Our portfolio company CircleUp is a marketplace where consumer goods companies raise equity capital from accredited investors. CircleUp is a registered broker dealer and does all of this in full compliance with securities laws. Over the past few years, CircleUp has helped 113 consumer goods companies raise over $130mm and they are growing quite rapidly now as entrepreneurs who are building consumer goods companies increasingly understand the value of raising in a marketplace model vs the old fashioned “knock on doors” model.
I think the growth rate will accelerate in the coming months as CircleUp launched a secondary market last week they called Rights+. First a bit about the importance of secondary markets and then I’ll talk about what makes Rights+ different from other secondary markets.
One of the big challenges for investors in private markets is the securities we buy are illiquid. That means most of the time we will need to hold the investment until “maturity” whatever that is. And in early stage investing, that can often be 5-10 years (or more). If you suddenly have a need for cash, you can’t easily sell your angel investments. If you think the company is being managed badly, you can’t easily sell your angel investment. So the illiquidity significantly increases the risk of an private investment vs a public market investment. If, on the other hand, you could easily sell your angel investment (at a loss or a gain) if you needed to raise cash or if you lost confidence in the management, I believe the market for angel and early stage investing would grow significantly. Lower the risk of illiquid early stage investing and you will see a lot more people interested in doing it and you will see the ones who are doing it allocate a larger portion of their investment capital to it.
When we invested in CircleUp back in May of 2013, I asked Rory and Ryan “when are you going to launch a secondary market?” I’ve always thought that the key to making a marketplace model work in early stage investing is the ability to easily do secondaries. And now, roughly two years later, they have done it.
Why did they take so long? Well there have been a number of problems with secondaries in the early stage market. First and foremost, the companies themselves don’t generally like the idea that their investors are selling in the secondary market. So they do all sorts of things to prevent it. And second, investors who buy a secondary often get no rights that come along with the securities they buy. In particular, they have no rights to information from the company to ascertain how the investment is doing.
So CircleUp decided to fix those things as part of their secondary market. CircleUp’s CEO Ryan told me this via email last week:
CircleUp Rights+ rights give investors the ability to sell shares early – including through the CircleUp marketplace. We’ve standardized the rights (transfer rights & information rights) to streamline the process. A key difference between this and previous secondary marketplaces is that it is fully integrated with the primary investments. Thus the companies themselves are actively giving these rights, which we think is key to success.
So when you decide to buy in an offering on CircleUp, you can see if the company is offering transfer rights. You can decide, for example, to only buy into offerings where there are transfer rights being offered. And you can sell these securities on CircleUp if you so wish.
This is a great thing for CircleUp, for the entrepreneurs who choose to raise capital on CircleUp, and for the investors who invest capital on CircleUp. And this shows others the path to creating a truly vibrant marketplace for private equity capital.
Broker dealer+accredited investors+marketplace+information rights+transfer rights=a vibrant marketplace for early stage equity capital
It would be nice for the accredited investor requirement to go away for smaller investment amounts so that this model could be opened up for all investors. Then we would really have something transformative. And maybe I would be out of business 🙂
so entrepreneurs choosing not to allow secondary activity may find it more difficult to attract primary investment. the entire market will shift to a secondary basis over time.
Fabrice Grinda revealed in an interview his trick for the secondary market. He looks up on LinkedIn for the employees of companies he likes, and he offers to buy their vested shares directly.
haven’t checked it out, but if they charge a small tx fee on secondary transfers lovely profit engine for just making a name change in their DB.
In addition to cash investment, early stage investors also offer a great deal of support, guidance, and connections. A good company picks its investors on more than just the price they will pay.If a platform can crowdsource the cash, how can it also crowdsource the wisdom, connections, and other benefits that a devoted early stage investor provides?
The entrepreneur still gets to vet & choose the investors they want. But you’d be surprised, sometimes the investors that invest the least provide more value that others.
Re: “But you’d be surprised, sometimes the investors that invest the least provide more value that others.”You’re probably referencing fund size?
Not necessarily. I’m referring to the actual participation of investors in a particular round or company, i.e. someone putting $25K may end-up working harder and helping more than another party who put $250K.
But there is more…do your due diligence when it comes to early investors, have they filed for bankruptcy, have they been a party to a share holder law suit, do they have drug or alcohol problems….
I really suppose if you’re going for an angel party round and aren’t offering shares priced based on expecting much advice or help from them then it makes sense to allow it, however if you’re more hoping for good advice throughout then maybe keeping them onboard is a good idea — though an angel’s advice and ideas may be limited.
Those with the money are usually not the best advisors. There are lots of exceptions, but rich does not equal smart or experienced. Separating the money from the advice is a benefit of such a platform.
but rich does not equal smart or experienced.Agree. Especially when the way they made their money has nothing at all to do with the company that they are investing in. Meaning they have no particular edge. An often newbie error to those in business is to assign super powers to someone, let’s say who is older and who has made money. As if they spin gold on a regular basis. The assumption is that brains and hard work played a larger role than just luck in their success.
