What’s next for the ICO? Reflections on Securities Law and the Future of Initial Coin Offerings

 

To date, fundraising has been blockchain’s killer app.

In 2017, Initial Coin Offering (ICO) fundraising eclipsed that of traditional venture capital, and in 2018, ICOs have already raised nearly $3 billion in non-dilutive funding. This new form of early-stage financing is incredibly promising, at least in theory. For one, it can be more than “dumb money,” as tokens can enable platform participation and allow post-ICO startups to bootstrap network effects. Even better, ICOs promise decentralization; from a technological perspective, there are no formal barriers to ICO fundraising.

From a practical perspective, however, Initial Coin Offerings are far more complicated; the barriers to legal fundraising via ICO are quite high. The U.S. Securities and Exchange Commission (SEC) has been outspoken in their opinion that ICOs have been drastically “under-regulated” – which is a nice way to say that many founders and investors may have unwittingly broken securities law.

Such opinions began to surface in mid-2017 after The DAO – then the largest crowdfunding campaign in history – was hacked and initially lost around 4% of all existing Ether to theft by a rogue actor. In the wake of that attack, the SEC declared that “DAO Tokens are securities under the Securities Act of 1933 (‘Securities Act’) and the Securities Exchange Act of 1934 (‘Exchange Act’).” And, even more recently, SEC Chairman Jay Clayton doubled down by stating directly, “every ICO I’ve seen is a security.”

The immediate reaction to such comments by the broader cryptocurrency community was intense, immediate, and almost exclusively alarmist. Pundits declared the ICO “dead” and the “death knell” sounded; sober, alternative opinions in the intervening weeks have been hard to come by.

In the remainder of this piece, we will assess the likely impact of the SEC’s statements and attempt to answer three questions: How should we feel? How should we respond? And, ultimately, what does the future hold for Initial Coin Offerings?

[clickToTweet tweet=”What does the future hold for Initial Coin Offerings? #ICOs” quote=”What does the future hold for Initial Coin Offerings? #ICOs”]

How should we feel?

The road ahead for ICOs is certainly more complicated than many community members may have initially expected.

First, this judgment may signal the death of the cypherpunk dream of radically open, borderless, and authority-free fundraising in the US. If token sales are indeed securities offerings, an imposing set of  potential compliance activities may be necessary, including Know Your Customer and Anti-Money Laundering (KYC/AML) laws, which mandate collection of personal information from prospective buyers, accredited investor checks, and more. Compliance with these laws can be difficult for the unacquainted, so it’s reasonable to fear that ICO regulation may stifle innovation from blockchain entrepreneurs by raising barriers to entry.

[clickToTweet tweet=”it’s reasonable to fear that #ICO regulation may stifle innovation from #blockchain entrepreneurs by raising barriers to entry” quote=”it’s reasonable to fear that #ICO regulation may stifle innovation from #blockchain entrepreneurs by raising barriers to entry”]

Similarly, these SEC judgments pose significant challenges for founders who have completed ICOs: in cases of an illegally sold security (i.e. not registered with the SEC or not relying on an appropriate exemption), investors have rescission rights (to receive their money back); issuers may be precluded from using certain exemptions to raise capital in the future; plaintiffs may attract class action attorneys to bring potentially firm-ending lawsuits; and, last but certainly not least, government sanctions, fines, and jail time for issuers are not off of the table.

Despite this ex-ante and ex-post negativity, however, history may prove these SEC judgments to be a blessing in disguise – or at least a less catastrophic development than they are popularly understood.

We expect that the SEC’s declarations may:

Remove Uncertainty

For better or worse, the community is no longer in limbo: the SEC has provided a clearer position, which allows founders to act with conviction. With the knowledge that token offerings are nearly always securities, entrepreneurs can structure their fundraising efforts accordingly.

Clear Out Bad Actors

Many prominent figures within the blockchain community — including Brad Garlinghouse and Joseph Lubin — have argued that many ICOs to date have been fraudulent, an unfortunate feature of the current ICO landscape. This round of enforcement and investigation should curb that kind of behavior. In the long run, this culling of the community may strengthen the perceived legitimacy of blockchain and cryptocurrencies and help it shed its unfortunate associations with the sin economy and fraud.

[clickToTweet tweet=”this culling of the community may strengthen the perceived legitimacy of #blockchain and #cryptocurrencies and help it shed its unfortunate associations with the sin economy and fraud #ICO” quote=”this culling of the community may strengthen the perceived legitimacy of #blockchain and #cryptocurrencies and help it shed its unfortunate associations with the sin economy and fraud #ICO”]

Incentivize Education

These provocative headlines and the attention they attract may prompt the general public to better understand the blockchain ecosystem and the regulatory regime in which it operates. This rising tide of consumer attention may raise all ships, for if token issuers truly want to build network effects via ICO, they will benefit from educated, meaningful investment far more than speculative investment by “greater fools.”

Spark Legitimate Industry

Once bad actors are eliminated, remaining industry participants will have been tried by fire and validated by survival. New entrants, then, may be able to rely on such stalwarts, building on their successes to recreate the energy seen in this first wave of decentralized fundraising.

How should we respond?

Realizing such a solution will require a deliberate focus on compliance, the seemingly inevitable conclusion of the SEC’s statements to date is just this: innovative as it may be, the ICO structure didn’t supersede nearly 100 years of legal precedent. While blockchain technology is certainly novel, the way that innovators finance blockchain projects need not be. We identify three complementary strategies that prospective token founders should consider: shape the definition of “utility tokens,” hold compliant Initial Coin Offerings, and develop technology solutions to help others do the same.

[clickToTweet tweet=”Innovative as it may be, the #ICO structure didn’t supersede nearly 100 years of legal precedent” quote=”Innovative as it may be, the #ICO structure didn’t supersede nearly 100 years of legal precedent”]

(1) Shape the Definition of “Utility Tokens”

An important, but as yet undefined, distinction may exist between normal securities tokens and utility tokens. In theory, the latter would fail to meet at least one of the criteria of the Howey Test and would thereby not be subject to securities law.

The name “utility token” comes from the belief that tokens with utility – i.e., concrete use, like the ability to bid in a decentralized prediction market – do not qualify as securities under the Howey Test. The SEC clarified that the Howie test has gradations to each factor in determining if a token is a security, however, when it stated in a cease-and-desist letter to ICO-issuer Munchee (MUN):

“Even if MUN tokens had a practical use at the time of the offering, it would not preclude the token from being a security. Determining whether a transaction involves a security does not turn on labelling – such as characterizing an ICO as involving a ‘utility token’ – but instead requires an assessment of ‘the economic realities underlying a transaction.’”

Clearly, further definition is needed. Technologists, founders, investors, and, yes, even government officials should work to have their voices heard as these standards take shape. One such influencer, Albert Wegner of Union Square Ventures, publicly advocated for an ICO “Safe Harbor”:

A Safe Harbor for initial token sales and issuance could impose requirements on investors that are along the lines of Rule 144 governing Restricted Securities, such as imposing holding periods and information requirements prior to sales. Token distributions via faucets or crowd sales with small dollar amounts per buyer should be exempted from this requirement.

Such statements of advocacy are laudable, and we expect others to follow Wegner’s lead and fight for greater regulatory clarity.

(2) Hold Compliant Initial Coin Offerings

The safest strategy in the near term is to treat all ICOs as securities offerings. Token issuers, then, have two possible courses of action: register the ICO with the SEC and conduct an initial public offering, or find an exemption.

In the remainder of this section, we will define five such exemptions: Regulation D Rule 506(c), Regulation S,  Regulation CF, Regulation A+, and Rule 147.

Regulation D

Most token sales to date have used Rule 506(c) of Regulation D, which covers the general solicitation of securities. This option is a popular choice because it allows for general solicitation and has no cap on the amount of money that can be raised. In addition, this rule preempts state securities laws; state-by-state registration and pre-launch disclosure filings are not necessary.

The drawback to this option is that tokens or token-based securities can only be sold to accredited investors, and issuers must verify this status by receiving certain personal information from those investors – which may significantly limit participation in the sale. (Accredited investors make up just 7% of the US population.) Tokens or token-based securities sold pursuant to this exemption also generally have a one-year holding period before they can be freely traded.

Regulation S

Regulation S concerns securities offerings that take place outside of the United States, and can apply as long as the issuers conducting an offshore transaction make no “direct selling efforts” in the United States. Regulation S offerings are categorized by the likelihood that securities will flow back into the United States, and face variable restrictions on holding periods, information requirements, and the like depending on that categorization. A Regulation S deal can be run simultaneously with a Regulation D deal in order to solicit both US and foreign investors where investor qualifications differ from those in the US (assuming compliance with local laws).

Regulation CF

Regulation CF, in contrast to Regulation D, allows anyone (including non accredited investors) to invest but limits the fundraise to just over $1 million in a 12-month period. Each investor is also limited to a certain investment amount, usually around $2,000. (Considering the size of many ICOs and ICO investments to date, these limitations may seem particularly onerous.)  This transaction can, however, be combined with a Regulation D transaction mentioned above to increase the amount raised and allow for non-accredited investor participation.

Regulation CF brings its own regulatory obligations, like the need to use a registered crowdfunding platform and to file certain documentation with the SEC prior to launching the deal and on an ongoing basis. This exemption also preempts most state securities laws and requires a mandatory one-year holding period prior to trading.

Regulation A+

Regulation A+ allows token developers to raise up to $50 million from unaccredited investors, increases the possible investment amount to roughly 10% of an investor’s income or net worth, and allows tokens and token-based securities to be freely tradeable once issued.

This regulation necessitates an arduous SEC qualification process, however, that requires communication with the SEC in advance of the token offering. Regulation A+ also mandates the provision of audited financial statements and continued reporting once the offering has concluded. The security types that can be issued in these offerings are limited, and state securities laws are again preempted.

Rule 147

Rule 147 allows for intrastate offerings so long as such sales comply with that state’s securities regulations. In order to qualify for this exemption, the issuer must have some “nexus” (business operations, employees, customers, assets, etc.)  within the applicable state and can only raise funds from residents within that state. Investors do not need to be accredited investors, and after a six-month holding period the securities are freely tradeable (prior to the holding period they can be resold within the state).

(3) Technology Solutions for ICO Compliance

Where there is pain, there is opportunity, and it strikes us that a technology solution to manage and comply with ICO regulations is a necessity.

Compliance with securities law – and its many, varied exemptions – is far from simple, but the SEC seems to have little sympathy for would-be issuers. SEC Chairman Jay Clayton said recently that “Many ICOs are being conducted illegally. Their promoters and other participants are not following our security laws. Some people say that’s because the law isn’t clear. I do not buy that for a moment.”

Clayton also reportedly isolated the importance of compliance with the “spirit of the law” and “the professional obligations of the U.S. securities bar.” These broad concerns, when paired with the immense scale at which some of these ICOs operate, compound potential compliance issues.

This is a real, present problem for individuals trying to raise collectively billions of dollars. To us, that feels like a prime opportunity for technology innovation.

What’s the future of the ICO?

Looking forward, we appear to be entering a new era of distributed fundraising. The cypherpunk dream of radically decentralized fundraising may be lost, but there is still reason for tentative optimism: regulatory uncertainty is largely gone, fraud is likely to decrease, and the crypto community may be bolstered by additional education and public awareness.

In the end, well-intentioned founders still have a path to raise vast sums of money and develop the next generation of blockchain technology. Despite the challenges of compliance, the outlook for ICOs is bright. We hope that this rational, measured optimism can nudge the community towards fighting for regulatory clarity, and cashing in on the legitimacy that increased consumer protections may  bring to the blockchain ecosystem.

[clickToTweet tweet=”well-intentioned founders still have a path to raise vast sums of money and develop the next generation of #blockchain technology. Despite the challenges of compliance, the outlook for #ICOs is bright” quote=”well-intentioned founders still have a path to raise vast sums of money and develop the next generation of #blockchain technology. Despite the challenges of compliance, the outlook for #ICOs is bright”]


 

Andy Bromberg is the CEO of CoinList, a platform for token sales which emerged as an independent company from AngelList and Protocol Labs’ collaboration. Bromberg is the co-founder and former CEO of Sidewire. He attended Stanford University studying Mathematics and Computer Science. Bromberg co-founded the Stanford Bitcoin Group while studying there.

 

 

 

Georgia P. Quinn is a Senior Contributor for Crowdfund Insider. Quinn is a prominent securities attorney and is current General Counsel for CoinList. She is also the co-founder of iDisclose, an adaptive web-based application that enables entrepreneurs to prepare customized institutional grade private placement documents.

 

Regan Bozman is Business Operations Lead at CoinList. He previously worked at AngelList where he led the growth for AngelList’s last fund. He is a graduate of Harvard University.

 

 

 

 

 


References
https://www.cnbc.com/2017/08/09/initial-coin-offerings-surpass-early-stage-venture-capital-funding.html
https://bitcoinmagazine.com/articles/the-dao-raises-more-than-million-in-world-s-largest-crowdfunding-to-date-1463422191/
https://www.sec.gov/litigation/investreport/34-81207.pdf
https://www.wsj.com/articles/sec-chief-fires-warning-shot-against-coin-offerings-1510247148
https://hackernoon.com/the-ico-is-dead-long-live-the-ico-2-0-7bb269987513
https://www.lexology.com/library/detail.aspx?g=b4151969-5b94-41c5-b996-0fc3ac42bb66
https://www.cnbc.com/2017/11/17/many-icos-are-fraud-according-to-ethereum-co-founder-and-ripple-ceo.html; https://www.wsj.com/articles/sec-launches-cryptocurrency-probe-1519856266?mod=searchresults&page=1&pos=2
SEC v. Howey Co., 328 U.S. 293 (1946)
https://www.sec.gov/litigation/admin/2017/33-10445.pdf
http://continuations.com/post/171125433630/cryptoblockchain-safe-harbor
https://www.theverge.com/2018/3/1/17066828/sec-cryptocurrency-companies-icos-initial-coin-offerings-regulation
http://fortune.com/2018/01/23/sec-ico-cryptocurrency/

France is Upping its Game When it Comes to Fintech and Entrepreneurship

This past week, I had the chance to attend a Fintech focused event put on by the Consulate of France in Manhattan and, honestly, I came away very impressed.

For too many years, France did not have much of a reputation in the startup world. This has been changing slowly over the past few years. But the election last year of relatively young President Emmanuel Macron, put a new focus on innovation and fostering a robust startup ecosystem. Fintech innovation, a hot sector globally, has received much welcomed special attention.

Vive Le France et Entrepreneuriat

Speaking at Viva Technology in 2017, Macron clarified is ambitious vision;

“The choice has been made. French people have expressed their will: France will be the country of entrepreneurship and innovation.  I want France to be a start-up nation. A nation that thinks and moves like a start-up. I want it to be a country of unicorns, too.”

This objective has been repeatedly and vocally reaffirmed. One of the most recent indications of French entrepreneurial determination came from the French Minister of the Economy Bruno Le Maire. Last week, he shared with the world that France wants to become the leading initial coin offering (ICO) jurisdiction, becoming the first major financial center to accomplish this goal. Having staked this claim, France continues to execute on the innovation nation vision of President Macron.

Dirigisme Non-Plus?

Anne-Claire Legendre, Consul General of France in New York, welcomed the French Fintech Symposium participants in Manhattan. She emphasized the importance of change and embracing the disruption that is taking place today in financial services.

Mme. Legendre was followed by Nathalie Beaudemoulin, head of the Innovation Hub of the ACPR (part of the Banque of France). Mme. Beaudemoulin told the audience, “France wants to be a gateway for financial technology.”

The landscape in France is changing. The French government, along with private sector participants, are engaged in very ambitious reforms. This is a country that is veering from the past “Économie dirigiste”. More business and investment friendly.


We Crossed the Ocean to Express the Desire to Welcome Financial Technology

These sweeping Macronist reforms are aimed at attracting foreign investment. Making the business environment more conducive for early stage companies to set up shop and stay. From now on forward, France wants to be known as a startup nation. They also want to be known as a center of VC activity

One of the most impacted sectors of finance is banking – an industry of great importance in France with its many global banks. ACPR recently conducted a survey of the shifting landscape and they found that the digital revolution is generating a structural shock sweeping through the entire sector driving various levels of new development.

