites.   

If you look at the numbers you can get an idea of how this works.  I can hire a financial “expert” to tout any stock that I wish. The “expert” will send his/her followers a series of e-mails, appear at a series of conferences and write a series of articles about that company. An expert with 1 million followers might reach 2 million other investors who see re-prints and references to it.

If only 10,000 investors of those followers invest an average of $1000 a new issuer can raise $10,000,000. That much new money coming into a thin trading market can often raise the trading price of the shares of a smaller company.  

There is no limit to the number of experts I can hire or the size of the e-mail lists I purchase for their use to augment their own list of followers.  If I hire multiple experts to hype the same stock, other experts who have not been paid may mention the company independently.  And before you say that this type of scheme using paid experts to hype the stock may be questionable under US law, who said that US law applied?   

If you solicit investors in the US for a new issue the offering is subject to US law.  That would require full and fair disclosure to investors in the US and provide for government penalties for non-disclosure.  But what if you donot make the necessary disclosures and you only solicit investors in other countries? 

The capital markets are regulated country to country.  Each country has its own rules which apply to financial transactions involving its citizens and issuers.  Each has rules governing transactions executed on the exchanges domiciled in their country. The laws of the country where the issuer is domiciled, the exchange is located and where the investors reside may all apply to a single transaction.  An overriding question with the direct to investor market is which country has jurisdiction and over what actions and activities.

If an article about a company’s share price or prospects from a European website gets republished or re-distributed in the US is the author subject to US law? What if the author knew the information in the article was false; do US investors have any recourse?  Does it matter if the author got a royalty for the re-print?

Would the answer be different if the false information originated with just one shareholder who bought a large block of shares cheap and now wants to pump up the price?  Does it matter if that person is in a country other than where the shares trade or the articles originate? 

I recall that when the Lebed case was discussed a lot of people thought that the internet would change and globalize the capital markets. It clearly has.  

I think that there is still a lot of discussion that needs to be had and a lot of questions that need to be asked and answered.  In the meantime, it should be obvious that the current international regulatory scheme does not overlap as well as it could.   

The current and expanding global reach of social media create opportunities and but also highlights problems.  The flow of capital and information continue to globalize. At the same time I am certain that it would is a lot easier today for a 14 year old to manage a single successful, global stock manipulation.    

Cannabis Stocks and the Old Pump and Dump

People seem to hate me when I state the simple truth that cannabis  is illegal everywhere in the US. The Obama Administration decided to focus its drug enforcement budget on the cartels and large suppliers and not on small retail dealers.  Deciding not to bust small dealers did not make cannabis legal anywhere in the US.  Just because the federal government will not spend money to send 20 officers to kick down the door of a small dealer, they will still charge you with “intent to sell” if they find a few pounds of cannabis in the trunk of your car.

The former US Attorney General, Jeff Sessions was fairly clear that he wanted to keep cannabis illegal. What the incoming Attorney General will do is anyone’s guess.  The one clear truth is that action by states purporting to make cannabis legal within their borders does not actually make it legal anywhere under federal law.

Notwithstanding,many people seem to believe that there is a “legal” market for cannabis and a lot of people are finding ways to cash in believing that the federal government will continue to look the other way. That has encouraged the flow of a lot of new money into the “new” cannabis marketplace. As these cannabis companies are new, small and somewhat precarious given they often cannot get a bank account,some companies have sought funding in the microcap stock market where small companies can go public.  

Few investors come in contact with “microcap” or “penny stocks”.   Many of the very large brokerage firms will not touch very low priced shares and certainly will not recommend them.  Fewer investors are the victims of the “pump and dump” schemes that plague this portion of the marketplace. Even fewer investors actually understand how a pump and dump works or how to spot one.

The  blueprint for these pump and dump scams is often the same. These scams will often start with a “shell” corporation, a public company with few assets and minimal operations.  In a typical scenario a public “shell” corporation would acquire a private, ongoing business in exchange for stock.  There would be a press release, often several over the first few months that would begin to tell the story that the promoters wanted to tell, especially how this company was going to grow and grow.

The story would be told to thousands of investors through the stockbrokers who would be on the phones, cold calling people around the US with this week’s“tip”.  They would stay at it until enough people bought the stock to make the share price go up. There would often be subsequent acquisitions, subsequent press releases and subsequent hype.  All of the hype caused more people to buy the stock and the price to go further up.  As the price moved up, the insiders who bought for very little when the company  was still a shell could dump their shares.

