Crowdfunding Archives - That's Not Market

Why Startups Fail – Crowdfunded Tech Startup Shuts Down With Open Letter to Backers

Despite successful crowdfunding campaign, tech startup KANOA shuts down after bad product review without sending out products.

KANOA, would-be producer of some sort of wireless earbuds, shut down. They announced their demise with an open letter to their backers.

They began with their founder’s initial capital spent on market research and design study by an engineering firm.

It appears that their crowdfunding may have been a pre-order campaign, but information is scarce at this point.

KANOA, crowdfunded tech startup, describes its demise

However, KANOA has said that they hired internally and engaged a contract manufacturer. They began to ship a few units, but they were absolutely savaged by one YouTube review, which seems to have been the knockout blow. Ironically, according to the reviewer, KANOA reached out to him as an influential personality to review the earbuds and garner publicity. iTwe4ks has about 486,000 subscribers, and some of his videos have exceeded 1,000,000 views. He did like the free t-shirt, if that is any consolation.

KANOA claimed in their farewell letter that they are in negotiations with investors for funding or an acquisition, but they do not have enough money to continue operations. Backers or pre-ordering customers are out of luck. They will not be fulfilling more orders.

Some farewell letters give a detailed post-mortem explaining what went wrong. They leave a memorial to what went wrong.

It is difficult to see what happened to KANOA, or at least what KANOA thinks went wrong, other than they ran out of money. Too many employees? Ineffective design and manufacturing? Lack of market?

No. They were too honest and transparent:

Unlike on typical crowdfunding platforms we allowed backers to ask for refunds at any time. This policy kept us honest, but also added vulnerability once we had made major financial commitments. Setbacks and some bad publicity, like reviews of non-shippable beta units, stirred our audience. Most significantly and to our unpleasant surprise, our investors recently backed out of our funding round. We do not blame them, but this was a pivotal setback since capital was essential for ramping up production.

Perhaps the actual story will be uncovered in the class action lawsuit. However, a lawsuit is unlikely if there is nothing to go after.

SEC Warns of SAFE Investment Instrument Popular in Equity Crowdfunding Campaigns

The SEC issued a bulletin warning investors about SAFE securities used in equity crowdfunding offerings.

Issuers in equity crowdfunding campaigns have offered various types of securities since it became legal to do so, such as various classes of stock, notes and instruments known as SAFE instruments. ‘SAFE’ stands for ‘Simple Agreement for Future Equity.’

SAFEs were originally designed to be an alternative to convertible notes for early-stage technology investments. The idea was that they would become simple, standardized vehicles for investing in very young companies without dealing with a lot the terms needed to make a convertible note or stock investment.

As the SEC points out, a SAFE is not like investing in common stock. It is an agreement that converts into issuer securities in the event of future triggering events, such as a future investment round, an IPO, a change of control or a liquidation.

Some people seem to think of them like convertible notes. However, convertible notes have maturity dates, among other terms. SAFEs do not and may never convert. SAFEs are more like derivative contracts with springing conversion based on listed events.

SAFEs have been increasing in use in the venture capital and angel investing worlds, and more recently other investors have gained some exposure and comfort with them. However, the SEC wants investors to know that:

SAFEs do not represent a current equity stake in the company in which you are investing.
SAFEs may only convert to equity if certain triggering events occur.
Depending on its terms, a SAFE may not be triggered.

To the people who have seen them before, none of this is a surprise. To a new investor, the SEC is concerned that these terms may be unexpected. As the SEC said:

SAFEs were developed in Silicon Valley as a way for venture capital investors to quickly invest in a hot startup without burdening the startup with the more labored negotiations an equity offering may entail. Oftentimes, for the venture capital investor, it was more important to get the investment opportunity, and possible future opportunities, with the startup than it was to protect the relatively small investment represented by the SAFE. In addition, the various mechanisms of the SAFE, from the triggering events to the conversion terms, were designed to best operate in the context of a fast growing startup likely to need and attract additional capital from sophisticated venture capital investors. This may or may not be the case with the crowdfunding investment opportunity you are exploring.

SAFEs can make a lot of sense to particular parties in particular deals, but investors such as crowdfunding investors should make sure to understand exactly what rights they have in what they are purchasing.

SEC issues warning about SAFE instruments in equity crowdfunding campaigns.

Equity Crowdfunding Risks and Liabilities – Yes, They Do Exist

Sorry startups, you actually have to be careful with equity crowdfunding disclosures. There is substantial risk of liability for securities fraud.

Based on discussions with the equity crowdfunding-curious, people seem to believe that equity crowdfunding is the wild west where anything goes. Raise lots of money and do it cheaply! Do what you want, say what you want and the SEC does not care! Look at the Form C’s, there were probably no lawyers anywhere near them. Think of the savings!!!!

None of that is true.

Done correctly, an equity crowdfunding offering should be done with as much care as any private placement. The actual information requirements are more extensive than a typical Rule 506 offering. Most importantly, crowdfunding issuers are subject to the same liability as any other securities selling issuer.

