Recently, CI reported that Silicon Prairie had exited its status as a Funding Portal. A Funding Portal is a relatively new FINRA-regulated intermediary created under the JOBS Act of 2012. Initially viewed as a path for firms to issue securities under Reg CF, most Funding Portals expanded into other private securities exemptions. At the same time, Broker Dealers were allowed to issue securities under Reg CF. Today, some online capital formation firms are broker-dealers with several having made a similar decision to cancel their Funding Portal status.
Silicon Prairie is a multi-faceted platform based in the Midwest. The company not only enables firms to raise money online but it also licenses its technology to other firms in the securities crowdfunding sector.
CI connected to founder and CEO David Duccini to better understand his decision to exit the Funding Portal business and his expectations for crowdfunding going forward. Ducinni also shared his extensive experience in dealing with FINRA, a hybrid regulatory agency that has been criticized by some insiders for its heavy handed activity and that it claims to be an SRO [self regulatory organization] while not being inclusive of firms it claims to represent. Some policy experts would like to see FINRA rolled into the Securities and Exchange Commission.
Our discussion is shared below.
You recently exited your Funding Portal status. Can you share why you decided to do this?
David Duccini: We had dual registrations as both a Funding Portal and a Broker Dealer. We were paying double the membership fees and getting double exams for less than zero return. This [change] allows us to offer a unified issuer experience, especially for co-offerings under REG-CF and REG-D 506C.
And, honestly, the quality of the FINRA staff in the Broker-Dealer side of their house is much higher than the Funding Portal group, where there seemed to be a high level of staff turnover and nearly zero ability to interpret and apply the rules across funding portals consistently. They would tell us we could not do something when I could point to four other (top) platforms doing the exact same thing in the exact same way. We have literally sent random individuals there the same documents dozens of times. Lastly, it’s exhausting to provide free education to new staff.
When you learn that FINRA derives over 80% of its revenue from fewer than 35 firms (out of about 3,000 members), you’ll understand why it has a disdain for small firms and funding portals in particular.
We paid $1,200 per year for our membership, and I’m certain they have spent over $100,000 on endless exams where there has been no investor harm. You cannot run a business like that, especially one that purports to be a non-profit! It likely explains why FINRA has a reputation for “enforcement” because their payroll is not sustainable, and it is a conflict of interest to reward employees as part of the settlement.
The incoming administration, in addition to moving to potentially abolish FINRA, has also stated that, at a minimum, those fines should be remitted to the US Treasury or held in a fund to compensate investors.
How does shifting offerings to your Broker Dealer help your platform and issuers?
David Duccini: The reality is when we first engage with an issuer they really do not know what exemption(s) they might end up using. It is highly consultative, and we had to triage it in our holding company before assigning the work to either the BD or the FP (or both). We have an issuer right now who is doing a dual Reg CF and Reg D, as well as having engaged our Broker Dealer for an institutional raise, so having that relationship managed by the BD streamlines our contracts and servicing.
You are also doing Crowdfunding as a Service. Can you share some insight into that?
David Duccini: We have long held the position that we do not have competitors. Rather, we have “contemporaries.” In fact, our original 2016 business plan recognized that running a funding portal would likely not support more than a “skeleton crew,” and we were right about that!
Our hypothesis was that we could likely provide our platform and expertise to others in the space. Today, we power a dozen portals, broker-dealers, and angel groups who are either using our full web stack under private label or via API. We have contracts with a half-dozen more rolling out in Q1.
I often joke and say, “I’m a Fintech nerd who accidentally became an investment banker!”
At this stage, we have collectively handled more exemptions and more security types than anyone else in the business. We recently picked up a number of former Mainvest issuers and are now servicing their Revenue Share Agreement repayments.
One of the key advantages of having a Transfer Agent affiliate is the ability to establish master treasury agreements with banks to offer escrow and lock-box services. This, combined with our transactional API, means nearly automatic rolling disbursements via ACH on a daily basis!
It is a privilege to be able to observe the transactional volumes. For example, we know from handling angel groups that your average check size per angel investor is closer to $5,000!
You have an ATS [alternative trading system]; what are your plans for secondary transactions?
David Duccini: We have built a very founder-friendly secondary market system that requires permission to gain access and can enforce rights of first refusal. Issuers decide who can come onto their cap table and under what conditions.
As restricted securities, there is no trade-reporting, and the issuer can elect to disable all precedent sales data. Obviously, an investor could get some price discovery by looking at the open bids and asks, but the issuer does not have to worry about the optics of their valuation, which is often problematic for OTC companies. We also do not allow short sales.
We are lighting up our first issuer this month, a group that has done multiple Reg-CF offerings over the years who wants to provide its early investors with some path to liquidity, some of whom invested as little as $100. One of the really cool features of our system is the ability to revoke access after an investor liquidates their position. This means issuers can use our secondary market to “de-frag” their cap tables! A new investor might be required to buy a larger block size just to get in. Issuers must have a transfer agent that can work with our system.