Well said. Sage advice. Ergo, you’re not that wealthy, are you? 😉
I am not foolish enough to be wealthy.
Do you think that transfer rights in traditional deals will continue to be restricted, or they might loosen up?If secondary is good for CircleUp deals, it must be good for the whole industry, no?
What’s the upside of restricting transfer rights? Just that the founders want investors committed for the long haul?Are there situations where lack of transfer rights meant an investor fought and turned around a company that they’d have otherwise sold off and given up on?
a) Signalling, and b) control of company information – would be my main two concerns.
It can have an impact on the governance of the company if the major shareholders transfer, but not so much for minor shareholders.
I think a “time transfer right” would be fair. I think angel money and early venture should not be able to get out within 3-5 years, due to signalling, lack of committment, and information rights. But i do think after 3-5 years a legitimate investor could have liquidity needs. After 5 years if an angel wants liquidity on a small part of the business that won’t kill any company that really has their stuff together. However it could kill / severly hurt a 12 month old company per se
Can’t imagine a steady at the tiller VC on your BoD going out of business when the alternative is a black box.
Any instruments in markets that enable a more clear and transparent price discovery are valuable. It would be superb if somebody created an instrument to allow for shorting into funding rounds.
Really interesting! I think this is similar to Nasdaq’s Private Shares platform, which will use Bitcoin and blockchain technologies to issue and transfer the shares of privately held companies. http://www.bloomberg.com/ne…This is also something that could be implemented as a decentralized app in Ethereum, a totally new blockchain platform where the contract rules are implemented in code and locked into a blockchain record. It’s like PaaS for multi-party financial transactions. Currently, Ethereum is still launching but the momentum growing. https://www.ethereum.org/
Yes, the title transfer & settlement logic can certainly be encoded as a smart contract on the blockchain. But they’d need to issued (or pegged) on the blockchain too for this closed loop to be effective.Private stock transactions is definitely a potentially big applications segment for the blockchain, and I know that several companies are pursuing it.
Yep – this list of requirements has so far been a nice big moat for the likes of you, Fred 🙂 http://www.ecfr.gov/cgi-bin…Do you think this will encourage the bigger banks to make VC more directly accessible to its clients?
When are they expanding to more than consumer goods companies?
Serious question – what prevents a competitor from buying an angel investor’s stake and then getting information rights?
Honestly probably nothing. Even if they “try to ban it” you may be able to say I as your competitor can’t buy in but how would you possibly stop any of my dozens / hundreds of close contacts from doing so? You can’t.. would love to hear fred or the companies opinion or at least best opinion of this.
Usually info rights clause has a caveat, that the board can choose not to provide info if competitively sensitive.
and you could easily proxy your way in to a competitor’s deal…..this to me seems to be a problem.
.The mythical general information right that a shareholder is entitled to is guard railed by constraints that the company can erect as it relates to materiality, non-public nature, competitive advantage, trade secrets, proprietary information, and other qualifiers.Just because you own a share of Coke doesn’t mean you get the secret formula.A good guideline is Delaware Gen’l Corp Law Sec 220 which deals with the rights that even a public company shareholder is allowed including the above noted constraints.You would be surprised at how limited they can be.Where companies may get themselves into trouble is SEC Reg FD (fair disclosure) which stands for the proposition that no shareholder can be exposed to a superior font of information — it must be “fairly” revealed.This does not apply to certain positions such as board members. The big problem becomes when board members are also shareholders (as they almost always are) and do something in reliance upon the material, non-public information they possess.This entire matter is much, much murkier when dealing with private investments v public investments. One could argue that the mechanism Fred is describing is more “public” than private.JLMwww.themusingsofthebigredca…
Puzzled how this complies with single share class limitation.
.That is a very complicated subject and weaves C corp and S corp issues together but as a general proposition there is, effectively, no “second class” of stock if the distribution provisions are not different for the two classes of stock.Even if an S corp runs afoul of the rule, the result is they are taxed as a C corp which means any distributions to shareholders are taxed a second time.This is a fairly unlikely proposition as there are not likely to be any distributions (dividends).You can have whatever classes of stock you want as it relates to voting rights — this does not run afoul of the second class of stock issue.That is all the unlawful practice of law for today.JLMwww.themusingsofthebigredca…
It’s been a while since I looked at the regs, but I was referring to the 2007 public offering reg d exemption.
.The Reg D stuff was modified by the JOBS Act but it would still likely require SEC registration before sale in any event which makes it a different breed of cat.JLMwww.themusingsofthebigredca…
Your detailed reply to Matt (and the one below to Rich) is a good example of how ordinary folks have no idea of what goes on under the hood in a business that they are not involved in. All they see is the known knowns. They have no clue or any way to evaluate the risk of the unknown knowns or the unknown unknowns. Which is why all of that financial industry “as always do your research” is such bullshit.
