Title III or Reg CF crowdfunding holds great potential to provide access to capital for smaller companies but also includes multiple shortcomings. The woefully small funding cap and the hobbled rules stapled on by regulators have created a securities exemption that is ok but could be way better. The Fix Crowdfunding Act, in its first incarnation, addressed most all of these challenges. As it stands now following its passage in the House of Representatives, the legislation falls short in fulfilling its goals.
One area that did make the final cut in the Fix Crowdfunding Act was the approval of SPVs (you may read more about it here). This is a partial “fix” but further changes are needed.
SeedInvest, a prominent investment crowdfunding platform, is moving forward to tackle these challenges without legislative assistance. The company is asking for help from a wider audience to “crowdsource” their proposed security structure the “Crowd Note,” a derivative of the 500 Startups KISS Note.
Ryan Feit, SeedInvest co-founder and CEO, is keenly aware of the characteristics of Reg CF and the concerns for a small company to have to manage many shareholders. Small firms should be growing their business – not spending time responding to every text and email from each shareholder. There is also some fear that follow-on funding rounds for Reg CF issuers may not be as amenable to VCs due to a bloated cap table. Feit has published an “Open Letter” to pitch their proposal and is asking for feedback to improve upon the Crowd Note structure.
The letter by Feit, and his call for assistance, is republished below.
One of the biggest early challenges to Title III equity crowdfunding adoption has been startups’ concerns about lots of small shareholders. As a result, we are proposing a new security designed by the crowd and for the crowd. Given that crowdfunding is by definition a type of crowdsourcing, we thought it was only appropriate to crowdsource the Crowd Note.
Title III of the JOBS Act opened the door for startups to fundraise online by raising small amounts from lots of people (ie. Kickstarter with Equity). It is still early days but one of the biggest headwinds slowing down the best companies from utilizing equity crowdfunding with non-accredited investors is what we call cap table concerns. We believe the industry needs to adopt a new type of investment security for startups which alleviates these concerns head-on in order to speed-up adoption of Title III equity crowdfunding by the very best startups. We edited the 500 Startups KISS Note to get to a first draft but we need your help to improve it.
Current Title III Structural Challenges:
- Managing hundreds of small shareholders can be potentially burdensome if you need to solicit shareholder votes or provide information on a one-off basis.
- VC firms might be nervous about investing in a startup which has hundreds of equity shareholders on its cap table.
- Companies with 500+ non-accredited shareholders of record and $25 million of assets could be forced to comply with onerous public company reporting requirements.
Goals of the Crowd Note:
- Modify the typical convertible note so that the crowd does not automatically convert to equity shareholders (and therefore may remain off the company’s cap table).
- Give the company the ability to keep the note outstanding until an exit while ensuring the crowd locks-in the same price per share they would receive with a typical convertible note.
- Minimize voting and information rights so the crowd does not interfere with the company’s operations but ensure that smaller investors have the same economic terms as larger investors.
Key Current Features:
- Company may extend or convert the Crowd Note at its option upon each qualified financing.
Investors lock-in the conversion price per share of the initial qualified financing and preferred stock, even if the note ends up converting later.
- Investors receive at least a 2x acquisition premium if an acquisition occurs prior to initial qualified financing (investor protection against an early exit).
- No voting, information or inspection rights. To the extent investors are required to vote by law, investors automatically agreed to vote with the majority of the preferred.
- Valuation cap and discount but no maturity or interest rate; enables startups to potentially keep the note outstanding longer, past the initial qualified financing.
The industry needs your help. Attorneys, platform operators, entrepreneurs, angel investors and VC friends- we could especially use your input. This first draft was not done by lawyers so tell us what we got wrong. Together let’s develop a new security the entire equity crowdfunding ecosystem is proud of. Let’s develop a Crowd Note which appeals to investors, entrepreneurs and VCs alike. You can review and comment on the note here and we will publicly recognize contributors when we release the final version.
Let’s make crowdfunding great again,