One of the biggest early challenges to Title III equity crowdfunding adoption has been startups’ concerns about lots of small shareholders. As a result, in partnership with securities experts, startup attorneys, traditional venture investors, and the greater crowdfunding community, we have created a new security designed by the crowd and for the crowd. Given that crowdfunding is by definition a type of crowdsourcing, we thought it was only appropriate to crowdsource the Crowd Note.
Title III of the JOBS Act opened the door for startups to fundraise online by raising small amounts from lots of people (i.e. Kickstarter with Equity). It is still early days, but one of the biggest headwinds slowing down the best companies from utilizing equity crowdfunding with non-accredited investors is what we call “cap table concerns.” We believe the industry needs to adopt a new type of investment security for startups which alleviates these concerns head-on in order to speed-up adoption of Title III equity crowdfunding by the very best startups.
Current Title III Structural Challenges
- Managing hundreds of small shareholders can be potentially burdensome if you need to solicit shareholder votes or provide information on a one-off basis.
- VC firms might be nervous about investing in a startup which has hundreds of equity shareholders on its cap table.
- Companies with 500+ non-accredited shareholders of record and $25 million of assets could be forced to comply with onerous public company reporting requirements.
Goals of the Crowd Note
- Modifies the typical convertible note so that the crowd does not automatically convert to equity shareholders (and therefore may remain off the company’s cap table).
- Gives the company the ability to keep the note outstanding until an exit while ensuring the crowd locks-in the same price per share they would receive with a typical convertible note.
- Minimizes voting and information rights so the crowd does not interfere with the company’s operations but ensure that smaller investors have the same economic terms as larger investors.
Key Crowd Note Features
- A company may extend or convert the Crowd Note at its option upon each qualified financing.
- Investors lock-in the conversion price per share of the initial qualified financing and preferred stock, even if the note ends up converting later.
- Investors receive at least a 2x acquisition premium if an acquisition occurs prior to initial qualified financing (investor protection against an early exit).
- No voting, information or inspection rights. To the extent investors are required to vote by law, investors automatically agree to vote with the majority of the preferred.
- Valuation cap and discount but no maturity; enables startups to potentially keep the note outstanding longer, past the initial qualified financing.
In partnership with the greater equity crowdfunding community, we’ve developed a Crowd Note which appeals to investors, entrepreneurs, and VCs alike. When executed in a manner that is friendly to founders and fair to investors, the opportunity Title III presents is unprecedented. With the Crowd Note, startups will be able to reap the benefits of the crowd, maintain a clean cap table, and continue to raise capital from institutional investors.
Ryan, CEO of SeedInvest