Equity Crowdfunding: A Ticking Time Bomb

Investing in startups is now open to non-accredited investors, but have we created a system that is doomed to fail?

On May 16, 2016 Title III of the 2012 JOBS Act’s Regulation CF came into effect. This law enables startups to accept investments from non-accredited investors through licensed online portals. This was great news for both startups and consumers looking to strike it rich and invest in the next Facebook.

Everything sounds great, but this structure has eliminated a lot of the safety measures that allows venture capital funds to achieve their impressive returns without imploding.

Deal Structure

With Reg CF being such a new vehicle, a standard deal structure has yet to immerge leaving a lot of investors lost. Some of the common deal structures being used are SAFE’s (simple agreement for future equity), Convertible Note’s and the standard equity round. With each of these deal structures there are thousands of different clauses that can completely change the quality of the deal. On top of this, does the investor get preferred stock, common stock, voting rights, liquidation preferences, or any of the other safety measures Venture Capitalists use to limit downside risk?

High Valuations

Equity crowdfunding is set up as a take it or leave it system when it comes to valuations. When the startup is able to set a valuation at whatever they please, of course it’s going to be unrealistic. Imagine trying to buy a house in a market with limited inventory and not being allowed to negotiate the price. The power of “you want our money and we want a fair price” is gone.

Due Diligence

Does your average non-accredited investor take the time to analyze the financials, the cap table, the exit strategy, the competition, the potential roadblocks? One negative in any of these could kill a deal from a Venture Capitalist perspective, so why is this information being buried on crowdfunding portals where it most likely will never be read or considered.

Lack of Deals

Hopefully a lot of the issues I mentioned above will be taken care of when there is an abundance of deals on each crowdfunding portal and the market is allowed to weed out the bad deals. Currently we don’t have that luxury, with so few deals being posted investors are treating them like a Kickstarter campaign where if the idea sounds interesting their investing, regardless of the deal terms.

Selectivity

Currently crowdfunding portals have no reward for pressuring the startups to offer fair terms. Crowdfunding portals operate as a registered broker dealer getting commissions around 5% on anything that is raised on their site. They have no motivation to screen deals that have a higher chance of success or limit the downside failure rate.

What is the Solution?

Standardized Terms

First of all, the industry needs to set some standards as far as how deals are structured. Limit the variables so investors can do some research and make better informed decisions without needing a law degree.

Holding the Crowdfund Portals Responsible

The crowdfunding portals need some sort of incentive to keep the deal terms fair for investors and create successful long term returns. Sites like Angel.co allow accredited investors to invest in syndicates that are led by respected individuals with industry experience. This syndicate leader invests some of their own capital in each deal but they also receive 20% of the profits retuned from each deal their backers invest in. This is a great model that allows somebody to truly vet a deal and potentially negotiate terms before recommending to their backers.

Voting Rights

Most deals currently do not allow crowdfunded investors to have voting rights. Understandably you don’t want to require startups to reach out to potentially thousands of investors that put in as little as $50 every time a shareholder vote takes place. This doesn’t mean that the votes of those shares should automatically go to the CEO. This could lead to difficulties attracting future venture capitalists or angel investors. The crowdfund investors need a single lead investor that represents the interests of all the investors.

I don’t think that equity crowdfunding should be turned into a form of mutual fund which can be very similar to the syndicate model. That takes some of the fun and excitement out of the entire experience of picking startups that you think have great ideas. The equity crowdfunding model does need either a lead investor for each deal or crowdfunding portals that negotiate the deals, that are looking out for the interests of the investors not their own commissions.

Without changing the process of how equity crowdfunded deals are handled, I fear that in a few years a lot of people will find out they invested in a lot of losing deals without any winners.

Pitch Deck Problems - Common Mistakes

I have reviewed pitch decks from experienced entrepreneurs, entrepreneurs who are just starting out, or anywhere in between. I see a lot of reoccurring mistakes made by entrepreneurs, some could even cost you an investor. Read on to see what the most common mistakes are and how to avoid them.

What do you do?

When I’m looking through a pitch deck I want to know from the start what your good or service is, and who is your intended customer. Before you start going over your great market and industry data or the taglines of problems customers face, I want to know why that information is relevant. By the time you are a third of the way through your deck, or 5+ minutes into your pitch, your audience shouldn’t still be trying to decipher what you do.   

Lack of visuals                            

One of the main reasons I like visuals is that they take up space. If there is empty space on a slide, too many entrepreneurs will take that space and fill it with an abundance of text. Another benefit of visuals is they make a message quick and easy to interpret. Simple is better, a picture is worth a 1,000, and any other slogan you can come up with; make it easy for your audience to comprehend your message.

Overly Wordy

Too much text is the most common mistake I see. As a reader, if I see a slide full of text all I’m going to do is skim the headlines. If the text is going to be skimmed over, why have it at all? The common push back I hear from entrepreneurs is they need all this text to fully describe their solution or all the text is necessary because investors should have every detail. Make sure you understand how your deck will be consumed and the amount of information needed for the stage of funding you are in.

If you are sending your deck via email to a potential lead, think of it as a movie trailer. The goals of a movie trailer are the same as the goals you should have for your start up pitch deck. A movie trailer gives the audience a general idea of the plot, who is starring in it, and leaves a bit of a cliffhanger, causing you to turn to your spouse and say “that looks really good; we should go see it.” You don’t need to explain every possible detail; the audience can connect the dots to some extent.

How are you different?


Simply put, if you just tell me your solution is an online video platform I will assume you’re a YouTube knockoff that doesn’t stand a chance. Competing against a dominant competitor is not something I would invest in without a major differentiating factor. 

