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.

 

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.

 

Equity Crowdfunding 2018

I received year end 2017 reports from quite a few equity crowdfunding platforms and consultants. All were glowing with their accomplishments.  Several reported the number of offerings that had successfully raised money. None spoke of the offerings that paid the listing fees and failed to get funding.

Overall the equity crowdfunding industry continues to grow and become more popular with both issuers and investors.  Still, no one wants to look at the significant problems that still plague this industry.

There is absolutely no reason why any company that lists on a crowdfunding platform should not raise the money that it seeks.  There is no reason that investors should be offered the opportunity to invest in scams or in businesses that are unlikely to succeed.  The amount of effort that the crowdfunding industry expends to protect investors from scams and losses is virtually nil. The crowdfunding industry cannot expect to succeed if it does not get its act together and begin to address these issues.

Equity crowdfunding allows a company to sell its shares, bonds or notes directly to investors through a website rather than through a licensed stockbroker. That can save a company a lot of money. It also allows start-ups and companies that are too small for most stockbrokers to handle efficiently to raise capital.

A stockbrokerage firm provides two specific and necessary tasks to any stock offering. First it provides investment banking services to the company to assist properly structuring the offering so that it will be accepted by investors.  Second, the brokerage firm provides the sales and marketing efforts that attract the investors, close the sales, and raise the money.  Both tasks are necessary. Offering a new issue of securities without either being done well is like changing a tire without a jack.

The platforms are remarkably passive as regards the structure and sales of any offering. They are content to accept listing fees from any company that wants to list. They do not care if the offering is successful. They do not care if the company is a good investment or if the investors will make a profit.  These are the crowdfunding industry’s biggest mistakes. For the crowdfunding industry to succeed it must reduce the risks to its investors.

The largest beneficiary from equity crowdfunding has certainly been the real estate industry. There are established real estate syndicators in this market offering investors participation in single properties and in public and private REITs.  Several have set up their own proprietary platforms to showcase their own offerings; others use public platforms where their offerings compete with other properties.

Many of these syndicators have always used private placements as a source of equity funding. Crowdfunding has enabled real estate syndicators to save the 10% -15% that stockbrokerage firms charge to fund their projects.  This lower cost usually provides more cash flow for investors.

Most of the platforms are using Regulation D private placements because there is no reason for an income producing property to be “public.”  Real estate is easy for investors to understand. Investors trust real estate not just as an asset class, but as an investment.

Start-ups have a more difficult time raising funds on crowdfunding platforms.  And before you say that is to be expected, when you compare most start-up offerings with real estate offerings it should become obvious that most of the deficiencies with start-ups are correctable.

If you are investing in the equity of a commercial real estate offering there is usually a bank that has done an appraisal of the property and a physical inspection.  With start-ups the valuations are often off the charts. Rarely has anyone actually tested the product to see if it is viable or conducted a patent search to determine if the product infringes on someone else’s patent.

With a commercial real estate offering there is usually a seasoned property manager to handle the day to day business affairs.  With many start-ups the management is often less experienced than it should be.  Asking for investors to fund your business if you have never run a business, or do not have good managers or advisors in place becomes an up-hill fight.

Real estate offerings are most often structured to provide income to investors. Simply stating that the property will be sold after 7-10 years is all the exit strategy most investors need.  Many start-ups would have a much easier time raising funds if they structured the offering as preferred shares or provided income through revenue sharing or royalty payments.

When I advise a start-up seeking to raise capital I always offer my sense of what they should do prior to the offering to strengthen the company. I advise them how they should structure their offering to increase the chance of success.  This is the advice that the crowdfunding platforms should offer to every start-up that is paying for the privilege of listing, but do not.

My hope for 2018 is that the crowdfunding platforms get on board and do the same.  The platforms handling start-ups just need to become more proactive. There is no reason that every offering that lists on a crowdfunding platform should not be funded.

When the JOBS Act was passed there was a lot of discussion about small investors being able to invest. Millennials, especially, were arguing that they were being denied the opportunity to invest in the next Facebook.   So at the end of 2015, the SEC promulgated changes in Regulation A allowing a slimmed down registration process for smaller offerings of up to $50 million.  By any standards Reg. A has been an abject failure.

It takes a lot more money and a lot more time to prepare and complete a Reg. A offering than a Reg. D offering. I will advise any company seeking funding to use the latter instead of the former.  A company that spends an additional 6 months and $200,000 to reach small investors is usually telegraphing that the more sophisticated accredited investors do not want to invest.

Reg. A has been used to raise a fair amount of money, but the issuers themselves have not prospered. Several of the most hyped offerings, such as Elio Motors, have crashed and burned taking the investors with them. The share price of most of the other companies that used Reg. A to raise capital have not been able to maintain the original offering price. And this is in the middle of an historic bull market.

The Reg.A platforms and advisors do not support the price, after the shares have been issued,the way a stockbrokerage firm would.  Again, my hope for 2018 is that they get their act together and provide all the services that a company issuing shares to the public needs, both before and after the offering.

Perhaps the most disappointing aspect of the crowdfunding market has been the lack of attention to the Reg. CF portals. These handle the smallest offerings of up to $1,000,000 that cater start-ups in need of seed capital.  They represent the very essence of what crowdfunding should be about; small investors helping small companies.

Unfortunately, only about 35 Reg. CF portals are operating.  Those that are operating also take a passive role. They fail to assist the companies with the structuring of the offering. They fail to assist with marketing.  The simple fact is that if you are going to raise $1,000,000 by taking one or two hundred dollars from a lot of small investors, then you need to reach out to tens of thousands of investors before you find enough who are willing to invest.  That takes both marketing money and muscle.