Thanks for calling me a nube basically? 🙂 Having worked for 9 months at a VC firm and having other financial experience, and currently launching a company my point still stands. The information that you have to make available for people to invest would definitely help your competitors. Full stop. So unless they are arguing that investors who are buying the secondary shares don’t get to see the same materials that initial investors get / got to see, then they can’t protect nearly the same amount of information.
LE – my apologies for oversensitivity.. replying to a different matt i see. Still the information rights are an important complication. Not impossible to overcome, but definitely a downside feature
.In the first instance, the company is attempting to “induce” investors to invest and is the driving force behind what is a classical solicitation. Not unlike an offering memorandum or a prospectus.In the second instance, the company has no interest in the deal other than a tangential desire to know who owns its stock and why.In the second instance, the company will not receive any money as the trade is between two shareholders — one current and one future.The right of any shareholder to receive any information is the right to “inspect books and records” and nothing more.The company does not have to answer questions that it finds to violate the company’s interest even in a Del Corp Law Sec 220 inquiry.The right to inspect books and records also entails a right to copy those documents and to retain them. It therefore conveys a duty to safeguard the information which may be way more trouble than it is worth as its compromise may lead to costly litigation.I personally would never take a copy of records and when I have done exactly this, I have inspected books and records at the company’s law firm and returned them to the company to be held in a file to be retained at the law firm.This, like sex, has been around for a long time and it wasn’t invented recently.JLMwww.themusingsofthebigredca…
It will be interesting to read how circleup’s legal language reads for the offering they are talking about. If they share the some type of quarterly reports / updates we got as a VC firm, then there is valuable information. If they don’t share any of this information (either on an ongoing basis or at the time of the secondary buyer initially buys in), then what is the secondary buyer really buying into? They are just taking the word of someone who is saying the company is so great that they are selling???
.When you punch the button and buy AAPL, what representations are being made?None.The buyer of any security is required to do their own due diligence. That is how stock markets work though there may be market required eligibility requirements.Smart sellers do not make any representations or warranties.Caveat emptor.JLMwww.themusingsofthebigredca…
You have 10k’s, 10q’s, 8ks, investorr presentations.. a ton of information to go off of.
.These are not seller “representations” and, in fact, are company generated. They are not generated by a seller of stock.They are public company SEC requirements and would not apply to a private, startup company.They are also widely disseminated, IAW Reg FD, and are not created for any other purpose other than the SEC reporting requirements — though they are obviously used for other purposes.All of these documents require a buyer to do his own due diligence which is the obvious retort to any suggestion that a seller should be making reps of any kind whatsoever.JLMwww.themusingsofthebigredca…
I understand the company generates them. I think we are talking past each other at this point. My general point for their to be a secondary market in the shares of a company whoever is buying needs something to buy off of… and for that to occur they need information, whether from the seller directly or the company. I can’t believe anybody would buy shares of a company with no insight into the company… so either they will burden the company to provide this or past documents given to the current investors would / will be passed along. This disclosure of information WITHOUT raising new funds to the company is what I and others I think are arguing is not entrepreneur / startup friendly, and which many would prefer not to have.
.Let me start with my apology. Sorry, Mr. Sensitivity.We are not “talking past each other” at all.I’ve been a CEO for over 33 years and have dealt with these subjects for a long time including extensive dealings with the SEC. I have had the benefit of years of working with top notch securities lawyers and having owned securities in both public and private companies in which I have used Del Sec 220 Requests to Inspect Books and Records.I did this just today.None of what I say to you is theory. It is practice.The company has no direct interest in the sale of shares between two investors unless they have placed restrictions on such transfers. This is not uncommon and may involve those who own more than 9.99%, insiders, option beneficiaries, or original investors.The company may enact rights of first refusal, re-acquisition restrictions, and other ways to control who owns their stock at an early instant in its history.No company is going to undertake any liability by getting in the middle of a transaction from which they derive no financial benefit.Many companies use transfer agents who keep the “books” as it relates to shares and many shares are “book entry” only shares in which the possession of an actual share certificate is not necessary.This fact is stated so you can see that companies not only don’t get involved in the transfers, they don’t even need to know until it comes time to mail out shareholder info which is often done by the same transfer agents.This is a fundamental business skill and body of knowledge like learning how to fly an airplane and to operate with ATC (air traffic control).There is almost no leeway in these matters and while startups are gangly, adolescent beasties — lose somebody’s money and see who is held to be negligent.Your generation not only did not invent sex, it doesn’t know who did.Peter DruckerJLMwww.themusingsofthebigredca…
As you stated “The company may enact rights of first refusal, re-acquisition restrictions, and other ways to control who owns their stock at an early instant in its history.” Isn’t this the crux of the matter? Since most private startups (angel and vc stage) have these restrictions it is hard to get the liquidity that fred is talking about. Since circleup wants to reduce / eliminate these restrictions (to offer said liqudity) the argument is that information about the company will be more broadly shared from existing investors to new investors which can / may be detrimental to the company. I get that the startup probably won’t (or almost certainly) won’t be involved in that transaction… but the simple fact that there are no restrictions on the secondary sales conversation is what would make it easier for competitors to get their hands on information about the company. Still don’t see how that isn’t likely. Lastly, i don’t think i am very sensitive, but perhaps my comment came across that way. I enjoy the back and forth
Still, the right to inspect books allows one to see where the profits are coming from – a segment a competitor may not have discovered or has targeted yet..