This can be very lucrative for the people who bought the shares in the shell for pennies a share. It can also be lucrative for the brokers because getting the stock price up and then selling it to unsuspecting members of the public can mean a lot of transactions and a lot of commissions and mark-ups.  It is not unusual for even a small pump and dump scheme to net the promoters and brokers $10-$20 million or more. Consequently, people who pump and dump the shares of one company (often a team of promoters and stockbrokersfrequently do it repeatedly.

Organized crime settled into the stock brokerage industry in a big way by backing or owning a number of small brokerage firms in the 1980s and 1990s. Many of the firms were the quintessential boiler rooms like the ones depicted by Hollywood in The Wolf of Wall Street or BoilerRoom. By the early 1990s these boiler rooms proliferated in lower Manhattan, Long Island, New Jersey and Florida.  By 2000, the SEC was telling Congress that several of these firms were owned by or worked with the Bonanno, Gambino and Genovese crime families.  

A significant amount of regulatory scrutiny and regulatory actions followed,but that did not stop the billions of dollars of profit that was skimmed off by the miscreants.  The SEC closed down a few of those firms, barred a few people from the securities business and put a few of the people in jail.  But the beat goes on. 

Boiler  rooms are still active today and still working out of Manhattan, Long Island, New Jersey and Florida. They are still cold calling unsuspecting retail investors around the country. They are still using press releases and more recently “independent” fake investment newsletters to pump up what are essentially shell companies. 

In the 1990s the companies were “exciting” because they were going to capitalize in some way on the internet, a new and exciting technology that a lot of people believed could make a lot of money. People were happy to invest in every “internet” company that came along.Today, the pump and dumps have found cannabis stocks as a perfect substitute.   Which brings us to Aphria (NYSE:APHA). 

Aphria is a Canadian cannabis company that is trying to rapidly stake out its territory in new foreign cannabis markets. It traded over the counter in the US until November when it up listed to the NYSE.   The stock price has moved up as the company made a series of acquisitions and announcements in the last year. 

Last week it was the subject of a fairly scathing report by a research company and short seller that questioned whether the company had grossly overvalued some of those acquisitions.  Aphria has retorted that the company’s acquisitions were fine and properly valued and essentially that short sellers cannot be trusted.

Personally I thought that the research report was well written and seemed to have been well researched. There were photos of the headquarters and operations of some of the acquired companies that left a lot to be desired. There were copies of documents that supported the idea that insiders may be guilty of undisclosed self dealing. I thought that the valuations are clearly questionable and that alone was a big red flag. 

What got my interest and what troubled me the most was the discussion of who was involved with Aphria.The report goes out of its way to set out the facts and affiliations surrounding Andrew DeFrancesco who was apparently a founding investor and strategic advisor to Aphria. The report ties Mr. DeFrancesco to  several pump and dump schemes and affiliations with several pump and dump schemers.

These schemers include Paul Honig, John Stetson and John O’Rourke. The SEC brought an action against these three in September specifically charging them with operating pump and dump schemes in the shares of three companies.  I suspect there were other companies whose shares were manipulated by this group as well.  The report points out that in at least one company DeFrancesco’s wife was an early holder of cheap stock.

The report also ties DeFrancesco with a gentleman named Robert Genovese. In 2017,the SEC charged Genovese with operating a separate pump and dump scheme.  So if Aphria’s founding investor has connections with 2 separate pump and dump operators,, and has set himself up to benefit handsomely if Aphria’s stock price should be pumped up, what inferenc e would you make? 

The research report was published by a company called Hindenburg Investment Research. I have no affiliation with them whatsoever and I have never traded shares of Aphria either long or short.  Not surprisingly, a lot of market “experts” refuse to accept any information put into the market by any short seller.  That would be a mistake.

In addition to providing liquidity for the markets, short sellers provide a valuable service because the investment world is grossly overpopulated by“longs”.  The prospects for every company cannot always be rosy. If standard analysis can tell us when the price of a stock is likely to go up, that same analysis can tell us when the price is likely to come down. 

Short sellers truly love to spot scams. If this report is correct about Aphria and the company has grossly overvalued its acquisitions and is being pumped up only to have the insider’s shares dumped into the market, then sooner or later the stock may go to zero or very close to it. That is a win for any short seller.

There is more than enough information in the research report for any small investor who wants to invest in a cannabis company to make an intelligent decision not to invest in Aphria. But please do not think that Aphria is the only cannabis stock whose price may be the pumped up not because its prospects are actually good,but because someone has a lot of stock to dump into the market. As I was researching this article I saw at least a half dozen cannabis related microcap stocks that did not pass the smell test. There are undoubtedly more.

