Monday, April 4, 2016
A Constructive Resolution to [What Otherwise Would Have Been] Another Ugly Law Review Experience . . .
Imagine this: You open an email message late in the evening from a law review managing editor. The message includes as an attachment the edited version of an article being published by the law review--or, more precisely--reprinted by the law review. So far, so good.
But also imagine your surprise when you open the attachment and find that the edits are extensive--more extensive than you had expected. So, you dig right in to see what's amiss. The first three modifications are changes to footnote citations. They are incorrect edits. As you review the edited draft, you find that most of the suggested changes are erroneous or unnecessary. Some are even undesirable or undesired (e.g., edits to the text of quoted passages that deviate from the source quoted). In frustration, you wonder whether you should complete your review of the edits or just, based on what you've read to date, throw in the towel and ask the law review to start all over, reminding the law review managing editor that the article already has been published and, in the process, edited by you and the other journal's editors and staff.
I experienced a version of this law scholar nightmare recently. What did I do? I completed my review of the edits (which took six solid hours) and sent the law review managing editor my responses under cover of an email message that explained (1) my likely-to-be-interpreted-as-curt tone and (2) the nature of the changes or reversals of changes I made. I tried to educate through these materials. But I was worried that the managing editor (with whom I had exchanged productive emails on other subjects, including the reprint permission and the publication agreement) might be angered by or otherwise negatively predisposed against my comments.
What happened next was absolutely super, however. Later that day, I received a message from the managing editor reading as follows, in relevant part:
Hello Professor Heminway,
Thank you so much for such a detailed and quick response! I understand your concerns, and we will work through the comments and suggestions that you have made. . . .
Your explanations and feedback throughout this process have been both educational and humbling. I appreciate your attention to detail as well as your willingness to ensure that you thoroughly explain your basis of thought behind certain suggestions and concerns. There's no doubt that your students have a lot to learn from you. Thank you for everything.
I was blown away.
I offer this correspondence and this entire story not to toot my own horn for having made the right decision to "stick it out" and offer explanations for my dissatisfaction with the draft that was returned to me by the law review. Rather, having earlier vented here about the law review editorial process and read similar blog critiques written by others (like this one or this one), I want to offer, as Haskell recently did here, a net positive view of the law review editorial experience with a student-edited publication. Bloggers here and elsewhere have made many suggestions on how the student editorial process may be able to be improved (see, e.g., here, here, and here). In the mean time, however, I continue to believe that a bit of patience and good communication can extend the learning experience for student editors in meaningful ways.
Tuesday, March 22, 2016
Jet lag prevented me from posting this yesterday. (Yes, I am scheduled to be the BLPB every-Monday blogger going forward.) But at least I am awake enough now to post a bit more on the 7th International Conference on Innovative Trends Emerging in Microfinance (ITEM 7 Conference) I attended last week in Shanghai, China. My initial post on Wednesday provided some information on Chinese microfinance and the initial day of the conference. This week, my post focuses on definitional questions that I have been pondering relating to my participation in this series of conferences. Specifically, I have been sorting through the relationship between microfinance and crowdfunding. My understanding continues to evolve as I become more familiar with the literature on and practice of microfinance internationally.
At the conference, one of the participants noted that while microfinance and crowdfunding appear to be mutually reinforcing, they still do not enjoy comfortable relations in scholarship and practice. After weighing that statement for a moment, I had to agree. I actually have been personally struggling with the nature of the relationship between the two for a few years now. (I often wonder whether folks like co-blogger Haskell Murray who commonly work in the social enterprise space have this issue in talking about the relationship between social enterprise and corporate social responsibility . . . .)
Two years ago at the ITEM 5 Conference, I posited that crowdfunding could be a vehicle for microfinance. The establishment of this point required defining both microfinance and crowdfunding--in each case, no small task. To enable the audience to understand my observation, I used a broad definition of microfinance that focuses on financial inclusion (like the one found here). I believed after my presentation that I had made the point well enough.
Yet, something still niggled at me after the presentation and conference were long gone. I kept feeling as if I had inserted a square peg into a round hole. Something was just a bit off. Part of the issue is, no doubt, the fact that my observation was incomplete. Microfinance is bigger than crowdfunding, and not all crowdfunding is microfinance, even under a broad definition. So, picture a venn diagram like the one below.
The red point of intersection illustrates crowdfunding's place as a means of conducting microfinance. This leaves part of microfinance to be handled through other types of financing (e.g., microcredit). It also leaves part of crowdfunding to other capital-raising uses. This conception of the relatonship between microfinance and crowdfunding is undoubtedly more complete.