.Actually the term “segment” is a GAAP defined term and refers to like kind business units usually grouped for the purpose of evaluating goodwill (the difference between the book value of an asset and its true hard asset value).Goodwill is evaluated at the time of the annual audit and is either declared as “impaired” or “unimpaired.”It is a constant issue with auditors as goodwill can be written down but not written up. Makes sense when you think about it.When one uses the term Financial Statements (capital F and S), one is talking about consolidated financial statements (income statement, balance sheet, statement of cash flows) and not any more detail.I tell you this because a consolidated income statement (meaning a financial statement which consolidates all the information from all the subsidiaries) is likely the extent of information necessary to evaluate the pecuniary value of a security.It would be nice to know something about the growth of different product lines but that goes to “growth” rather than “pecuniary value” and all you are entitled to evaluate is the current pecuniary value of your securities.Long way of saying — you would not get an opportunity to drill down to that level of detail. A 10K would be a consolidated income statement while the footnotes might touch on some comparative segment info but not in any truly useful detail.A company would not be unwilling to discuss such a matter in a conference call with investors but some might not.This is a very, very, very well tested and litigated element of the pertinent law and has been so for a long time.JLMwww.themusingsofthebigredca…
.A general consideration as it relates to the issue of “information” is this –There are only three legitimate reasons why a shareholder is entitled to information — again, a general proposition as litigated and enshrined in Delaware law, as an example.The first is to establish the “pecuniary value” of the securities owned by the shareholder.The second is to contest the management/mismanagement of the company; and,The third is to investigate the misbehavior of a board of directors.As to the issue of pecuniary value, the shareholder can only inspect information which is of a financial nature such as financial statements. No marketing plans, no acquisition targets — information that will establish the value of the securities which might generally be considered a liquidation value at an instant in time.To contest the management of a company, one must make a specific and credible charge of mismanagement. You cannot conduct a fishing expedition. These matters always end up in front of the Chancery Court.As to the misbehavior of a board (not correctly approving a disposition or acquisition, as an example) again there has to be a specific allegation of wrongdoing.While the law on this is very well litigated, it is clear that the Chancery Court is not allowing fishing expeditions and it is absolutely limited to “books and records” as they actually exist. The company does not have to answer questions or to create documents.JLMwww.themusingsofthebigredca…
I’m not sure where that remark came from. I suggest that LE have some fiber with his lunch as he seems a little constipated.
Metamucil and typically it’s at breakfast time. I highly recommend it. Comment was definitely not directed at Matt Kruza by the way.
Not sure if you want to get in a pissing match over issues of Finance, but let’s just say if you did you wouldn’t need that Metamucil.
I don’t claim nor did I ever claim to know a great deal about “finance”. My knowledge is more nuts and bolts of the actual making of a $.
Wasn’t referring to you. But I will now read your point and see if I can figure out how you feel that I was!
The information that you have to make available for people to invest would definitely help your competitors.Agree 100%. Information is power. No question about that. Loose lips sink ships unless we are talking about disinformation. Basic principle.My larger point is that in business you need what I would call “a seat of the pants feel” for the issues and the potential pitfalls. Someone who has not operated a business (or even a particular type of business) will tell you that they learn something new every single day. And that they know more at 40 or 55 than they did at 25. You learn over time by experience. It’s not knowledge you pickup in blog articles or magazines or the Harvard Business Revew which discuss and masturbate over different thing and are often hard to apply when you need to draw on the info. Anyone who tells you different is not learning. JLM will not disagree with that at all.The “ordinary folks” that I was referring to in my parent comment would mean that the average “investor” would have no idea of the intricacies of corporate finance as shown by things that JLM wrote. And those that are able to understand corporate finance may not have enough actual business experience to even understand things that can happen when operating a typical small business (which is what all of these investments are).
You are on a (down hill) roll today. The SEC divides investors into two classes, accredited and non-accredited. Note it has nothing to do with with being “ordinary and non-ordinary folks”. Its only a function of wealth, Don’t conflate wealth with abilities. Ask Bernie Madoff.
I believe you are trying to make a point about reg d and its exceptions. I just have no idea what it is.
As in the primary raises, companies ultimately control their cap table. They can prevent a sale to a competitor at the time of the transfer
Matching markets don’t have to be continuous. In the book, Who Gets What economist Alfred Roth shows how market structure can contribute to better markets. He assails the current structure of the stock/futures markets and HFT. He also describes how he set up matching markets in kidney donation, and in school choice. I think the latter are more akin to the marketplace that CircleUp+ is trying to create than the former.