The current (recently commenced) strategies of French financial institutions are outlined by the following four levers:

  • Shifting corporate culture towards innovation
  • [Rapidly] Modernizing information systems
  • Overhauling the entire consumer experience
  • Leveraging intrinsic data (with approval)

While these changes create opportunities there is also intrinsic risk. Becoming a digital first operation means cybersecurity and data protection are at the top of the list. Compliance must be updated as well to accommodate the emerging Fintech ecosystem.

Five potential scenarios for the future of banking were shared;

  1. A better bank provided by established players
  2. An Open Bank that provides financial services with an open architecture (API) that enables 3rd party participation
  3. A “Re-intermediated” Bank where the establishment declines and new intermediaries emerge to fill the void
  4. Entirely new banks with the legacy banks no longer existing
  5. A peer to peer banking system that is decentralized (IE Blockchain) and completely reconstituted

So where does this all go? Everyone understands that change takes time but a willingness to adapt is necessary to maintain relevance and cater to the needs of the next generation.

France has invested approximately $390 million into Fintech firms in the last year. While not huge compared to some other countries it is still substantial. They expect this number to grow going forward.

To help fuel sector growth, the French government is creating a €10 billion Fintech startup fund, invested over the next three to five years.. That should help push the Gallic nation forward when it comes to the global Fintech revolution.


 

Georgia P. Quinn is a Senior Contributor for Crowdfund Insider. Quinn is a prominent securities attorney and is current General Counsel for CoinList, a platform that provides financial infrastructure for the next generation of technology companies including digital assets. She is also the co-founder of iDisclose, an adaptive web-based application that enables entrepreneurs to prepare customized institutional grade private placement documents for a fraction of the time and cost. iDisclose users may file Form C’s and Form C-AR automatically with the SEC. Quinn previously served as of counsel at a leading law firm in crowdfunding, Ellenoff, Grossman & Schole, specializing in facilitating financial transactions and compliance with JOBS Act regulations. 

Sober Enthusiasm for Blockchain While ICOs Create a Crypto Bubble

 

Sober enthusiasm is the way I would describe a recent LAT Blockchain Economic Forum I attended in New York City. Most speakers at the event noted that we are in a crypto bubble referencing the gold rush mentality embracing the Initial Coin Offering (ICO) market.

Miko Matsumura of Pantera Capital and the ICO Governance Foundation even joked that right now the main thing you can buy with crypto is more crypto. Also, many are of the opinion that most ICO’s have little to do with the Blockchain and more to do with a novel and unregulated way to raise money.

The enthusiasm comes from the Blockchain technology, though again referred to as a “shitty database” by Matsumura, the potential is unquestionable. The ability to have a decentralized immutable public ledger when dealing with our most precious assets in a world where trust is scarce in theory seems invaluable.

Before we get started with the program content, let’s take a step back and make sure we are clear on the terms flying around, because there is a lot of jargon.

First up: Blockchain.

Blockchain is also called distributed ledger technology (DLT) and is a way to transparently track the ownership or other attributes of an asset using cryptography. (I am using “asset” in a general way and not as defined under tax law.)

Blockchain can be applied to anything and can simply be thought of as a giant database. The most notorious use of Blockchain is cryptocurrency and most prominently Bitcoin. In this case the asset is a coin or a token which serves as a proxy for some underlying value similar to the way a US dollar represents the ability to purchase a certain amount of goods and services.

These currencies are traded on online exchanges. Tokenization is when an entity (usually a company) creates a proxy called a token or coin which then represents some (usually future) value or utility related to the company. Often these tokens are exchangeable for cryptocurrency. An ICO is when a company issues these tokens or instruments exchangeable for such tokens to the public in exchange for traditional currency or cryptocurrency. To date, companies have raised over $3 billion globally using this ICO strategy.

Jalek Jobanputra of Future/Perfect Ventures described tokens and tokenization are just one use of the blockchain. She went on to describe one of her firm’s investments, a company that applies the Blockchain to diamonds as they are mined from the earth in order to prevent fraud and theft.  She also noted that transactions taking place in third world countries that don’t have the legacy infrastructure of retail banks, escrow, ATMs, etc., can really benefit from Blockchain based financial services. Jobanputra feels a strong parallel between now and the late 1990s as everyone seems to be starting a blockchain/crypto related company. Remember back in the 90s when everyone and their dog (or sock puppet) was forming an internet company.

One sentiment that is circulating is that it is somewhat of a shame that the first major use of Blockchain was in the context of a currency, which is highly regulated and calls into question a whole host of laws and regulations. I think this is, of course, no coincidence. Areas of inefficiency call for such solutions and areas of extreme regulation are almost by definition inefficient.

Alex Mashinsky of Governing Dynamics and Celsius Foundation was extremely optimistic, likening Blockchain technology and pending human advancement to the Cambrian explosion when most major animal phyla appeared on earth. He also felt that Russia is supporting cryptocurrency because it is destabilizing to the US government. One of his points I agreed with is that Blockchain takes a lot of the roadblocks and toll collectors out of transactions.

Eran Eyal, serial entrepreneur and founder of ShopIN broke down the ICO market saying that a small portion of the companies are actually using Blockchain to innovate new or disrupt current systems and 90% of companies are just using it as a novelty to raise money.

Matsumura chimed in with the Elon Musk quote that;

 “it is better to be optimistic than not.”

He also stressed the importance of developing disclosure rules around Blockchain, cryptocurrency and ICOs. He is currently working on a system that he claims will create a disclosure document the quality of an S-1 (which is the current disclosure requirement for a company conducting an IPO with the SEC) in one hour without the assistance of legal counsel or any outside advisors. I question the reality of this, but am looking forward to what he comes up with.

Reese Jones, associate founder at Singularity University analogized the internet which is a global network without real global regulation to the way he envisioned Blockchain eventually operating. Just like with the internet, individual countries can, and will, regulate in attempt to protect or control their citizens.

For the most part, the speakers agree that ICOs are out of control and need to be (and will be) regulated.

According to Carol Van Cleef, a partner at Baker Hostetler, the SEC has counted over 5,300 ICOs to date, the vast majority of which have been the unregistered or non-exempt sales of securities.

Amy Wan, founder of Bootstrap Legal and a Crowdfund Insider Senior Contributor, reminded the participants she led in a roundtable discussion of the multiple assumptions that ICO issuers are making and the need to question them, including the current practice of domiciling in foreign jurisdictions and accessing foreign investors.

[clickToTweet tweet=”the SEC has counted over 5,300 #ICOs to date” quote=”the SEC has counted over 5,300 #ICOs to date”]

To be clear, no one expects transactions to be unwound, but there is now a line in the sand based on the current guidance.

In addition, much will be settled by the plantiff’s bar and class action lawsuits, which interestingly, on aside note, may or may not be subject to the PSLRA, depending on whether the tokens are being deemed securities or not.

However, once the dust settles, there is still a valid use case and market for ICOs under an organized regime. There is a hope that the industry will be able to unite and have a voice in such regulation and also that the regulation will contemplate the global nature of this technology and marketplace.

Van Cleef mentioned that in the US the National Conference of Commissioners on Uniform State Laws, the group responsible for bringing us the Uniform Commercial Code, is actually working on a model code for virtual currency, so if the state regulators are actually being proactive, perhaps there is hope.

The SEC, CFTC and FinCen have recently provided a modicum of guidance. For the most part, we can expect regulation through enforcement actions such as Ripple and BTCE, which is not perfect, but is less ham handed than a blanket cease and desist.


 

Georgia P. Quinn is a Senior Contributor for Crowdfund Insider. She is also the CEO and co-founder of iDisclose, an adaptive web-based application that enables entrepreneurs to prepare customized institutional grade private placement documents for a fraction of the time and cost. iDisclose users may file Form C’s and Form C-AR automatically with the SEC. Georgia also serves as of counsel at a leading law firm in crowdfunding, Ellenoff, Grossman & Schole, specializing in facilitating financial transactions and compliance with JOBS Act regulations. 

US Investment Crowdfunding Regulations Explained (Document)

Some time ago, I created a grid comparison that addressed the differences between the various iterations of investment crowdfunding. In the US, there are effectively three different securities exemptions, created by the JOBS Act of 2012, that allow issuing business to raise capital online by selling securities. These include Title II or Regulation D 506c, Title III – Regulation CF, and Title IV – Regulation A+.

The original version comparison grid, widely duplicated, was created prior to all of the regulations were finally implemented. Additionally, it did not include ongoing reporting requirements – an important aspect that both issuers and platforms must comply with to maintain good standing with the Feds.

Recently, a friend of mine requested information regarding the US crowdfunding securities exemptions. I thought it was worthwhile to dust off the old grid and update it to better reflect the final rules.

Since the first exemption became actionable in 2013 (Title II), a nascent industry has emerged with hundreds of million of dollars being raised for early to mid stage companies along with real estate investment opportunities. While the industry is still young and evolving – and Congress may update certain aspects of these rules, this grid is designed to be a good touchstone overview of what is necessary to remain compliant.

This is intended to be a quick reference and doesn’t go into the nitty gritty details, but it should provide a general understanding of the major differences between the regs and an indication as to which one or combination of provisions might be appropriate for a given issuer.

Additional information may be viewed here.


[scribd id=357856678 key=key-kTsW1Ploi8zxVzExLFXj mode=scroll]

Georgia P. Quinn is a Senior Contributor for Crowdfund Insider. She is also the CEO and co-founder of iDisclose, an adaptive web-based application that enables entrepreneurs to prepare customized institutional grade private placement documents for a fraction of the time and cost. iDisclose users may file Form C’s and Form C-AR automatically with the SEC. Georgia also serves as of counsel at a leading law firm in crowdfunding, Ellenoff, Grossman & Schole, specializing in facilitating financial transactions and compliance with JOBS Act regulations. 

Congressman Patrick McHenry Asks SEC Chair Jay Clayton to Act & Fix Crowdfunding Rules

Once again, crowdfunding’s white knight rides into action. Congressman Patrick McHenry sent a letter to the newly sworn in Chairman of the U.S. Securities and Exchange Commission Jay Clayton outlining certain provisions of the regulations relating to Title III of the JOBS Act that need to be amended in order for investment crowdfunding to reach its full potential. For those of you unfamiliar with Congressman McHenry, he was a champion of the JOBS Act, which was passed in April of 2012 and in particular Title III which legalized retail investment crowdfunding. The SEC promulgated regulations to effect Title III called Regulation CF (Reg CF). With perfect timing, Congressman McHenry’s letter is dated May 15, 2017, almost exactly one year to the date of the enactment of Regulation CF and sets forth certain problems that the current rules have created in practice.

The letter discusses 13 provisions, which require amendment to improve the efficient operation of the nascent crowdfunding industry. Importantly, Congressman McHenry and his staff derived these issues from discussions with actual industry practitioners, meaning platforms, issuers, attorneys and other service providers who are doing deals and raising (or at least attempting to raise) capital, and not from academics or economic theorists. This list was developed from “in the trenches” experience and out of a belief that this path to small business finance is crucial to the U.S. economy as a whole.

The thirteen policy changes are summarized below:

Testing the Waters

This provision would allow companies to advertise their potential offerings prior to officially launching their deals and filing their Forms C. This could save companies a significant amount of money if their testing for “indications of interest” informs that a potential raise would not be successful. Allowing companies to test their ideas and the viability of a financing before incurring the legal, accounting and other fees upfront is crucial not only to assisting startup companies raising capital, but also to screening out deals that are not ready for the investing public.

Special Purpose Vehicles (SPVs)

This fix allows for the use of an entity to collect all of the investors in a crowdfunding offering. Rather than invest directly into the operating company, investors invest into a limited liability company (LLC) or other entity that then invests into the operating company. This makes the entire crowdfunded investment one line on the capitalization table and makes it much easier for a small business to administer its investors.

Section 12(g) Reporting Requirements

Currently, once certain revenue or asset tests are met, crowdfunded companies could have to provide full Securities Act of 1934 reports, such as 10-Ks, 10-Qs and 8-Ks. This type of reporting is completely out of scale to a small business conducting a crowdfunding. This fix would ensure that the reporting requirements would not apply to crowdfunded companies.

Offering Limit

This request to raise the limit highlights the benefits to both companies seeking funds and investors by brining a higher caliber of issuer to the table. Many state crowdfunding laws have already raised the limit to $2-$5 million annually.

Accredited Investors Limit

This fix would eliminate the investment caps on accredited investors who arguably do not need the protections limiting the amount of money they can invest.

Accounting Disclosure Requirements

Currently the accounting disclosure requirements require financial statements to be in GAAP format and in most cases at least “reviewed” by an independent accountant, depending on the amount of money being raised. Most small businesses do not use GAAP accounting, so changing their books to GAAP compliance adds expense as well as having the statement then reviewed by an additional accountant, who must necessarily be independent. All of this additional expense leads to very little pertinent information for a potential investor, who could glean necessary information from tax returns or cash accounting statements.

Advertising Guidelines

The advertising guidelines limit the type of information that can be presented about an offering. This fix would allow for companies to more freely communicate about the company and the offering to then direct a potential interested investor to the funding portal or other intermediary where full information can be found. This would also allow companies to interact with third party media outlets that are producing stories or other content about the industry.

Multiple Posting (Fee Splitting) For Portals

This would allow multiple funding portals or other intermediaries to list offerings and share in the transaction fees. The thought is to allow companies to utilize multiple channels to raise funds as long as they are coordinated and provide the same information. This also serves to protect investors by having multiple intermediaries review the particular offering.

Multiple Closings

While this is already arguably allowed to a certain extent under current regulations, this would clarify that companies can close their offerings in stages as money is received from investors once the target amount has been received.

Reconfirmation Time for Material Change

This would extend the amount of time an issuer has to receive reconfirmations after initiating a material change to its offering. The current requirement of five days is often not enough time to get a response from an investor and leads to unnecessary attrition.

Credit Card Payments

This is currently allowed but confirmation is requested to ensure that funding portals, who are trying to modernize the transaction process for all parties.

Warrants as Compensation

Allowing funding portals to receive warrants as compensation in addition to the underlying securities being offered in a transaction is essential. While this is already arguably contemplated in the regulations, receiving warrants is much more efficient for the funding portal as there are no initial tax consequences.  IN contrast the payment in the underlying securities is a taxable event even though such securities may ultimately be worthless.

Secondary Market

This request is really for an extension of the current regulations to go the next step and provide a secondary market for crowdfunded securities. This would provide liquidity, which is a form of investor protection in itself, and provides legitimacy and transparency to the industry.

This list does not fix all of the problems with crowdfunding, but it does represent a practical approach to remedy several hurdles that have arisen under these new regulations. Many of which were unintended consequences and fortunately like all beta versions can now be thoughtfully debugged.

The letter is embedded below.


[pdf-embedder url=”https://staging-crowdfundinsider.kinsta.cloud/wp-content/uploads/2017/05/349098170-Rep-McHenry-Letter-to-Chair-Clayton-May-15-2017.pdf”]


 

Georgia P. Quinn is a Senior Contributor for Crowdfund Insider. She is also the CEO and co-founder of iDisclose, an adaptive web-based application that enables entrepreneurs to prepare customized institutional grade private placement documents for a fraction of the time and cost. iDisclose users may file Form C’s and Form C-AR automatically with the SEC. Georgia also serves as of counsel at a leading law firm in crowdfunding, Ellenoff, Grossman & Schole, specializing in facilitating financial transactions and compliance with JOBS Act regulations. 


Attention! Crowdfunding (Reg CF) Filing Deadline: Don’t Get Caught Unaware

Many entrepreneurs that successfully raised money using the newly enacted Regulation CF (or Reg CF for short) have likely tried to put the tiresome process behind them and are focusing on company operations and executing on their business plans. However, all successful issuers need to be aware of the Form C-AR filing deadline, which is fast approaching.

In addition, companies with currently outstanding offerings may need to file updated financial statements on a Form C/A as well. Many companies do not know about these requirements tucked away in the 600+ page rule release, but the failure to comply would not only be a violation of federal securities law but could prevent the company from being able to raise money in the future.

Pursuant to Rule 203(b) of Regulation Crowdfunding, companies that have conducted successful crowdfunding offerings are required to file a Form C-AR or “annual report” providing certain updated information since the time of their offering. These reports are due within 120 days from the end of the issuer’s fiscal year. Most issuers have a December 31 fiscal year end and thus will need to file their Forms C-AR on or by May 1 of this year (you get an extra day because April 30th falls on a weekend).

