Cutting Edge Capital is excited to announce our partnership with SVX! SVX is a community capital raising platform in Canada and the US (coming soon). To support our California community, Cutting Edge Capital & SVX are co-sponsoring an Impact Bootcamp to discuss and develop funding solutions for social enterprises to enable them to raise capital in alignment with their missions.
When: Monday, September 12th (1 – 5 pm)
Where: Impact Hub San Francisco: 901 Mission Street Suite 105 San Francisco, CA 94103
Are you a California impact venture looking for capital and opportunities to scale your business? US and Canadian impact investing and social enterprise experts from Cutting Edge Capital and SVX are hosting a FREE half-day bootcamp on September 12th featuring expert content, coaching, and peer-to-peer learning. Bootcamp sessions will include the following:
Social Impact Business Model Canvas: Tighten up your business model by preparing or refining your mission and vision with our expert advisors and fellow entrepreneurs
Private Placements, Direct Public Offerings and Investment Crowdfunding: Learn how you can raise capital from your community using various regulatory compliance mechanisms
Pitch Preparation and Demo: Gain insights on pitching to impact investors and have the opportunity to practice your pitch with our expert coaches
Ventures will also have the opportunity to learn how they can leverage the new SVX platform to support their capital raise efforts from both accredited investors and the general public.
Target Ventures Early and growth stage impact ventures in the Bay Area and Northern California that will be raising capital in the next 12 months, ideally in the following sectors: clean technology, education and social technology, health and wellness, sustainable food and consumer products, impact real estate, and social inclusion (serving, employing or led by members of underrepresented communities).
Venture Selection Criteria
Incorporation: US incorporated for-profit or non-profit (includes co-operatives).
Operating History: Preferred (not mandatory) one (1) year operating history.
Market Traction: Ventures with existing revenue, customers, and/or investment preferred.
Business Plan: Business plan that demonstrates understanding of long-term finances, operations, and strategy.
Impact Focused: Description of current or planned measures to track impact.
Capital Need: Ventures must be interested in raising debt or equity investment capital in the next 12 months.
Application and Deadline
Applicants should provide the following: a complete application form and a pitch deck.
Ventures should send their materials to firstname.lastname@example.org by Wednesday, September 7th at 5 pm. Note that we will be accepting applicants on a rolling basis until full so please submit your materials as early as possible. Please reference “Impact Bootcamp” in your email subject line.
If you know an entrepreneur that is looking to raise capital for their small business
These days social entrepreneurs are increasingly attracted to capital raising methods that are designed to reach mission-aligned investors, believing that these investors will best support the entrepreneurs’ vision and impact. Crowdfunding (investment, donation or pre-sale), direct public offerings and private placements are all methodologies that entrepreneurs can employ to reach such investors. But, if you build it, will investors come? “Your network is your net worth” explores how the right offering strategy combined with your network can can make all the difference in your upcoming capital raising campaign. See the replay below.
When considering an investment in a direct public offering, potential investors may want to understand how they can get their investment back, i.e. their exit strategy. Organizations raising capital via a DPO should expect questions from potential investors on this subject.
An investor’s sale of their investment is itself regulated by securities laws, so in addition to the pragmatic question of finding a buyer, the investor needs a strategy for compliance with these securities laws.
The following summarizes a number of exit strategies that may be available to investors in a DPO, depending on the type of security and other circumstances. The discussion is organized into four sections: i) exit strategies that are built in to the security itself, ii) those that may arise based on future events, iii) those that may be available on an investor’s initiative, and iv) trading mechanisms that may be available.
I. Exit strategies designed into the security
These strategies are built right into the investment from the beginning and don’t generally raise additional securities compliance issues at the time of the exit.
Debt: Many of our DPO clients offer investment notes, which are debt instruments with a specific maturity date. Of course, an issuer offering debt needs to think about how it will repay the principal at maturity. Some may establish a sinking fund, or will make annual principal payments rather than a balloon payment at maturity.