So much to unpack in this post. Great for Circle Up. I agree with a lot of what Fred says, especially the last paragraph. Although, if we had more investment, the best VCs would be even busier.I have only angel invested. I have invested in 22 companies. Some good, some bad. Most of the companies I invested in are operating and raising next rounds of capital. Some have failed. Two have exited.I want to focus on the failure and the “lose confidence in management” piece of Fred’s post. I am not sure that works in a secondary market. If I as an investor want to get out, it sort of sends a signal to the market. I get the “raising cash” part. Heck, as a self employed guy liquidity is always important to me.I can think of an example. One, I totally lost confidence in management. It was a consumer product and I am not sure anyone would have bought my shares at any price. The company failed and it’s in all kinds of lawsuits now. If it wins the suit, I might get enough money back to buy some ice cream. With the money I invested I could have started an ice cream stand.At the same time, I totally support any effort to make any market deeper and more transparent. The deeper and more transparent markets are, the more volume and velocity they have.I am not sure if Circle+ makes it less risky to angel invest at the margin. But it surely will be awesome to watch and if they can take some risk away consumer products entrepreneurs ought to benefit. If they benefit, so should society so that’s pretty cool.
Yep. That is a great point, its a HUGE signalling bias. Or conversely it may indicate that those looking to buy in now because of enhanced liquidity won’t be helpful investors as they are going about angel / venture investing all wrong (ie hoping for short-term liquidity)
If this makes the private market more efficient, it could possibly remove some of the profit from people who are adept at working the existing illiquid and opaque system. But overall it must be a good thing.
“I might get enough money back to buy some ice cream. With the money I invested I could have started an ice cream stand.”Rocky Road indeed. Thanks for your sprinkles of wisdom.
Icecream every time you make puns – we’re going to get very bloated.
Comments like that get a frosty reception here. Try something less vanilla.
Bean there, done that.
At least with an ice cream stand it’s always easy to liquidise your assets.
Soft serve, that.
You’re starting down a rocky road..
Jim’s already scooped that pun.
No seconds allowed?
A slippery track ?
Investing without access to corporate financial + info is a dangerous leap of faith.Let’s hope that this flies.Did SecondMarket ever do this?
“It would be nice for the accredited investor requirement to go away for smaller investment amounts so that this model could be opened up for all investors.”Amen to that. Just feels unAmerican to me.
Actually, it seems totally American to me.
Yeah, I guess if you’re pessimistic, this is American.
Nope. No joke, people do stupid things and are foolish with their money. Needs to be there to protect people from their folly. If not, some type of governor needs to be put on the process.
Really? How is this different than the hypothetical that @pointsnfigures:disqus jokingly mentioned re openning an ice cream stand? IOW, I can put $50k into opening an ice cream stand but I can’t put $50k into the next Uber? There are plenty of ways to lose your shirt. This accredited investor thing isn’t protecting anyone other than big money investors that want to keep the small fry out.
Great question.Here is how it is different.1) It’s is easier to put 50k “into the next Uber”. Note also that you have picked an example of what is known as (unfortunately) a Unicorn. You didn’t say “into the next Homejoy”.  (Obviously). This would be like saying “so what if people want to spend 50k on a Harvard Education (as opposed to a shit no name private college). Or “so what if my son wants to be the next Louis CK”. My guess is that if you felt you could be “the next Louis CK” you would have gone down that path. And you know it has little to do with talent and drive. (Maybe that’s not the best example but I will still use it). Lot’s of competition.2) To start “the ice cream stand”. There is plenty of friction and ways you can end up deciding you shouldn’t start the ice cream stand. Magnitudes of greater work involved. Work is a barrier to entry and making a bad decision. Survival of the fittest. And it’s an active investment process not passive. So you have more control over the outcome since you are able to make decisions (for better or for worse) For one thing you have to find a retail location that is good for an ice cream stand. That process alone will take quite a bit of time. Negotiate a lease and options. Don’t forget to make sure that the landlord needs to be prevented from allowing a similar product in the same shopping center. Try to locate next to a blockbuster video. Oops, they don’t exist anymore but you get the point. Next you have to find equipment for the ice cream stand. (Assumption is you are not buying a franchise of course). Of course you need to talk to lawyers and accountants perhaps (I could skip that phase but you or most people would need to). There is marketing to prepare, signage, logos, promotions, hah hah domain name, and so on. Menu. Ingriedients. At each phase you can easily change your mind and might back out. Oh yeah insurance hire people. I am sure I have left out 20 other things.When I sold my first business the process took easily a year. All along the buyer could have changed their mind (and I could have changed my mind to sell).When I started another business pre-internet in the mid 90’s I had to get into an airplane and fly all over the country to be able to see the equipment and talk to people operating the equipment. Maybe today I could probably skip most of that work. The process took roughly 1 year to complete. Cost money to do that (as well as opportunity cost). At the end (1996) after doing all of the work I decided the Internet was a better opportunity. So I shut down that business and sold all of the (mostly new equipment) to some guy who flew in with his son from Beirut Lebanon with prayer beads (true story). Was lucky that some broker found that guy actually lucky break. After flying in the guy actually tried to bargain me down on the purchase was pretty funny. The warehouse came in handy (that I rented) I had also installed a brand new HVAC in it oh well. Next place when that lease ran out I [email protected]:disqus might of course invest in someone else opening an ice cream stand but my guess is he would not start and be the operator of an ice cream stand, at least at this stage of his business life. The reason is it makes more sense for him to leverage his invested dollar while having the entrepreneur do the heavy lifting and most importantly spread the risk. http://www.entrepreneur.com…
I could have easily used the example of granny opening an eTrade account and making her own good and/or bad decisions.It doesn’t matter that I picked a unicorn in my first example, or that I picked an active vs passive investment. You’re accurate in your criticism of them as example attributes. But that doesn’t change my point…Point is, granny can invest her money in equally uncertain outcomes, whether she’s accredited or not.