Business Model

Often times the business model is the weakest slide in the decks that I see.  To me this is one of the most important slides. You may have a great idea, but I want to see that you have a way of making it a great business. I want to know who you are charging, how much you are charging, and what the profit is.

 

Outrageous claims

“Revolutionary”, “game changing”, “first of it’s kind”, “the next Facebook”, all buzzwords or phrases that hold not meaning or value. Along those lines I would add in hockey stick shaped growth or financials, and stating social media as a marketing strategy. My other pet peeve is using the term viral videos as a marketing tool because we all know every video posted on YouTube goes “viral.”

 

What do you need?

Give your audience a call to action, state how much capital you need, and clearly state how to get ahold of you if I want to learn more.

 

Make me want more

After reading a pitch deck I love when I feel like I stumbled onto something that has real potential. Don’t make it too long; I’m okay with being left with questions and wanting to know more at the end of a pitch deck. If you have me interested and excited about your solution, I’ll want to set a meeting to find out more!

8 Things Everyone Should Know About Venture Capital Funds

In providing funds to high potential early stage companies, venture capital plays an important role. The Money invested in an innovative enterprise in the form of a fund, in which both the potential for profit and the risk of loss are considerable is known as Venture Capital Funds. This type of funding has played a significant role in uplifting many companies such as Apple, Amazon, and Google. 

For a better understanding, these important points should be kept in mind. 

1. VC funders usually do not go for pre-revenue businesses. Hence it is not the first step of your business. You need to fulfill specific criteria to get your funds. 

2. VC funding has various stages:

A. When the company has a growing number of customers

B. The company makes sizable revenues

C. The company is mature and close to exit

You do not have to repay the VC fund, but Venture Capitalists do posses an equity share in your company. In addition to the financial capital, they also provide expertise, advice, and industrial connections. 

3. Venture Capitalists usually look to deploy millions and billions of dollars and they are seeking a return much greater than the amount deployed. They focus mainly on the size of the market; if the size of your market is small they likely won't invest. Hence, it is important for you to know the size of your market before going out for VC funds. 

4. It is important for you to understand the fund cycle. Funders usually do two "A" stage deals per quarter. If the funder has already done 4 "A" stage deals, it is unlikely they will do another. As a founder you should have knowledge regarding the funders per quarter investments. 

5. Venture Capitalists expect founders to use their network and get introductions. This negates three boxes 

  • Founder's understanding of how VC functions
  • To get the introduction and the ability to hustle
  • A trusted connection via someone who knows the founder

This reduces the risks of backing a business for both the founder and the venture capitalists. The deal comes with restriction and a compromise on the autonomy of the company.

6. You need to understand the funding process. Most funds approve funding through a partner meeting. During meetings, existing investments and new investments to be made are discussed. As a founder, your goal is to get that meeting and to get an approved investment for your own business. 

7. If a venture capitalist is interested, he will offer the founder a term sheet. The sheet covers the economic and governing terms of the investment. It usually contains valuation of the company, investor rights, board composition, option pool, voting rights, etc. Term sheets are complicated and will require lawyers to review and negotiate on them. 

8. Venture capital funds can act as a stimulus for your business. They increase the speed of your growth, which would have taken a long time while waiting for the revenues. It will also help you by funding a bigger sum in a smaller time.   

3 Tips for Picking the Best Startup Advisor

"Your work is going to fill a large part of your life, and the only way to be truly satisfied is to do what you believe is great work. And the only way to do great work is to love what you do." - Steve Jobs

Having an advisor who truly loves what they do and will be important to your companies success. Have you run into a few rough patches with your startup? Almost everyone does. Are you surrounded by advisors? Most startups are. Are the advisors offering the strategic, tactical advice that you need? It's important to find a startup advisor that works well with your business.

What Do We Want Right Now?

The complexity of launching a startup with success calls for a collection of advisors who will assist with making things happen. Whether it's a targeted introduction or a recommendation on user acquisition, be sure you recognize specifically what you would like from the advisor you are targeting. You may notice that the advisor isn't right for your company or that you would like to carry off on transferring them on board. 

What is the most effective and easy way to select the best advisor? Simply talk to them. The best way to judge a startup advisor is to take a seat in front of them and have a conversation and ask questions. It is also important to answer any questions they will have about you or your business. They should instantly assist you in recognizing if you are a right fit for each other. 

The following are key topics to talk about:

  • Relevant experience, skills set, and connections:

Where will the business have gaps? Which connections do they have that will give immediate worth to your company's bottom line? How do you prefer to work? Work styles vary dramatically from resistance to encouraging to analytical. Some advisors dive right into what is happening in your business and immediately tear it apart in a hundred completely different ways. As a founder, it's important to decide what type of investor you will best relate to before you decide to work with anyone. What you don't want is to learn that you have conflicting styles once you have hired an advisor. This can be avoided by simply interviewing them, be sure to get references from corporations they have previously worked for.  All of these factors are critical to finding and partnering with the proper advisor. 

  • Availability and Desire:

Growing companies can't afford to wait for a startup advisory to come along who will fit perfectly into his or her schedule. When you are on the hunt for a startup advisory specifically, it is necessary that you verify how accessible they are. It is also important to determine with what vision and impassioned way they will be helping your business reach its full potential and growth. 

  • Goals and Compensation:

Advisor/advisee relationships won't be productive if both parties are not aligned around accomplishable goals, milestones, and compensation. Most of the time the initial instinct is to seek out a startup advisor who is an expert at one terribly specific thing. Their expertise appears nice on paper, however it is necessary to balance that against how you relate to the person, associating their personal style in a consultative role. 

Just let the conversation evolve and you'll find your desired startup advisor in record time!