The importance to microfinance of the non-microfinance part of crowdfunding was confirmed at our microfinance site visit last week in Shanghai. Our host for the visit explained, in response to my question about the relationship of microfinance to crowdfunding in China, that crowdfunding typically is seen as an alternative to, rather than a means of, microfinance in China. He noted that equity crowdfunding is uncommon (although growing) in Chinese small business finance overall because the number of shareholders of Chinese limited liability companies is statutorily capped. Specifically, Article 20 of the Companies Law of the People's Republic of China provides that "[a] limited liability company shall be jointly invested in and incorporated by not less than two and not more than fifty shareholders." I made a mental "note to files" that crowdfunding might get crowded out of microfinance or other types of financing--intentionally or unintentionally--by positive regulation.
I invite any readers who are more familiar with world-wide microfinance than I to comment further on its relationship to crowdfunding. Do I have the principal story right, in your view, based on your experience? Can you provide examples from your work or life that help me to see new aspects of the relationship between the two? I invite any related thoughts.
Monday, December 28, 2015
Andrew Schwartz, a professor at the University of Colorado, has recently published an interesting article discussing how crowdfunding deals with the fundamental problems of startup finance: uncertainty, information asymmetry, and agency costs. His article, The Digital Shareholder, 100 MINN. L. REV. 609 (2015), is available here.
Here’s the abstract:
Crowdfunding, a new Internet-based securities market, was recently authorized by federal and state law in order to create a vibrant, diverse, and inclusive system of entrepreneurial finance. But will people really send their money to strangers on the Internet in exchange for unregistered securities in speculative startups? Many are doubtful, but this Article looks to first principles and finds reason for optimism.
Well-established theory teaches that all forms of startup finance must confront and overcome three fundamental challenges: uncertainty, information asymmetry, and agency costs. This Article systematically examines this “trio of problems” and potential solutions in the context of crowdfunding. It begins by considering whether known solutions used in traditional forms of entrepreneurial finance—venture capital, angel investing, and public companies—can be borrowed by crowdfunding. Unfortunately, these methods, especially the most powerful among them, will not translate well to crowdfunding.
Finding traditional solutions inert, this Article presents five novel solutions that respond directly to crowdfunding’s distinctive digital context: (1) wisdom of the crowd; (2) crowdsourced investment analysis; (3) online reputation; (4) securities-based compensation; and (5) digital monitoring. Collectively, these solutions provide a sound basis for crowdfunding to overcome the three fundamental challenges and fulfill its compelling vision.
Andrew was kind enough to share a draft of this article with me earlier this year, and I’ve been waiting for him to make it publicly available so I could bring it to your attention. I’m not quite as optimistic as Andrew that crowdfunding will solve the problems he identifies, but it’s a good piece and worth reading.
Monday, December 21, 2015
I mentioned back in October that I spoke in Munich on Regulating Investment Crowdfunding: Small Business Capital Formation and Investor Protection. I discussed how crowdfunding should be regulated, using the U.S. and German regulations as examples.
If you’re interested, that talk is now available here. I expect this to be the top-rated Christmas video on iTunes.
If you want to know more about how Germany regulates crowdfunding, I strongly suggest this article: Lars Klöhn, Lars Hornuf, and Tobias Schilling, The Regulation of Crowdfunding in the German Small Investor Protection Act: Content, Consequences, Critique, Suggestions (June 2, 2015).
Friday, December 4, 2015
Earlier this week, my co-blogger Josh Fershee authored an interesting post about the surprising crowdfunding success of the PicoBrew "Keurig for Beer.” After reading Josh’s post and the embedded links, I have to agree with him; I have no idea how they raised $1.4M for a product that I don’t see being that useful. The product appears to be both overly expensive and overly time-consuming.
I think many venture capitalists would join Josh and me in questioning the wisdom of PicoBrew, at least before it raised $1.4M. But as I wrote in an earlier post, crowdfunding may help overcome biases of venture capitalists. In the days since Josh’s posts, I have heard a few people talk about how excited they were about PicoBrew. These people were all at least 10 years younger than Josh, me, and most venture capitalists. While us “older folks” may not see a use for the product, judging from the crowdfunding results and a little anecdotal evidence here in Nashville, there appears to be significant market demand for PicoBrew. Similarly, on the show Shark Tank, the female “sharks” have accused their male counterparts of largely avoiding companies with products aimed at women; and while I have not run the numbers, it does seem like the sharks' investments skew toward products that they (or maybe their family members) would use. Very few venture capitalists are under 30 years old, so perhaps products aimed at younger people got passed on more often than they should have before online crowdfunding became popular. Of course, crowdfunding can have a dark side as well; crowdfunding may be used not only to uncover good products that were passed over, but could also be used to lure more gullible funders.