granny can invest her money in equally uncertain outcomesYou are using the “well it’s no more dangerous than X” to make your point. Same thing I hear trotted out with legalizing marijuana. “Alcohol in the hands of the wrong person is bad and marijuana isn’t any worse.” The fact that something (stock gambling) is grandfathered and accepted doesn’t mean that you can hold it as some kind of a gold standard and say “not any worse than”.Anyway, there is one big difference between granny and etrade investing (old school) vs. startup investing (new school). What is that? The fact that in this day and age there is a ton of and overwhelming amount of positive press coverage surrounding startups and the money that some people have made with startups. You don’t find any of that with stock investing. I am referring to stories of mainstream success. For that matter entrepreneurship over the last probably 10 years has become the ticket. Now the “it” thing to be doing.All of that positive press means that people are going to be way more likely to “gamble” on a startup thinking they will hit it big (greed reflex) than in stock investing something they already know about (especially granny). Maybe penny stocks are somewhat similar.
To clarify my point it’s easier for a fool to part with their money on these types of investments mainly because there is so little friction to making the investment. Same reason people would gamble more if a casino is located in the local shopping center vs. operated by some tribe in the state that you live in. Or on the Internet.
Yeah, gambling; just furthering my point.Granny can piss away $50k at the casino, but she can’t pick private companies to invest in?
Three questions:1) what information is a prospective investor privy to prior to buying secondary shares? 2) if the hypothesis that a secondary market holds true and risk is minimized, will we see a further increase in price for private initial offerings?3) if the secondary market provides enough liquidity for entrepreneurs and early employees to have a way to cash out, why would anyone ever go public?
1) This varies by company to company. Most companies agreeto provide a specific set of information included in its information rights andcan augment as appropriate.2) Ultimately, this depends on each individual investor andhis/her own risk/reward profile. We believe that increased liquidity forthe sale of private securities is overall a benefit for all investors. Whether an investor is willing to pay more for this added benefit/liquidity (as is basically the case in the public markets) is case dependent3) Secondary sales do not provide fresh capital to a company’s balance sheet. IPOs are financing events to raise fresh capital for the Company to continue to grow. Therefore, companies my still need to go public in order to access the capitalpools available in the public markets.
Attention contributors to this blog. It appears that the majority of entries are asking Fred legitimate questions but weneed to realize he isn’t a machine and theanswers need to come from the community at large. Fred is human with responsibilities. One or two questions but every entry a question. Think this out…
the people from circle up should step up and answer here.. its a good litmus test for founders if they answer difficult questions or slink away.. hopefully they choose the former 🙂
I have asked the folks from circleup to stop by and respond. They are west coast based so it will be a few hours before that happens
Fred:we are West Coast based and up at 4:30am for markets, your blog entry, etc.Time element for West Coast doesn’t count until three hour difference. 🙂
The man 45,533 comments. I think that qualifies as at least part-machine.
This will have the classic “lemon problem”. I can think of almost no reason an entrepreneur would want to raise money on these terms, short of “its the onlly way i can access funding”. Which i grant is better than no money. However, the most conncted, successful, or ones with most traction won’t agree to these terms. Likely a terrible long-term investment
What specific terms are you referring to?
information rights on transfer most specifically .. ie anyone can see what your corporate strategy is if they hold shares (or so it appears). Also way less comittment from the angel.. they can cut bait much easier than currently
Hi Matt- respectfully, we disagree with the premise. In conversations with many entrepreneurs so far, they like the benefit of a wider selection of potential investors that these rights may provide. As Fred notes in the blog, providing these rights will likely expand the pool of potential investors, thereby increasing demand for the offering, which will benefit the entrepreneurs.You could make your same argument amount any term that an entrepreneur offers that favors investors (e.g. why would any entrepreneur offer preferred shares if they could common). The difference here is that the marketplace will provide clear data and transparency to both entrepreneurs and investors so they can see the price premium, and speed to close, that comes with offering these standardized rights. The standardization and transparency are what will reduce friction for both sides in the market.
providing these rights will likely expand the pool of potential investors, thereby increasing demand for the offering, which will benefit the entrepreneurs.”Increase of demand = better for entrepreneurs” – Implication is then that it is less favorable for investors (race to bottom of returns simplistically).
