You have some well-known experience raising capital during your time as CFO of FLAVORx. How did the current regulatory environment affect your efforts (positively or negatively) to raise capital for your company?
Prior to the collapse of the financial markets we were
operating under the status quo environment of Regulation D and what
the banks loans, credit cards and home equity lines afforded us for
growth/expansion capital. I was fortunate enough to have a business that
was cash flow positive (mental note – want to raise money, have a cash flow
positive company. Investors will throw money at you). While the
burden of the regulation (hiring lawyers at $50,000 pop to raise $750k) was
required, the capital was available. There also wasn’t any other choice.
You HAD TO find lawyers (time and effort), you had to HIRE them (cost)
and you had to follow all the statutory requirements including individual state
filings (Blue Sky laws) for each state where you had an investor. While
it was a nuisance, it was the process and neither I nor any of my peers argued
with it. I was able to do 3 rounds of financing and even sold the company
in 2007 in the private capital markets. (Please note, we SOLD, we didn’t
IPO. Many companies just like ours follow our path of growth and
strategic sale. There’s plenty of money to be made for investors in this
type of non-ipo strategy). That all changed with the collapse of the financial
markets in 2007. While the burden, cost, etc. were necessary before, now
those providers of capital disappeared. So we (entrepreneurs, aka our
nation’s job creators) were left sitting in a room going, “did they just
realize that they cut the funding off to the people that are supposed to create
the jobs to get us out of this recession?”
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| Woodie Neiss |
Investor protection was considered in everything we
did. For instance, the $1M cap on entrepreneurs was put in there because
while it would solve the funding void problem it would restrict any potential
fraudster from taking off with more than that amount.What did you experience during that process that led
you to become involved in crowdfunding?
It was that shock coupled with my trying to go out and
start a company in 2010 after winning a business plan competition that forced
me to address this issue head on. I won the plan and went to all the
traditional sources I received capital from before; my bank (don’t loan unless
you have 3 years of financials), my home equity (disappeared – i live in Miami
and with the crash was 60% underwater on my mortgage), my credit cards (they
slashed the credit and raised the interest rates – skip that), my private
equity investors (we don’t invest in companies like this – seriously? you
invested in me before? I thought it was about the people???). Realizing
all the excuses around me, I was venting my frustrations with my
entrepreneurial peers Jason Best and Zak Cassady-Dorion. Turns out they
too faced the same problems. Since we’d collectively probably spent over
$250,000 on lawyers raising capital prior to the collapse of the financial
markets and read all the documents, we clearly understood the rules.
They just didn’t relate to the internet age. We were also giving
money to entrepreneurs on Kiva and artists on Kickstarter. Why shouldn’t
we be able to use those same dollars to fund jobs in the USA? From there
we sat down and went right to each of the bottlenecks in the 80 year old
securities laws. We drafted the Startup Exemption
framework. Since I testified in front of Congress once before, I was
tasked with it again and made the first venture to DC.
To what degree was investor protection considered when drafting the Startup Exemption and/or the JOBS Act?
Investor protection was considered in everything we
did. For instance, the $1 million cap on entrepreneurs was put in there
because while it would solve the funding void problem it would restrict any
potential fraudster from taking off with more than that amount. The all
or nothing cap was put in there to deter fraudsters from trying because they
knew they’d have to hit 100% of their funding target or no money would hit
their greedy hands. The background check was mandated because isn’t it
obvious that we should weed out bad actors up front (turns out we were the
first ones to put such a thing in legislation). The caps on investors
were put in there to protect them from going over their heads, and the investor
education was put in there so people would be forced to understand the risks
they were taking. Yes, we thought “you don’t have to take an education
class when you buy a lottery ticket or when you land in Vegas, but the world
looks at investments differently and so should we.” Everything from
disclosures to SEC registered websites were considered as investor protection
mechanisms.
Investment crowdfunding has largely been characterized
as deregulation in the media, and to be fair there are certain rules and
requirements that will be loosened to make crowdfunding possible. However, this
week you referred to a process of “re-regulation” in the implementation of
crowdfunding. Can you expand on what you meant?