It is pretty clear that most start-ups will fail within 24 months and these investors will lose their money. It is these small start-ups that need the most help and these small investors who need the most protection from loss.  But again, the crowdfunding industry has just not provided that help in any meaningful way.

I hope to make a contribution to the crowdfunding industry in 2018.  I am working with a group that wants to provide a measure of protection to small investors that are investing in these small offerings.  They are discussing starting a new Reg. CF portal where small companies can raise $500,000-$1,000,000.

They intend to offer a program to buy back any shares of any offering that lists on their Reg. CF portal if the company fails within 24 months.  You know that they can only do this if they offer only companies that they think will survive and succeed.

This type of vetting is missing in the crowdfunding industry and I am pleased to be part of the team that is putting this together. Besides me the team includes people with years of investment and commercial banking experience and a young, dynamic marketing team.  The goal is to select only the best companies to offer to investors, help those companies get the funding they need and help them succeed thereafter.

Right now, the group is seeking a very small number of investors to help fund the platform itself.  It is using a revenue sharing model so these investors can expect their investment returned quickly with significant return thereafter. If you have an interest in participating with an investment, contact me and I will put you in touch with the CEO.

 

Any Good Business Can Get Funded

I am always amazed when I get negative feedback to the premise that any good business can get funded. This is especially true when people tell me that businesses owned by women or minorities cannot get funded or that businesses locate outside of New York, Silicon Valley or some other money center have limited access to capital.

Frankly I think that a failure to get funding demonstrates ineptitude on the part of the entrepreneur. Inexperience is a greater impediment to attracting capital investment than gender, race or location.

When I was younger a business had two choices for funding, banks or Wall Street.  Wall Street would not take a company public until it was profitable. Companies often used an IPO to pay down debt and improve cash flow to pay dividends to the shareholders. If you wanted to get funded on Wall Street, it helped if you went to Princeton or Yale or your father did. It was very much a “who you know” network.

Banks provided the bulk of the capital that was available for small business. They still do. They do not care who you are as much as they want to know that you will pay them back.

When I graduated law school in the 1970s women could not get credit cards and minorities could not get even a loan application at any bank. So you cannot tell me that it is more difficult for women and minorities to get funded today.

The US Small Business Administration (SBA) has programs which will guarantee bank loans for about 20,000 small businesses every year.  I speak with entrepreneurs seeking capital all the time. I always ask if they have tried the SBA.  Most of the people I speak with never heard of the SBA or never considered it.  If you are looking for funding for your business, that is mistake number one.

Even if you do not qualify for a bank loan the cost of capital should be your primary concern. Shopping for a loan will give you an idea of how much money costs and how loan payments would impact your cash flow.  If, for example, you intend to borrow $1 million at 6% for 10 years, then the loan will cost you $600,000 and you will need to take $1.6 million out of cash flow to pay it back.

Many people think that venture capitalists will fund their business. That is simply not true. There are actually very few VC funds and they fund very few businesses every year. Some VCs specialize, i.e. they only fund biotech companies. That is great if you are a biotech company and know where to find those VCs with the expertise to evaluate your company. Randomly chasing after VC funds is a waste of time.

The serious money in venture capital is controlled by people who do a lot of analysis and extensive due diligence. Consequently, they like to invest in somewhat larger slices of $10 million or more. If they get 10% of your equity for that amount you are going to have to sell a lot of your product to bring the real value of your company up to the point where they will make a sizeable profit.  Consequently, not many companies will qualify.

The start-up world and especially Silicon Valley are full of stories about start-ups that become unicorns that exceed a $1 billion valuation but they are few and far between. If you are going to swing for the fences, fine. But for most companies this is not an option.

What makes the statement “any good business can get funded” true is the JOBS Act or what most people call equity crowdfunding.  It affords any company the opportunity to sell debt or equity securities directly to investors.

The JOBS Act opened the door for smaller companies to reach investors.  For most companies Reg. D is best because it is the least expensive and it has the largest developed market. Over $1.7 trillion is raised by businesses using Reg. D every year. If you want to raise money for your business, logic would tell you to go where the money is.

The best thing about equity crowdfunding is that the business owner controls the process. You hire an attorney to prepare the legal paperwork for you, prepare the marketing materials, list it on one of many crowdfunding websites and use your marketing program to attract investors.  You do not have to wait for the loan committee at a bank or for a broker/dealer to put you on their calendar. You can usually start raising money in 4-6 weeks from when you start the process.

Despite what you may have heard about crowdfunding campaigns that are not successful, it is really not that difficult if you hire people who know what they are doing.  Business owners call me about crowdfunding all the time. I always ask them the same four questions.

Questions 1 and 2. How much money do you want to raise and what do you intend to do with that money?  If your answer to the second question is that you intend to “disrupt” this industry or that industry, you better be able to demonstrate that you know a lot about that industry and especially about your competitors.

What investors really want to know is that you have a good business plan and that you are raising enough money to execute it.  It is always better to stick with what you know and hire people who know what you do not.  You should be able to show that you are not just building a better mousetrap but that you are building a good, profitable business.

Question 3. What is in it for the investor?  Investors are often disrespected in the crowdfunding universe. This is partially because the crowdfunding platforms compete for issuers and partly because many crowdfunding platforms are operated by people who do not understand what investors want.  In truth all investors want the same thing; they want to end up with more money than they originally invested.

