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7 Insights & Tips On American Equity CrowdFunding (JOBS Act) From Sherwood Neiss

Successful entrepreneur Sherwood Neiss of Crowdfund Capital Advisors gave a remarkable, well-attended lecture on raising capital for startups, for Siftech’s 10th “Off The Record” event.

Sherwood Neiss speech

Neiss founded FlavoRx, a medicine-flavoring company, and expanded its clientele to 80% of pharmacies in the US. After selling FlavoRx, Neiss got involved in investing and crowd-funding, and co-wrote the framework that would later be used for the JOBS Act (the US law that makes equity-crowdfunding legal) as well as a book on equity-based crowdfunding.

A quick explanation for readers: equity crowdfunding means raising money by selling shares (“equity”) in your company. This contrasts with most forms of crowdfunding that existed previously where people provided funding as donations (e.g. charity-style) or got rewards/products like DVDs, art etc.

Here are 7 key takeaways from the speech:

1. Crowdfunding isn’t new – it’s just a modified version of “friends and family financing.” Therefore, success depends on “how strong your social network is.”

2. The JOBS Act gives lots of protections for investors, in the knowledge that most small investors won’t have the time or interest to perform proper due diligence, just as they don’t do so when investing in the [public] stock market. These protections include:

  • All-or-nothing financing. If a startup doesn’t manage to get commitments from investors for 100% of its financing goal, then the startup won’t get any of the pledged money.
  • Third-party escrow holds pledged investment money. This protects investors from the risk of the crowdfunding website going bankrupt. If the site were to go bankrupt while having investors’ money in their bank account, investors still get their money back — because it’s in the escrow firm’s bank account.
  • Investment caps. There’s a max limit on how much money can be invested via crowdfunding sites; this limit varies according to someone’s annual revenue. In case someone loses all their crowdfunding investments, it still won’t be a catastrophe for them.
  • 21-day holding period. In case someone were able to fraudulently raise lots of funding in only a few days, they still wouldn’t get the money until the 21-day holding period is complete. This gives investors time to research and perform due diligence.

3. “The rules of the game (i.e. raising investment capital) don’t change.” Just because it’s crowdfunding, doesn’t mean you can take shortcuts. For example, “Don’t pivot without notifying investors. Tell investors everything they need to know as soon as they need to know it. [Emphasis added]”

Neiss shared his experience with FlavoRx to illustrate. While fundraising, Neiss told investors that the company had no direct competition. He raised $3M. A month later Neiss found out that a FlavoRx customer decided to compete with them and opened a company called TastyMeds.

Neiss was worried sick – he candidly admitted he was concerned that investors would ask for all their money back! So he immediately called his investors, who told him he’d done the right thing to call right away.

What do we do next, Neiss asked them? Wait 6 months, came the reply.

During the next 6 months, TastyMeds rapidly built their business, taking many customers away from FlavoRx. Neiss updated investors as this was happening, and after 6 months they said, “Now we sue.” FlavoRx had a non-compete clause in the contract with their former customer; the investor knew this and wanted to see if TastyMeds would have any success. As Neiss concluded “We bought TastyMeds and their new product line, customer list etc… for $1.”

4. Presell or “soft-circle” the investment with friends to establish social proof. Just like Honda boasts about how many people buy the Civic, entrepreneurs need to get people to commit to investing before putting their page up on a crowdfunding site.

Hardly anyone wants to be the first, second or third to invest… but once you get your first investors, it appears less risky for others who then are more comfortable joining in.

With FlavoRx, Neiss got an acquaintance to make an initial $100,000 commitment, which in turn lead to three more $100,000 investment commitments.

5. Reach out to your circle of contacts for help in areas where they are strong. No one’s good at everything, so don’t try to do it on your own.

6. Investment crowdfunding will provide greater transparency. One area this affects in particular is deal pricing, since until now everything was done behind closed doors. The only comparable companies were public companies, and obviously there are significant differences to public companies. By making the private capital markets more transparent, supply and demand will meet at the equilibrium point on a more regular basis.

[As a correlary, yours truly would like to point out that a greater percentage of deals should close as result. Since some people may have misvalued deals and refused to invest/take investment as a result, better information and valuation should lead to fewer missed opportunities.]

7. Collaboration will reduce risk. When professional investors invest, they’re hoping that the market will also like the company so that they can sell their shares later. Neiss cited the head of the British angel investing association as saying that the British angels look at what the crowd invests in and provide follow on financing. Successful crowdfunding indicates some validation for the company at least in the capital markets.

Similarly, even though many individuals won’t do proper due diligence, the crowds involved in crowdfunding include angels and venture capitalists, amongst other savvy investors. These people will ask challenging questions and thus benefit the remainder of the crowd.

A third way that collaboration will reduce risk is through the introduction of rating mechanisms. Does investor X make too many critical comments? Does entrepreneur A answer questions in a timely manner? Is he transparent?

What next?

For now, Sherwood Neiss and the JOBS Act are academically interesting, but of little practical import to most Israelis since American and British crowdfunding are limited to residents of their respective countries.

However, the entrepreneurial advice Neiss gave will certainly come in handy to many entrepreneurs, who will owe a debt of gratitude to Siftech and the American Center for organizing the event. And perhaps the Knesset might see fit to adopt some of the solutions pioneered abroad to enable Israelis to crowdfund locally, as well.

Posted in Business.

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