William Carleton, Counselor @ Law

Taking in the last day of the ACA 2013 Summit

Am enjoying the beautiful Saturday in San Francisco, the day after an eventful conclusion of the Angel Capital Association 2013 Summit at the Hyatt Embarcadero in San Francisco.

Two things made Friday special for me: (1) angels from France, the UK and Hong Kong presented on what government does to support angel investing in their regions of the world, and (2) Rep. Dave Schweikert of Arizona, a sponsor of the JOBS Act, joined the panel Dan Rosen moderated and that Joe Bartlett and I took part in.

I will have more to say about what I learned Friday but today I'll just digest at the subconscious level while enjoying the sun and walking across the Golden Gate Bridge in my red, cotton Docracy t-shirt.

Jean Peters' testimony before Congress last week

Just this week catching up to the testimony Jean Peters, managing director of Golden Seeds Angels and a board member of the Angel Capital Association (and, incidentally, moderator of yesterday's accredited crowdfunding panel at the ACA Summit), gave last week before Representative Dave Schweikert's Small Business Subcommittee on Investigations, Oversight and Regulations.

Peters' prepared remarks are both an excellent summary of how angel investing catalyzes entrepreneurial and startup activity, and how organized angel investing, through angel groups, can help the country manage the transition to newer rules around the means of private financing.

I'm going to quote liberally below from Peters' prepared remarks. Here also is a link to an archive of the committee hearing webcast.

"Startup investing is a disciplined and long-term process. Angels bring careful due diligence, negotiations and experience to the table.

"We have to: angel capital comes from our own pockets. We are not investing other peoples’ money. We invest our own, and more often than not use our successes to fund the next round of startups.

"We understand that what we do is highly risky and extremely illiquid. Angels give time and expertise, without compensation, and often without liquidity for 8 to 10 years. We do this to make a return – but also to give back, to keep up with our industry -- and because start-ups value what we do. As a result of the thoughtful work of angel groups, the strong growth in angel financing over the past decade has remained virtually free of fraud or abuse."

. . .

"Angels have a long history of adhering to disciplined due diligence, deal screening, term sheets and corporate governance. As more accredited investors come into this class, ACA will play an expanding role in helping high-growth startups and investors intelligently and successfully come together.

"ACA will continue to provide adult supervision in this shifting landscape of social media, general solicitation, and the nascent conduit of crowdfunding.

"We will be there when companies that are crowd-funded need additional capital.

"We will continue to be the primary sorting mechanism for those startups that are most promising.

"We will help ensure that companies seeking funding are legitimate, appropriately structured, managed and valued.

"Angel groups can provide a substantial barrier to the types of hazards that might face accredited investors – and others trying to sift through advertising or crowdfunding to identify great entrepreneurs and startups.

"And that will mean that the innovation now bubbling up in every congressional district and jobseeking community will stand a far better chance of success for the entrepreneur, for its employees, and for the investor willing to take that risk."

Debrief of yesterday's talk

Quick debrief of the event yesterday at the SURF Incubator for the Seattle Angel Conference, about the possible convergence of angel investing and crowdfunding:

• Several indications from workshop participants that the effective lowering of the average investment per deal correlates strongly with getting more people who meet the accredited investor standard into the private investing pool.
• From the entrepreneur's perspective, one would rank the different types of crowdfunding in the following order of priority: (1) donation, rewards-based (or Kickstarter-like) crowdfunding; (2) angel crowdfunding under Title II of the JOBS Act; and (3) Title III crowdfunding, if in fact there were such a thing.

• I pressed that Title III crowdfunding is not workable, and got no pushback. The points that the legislation requires business plans and reviewed or audited financial statements, those were probably the most compelling.
• Different practices in accredited investor verification were raised: who performs it; how extensive is it; in the platform context, how important is it that the process is separate from the pitching of a given deal.
• Even though the ban on general solicitation has not yet been lifted, angel platforms move ahead, relying on Title II.

Pictured are views from the SURF Incubator offices on Second Avenue in downtown Seattle, looking west and east respectively.

Trying to make sense of an SEC staff FAQ

Turning back for a moment to the recent SEC staff FAQ, published on the SEC site earlier this month, which purports to interpret the federal broker-dealer registration exemption for angel groups and angel platforms that is a feature of last year's JOBS Act:

How is it that the staff conclude that Congress meant the exemption to be essentially worthless, unlikely to be available to anyone "outside the venture capital area?"

We don't have answers yet, but it occurs to me that we need to get grounded again in what was said on the House floor at the time that the exemption was introduced. The exemption took the form of an amendment to Title II, the provision of the JOBS Act that also contains the mandate that the SEC lift the ban on general solicitation in offerings limited to purchasers who are verified as accredited.

The introduction of the amendment, by Patrick McHenry of North Carolina, was a love fest. Barney Frank rose to support it and labeled it non-controversial. Here's a link to a pdf of two telling pages from the March 8, 2012 Congressional Record. And here's a key excerpt, the speaker being Representative McHenry:

"It takes away some red tape that is within securities regulations, and it allows incubators, forums, and online platforms which only connect accredited investors to start-ups to be exempt from SEC registration as a broker-dealer if they, number one, do not charge a commission or fee for their service; number two, do not handle the moneys of investors; and, number three, only permit accredited investors to use their platforms.