For issuers that have conducted successful raises:

Form C-AR is very similar to the Form C disclosure document required in the initial offering, except that it does not include offering specific details and must be updated with the most current information. In addition, although it requires GAAP financials to be attached as exhibits, the financial statements do NOT need to be audited or reviewed by an accounting firm, regardless of how much money the issuer raised.  The Form C-AR must be filed with the SEC and posted on the issuer’s website.

For issuers with ongoing raises:

All open deals must have financial statements for the immediately preceding fiscal year dated within 120 days from the end of that fiscal year. Thus, issuers with December 31 fiscal year ends, must provide financial statements for 2016 in their offering exhibits by May 1 of this year. These updated financial statements will be filed as a Form C/A. The updated financial statements must be of the same review level as the ones initially filed. Thus a company raising $250,000 would still need to file “reviewed” financial statements for 2016. The Form C itself does not need to be amended, unless a material event has transpired.

A question arises as to whether the updated financial statements are material and require the reconfirmation of all current investors. While the SEC has said that it is a company specific determination and will not provide guidance, certainly if the financial statements are wildly different from prior statements or what was projected by the company, this would rise to the level of “material” and require reconfirms. If an issuer has an outstanding offering but has reached its minimum amount, it should consider whether continuing the offering and preparing another set of reviewed financial statements and potentially getting reconfirms from all investors is worth it, versus closing their deal early and filing the Form C-AR which does not require reviewed financial statements and will not require investor reconfirmations.

The basic rule of thumb is that:

  • Successfully closed deals need to get their Form C-AR filed by May 1, 2017.
  • Open deals need to have the immediately prior year’s financial statements attached as exhibits by May 1 (many recently launched deals may already have 2016 financials in which case no action needs to be taken)

It is important to ensure that entrepreneurs engaged in Reg CF crowdfunding do not unintentionally run afoul of the regulations and jeopardize their ability to operate their businesses and raise money in the future.


Georgia P. Quinn is a Senior Contributor for Crowdfund Insider. She is also the CEO and co-founder of iDisclose, an adaptive web-based application that enables entrepreneurs to prepare customized institutional grade private placement documents for a fraction of the time and cost. iDisclose users may file Form C’s and Form C-AR automatically with the SEC. Georgia also serves as of counsel at a leading law firm in crowdfunding, Ellenoff, Grossman & Schole, specializing in facilitating financial transactions and compliance with JOBS Act regulations. 

The Invest in America Act: Supporting Entrepreneurs & Innovation While Empowering Everyday Americans

 


First off, we all owe Tony a debt of gratitude for actually drafting this set of regulations. Legislative drafting is yeoman’s work especially when it comes to tax law. This new legislation solves for two extremely important problems in the U.S. economy and society. The first is the lack of capital being allocated to small and startup businesses, which are the largest driver of economic growth and job creation. The second is the exclusive nature of private investments and the basic shutting out of everyday Americans from participating in high growth startups.

The Small Business Administration reports that small businesses account for 99.7% of U.S. employer firms, 64% of net new private-sector jobs, 49.2% of private-sector employment, and 43% of high-tech employment.

Importantly, when one thinks about small business, it is also a bit of a false distinction between jobs and economic growth created from small versus large businesses since all large enterprises were once start-ups, so in a sense, all job creation comes from small and start-up companies.

It is thus imperative that we support these vital economic drivers.

Despite this truism, chief economist for the Small Business and Entrepreneurship Council found that:

“Compared to the average growth rates prevailing over the past six decades, the U.S. has experienced a historic private investment gap or shortfall during this current recovery/expansion period. This amounts to a lost decade when it comes to private-sector investment…Real gross private domestic investment grew at an average annual rate of 1.8% from 2007 to 2016, compared to the 4.9% average growth rate from 1956 to 2016. This difference leaves a real gross private domestic investment gap of at least $1.4 trillion (in 2009 dollars) in 2016.”

With data like this, it is astounding that our economy has grown at all.

In addition to decreased private investment, bank loans, the traditional source of capital for small business has dried up over time.

In 2015 the Wall Street Journal reported that;

“[t]ogether, 10 of the largest banks issuing small loans to business lent $44.7 billion in 2014, down 38% from a peak of $72.5 billion in 2006, according to an analysis of the banks’ federal regulatory filings.”

And due to consolidation, many of the small community-based lenders have been amalgamated into the larger institutions leaving no outlet for small and startup businesses.

What is causing this?—several factors, including an economic crisis, but also and just as importantly, the reaction to that crisis bears much of the blame.

The Dodd-Frank Act constrained banks and their lending practices and made the smaller and often higher risk loans unprofitable or illegal to make. Over-regulation in the area of securities law and other regulatory agencies, as well as high tax rates, have also had a chilling effect.

Leveling the Playing Field

The other issue addressed by the Invest in America Act is the inability of average citizens to participate in private investment.

Except in very limited situations, the securities laws of this country prevent anyone who makes less than $200,000 a year, or has a net worth of less than $1 million, from investing in private companies. And as anyone who has followed the recent tech boom in this country knows, it is the private investments that have the greatest upside potential (think Uber, AirBnB, Oculus, etc.). The SEC, in its paternalistic wisdom, has long deemed these type of investments too risky and off limits to 93% of the population.

One bright spot, however, has been the JOBS Act of 2012, which took a long time to become effective but is now showing real promise by allowing average Americans to invest (in capped amounts) in small and startup businesses and utilizing technology to reduce transaction costs. Add to it the Invest in America Act and there might be hope for us yet.

The Act, with its two-pronged approach, not only incentivizes all investors to invest in small and start-up businesses which bear more risk but ultimately more opportunity for reward but also incentivizes the big players such as VC firms to open up their exclusive deals the average citizen so they may participate. It is truly an elegant solution, which piggybacks off of the SEC’s and various state crowdfunding rules to incorporate all of the necessary safeguards and protections without being overly paternalistic.


The beauty of this proposal is that it works.

It is often difficult to know if potential legislation will have the intended effect and unintended consequence are all too familiar when it comes to government regulation, however with the Invest in America Act, all we need to do is look to our allies across the Atlantic who have had a similar tax initiative in place called the Enterprise Investment Scheme (EIS) for over 13 years and the more recent Small Enterprise Investment Scheme (SEIS) with great success.

In fact, in 2015 the UK Treasury reported that;

“[t]he tax- advantaged venture capital schemes continue to be an important part of meeting [our] aim, providing valuable support to small and growing businesses seeking finance to develop and grow. To date they have supported over 22,000 businesses to gain access to finance, with over £17.5 billion of funding provided.”

While this may seem like small numbers, don’t forget that the US economy is roughly 8 times the size of the UK, which equates to $175 billion with the current exchange rate of potential for the US market.

The British government further stated that;

“[it] is committed to ensuring continued support for small and growing businesses that are key to the UK economy. The tax-advantaged venture capital schemes are an important part of the government’s growth strategy, facilitating access to finance and providing support for smaller companies, which would otherwise have difficulty finding the necessary finance to develop and grow.”

One of the remarkable things about the success of the UK tax schemes is that it has not just benefitted the urban tech center of London, but 63% of the money was raised by companies outside of London, many in more rural areas of the UK. In addition, although the maximum amount of money that can be raised by a company utilizing the Enterprise Investment Scheme is £5,000,000, the vast majority of transactions utilizing the tax schemes are for £250,000 or less, so true startups and small businesses.

The UK system is very similar to proposed Invest In America Act. You can find the details here and here.

In summary, it allows small business to conduct qualifying capital raises for which investors can deduct a portion of their investment from their taxable income. In the event the investment goes belly up, the investor can deduct the full amount of the investment.

The UK plan goes even further than the Invest in America Act in that it also eliminates the cap gains tax on the eventual exit after a certain holding period of the investment. It does not, however, have the equalizing feature of allowing the “sophisticated” investors to receive a tax benefit if they bootstrap a crowdfunding transaction to their deal and open up investment opportunities to average Americans.

In both plans the offering amounts are capped as are the investment amounts to reduce risk to both investors and taxpayers.

And should those taxpayers be concerned?

The economic insight to these regulations is that by financing small business, you actually create new revenue streams from an increase in the payroll tax and sales tax attributable to those enterprises. This is not a pure redistribution of the tax burden, however, because these businesses eventually generate revenue and actually grow the economy.

In a nutshell, this proposal could unleash capital to small business while taking a step to equalize the playing field when it comes to investment opportunity; it is like a win win win. In addition, rarely do we have such a clear example of successful legislation, which should alleviate the hesitation of any skeptics.


Georgia P. Quinn is a Senior Contributor for Crowdfund Insider. She is also the CEO and co-founder of iDisclose, an adaptive web-based application that enables entrepreneurs to prepare customized institutional grade private placement documents for a fraction of the time and cost. Georgia also serves as of counsel at a leading law firm in crowdfunding, Ellenoff, Grossman & Schole, specializing in facilitating financial transactions and compliance with JOBS Act regulations. 

How to Fix the Fix Crowdfunding Act

fix-repair-damaged-mechanic-blurry


Let me begin by saying god bless Congressman Patrick McHenry. He is out there on the front lines actually trying to make a difference and help entrepreneurs and small businesses get off the ground and succeed. Of course, no good deed goes unpunished, and a punishing is what his proposed Fix Crowdfunding Bill received in order to get passed by the House last July. Granted it was a landslide victory, because NEWSFLASH! – this is a bipartisan issue, and anyone who tells you different does not understand the economy, politics or both. The rub is, in addition to being stripped of many of the most valuable features, the bill also acquired a lot of regulatory detritus that threatens to make this “solution” more of a problem.

What could have been…

congress-in-session-house-of-representativesThe wonderful provisions that were ultimately stricken from the original bill would have achieved some practical and vital results such as (listed in my order of preference):

1.     Allow for Regulation Crowdfunding deals to engage in “testing the waters” or the ability to solicit interest in your deal before actually filing the documents with the SEC and going through the expense of launching an offering. This feature is invaluable for cash-strapped companies who could use this to determine if they should even go through the time and expense of conducting a securities offering or instead head back to the drawing board to refine their product or business plan.

2.     Raise the maximum offering amount to $5 million in a rolling 12-month period from $1 million. While I don’t believe this is necessary for these early days for entrepreneurs and small business, I do think this would go a long way in eliminating the quality bias or “race to the bottom” of companies that use Regulation Crowdfunding as a last resort, by attracting more established companies with higher capital requirements to utilize the regulations.

3.     Clarify that a funding portal does NOT bear issuer level liability unless it knowingly participates in the fraud.

4.    Broken Benjamin Money Simplify and potentially increase the amount that individuals can invest in crowdfunding. Currently, the rule is an overly complex capping the amount an investor can invest in all Regulation Crowdfunding deals in a 12-month period at an amount based on a percentage of the lesser of your income or net worth.  This disadvantages people (generally the young and the old) who either generate income but haven’t yet acquired the assets to attain significant net worth or those who no longer generate significant income but have sufficient assets due to a lifetime of earning income. Although it left the complexity, the original bill allowed for the investment amount to be based on the greater of income or net worth accommodating individuals who are on both ends of the spectrum.

5.     Clarify what a funding portal MUST do with respect to preventing fraud and screening candidates on its platform – which boils down to conducting backgrounds checks on issuers, officers, and 20% owners and to the extent the funding portal knows or learns of any prior fraud or attempted fraud to decline to list the issuer on its site.

6.     Create a grace period, whereby a funding portal could not be found in violation of the Regulation Crowdfunding until 2021. This was a pipe dream and I had no illusion of it passing.

So with all of that laid to waste, what did make it? And in what form?

Unhappy Balloon SadThe only two provisions that survived, though significantly altered were a provision allowing for the use of special purpose vehicles to collect the crowdfunding investors in so they do not overly complicate the cap table of the company raising money and the revision to the Rule 12(g) caps. This is what we have to work with, and it will take some work…

The original bill allowed for the use of special purpose vehicles (“SPVs”) in a crowdfunding scenario by amending both Title III and the Investment Company Act. This is a fairly complicated area of law but the basic issue is that SPVs which allow for the aggregation of investor funds to invest in other companies usually fall under the Investment Company Act of 1940 or are subject to an exemption based on certain characteristics. Title III prohibited the use of investment companies or companies taking an advantage of an exemption from being an investment company from using Regulation Crowdfunding. The original bill attempted to remedy this by specifically carving out the use of SPVs, which would only hold the securities of one issuer that was also utilizing Regulation Crowdfunding, and allowing them to take advantage of the new rule. This would be extremely beneficial to crowdfunding issuers who are concerned with managing an unwieldy cap table and the chilling effect it could have on future rounds of financing because the company would simply have one investor, the SPV, rather than potentially thousands of crowdfunding investors.

The way this structure is implemented in the accredited investing world is that the SPV is set up by the online platform (or an affiliate) and the platform (or an affiliate) receives a fee for managing the SPV. Usually some variation of 2% of the value of the securities sold and 20% of any appreciation in those securities. This aligns the manager and the investor because the meaningful chunk of the compensation only occurs if the company is successful in the long term. The services that are provided are the management of the SPV, making any distributions to investors, making sure the K-1s or other tax documents are distributed to investors, making sure any mandated information is distributed to investors, keeping track of investors and any transfers of interests.

AngelList 2015One thing both the original bill and the one that ultimately passed would not allow for is the creation of funds where the crowd could invest in a basket of crowdfunded companies (say all companies that raised funds successfully on a particular funding portal in a year) and thus diversify their investments. These vehicles have been successful in the UK on platforms such as CrowdCube and Seedrs and for accredited crowdfunding investors in the US with such funds as AngelList and Funder’sClub showing 46% and 37.1% IRR, respectively. The requirement that the SPV hold the securities of a single issuer prevents this.

But I digress—one problem at a time! So the version of the Fix Crowdfunding Act that ultimately passed in the House contains additional language requiring that in order to receive compensation for or from such SPV, the person or entity receiving such compensation must be acting as, or on behalf of, an either federally or state registered investment advisor. This adds an entirely new level of regulation and frankly doesn’t make much sense. In order to be an “investment advisor” pursuant to the federal and most state regulations, an entity must meet the following three criteria:

  • receives compensation;
  • for engaging in the business of;
  • providing advice to others or issuing reports or analyses regarding securities.

As you can see from the activities and services that are provided to the SPV above in the accredited investment context (and we have every reason to believe that this model will be applied in the retail Title III context) providing investment advice or reports and analysis regarding securities are not in the wheelhouse of managers of these type of SPVs.

Why do we now need to go hire an additional service provider to simply increase costs for both investors and companies?

The managers of the SPVs do not provide investment advice, in fact in most cases the SPV isn’t even formed until the investment decision has been made, the target amount has been reached and the funds are released from escrow. Additionally, the managers do not provide investment advice on an ongoing basis as the securities operate by their terms and the manager has no discretion over whether they are bought or sold. Furthermore, the manager does not provide reports or analysis, but rather acts as a conduit between issuer and investor providing the mandated disclosure either by the terms of the securities or by law. The manager simply operates the SPV and conducts the mechanics to service the investors therein. There is no judgment or discretion being applied. This is a job most suited for the funding portal or an affiliate thereof. And guess what? Funding portals are already regulated by the SEC and FINRA!

Now we can rest assured that these SPVs will not run amok in a lawless environment. The revisers of the original bill probably envisioned the funding portals or their affiliates registering as investment advisors in order to conduct this business, but it is not clear they would even qualify based on the services they provide and more importantly, why should they do so if they are already regulated as funding portals by the SEC and FINRA as funding portals?

Of course, the managers should be able to receive compensation for their valuable services, but requiring them to be investment advisors to do so will only add additional burdens and costs to the very constituents the JOBS Act was intended to help. Plus, as I mentioned it is apples and oranges – in the scenario laid out, there are no advisory services to perform which makes the requirement completely inapplicable.

The other provision to survive was a revision to the 12(g) cap exemption that is in Regulation Crowdfunding. Section 12(g) of the Securities Exchange Act requires that companies that have over 500 unaccredited holders or 2,000 accredited holders and $10 million in assets have to file as public reporting companies with the SEC.

In the current Regulation Crowdfunding, there is an exemption for companies that are over the holder limits due to crowdfunding investors, have less than $25 million in assets and have engaged a third party transfer agent. This is a plus, but pretty complicated and adds additional expense of a transfer agent and the threat that if you are successful and achieve a certain amount of assets you will be punished with public reporting.