People who are willing to invest in a start-up understand that most start-ups will fail.  It is important to distinguish yourself and convince investors that your company has a better chance to succeed because you have mitigated some of the risk.

Over the years, I have used a variety of financing tools including preferred shares and revenue sharing models to help start-ups manage their cash flow and still make the investment attractive to investors.  No two companies are the same. If you are thinking that you can just download a template for your offering without some real advice about how to structure it, you are not likely to be successful.

Question 4. What is your fundraising budget?  This is what really separates successful fundraising programs from unsuccessful ones.  You should always be prepared to spend a little more than you think you may need.

What is an adequate budget?  Enough to prepare the legal paperwork, marketing materials and to drive enough potential investors to your offering to get it funded. For a Reg. D offering, few companies spend as much a $50,000 unless they are raising $10 million or more.

One of the common mistakes people make is selecting the wrong crowdfunding platform.  Several advertise that they have had 10,000 investors or more but most crowdfunding investors are not loyal to a particular platform. Only a very few platforms are right for any particular offering. You need to make a decision about which platform to use based upon a number of factors including the size of your offering, the industry that you are in and how your offering is structured.

Under the JOBS Act you can make a Reg. D offering on your own website if you wish.  Given the fact that you will be paying for the marketing costs, it may make sense to be on your own platform where there will be no competition from other offerings.

I speak with about a dozen companies every month and I only take on one or two because I do not want to work full time. If I take you on I will walk you through the process and usually get you funded. That goes for companies owned by women and minorities and those located in Toledo or Tallahassee.

Using the JOBS Act any good business can get funded. If you are going to run a business, then you have to get things done and not make excuses. That goes for financing your business as well.

If you cannot fund your business with equity crowdfunding then it is on you not the market. It is actually a lot easier, faster and more certain than chasing venture capital.

The Start-up Funding Wars-Another Dispatch from the Front Lines

I speak with start-ups and business owners who are trying to raise capital for their businesses several times a week.  Some are my age or close to it; others are very much younger.  Most know their own business well, but few understand the ins and outs of raising capital which is why they call me in the first place.

If I take on the task of helping a start-up raise funds I can usually get them the funds they need.  That is not an idle boast. I will not even attempt to help a company solicit investors if I do not think that the company is a good investment.

That is unfortunately the case with the vast majority of the companies with which I speak.  I will review any pitch deck and offer comments and suggestions for free.  I will spend an hour of my time on the phone with any entrepreneur, no charge. Most simply do not measure up.

What I want to hear is that you have a business.  I want you to tell me that you have a product; that you know what it will cost to source your product and that you have actual customers who have bought or at least used the product and have reacted favorably to it.  If you are not yet at that stage, at the very least I want to know that you are close.

The difference between raising funds for a product that has been developed and raising funds to develop a product is huge. The number of investors who will take a chance on the latter is much smaller. It can still be done but it might take a little more time and money to reach them.

The two things that I do not want to hear is that your product will “disrupt” the market or that your company is destined to have a billion dollar plus valuation.  Neither is likely to come true.  I would rather hear that you have a good marketing and sales plan in place and have hired good, experienced people to execute it.

Please do not ask me to sign a non-disclosure agreement (NDA) before we speak.  In the first place, I am an attorney at law, so everything that you say to me is confidential if you want it to be.  In the second place, if your product or process is so novel, valuable and proprietary then get it patented.

Please do not send me a pitch deck that has no resemblance to a business plan. If your pitch is all flash and no substance it is not going to work. Investors want to see what you are going to do with their money and how and when your company will become profitable.

Please do not tell me that you have read all the books about funding a start-up and have attended several conferences featuring the best start-up “gurus”.  If you had read all the books that actually count, you would probably have an MBA in Finance.

Sometimes I can help a small company up its game by suggesting that it add some additional directors, patent its product, refine its business plan or change the terms or structure of its offering.  But more often than not, I find myself turning away business.

What I really want to hear most in that first phone call with any entrepreneur is that he/she can close the sale. If you are going to deal with investors, you are going to have to do more than tell them about the great company that you are building. You are going to have to ask them for a check. To get it, you need to tell investors how they are likely to profit from the investment in your company and why you can make it happen.

I am not a philanthropist. I charge for my services albeit less than I used to charge when I was paying rent for an office in a financial district high rise.  I will not work for stock in your business and you cannot pay me later after we raise money for you.

It takes money to raise money.  If you raised seed capital from friends and family to develop your product and did not raise enough to take you to the next level of fundraising at the same time, let me say this judiciously, you blew it.

I generally tell people to budget between $35-$50,000 if you need to raise between $5-$15,000,000.  So far none of my clients have gone over budget and most have spent less, but running out of money would be aggravating to all concerned.

A lot of people ask me to introduce them to VCs. I know a few VCs on both coasts and a few in between.  Most are serious investors meaning that they want to invest in companies that will succeed and produce a good return on their investment.  This is true of all investors, not just VCs.

For most start-ups seeking venture capital is a waste of time.  VCs actually fund very few businesses every year and each has its own funding requirements. The process is time consuming (even companies that get funded can be at it a year or more) and often political (like a lot of things in life it is often who you know that is important).

For most start-ups and small companies, equity crowdfunding would be the preferred way to raise funds.  It can be quick (90-120 days) and inexpensive ($35-$50,000).  I work with several equity crowdfunding platforms and several different marketing companies.  If you start with the idea that you are just going to slap an offering together as inexpensively as possible, put it up on a crowdfunding platform that has dozens of competing offerings and send out an e-mail or two to prospective investors, you are more likely than not going to fail.