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.

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.

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.

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.

 

 

DreamFunded – Crowdfunding the Dream – Poorly

One of my pet peeves about the crowdfunding industry is that the so-called professionals take Pollyanna views of bad acts and bad actors. They ignore felons and felonies. When someone screws over investors, they make excuses or worse, simply ignore it.

When the SEC brought its very first action against a crowdfunded offering, Ascenergy, I wrote an article about it. I called out how the lack of due diligence would be a problem for the industry. That was in 2015.  A lot of people told me then that the crowdfunding industry would get its act together.

In 2016 when FINRA brought its first action closing down crowdfunding portal UFunding, I wrote an article pointing out the need for better compliance for crowdfunding portals. The crowdfunding industry gave a concerted yawn.

I have written several articles about companies that were raising money on crowdfunding platforms that looked and smelled like scams.  No one else seems willing to do so. The idea of protecting investors from scams and scam artists seems to be an anathema to the crowdfunding industry.

So I really was not that surprised when someone sent me a disciplinary complaint that FINRA had lodged against one of the better known Reg. CF crowdfunding portals last April.  Even though the industry publications had published every press release and puff piece about this portal while it was operating, I could not find even a mention of the FINRA complaint in the crowdfunding media, let alone a serious discussion about what this platform had done wrong. Perhaps I missed it.

It is not like FINRA’s complaint was not noteworthy. The portal, DreamFunded, was owned by Manny Fernandez a serial angel investor, CNBC celebrity, White House invitee and noted author who has appeared on many TV shows and podcasts and in article after article about crowdfunding. If you are going to run any business having a celebrity out front is usually an asset.  But that does not mean that a celebrity can run the business.

Mr. Fernandez was able to assemble a large group of well credentialed advisors for his portal, some of whom were angels and VCs, but all of whom apparently lacked experience in the business that the portal was set up to do, sell securities to investors.  No competent securities attorney was involved even though selling securities is a highly regulated business.

The crowdfunding industry is supposed to follow those regulations but quite often does not.  FINRA’s complaint against DreamFunded and Mr. Fernandez lays out a road map exactly on how not to run a crowdfunding portal. And, again, the industry has ignored it.

At the heart of the complaint is the fact that companies that were selling securities on the platform were lying to investors or making unsupported claims about their business. That is securities fraud, plain and simple.  Every crowdfunding platform or portal is supposed to take steps to see that it does not happen.  DreamFunded listed fraudulent offerings on its portal even when the fraud was obvious. And worse, Fernandez affirmatively told lies to investors himself to help at least one of those companies scam investors.

DreamFunded operated as a funding portal beginning in July 2016, shortly after Reg. CF became effective, until November 2017 when FINRA apparently began to ask questions about its operation. During that time, it managed to list only 15 companies. How many of those offerings actually raised the funds they were seeking is not disclosed. FINRA takes specific issue with three of the offerings.

The first was a social networking company that had no assets, revenue, or operating history.  Notwithstanding, it claimed a $1 million valuation without providing any support or basis for that valuation. Valuation of pre-revenue start-ups is a significant problem in crowdfunding but you will not find a discussion about it at any of the industry conferences.

The company also claimed that it was in a “$9B market,” that it could achieve a “$900MM+ market cap” and that it projected 100 million active users by its fifth year of operation.  The company claimed that its exit strategy was to be acquired at a sales target of $500 million, which would provide a significant return to investors. The company then listed numerous well-established internet and technology companies as potential “strategic acquisition partners” with no basis or support for doing so.

The company closed its offering early without notifying investors as it was required to do.   “DreamFunded, through Fernandez, transferred the investor funds raised through DreamFunded’s portal to the personal checking account of the company’s CEO. Communications from the CEO available to DreamFunded and Fernandez at that time indicated that the relevant checking account had a negative account balance and was being charged overdraft fees.” No competent securities lawyer would have allowed that to happen but apparently consulting with an attorney who understood this business was not in Mr. Fernandez’ playbook.

The second of those offerings involved a health and wellness company, which claimed assets of less than $5,000 and prior-year (2016) revenue of $12,250. Elsewhere it also claimed assets of $2.3 million, which it attributed almost entirely to an online content library, though it provided no support or basis for this valuation.

Moreover, the company’s “business plan” projected 2017 revenue of $500,000 and 2018 revenue of $2 million but provided no basis or support for these projections.  According to FINRA, the company made unrealistic comparisons between itself and established companies and falsely implied that it was endorsed by a leading entertainment and lifestyle celebrity.

