SEC Greenlights One Style Of Equity Crowdfunding For Startups

They do make things pretty easy on the startup. Having gone through a Reg D/504, it does take time to deal with the EDGAR and state-specific filing requirements, but it's not exactly rocket science either, and personally I found it fun to learn the system and successfully close a round on my own.

There are some interesting terms attached... In particular: - They vote all the shares on behalf of the investors, - They take up to 30% of the profits as carried interest, - They can resell on secondary markets if they become available, - And they can fully withhold their shares from an offer they don't like. For comparison, YC Series AA term sheet requires consent of 50% of the preferred to sell, and they can participate pro-rata. TechStars Series AA term sheet simply allows the preferred to participate pro-rata. - No mention of if their standard liquidation preference is participating, or anti-dilution clauses, neither of which [a startup] would typically want in a Series AA, but that's irrelevant to the SEC.

Quoting their letter to the SEC:

- FC Management manages the investment funds of which it is the manager. FC Management exercises any management rights negotiated with the start-up company (for example advisory board status, rights to review books and records, access to board materials, and/or access to management).

- FC Management has the ability to vote the investment fund's shares in any matter requiring a vote of the start-up company's shareholders. FC Management has the ability, subject to the terms of its agreement with the start-up company and applicable federal and state securities laws, to offer or sell its securities in the start-up company in the secondary market (if such a market exists or develops), or to offer or sell those securities back to the start-up company or to other existing investors in the start-up company.

- If the start-up company is the subject of a tender offer, FC Management has the right to decide whether or not to tender the shares owned by the investment fund.

Upon the liquidation of such a fund,the proceeds of the fund would be disbursed as follows:

(1)first any remaining out-of-pocket third-party expenses of the investment fund, to the extent not already paid out of the administrative fee, would be paid;

(2) second, the capital contributions of each of the investors in the investment fund would be repaid; and then

(3) third, any remaining profits of the investment fund would be distributed on a pro-rata basis, with a percentage to be paid on a pro-rata basis to the investors who had made capital contributions to the investment fund, and the remaining percentage to be paid to FC Management, Inc. in return for its role in organizing and managing the investment fund. The amount of this "carried interest" to be earned by FC Management would be disclosed to all investors in the fund at the time of the organization of the fund. We anticipate that amount of carried interest in most cases would be 20% or less of the profits of the investment fund, but in no event would the amount of carried interest exceed 30%.

As for whether this is investment or speculation, as I understand the Funders Club model, every extra dollar that comes out of an investor's pocket results in one extra dollar going to a startup company. If providing a company with additional capital to pay for up-front costs before they're profitable isn't investing, what is?

Personally, I'd like to see a way for investors to put money into some kind of broad-based startup index fund. I agree that people shouldn't be putting their life savings into a single startup. We don't like taking on that kind of personal risk (that's why we raise money) and they shouldn't have to, either. They should be able to take, say, $10,000 and put it into startups, plural.

Also, given that you're going to have a "power law" distribution of returns where a couple black swans are responsible for a large amount of the return, it's good for most investors to be in the whole spectrum; otherwise you get a St. Petersburg Lottery phenomenon where median returns are much lower than the (presumably quite high) expectancy.

Yup, and this is essential.

The failure mechanic is that if you're successful, there will be a number of people who don't pass the 'vetting' but they want to participate. That demand will be met by people who don't do vetting, or choose to interpret vetting in a way that allows this person to participate.

A lot of the bad mortgages that were written in the real estate bubble were fraudulent, the "good" mortgage companies took care to insure that their customers could afford a mortgage and would be reasonably able to pay it back. The people who didn't qualify weren't served by them. Instead they were served by people who were less scrupulous.

This is the conversation we need to be on the look out for;

"Those guys turned you down because the rich folks don't want people like you getting in on this sort of deal and suddenly becoming rich like them, they are trying to keep you out by setting bars that says, 'Hey, if you aren't already rich you can't play here.' but that's not fair, is it? We are on your side, we're here to make you rich not to make rich people richer. Sure you can invest your 401k in so called 'index' funds, but with our clients will put it in a dozen different startups, anyone one could make you a millionaire and if two or more make it big, well lets just say I hope you remember the guy that made it possible for you. So are you in or not?"

Wefunder, FundersClub, the initial round of crowdfunding will all (hopefully) be great success stories. And if they are successful someone is going to create the "Countrywide" equivalent to them and fleece a ton of people. That is my fear and I don't know how to prevent it.