I know a lot of people in the crowdfunding industry and I think that I know the best of the best.  I can usually direct a client to an appropriate crowdfunding platform and a marketing firm that will get the job done. I use different firms for different offerings of companies in different industries and at different stages of their corporate development.

Funding is always a team effort. That is why I like to pick the team.  I try to use the best people for each job.  Some charge more than others but like everything else in life, you get what you pay for.

To save time here are three types of offerings that I do not do.

1) Anything to do with cannabis. It is not that I am a wimp on the subject of marijuana. I was in college in the 1960s.  It is just that I can read the handwriting on the wall. Cannabis is illegal in all 50 states, no matter what the state legislature may have enacted.  The current US Attorney General, Jeff Sessions, seems to be getting ready to start enforcing federal law and closing down the retail stores and medical dispensaries.  He recently loosened the rules on asset forfeiture, meaning that nice warehouse where some company is growing cannabis might be seized and sold without a trial.  If I was an investor who helped to fund the purchase of that building I would sue the principals for using my money to participate in an illegal enterprise.

2) Any Reg. A+ offering. Reg. A+ requires the registration of shares with the SEC so that they can be sold to smaller investors. There is more than enough money in the Reg. D private placement market to fund your business. A Reg. A+ offering will likely cost you $150,000 or more to raise the same amount of money. That does not scream “look how smart I am” to any investor.

3) Any ICO. Recently I have been asked by more than one company to do an Initial Coin Offering (ICO).  These are offerings denominated in crypto-currencies. Several have raised significant amounts of money.  The SEC has declared that depending on how these offerings are structured they may be securities. Most of the lawyers with whom I spoke would err on the side of caution if they were asked to prepare an ICO. I got quotes in the range of $150,000- $250,000 just for legal fees. Again why spend that much more than you need to spend to fund your business.  And if you need a gimmick like an ICO to fund raise funds, what does that say about your business?

By refusing to fund businesses selling cannabis, any Reg. A+ or any ICO, I am leaving a lot of money on the table because these offerings, especially the latter two, pay well.  I have the expertise but I also have a reputation. I will not advise a client to use Reg. A+ or an ICO when a Reg. D offering will work just as well and cost them much less.

Good businesses get funded. While 90% of start-ups fail,  the key is to convince investors that you are among the 10% that will not.  If you are unsure, you are welcome to try to convince me first.

 

ShiftPixy – A Reg. A+ Question Mark?

 I frequently get into discussions with proponents of Regulation A+ who believe small investors should be encouraged to invest in start-ups.  The proponents argue that small investors are being deprived of the opportunity to invest in new companies that may turn into the next Facebook.  Why, these proponents ask, should these “opportunities” only be available to Wall Street fat cats and the wealthiest 1% of the population?

The proponents of Reg. A+ shine the spotlight on those companies that have made successful offerings. That is a function of the sales and marketing effort. They fail to discuss the fact that just because an offering is successful does not mean that the company itself is a good investment.

Proponents of Reg. A+ and especially those who suggest that start-ups are suitable investments for small investors have convinced themselves that these small investors have the skills necessary to evaluate investments.  They constantly tell me that small investors can judge a company and separate the good investments from the not-so-good ones.

In the mainstream markets the task of judging the potential for success of a private company that is about to go public is left to very highly paid investment bankers and research analysts.  It takes a great many hours of hard work and in the end these highly paid professionals do not always get it right.

Simply put, evaluating a new company as an investment is a lot like sizing up a doughnut.  You are attracted to the sweet frosting which is the reward, but you really need to focus on the hole. The hole is what is left out. No company can succeed if key components are absent.

Whenever you evaluate a start-up as an investment the essential question is always the same; given the information presented, can the management make it happen?  Can they execute their business plan with the talent on their team and the money that they are going to raise?

This brings us to a company called ShiftPixy, Inc. which is currently making a Reg. A+ offering of 2 million shares that will be priced at between $6 and $8 per share.  Although the company is only 2 years old, it shows sales of $65 million in the last six months and may have gross sales of $125 million in 2017. There is even a research report from Zacks which suggests that the shares could be worth $12.60 in 2018. Not bad for a start-up. There is a lot of tasty frosting on this doughnut.

According to the registration statement the company is “a leading provider of employment law compliance solutions for businesses and workers in an environment in which shift or other part-time/temporary positions, commonly called ‘gigs’ are performed.”

Essentially, the company provides shift workers, currently in the restaurant and hospitality industries.  Customers move their workers over to be employed by ShiftPixy which then acts as a staffing agency for the customer. By pooling the employees of many smaller companies, ShiftPixy can administrate the human resource management function with economies of scale.

“In return for providing insurance, payroll processing, benefits, and compliance services these enterprises pay ShiftPixy a fee based on their payroll that is much less than the cost of doing these functions in house.”

The registration statement says: “A significant problem for employers in the Gig Economy involves compliance with regulations imposed by federal, state and local governments, including requirements associated with worker’s compensation insurance, and other traditional employment compliance issues, including the employer mandate provisions of the Affordable Care Act.”

I agree that this is a significant problem and any company that can solve a significant problem is worthy of attention.  Government regulations and the attendant paperwork can be expensive and strict compliance is a requirement at every level. A company that can provide employees to other companies while retaining the burden of benefits and paperwork would seem to have a good chance of success.