We agree it is better forentrepreneurs. We also believe that “increase liquidity and informationtransparency = better for investors”. Investing into an illiquid securityadds additional risk to any investment decision. Secondary sales helpinvestors minimize this risk associated with investments, and thus a moreattractive risk-adjusted return.
I love this investment. Has true possibility to be a game -changer.
Hi Fred, If an investor wants to sell their shares because of poor performance then you’d need someone on the other side of the trade. This would be a negative market signal and hard to create a robust buyer side or a buyer side looking for a discount to reflect the weakened value. Or if an investor needed cash not selling for poor mgt, this is a “need to sell” situation where buyers will look for a bargain also a confusing market signal. These are all dynamics that happen in the public markets so as the secondary market matures on line the same dynamics are likely to emerge.Deborah Jackson @dbdj1007
Hi Deborah, nice to see you here. We believe signaling risk in general is a function of asymmetric information. The benefit of having the marketplace overall, vs offline angel networks, is that we can be much more transparent about comps and the performance data. So, new potential investors, will have access to the same information reports that the potential sellers receive as well as aggregate data from the thousands of other consumer companies in our data set. You are right that the price the buy side is willing to pay will be a function of the performance, which is entirely appropriate. However, having a market that can help with price discovery at will benefit both the entrepreneurs and investors through reduced friction and increased liquidity.
Hi Rory, great to read your response. All investors will be better off with private company transparency and disclosure of information. Onward trailblazers.
So… a competitor to a company could buy it’s stock in the secondary and then receive information rights as well? That doesn’t feel right.
CircleUp could put restrictions on the market to make sure that doesn’t happen. It doesn’t have to be a continuous matching market like the stock market. It can be a matching market similar to charter/public schools.
Great question. Most companies protect themselves fromcompetitors by having mechanisms to either (a) approve/reject recipients oftransferred shares (and hence the information) – similar to my point about primary investments above or (b) buying back proposedsecondary sales itself (through Right of First Refusal) to prevent shares fromending up in the hands of unwanted buyers. Per @JLM’s prior post earlier,the amount of information provided through standard information rights is limitedby the regulations and the information a company wants to include as part oftheir information rights.
So the secondary market is made up of regular people who aren’t accredited investors?
No, given current regulations, will still only be accredited investors.
Super interesting release. What’s the incentive for a company to add Rights+ to the shares they sell in a Primary offering? If I’m the owner of the company and am thinking ahead, Rights+ will compete with my ability to sell shares to benefit the balance sheet. So, I’m unlikely to want to offer them in case I need to raise more capital in the future. Is my incentive that shares with Rights+ will generally sell in the marketplace in Primary at a substantial premium over other companies selling shares without Rights+? Seems like the premium would need to be quite large to make this an enticing decision for the business owner.
In general, speed to close and higher valuation potential. We believe data will show that companies that offer these standardized rights will close faster with better relative valuations because there will be a reduced liquidity premium demanded from investors. Over time, we will provide the data directly to companies considering the option – allowing for transparent, informed decision making on both sides of the marketplace
Circle up is perfect for the consumer facing legal business I am working on. Definitely will try then and report back how it goes!
Good concept to open up liquidity, with an easy to use secondary market there’s always more room for manipulation, shorter term trading, and a desire to use leverage. If the market works as expected I don’t think it will be long before we see these show up there.
This was a really great post.However the one thing that I don’t agree with is this statement:It would be nice for the accredited investor requirement to go away for smaller investment amounts so that this model could be opened up for all investors. Similar to the stock market, while this is called “investing”, let’s put ass on table here,it’s really gambling and to a lesser extent entertainment. And while the secondary market feature is nice, all it does is allow a greater fool to let you get out of the investment by buying you out. Then he has the problem down the road.I just can’t wrap my head around ordinary people, almost certainly with no or little actual business experience themselves, taking any portion of their money (let’s say enough money to make a dent if they are right) and investing it this way.  And no, I don’t think the stock market is any better than a gamble that’s obvious. Fred (and most sophisticated investors) don’t put their money into any that they don’t have an information edge in or that they can control.By the way similar to a casino, it’s quite possible that over the short term you can make money. But in the long term I think it’s fairly well known that the house has the advantage. That’s one of the reasons I don’t put a dime into stocks. I can have a great thought and think “yeah Apple should go up” or “REITs are the way to go” but lacking an information edge if I play the game over time I know I will probably lose unless it’s my full time job to keep on top of the market (and even then I am at a disadvantage). Obama just decided that all federal contractors need to give their employees 7 days of paid leave.  You know why companies need to do this? Because people (even apparently people working for federal contractors who I will assume are somewhat well paid) live hand to mouth and don’t have enough liquid savings and are operating so close to wipeout that if they miss a few days of work they can’t pay the rent or fall behind in their mortgage. This is a really a tax disguised as a benefit by the way. If all contractors have to pay this “benefit” all they will do is increase in tandem the bid that they give the federal government. Then we all end up paying for the 7 days. The money will not come out of the profits of the federal contractors.