Elegance in Simplicity

Patrick McHenryIn McHenry’s original bill he simply and elegantly provided for an exemption from the 12(g) reporting requirements for all companies whose crowdfunding investors push them over the limits, period. Simple, understandable and administrable—my favorite kind of law. Unfortunately, this got revised to first allow for an exemption for companies that have a public float of less that $75 million which is a public company concept and inapplicable to crowdfunding. As you know, public companies are ineligible to use Regulation Crowdfunding. I frankly do not know what this language is doing here.

Secondly, the revised bill allows an exemption for crowdfunded companies that have less than $50 million in revenue and no reference to a third party transfer agent. While I guess it is good to not have the added expense of a transfer agent (although with a significant number of beneficial holders it may be helpful), I do not know if the $50 million revenue cap is better or worse than the $25 million asset cap we currently have. It would seem to just benefit certain types of companies over others. For capital intensive companies such as manufacturing or biotech you would prefer a revenue test, tech and services companies would prefer an asset test.

So there you have it—what Congressman McHenry’s bill has been reduced to…

While I am the first to appreciate anything that will make capital raising for small business more efficient, we need to fix this fix in order for this piece of legislation to do so.


 

Georgia Quinn National Press Club 2014 AGeorgia P. Quinn is a Senior Contributor for Crowdfund Insider. She is also the CEO and co-founder of iDisclose, an adaptive web-based application that enables entrepreneurs to prepare customized institutional grade private placement documents for a fraction of the time and cost. Georgia also serves as of counsel at a leading law firm in crowdfunding, Ellenoff, Grossman & Schole, specializing in facilitating financial transactions and compliance with JOBS Act regulations. 

Online Lending at AltFi: A New Phase for a Growing Industry

 

ron-suber-at-the-pierre-altfi-2016-2


When I realized the 2016 AltFi Conference was at the posh Pierre Hotel on the corner of Central Park, it immediately gave me pause. I remembered 2007 and 2008 when certain mortgage-backed security investment conferences were held at such addresses. Also, is the storied (and stodgy) Pierre Hotel, the appropriate venue for the “alternative finance” conference? Oh well, I still wore jeans and at least the food was certain to be good.

Upon arrival, what stood out were the conspicuous absences. While no one expected to see Lending Club on the sponsor board or its representatives on a panel, other staples in the industry were conspicuously missing. Noteworthy absentees from former years were SoFi, Dealstruck, OurCrowd, Symbid, LendKey, Biz2Credit, OneVest, Realty Mogul, Assetz Capital, CommonBond, Seedrs, Crowdcube, P2BInvestor, and Zopa. Is this due to the Lending Club scandal earlier this year and the aftershocks it sent through the industry or simply natural market mechanics where certain winners no longer need to participate in such events and certain losers are not around any more?

clouds-sky-turbulenceOne comforting element that provided a sense of institutional consistency was Ron Suber, of Prosper Marketplace, presenting the opening keynote. Suber has often been a champion of the industry, and he reassured the audience saying that the industry must get past this “year of turbulence.” He likened marketplace lending to Boeing in 2013 when it manufactured faulty batteries for its new Dreamliner aircraft. He noted that loan volumes are increasing, loan values are coming back and quality securitizations are back since the second quarter of this year.

He also noted that the industry needed to focus on developing a deep liquid secondary market, securitizations with a cusip and a rating so that institutions with certain investment criteria can invest, and properly executed derivatives and synthetic market. When pressed on this latter point, Suber clarified that “if done poorly or wrong, synthetic derivative instruments on assets produced by online marketplaces for credit will be detrimental to the industry.” This statement helped assuage my aforementioned 2008 déjà vu.

the-new-necessary-nine-ron-suberA few years ago, I wrote about Suber’s “Necessary Nine” criteria for a successful marketplace lending platform. Today he offered a new necessary nine, essential for funds looking to invest in this asset class, many of which were tested earlier this year. They are as follows:

  • Proper loan valuation – did they value them correctly?
  • Adequate accruals for defaults – in the second quarter, many didn’t set these correctly and had to true up accruals
  • Effective loan selection – obvious
  • Account for platform performance – many struggled with losses exceeding projections and this was felt by the funds that invested in them
  • Fund fees – are these billed and set up correctly?
    Manage use and cost of leverage
  • Manage use of cash – many funds stopped purchasing new loans and experienced a cash drag
  • Purchase price of loans (premium vs. origination fee) – borrowers prepaid and many funds never realized those premiums they anticipated
  • Currency hedge – Brexit affected many funds who did not hedge against currency fluctuations

bulletsSuber then focused on the question of a “silver bullet” and if there is a particular structure for a platform that works the best between a pure online marketplace which takes no balance sheet risk and simply collects fees and a balance sheet lender that retains the loans. He settled on some form of hybrid that would have the flexibility to adapt to the current environment. He then projected that soon very big players such as Goldman and JP Morgan would be entering this space.

As final thoughts, he left us with four things the industry needs to get right:

  • Risk management groups – meaning the industry needs to ensure that it has appropriate safeguards when it comes to legal, compliance, data and other risks
  • Sustainability/profitability
  • Equilibrium (between borrowers and investors) – platforms need to be able to balance supply and demand
  • Trust and transparency

Simon ChampThe fist panel addressed alternative finance assets and where they sit in the broader investment landscape. Simon Champ, of MW Eaglewood Europe LLP, commented that often (especially in the UK) marketplace lending assets are classified as an equity instrument, but are better characterized as fixed income. The panel had a basic consensus that liquidity is a primary issue, which makes these assets look like private equity instruments with a fixed income return. One point of concern occurred when Etienne Boillot of Eiffel eCapital was asked what effect would a bond market crash have on his funds; he stated “none.” Again that old 2008 feeling started creeping in. To be fair, he was giving a glib answer since his fund or funds are comprised of private assets, which are not publicly traded and not valued on a regular basis and thus would not be priced in such a “crash.” However, this is far too simplistic, and the marketplace lending industry has a correlation to the public bond markets and broader capital markets as a whole, which shouldn’t be overlooked.

The next speaker was Rupert Taylor of AltFi Data who discussed the current standards of disclosure and the need for what he calls the “4 C’s” – comparable, consistent, consumable, and credible data for investors.

defending-online-lending-at-altfi-2016

In the next panel titled “In defense of online lending” the panelists were asked, “what value does the platform bring?”

Christian Faes of LendInvest, answered that it was the ability to originate loans online and streamline the previously grueling process of origination and underwriting. Eric Thaller of Prosper Marketplace explained that it simply helps borrowers get lower rates, and it helps investors get access to assets that have historically sat on a bank balance sheet. Nat Hoopes of the Marketplace Lending Association felt that the online model allows for greater operational flexibility and the ability to adapt to changes in both borrowing and investing trends.

The next panel focused on the evolution of the marketplace lending industry. Rupert Taylor once again chimed in regarding the need for more transparency in the industry, and that what exists now is not sufficient because “standards are ill-suited in what they are attempting to achieve.”

Bill UllmanBill Ullman of Orchard confirmed that platforms have not standardized information and investors need standardization to be able to compare data across the industry.

According to Charlie Moore, of Global Debt Registry, investors are starting to demand more information and in different ways, such as via APIs, etc., and the events of the second quarter of this year showcased the need for standardized loan disclosure and third party verification.

albert-periuThe third keynote of the day was Albert Periu of Funding Circle US, whose focus was on the need for diversity of funding sources for platforms. He also shared that since formation in 2010, Funding Circle has lent over $2.5 billion to over 20,000 businesses. Periu conceded that diversification of funding sources is difficult to achieve but is the only way marketplace lenders can scale. Periu was optimistic that the largest pools of permanent capital have yet to play a meaningful role in the marketplace lending ecosystem. These pools are endowments, sovereign funds, pensions, banks, family offices, insurance, and governments.

In his final remarks my ears pricked up when he mentioned that while Funding Circle has used retail investors as a source of capital in the UK and EU for some time, they will soon be utilizing such investors in the US as well. I am quite curious as to how they will achieve this due to the current regulatory regime. Will they try to use some private exemption or do a full registration similar to Prosper and Lending Club?

Peter Renton at Lendit USA 2015The final event of the morning session was a debate of sorts about the importance of retail investors to the future of marketplace lending between Peter Renton of LendAcademy and David Stevenson, of AltFi. Stevenson argued that accessing retail investors brings the ire of regulators and that the herd mentality of retail investors causes them to be less permanent. Renton countered that institutional investors are less sticky and move massive amounts of money at a time causing volatility, and further, that the financial crisis was driven by institutional investors and not retail investors. Renton proffered that open-ended mutual funds are the solution to accessing retail investors in a responsible, sustainable way. Stevenson dismissed the idea, stating that it does not work to mismatch a liquid investment vehicle such as a mutual fund with underlying illiquid assets such as online loans. Stevenson continued that managed accounts were all held by the big brokers, and it would be too hard for new entrants to break into the space because retail investors would never trust them. Renton’s final point was that there are currently over $12 trillion invested in IRAs and 401k accounts, and as individuals start to retire and draw down those funds, they will need a fixed income asset that pays more than 1%. It would not take a large percentage of such current retail funds to move into this asset class to create a meaningful shift. This point seemed to resonate with the audience, as it bumped the online audience poll to 44% agree that retail investors will become a more important source of capital to 56% feel that it will become less meaningful over time. I think it is obvious that it will become less and less significant, although I take the point that individually directed retirement assets could be a huge shift at some point, I just do not see it anywhere on the horizon.

All in all, I felt the conference lacked some of the energy of past years, which was a direct result of the Lending Club fallout and the market correction the industry experienced earlier this year. I do not, however, believe this is the beginning of the end, but perhaps a new phase that a growing industry is entering. This is a time for licking wounds, learning from mistakes and creating something stronger and more transparent than before.


Georgia Quinn National Press Club 2014 AGeorgia P. Quinn is a Senior Contributor for Crowdfund Insider. She is also the CEO and co-founder of iDisclose, an adaptive web-based application that enables entrepreneurs to prepare customized institutional grade private placement documents for a fraction of the time and cost. Georgia also serves as of counsel at a leading law firm in crowdfunding, Ellenoff, Grossman & Schole, specializing in facilitating financial transactions and compliance with JOBS Act regulations. 


What is Title III Crowdfunding and Why Should I Care?

REGULATION CF TITLE III


Overview of the regulatory framework

Although the Jumpstart Our Business Startups or JOBS Act was passed in April of 2012, the rules implementing Title III of that Act relating to retail investment crowdfunding have been a long time coming. They were finally promulgated on October 30, 2015, more than three years after President Obama signed the JOBS Act into law. There is much speculation around the long awaited delay but the understood rationale is that the wait was due to the sweeping transformation in the law and certain regulators’ hesitance to adopt such changes.

JOBS Act 2012 jumpstart our businessIn brief, the new regulations allow for private businesses to raise money via online intermediaries from retail investors. It is important to understand what a radical change from traditional securities laws this concept is. Prior to this law, companies were only allowed to raise money from average investors through the IPO process or other limited exemptions (and certainly not over the internet). Otherwise, they could only raise money from high net worth individuals and institutions. The new crowdfunding laws allow companies to raise money from anyone – friends, neighbors, customers, even widows, and orphans. Of course, the devil is in the details and the final rules have 686 pages of details, the highlights of which are set forth below.

Issuer Limits/Requirements

The most important restriction is that companies can only raise $1,000,000 in a rolling 12-month period using these new regulations. While a lot of people claim this will stop crowdfunding before it begins because it is simply not enough money, the fact that the majority of small business loans are under $200,000 seems to indicate that a much smaller sum is enough to get a business off the ground. Companies raising money or “issuers” must also provide a detailed disclosure document to the SEC and potential investors and they must conduct the transaction over the internet using a registered intermediary. One component of that disclosure document or “Form C” is that it must include financial statements prepared for the company in accordance with GAAP and, depending on the amount of money being raised, must have various levels of accountant review or audit. Issuers are also required to file annual updates with the SEC with respect to their business operations.

Investor Limits

slow investor limitsInvestors too are limited in the amount that they can invest in crowdfunding transactions on an annual basis. If their annual income or net worth is less than $100,000, then they can only invest the greater of $2,000 or 5% of their annual income or net worth (whichever is less) on an annual basis in crowdfunding investments. If their income and net worth is $100,000 or more, then they can invest 10% of their income or net worth (whichever is less) up to a maximum $100,000 in crowdfunding investments on an annual basis.

Intermediaries

Intermediaries are the online platforms where the transactions will actually be conducted. Issuers must use an SEC and FINRA registered intermediary to conduct their deals. The intermediaries have a multitude of regulations that apply to them, pursuant to the SEC and FINRA registration, but importantly they are required to provide educational information to investors to explain the investment process and risks involved, provide a communication channel among investors and between investors and issuers and assist the issuer in conducting the mechanics of the transaction.  They must also perform a preliminary diligence or gatekeeper function in an attempt to reduce the risk of fraud.

Views on Title III Crowdfunding’s place as a fundraising tool in the startup ecosystem (what types of companies are most likely to use Title III)

Title III crowdfunding is not for every company seeking financing. In fact, companies that can raise funds using less regulated means should do so. However, Title III crowdfunding opens up financing opportunities for many types of businesses that have traditionally been denied other means of capital. In addition, there are certain business types that lend themselves to the medium of crowdfunding and are more likely to be successful using this strategy.

Consumer Products Companies

One such type of business is a consumer-facing company that has a passionate and preexisting user base. Crowdfunding will allow these companies to leverage each and every satisfied customer, and convert them into an investor. This could have great appeal for “treats, potions and lotions” as I call them. These are products that people are passionate about, that they use frequently and that they want to promote and participate with in the brand awareness. Now instead of just purchasing and using your favorite organic moisturizer or eating your favorite all natural fruit snack, you can invest, become a part of the team and a brand champion. This will be extremely valuable to companies who have already done a great job of building brand loyalty and fervor around their products. Companies will simply be able to reach out using social media to inform their customer base that they now have the opportunity to invest in the company. This is truly a “never before” opportunity. Even before the securities laws, which restrict selling to unaccredited investors, because the ability to connect instantly with so many customers and potential investors was not possible, investment on this scale is truly unprecedented. Previously, in order to invest in private companies, investors primarily had to be accredited investors (high net worth individuals), but with Title III crowdfunding, anyone is eligible to be an investor, which opens up every single customer to being a potential financier.

Affinity Companies

Another related group of businesses are those with affinity products that have an almost cultish following built in. These companies include certain exercise regimes (think SoulCycle), health products, video games or game series, niche media (like campy horror films) and breweries and distilleries. These companies and products draw in a passionately loyal following who are quite likely to want to invest in something they believe in alongside the founders or creators. In addition, the online medium of crowdfunding will allow for the communication of the opportunity in a way that resonates with the potential investor. In many ways, the medium is the message. There is a coolness and anti-establishment factor to this type of financing which has an appeal to certain types of companies and their respective customers.  The followers of these companies may jump at the opportunity to be an “insider” or “team member” of the company and this stronger sense of community and longer-term view may provide more than just cash to the company in the future.

Local Brick and Mortar Businesses

Cheese FoodAnother type of business that could get a revitalization from crowdfunding are the local brick and mortar businesses, specifically, restaurants, coffee shops, beauty shops, etc. These are places with a strong local appeal that again, have a loyal customer base, which can be converted into investors. In addition to investing in a product or service that they appreciate, the investor is investing in his or her community to ensure that reputable establishments remain a part of the local fabric. This has multiple benefits including giving investors a sense of ownership in their communities even at low investment amounts. Crowdfunding could also fill the void left by the community banks, which were the traditional sources of capital for these types of businesses. In the wake of bank consolidation and the Dodd-Frank capital requirements, those traditional lenders have dried up, leaving small, local, low-growth business with few financing alternatives. Large banks have not found these low-dollar loan amounts to be profitable and venture capital firms have no interest in the low-growth profile of these local operations.

Women and Minority Owned Businesses

Global WomenSpeaking of traditional capital sources, there is no mystery that traditional financing sources have a typical racial and gender profile. It is also no secret (and statistically proven) that people tend to invest in and lend to people that look like themselves and have similar backgrounds. Only 7% of venture capital principals are women, and I think we can all agree about the demographics of the banking industry. This has left women and minority-owned businesses with few places to turn for financing. In addition, some of the traditional qualifiers such as individual wealth, uninterrupted employment history and certain levels of education have prevented women and minorities from “qualifying” for traditional sources of capital, such as small business loans, based on a fixed criteria. By simply broadening the gender and racial makeup of potential investors, which crowdfunding does, opportunities for women and minority-owned business will increase. By expanding the pool of individuals who might be able to identify with you or your business you will increase the chances of finding financing. In addition, the medium of crowdfunding allows women and minorities to leverage their skills and assets, which are not valued by the traditional financing criteria. Those assets are their social networks and brand equity, which can be utilized to convert customers and fans into investors and partners.