But can they?  The move to the “gig” economy is being fueled by the employer’s desire to reduce the cost of employees.  According the financial reports in the registration statement, ShiftPixy had deployed fewer than 1800 employees to other companies through the end of February 2017.  How much of an extra fee per employee do they charge?  How much of an extra fee will employers be willing to pay?

The financial reports in the registration statement are not audited. This is not a requirement for a Tier 1 Reg. A+ offering and it is one of my pet peeves.  I have seen too many questionable financial statements over the years.  Proponents of selling Reg. A+ shares to smaller investors necessarily assume that those investors are adept at reading and analyzing a financial statement even as accounting and MBA students struggle to learn how to do it properly.

How does ShiftPixy’s gross margin of compare with competing firms?  Do the smaller investors in this offering know enough to ask that question? Do they know how to find the answer?

For this offering, let’s stick with the more simplistic: can the management make it happen?

In this case the company has two founders; Scott Absher and J. Stephen Holmes. Mr. Absher is the current CEO. The only other executive officer is a newly appointed CFO.  There is a single outside director from another industry.  Since February 2010 Mr. Absher has also been President of Struxurety, a business insurance advisory company.  Neither Mr. Absher, the CFO, outside director or anyone else at the company seems to have any connection to the staffing industry.

There are several well known staffing companies from whom an executive or two might have been acquired. That does not seem to be a priority and it is the primary reason why I have trouble answering the question “can management make it happen?” in the affirmative.

The other founder, Mr. Holmes is not an officer or employee of the company. He is an independent contractor focusing upon building a sales network and providing consulting in relation to worker’s compensation programs as well as Affordable Care Act health insurance programs that the company will offer.  The registration statement notes that he is not involved in any part of the accounting or taxpaying and IRS return filing areas of ShiftPixy’s operations.

I suspect the reason for that disclosure is Mr. Holmes was convicted “for acts related to making false statements in relation to two quarterly IRS Form 941 Employer Federal Quarterly tax returns, one in 1996 and the second 1997, for a company for which he was an officer at the time.” That disclosure is in the registration statement. It does not disclose that Mr. Holmes was sentenced to 15 months of incarceration and apparently served at least part of it.

In order to find out the actual disposition of the case, I had to do some additional research. If you are evaluating any investment, you always need to look at facts outside of the offering paperwork in order to give what you are reading proper context.  That is what is meant by looking at the hole in the doughnut.

I am not here to sling mud. I, for one, think everyone who serves their time is entitled to a second chance. Mr. Holmes, because he owns over 12 million shares of the company will remain a “control person” of the company. He is going to be building up the sales force, not dealing with the paperwork involving taxes or employees. Being able to do that paperwork is this company’s critical task.

That brings us back to Mr. Absher, the CEO, who apparently has also had some issues with government required paperwork.  The registration statement discloses that: “On June 25, 2013, the Alabama Securities Commission issued a Cease and Desist Order (the “Order”) against Scott W. Absher and other named persons and entities, requiring that they cease and desist from further offers or sales of any security in the State of Alabama. The Order asserts, regarding Mr. Absher, that he was the president of a Company that issued unregistered securities to certain Alabama residents, that he was the owner of a company that was seeking investments, and that in March 2011 he spoke to an Alabama resident who was an investor in one of the named entities. The Order concludes that Mr. Absher and others caused the offer or sale of unregistered securities through unregistered agents.

Per the registration statement: “While Mr. Absher disputes many of the factual statements and specifically that he was an owner or officer of any of the entities involved in the sale of the unregistered securities to Alabama residents or that he authorized any person to solicit investments for his company, in the interest of allowing the matter to become resolved, he did not provide a response.”

If Mr. Absher was not an owner or officer of the company in question, he likely could have contested it by filing an affidavit with the State of Alabama.  In my experience, intentionally taking a default, usually indicates that the allegations are true and not worth the effort of fighting. By allowing this order to be entered these facts are deemed to be true.  Saying that he disputes them now has no legal effect and, to me, raises a “red flag”.

There is no prohibition against selling unregistered securities in Alabama (or anywhere else) as long as you file a form with the state, pay the filing fee and make the proper disclosures.  Given that the state of Alabama says that some of that did not happen, it seems difficult for me to imagine that Mr. Absher is well suited for the difficult world of employment law compliance.

I claim no expertise in employment law. I do know that it can be complex and that some aspects of it vary location to location. San Francisco, for example, prohibits employment discrimination and harassment based on the employee’s height and weight. That cannot be the law everywhere.

I would have expected to find an experienced employment lawyer, or more than one on the payroll of this company.  They do not disclose that they have one, nor do they seem intent on hiring one after the offering although “employment law compliance solutions” is what they sell.

Much of the current focus of ShiftPixy is in the restaurant and hospitality industry. Reporting and collecting taxes on tips paid to employees in those industries is another burden.  The IRS requires that an employer must ensure that the total tip income reported by employees during any pay period is, at a minimum, equal to 8% of the total receipts for that period.

ShiftPixy has responsibility to file the paperwork because they are the employer but they have no access to the cash register to see if the information they are reporting is correct or in line with that requirement.  The financial reports also note that there has already been a $280,000 reversal of a charge for workman’s compensation expenses that were “misclassified”. So to me this company has not demonstrated that it can solve the problem that it claims to solve.

ShiftPixy is a staffing/HR company that seems to lack any employees with significant expertise in this often complex field. I would have expected to have seen several people with this expertise in senior management and there is no mention of the need or intent to hire any at the culmination of the offering.

The company sells employment law compliance without employment lawyers and accounting services where everyone important to the company has prior problems with government paperwork.  There are other staffing companies and there is nothing here that screams “we are better.”