Revenue share: Also known as revenue-based financing (or RBF), this is an increasingly popular investment model in which payments to investors is a function of the issuer’s top-line revenue, so that the issuer pays less during lean times and more when it’s flush with cash. There are several variations on the theme, but in the most common variations the investor’s rights expire when the investor has received a pre-set multiple of their original investment (typically 2x to 3x).
Preferred stock with redemption feature: Preferred stock can be designed with a built-in redemption feature. There is a lot of flexibility in how to do this. Key decisions for issuers who want to go this route are:
– Who has the right to initiate a redemption? In other words, does the issuer have a call right or do the investors have a put right? Or should it be automatic upon some triggering event?
– When does the redemption right arise? Often it arises after some period of years, say five or seven years.
– How should the redemption price be calculated? To avoid having to pay for a professional appraisal, it could simply be the original purchase price (which means those investors won’t share in any appreciation), or it could be based on some formula based on revenue, profit, or other metrics.
– How should the redemption price be paid out? If it is at the investor’s election, the issuer should have the option of paying in installments over, say, five years.
II. Exit strategies based on future events
These exit strategies involve someone other than the investor taking the lead – someone who typically handles securities compliance issues.
IPO: An initial public offering (IPO) entails a full registration with the US Securities and Exchange Commission (SEC), usually accompanied by a listing on a national trading market, either over-the-counter (OTC) or on a stock exchange (like NASDAQ or the NYSE). This usually allows existing investors to buy and sell their shares freely. For example, Annie’s Homegrown raised capital through a DPO in 1995 and then went public with an IPO in 2012.
Merger or Acquisition: A number of companies that have done a DPO have subsequently been acquired by a larger company. Perhaps the most prominent example of this is Ben & Jerry’s, which completed their a DPO in 1984 and was later acquired by Unilever in 2000. Annie’s Homegrown, following its IPO, was acquired by General Mills in 2014. When an acquisition happens, the acquiring company makes a tender offer to all shareholders to purchase their shares, often in cash at a premium over what investors paid. Sometimes, if the acquiring company’s stock is publicly traded, it may offer to exchange the shares of the acquired company for its own shares, which can then be sold.
Listing on the OTC Market, or stock exchange: Even without going public via a full IPO, a company that has raised capital via a direct public offering may decide to register its shares to trade on a national market such as NASDAQ or the NYSE. Since doing so does not raise capital and can be expensive to accomplish, however, there may be little incentive for the company to go this route.
Issuer’s Tender Offer: Even if an investment has no built-in redemption feature, an issuer can still redeem investments by making a tender offer. This typically occurs in conjunction with a new investment into the issuer — so the new investment proceeds are used to redeem the earlier investors. This new investment can be in the form of a private placement, or it could be a subsequent (or renewed) DPO. The issuer has some flexibility as to which classes of investment and which investors it will redeem; and it can structure the transactions so only a portion of the new investment will be used to redeem earlier investors, so as to have a net new infusion of capital. As with other types of securities transactions, tender offers must comply with a set of rules that govern them.
III. Exit strategies at the investor’s initiative
If none of the strategies above are available to an investor who wants an exit, there are other ways to sell an investment, as long as the investor is careful to comply with securities laws. These laws generally forbid an offer or sale of an investment unless it is either registered or exempt from registration; and this is true at both the state and federal level.
Federal law provides an exemption from registration for sales by someone other than the issuer, an underwriter or a dealer. While that would appear to allow secondary sales by an investor, there is an important nuance: A selling investor might inadvertently be deemed an underwriter. In other words, if an investor buys shares of stock in a DPO and then later turns around and sells them (a “secondary sale”), the investor could be deemed to have participated in a distribution on behalf of the issuer. In that case, the exemption is not available.
However, there are three strategies an investor can use to ensure that a sale of their investment complies with federal law:
Rule 144 sales: Under Rule 144, if an investor that is not an affiliate of the issuer (that is, not an officer, director, or 10% shareholder of the issuer) holds the investment for one full year, they can’t be deemed an underwriter and can sell the investment. However, the investor would also need to comply with their state’s securities laws.