Businesses in the Middle of the Country

Crowdunding US Exemptions JOBS ActAnother bias that crowdfunding solves is that of geographic bias. Because venture capital firms and other institutional investors are concentrated on the coasts of the United States for the most part, companies located in the middle of the country have an additional challenge of just getting in front of potential investors. They either have to expend significant resources traveling to San Francisco and/or New York or hope to get “discovered” at some regional demo day or showcase. This puts these companies at a significant disadvantage and is often an insurmountable hurdle to receiving financing. Keep in mind there are likely legitimate reasons for such companies to be located where they are, such as proximity to research facilities, lower cost of overhead and labor, regional customer bases, etc. Crowdfunding and the internet solve this geography problem by bringing everyone together virtually. Investments are presented and made online, so no need for in-person meetings. Meetings, presentations and chats are held on the online platform and available to all potential investors. Access is the name of the game and neither investors nor issuers are limited to a select few. This could have a profound effect on certain capital starved areas of our country – think about places like Michigan and Mississippi. These are areas where there are passionate supporters throughout the United States who until now have lacked the medium to invest in those areas important to them. Now businesses in those areas have the opportunity to reach out to the diaspora of potential investors across the country with roots or ties to the area and additionally simply to people who are passionate about their business regardless of where they live.

The Future of Title III Crowdfunding

“Whimper Not a Bang”

The Title III crowdfunding industry will not start with floods of new issuers pouring forth, but will instead begin with several highly vetted potential deals. Once proven as a viable option, more companies will use the channel and more investors will be attracted to the opportunity.

Steady Growth

I predict steady yet measurable growth over the first two years similar to the marketplace lending industry when it began. After several successes and pending the absence of a major fraud, I foresee new legislation easing some of the burdens of crowdfunding and allowing for a more robust industry.

Need for Education

The most vital thing for crowdfunding is education of both the investors and the issuers. People need to understand the pros and cons of this as an investment and as a financing alternative. The vast majority of Americans have no idea what investment crowdfunding is, and that needs to change if this industry has any chance of survival.

The Unknown

The most important insight I have, however, is that the problems people are projecting are not the problems that will impair the industry. All of the concerns over disclosures, cap tables, investment limits, etc. will be, and many have been, solved. The real problems with this new industry and set of regulations are unknown to us and will only be uncovered in practice. We must do our best to anticipate these challenges and remain alert to identify them when they do materialize.

 

Thomson Reuters Practical Law is collaborating with Crowdfund Insider on a series of articles about the recent regulatory changes in the crowdfunding industry. The themes include JOBS Act Title III overview, global regulatory framework, and future regulatory improvements for existing crowdfunding regimes. The views expressed by the authors of these articles do not necessarily represent the views of Thomson Reuters nor any of its affiliates.


 

 

Georgia Quinn National Press Club 2014 AGeorgia P. Quinn is a Senior Contributor for Crowdfund Insider. She is also the CEO and co-founder of iDisclose, an adaptive web-based application that enables entrepreneurs to prepare customized institutional grade private placement documents for a fraction of the time and cost. Georgia also serves as of counsel at a leading law firm in crowdfunding, Ellenoff, Grossman & Schole, specializing in facilitating financial transactions and compliance with JOBS Act regulations. 

I Tried the Virtuix Omni / Oculus Combo and It Was Amazing

Jan Goetgeluk and Georgia QuinnVirtuix, a virtual reality motion platform that may transform the gaming industry with a previously unheard of sense of immersive gameplay experience, is preparing to raise capital under Regulation A+ on SeedInvest.  The company has generated over $19 million in indicated interest to date.  The Series A funding seeks a max raise of $15 million – so it looks pretty good so far.  Crowdfund Insider has covered the funding round and recently Virtuix offered me the opportunity to experience the Virtuix Omni, along with the Oculus headset, and it was simply awesome.

First things first, I was worried that it would be flimsy and I wouldn’t feel safe. It was sturdy and there was no way I could “fall”. Also, once in the game, while the graphics weren’t realistic, the spatial relationships and movement was, and it was so fun to be Georgia Quinn using Virtuix Omnisurrounded by the robot aliens and shoot them. I am not a gamer but could really see myself enjoying this. I see how this could be used by the whole family, and my husband is totally jealous I got to try it. I also love all the potential uses, from education to health care; I am excited to see where they take this.

Virtuix is preparing to ship its first batch having presold thousands of Omni’s and will be first to market with their VR motion platform. I can see the Omni becoming standard equipment in every household with a serious gamer. Beyond gaming, Virtuix sees many other potential vertical uses.

Will 2016 be the year of Virtual Reality? I don’t know if this is the year but it is definitely coming.

via GIPHY


 

Georgia Quinn National Press Club 2014 AGeorgia P. Quinn is the CEO and co-founder of iDisclose, an adaptive web-based application that enables entrepreneurs to prepare customized institutional grade private placement documents for a fraction of the time and cost. Heralded by Thomson-Reuters as a Top Female Attorney in New York City, she also serves as of counsel at the leading firm in crowdfunding, Ellenoff, Grossman & Schole, specializing in facilitating financial transactions and compliance with JOBS Act regulations. A foremost expert in corporate finance, she has worked on over $1 billion in business transactions over the course of her legal career. Prior to founding iDisclose, Georgia represented several Fortune 500 companies in financings for six years at Weil, Gotshal & Manges, one of the top ten law firms in the world, and then for over two years at Seyfarth Shaw, a leader in legal technology. As a globally recognized thought leader in the crowdfunding space, she has been a featured speaker at multiple conferences and has presented to such authorities as the Securities and Exchange Commission (SEC) and the American Bar Association (ABA).

Crowdfunding Portals Prepare for Title III Retail Crowdfunding

Gates Open for Title III

Last week both the SEC and FINRA finalized the rules for funding portals to offer securities under Title III of the JOBS Act of 2012.  The journey to get to this place has been long and at times challenging as regulators and industry participants debated the best approach to take regarding the highly prescriptive  law as defined by Congress. Unlike Title IV, Regulation A+,  which gave the SEC leeway in crafting the updated exemption, Title III was more tightly defined.

For better, or for worse, what was supposed to be a lightly regulated method for small companies to easily raise capital, ended up being 686 pages of rules requiring both issuer and platform to adhere to strict standards.

Money Benjamin Franklin 100Some commentators are of the opinion that Title III will be lightly utilized. The other options available in the crowdfunding space are simply too enticing and easier to comply with. Title II has no funding limit under Regulation D.  Title IV, a mini-IPO type offer, allows a company raise up to $50 million and once capital is raised may choose to list its shares on an exchange such as OTC Markets. Several industry advocates have expressed explicit concern of the risk of negative selection. In their profound concern for small investor protection, policy makers may have institutionalized high-risk offers as only issuers who have been turned away elsewhere will seek capital from the masses. What company in their right mind will turn away big money and a manageable cap table and choose to have hundreds of shareholders clamoring for information and access?

But warts and all, many industry proponents believe the existing rules are “workable” with hope on the horizon that Congress may provide a couple quick fixes to make the exemption a bit more practicable. In the end, this is about providing access to capital for SMEs and other investment opportunities while mitigating fraud.

Hour glass TimeSo the gates have opened and prospective funding portals are now free to file Form Funding Portal with the SEC and Form FP-NMA to become a funding portal pursuant to Title III of the JOBS Act. It was touch and go and many (including us) were worried that the two agencies would not be able to meet the January 29, 2016 deadline that had been set by the SEC’s adopting release last October. The SEC site did not allow potential filers to apply for EDGAR CIK codes, which can take up to two weeks to obtain, until Monday, January 25. The codes are necessary to be able to file documents on the SEC’s EDGAR system. The final FINRA rules were not even approved until January 28. Although it was down to the wire, we can all take comfort that the rules are in effect and prospective funding portals can file their applications and start moving forward with developing their systems and compliance infrastructure.

US Capitol Green Light GoImportantly, FINRA announced rules on January 22nd which were approved on Friday, January 29.  The rules stated that broker-dealers that are already FINRA members will not be required to make any further applications and need simply give amend earlier filings noting the new line of business they will be entering. At first glance, this gives a major advantage to existing broker-dealers as they must undergo no additional scrutiny in order engage in Title III crowdfunding and can simply begin operations on May 16, 2016, the effective date of the rules. However, many broker-dealers are choosing to set up a subsidiary to register as a funding portal in order to separate operations and liabilities of their different business lines, and thus must register the new subsidiary as a funding portal under the new rules.

The only change made to FINRA’s proposed rules is that all entities and individuals listed on Schedule A to the application must provide information and testimony and must permit an inspection and copying of books and records. This amendment is currently effective, but the SEC and FINRA are accepting comments from the public. Unfortunately at the time of publication, the SEC has not made the filed Forms Funding Portal available to the public, so we cannot yet see how many potential platforms have filed. However, all eyes are watching to see who will be entering this legal and financial frontier.

The newness of this exemption for both issuers, platforms and regulators alike will probably make uptake slow.  It takes time for change, especially within the securities industry. StartEngine, an investment crowdfunding platform, revealed they had commenced the process on Friday. We expect others to follow as raising capital continues to push forward and move online.


 

Georgia Quinn National Press Club 2014 AGeorgia P. Quinn is the CEO and co-founder of iDisclose, an adaptive web-based application that enables entrepreneurs to prepare customized institutional grade private placement documents for a fraction of the time and cost. Heralded by Thomson-Reuters as a Top Female Attorney in New York City, she also serves as of counsel at the leading firm in crowdfunding, Ellenoff, Grossman & Schole, specializing in facilitating financial transactions and compliance with JOBS Act regulations. A foremost expert in corporate finance, she has worked on over $1 billion in business transactions over the course of her legal career. Prior to founding iDisclose, Georgia represented several Fortune 500 companies in financings for six years at Weil, Gotshal & Manges, one of the top ten law firms in the world, and then for over two years at Seyfarth Shaw, a leader in legal technology. As a globally recognized thought leader in the crowdfunding space, she has been a featured speaker at multiple conferences and has presented to such authorities as the Securities and Exchange Commission (SEC) and the American Bar Association (ABA).

Potential Pitfalls of Regulation CF – Part II: Practical Concerns for Funding Portals

Look Out for Traps Charlie DeTar

As discussed in part one, the SEC’s final Regulation Crowdfunding rules require thorough analysis to not fall prey to potential traps. While I firmly believe that we can make crowdfunding work regardless of the roadblocks set forth, it does not mean that we can afford to play fast and loose with the rules in effect. Below are some potential hazards for funding portals wishing to enter this space and facilitate the online transactions between issuers and investors. Funding portals are subject to both the SEC and FINRA regulations with respect to their operations and thus, have a doubly burdensome row to hoe. It will be important for all funding portals to become familiar with these rules and to institute procedures and technology to ensure compliance.

Background Checks

Good Bad UglyA funding portal is required to deny access to its platform to any issuer if it has a reasonable basis to believe that the issuer, any of its officers or directors, any 20% Beneficial Owner or an person getting compensated to promote the transaction is a “Bad Actor.” A Bad Actor is a lengthy defined term, which should be reviewed in detail, but basically is anyone who has been convicted of financial fraud or SEC violations, or been evicted from an SRO such as FINRA or made false representations to the postal service. Issuers are not allowed to use Regulation Crowdfunding if they are Bad Actors or if they have any officers, directors or 20% Beneficial Owners or any people getting compensated to promote the offering,  that are Bad Actors. How is a funding portal supposed to Punishment Prisoner Criminalestablish such a reasonable basis? Well in addition to denying access, funding portals are required to conduct a background and securities enforcement regulatory history check (or pay a third party to conduct such check) on the issuer and its officers, directors and 20% Beneficial Owners. The combination of a negative background check and an executed questionnaire on behalf of the issuer and each party in question should be sufficient to provide a reasonable basis on the part of the funding portal absent other facts and circumstances known by the funding portal that would suggest otherwise. These procedures and the related expenses are necessary actions for each offering conducted and should be calculated into the time and cost of operating a funding portal. Also, there is a caveat, if the conviction or finding relating to the Bad Actor occurred prior to May 16, 2016, then the issuer may still use Regulation Crowdfunding, but must disclose the presence of the Bad Actor and the details of such conviction or finding.

Potential for Fraud

Stop-Fraud-600A much more nebulous requirement is that funding portals must deny access or remove any issuer that it has a reasonable basis to believe presents the risk of fraud to investors. At first blush, this seems like we are asking funding portals to police the capital markets, but the regulations and guidance provide some clarity, stating that access should be denied if the funding portal is unable to assess the risk of fraud or if any information comes to light after the deal is posted and live on the funding portal. This is a pretty broad mandate and one of the biggest traps for potential funding portals, especially when you consider that all of these requirements will be contested in the wake of a fraud, when the “warning signs” become so “obvious.” The best way for a funding portal to protect itself is to have standardized diligence and disclosure procedures in place to which all potential issuers are subject. Requiring documents and asking questions goes a long way to ferreting out unscrupulous issuers. Importantly, when fraud occurs (and unfortunately it will), we must not be so quick to blame the gatekeeper and realize that the funding portal was likely duped just like everyone else. Even good processes can have bad outcomes, but the procedures must be in place.

Educational Materials

The new regulations require a laundry list of educational information to be provided to potential investors. While I do not think this is overly burdensome and, to the contrary, believe this is quite necessary, there is a lot of information that needs to be provided and funding portals need to ensure each item is addressed. Also, I see this as a potential point of differentiation among funding portals, allowing those who truly educate this new class of investors in an innovative and interactive way to rise to the top.

Compensation Disclosure

Fire Cook HotThis is a hot button issue for the SEC. The funding portal needs to clearly disclose how it will be compensated for the transactions on its platform at the time the investor signs up to use or opens an account with the funding portal. In addition, with respect to each deal, all fees and any equity (or other types of securities) that the funding portal is receiving from the issuer must be clearly disclosed. These multiple disclosures may seem like overkill, but the SEC is concerned with the compensation structure of funding portals and any conflicts of interest that may arise. The SEC wants to make sure that potential investors are fully aware of how the platforms are incented and compensated. Having the investor acknowledge in some way that they are aware of the compensation structure of each deal they invest in would be helpful to ensure compliance with this requirement.

Mechanics, Notices and Confirmations

There are many time-specific notices and confirmations that must be delivered to potential investors during the course of an offering such as when the target amount is reached, if a material change occurs and a reconfirmation is required, if the deadline is extended, etc. Funding platforms should utilize technology to automate this process from an efficiency standpoint, and also to eliminate any human error.

Registration

This is not a “hidden” trap, but this is a requirement that must be allocated ample time for compliance. Registration must be filed with both the SEC and FINRA and requires affirmative approval from FINRA. FINRA has not finalized its requirements yet, but prospective funding portals should begin preparing their infrastructure and internal procedures now to ensure they will be ready when the rules become effective.  Funding portals will be able to file their respective registration forms January 29, 2016 to start the review and approval process. FINRA has established a $2,700 filing fee for funding portals.

Written Policies

Duffy's Blunders Errors MistakesFunding portals must have written policies with respect to almost every aspect of their operations. This may seem onerous, but the SEC believes that written policies “provide important investor protections…[and] necessitate that funding portals remain aware of the various regulatory requirements to which they are subject and take appropriate steps for complying with such requirements.” These policies need to cover not just the basic mechanics of onboarding investors and issuers but also for example, the circumstances on which it may rely on the representations made by others, in what situations it will take further steps to diligence such information and the criteria it will use to limit, highlight or advertise issuers and their offerings. Having a formal set of policies accessible by all employees (and investors and issuers in many cases), mandatory employee training sessions and periodically reviewing and updating such policies will be essential for all funding portals utilizing Title III.

Record Keeping

This is one of the most important provisions and requirements for funding portals. The SEC is requiring extensive record keeping of all investors who purchase or attempt to purchase securities (not just completed transactions), all issuers who offer, sell or attempt to offer or sell securities and their control persons, all communications that occur on or through the platform, all records relating to the promotion of an offering using the platform, all records demonstrating and validating compliance with other sections of the regulations (such as the registration requirements), all notices provided to issuers or investors, all written agreements the funding portal enters into, daily, weekly and monthly transaction summaries, and a log reflecting the progress of each issuer as funds are received into escrow over the course of the offering. This is a huge amount of material, which must be “promptly” accessible for the first two years and stored for at least five years. The records must be maintained in the original, non-alterable format in which they were created. This will require significant infrastructure on the part of a funding portal and platform operators should expect to devote substantial resources to developing this functionality.