Any start-up that is going to compete in an established industry needs to distinguish itself.  To me, this company distinguishes itself by the size of the hole in the doughnut. I think that it specifically lacks the people who can get the job done.

It would seem to have been in Mr. Asher and Mr. Holmes’ best interest to fill this company with knowledgeable employees.  Each of the two founders owns in excess of 12 million shares. If the offering is completed at $7 per share it will increase their net worth by $90 million each. If the share price goes to over $12 in a year as Zacks suggests, by over $150 million each.  With that much on the table I find it surprising that the company seems to be so careless about hiring people with appropriate skills.

Finally, I noted that the attorney who prepared the registration statement was given rights to buy 200,000 founder’s shares at par value $.0001. No other legal fees were charged.

There is nothing illegal about this. Some securities lawyers accept stock in lieu of cash; personally I do not.  I think that it creates the appearance of a conflict of interest.

In a money center like New York or San Francisco, a lawyer preparing a Reg. A+ offering might charge $150,000.  If this lawyer’s gamble pays off and the share value does top $12 per share, he might walk off with more than $2.5 million.  He will be on his yacht while I am still writing blog articles.

Of course if the disclosures later prove to be somehow deficient and a regulator comes in and investigates, an allegation that the lawyer cut corners to get the offering sold may be hard to avoid.

In my opinion what this company lacks is the internal talent to perform the complex tasks that it is selling. It is talent that its more established competitors certainly have and without which I do not think this company can succeed.

The talent at this company is so thin and the payday so concentrated, there is certainly enough here for me to have considered that this offering may be nothing more or less than two people with checkered pasts trying to put one over on unsuspecting investors.  I am more skeptical than most people, but skepticism is what people who evaluate start-ups are supposed to have.

 

 

Crowdfunding Myths and Realities

I speak with people about crowdfunding every week. I learn a lot from others. But there is a lot of bad information about crowdfunding in the marketplace. Most of it comes from the mouths or keyboards of people who claim to be crowdfunding experts but lack a clear perspective of what equity crowdfunding is and how it should operate.  To make up for their deficiencies, these experts often pontificate about crowdfunding and disparage the capital market of which crowdfunding is a tiny, though useful backwater.

I have heard or read every one of the following statements about crowdfunding uttered by people who claim to be crowdfunding “experts.”  I have included my explanation of empirical reality after each one.  If you attend a crowdfunding conference and hear any one of these statements, ask for your money back.

1) “Wall Street is evil”

Reality:  I have probably seen more bad actors in the mainstream financial markets than most people.  I worked on close to 2000 arbitration claims brought by unhappy and defrauded investors against mainstream financial firms.  I wrote a book about the many things that Wall Street does wrong, so yes there are indeed bad actors in the mainstream financial markets.

But those markets also fund local governments, schools, roads and hospitals. The mainstream markets funded Apple and Microsoft, companies that developed life saving drugs, allowed a lot of people to buy homes and financed almost all of the innovative technologies that we take for granted.  Trillions of dollars worth of transactions take place every week in the mainstream capital markets. The overwhelming majority of those transactions settle without complaint or any reason for concern.

2) “Wall Street freezes out new businesses that deserve to get funding”

Reality: The key word here is “deserve.” Entrepreneurship has always been a core American value. A lot of entrepreneurs are passionate about their businesses.  But passion only gets you so far.  A lot of entrepreneurs fail because they do not have a good business plan, a good team or a good sense of what their market really wants.

Billions of dollars flow to new businesses every year.  There is actually more money available for small business in the US today than ever before and it is a lot easier to reach. The Small Business Administration (SBA) continues to make loans and groups like AngelList have made venture capital available where it was previously very hard to find.

3) “Crowdfunding democratizes the marketplace; it lets the little guy invest in great companies that were only available to wealthy investors”.

Reality: Most of the companies on crowdfunding websites have been or would be passed over by VCs and professional Angel investors. That money is cheaper to obtain and often comes with management and other assistance.  For many companies crowdfunding for capital is a last resort, not a first choice.  There are some good companies on crowdfunding websites, but the bulk would never be considered to be “great” by any standard and all come with a very high likelihood that investors will lose their money.

4) “People are being kept out of start-up investing and cannot profit from investing in the next Facebook”

Reality:  Show me the company listed on any crowdfunding platform that has the potential of becoming the next Facebook.  Facebook did not crowdfund for money and no crowdfunded company has approximated Facebook’s success.  It may happen or it may never happen.  Facebook, and Apple and others, all had IPOs which were open to all investors.  If there is a Facebook lurking on a crowdfunding website, it is currently hidden among a lot of offerings that I believe are absolute crap.

5) “Millions of people would invest in crowdfunding if they understood it and they eventually will”

Reality:  This argument is usually used to convince people that the crowdfunding market will explode when people get the hang of it.  More than one crowdfunding “expert” has suggested that these regulations would open the crowdfunding market to as many as 220 million people in the US.  This, of course, ignores the fact that roughly 50% of US households live at or below the poverty line or are living paycheck to paycheck.

Yes, there is still a lot of disposable income in the US. The lines at Disneyland always seem to be long and the hotels in Las Vegas are perpetually full.  Both Disneyland and Las Vegas are selling instant gratification. Equity crowdfunding sites are not. The most successful crowdfunding sites are offering real estate to accredited investors seeking steady, passive income.  That is likely to continue.