Private sales: Another way to ensure the investor is not deemed an underwriter, even if a full year has not elapsed, is to offer and sell the investment privately. This requires that the investor have an established relationship with someone before offering the investment to them. As with Rule 144, the investor would also need to comply with state securities laws.
Section 4(a)(7) sales to accredited investors: Section 4(a)(7), which was added in 2015 to the 1933 Securities Act, provides a new exemption from registration for secondary sales to accredited investors, as long as there is no advertising and as long as the issuer provides disclosure of key information about the company. This is a federal exemption that preempts state law, so investors don’t need to be concerned about their specific state rules. An individual is accredited if they have either $1 million in net assets excluding their primary residence, or $200,000 in annual income (or $300,000 together with their spouse).
With secondary sale strategies that also require compliance with state law, the selling investor is responsible for understanding what their particular state requires. In California, for example, Corporations Code section 25104(a) provides an exemption for secondary sales if there is no advertising and the sale is not conducted through a broker-dealer in a public offering. Many states have a similar exemption.
An investor looking to sell their investment should be aware of other restrictions that may be imposed due to the nature of the original offering. Perhaps most prominently, if the investment was made in an intrastate offering (a common DPO strategy), the investment may not be resold to a resident of another state for at least nine months after the date of the last sale by the issuer in the intrastate offering.
IV. Secondary Sales Mechanisms
The above strategies are the legal compliance strategies. Some practical mechanisms for secondary sales under these legal strategies include:
Broker-managed trading platform: Companies like NASDAQ Private Market (which acquired SecondMarket), OpenShares, and SharesPost operate platforms on which securities acquired in a DPO can be sold. Since they receive compensation for their services, these platforms need to be licensed as a securities broker-dealer.
Trading bulletin board hosted by issuer: This may be similar to a broker-managed platform; but as long as the issuer is not receiving any compensation for facilitating securities transactions, it does not need a securities broker-dealer license.
Privately negotiated sales: An investor can sell their investment in a private transaction to a buyer in their network, as long as they follow the rules, such as not advertising or announcing the potential sale in any public way.
While there are a number of exit strategies available, each has its limitations, and an investor in a particular situation may very well find that none of them is feasible. One of our goals at Cutting Edge Capital is to eliminate barriers to a vibrant and efficient community capital market. Therefore, we are exploring two possible strategies that could help alleviate investor concerns about a future exit from a DPO investment:
– A nonprofit market participant that can purchase securities that were acquired in a DPO, hence creating a kind of market appetite. It could raise capital via a debt offering (like other nonprofit investment funds).
– A for-profit investment fund that would invest in DPOs, as well as in privately offered securities of social enterprises. As an open-ended fund, it would itself issue shares to investors and redeem them as needed.
An Oregon real estate company and CEC client, Guerrilla Development, is focused on “creating inventive and experimental projects that use both hemispheres of the brain.” Coincidentally, earlier this month they have been busy engaging both “hemispheres” of investors: accredited investors (a.k.a. wealthy individuals) and non-accredited investors (a.k.a. the rest of us). They are using one of the newest legal strategies for ventures to “crowdfund” investment capital, Regulation A, through which they are offering $1.5 million of preferred equity in the Fair-Haired Dumbbell, an office building with ground floor retail in Portland, Oregon. The offering is open to residents of California, Oregon, Washington, Massachusetts, Virginia, and the District of Columbia. If you’re curious about Regulation A offerings, check out their campaign video for a great overview:
While the idea of raising capital from the “crowd” is catching on around the country with private enterprises seeking growth capital, the Guerrilla Development offering is different from other offerings in that it is part of a broader trend to use today’s investment crowdfunding tools for economic and community development purposes—specifically, downtown revitalization.