Secondary Markets

MarketA big open question remains with respect to a secondary market for crowdfunded securities. Technically they are freely tradeable after one year from the date of issuance, however, it is not clear and seems unlikely that funding portals would be allowed to establish a secondary market for securities issued on their platforms. Broker-dealers would be able to establish such markets, but state blue-sky laws may come into play, which could hamper the effectiveness of such markets. Many are concerned that allowing the securities to be traded will negatively affect the issuer by distracting it from its business, others feel that providing liquidity to retail investors is an essential part of the bargain. Regardless it is not certain that an efficient marketplace will materialize.

As you can see the regulations are extensive but manageable. This analysis is no substitute for detailed review of the rules and consultation with legal counsel, but hopefully, will alert potential funding portals to some of the issues they will face.  As I have said before, it is up to us to make crowdfunding work and understanding and complying with both the letter and the spirit of these new regulations is the first step.

READ Part 1: Potential Pitfalls of Regulation CF – Part I: Practical Concerns for an Issuer


 

 

Georgia Quinn National Press Club 2014 AGeorgia P. Quinn is the CEO and co-founder of iDisclose, an adaptive web-based application that enables entrepreneurs to prepare customized institutional grade private placement documents for a fraction of the time and cost. Heralded by Thomson-Reuters as a Top Female Attorney in New York City, she also serves as of counsel at the leading firm in crowdfunding, Ellenoff, Grossman & Schole, specializing in facilitating financial transactions and compliance with JOBS Act regulations. A foremost expert in corporate finance, she has worked on over $1 billion in business transactions over the course of her legal career. Prior to founding iDisclose, Georgia represented several Fortune 500 companies in financings for six years at Weil, Gotshal & Manges, one of the top ten law firms in the world, and then for over two years at Seyfarth Shaw, a leader in legal technology. As a globally recognized thought leader in the crowdfunding space, she has been a featured speaker at multiple conferences and has presented to such authorities as the Securities and Exchange Commission (SEC) and the American Bar Association (ABA).

Potential Pitfalls of Regulation CF – Part I: Practical Concerns for an Issuer

 

When SEC Commissioner Piwowar lodged his controversial “NO” vote for the final rules implementing Title III Regulation CF last October, he did so with concern that the overcomplicated rules were laden with “traps” that could snare an unassuming company trying to raise funds. Unfortunately, he was right and upon deep analysis of the new regulations, I have found several issues and potential pitfalls, of which the average small business owner or potential funding portal may not be aware. In my tireless effort to “make crowdfunding work” I have embarked on this two part series to highlight these issues and elucidate them, before they ensnare the unwitting entrepreneur. This first part Commissioner Piwowaraddresses issuers or those seeking funds through a crowdfunding. Part two will address issues faced by funding portals attempting to facilitate crowdfunding transactions.

Investment Limits

For individuals with a net worth or annual income below $100,000, the investment cap is the greater of $2,000 or 5% of the lesser of your net worth or annual income. The annual income and net worth can be combined with one’s spouse – but collectively the spouses can only contribute the maximum amount for an individual. The number of people, including highly trained and experienced securities attorneys, that get this wrong is staggering, and why not? This is a complicated formula with multiple disjunctive clauses that really only differentiates between people making between $40,000 and $100,000 a year or with a net worth in that band – so a scale of investment from $2,000 to $5,000. Do we really need all this complexity and potential for violation to prevent people from investing $3,000? Also, it doesn’t account for the expenses of those individuals. A single professional living alone certainly has a different slow investor limitsamount of expendable income than a mother of four, but that is not accounted for. It also doesn’t account for one-time pay increases due to a bonus or other events. Since this cap is ultimately arbitrary, why not at least make it simple to understand and easy to administer like a flat cap of $5,000? Then we do not have to worry about unwary issuers or platforms who take investments from people who lie about their income/net worth, inaccurately calculate their income or net worth (how do you even calculate this – is it at time of investment decision or time of close, assets netted against only liabilities that come due in the current year?) or simply don’t understand the rule because of its complexity. Regardless, hopefully we get some clarity on these issues or develop an industry standard for the calculation of these amounts to provide some comfort when accepting investments.

Beneficial Ownership

Understanding the ownership structure is essential to making an informed decision, however, the calculation of the beneficial ownership pursuant to new Regulation CF is no small feat and will definitely take guidance. The beneficial ownership should be calculated based solely on voting power, so you would not take into account holders of non-voting stock. What the release doesn’t say is that the analysis doesn’t end there. In fact, the calculation of Beneficial Ownership (note the capitalization of the term) also includes the owners of any securities convertible into voting securities within the next 60 days, so that includes option holders who may convert their options. Also, the way the SEC has generally required an issuer to calculate the percentage, is by assuming the conversion of the beneficial owner in question’s convertible securities thereby increasing the outstanding amount of voting securities, but not assuming conversion of any other beneficial holders’ convertible securities. However, it is not clear if the traditional method of calculation is what the SEC intended and thus, the calculation methodology is an open issue upon which we await guidance. Pretty complicated right? How is a small business owner supposed to know that?

Counting MoneyMaterial Changes

If during the course of the offering something happens to the business or its prospects that rises to the level of materiality, issuers will need to inform investors and ask for reconfirmations. This requires a level of judgment that issuers should be sensitive to and seek counsel.  Materiality is an issue that firms large and small struggle with. I have seen Fortune 100 companies spend days agonizing over whether something was material or not and thus required disclosure. This analysis often costs hundreds of thousands of dollars. Material information is information that would be useful to the average investor when making their investment decision. The issuer needs to think, would I want to know this before making a decision to invest in this company? If the answer is yes, then the Form C should be amended and the investors provided an opportunity to withdraw.

Ownership and Capital Structure

This short section of the release is deceiving. It seems to concisely require only a few items, when in fact it requires extensive and complicated disclosure. In addition to listing and describing each outstanding class of securities of the issuer, the issuer is required to compare and contrast them to the securities being sold in the offering. This is important to investors as they need to understand their place in the capital structure of the company, but this will require detailed analysis and disclosure of risks, which the six bullets do not suggest.

Risk Factors

Photo courtesy http://www.flickr.com/photos/pastalaneThe issuer is required to list “the material factors that make an investment in the issuer speculative or risky.” This is the exact language used in Forms S-1 and 10-K, that also require public companies to provide risk factors, suggesting a similar form of disclosure. In those types of filings, risk factors are basically a term of art and simultaneously formulaic yet highly customized to specific businesses. I have spent months working on a public filer’s risk factors, analyzing comparable company risks and crafting them to the specific business at hand. In addition, to fulfilling a requirement, risk factors also serve the comforting function of providing an insurance policy to the issuer. Unfortunately this is counterintuitive and most small business owners are not going to realize that it behooves them to list these risks, as they protect them from future lawsuits if any of the risks come to fruition. The entire concept of “risk factors” is completely foreign to a typical entrepreneur or small business owner who may not even know where to start. This is an area where I am working to provide a technology solution, but issuer’s need to take this section seriously and take advantage of the protection it can provide.

Related Party Transactions

This is a real potential trap for issuers. The release basically just asks that related party transactions be disclosed and even the Q&A form requests that all “transactions” between a defined set of related parties be disclosed. What the unwary issuer needs to be aware of, is that related party transactions again are basically a term of art and a way to describe transactions between the company and its affiliates or officers, directors, founders and their families. This can range from renting office space, to loans to licensing IP from or to certain entities or individuals that have a relationship with the company or its management. The point of this disclosure is to ferret our self-dealing and conflicts of interest. These are things that all investors want to be made aware of and can raise alarm bells if not provided with sufficient justification. Related party transactions may work to the benefit of the company and thus the investor, but regardless they need to be disclosed to allow the investor to make and informed decision.

mouse trap dangerIn addition to not explaining this concept at all, the rules also establish a false time cutoff. The rules require disclosure of all transactions with a value of 5% or more of the offering amount with a related party that is a related party as of the most recent practicable date but not earlier than 120 days from the date of filing the Form C unless otherwise material. In addition, the Q&A format only mentions transactions that have been conducted in the past year. I find this very confusing. First off, why not just disclose all related party transactions over a certain value as of the date of the offering? The issuer will know if it is intending to conduct such transactions, and therefore, can provide for them in the disclosure. These are private illiquid companies so it isn’t as though some unknown shareholder is going to come in and purchase more than 20% of the company just before the offering and the company won’t be able to determine if any transactions have occurred. Also, it isn’t clear when the cutoff for the actual transactions is – is it one year from the date of the offering? Finally, all of this is a red herring in my opinion, because related party transactions are inherently material. They are in essence self-dealing and conflicts of interest and should thus be disclosed. These arbitrary look-backs will give issuer’s a false sense of security when determining whether or not to disclose a particular transaction. Just because that loan the company made to the CEO took place over a year ago does not mean it doesn’t need to be disclosed. This is one of the most dangerous traps in these regulations in my opinion.

Other Material Information

As I have touched on in other areas, all required disclosures are caveated with the fact that any other material information not specifically called for must be disclosed. This is the regulatory premise of securities law—all disclosures must not contain material misstatements or omissions. Here is another potential trap in that issuers may simply look at all the requisite disclosures or the Q&A form, tick all the boxes and think they are finished. This is not the case and they will be on the hook for any information that they possessed and failed to disclose that an investor would find material in making and investment decision in the company. How can a company be sure that the statements it is making are adequate? This requires a thorough analysis and frankly some soul searching. They must put themselves in the shoes of the investor and think about what information they would like to know. Often the small business owners and entrepreneurs are the major shareholders of the company, so they need to think long and hard as the person wearing that hat and determine what information is necessary to purchase, hold or sell their securities.

Use of a Transfer Agent

The proposed crowdfunding regulations had an important provision that exempted crowdfunded companies from Rule 12(g) of the Securities Exchange Act of 1934. Rule 12(g) requires any private company that has over 500 unaccredited investors or over 2,000 accredited investors to become subject to the public reporting requirements of the Exchange Act. In essence, once a company passes the holder threshold, it will become a defacto public company subject to most of the burdensome reporting requirements but without any of the benefits of a publicly traded company. For a crowdfunded company with potentially vast numbers of holders this would not make sense, as their very success at financing would mean certain disaster due to the public reporting regime. Thus, the initial regulations, wisely excluded companies using Regulation CF from the reach of Rule 12(g). However, in the final rules, there is a catch. In order to receive the reporting exemption, the company must meet two conditions: 1) it must utilize a third party transfer agent and 2) it may not have assets in excess of $25 million. The second is a longer term issue, but this means that crowdfunding issuers must engage a transfer agent. The role of the transfer agent is to maintain the shareholder record and facilitate share transfers; in private companies this is often (wisely or not) handled by the company itself. I am in hopes that transfer agents sensitive to the capital constraints of these issuers will enter the market with their services, but regardless, companies need to add the costs of engaging a transfer agent into the offering cost calculus when contemplating a crowdfunding.

As you can see there are numerous issues that require attention in the final regulations. The devil truly is in the details. It is currently rumored that Congress is working on a bill to amend or fix these and many of the other issues or “traps” in Title III, but in the meantime, we must be aware of and work through these obstacles to make crowdfunding work. Stay tuned for potential funding portal foot faults to come.

 


 

Georgia Quinn National Press Club 2014 AGeorgia P. Quinn is the CEO and co-founder of iDisclose, an adaptive web-based application that enables entrepreneurs to prepare customized institutional grade private placement documents for a fraction of the time and cost. Heralded by Thomson-Reuters as a Top Female Attorney in New York City, she also serves as of counsel at the leading firm in crowdfunding, Ellenoff, Grossman & Schole, specializing in facilitating financial transactions and compliance with JOBS Act regulations.  A foremost expert in corporate finance, she has worked on over $1 billion in business transactions over the course of her legal career. Prior to founding iDisclose, Georgia represented several Fortune 500 companies in financings for six years at Weil, Gotshal & Manges, one of the top ten law firms in the world, and then for over two years at Seyfarth Shaw, a leader in legal technology. As a globally recognized thought leader in the crowdfunding space, she has been a featured speaker at multiple conferences and has presented to such authorities as the Securities and Exchange Commission (SEC) and the American Bar Association (ABA).

Orchard: Helping Marketplace Lending Investors Make Their “Pick”

angela ceresnie at Orchard

The marketplace lending industry has been above the fold lately, in particular the online platforms, borrowers and investors, but it is important to remember that the MPL ecosystem is made up of many other players. If you need evidence of this, just check out the MPL “Lendscape” slide available on Orchard’s website, which denotes around 200 entities and the function they serve in the industry. Orchard of course, is one of these “other” service providers, who is quickly demonstrating its value to investors, originators, and platforms. I was fortunate to sit down briefly with Angela Ceresnie, CFO and co-founder of Orchard, to discuss the industry in general and Orchard and her path specifically.

Welcome to OrchardPrior to founding Orchard, Angela was working in risk management for American Express and Citibank. She was crunching consumer and small business data and building credit models for these giants when she discovered the tiny marketplace lending market. She came across Lending Club in 2011 and was amazed that the platform provided here with all of the same data to select her own investments as she was used to analyzing for her employer. You can quickly see where this story is going when she met Matt Burton, her tech-savvy co-founder, who was similarly investing in Lending Club notes, and together they envisioned a scalable tool that could be used by investors to make credit decisions similar to what Angela had been making from an institutional level on a daily basis.

The trend was obvious—technology was disrupting every industry imaginable and finance should be no different. As they began researching the space, they realized that the needs of many investors (or potential investors) were not being served.  Originating platforms were developed with retail investors and borrowers in mind and weren’t providing institutional investors, such as hedge funds, family offices and business development companies, with the analytics they needed.

Orchard Lendscape as of July 2015

Today, Orchard fills that need by providing technology and services to institutional investors and asset managers who are providing capital by purchasing the loan products from MPL platforms. In addition, Orchard also provides market data, analytics, reporting of transaction executions and order management—Orchard does not conduct transactions or custody funds. Angela noted the positive trend that has developed, allowing the loan originators to focus on the needs of the borrowers, while Orchard takes care of the other side of the marketplace.

Angela explained that Orchard wants to make MPL frictionless, by using technology to provide all of the mechanics and reporting related to the investments made, much of which is still fairly manual and bespoke. In addition to Orchard’s investor products, about a year ago they started rolling out their “originator database” which helps originators better utilize data to make credit decisions and service their customers. The philosophy is that everything that is helpful to originators is ultimately beneficial to investors.

Although my time with Angela was cut short (due to NYC traffic), she graciously continued the Q&A with me below:

Georgia Quinn: How does Orchard collect the data it uses?

Angela Ceresnie: Orchard accepts data in a variety of formats. We can pull data from an originator if they have an API set up or data can also be delivered in a CSV via an SFTP.  Upon review of API specifications and structure of data provided, Orchard will develop and execute a roadmap for the integration and mapping of the data into our system. Our analytics, engineering, and product teams then conduct a thorough quality testing process for each new dataset, metric, table, graph or chart set to be included in an Orchard product.

angela ceresnie in officeGeorgia: How does it work? Do both investors and platforms/originators subscribe?

Angela: Orchard began as an investor-facing platform, offering order management, customer reporting, and analytical solutions to wide range of investor types. However, as the industry has matured, we’ve noticed an opportunity to create operational efficiencies on both sides of the platform, and now provide an increasing number of products and services to loan originators as well. We recently launched the Orchard Data Partner Program, which we’re really excited about. It offers qualified originators the ability to seamlessly and securely integrate their data with Orchard and streamline the process of data delivery to investors, prospects, or counterparties, along with a host of other benefits.

Georgia: What are you most proud of with respect to Orchard?

Angela: While I’m very proud of the business we are building, I’m perhaps most proud of the culture we’ve been able to cultivate at Orchard. Company culture is something that you would like to happen organically, and is does for the most part, but it’s also something that requires guidance and management. As a founder, it’s something that I take very seriously. First and foremost, the level of support and encouragement that permeates every level of the organization has greatly influenced our success and where we are today. We have also always maintained a forward-thinking mindset, a perspective that has really guided our decision making and has given us the greatest chance to execute on our long-term vision. Finally, we have a saying at Orchard, “seek the truth.” Fundamentally, it means that we strive to be honest, direct, and efficient in our thoughts and in our actions. Not only does this apply to how we work internally, but also how we interact with our clients and our partners and even how we build our products and services. Efficiency and transparency are at the core of everything we do.