I disagree. Well, I don’t disagree, but I think you’re wrong. Sure, it IS “gambling”. But you know what? So is everything else in life. When you eat, you’re gambling that your food is not poisoned. When you drive to work, you’re gambling that you’re not going to get in a fatal car crash. When you go to sleep, you’re gambling that you’re not going to be hit by a meteorite. Etc. Everything is essentially a gamble if the definition of gambling is simply that there is a chance of a good outcome and a chance of a bad outcome. But to call it all gambling and then comparing it with a casino is deceiving. Casinos are zero-sum games that has a known house edge. Therefore the EV of the player is negative.But real life and companies are different. Companies actually create value, and they can grow so that everyone gains. There doesn’t have to be a loser.
How does this compare or contrast with eShares’ plan to convert their digital cap tables into a marketplace for shares of early stage companies that you’ve alluded to in the past?
another “quarter maker” market. I’m Long the short term.
This is a game changer potentially but I need to say that the ease of information access on Circle Up is a concern.In the consumer hard good space its insanely competitive and what has kept investments of mine from using the service is the ease of information access and the levels of protection.I can literally find out anything about any company in the space.Big embracer of transparency. Only when it is manageable.I want to use CU. May. But this concerns me honestly.
Hi Awaldstein- I would argue that consumer goods are no less competitive than the tech space (which is one reason the failure rate in tech is much higher). On CircleUp the entrepreneur decides who can see information through a private deal room, which investors apply to after showing their backgrounds. It is a better experience than the offline world where information tends to get quickly forwarded around -especially here in Silicon Valley – because the info is largely in that deal room. Separately, in the consumer space the key asset is not the financial info and is very rarely a patent (Coca Cola doesn’t have a patent on either Coke’s formula or vitmainwater). You can usually back into revenue and growth (i.e. using Nielsen/IRI data). The core asset is usually the brand-which is trademarked. So while CircleUp gives entrepreneurs more comfort about privacy, in the consumer space it is less relevant because the core assets can’t be stolen.
A strong brand doesn’t really exist at a sustainable scale until you’ve found your growth path, does it? And a brand only exists because of the products they create — if someone else gets to mass market first with a key feature then you’re very possibly SOL.
I would respectfully disagree. Brands can often far outpace their revenue – and that performance is usually reflected in the company’s valuation. This is also why strategics are moving down market rapidly and acquiring businesses earlier and earlier than they ever did before (as an aside consumer M&A last year was $200B, 2x the size of tech. The market for smaller deals was larger than the entire tech M&A market). When vitaminwater sold to Coke for $4B, they had ~$200m-400M in revenue. Its exceptionally rare for a consumer products companies to sell for >10x revenue, but Coke would say they paid that because of the brand they had built – not just the size or growth of the co.
How are you valuing brand outside of revenue, profitability and established market reach?
I think we’re talking about different stages.
Thanks for this thoughtful answer.And please don’t mistake a concern for a criticism–they are not the same thing.I’m a CU fan, was accepted to do a raise there and for the time being chose not to although that may change.And maybe its not structural but the way it is used but honestly, the ease of access of companies P & L is both a dream from a research perspective but as I said–a concern.To your most important point of the competitive nature of consumer goods and tech, I see it differently.As someone who has built consumer tech companies, straight tech software companies and consumer hard goods ones, two pieces distingush the hard goods consumer ones-especially if the product is shelf life restricted.The first is the need for capital from a prepaid inventory perspective. Nothing quite like it in the software world and its a challenge for startups.The second is that the channels themselves are very limited and to date-non disruptable-and likewise with shelf space restrictions comes more competition with the funds to go after them.From that perspective it may not be the Coke formula you are protecting the the market side view of you brand sure is and your economics is part of that.Thanks!
It exists. And it’s global.
Absent the company getting involved with 3rd party transfers (and applause to Circle Up for getting involved) i always thought the best mechanism for accomplishing these transfers are total return swaps. Typically used in other portions of finance – there’s no reason why I couldn’t pay Fred and his partners some $ for the total return represented by a certain number of shares of their Series A preferred in Circle Up. Include in the contract parallel investor rights – and voila – you have liquidity with similar rights – and the company has nothing whatsoever to do with the transaction.
This is huge, your last statement even more profound when if/when! it becomes a reality.