Many smart people believe the main impediment to Crowdfunding in general and Reg CF in particular is the lack of liquidity. Who wants to invest without the chance to get out?
I don’t agree. I note that:
- Plenty of money flows into real estate projects with no guaranty of liquidity.
- Enormous amounts of money has flowed through Silicon Valley over the last 40 years with no guaranty of liquidity.
- Even before Crowdfunding and outside Silicon Valley, lots of money flowed into private companies with no guaranty of liquidity.
Nevertheless, I agree the lack of liquidity is important and have a proposal to fix it, for those willing to take some risk.
Too often, in my opinion, proposals to allow liquidity focus on the SEC. For example, smart people propose that the SEC should adopt a rule providing that an online marketplace for Reg CF securities won’t be treated as an “exchange.”
I don’t agree with that, either. One, the SEC probably doesn’t have that authority. Two, and far more important, it wouldn’t help. As described here and here, the absence of vibrant secondary markets for private securities isn’t because of the law. It’s because private securities are really hard to market and sell. The lack of transparency, the reliance on a tiny management team, the lack of the investor protections built into NASDAQ and other national exchanges, the miniscule market cap and public float – all these things and more make private securities illiquid.
Forget about petitioning the SEC or introducing another “Improvements in Crowdfunding” bill in Congress. Trying to create liquidity by legal fiat is like pushing string.
Funding portals can provide liquidity on their own. A funding portal could simply require every issuer to provide for liquidity in its organizational documents. The organizational documents could provide, for example, that within some period of time, say seven years, the issuer would either (i) buy out investors, or (ii) arrange for an exit, either a cash sale or a merger with a company with publicly traded securities. Only with a majority vote of investors (super majority?) could the deadline be extended.
Even an individual issuer could provide such a guaranty, without a mandate from the funding portal.
Think of the marketing campaigns. “Our company guaranties liquidity!” “Every company on our platform guaranties liquidity!”
For those who think seven years is too long, don’t buy private securities if you might need to sell them sooner. For those who think seven years is too short, write your own blog!
Seriously, the proposal has one big flaw, from the perspective of issuers. I’ve recommended before that Crowdfunding investors shouldn’t have the right to vote. My liquidity proposal, in contrast, gives investors the right to force the sale of the company. That might hamstring the company and, more important, it might inhibit the company’s ability to attract future, large investors.
To address that flaw, should we provide that the right of liquidity goes away if the company raises $X in the future?
Everything is a tradeoff. If you believe a guaranty of liquidity will open the floodgates of investors, you’ll consider taking the plunge. If you doubt that a guaranty of liquidity will attract investors, on the other hand, then the tradeoff might be too high. But that takes us back to the beginning. If you think liquidity is the key, and you acknowledge that no change in the law will get us there, a proposal like this could be an option worth considering.
Questions? Let me know.
Following on the overwhelming success of our VHS video “8-minute abs”, we’re now offering a new blog: 8-year guaranty. We’ll blow those 7-year guaranty people right out of the water.
I understand the desire and need for liquidity in some circumstances. And I’m always for more optionality and decision control being in the hands of investors themselves. I do worry, however, that in aggregate, increased liquidity might lead more investors to make more emotional sell decisions at the wrong time. I think part of the reason that we see so many massive returns in traditional angel investing is because of the fact that shares are often tied up. We could rattle off the number of household tech names now that were on the brink of failure – would I have been able to hold on through those swings? Or after a share 10X’d in value – potentially missing out on the 100X and 1000X? That being said, have the option to take a little off the table never hurts.
The “providing for liquidity” idea is also something that we are starting to see a few funding portals starting to adopt (e.g. Silicon Prairie with their SAFE+Repurchase). We just need to be careful as an industry with how the repurchase clauses are structured to keep issuer and retail investor incentives aligned. i.e. Putting the power in the hands of the investor class to force liquidity is one thing, but when I see deal terms with repurchase clauses that allow the issuer to buyback securities under certain conditions (or worse, at their choosing) from investors at “fair market value” or the initial investment amount, that’s where I’ve seen issues. e.g. The only issuers who would exercise that type of repurchase are likely those who are doing very well and want to “buy out” their early investors – often being forced to do so at the hands of a larger VC or institutional investor that wants to “clean up” retail from the cap table, meaning they miss out on the future potential gains. Whereas issuers who don’t do well would never execute that.
This is the exact reason we proposed the Simple Agreement for Future Exchange Plus Repurchase aka the “SAFE+R” security! See https://sphi.io/safer/ for more info and a model document.
Under a 36/36 plan the issuer gets 36 months to hold a priced round or individual investors could elect to enter “repo” and move to a note that gets repaid back over the next 36 months. The investor in “repo” forgoes any equity upside but obtains a liquidation preference over the equity holders.
Additionally using a private “bulletin-board” like system, potentially in conjunction with an Alternative Trading System aka “ATS” the issuer could offer its investors the opportunity to buy and sell to each other, or as you suggested, they use a preemptive right of first refusal aka “ROFR” to buy its securities back.
Lastly we believe that it will become the normal cadence to have issuers “carve out” new funds raised in successive rounds to buy out selling shareholders as we have seen in in REG-A+ offerings where up to 30% of the funds raised can be used to cover the sellers. As long as the use of funds is disclosed we believe that investors will find comfort in the concept that a percent of their funds injected may be used to repurchase securities.
Hi, thanks for the great article! Building on your ideas, could I go even more radical given that we’re a profitable company? I’m considering an ongoing crowdfunding model where we implement an annual discretionary tender offer. In this approach, we would determine the timing and volume of shares for repurchase based on a fraction of our cash reserves, earnings, and funds raised during the previous year. Shareholders would submit the amount they wish to tender, and if submissions exceed the repurchase cap set by the Board, shares would be repurchased on a pro-rata basis, with those annual tender offer conditions clearly outlined in advance before an investor sends the first check.
I’d love to know if this or something like it is feasible.
There is no evidence that investors are refusing to invest in Reg CF offerings due to lack of liquidity. The idea behind crowdfunding was to let small investors into the same type of offerings that accredited investors have been allowed to buy, Wall Street sells those Reg D offerings by promising passive income, not liquidity. Forcing issuers to sell after a fixed period of time will keep those issuers in the Reg D market and kill Reg CF once and for all,
Irwin, I agree with you that liquidity isn’t the issue. But many people disagree.
“An investment without an exit is just a donation!” — Cedric Long, President of Silicon Prairie Capital Partners