Georgia:  What surprised you the most about starting Orchard?

Angela: Being a first-time entrepreneur is both frightening and exhilarating. As any business owner can tell you, there are certain things that keep you up at night – hiring, firing, competition, fundraising, and a million other things. All of the sudden, there are a bunch of people relying on you, trusting that you know what you’re doing, and it’s up to you to make sure the wheels don’t fly off.  Starting your own company can also be less than glamorous at times – in the early days, I’d spend the whole day coding models and then have to take out the trash at night – all in a day’s work.

Team OrchardIt’s also somewhat surreal that about two-and-a-half years ago, Matt, David, Jon and I were getting together at Spitzer’s Corner on the Lower East Side to talk about the nascent marketplace lending industry. However, I wouldn’t label it surprising given that the very reason that we decided to create Orchard was that we observed an emerging problem in need of a solution – institutional investors loved marketplace lending as an asset class but had no scalable system to use as a vehicle for participation. We decided to build that technology, and a lot more.

Georgia: Do you think Orchard will enter into any new offerings/business lines or just stick with data and services for MPL industry?

Angela: Orchard is always exploring new opportunities and ways to create value for clients on our platform. While we’re fully committed to providing investment managers and institutional investors the resources necessary to help them achieve their marketplace lending objectives, we’re also beginning to expand our line of products and services offered to loan originators. Not only is Orchard well positioned to deliver technology-enabled solutions to originators given its existing marketplace infrastructure, but building out the other side of our platform provides a host of benefits to our investor clients as well.

Orchard Lift OffGeorgia: Any 2016 predictions for the MPL industry?

Angela: Data standardization has been a big topic of discussion amongst industry participants as it attracts an increasingly diverse set of originators, financial products, sources of capital, and transaction types. Given these growing complexities, I think that we’ll see big strides made on development of clear standards in 2016. Moreover, I think that Orchard is uniquely positioned to play a large role in creating such standards given the wide range of industry participants with whom we interact as well as our experience in working with data and building scalable data processing technology.

All in all it was great meeting Angela and wonderful to see another savvy female changing the shape of finance.


 

Georgia Quinn National Press Club 2014 AGeorgia P. Quinn is the CEO and co-founder of iDisclose, an adaptive web-based application that enables entrepreneurs to prepare customized institutional grade private placement documents for a fraction of the time and cost. Heralded by Thomson-Reuters as a Top Female Attorney in New York City, she also serves as of counsel at the leading firm in crowdfunding, Ellenoff, Grossman & Schole, specializing in facilitating financial transactions and compliance with JOBS Act regulations.  A foremost expert in corporate finance, she has worked on over $1 billion in business transactions over the course of her legal career. Prior to founding iDisclose, Georgia represented several Fortune 500 companies in financings for six years at Weil, Gotshal & Manges, one of the top ten law firms in the world, and then for over two years at Seyfarth Shaw, a leader in legal technology. As a globally recognized thought leader in the crowdfunding space, she has been a featured speaker at multiple conferences and has presented to such authorities as the Securities and Exchange Commission (SEC) and the American Bar Association (ABA).

Will Indiegogo Into Investment Crowdfunding?

Slava Rubin

 

In the wake of the recent passage of the final rules implementing Title III of the JOBS Act and Regulation CF, Indiegogo has been on my mind. And why not, they are one of the leaders in the US crowdfunding industry, focused on rewards and donation-based fundraising and have made public statements regarding their interest in the investment crowdfunding arena—it just seems natural. Fortunately, I had the opportunity to sit down recently with Slava Rubin, CEO and co-founder, who provided a bit more color on the company’s intentions, though not as much as I would have liked.

INDIEGOGO STATS 2015When asked point blank what Indiegogo intends to do about investment crowdfunding, Slava said he would provide no juicy tidbits. They remain very interested in investment crowdfunding, after all that was their initial business plan.

In 2008, when Slava, Danae Ringelmann and Eric Schell first envisioned Indiegogo, it was as a capital raising tool that would allow for investment in the companies that were seeking support via an online medium. The term crowdfunding did not exist at this point—they just called it funding. Only after they were informed of the legal ramifications to such an endeavor did they settle on the perks and rewards-based model that is currently in existence. Offering a platform for investment crowdfunding would be returning to their roots in a way.

Indiegogo would certainly have a leg up on any competitors in this new space, as they have a deep well of experience in operating their platform for seven years, not to mention their extensive pool of potential investors. These elements are not lost on Slava, who noted they are currently weighing the pros and cons of Titles III and IV and what the new regulations could mean for their business.

Slava Juggles ApplesThe pros of investment crowdfunding are of course the ability to raise more capital for entrepreneurs and to allow funders to go from merely receiving a perk or product to owning a piece of the company. Thus benefiting both sides of their customer base. The cons are the extensive regulatory requirements, including the registration and comment process with Title IV, the expense for legal and accounting services, the time it will take to comply with the rules set forth and the potential liability to Indiegogo. Another concern is the decision whether or not to become a broker-dealer, which has a similar set of positive and negative consequences, but Slava noted that everything is on the table.

Wall at IndiegogoWhen asked specifically about the final rules for Title III, Slava stated that “overall the SEC has done a great job,” and he is glad that the rules are going to live and be out in the world. We share the sentiment that it is better to get the rules out and see how they work, rather than just have everyone sitting around pontificating as to the best way to do things. In practice, we will learn so much more, including what we don’t even know we don’t know.  He was glad to see the audit requirement diminished, as it was too onerous for small and startup businesses; he thinks the million-dollar limit is fine as is the restriction on transfer for the first year. He is concerned about the potential for platform liability, but at least we can take solace in that the de facto issuer level liability has been reduced to a facts and circumstances reasonable basis standard.

When asked if their flat 5% fee of funds raised model would be used in an investment scenario, Slava did not have an answer.

Amanda HatOn the issue of hybrid offerings, whereby an investor would receive not only equity in the company but perks or rewards as well, which again seems natural, Slava noted that was likely in the cards as they have had many backers who had expressed a desire to invest in the companies in the comments sections provided on the site. This is consistent with remarks made by Amanda Hat, Senior Director of Growth Innovation, at the recent NextGen Crowdfunding Conference, who remarked that merging both options just makes sense. Slava and Amanda both described the two kinds of investors expected to come to the platform if investments are offered. First the conversion of existing backers from donors to owners, and second, a new wave of people interested in the investment opportunity.

Stop-Fraud-600When asked about fraud, a common concern of critics, Slava noted that fraud is nothing new and fraud can exist in the donation and reward context as well. Indiegogo has developed algorithms that detect fraud in addition to alerts that are set up based on the data provided. Also, the crowd has been helpful in ferreting out fraud and bad actors based on their feedback and comments. Indiegogo would build on this legacy of trust and integrity to deter fraudulent activity.

Indiegogo has raised over $750,000,000 for entrepreneurs and ideas, they have over 130 employees in two offices, they operate in five languages and six currencies and reach over 100 countries, but they are waiting to see how the US investment market pans out before venturing abroad.

While it was great to have this brief window into the inner workings of Indiegogo, in P.T. Barnum style, Slava certainly left me wanting more. I eagerly await what he and the Indiegogo team have in store.


 

 

Georgia Quinn National Press Club 2014 AGeorgia P. Quinn is the CEO and co-founder of iDisclose, an adaptive web-based application that enables entrepreneurs to prepare customized institutional grade private placement documents for a fraction of the time and cost. Heralded by Thomson-Reuters as a Top Female Attorney in New York City, she also serves as of counsel at the leading firm in crowdfunding, Ellenoff, Grossman & Schole, specializing in facilitating financial transactions and compliance with JOBS Act regulations.  A foremost expert in corporate finance, she has worked on over $1 billion in business transactions over the course of her legal career. Prior to founding iDisclose, Georgia represented several Fortune 500 companies in financings for six years at Weil, Gotshal & Manges, one of the top ten law firms in the world, and then for over two years at Seyfarth Shaw, a leader in legal technology. As a globally recognized thought leader in the crowdfunding space, she has been a featured speaker at multiple conferences and has presented to such authorities as the Securities and Exchange Commission (SEC) and the American Bar Association (ABA).

Funding Circle is Creating Meaningful Change in Lending

sam hodges Funding Circle

At a time when some are claiming that marketplace lending has not gone far enough to challenge the traditional banking system, Sam Hodges and Funding Circle have quietly proven that steadily acting on your principles and advancing your mission, can achieve meaningful change. It had been over a year since I last sat down with Funding Circle’s Co-founder and US Managing Director Sam Hodges, so I thought it time to head to San Francisco and pay a visit.

Funding Circle is a marketplace lending platform that focuses on small business loans averaging around $130,000. When asked about Funding Circle’s non-radical tactics and lack of an all out assault on banks, Sam noted that banks play an important role in our economy as aggregators and custodians of deposits, however there is an important place for non-deposit based capital as well. In fact, Funding Circle has no problem being a lead generation tool for banks, as long at it helps accomplish their goal of providing fair financing to small businesses. That is Sam’s number one priority.

Funding Circle Better Finanical WorldLately, marketplace lenders have been getting a bad rap with respect to the treatment of borrowers and predatory lending practices. Sam noted that commercial lending (lending to businesses) is less regulated than consumer lending (lending to individuals). Smaller company borrowers get taken advantage of due to opaque lending practices, with the merchant cash advance space as the worst example – borrowers are charged astronomical daily fees which work out to a greater than 50% annual percentage rate. This is what Sam and Funding Circle are working against and why they and many other industry leaders have executed the Borrower’s Bill of Rights, to ensure that borrowers can make informed decisions in a completely transparent environment and are treated fairly. Pursuant to these principals, Funding Circle has helped over 12,000 small business attain the capital they need to operate and grow. Funding Circle’s global growth rate is 150%, and in the US they are growing at 300%. The average use of proceeds of the loans provided is for growth and expansion. The average default rate for their loans is 2-3%, which is in line with projections. The average loan size is around $130,000 with a term of one to five years and a rate of 5.5% to 22.7%.

sam HodgesWhen asked what Funding Circle’s greatest achievement in the past year was, Sam listed several things, including the growth of the business from $60M to a $250M in originations, adding an array of investment products from A+ to D risk profiles, the receipt of a $150M equity infusion to invest in more technology and talent, hiring a slew of top talent plucked from organizations like Amex, Salesforce and Barclays, growing to over 160 US employees by Q1 of next year and the purchase of ZenCap a German based small business marketplace lender with a footprint in Germany, the Netherlands and Spain, giving them a truly global presence. When asked about disappointments in the past year, Sam responded that he wished they had more product coverage to assist more businesses, such as equipment finance and commercial property finance, which is in the works.

Zencap becomes Funding CircleThe typical US borrower on Funding Circle is from one of 49 states (not Nevada, due to state regulations), has been in business for an average of eight years, has an average of  $1.7M in revenue, is from a multitude of industries that range from services to products to light manufacturing to logistics. The typical investor may be one of 40,000 accredited investors or an institution and is seeing returns upward of 10%. In the UK, Funding Circle can also cater to retail investors.

Sam stated that they have no desire to file a registration statement anytime soon – either for the loan participations they offer to investors or to conduct a public offering for the company itself. While they would love to be able to access a broader base of investors in the US, the cost-benefit analysis doesn’t justify the expense and risk. Plus, due to the recent capital infusion, they are not in the market for additional financing at this time.

US Department of TreasuryWhen asked about a trade association, which boggles my mind that the marketplace lending industry does not have one, Sam thought one would likely develop in the next year. A trade association could assist with addressing industry regulatory issues such as the Treasury’s request for information, to which Funding Circle submitted at 42-page comment letter. Sam noted the important issues are borrower and investor protections, access to and ownership of data and data portability. Since Funding Circle originates its own loans using its California lender’s license, Sam felt the recent Madden v. Midland Funding decision was not really applicable. As for the recent Title III crowdfunding regulations, Sam suggested it was a missed opportunity and not really helpful for most small businesses which are operated on a cash basis and require credit not equity financing.

When asked about the future, in addition to new product offerings, Sam is excited for securitization markets to provide a more permanent capital vehicle.  Funding Circle has taken steps to set up that model in the UK and are eyeing the US market for a similar move.


 

 

Georgia Quinn National Press Club 2014 AGeorgia P. Quinn is the CEO and co-founder of iDisclose, an adaptive web-based application that enables entrepreneurs to prepare customized institutional grade private placement documents for a fraction of the time and cost. Heralded by Thomson-Reuters as a Top Female Attorney in New York City, she also serves as of counsel at the leading firm in crowdfunding, Ellenoff, Grossman & Schole, specializing in facilitating financial transactions and compliance with JOBS Act regulations.  A foremost expert in corporate finance, she has worked on over $1 billion in business transactions over the course of her legal career. Prior to founding iDisclose, Georgia represented several Fortune 500 companies in financings for six years at Weil, Gotshal & Manges, one of the top ten law firms in the world, and then for over two years at Seyfarth Shaw, a leader in legal technology. As a globally recognized thought leader in the crowdfunding space, she has been a featured speaker at multiple conferences and has presented to such authorities as the Securities and Exchange Commission (SEC) and the American Bar Association (ABA).

Growing Up: Lending Club Has Been Tested, Survived & is Getting Bigger

 

Lending Club Office October 2015

It has been almost a year and a half since my last visit to Lending Club and my last interview with Renaud Laplanche its CEO. A lot has changed since then, but even more has stayed the same. Lending Club is now a public company, listed on the New York Stock Exchange. It has grown from around 500 to over 1,000 employees and has sprawled to requiring space in three San Francisco office buildings. What remains the same however, is the mission of the company, to make credit more affordable and investing more rewarding.

To date, Lending Club has helped over a million borrowers pay off credit card debt or avoid credit card (or other forms of) debt with a lower cost and more transparent product, the average interest rate of which is below 12% compared to above 17%. This is a meaningful savings all at a fixed rate with monthly payments.

One of the changes, is Lending Club’s foray into small business lending. Their initial focus has been consumer lending and when asked why the transition, Renaud explained that there was an unmet opportunity and he felt like the right thing to do was to apply technology to facilitate the underwriting process for small business loans between $50,000 and $300,000 which were too costly for banks to underwrite. Renaud has a direct connection to small business, due to his father’s ownership and operation of a grocery in the south of France. Renaud remembers accepting deliveries and stocking shelves in the morning before school. I find it interesting that two generations of Laplanches have built and maintained marketplaces, although for markedly different products.

Renaud Laplanche Lending Club Presentation

Because small business lending is less predictable, Lending Club is only offering the business lending product to institutional investors until they get the right metrics around it. The business lending market depends on the company’s own credit performance, as well as the current investor appetite and economic cycle adding more variables to the equation. Renaud concedes that the current economic cycle is probably closer to the end of this expansion than the beginning. Once, Lending Club better understands the performance of these new products, it will roll them out to its retail investors. This is the strategy that Lending Club employs for all new products.

Another change is the typical consumer borrower Lending Club is servicing. While it used to be the early adopter, late 20’s early 30’s, single or recently married, city dweller it has now become a more mainstream, older and more established borrower. Lending Club is gaining more brand awareness though word of mouth, which they measure by a net promoter score focused on the likelihood of a borrower to recommend their service. Renaud noted that Lending Club scores in the 70’s while most financial services companies score in the 20’s. Furthermore, the average for large credit card issuers is in the single digits. What has stayed the same however are the standards for borrowers, who still have higher than average credit scores of 700 and way above average income of $70,000 annually, which is the top 15% of the US population.

Renaud Laplanche Presenting

The typical investors have changed from individuals to institutions, marking the trend we have seen throughout the marketplace lending industry. When Lending Club started there were only retail investors, now they cater to high net worth individuals, family offices, hedge funds, pension funds, banks, insurance companies and other huge institutions. Many investors preferred to invest in a managed fund rather than pick and choose their own loans so Lending Club launched LC Advisors in 2011 to put together funds. Currently, the rough breakdown of investors is retail 20%, institutions 30%, and funds 50%.

In order to protect the retail investors from institutional investors cherry picking the better loans and gaining access to better information or products, Lending Club bifurcated the platform into the whole loan platform for institutions and the fractional loan platform for retail investors. Loans are randomly selected to be sent to each platform based on the social security number of the borrower, and there has been no difference in the performance of the loans (or the risk adjusted performance of the loans) on the two platforms since 2012.