While the ATS does not have “market makers” standing by to fill orders, we believe that the issuer themselves could offer a kind of “floor stabilizing bid” in their market. In fact, I predict that issuers will start using a “carve out” in new offerings to provide that liquidity. You see it now in Reg A+ offerings where something like up to 30% of the funding goes to selling shareholders. So, in the near future, I could see a Reg CF issuer pledging to commit 10-20% of the new funds to be used to buy back securities in its secondary market, likely at a discount.
What needs to be improved for online capital formation to thrive? Do the exemptions need to be fine tuned? Tax exemptions enacted? A change to the Accredited Investor definition? How can this industry scale?
David Duccini: The first fix that needs to be enacted is to remove the requirement to have the firm’s financials reviewed for amounts up to $1 million. This would align Reg CF with most intrastate exemptions. A review or even an audit is by no means any kind of “insurance” policy on the offering. Few people even click on them in the portal because they are not primarily investing for financial reasons, and many issuers are simply forming brand-new entities that have no financial history to review or audit. Therefore, it’s not in any way improving investor protection.
I’m not a fan of “wealth transfer” and the so-called “angel tax credits” that have disproportionately rewarded the wealthy.
Better yet I think more businesses should consider Revenue Share Agreements with simple multiples like Mainvest offered.
The definition of an accredited investor is probably unconstitutional as money is a matter of free speech. It is offensive that I can go and buy a $10,000 wedding cake, but I might have to ask for permission to invest $10,000 in the bakery so that it can expand and open a second location.
A means test based on income and net worth is ridiculous and has zero actual utility in determining if someone has “financial fitness” literacy or not. It is not the government’s place to tell consenting adults what they can and cannot do with their own money. Not a single investor has hired FINRA to “protect” them, and I consider their insinuation that they do as false advertising.
For the industry to grow, it is going to require more broker-dealers to offer online capital formation, and for funding portals to actually run a viable business, they will have to either become broker-dealers or simply register with one in order to earn success fees on Reg-D’s and A’s. We are talking with a number of our portal-as-a-service clients right now about the opportunity to register with our firm while still maintaining their independent brands.
Lastly, the ceiling needs to be raised to $10 million or $25 million in order to attract more quality micro-cap issuers.
As you know, multiple platforms have shut down, been sold, or are simply doing little business. Where do you see the industry heading?
David Duccini: I think the bloom is off the rose.
This industry would have likely collapsed had the ceiling not been raised to $5 million, as it was, and still is, the highest-cost capital option available.
Every new business goes through a boom and bust cycle. Consolidation is at hand.
When I first met Sara Hanks back in 2018 at the Securities Transfer Association annual conference, in her presentation, she predicted that there would only be room for maybe a dozen portals. I think now that might even be a generous number.
The problem has never been one of technology. It is the officious regulatory apparatus that is choking the life out of the otherwise earnest founders who are trying to make a go of it. It is also not about flashy websites. Investors are looking for a fast “checkout” process. Operating a Funding Portal is little more than being a licensed bill pay service provider, and a number of the portals, past and present, have spent obscene amounts of other people’s money chasing vanity and hype.
We as an industry need to have more honest expectations set with issuers that platforms do not control investors’ eyeballs or wallets.
Many of the so-called top platforms are outright lying to issuers about their user/investor base sizes and transactional volumes when we know that 99% of all investment activity is a one-time event because the investor already knows, likes, and trusts the issuer. All fundraising, from selling cookies door-to-door up to raising capital for a venture, is the SLOW conversion of social capital into financial capital.
That’s why Silicon Prairie is all in on “private label walled-garden landing pages” on our client’s own domain names and why we are investing heavily in WordPress plugins to allow for a truly “self-hosted” experience. Nobody brags about which ISP hosts their website, after all.
I think we’re going to see the pendulum swing on the use of SAFEs — especially, if the issuer has already issued one.
It was never meant to be a terminal security, and most people are “wagging the dog” by touting the YC origin story but without having the benefit of going through their program where the focus is actually on raising and converting it as soon as practicable.
A SAFE in an SPV is about the dumbest investment anyone could ever make, and I do not recommend investing in anything where the word “phantom” appears in the subscription agreement.
We think a superior option is a Simple Agreement for Future Exchange Plus Repurchase or a “SAFE+R” that uses time as the conversion factor. For example, we’re offering a “36/36” agreement where our investors give us up to 36 months to hold a priced round (likely under Reg A+), OR they can individually elect to get repaid their principle over the next 36 months. By entering a repurchase or “repo,” they forgo equity upside but move the debt side of the balance sheet and would get a liquidation preference. After all, “An investment without an exit was a donation!”
I think we’re rapidly racing towards a tokenized asset future where fractional ownership interests can be verified and fungible with good liquidity options. I envision a world where I could offer a kind of reverse mortgage on my own house, selling off up to 49% ownership interest in it today for the cash and then the investors getting the long-term gains when I sell. Imagine the impact that would have on “aging in place” and improving the quality of end-of-life for untold millions of baby boomers whose largest asset is their house.
Lastly, I would not be surprised to see the SEC and CFTC merged with the leadership change coming into the White House and the role of FINRA largely eliminated save for servicing their top 35 clients. At a minimum, a competitor SRO is on the horizon as the middle can no longer HODL.