Somewhat related, the Chronicle of Higher Education recently ran an article entitled “When Recruiting Teenagers, Don't Forget to Question Your Assumptions.” The article is focused on undergraduate recruiting practices and challenges readers to question conventional wisdom. The article notes a disconnect between what universities think applicants want and what applicants say they want. For example, “[a]lthough 30 percent of admissions officials said social media was the most effective way for a college to engage students who had never heard of it, just 4 percent of students said the same. . . . And while 64 percent of admissions officials said a college’s official social-media accounts were important to prospective students after applying, only 18 percent of teenagers said the same.” The article’s main directive appears to be, don’t assume what prospective students want, ask them and use evidence to craft your recruitment programs. Using evidence rather than hunches to make decisions may be obvious to professors, but I wonder how many schools use sophisticated studies in designing their recruiting programs.
Like all of us, venture capitalists and university recruiting staff members have blind spots. Perhaps evidence, from crowdfunding and student surveys, can help these respective groups shrink those blind spots.
Tuesday, December 1, 2015
No, I am not really going too deep into the crowdfunding legal world. I am mostly venting. My co-bloggers, especially Steve Bradford, Joan Heminway, and Haskell Murray, are far more knowledgable than I am on the actual legal regime.
Kickstarter and other sites have done some creative things to help people start their businesses, and I am fine with that. There are travel jackets and luggage, as well as other things like potato salad and gadgets that someone thinks someone else needs. That's all good. But some of the ideas just seem dumb to me. Case in point: the PicoBrew, about which one outlet noted: Seattle company develops 'Keurig for beer.'
So, the deal is that you can make your own beer recipes (or borrow from others), and make beer at home. Fast(ish). KOMO News explained:
Depending on the recipe, users add grain to the main compartment of the step filter and add hops into the appropriate hop cages inside the unit. The entire canister slides into the Zymatic and the brewing begins.
The brewing takes about four hours, leaving the unfermented beer in the keg that originally held the water. Add the yeast, then after a week of fermentation you get beer ready to be carbonated for dispensing from the keg.
So, if I want a (potentially) good craft beer, I can plan a week ahead, and zowie, with a little work I will have a bit more than a 12 pack at the ready. The Keurig was bad enough -- it's wasteful, expensive. And, did I mention it's really wasteful? But it can make pretty good coffee in a way that is more convenient in some circumstances. So there's that.
PicoBrew doesn't seem to have any of those things. I mean, it does let you act like you brewed beer yourself, if you wanted to be that guy or gal. But really, this seems like an expensive gift for people who don't know really understand what it means to make your own beer.
I am all for people coming up with ideas to build creative businesses. And I am all for letting people spend their money on things they like (goofy or not). But that this thing raised $1.4 million still seems wrong to me. I know, some people really like this making stuff at home without really "making" much of it, but even with the recipe delivery services, there you're just over paying for someone else to do most of the work for you. I get that. That allows you to pay someone else to do most of what you don't want to do, while giving you flexibility and fresher food. Maybe it's pricey and not too creative from a cooking perspective, but still sensible for some folks.
The PicoBrew website quotes CNET as saying, "They tasted liked craft beers I would pay money for." After paying $500 to $1000 for the machine, plus ingredients, I am pretty sure you would still be paying money for the beer. And you would be doing the work, waiting for it to ferment, and carbonating it, too. I just don't see the great value. Personally, I'd much rather buy my craft beers straight from the good folks at places like Bell's, Founders, and Chestnut Brew Works, LLC(!). Now if I could just get a distributor in the state to make the first two more accessible. Hey, Kickstarter . . .
Monday, November 16, 2015
One final post on the SEC’s proposed changes to Rule 147 and I promise I’m finished—for now. Today’s topic is the effect the proposed changes will have on state crowdfunding exemptions. If the SEC adopts the proposed changes to Rule 147, many state legislatures will have to (or at least want to) amend their state crowdfunding legislation.
As I explained in my earlier posts here and here, the SEC has proposed amendments to Rule 147, currently a safe harbor for the intrastate offering exemption in section 3(a)(11) of the Securities Act. If the proposed amendments are adopted, Rule 147 would become a stand-alone exemption rather than a safe harbor for section 3(a)(11). There would no longer be a safe harbor for intrastate offerings.
