No-action letters are not laws or rules
When the SEC takes a "no-action" position in
a letter to a company or individual, it isn't actually making a rule that has
the force of law. In fact, technically speaking, the SEC itself isn't acting,
or not acting. Instead, the letters express a sense of SEC staff, who, when the
"no-action" request of a company is answered positively, say:
"Based on the facts and representations set forth in your letter, and
without necessarily agreeing with your conclusions and analysis, the Staff will
not recommend enforcement action." That exact quote appears in both the
FundersClub and AngelList no-action letters.
No-action letters are always fact-specific and are
always conditional. Indeed, both the FundersClub and AngelList letters
expressly state that the SEC staff might modify or revoke the position "at
any time the Staff determines that such modification or revocation is
consistent with the public interest or the protection of investors."
FundersClub as retail VC
What FundersClub's
no-action letter signals is that FundersClub can legitimately rely on
the kind of legal exemptions that permit VCs to set up and manage venture
capital funds without registering or being regulated as broker-dealers. All
while conducting its business online and "crowdfunding" the
investment dollars.
Unlike a typical VC firm, however, FundersClub
stipulates that it will not charge a management fee for the investment funds
its management arm will operate. Eschewing the typical "2 and 20,"
where a VC firm charges an annual fee equal to 2% of funds under management and
takes a 20% backend carry (or interest in the profits of the fund), FundersClub
tells the SEC staff that it will take only the backend carry. Moreover,
FundersClub discloses that it may increase the size of the backend carry, on a
case by case basis, to as much as 30% of a given fund's profits.
AngelList and the power of curation
AngelList's request for a no-action position
(contained within the AngelList
no-action letter) lays out a model where AngelList might also
facilitate the setup and management of startup-specific investment funds, not
unlike the FundersClub vehicles. But in AngelList's proposed model, the
attraction of the given investment opportunity would be in how it leverages the
skills and experience of a "Lead Angel," who would pick the given
startup and might structure and negotiate the terms of the deal. The Lead Angel
might also provide hands on assistance to the startup, post-investment.
As does FundersClub with respect to its model,
AngelList stipulates that its new, Lead Angel-centric fund model will not
involve a management fee, but instead will restrict compensation to a backend
carry. In AngelList's case, the carry would be shared between an affiliated
AngelList company, AngelList Advisors, which will register as an investment
adviser, and the Lead Angel.
The strings attached
What are the limits of the FundersClub and AngelList
no-action letters as precedent for other platforms?
First and foremost, neither AngelList nor FundersClub
are relying on investment crowdfunding under Title III of the JOBS Act, the
implementation of which true believers in the democratization of private
financing are anticipating with high hopes (in vain, in this writer's opinion). No,
FundersClub and AngelList restrict the investment opportunities they facilitate
to accredited investors, angels, in order that their startups may rely on the
Rule 506 exemption that has been the legal linchpin for angel investing in
America for decades.
What's next for everyone else?
Committing to take only a carry is a true kind of
co-investment - if in time and opportunity, rather than cash - and, as I said
above, it is admirable. But a 100% dependence on a carry can't be the only
model for all angel crowdfunding platforms, and the nascent industry is going
to need to see other precedent develop around the shiny new exemption provided
by Section 201(c) of the JOBS Act.
Moreover, given all the restrictions imposed by Title
III of the JOBS Act for crowdfunding platforms that desire to be open for
non-accredited investors, there may be very, very little in the FundersClub and
AngelList models to imitate. (Aside: I think the future for non-accredited
investment crowdfunding law is in pressing state legislatures to pass simpler,
straightforward intrastate exemptions. See this crowdfunding
bill introduced in Washington State by Representative
Cyrus Habib, inspired by a post in
GeekWire by Seattle startup attorney Joe Wallin.)