DreamFunded stated on its website that it followed the Angel Capital Association’s “strict due diligence guidelines,” the purpose of which was to “mitigate investment risk by gaining an understanding of a company and its market.” DreamFunded also claimed that the firm’s “due diligence and deal flow screening team screened each company that applied to be featured on the DreamFunded platform.”

DreamFunded and Fernandez did not follow the Angel Capital Association’s due diligence guidelines. Likewise, DreamFunded did not have a due diligence and deal flow screening team. Its claims of due diligence and deal flow screening were false and unwarranted and were designed to mislead investors into a false sense of security regarding the level of due diligence conducted with respect to the offerings featured on the DreamFunded portal.

There is a horrible lack of real due diligence in the crowdfunding industry but that is really not the problem here.  In plain English, the problem here, in my opinion, is Mr. Fernandez’ lack of honesty and integrity. The problem is that Mr. Fernandez apparently has a problem telling investors the truth.

Fernandez was a guest on a cable television network program that purported to match inventors with investors. On the program, Fernandez claimed to have invested $1 million for 30 percent ownership in a third company which subsequently conducted an offering through DreamFunded’s funding portal. Fernandez had not, in fact, made any investment in the company. His statement that he had made an investment was a lie and it seems that it was intended to help that company successfully complete its offering on the platform.

Despite the fact that he lied to investors, I am confident that Fernandez could have settled this complaint with FINRA and would have been permitted to continue to operate DreamFunded provided he cleaned up his act. There are larger FINRA member firms which have done far worse that FINRA has fined but whose memberships they have not revoked.  But Mr. Fernandez’ duplicity did not end with lying to investors, it looks like he lied to FINRA as well.

From the FINRA complaint:

“On January 5 and January 19, 2018, DreamFunded and Fernandez provided limited document productions in response to only a subset of the requests contained in the Rule 8210 request. For example, they did not produce financial records, bank account statements and investor agreements responsive to the request. Without such documents, FINRA staff was unable to fully investigate whether Fernandez and/or DreamFunded violated additional rules in connection with their fundraising efforts conducted ostensibly on behalf of DreamFunded. 

The January 19 production was accompanied by a doctor’s note representing that Fernandez was ill and unable to work between January 17 and January 20, 2018. In light of the doctor’s note, FINRA staff granted DreamFunded and Fernandez yet another extension of time, until January 29, 2018, to provide a complete response to the Rule 8210 request.

On January 25, 2018, new counsel informed FINRA staff that he too would no longer be representing DreamFunded or Fernandez. The following day, Fernandez sent FINRA staff a second doctor’s note, this one dated January 23, 2018, which stated that Fernandez would be unable to resume a normal workload until February 5, 2018. The note did not identify any illness that Fernandez was suffering from or otherwise specify the reason for his alleged inability to work. Moreover, during the time period when Fernandez claimed he was incapacitated, his social media posts indicate that he traveled out of town to enjoy, among other things, a film festival in Salt Lake City and a concert in Las Vegas.”

In truth, Mr. Fernandez did not want to maintain his membership in FINRA.  At the first whiff of the investigation he filed the paperwork to withdraw his membership and just walked away.

What he left behind were perhaps thousands of investors who were defrauded and a number of start-ups and small companies that may be sued by those investors.  These are investors who gave crowdfunding a try and who are unlikely to give it a try again. As I said, the crowdfunding industry has refused to condemn this fraud and in my opinion is shooting itself in the foot by ignoring it.

Operating a crowdfunding platform can be a very lucrative business. There is no shortage of small companies looking for funding. Several of the Reg. CF portals charge 7% of the money that a company raises and take a carried interest in the companies which can be very valuable if one actually takes off.  I can tell you from experience that a good portal should be able to raise $2-$3 million a month or more.  Paired with a Reg. D platform side by side, a good team could demonstrate that the JOBS Act can deliver everything it promised.

I have actually worked in the securities industry; this is my home turf.  If I had a backer, I would open a crowdfunding portal tomorrow because a well run portal can make a lot of money. (This is a serious request. I am actually looking for a backer who wants to make more than reasonable ROI. Send me an e-mail if you want to fund a crowdfunding portal run by a serious team of professionals.)

As for Mr. Fernandez, like a lot of people who failed at crowdfunding he has apparently moved on to greener pastures. He currently speaks at crypto currency conferences and undoubtedly holding himself out as a financial “professional”.

The crowdfunding industry is busy lobbying Congress asking it to change the rules to make it easier for more small investors to participate in this marketplace. Perish the thought that they should spend any time or effort cleaning their own house first. Lobbying for more investors without real compliance with the existing rules and protecting the investors they already have is really a waste of time.