That creates some issues for the states. Many states have adopted state registration exemptions for crowdfunded securities offerings that piggyback on the federal intrastate offering exemption. That makes sense, because, if the offering isn’t also exempted at the federal level, the state crowdfunding exemption is practically worthless. (An offering pursuant to the federal crowdfunding exemption is automatically exempted from state registration requirements, but these state crowdfunding exemptions provide an alternative way to sell securities through crowdfunding.)
The SEC’s proposed amendments would actually make it easier for a crowdfunded offering to fit within Rule 147. (In fact, the SEC release says that’s one of the purposes of the amendments.) Most importantly, the SEC proposes to eliminate the requirement that all offerees be residents of the state. That change would facilitate publicly accessible crowdfunding sites which, almost by definition, are making offers to everyone everywhere. The securities would still have to be sold only to state residents, but it’s much easier to screen purchasers than to limit offerees.
Problem No. 1: Dual Compliance Requirements
Unfortunately, many state crowdfunding exemptions require that the crowdfunded offering comply with both section 3(a)(11) and Rule 147 in order to be eligible for the state exemption. Here, for example, is the relevant language in the Nebraska state crowdfunding exemption: “The transaction . . . [must meet] . . . the requirements of the federal exemption for intrastate offerings in section 3(a)(11) of the Securities Act of 1933 . . . and Rule 147 under the Securities Act of 1933.” (emphasis added).
Currently, that double requirement doesn’t matter. An offering that complies with the Rule 147 safe harbor by definition complies with section 3(a)(11). That would no longer true if the SEC adopts the proposed changes. Since Rule 147 would no longer be a safe harbor, an issuer that complied with Rule 147 would still have to independently determine if its offering complied with section 3(a)(11). Because of the uncertainty in the case law under 3(a)(11), that determination would be risky. (But see my argument here.) The leniency the SEC proposes to grant in the amendments to Rule 147 would not be helpful unless state legislators amended their crowdfunding exemptions to eliminate the requirement that offerings also comply with section 3(a)(11).
Problem No. 2: State-of-Incorporation/Organization Requirements
There’s another potential issue. Many state crowdfunding exemptions include an independent requirement that the issuer be incorporated or organized in that particular state. That’s inconvenient, and reduces the value of the state crowdfunding exemption, because corporations and LLCs are often incorporated or organized outside their home states. But, until now, that state requirement hasn’t mattered because both section 3(a)(11) and Rule 147 also impose such a requirement.
The SEC proposes to eliminate that requirement from Rule 147, so it now matters whether the state crowdfunding exemption independently imposes such a requirement. Issuers won’t be able to take full advantage of the proposed changes to Rule 147 unless states eliminate the state-of-incorporation/organization requirements from their state crowdfunding exemptions as well.
On to More Important Things
That’s the end of my Rule 147 discussion for now. I promise! Now, we can turn to more important questions, such as why your favorite team belongs in the college football playoff. (I know for sure that my college football team won't be there. I would be happy just to have my college football team in a bowl game.)
Friday, October 30, 2015
Tuesday, October 27, 2015
This hit my mailbox this morning. If the report is correct, we'll know in a few days whether we have a path to unregistered, broad-based securities crowdfunding in the United States. More as news is reported . . . .
[Additional information: Based on the link to the SEC's notice of meeting in Steve Bradford's comment to this post, it also appears that the SEC is considering amendments to Rules 147 (intrastate offerings) and 504 (limited offerings under Regulation D of up to $1,000,000).]
Wednesday, October 21, 2015
As Steve Bradford mentioned in his post on Monday (sharing his cool idea about mining crowdfunded offerings to find good firms in which to invest), our co-blogger Haskell Murray published a nice post last week on venture capital as a follow-on to capital raises done through crowdfunding. He makes some super points there, and (although I was raised by an insurance brokerage executive, not a venture capitalist), my sense is that he's totally right that the type of crowdfunding matters for those firms seeking to follow crowdfunding with venture capital financing. I also think that, of the types of crowdfunding he mentions, his assessment of venture capital market reactions makes a lot of sense. Certainly, as securities crowdfunding emerges in the United States on a broader scale (which is anticipated by some to happen with the upcoming release of the final SEC rules under Title III of the JOBS Act), it makes sense to think more about what securities crowdfunding might look like and how it will fit into the cycle of small business finance.
Along those lines, what about debt crowdfunding as a precursor to venture capital funding? Andrew Schwartz has written a bit about that. Others also may have taken on this topic. Professor Schwartz may be right that issuers will prefer to issue debt than equity--in part because it may prove to be less of an impediment to later equity financings. But I don't necessarily have a warm feeling about that . . . .