Lending ClubWhen asked for his response to critics who claim that the marketplace lending industry is one economic downturn away from annihilation, Renaud noted that Lending Club had already survived one economic crisis. He continued that it was a fair criticism as most platforms have not been tested in down cycle, but that actually Prosper and Lending Club have been tested and survived with good data that although small, is statistically significant. In a severe crisis, when unemployment doubled, credit losses doubled and were 4% to 8%. Renaud explained that this is a scenario where the power of the low cost technology model reveals itself, in that the lower operating cost of marketplace lenders means more loss coverage for investors. The ‘08 and ‘09 loan vintages still had a return of 3%, and Renaud hopes that Lending Club is even better at underwriting today and can achieve even better results. Of course, some platforms will see more volatility, and more recent platforms that don’t have same amount of data and resources will fail.

ResponsibilityWhen asked about a recent New York Times article that accused Lending Club of predatory lending, Renaud laid out the facts that regarding one of the individuals in question who had taken out multiple marketplace loans and gotten in over his head, the first loan that person received was from Lending Club and not the later loans. The borrower was a CPA and first went to Lending Club and acquired a loan, then went to Prosper for the next loan and finally to Avant for yet another loan. Lending Club cannot prevent a person’s future actions and from assuming more debt, they can only be responsible in their lending process. Renaud noted that the key insight to lending is the ability to repay the loan and the MOST important metric is the debt to income ratio. Importantly, when Lending Club makes this calculation, they do not assume that any outstanding debt will be repaid with the Lending Club loan, in other words they do not assume a refinance of outstanding debt.

When asked about any disappointments since last we spoke, Renaud just generalized that everything takes more time than he would like. Most likely a common sentiment amongst CEOs of public companies and something too that will stay the same.


 

 

Georgia Quinn National Press Club 2014 AGeorgia P. Quinn is the CEO and co-founder of iDisclose, an adaptive web-based application that enables entrepreneurs to prepare customized institutional grade private placement documents for a fraction of the time and cost. Heralded by Thomson-Reuters as a Top Female Attorney in New York City, she also serves as of counsel at the leading firm in crowdfunding, Ellenoff, Grossman & Schole, specializing in facilitating financial transactions and compliance with JOBS Act regulations.  A foremost expert in corporate finance, she has worked on over $1 billion in business transactions over the course of her legal career. Prior to founding iDisclose, Georgia represented several Fortune 500 companies in financings for six years at Weil, Gotshal & Manges, one of the top ten law firms in the world, and then for over two years at Seyfarth Shaw, a leader in legal technology. As a globally recognized thought leader in the crowdfunding space, she has been a featured speaker at multiple conferences and has presented to such authorities as the Securities and Exchange Commission (SEC) and the American Bar Association (ABA).

Title III Crowdfunding: Talking About a Revolution

SEC Commissioners Announce Final Rules on Title III Crowdfunding

What took place this morning is nothing short of revolutionary. For the first time in the history of the Securities and Exchange Commission (82 years), retail investors (ordinary people without income, wealth or sophistication qualifications) will be able to invest in private businesses en mass. It is as simple as that. Until now, in order to invest in a private business, investors had to be qualified intuitional buyers, accredited investors, or limited in number (35 total) or within the confines of a Commissioner Aguilarparticular state. No longer! Today the SEC promulgated Regulation CF to give effect to Title III of the JOBS Act, originally signed into law on April 5, 2012. Now within the parameters set forth by the SEC today, companies can seek financing from ordinary individuals without subjecting themselves to the public registration process.

As Commissioner Aguilar reminded us this morning, small businesses create two out of every three jobs in this country.  Today the SEC leveled the playing field for small business to allow them to raise much-needed capital from a broader base in investors to continue to grow, create jobs and stimulate the economy. Crowdfunding advocate Douglas Ellenoff noted that listening to the SEC staff and commissioners discuss these new rules, “reminds us all of the powerful Doug Ellenoffpolicy reasons for enacting many of the provisions of the JOBS Act – to facilitate and ease the process by which entrepreneurs may solicit funds and increase their prospects, which will result in the financing of numerous American dreams and the creation of jobs.” To balance the risk of retail investors placing their money in the coffers of these private businesses, the SEC has placed investment limits on how much any individual can invest. This strikes the appropriate balance between the SEC’s twin aims of efficient capital markets and investor protection and paves the way for this new capital raising avenue.

So what exactly are the parameters of these new rules and how do they differ from those originally proposed? On October 23, 2013, the SEC proposed Regulation CF in a 585-page proposing release. As the length suggests the rules were extensive and had many impediments to the efficient functioning of retail crowdfunding.  After an extended comment period whereby interested parties were able to share their concerns and issues with the proposed rules with SEC staff members, the SEC adopted the revised rules we have today.

Commissioner PiwowarOf course there are still many opponents to retail crowdfunding, and we will surely hear their rhetoric in the days, weeks and months to come. State securities regulators may take issue as they have with Title IV. Such parties will cite concerns of investor protection and fear of fraud. Instructively, we can look to other jurisdictions, such as the UK where retail crowdfunding has been in effect with far fewer regulations for over four years, with an almost nonexistent rate of fraud.

rory eakinIn addition, there will be current market participants, loath to the upset the status quo. Or, like Rory Eakin, founder of CircleUp an accredited investor platform, those concerned that the new regulations will place an expensive regulatory burden on burgeoning startups trying to raise capital and potentially amputate opportunities for early-stage capital formation and liquidity. Even Commissioner Piwowar called the new regulations a “complex web” with a surprising “no” vote today and is worried that small business will be “spooked” from raising capital. However, importantly, and where we owe a debt of gratitude to the JOBS Act, retail crowdfunding is but one avenue of the JOBS Act trifecta that companies can utilize to fund themselves. No one is going to force a company to conduct a retail crowdfunding offering.  It will be the decision of the individual company and its management to conduct a cost benefit analysis of financing alternatives. Given the length and breadth of the adopting release, I do not believe that will be a decision made lightly.

Final Vote SEC Commission

Of course, there is the risk that Title III crowdfunding will attract only the worst or most risky investment opportunities that can’t access the Title II or other private capital markets. This is certainly a valid concern but unfortunately nothing new – retail investors have historically gotten the worst investment opportunities and worse returns than accredited or institutional investors. At least finally there is an opportunity to view potential opportunities in the light of day with the scrutiny of Commissioner Stein 3PNGthe crowd and appropriate investor limits. This is an opportunity to reorient our population with respect to investments and educate people about wealth creation and capital formation. Crowdfunding could be the gateway for retail investors into the broader investing community and asset classes.

Commissioner Aguilar noted another risk, that of the lack of a transparent secondary market for crowdfunding securities. The securities offered pursuant to the new rules will be freely tradeable after one year, however due to the potential lack of publicly available information and marketplaces, the secondary sales may be made without adequate price discovery and execution. This too, is a valid concern and something that the industry and the SEC should work to overcome.

Sebastian GomezThe main concern I am focused on, however, is that given the length and complexity of these new regulations, retail crowdfunding simply will not work. I share this concern but say this is lazy thinking. Congress and the regulators have taken a monumental step and instituted something that many thought impossible. It is now up to us to make it work, and by us I mean those who believe in crowdfunding—those who believe in the power of raising capital for small and startup businesses, those who believe in the power of wealth creation and educating the retail population with respect to private investment, and those who believe in using technology to help local stakeholders build community and economies. For those of us who believe and are ready to roll up our sleeves, figure it out and get to work, the revolution has begun.


 

Below are some of the key provisions of both the proposed and adopted regulations:

[scribd id=287922878 key=key-gkwzShQmSMJhFyyxxD8Y mode=scroll]


Georgia Quinn National Press Club 2014 AGeorgia P. Quinn is the CEO and co-founder of iDisclose, an adaptive web-based application that enables entrepreneurs to prepare customized institutional grade private placement documents for a fraction of the time and cost. Heralded by Thomson-Reuters as a Top Female Attorney in New York City, she also serves as of counsel at the leading firm in crowdfunding, Ellenoff, Grossman & Schole, specializing in facilitating financial transactions and compliance with JOBS Act regulations.  A foremost expert in corporate finance, she has worked on over $1 billion in business transactions over the course of her legal career. Prior to founding iDisclose, Georgia represented several Fortune 500 companies in financings for six years at Weil, Gotshal & Manges, one of the top ten law firms in the world, and then for over two years at Seyfarth Shaw, a leader in legal technology. As a globally recognized thought leader in the crowdfunding space, she has been a featured speaker at multiple conferences and has presented to such authorities as the Securities and Exchange Commission (SEC) and the American Bar Association (ABA).

 


 

¹I caveat this full well knowing that Regulation A has been available since 1936, however, I consider such registrants quasi-public due to the registration and approval requirements, and cite the utter lack of use of the exemption until the recent amendments.

Nicola Horlick: A Road Less Traveled in Finance

Thirty-two years after starting her career in London, Nicola Horlick is still often the only woman in the room. Although she notes that is not a lot of progress, it has never fazed her. Nicola, once called London’s Superwoman, attributes her can-do attitude to a supportive father who told her she could do anything she put her mind to. In fact, in the UK where Horlick attended school, she attended an all boys school from age four to 13. And since Oxford only started accepting women at the time she attended, her college years were basically at an all-male institution as well. Thus, she is never affected by being in an all male environment.

Nicola HorlickHorlick is very self-assured, many people interpret this as arrogance or a sense of entitlement, and she knows it, but Horlick is unapologetic in her confidence. Although married at 19 and with a first child at 23, Horlick entered the grueling finance industry. She started at SG Warburg and quickly found her niche in asset management. She became their youngest director at age 28. She was then headhunted by a firm called Morgan Grenfell (now Deutsche Bank) to turn around their wealth management, charities and pension business which had gone from £10B to £6B in the prior three years. After some personality and management style issues, Horlick was able to make the cuts and changes, such as merging management and research, that she needed to turn the performance to the opposite direction from £4.5B to £45B in the following four years. Even with this type of incredible performance, Horlick found herself on the firing line due to a fund manager scandalously losing money, her boss getting fired and a new inexperienced man being placed over her while she was on maternity leave. She came back early to try to sort out the situation but her style conflicted with the new boss and she was asked to resign. This situation was the first London UK Taxi Flagtime Horlick said she had ever experienced sexism. She was a 36-year-old woman, making large sums of money, in a male dominated environment, with five children, and being blamed and pushed out of a business she created, which all escalated to a major news story. Reporters began following her, and even though she had been asked not to enter the premises she wanted to air her grievances to higher management at the company. After being denied in London, she ended up traveling all the way to Germany (without a coat and with reporters in tow) to meet with the senior management of Deutsche Bank. By the time she got there people were waiting for her and she was able to meet with the global heads of human resources and legal.  The Frankfurt office put out a statement that they had discussed the issues with Horlick and were handling the problem, but the London office put out a statement that Horlick had resigned, full stop.

She chose not to bring a case for constructive dismissal, even though she was counseled that it would be successful, and instead went home and waited for the phone to ring with new opportunities, and it did. She went to Societe Generale (SocGen) and started a fund that rapidly grew to $12B in three years, and her equity stake was bought out by SocGen in 2001.

After tiring of traditional investment management, Horlick turned to more offbeat investments such as film, distressed funds, John Paulson’s hedge fund, certain real estate and other outside the box and slightly random opportunities. In 2008, after the death of her partner she sold her portion of this business and really launched into alternative assets and finance such as film development, small infrastructure projects, crematoria, pubs, care homes all using tax advantageous structures for high net worth individuals. She also set up Glentham Capital, a film finance fund, and says that we may see her at the academy awards in a few years time.

Nicola Horlick Money&CoIn 2013 she started Money&Co, a peer-to-peer lending platform for small business lending which now takes the majority of her time. It has grown quickly with 11 full-time employees and two part-time business development staff. After an upcoming third round of financing, she plans to hire six or seven more people. Right now they are focusing on small business senior loans and plan to move into the lease financing vertical in the near future, with a group of lease finance specialists that will soon be joining the team. Interestingly, the lease fund (comprised of UK leases) will be financed primarily by US banks and investors. As Horlick notes, there is a lot of US money finding its way to the UK market as there is too much money chasing too few deals.

As for the small business lending site, it works a bit like an auction, where the loan is originated with a first lien over all of the assets of the company, then the debt is sliced up into different instruments than can be bid on at different interest rates. Money&Co’s  credit team applies a rating to guide investors on what the range should be. The borrowers are required to be profitable companies and will only be lent twice annual EBITDA. This lower risk profile is reflected in average interest rates of 9%. When looking at the entire loan portfolio, 70% has been financed by high net worth individuals, 24.5% has been financed by the crowd (what we would call unaccredited investors) and 5.5% has been financed by institutions. Horlick stated that the institutional investors are on the rise, and is wary that they cannot be allowed to cherry pick the better loans over the members of the crowd.

Money&Co signHorlick says that differentiation of Money&Co really comes down to technology, especially in credit analysis. They use a process like an like an electronic sieve to pull in an enormous amount of data from APIs to Companies House (like our state secretaries offices), Experion and other sources, and then distil it into a workbook for the credit analyst. If the loan is less than $300,000, then the loan may be approved promptly. After completing the platform’s due diligence process, management completes  a site visit with each borrower. If the loan is approximately $750,000 or a transaction based loan, then the borrower must have both a site visit and be approved by the credit committee which is comprised of Horlick, her number two, the nonexecutive director, and the managing director.

They have lent over $11M in the past 15 months, but Horlick states that due to institutional appetite, we can expect rapid growth in this amount.

Some of the borrowers include engineering businesses (part maker, aircraft servicing, and manufacturing), food businesses (soups, coconut products), a business that coaches people to do public speaking, a company that provides legal documents (such as wills, etc.), a debt collector, a barber shop that caters to males ages 15-25 and has play stations for use and free beer while getting their hair cut, a company that manufactures and rents out large tents for big events and a company that tracks large sea bound vessels.

When asked about defaults, Horlick noted that since their launch 15 months ago, they have had one company miss a payment; she expected it to make its payment the following day. Some borrowers are asked if they will provide a personal guarantee of the business owner if it is deemed “asset light”. The average term of the loans provided is four years.

British Pounds Money £10Horlick decided to focus on small business peer to peer lending when she looked at the P2P space and noted that Zopa and others had already cornered the consumer lending angle. Small business lending was appealing, especially at the loan size Money&Co is doing (average $500,000), since there weren’t many other players in the space. Horlick feels this is relatively safe niche for Money&Co, but wants to do more. She envisions providing additional services to borrowers and moving into other verticals such as leasing, used car finance, intellectual property, specialty real estate, import/export finance and invoice discounting.

Horlick is also contemplating expanding into the US and is researching the best way to do it.  She states that her platform can support 5,000,000 users and is agnostic to industry and product verticals and jurisdiction. She said she will likely greenfield rather than acquire a preexisting platform.

As a final thought, Horlick mentioned Asia and stated that it is totally underbanked and flush with opportunity. She projects that the cash economy there may completely bypass traditional banking and go straight to using platforms.

For a woman with a long career in high finance, P2P lending may seem like an odd place to end up, but the road less traveled is certainly not uncharted territory to Horlick.


Georgia Quinn National Press Club 2014 AGeorgia P. Quinn is the CEO and co-founder of iDisclose, an adaptive web-based application that enables entrepreneurs to prepare customized institutional grade private placement documents for a fraction of the time and cost. Heralded by Thomson-Reuters as a Top Female Attorney in New York City, she also serves as of counsel at the leading firm in crowdfunding, Ellenoff, Grossman & Schole, specializing in facilitating financial transactions and compliance with JOBS Act regulations.  A foremost expert in corporate finance, she has worked on over $1 billion in business transactions over the course of her legal career. Prior to founding iDisclose, Georgia represented several Fortune 500 companies in financings for six years at Weil, Gotshal & Manges, one of the top ten law firms in the world, and then for over two years at Seyfarth Shaw, a leader in legal technology. As a globally recognized thought leader in the crowdfunding space, she has been a featured speaker at multiple conferences and has presented to such authorities as the Securities and Exchange Commission (SEC) and the American Bar Association (ABA).


Women Changing FinanceThis is part of a series of articles where Crowdfund Insider will be interviewing the many women changing the profession of finance today. In FinTech, crowdfunding and peer to peer lending, there are many female entrepreneurs leading or assisting innovative firms that are altering the process of capital formation around the globe.