Chasing the Unicorn

About a year ago I got a fairly unusual phone call.  The caller told me he had been an early employee of a company that had started up about 8 years earlier.  He loved the work and the camaraderie of the core group.  He was upset that the company had been sold for several hundred million dollars because the team had always told themselves that the company would become a unicorn; a start-up valued at over $1 billion.  He told me his share of the sale was “only” about $25 million and he wanted to start up a new company so that he could reach that unicorn status.

I have a very different value system than this gentleman. In my mind, if I get to the point where I have $25 million in one place, my first thought would be about walking into the local food bank with a large check.  Values and valuations are what make people chase unicorns.

Unicorns, in case you need to be told, are not real.  When someone says that a business has a “value” of $1 billion or more, it is not real either. It is an accounting trick that is used by Venture Capital (VC) firms to pat themselves on the back.

VC’s are the key to your valuation becoming a unicorn.  You will need multiple financing rounds at ever increasing valuations to get there.

The idea is that if you sell 20% of your company to a VC in Round A for $5 million, then your company’s Unicorn value is $25 million (5x $ 5 million). Of course, assuming it had no other assets, for accounting purposes its book value is closer to the $5 million that you just raised.

If you burn through that $5 million and then sell another 10% of the company for $20 million you have a book value of that $20 million and a Unicorn value of $200 million (10x $20 million). By the “C” round it is usual for the VCs to push the Unicorn value up into the hundreds of millions or higher even if all the company has is the cash it just raised.

What may surprise you is that VCs often have an understanding between themselves: you invest in the “C” round of a firm I am already invested in and I will invest in the “C “round of one of the companies that you have already invested in. That way, the valuation of the early rounds that each is holding will show a paper profit, making the VCs’ investors very happy.

There is another value that accountants assign to companies that may help to illustrate the problem; replacement value.  It is the cost of starting a competing company from scratch.

The best example might be Uber which has a Unicorn value of $65 billion. The company is essentially an app and a lot of independent drivers. I am confident that anyone could develop a competing app for less than $10 million. If they pay their drivers a little more per ride Uber’s drivers will jump ship.  If you start slowly and run the company lean, you could actually make a profit which is something Uber cannot seem to do.  But you will never be a Unicorn.

Remember that the Unicorn value has nothing to do with running your business profitably.  It is all about VCs and their perception of you. What they care about most is that you tell a great story that will make them look good.

If you are interested here are 12 steps to help you achieve Unicorn status:

1)  Never approach a VC directly. Always find someone who can introduce you to a VC.  The founder of another company that the VC has funded is best.  In a pinch the VC’s frat brother will do.

2) Learn to pitch the VC correctly. Never use words like bottom line or profitable. Focus on growth and market share.  Tell the VC why every human being on earth will buy what you are selling every day.

3) Never, ever wear a necktie to pitch to a VC.  It is a sign of disrespect. Always wear a wrinkled tee-shirt or a hoodie. It is fine if there is dog hair on it, but never cat hair. Your company’s logo on the shirt is best. If it is a tech company a picture of Alan Turing will work. Use a picture of Michael Palin if it is a consumer goods company.  In a pinch you can have your college logo on the tee shirt as long as it is Stamford, MIT or NYU.  If you went to a state university, default to Michael Palin.

4)  Never discuss competitors with a VC even if your main competitor is a Fortune 500 company. Remind the VC that you have no competition because you are light-years ahead of everyone else and that if you had competition you would crush it.  If the VC is really concerned about this; tell them that in the worst case, if some competitor comes out of the woodwork that you can’t crush, the VC can always give you enough money to buy it.  After funding, always respond that you are closer to market with your product which is demonstrably better than the competitors, even if your product is way behind schedule and will cost more and do less.

5) Once you are funded, focus on selling your product even if it is not ready for market or for that matter does not exist. Sign “strategic partnerships” with other start-ups or with existing companies in need of a shot in the arm from new tech.  Remember, promising a product roll-out or a delivery date is just a promise.  It is like telling your kids that you will start spending more time at home.

6) Good “PR” is everything. Start talking about your IPO very early on.  Appear at conferences on panels with other start-up superstars. Do a Ted Talk.Tweet a lot. Support popular causes like saving trees or creating a gluten free America with a big check and a big press release. Remember that it is the VC’s money that you are giving away, so be generous.

7) Create a corporate culture that fits your personality even if you are a schmuck. Do not be afraid to yell and scream or call employees at 3AM with questions you could ask the next morning or just to brainstorm on something you know is not important. Employees will not love or respect you, so fear is everything.