And what about the crowdfunding of investment contracts (e.g., what I have previously called "unequity" in this article (and elsewhere, including in this further article) and perhaps even the newly popular SAFEs)? There is no equity overhang with unequity and some other types of investment contract, but crowdfunded SAFEs, which are convertible paper, may be viewed negatively in later financing rounds--especially if the conversion rights are held by a wide group of investors. While part of me is surprised that people are not taking the investment contract part of the potential securities crowdfunding market seriously (since folks were crowdfunding investment contracts before the JOBS Act came along--not knowing it was unlawful), the other part of me says that crowdfunded investment contracts would have a niche market at best.
So, thanks, Haskell, for the food for thought. No doubt, more will be written about this issue as and if the market for crowdfunded securities develops. Coming soon, says the SEC . . . .
Monday, October 19, 2015
My co-blogger Haskell Murray had an interesting post on Friday about the use of crowdfunding as a strategy to attract venture capital. He points out that many companies that had successful crowdfunding campaigns on Kickstarter or Indiegogo subsequently raised venture capital. He argues that a successful crowdfunding campaign might be a signal to venture capitalists.
If you haven’t read Haskell’s post yet, it’s well worth reading. I want to take the discussion in a slightly different direction.
I don’t think venture capitalists should be waiting to see if a company has a successful crowdfunding campaign. I think they should use crowdfunding listings as leads and try to preemptively capture those companies before they complete their crowdfunding campaigns—convince the good companies to forego crowdfunding and go the venture capital route instead.
If I were a wealthy venture capitalist, I would have someone skimming through all of the crowdfunding sites, including the equity crowdfunding sites, looking for potential investments. The venture capital business is extremely competitive. Getting to the good companies before they have a successful raise is one way to one-up the competition. Once a company has shown crowdfunding success, others will want a piece.
Many of the companies doing crowdfunding will not interest venture capitalists. But it only takes a few hidden gems to make the weeding process worthwhile. And most of the weeding out could be done quite easily by inexpensive, low-level staff. Even I could spot most of the obvious losers.
I have suggested this strategy at a couple of conferences where venture capitalists were present. It will be interesting to see if any of them try it. (For some reason, professional venture capitalists don't seem all that interested in my investment advice.)
As for me, I’ll file this in my “What I would do if I had a ton of money” folder. (It’s a very full folder.)
Friday, October 16, 2015
Recently, a number of the sports media outlets, including ESPN, the Pac-12 Network, and Fox Sports featured a company called Oculus that makes virtual reality headsets used by Stanford University quarterback Kevin Hogan, among other players, to prepare for games.
In 2012, Oculus raised about $2.4 million from roughly 9,500 people via crowdfunding website Kickstarter. Following this extremely successful crowdfunding campaign, Oculus attracted over $90 million in venture capital investment. In mid-2014, Facebook acquired Oculus for a cool $2 billion.
Oculus is only one example, but it caused me to wonder how many companies are using crowdfunding to attract venture capital, and, if so, whether that strategy is working. This study claims that 9.5% of hardware companies with Kickstarter or Indigogo campaigns that raised over $100,000 went on to attract venture capital. Without a control group, however, it is a bit difficult to tell whether this is a significantly higher percentage than would have been able to attract venture capital money without the big crowdfunding raises.
If I were a venture capitalist (and I was raised by one, so I have some insight), I would see a big crowdfunding raise as potentially useful evidence regarding public support for the company and/or product demand. Crowdfunding, in some cases, might also be a helpful check on venture capitalist groupthink and biases.
As a venture capitalist, however, the type of crowdfunding used would matter to me. In most cases, I imagine I would see a large gift-based or rewards-based crowdfunding raise as a significant positive. Gift-based crowdfunding is essentially free money for the company, and reward-based crowdfunding usually comes with minimal costs or is simply pre-ordered product. Gift-based or rewards-based crowdfunders could create some negative press for the company when the company raises outside money, as the crowdfunders did in the Oculus case (see here and here), but that seems like a relatively small problem in most cases.
In contrast, the costs and risks associated with equity crowdfunding, in the states it is currently allowed, would raise at least a yellow flag for me. Equity crowdfunding comes with so many strings attached to various small shareholders that I could see it scaring off venture capitalists. The administrative headache, plus the risk of multiple lawsuits from uninformed investors seems significant. In addition, owners who have engaged in equity crowdfunding have a smaller percentage of equity in their hands and may have raised the crowdfunded money at an unattractive valuation.
At least two of my co-bloggers have written significant articles on crowdfunding (see, e.g., here and here), so perhaps they will weigh in on whether they have seen companies using crowdfunding as a strategy to attract venture capital, whether it is working, and whether the type of crowdfunding really matters.