Deregulation is throwing out the process. Re-regulation
is adapting the process to the times. Crowdfunding is about bringing the
securities laws to the Internet Age to allow the SEC to do its job better
(investor protection) while allowing capital to form (flow). We don’t get
rid of disclosures. We mandate that they are there and uploaded on
SEC-registered websites. This forces a digital footprint so that if
anything goes wrong we can go back and look at the documents and easily find
who is responsible. Re-regulation is the process of forcing the
transaction which was taking place behind closed doors before to take place on
SEC-registered platforms so we can see who is asking for money, how much, who
is funding them and if they hit their funding target. All of this
information was unknown before. Finally the SEC can/will know
what is happening in the private capital markets. Knowing what is
happening will force transparency. Re-regulation is requiring
entrepreneurs to take an investor education component prior to investing.
Re-regulation is mandating audits for raises over $500k (never existed
before). Re-regulation is forcing a background check prior to anyone
investing. Re-regulation is allowing technology (social media) to do what
it does naturally (topple dictatorial governments) in a process that is opaque
(capital formation). It is about allowing the crowd via social media to
pick apart an entrepreneur, their business, their revenue model and their
valuation in a public forum prior to investing. There is nothing
more transparent than social media coupled with capital formation.
Try pulling the wool over 1,000 eyes and you will get busted.
There are numerous private companies queued up whose business models are based on an effort to improve investor education, disclosure and transparency around crowdfunding offerings. How important do you think this ecosystem of service providers will be to the health of the crowdfunding industry?
It is part of the backbone of the ecosystem. The
only way we will have an efficient marketplace is with companies like this that
can help the crowd to dissect information. Translate it into a form they
will understand and build tools to make them smarter investors. The end
result? We will demand these same tools for the public markets. And
I’d argue that would be a good thing.
There is nothing more transparent than
social media coupled with capital formation. Try pulling the wool over
1,000 eyes and you will get busted.
There seems to be a prevailing assumption that
investment crowdfunding will be dominated by startups and early-stage companies
with little to no history on the books. This has been at the root of
much of the concern about investor protection. Do you think startups will
dominate investment crowdfunding?
Absolutely not. The majority of businesses that
use Crowdfund Investing will be Main Street businesses. Why do I know
this? Because I was talking to the Western Association of Chambers of
Commerce a few weeks ago and after the talk they came up and told me we just
solved the number one problem facing all their constituents, where to find
capital. This isn’t about finding the next Facebook (although they will
be crowdfunded), it is about letting businesses that exist in communities all
across the USA have access to capital that will keep both them and the jobs
they create alive. Startups will play a role but you will see them come
out of universities, tech centers, incubators and the like. VCs will
force startups to prove there is customer validation for their product prior to
them getting involved by forcing those companies to crowdfund, because they
know their vested interest in the funded company is the same as those customers
who decide to put their money where their mouth is and pony up a few dollar to
invest in the company at its early stage.
To what extent do you expect a need to iterate on crowdfunding’s rules? Are you concerned about the SEC’s ability to respond quickly to an evolving marketplace?
I believe the legislation is very baked and that the
rules don’t need to be complicated. We provided limits, caps, actual
details about disclosures, etc. The SEC should move quickly to get this
going. There is nothing to limit them from making adjustments as they see
fit later on.
I’ve written in the past that crowdfunding stakeholders such as yourself have perhaps the most to lose in crowdfunding’s worse case scenario. What is your confidence level when it comes to crowdfunding’s eventual success as a means of capital formation?
I sincerely believe we are on a global movement.
Why? Because we are now engaged as partners with the US State
Department to promote crowdfunding as a policy to promote entrepreneurship
because that creates jobs, and we’ve been engaged by the World Bank to help
them understand how developing nations can leapfrog developed nations (just
like they did with the phone by going right to mobile phones) by implementing
regional crowdfunding ecosystems. This isn’t new. Crowdfund investing is
friends and family financing. All we’ve done is applied technology to
facilitate the transaction. To say it will fail is to say that we don’t
have faith in humans. And I just don’t believe that.
First published on Crowdfundinsinder