8) Treat the company insiders, the bros you need, to stock options with long vesting schedules, just in case they decide to jump ship.  Make them sign ironclad NDAs. Do not be afraid to stab them in the back. They would do the same to you in a heartbeat.

9) Treat everyone else at the company like they do not matter, which they don’t. Make them work long hours for minimal pay. Remember that a cappuccino machine in the employee lounge is cheaper than good healthcare insurance. Promise them bonuses when the company goes public. Always remind them that the company is a team effort and you could not do it without them. If they complain tell them that they do not share your vision for the company and should move on. If they will not move on, replace them. Nobody likes complainers.

10) Remember that rules and regulations do not apply to you. That includes rules about wages and hours, discrimination in hiring and conduct in the workplace. You do not need to apply for a permit if you want to modify your office space or any other type of permit to operate your business. Rules and permits are for legacy companies. Do not test your products for safety or your data storage for hackability. That is what insurance is for.

11)  If you get called before Congress to testify make sure that you look at them with disgust.  Tell them that they are old and do not understand new technology or your business model. You can admit that you made mistakes and promise to do better in the future. It does not matter.  By “do better in the future” they will understand that you will make a fat campaign contribution the next time they run for office.

12) Change your LinkedIn profile to “Visionary”.

And remember that unicorns are for children. If you are still chasing them it means that you have yet to grow up.

 

BrightCOIN- The Legally Compliant ICO?

I recently read an article citing a study that concluded that as many as 81% of initial coin offerings (ICOs) are scams. Several people contested that number but it cannot be too far off. If you have more than a cursory interest in crypto currency and ICOs it is hard to miss all of the discussion about ICO scams and what to do about them.

There is a general consensus among many in the ICO community that the ICOs need to stop kidding themselves that they are not securities and begin to seriously comply with US securities laws.  In crypto industry parlance, there is an expectation that ICOs have begun to evolve into STOs (securities token offerings).

A company issuing a securities token will need to register the offering with the SEC or seek an exemption from registration such as Regulation D.  Most STOs will be sold under Reg. D,in part because the SEC has yet to approve a registered offering and does not seem to be in any hurry to do so. US securities laws require that investors be given full disclosure of the facts that they need to make an intelligent decision whether or not to invest.

Around the same time, I came across a discussion on LinkedIn about an ICO for a company called BrightCOIN. The company is raising between $1 and $40 million to expand its tech platform which enables companies to launch their ICO in a “legally compliant” manner.

I read the white paper which is anything but legally complaint and I said so on LinkedIn. This got some brush back by the company’s CEO who commented, among other things that the company had a great lawyer who had helped prepare the white paper.  The CEO claims to be a Y Combinator alumnus with several successful start-ups under his belt. So, of course, he should have an excellent lawyer.

I offered to explain why I thought that lawyer needed to go back to law school and the CEO scheduled two appointments with me so the lawyer could tell me that he was right and I was wrong. They cancelled both appointments at the last minute.

The ICO for BrightCOIN is intended to be a Reg. D offering. I would have thought that since it was selling a service and a platform where other companies can make “legally compliant” offerings, BrightCOIN would have taken pains to make its own offering “legally complaint”. They missed by a mile.

The BrightCOIN offering document is in what is now being called a “white paper format”.  If you look at a lot of ICOs, a great many use this format. I do not know where it originated, but it does not generally make the disclosures that are required for a Reg. D offering in the format that the SEC expects. Using this format is an invitation to the SEC, state regulators and class action lawyers to come after you.

A Reg.D offering is also called a private placement and the offering document is called a private placement memorandum (PPM). There is a reason that most PPMs look alike. Back in the 1980s and 1990s regulators in several states required hands on review of every offering. I personally spent hours on the phone with the staff at these various state agencies going over specific language in Reg. D offerings. They usually wanted additional disclaimers; more risk disclosures; the words “this is a speculative investment” in the cover page in bold.

Congress eventually took away the states’ ability to comment on these offerings; but a lot of lawyers, including me, appreciate that much of what they wanted amounted to good practice. Disclosures are made for the benefit of the company that is raising the money. They are a prophylactic against legal action claiming fraud and misrepresentation.

BrightCOIN calls itself the Kickstarter for ICOs.  It is essentially a crowdfunding platform for ICOs including those private placements offered under Reg. D and registered offerings filed under Reg. A+.  BrightCOIN charges no upfront fees and will provide everything that a company needs to prepare and launch an ICO including “audited documentation”.