This approach marks a change from the way communities have typically sought funds for their improvement: through applying for state and federal redevelopment grants. This significant departure from the familiar approach presents a number of advantages for community-based ventures. For one, it allows for greater flexibility in the use of funds, which are often tightly regulated by grantmakers to specific types of community development projects. In the grant-driven approach, if the project or program doesn’t jive with the rigorous criteria of the grantmaker, there’s a good chance it will never see the light of day. Secondly, crowdfunding opens up a range of new possibilities for communities self-funding their own development. Now, rather than waiting for the state or federal government coming to the rescue of America’s urban cores and downtowns, communities can be empowered to raise their own capital to get projects done using these new tools.
We are working with other groups that are using Direct Public Offerings, or DPOs, to raise capital for downtown revitalization projects. As an example, one of the groups we are working with intends to raise $4.5 million for a real estate investment fund for the purpose of a major overhaul of downtown Fresno, through the purchase and rehabilitation of a number of properties for retail and other uses. Fresno, California, if you don’t already know, sits in one of the most productive agriculture regions on earth, and yet has some of the highest levels of poverty in California. Decades of disinvestment have led to a ghost town-like status in downtown Fresno, in sharp contrast to the abundant agriculture lands outside of the city. Through the use of a DPO, the group will give Fresno residents a chance to invest in the underlying real estate at the center of the revitalization plan, and be a part of the city’s success. The arrangement will ensure that the fund will never take on debt (which goes to the safety of the investments) and will be marketed specifically to local investors. Not having just one or two wealthy investors will allow the manager to make decisions based on the need for the revitalization of the area, without the typical shareholder primacy pressures. The offering is also devoid of the typical wiggle room that real estate developers typically add into their offerings that allows them to change the direction of the plan once it is funded.
Another group we’re working with, Our Katahdin, takes a broader approach to downtown revitalization, targeting the Kathadin region of Maine, which includes both small town and rural geographies. Seeing an opportunity to allow Maine residents to invest in the region’s development, this non-profit loan fund will cycle in capital from Maine residents through a DPO, before either loaning it out at a slightly higher interest rate to qualified ventures for their growth and development, or actually purchasing land for the non-profit to develop. In the process, everyone will benefit: Maine entrepreneurs will benefit from the access to capital; Maine investors (of the lending variety) will benefit from a modest return on investment; the region and its communities will benefit from enhanced economic activity; and the non-profit loan fund will benefit from the revenues for making it all happen.
We’re also excited to share that we’re in conversation with another real estate group, a non-profit Community Development Corporation in Rhode Island, which soon plans to pursue an innovative approach to real estate development in the state. Their approach centers on a public-private partnership with local municipalities to co-fund both the DPO and, if all goes according to plan, real estate development projects in Rhode Island’s distressed urban cores. They propose a fundamental rethink of housing development, bringing together spaces for living, co-working, and education, while also focusing on job creation, community revitalization, and “smart” growth in low to middle income neighborhoods. They, too, plan to use a DPO to engage a wide range of community stakeholders—and shareholders—in the success of the project.
We find a lot to like about this new trend toward greater democratization of investment in revitalization. Not only does it serve as a practical way to access capital for impactful projects that can breathe life into towns and urban cores, but it also serves to empower communities to take charge of their futures. When communities invest in themselves through local ventures, everybody wins.
Foundations, Families and Funds can play a very important role in helping to redirect capitalism toward a more fair and just application, while also finding the right social enterprises to support.
By playing a more comprehensive role in the creation and support of Community Capital Markets, these funding sources can build impact into a systemic approach. In addition to investments they make into the social enterprises either directly or through other intermediaries, they can also facilitate opportunities for the 90% of households that are prevented from participating in the private capital markets by investing in the structures that form alternative capital markets open to everyone.
We are better informed today than ever before about the rapidly expanding wealth and income gaps. Many recent studies show the top 10% of U.S. households now have over 75% of all the wealth in America. The next 24% of American households make up almost all the rest of all the wealth, leaving the bottom 40% with 0% wealth, and the bottom 60% with a whopping 3%! And the gap is growing fast, not shrinking, which portends many new challenges to our society.
Clearly we need to think about whether the current approaches are working, and if not, shift the paradigm.