6) “The crowd can discern good companies from bad ones”

Reality:  This is simply not true. Investors in the mainstream markets often depend on research analysts to parse through the financial and other information that companies present.  I have worked with investors for 40 years.  Most could not pass  the second mid-term exam that I used to give my freshman economics class. Most of the crowdfunding “experts” could not pass it either.

Even if the crowd spots a bad offering, there is no mechanism built in that would allow them to say so.  No portal has a place has a “comments” section next to any offering, nor would they be expected to have one.

7) “Due diligence is not necessary”

Reality:  I saw this statement in the very first article I ever read about crowdfunding. It was written by an attorney who claimed to be a crowdfunding “expert” and who wrote article after article on the subject although his resume indicated that he had never actually represented an issuer of securities or a broker/dealer.

Due diligence is how the platform or portal prevents the issuer from committing securities fraud.  There are good people who provide due diligence for the crowdfunding industry but there are many platforms and portals who do not even try to verify the claims that the issuers are making to investors. Due diligence protects the investors and it protects the platform or portal.

8) “There is very little fraud in crowdfunding”

Reality:  There have been only a handful of regulatory enforcement actions in the crowdfunding arena but more are clearly on the way.  Regulators use these actions to send a message about expected and aberrant behavior that the crowdfunding industry continues to ignore.

Some of the biggest lies that you will find on crowdfunding platforms concern the valuation and prospects of the business being funded.  I have seen start-ups with no sales and less than $1 million in development expenses value themselves at $20 million or more based upon sales projections of hundreds of thousands of units of a product that does not yet exist.  FINRA has already raised this issue, but the crowdfunding “experts” do not seem to want to address it.

Within the last few weeks, I saw one offering where an executive conveniently left out that he had twice been sanctioned for stock fraud, as if that fact would not be of concern to potential investors.  I recently reviewed a Reg. A offering that was structured like a classic pump and dump scheme and will probably turn into one.

It is not that there is not fraud or the potential for fraud in this market. The crowdfunding “experts” do not know it when they see it.

9) “Government rules make crowdfunding difficult”

Reality: The government rules make crowdfunding possible.  Several real estate funds have raised $25-$50 million and more using basic crowdfunding techniques and there are crowdfunding websites dedicated to films and entertainment that do not seem to be at a loss for investors. The problem is not the rules. The problem is that a lot of the “experts” do not know how to work with them. Those who do have no problem raising money in this market, but true experts are few and far between and compliance with the rules is sporadic at best.

10) “Investors understand that they will probably lose their money so none of this is important”

Reality:  Every new issue of securities, especially those being offered under Regulation D, will include the disclosure “These securities are a speculative investment.  Investors should be aware that they may lose all of the funds that they are investing.”  This is especially true given that most start-ups will fail.

But it is not a sustainable business model for the crowdfunding industry to blithely accept the fact that all investors will lose money. Several crowdfunding sites (most notably MicroVentures and WealthForge) spend a considerable effort vetting companies and are trying to list only the best companies on their sites.  If I were raising money through crowdfunding, those are the sites on which I would want to list my offering.  If I was considering investing in a crowdfunded offering, that is where I would want to spend my money.

Compare that with the statement recently made by an SEC Commissioner to the effect that there appears to be a “race to the bottom” in terms of listing crappy deals on many crowdfunding sites.  This market will become efficient when every company that lists its offering on a site gets the funding it seeks. It will only happen when the patently bad companies are weeded out. That will only happen when the patently bad platforms and portals are weeded out, either by competition or government action.

11) “Equity crowdfunding is disruptive”

Reality:  Crowdfunding may ultimately change the way in which some firms are financed but not in the way that a lot of people seem to think. The Wall Street firms are already positioning themselves to get into this market because it obviates the need to pay commissions to sales people.  Commissions have been on the way out since the 1970s, a trend that has been spurred on by the internet. Crowdfunding is just one more step on the ladder to lower and lower commissions.

It is much more likely that the Wall Street firms will take over the crowdfunding market than the crowdfunding market will supplant the Wall Street firms.  It is, in fact, already happening. I would not be surprised if Goldman Sachs, (some people’s idea of a financial Satan, see # 1, above) is already positioning itself to enter this market.

12) “Equity crowdfunding is new. The problems are just growing pains”

Reality:  Equity crowdfunding is the business of selling securities. There is nothing new about it.  Selling securities over the internet without using a traditional underwriter has been around for almost 20 years. The JOBS Act opened the door for people who are untrained and not knowledgeable about securities to sell them. These people are having growing pains, not crowdfunding. Many untrained people are making money for themselves at the expense of the issuers and investors.

All it takes to enter the crowdfunding market is to set up a platform which is relatively inexpensive and begin to solicit companies to list on it. Owning a platform or portal can be a lucrative business.  As this industry grows there should be a huge opportunity for skilled finance professionals and securities lawyers.

If you are a considering selling shares in your company by crowdfunding look for a platform that has people with experience in finance or the mainstream capital markets.  If the platform’s advertisements include any of the dozen statements highlighted above, pass them by.

 

The Cold Hard Truth About Funding Start-ups

Contrary to what a lot of people seem to believe, it is not that difficult to fund a start-up. Funding a start-up is a process.  It requires a plan and time, effort and money to execute the plan.  The process varies depending upon where you intend to procure the funds. That decision is most often determined by what sources of funding are or are not available .

More often than not the availability of funds depends upon the attributes of the company being funded.  Who you are, how far along your company is and the realistic chances for success are usually the determining factors.