Of course Kickstarter does not handle any securities offerings. They operate in the world of “rewards based crowdfunding”, not securities crowdfunding, so the comparison to Kickstarter that BrightCOIN makes in its ICO white paper is meaningless.

Elsewhere BrightCOIN claims that it will become the “next Goldman Sachs” and compares itself to Goldman, Merrill Lynch and JP Morgan.  The white paper included the logos for those companies, all of which I suspect are trademarked.

Did Merrill Lynch give permission for its trademark to be used in this offering? Does Goldman Sachs even know that BrightCOIN exists?  Is there any way to read this hyperbole and not consider it to be misleading?

BrightCOIN claims that its tech platform is valuable because an entrepreneur considering launching their own Reg. A+ or Reg. D offering in the form of a token might spend as much as $500,000 to have the tech built.  By “tech” it appears to be speaking about the crowdfunding platform that they are offering.

The last time I saw a bid to build a crowdfunding platform from scratch (November 2017) the cost was $50,000 and that had some unique CRM capabilities built in. I made a few calls and to add a token capability to that would cost no more than another $50,000 and probably a lot less. Where BrightCOIN gets that $500,000 number is anyone’s guess.

In any event there is no reason to create the crowdfunding technology from scratch. If you want to open your own crowdfunding platform there are several companies that offer white label products for a small upfront fee and even smaller monthly charge. At least one that I know of comes with AML/KYC capability attached.

For any offering of securities to be “compliant” it must present information in such a way that it is balanced to point that it is not misleading. The BrightCOIN white paper is full of interesting and unsubstantiated hyperbole.

Around the world, it appears that 10% of the funds that have been invested in ICOs have been hacked. BrightCOIN claims its platform is “100% hack proof”.  I have spoken with large, mainstream financial institutions that spend a lot of money making their platforms “hack-resistant” but I do not know a single attorney who would put the phrase “100% hack proof” in a securities offering document.  The truth is no one knows if a platform is hack proof until it happens.

The white paper discusses how BrightCOIN can be used to “tokenize” assets like real estate making those assets more accessible to small investors who will be able to trade those tokens on a global basis. The white paper notes (in bold type) that there are over $200 trillion worth of assets that can be tokenized.  In the context it is presented, that statement is akin to me saying that there are 1 million single women in California implying that I will always have a date on Saturday night.

BrightCOIN claims their platform is fully functional and that they are already in business. Do they disclose how many offerings they have done and how much money those offerings have raised? They do not. They also claim that they offer consulting services to help a company prepare and market its ICO. Do they identify the people who perform these services? No.

BrightCOIN estimates that it may be able to list and sell 20 ICOs per month and might be able to take in $6.5 million per month in “success fees” if it does. The lawyer who they claim prepared this offering and who was supposed to call me and explain it to me should have told them that unless the platform is a licensed broker/dealer “success fees” are forbidden.  No where does the white paper suggest that BrightCOIN intends to become a licensed broker/dealer.

People always ask me how is it that I can spot these scams when other people cannot.  In most cases, like here, they do not pass the simple “smell test”. The founder, in my opinion, should simply stop this offering until it is actually compliant. If not people at Y Combinator should pull him aside and ask that he stop using their name.

In my opinion, the attorney, if he actually wrote this offering, which I doubt, should go back to chasing ambulances.  When you prepare an offering of securities, it is expected that people will call up and ask some questions as part of their due diligence investigation. Any attorney, who agrees to field those questions, cancels two phone calls and makes no attempt to reschedule them, should refund the client’s money.

The entire ICO market has been one con after another. Telling investors the truth is not that difficult but it seems to be the one thing that the ICOs just cannot seem to do.

 

Crowdfunding Successfully

Over the last 3 years’ equity crowdfunding has evolved into a fairly easy and inexpensive way to fund a business. More and more businesses, including start-ups, are attracting millions of dollars from investors without having to deal with Wall Street stockbrokers who charge hefty commissions or venture capitalists who want a hefty portion of their company.

I speak with companies every week that are considering crowdfunding as a way of finding investors.  The questions they asked a year ago centered on what crowdfunding is and how does it work. Today the questions are much more practical. They want to know how to get it done and how much it will cost.

One of the great mistakes that people make when they consider seeking outside investors is failing to consider the investment they are offering from an investor’s point of view. Investors expect that you are going to use their money to make more money.  Investors want a return on their investment and they expect some of the money that you make to find its way back into their pockets.

It is very important that you structure your offering to maximize the probability that investors will actually get the return you are promising. It is equally important that you clearly tell them what you are going to do to get there.