As economists like Thomas Piketty have thoughtfully surmised, this growing gap will not improve without either government intervention or opportunities similar to what the wealthy have had – i.e. the same chances to invest and to begin to grow some wealth of their own. For anyone out there who follows the current dysfunctional state of our government, I would not hold out much hope for the first option anytime soon.
Regardless of the causes, our current state of affairs seems to point toward us having to right this very serious problem ourselves, and right it we must.
In the U.S., our government actually limits 90% of households from having any access to the private capital markets, leaving their investment options only in either the public capital markets, or alternatives that I’ve written about here, via Direct Public Offerings, or perhaps through the new state and federal crowdfunding options.
The irony is that, in the interests of protecting the 90%, only the very wealthy 10% continue growing their wealth. They have access to opportunities that far surpass anything found in the public capital markets. The 10%er’s may also use the public capital markets to hedge, speculate, or even arbitrage if they like, but their real wealth generation comes mostly from those private markets. But neither of these kinds of markets helps us to form the systemic structure we need to build healthier communities.
Which leads me back to how Foundations, Families and Funds can help.
The list of impact investors is growing every day, and we will all continue to work toward better identification of who is truly acting as a social enterprise, e.g. companies building business models to tackle some of the most difficult and seemingly intractable social and environmental problems, including climate change, poverty, water, energy and real estate, etc.
I refer to the entrepreneurs above as our new community of social enterprises, which includes those with a clearly defined mission, who are focusing on achieving impact at scale for all stakeholders (workers, customers, community, environment), but who also understand the importance of connecting via deep impact into their local populations. These kinds of entrepreneurs place a high degree of importance on the generation of mission aligned revenues (from clients or others who’s mission is aligned), and tracking/publicly reporting on their impact on a regular basis (transparency).
It’s encouraging to know that many investing organizations are now looking to make real impact via their investments by seeking out these entrepreneurs, even if we’re still in the nascent stages of trying to square that with the goal of getting back “market rate returns.” Leslie Christian just posted a great blog on this conflict here.
However, supporting those entrepreneurs with an investment is only one of two key components we need to have a healthy Community Capital Market. Focus also needs to be provided to the 90% of households so they can participate as well, even if half or more of them currently have no wealth to employ as investments into a market. These households need opportunity, which they are now starting to see with the alternative investment vehicles mentioned above, but even more important, they need experience, education and understanding in terms of what it means to be an impact investor – one that may not need those “market based returns,” whatever that means.
We need a whole system approach in place for community investors and community entrepreneurs to be able to find each other, which is what a Community Capital Market can be.
10 years ago, my good friend Don Shaffer (now at RSF Social Finance) and I embarked on a project to develop Local Stock Exchanges. I wrote about the need for these in several publications and even took a position at the Boston Stock Exchange to mirror a national exchange at a local level. But looking back, there is one critical element I got wrong. We don’t need to replicate the public capital markets with a lively secondary trading component that fosters speculation and arbitrage (using the need for liquidity to justify the madness they have become). We need a much more simple system in place that allows for the efficient transfer of individual’s savings into socially responsible companies, allowing for modest healthy returns, and some reasonable offerings of an exit if necessary. We need to power it with the right tools, education and mentors to help guide the ones that have not had access until now. We also need to reconsider what a capital market needs to be today, and not fall for the trap of manic returns and unlimited growth.
Foundations, Families and Funds can get behind this new kind of capital market by funding the system that can facilitate the Impact we need, and if they desire, they can also play a member-based role in how we operate it – much like exchanges used to be structured, before they turned into the same shareholder primacy driven entities that list on them today.
The Securities and Exchange Commission has recently estimated that approximately 10% of all U.S. Households are now in the “Accredited Investor“ category (for individuals, that means $1m in net worth not counting primary residence, or $200k of income). Assuming that’s accurate, there are now over 12 million households in the U.S. that meet the definition of Accredited Investor (“AI”).