"This is a very narrow amendment, very specifically crafted. In fact, the President’s Council on Jobs and Competitiveness in October of last year said in their report that the emergence of angel investors and networks have also played a crucial role in initial funding of companies, and that the council recommends that clarifying that experience and active seed in angel investors and their meeting venues should not be subject to the regulations that were designed to protect inexperienced investors."

Further context:

• The SEC staff's Frequently Asked Questions About the Exemption from Broker-Dealer Registration in Title II of the JOBS Act; and
• this blog's first post on the topic, Speed bump for online angel platforms.

Photo: Neil Harvey / Flickr.

More and more angels

Puzzling figures – numbers cited as averages - in the angel investing infographic published by VentureBeat (and perhaps others):

"$90,000 AVERAGE ANGEL INVESTOR ANNUAL INCOME"
"$750,000 AVERAGE ANGEL INVESTOR NET WORTH"

The numbers fail to clear either bar set by the accredited investor definition: $200,000 in annual income, or $1 million (of late, not including the value of the principal residence) in net worth.

If the $90,000 figure for average income is to be believed, then the angels in that pool must be exceeding the net worth threshold. But if the average angel net worth is $750,000, then the angels in that pool must be exceeding the $200,000 in annual income (or $300,000 in combination with your spouse) threshold.

Is such math possible?

At least plausible, to me, are the figures the infographic cites in the growth of the numbers of angel investors, and the total dollars invested by angel investors, over a recent ten year period.

At least part of this growth can be attributed to inflation: because the accredited investor thresholds have not been increased in the three decades since first set, the thresholds have, in effect, been decreasing over time, even as the population and the economy expand.

This is a good thing.

Good things don't always last. Under Dodd-Frank, Congress asked the GAO to undertake a study about the accredited investor thresholds; and the recently departed SEC Chair wondered publicly whether the definition should be soon overhauled.

Throw in the JOBS Act's lifting of the ban on general solicitation for Rule 506 offerings limited to accredited investors, and you have a cluster of contradictory indicators. Do we think angel investing is good for America and do we want more of it; or is the pernicious force of inflation surreptitiously and subversively democratizing private financing (regulators seem to congenitally feel that average people have no business financing private business)?

Image from the classic Wim Wenders film, Wings of Desire.

Crowdfunding, AngelList, and Angel Investors: The Venn of it all

John Sechrest of the Seattle Angel Conference recently invited me to give a workshop. We thought a good topic would be the overlap of angel investing and crowdfunding.

We came up with the title you see as the title of this post. "Venn" refers to Venn diagram. Hope that is not too obscure!

Below is the promotional copy for the workshop. If you're in Seattle March 4 and would like to attend, register here.

Time was, VCs didn't want angel investors mucking up cap tables. No more. Today everyone knows it's angel money, not VC money, that funds most tech startups.

Comes now investment crowdfunding: will angels now be the ones taking a turn looking down their noses at "amateur" investors?

Or is there a third way?

In this session, we will explore how crowdfunding is so very different from angel investing - but, also, where the two paradigms overlap. We'll also look at how innovations in angel investing may set "best practice" standards for crowdfunding portals.

Keytar playing platypus from Tenso Graphics.

Speed bump for online angel platforms

As we covered here eleven months ago, the JOBS Act contains an exemption from federal broker dealer registration requirements for angel platforms that syndicate deals, where participation is limited to accredited investors.

One might fairly characterize this new law, contained in Title II of the JOBS Act, as the foundation of accredited crowdfunding.

What's more, unlike the implementation of the lifting of the ban on general solicitation in Rule 506 offerings where purchasers are limited to accredited investors, Congress did not require the SEC to engage in rulemaking before this reform took effect.

In short, angel platforms are free to crowdfund, today, and, unlike JOBS Act Title III investment crowdfunding platforms open to all, need not wait on the SEC to draft regulations.

But wait: the SEC staff have something to say about the Title II exemption from broker dealer registration!

In FAQs posted last week, SEC staff took a narrower view of the federal exemption than those of us in the startup and emerging company financing ecosystem would prefer.

In particular, the SEC staff seem to believe that almost any kind of compensation can blow the exemption.

Here's what the legislation says in pertinent part:

"The exemption provided . . . shall apply to any person . . .  if . . .  such person and each person associated with that person receives no compensation in connection the purchase or sale of such security . . . ."

Elsewhere, the legislation says that it's okay for persons covered by the exemption to conduct due diligence services in connection with sales of securities on the platform, "so long as such services do not include, for separate compensation, investment advice or recommendations to issuers or investors."

Hang on to that phrase, "for separate compensation," in particular. There's an implication there, isn't there, that compensation for at least some activities or services is okay, isn't there, even if no commission on sales is allowed?

But the staff FAQs don't read the statute that way:

"Congress conditioned the exemption on a person and its associated persons not receiving any 'compensation' in connection with the purchase or sale of such security.' Congress did not limit the condition to transaction-based compensation. The staff interprets the term 'compensation' broadly, to include any direct or indirect economic benefit to the person or any of its associated persons. . . .

" . . . Any salary paid to a person for engaging in . . . activities [to promote, offer, or sell shares of privately offered funds] is compensation to that person in connection with the purchase or sale of securities. As a result, that person would not be able to rely on the exemption from registration as a broker-dealer . . . ."

The SEC staff FAQs do not have the force of law, or even necessarily the approval of the SEC. But these interpretations are troubling. We will have to take some time to sort through them and figure out the implications for angel platform best practices.

Photo: tyle_r / Flickr.