Structuring the offering correctly is a balancing act between an investment that will stand out from the pack and be attractive to investors and one that does not promise too much of the company’s profits that would stifle its growth or cause cash-flow difficulties. You can have a great little company with a great product and a huge upside but that does not mean you can attract investors if the offering itself and the return they will get is not attractive to them.

You can use crowdfunding to sell debt or equity in your company.  If you chose debt you get to set the terms and the interest rate. You get to decide whether the debt will be convertible to equity later on and if so when and on what terms. You can also sell common stock, preferred stock, convertible preferred or preferred stock that is callable. In many cases you can keep the financing off of your balance sheet by using a revenue sharing model or licensing your IP.

To structure an offering correctly you need to understand the company’s financial situation, cash flow and anticipated growth both of revenue and expenses.  You also need a good understanding of your competitors and how they approached their financing and the market if you are going to be competitive.

Serious investors look at your spread sheet first. They expect that you will be able to support the projections you are making with real facts and rational assumptions. If you are using investors’ funds to expand your business or introduce a new product into the market, you should have a good idea of what that market looks like, how you intend to reach it and what your competitors are doing.

Unless you have a finance professional on your staff or on your board of directors, you will need someone to help you structure and correctly set the terms of your offering. Very few of the crowdfunding platforms offer this type of advice, but that does not mean that you do not need it. The failure to understand finance is the root cause of the absurd valuations that are everywhere in crowdfunding and are a primary reason that serious investors will not look at your offering.

If you do not have a finance professional to help you, and the platform does not provide this type of advice, by default it is going to come down to the lawyer who is helping you prepare the offering paperwork. I have this discussion with clients almost every time I prepare an offering for crowdfunding.  If you are thinking about using a template to create the legal documents for your offering instead of a lawyer who can give you good advice you are likely to create an offering into which no one wants to invest.

Contrary to what any platform tells you very few platforms have a large audience of loyal investors ready willing and able to write you a check. I work with one platform that caters to institutional investors. Their investors are loyal because the platform is very picky about the companies that it will allow to list. Serious investors want this type of pre-vetting. Serious entrepreneurs want this type of investor.

Some of the worst advice you will get about raising money through crowdfunding is that you can use social media to build a community of potential investors or that crowdfunding for investors is a way to build your brand and solicit new customers at the same time. This actually makes no sense at all.

Customers and investors have divergent interests. Customers want you to sell them your product at the lowest price. They are consumers and think like consumers. Investors on the other hand want you to maximize your profits. They want you to sell your product for as much as the market will bear.

There are a significant number of people in the crowdfunding community who believe that the whole purpose of the JOBS Act is to allow small investors to invest in new companies. Both Regulation A+ and Regulation CF which were promulgated under the JOBS Act specifically allow for small investors.  Both are expensive and cumbersome. In my mind neither is worth the effort.

If you want to raise $1 million using Reg. A+ or Reg. CF you might expect an average investment of $250. That means you will need to reach 4000 investors. To obtain an investment from 4000 investors, your marketing campaign might need to reach 1,000,000 distinct prospects.

If you use Regulation D and make your offering to only accredited investors, you might set your minimum investment at $25,000. That way you need only 40 investors or less to raise the entire $1,000,000 and may need to reach out to only 10,000 prospects to do so.

I have worked with several of the marketing firms that specialize in equity crowdfunding. Some are more expensive than others. I always recommend spending your money on creating a good offering and a good presentation and not spending it on trying to reach 1,000,000 people or more

There are a lot of different crowdfunding platforms. Some specialize in funding real estate, some in solar projects and alternative energy projects. Sometimes a company can benefit by being on one of the larger, national platforms; often a local platform will work just as well.

There is technology available today that allows a company to set up its offering on its own website. You can set it up with what is essentially a drop box where the prospective investors can look at your offering and supporting documents. If an investor wants to invest, it will present the appropriate documents, accept his/her signature, verify the investor’s identity and qualifications and place the funds into an escrow account until the offering is completed.

You lose the advertising that a platform would do but you may gain from the fact that your offering is not competing with a dozen others all looking for investors. The fact that this technology is available has driven down the cost of listing on a platform.

Overall, if you want to raise between $1 and $5 million for your business using equity crowdfunding, legal and marketing costs and platform fees should run in the neighborhood of $50,000 more or less. Legal fees are usually the same but marketing costs increase with the number of investors you are trying to reach. Compared to the 10% fee that a stock brokerage firm would get, you can see why crowdfunding is becoming more and more popular.