Securities Act Section 4A(c) provides that an issuer will be liable to a purchaser of its securities in a transaction exempted by Section 4(a)(6) if the issuer, in the offer or sale of the securities, makes an untrue statement of a material fact or omits to state a material fact required to be stated or necessary in order to make the statements, in light of the circumstances under which they were made, not misleading . . .

Sound familiar? What is the difference between this liability and private placements? Equity crowdfunding is done publicly to more people who are potential claimants.

What does this mean for issuers? It means the Form C and the offering page on the platform site need to be done carefully and in compliance with SEC rules. Those rules sound a lot like watered down Regulation S-K rules for MD&A, description of securities, related party transactions, etc… If you have never complied with them, good luck doing this without experienced help.

Well, at least the platforms are safe, right? They are just dumb pipes for crowdfunding deals and have no responsibility for what the issuers do on their site, right?

Well, no. While the SEC did not impose issuer liability on the platforms, it specifically declined to exempt the platforms from liability under Section 4A(c). Why? So investors could bring suits against the platforms to make sure that the platforms take steps to keep from becoming conduits of fraud.

The SEC believes that the platforms should take steps to protect themselves. Congress provided them a defense if they could not have known of an untruth or omission in the exercise of reasonable care. In other words, the “head in the sand” defense will not work. In addition, I have seen them provide and even require standard language and provisions in their issuers Form Cs and offering pages. I doubt the SEC will ignore this if this becomes misleading.

As the SEC stated:

These steps may include establishing policies and procedure that are reasonably designed to achieve compliance with the requirements of Regulation Crowdfunding, and conducting a review of the issuer’s offering documents, before posting them to the platform, to evaluate whether they contain materially false or misleading information.

We are coming up on the one year anniversary of equity crowdfunding. It is still very early in the equity crowdfunding world to see where the liability issues will shake out. However, it is clear that the SEC and the state securities regulators take these liability issues seriously, and the issuers and platforms should too.

Equity Crowdfunding. Missing Category: Liability

Equity Crowdfunding Publicity, Or What Not To Do

Rules on marketing and advertising your equity crowdfunding campaign are more restrictive than you think. Startups accostomed to blogging your every thoughts and feelings beware.

When the SEC adopted the crowdfunding rules under Regulation CF, it included severe restraints on a company’s ability to publicize its crowdfunding campaign. Many people think the SEC allows general solicitation and it applies to everything. Wrong. It does not apply to crowdfunding.

You know those cool tombstone ads in the Wall Street Journal showing off an IPO? That shows the type of information that your crowdfunding notices can include.

A crowdfunding advertising is limited to:

a statement that the issuer is conducting a crowdfunding offering in reliance on section 4(a)(6) of the Securities Act of 1933
the name of the platform
a link directing the investor to the intermediary’s platform;
the terms of the offering; and
factual information about the legal identity and business location of the issuer, limited to:
- the name of the issuer of the security
- the address of the issuer
- phone number of the issuer
- website of the issuer
- the e-mail address of a representative of the issuer and
- a brief description of the business of the issuer.

The description of the terms of the offering must be limited to:

the amount of securities offered;
the nature of the securities;
the price of the securities; and
the closing date of the offering period.

That’s it. Some short bullet-pointy info dots.

There’s no “this is the Internet and I can say whatever I want.” There’s no “This is the new world and old rules don’t apply.”

Is it limiting? Yes.

Is there a reason? Yes.

As with public offerings, there is a required disclosure document, in this case Form C. The SEC wants to make sure you have access to it before you make an investment decision. The SEC does not want a hyped-up ad to entice you to purchase before you have the ability to review 50 to 100 pages of required disclosure.

Any good news? Well, the company does not have to file the notices with the SEC. The company is not limited to newspapers. The notices can go anywhere, such as social media or the company’s website.

Also, the company can communicate with investors through the crowdfunding platform. The SEC believes that this ability will facilitate the wisdom of the “crowd” in crowdfunding. The company must identify itself as the company and not as “Random Guy Who Believes Company Will Be the Next UBER x Google.”

Old timey Ford tombstone. Crowdfunding companies need to get used to this.

Reg CF’s Crowdfunding Green Shoots

SEC notes early Regulation Crowdfunding results

Regulation Crowdfunding finally went live in May 2016 to much fanfare. Detractors saw the beginning of a new age of fraud. Optimists saw the beginning of a free flow of capital to small companies and a flow of riches to investors traditionally shut out of private, early-stage investments.

The answer? Who knows?

What we do know is that the SEC released some early stats about how Reg CF has been doing since last May.

First, there are 21 funding portals. Each one of those portals is competing for the business of facilitating funding for private companies. It will be really interesting to see how these early-stage portals survive.

Of the 163 deals that have been initiated, 33 have been completed. There was no indication of how many are still pending or how many have been withdrawn.

The amount raised is approximately $10 million. *chicken-scratch on back of envelope to get about $300,000 per deal*

It will be educational to see if the SEC breaks out those numbers on a per-deal basis since a simple average does not tell us much.

Did one very successful deal account for a large part of the $10 million?

Did one or more deals stop at a few thousand?

How many of them are restaurants or breweries? There seems to be a lot of those when I look at the portal homepages.
Early equity crowdfunding results from Reg CF and SEC