The SEC defines the AI to determine their eligibility to invest in Private Placement offerings (i.e. funding rounds of securities that are sold not through a public offering (IPO), but rather through a private offering, and mostly to a small number of chosen investors). And as the private placement market edges toward $60 billion of deals a year, that may seem to most people as a sizable amount to participate in, with lots of opportunities to get in on the next big home run deal.
Some of those AIs, however, have begun to look for more than just a company swinging for the fences, but rather companies that look out for profits, people andthe planet. The rise of socially responsible or impact investing has now begun to take hold. And there are now more financial advisors becoming familiar with these kinds of investments, and helping their clients to find such deals.
Unfortunately, financial advisors feels constrained (for good reasons) to only show their clients deal opportunities of a certain size and nature. Many even limit their scope to only companies traded on public markets so that they reduce the risk of breaching their fiduciary duty to their clients. Other more adventurous advisors will brave the private investment landscape, where, with the right amount of due diligence, they can recommend impact deals to their clients that will also provide something close to market returns (whatever that really means).
But there’s another opportunity for AIs to make a significant impact. They can invest AND play an essential role in the stabilization, growth and resilience of the communities they live in or relate to. They can do this by participating alongside of the rest of the non-accredited investor community into investments offered by community entrepreneurs.
The kinds of investments I refer to here are Direct Public Offerings and certain state securities crowdfunding opportunities, both of which allow for investors to directly interact and engage with the entrepreneur/issuer. I wrote recently about this in previous blogs here, and also earlier today in a Locavesting article. As these crowdfunding offerings and the platforms they list on become more populated, investors will begin to find it easier to find offerings. Also, as we help clients obtain their approvals for DPOs, we post the offerings up on our CEX site so that investors can more easily find the issues and link to their sites.
The role AIs can play to support these much needed community enterprises cannot be emphasized enough. For one thing, as companies begin to turn more to using tools like DPOs to raise their funds, the size of the raise is going to increase well above the $1 million limit that the state or federal crowdfunding laws impose. DPOs, if done via the Intrastate exemption, are typically unlimited, as long as the state regulators approve them, and we are starting to see many more offerings in the $5-10 million range. Companies offering stock will want to limit the number of non-accredited investors to 500, and the total number of investors to 2,000, or face becoming “publicly reporting,” which is expensive to maintain. This means the offerings truly need the AIs to meet their targets.
Another key reason is the experience AIs may be bringing to these offerings. Clearly just because one is an AI does not mean one has the financial expertise of a typical VC or Angel who do this for a living or hobby. But there is no doubt that many AIs have some experience with investments, and likely more than their non-accredited counterparts. This can be very important when a company is even considering how to structure their offering, if they can learn beforehand what an AI will want to see before they participate.
And then there is, of course, the leverage an AI can bring to the offering, just by signing on and showing up. Some AIs provide the “prime to the pump“ so that the offering can take hold. Some even offer a matching approach. It can be an important signal to the non-accredited investors that they don’t have to shoulder the offering alone. Also, regardless of the wealth divide that exists, every member of the community can come together to make an offering successful. AIs can be an important kind of hero to this movement, while still obtaining enough of a return. Their participation can also lend the right kind of pressure to the entrepreneur to keep them on their toes, and striving to meet their mark.
AIs might do their own homework (due diligence), as they look at these investments, or they may be able to find a new breed of financial advisor who are willing to help analyze the offering, even if they stop short of making recommendations and risk their duty. And there are also new pioneers, like Marco Vangelisti, who has taken it upon himself to begin offering daylong workshops for community investors.
Marco is a veteran of global finance who walked away from the industry in 2009 after a 25-year career, and is now helping communities around the country understand the role investors can play in support of community. He created Essential Knowledge for Transition – an initiative to empower communities with a basic understanding of the large systems affecting our lives. Marco’s next workshop will be in Irvine CA the 7th of May, and after that, we intend to try cloning him so that we can help ALL kinds of investors, AIs and non-accrediteds alike, everywhere, to align their investments with their values, and create the world we want, and need.