If you believe the blather that successful start-ups must disrupt an existing market or must solve a problem that the market may not know it has, you are making it harder for yourself, not easier. Lenders want the loan principal returned with interest and investors want their capital returned and a return on their investment. You need to adopt that mindset if you want to attract funds.

A great many small businesses receive funds from the Small Business Administration (SBA) which has been making loans to start-ups and small businesses for decades. Like most lenders the SBA wants collateral for the loan and will review your business plan to satisfy itself that you will have the cash flow to make the payments.

The SBA will assist in the process and provides mentoring for businesses before they apply. There are also private SBA loan brokers in every major city in the US. Not every small business qualifies, but many of the SBA loan brokers will provide guidance and assistance if the company is close to the qualifying line.

Venture capital funds (VC) or angel investor groups seem to be the choice for most start-ups. VC’s can provide management and other assistance in addition to funding. The bulk of venture capital money goes into second round financing and many of the funds specialize in tech or bio-tech companies only.

Most venture funds are willing to take a calculated risk on young companies. That calculation includes their ability to recoup their funds with some type of post financing liquidity transaction, like a merger or IPO.  Consequently, a great many companies do not qualify.  In truth, VC’s only fund a very limited number of smaller start-up companies every year.

There are far more companies that are chasing venture capital than there are venture capitalists. Consequently, the VCs usually get to fund the best companies they see.

The world is full of stories of companies that pitched dozens of VCs before they got funded and even more companies who repeatedly pitched VCs and never got funded. There are a great many books and consultants who will tell you how to make your pitch better but the truth may be that your company is just not as attractive as the others competing for the same funds.

I would hope that it would be obvious that it is easier to find funding for a company with a well thought out and well prepared business plan than a for a company whose business plan looks like it was written on a napkin by a couple of drunken frat boys.

Investors will certainly want to know if your product works, whether or not it can be sourced, whether or not people will purchase it and at what price.  You can show them with spreadsheets and marketing studies or you can start selling your product and generate some revenue.  An operating company should always be easier to finance than a company that needs funding to begin operations.

This flies in the face of the idea that all an entrepreneur need do is develop a minimum viable prototype (MVP) and then shop it around to venture capitalists. I have known a lot of VC’s over the years and almost all would tell me that they fund businesses not prototypes.

Investors also legitimately want to know exactly what you intend to do with the funds that they give to you. They also want you to use their money efficiently.

Several years back I met with a young code writer who was working at one of the larger Silicon Valley companies. He and a few of his co-workers had an idea for an APP. They wanted my help to raise $1 million so that they could quit their jobs and spend a year working on it full time.  Once the APP was developed and tested they would have had no money left for marketing and no one with any marketing experience to help them.

I suggested to him that it might easier to raise the money if their plan was to have the code for the APP written in India for a lot less and use the difference to package and promote the finished product. That way he and his cohorts could keep their day jobs and they would have a sufficient monies to hire a real marketing pro to help sell the product once it was developed.

I might as well have suggested that they enlist in the Army. They wanted the entrepreneurial experience paid for by someone else.  A good VC will see through that attitude and as far as I know that particular group never got the funds they were seeking.

Crowdfunding`is the financing tool that is the foundation for my belief that funding any start-up is not that difficult. If you follow this blog you certainly know that I continue to be concerned about the absolute disregard for investors in this market. But executed correctly, a good crowdfunding campaign should obtain the funds it seeks almost every time.

I recently had a beer with a long time friend is a lot more cynical than I am.  His thought was that since you could fool some of the people some of the time, I should just embrace that fact and come around to the thinking that any start-up could get funded if it spent enough money advertising its offering in the right way.

My friend was thinking that a good advertising company could put lipstick on any “pig” of an offering and sell it to investors on a crowdfunding website because most investors in this market really had no idea what they were doing.  While I personally decline to assist bad companies looking for capital, many in the crowdfunding market will simply list any company that shows up on their website.

I have a little experience in advertising and a lot of respect for people who do it well.  Selling securities usually takes a different approach than selling a product but my friend was thinking in more generic terms.  The point here is that selling securities is often referred to as a “numbers” game.

Advertising is about “eyeballs”.  If you want to sell shares in your company to 500 people, then a lot more than 500 people need to see your advertisements for the offering.

When someone comes to me with the desire to crowdfund an offering, I always recommend that a good marketing company is essential.  Several marketing companies that work in the crowdfunding market are careful to follow the rules. Many more are not.

Whether you are selling a loan package to the SBA or equity to a VC, angel or crowdfunding audience the operable word is sell.  Selling is not free. The old saying that it takes money to make money is true here as well. It takes money to raise money.

If you want to fund a new business you should be prepared to spend money for a professionally prepared presentation. I know a company that sent e-mails and their presentation to a list of one thousand VCs and Angels six times before one responded. They then flew cross country, made a presentation and got nothing.

With crowdfunding, I again recommend that you hire someone to prepare a professional presentation, a good lawyer to help you prepare the paperwork and budget enough money to drive potential investors to your offering. If you want to raise funds for your business, it will cost you money to do so.

I speak with a lot of people who essentially bootstrap their business until they are ready to bring it to market and then seek funding. Many are stymied because they are essentially broke at this point and do not have the resources to pay for lawyers, business plans, videos and a marketing campaign.

A lot of people wring their hands and feel sorry for this group. I,however, am not among them.  I believe that any company good enough to seek funding from strangers, should be able to borrow enough from family, friends, neighbors and college roommates to pay for a campaign to raise more funds.  If your Uncle Fred who has known you since childhood is not willing to invest in you, why should you think that my Uncle Fred or anyone else’s would?