Why are we building Conception Fund? To Disrupt how 85 million Americans invest their collective $30 trillion

Americans have $30 trillion collectively invested in long term equity.  We are the largest collection of individual investors in the world.  85 million individuals and 52.7 million households own equity in our major stock exchanges.

Most of our capital is invested in large publicly traded companies that do little to improve our main streets and commercial centers.  If 1% of that capital were reallocated into America’s 27 million small businesses and startups, $300 billion would be injected into our main streets and commercial centers.

Amy Cortese, author of Locavesting: The Revolution in Local Investing discuses how communities are presently reinvesting their capital to improve their commercial centers.  Check out her blog for more of her insight on this topic.

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VC: 90% of Startups should not take institutional money. Conception Fund: Is Crowdfunded Capital Ok?

By Co-Founder Arthur Hardy-Doubleday

Last Tuesday, the Boston office of McCarter & English, LLP held a Venture Capitalist (“VC”) Roundtable.  Whenever VCs chooses to speak about their approach, I listen.  VCs are charged with seeking out startups that will realize a 5x return in a limited time period.  It’s high risk, but when they hit, they HIT!  For example VC firm Andreessen Horowitz  invested $250,000 in Instagram that is worth $78 million two years later.  Check out Ben Horowitz (founding Partner at Andressen Horowitz) blog post on this investment.

The stories of startups experiencing skyrocketing growth which creates immense wealth for its early stage investors are far and few between.  However, if one reads TechCrunch or Betabeat, one might get the impression that venture capital is the new asset class that can do no wrong.  It seems like every day these webzines publish news about a startup realizing incredible growth and therefore commanding a large valuation.

The truth is nearly 90% of all venture back companies fail to live up to their growth expectations or worse fail all together.  At the roundtable, one VC shared that of the twenty startups a West Coast VC firm invested seed capital into, one or two will get more funding in the form of a Series A.    That means at best only 10% of VC seeded startups make it past the early stage.  If a VC firm passes on further investment, a company must either self-sustain on existing traction or fold.

This same VC shared his own insight into startup capital.  To paraphrase he said, “90% of startups should not take institutional money.”  What he was referring to is many VC firms create funds.  These funds are a collection of capital from many different sources that together create a pool of money that the VC firm then invests into a number of startups.  For example, California Public Employees’ Retirement System (“CalPERS”), a retirement fund with $240 billion invested in various asset classes will contribute to a VC fund as a means of diversifying its own portfolio and possibly realizing outside returns such as the Instagram story.  When CalPERS invests its capital, that capital is considered “institutional money.”  When it invests in a VC fund which then invests into a startup, that startup is now taking institutional money.

The VC had a number of reasons for stating 90% of startups should not take institutional money.  His main point was, when a startup takes institutional money, it’s like running up the credit card.  That money is being invested with the expectations that the value of that investment will grow. It’s not free money.  On average a VC invests in a startup with the expectation that its investment will grow by five times over a period of nine years.   If I understood this VC’s point correctly, if a startup cannot articulate how it will achieve this goal, it probably should not seek VC capital.

Where VC Capital is not Applicable, Equity Crowdfunding is.

A Startup may not be right for venture capital, but that does not mean outside capital in the form of equity cannot help that startup grow.  Take for example Bootstrapp Compost.  Bootstrapp Compost is Greater Boston’s only year-round kitchen scrap pickup service. They use bikes, trains, hand trucks, and the occasional vehicle to collect and transport compostable material from houses, apartments, dorms, co-ops, and condos. That waste is then taken to local farms where it can be composted thereby enriching the soil and keeping reusable material out of landfills.  Great idea!

Should this team accept VC money?  Hells no!  Why?  It would be hard (not impossible) to foresee a 5x return on a limited time horizon.  Does that mean Bootstrapp Compost should only “bootstrap” or self-fund during its early stage growth.  No.  The team has other options.

Bootstrapp Compost is a perfect example of a local company that could raise capital through equity crowdfunding in-order to grow operations.  Why?

Self-funding growth limits a company to how much capital the principal or principals have.  If they have a lot of capital, great, but if they are like the majority of us, they have limited capital.  If their only means of growing the company is through existing revenue and limited capital from the principals, the company may be missing opportunities to grow because of limited working capital.

There are many examples of companies using crowdfunding to grow.  The most recent one would be the Pebble smart watch.  The team raised nearly $9 million and presold it product to over 58,000 customers.  Bootstrapp Compost could use the same approach to grow its own company.   While it might not raise as much money as the Pebble team, it could grow its customer base and raise outside capital through making an equity crowdfunding offer.

Bootstrap would receive debt free working capital in exchange for equity.  Investors may be incentivized to buy shares by Bootstrapp offering discounts on its subscription service.  In addition to increasing its working capital, Bootstrapp would also grow its customer base and increase brand awareness.

Investors would be helping a local company grow.  Additionally, as the company grows, their equity investment would increase in value.  One might refer to this type of investment as local-vesting, a means by which a community invests in local enterprises to improve the community and the economy.  The investors in this case, would not be seeking a 5X return like VCs.  Rather, investors would be looking for Bootstrap Compost to grow its geographic coverage, help the region decrease in carbon footprint, and create more jobs.  Eventually, if the company grew large enough, the investors could sell their equity to other willing investors who would want to see Bootstrap continue to flourish.

Not every startup fits the investment criteria of venture capital.  In fact, according to some, 90% don’t.  But that does not mean these startups should not accept outside money.  There are compelling cases for many startups to raise early stage seed money through crowdfunding.  Where VC money may not see opportunity, the crowd sees plenty.

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How Equity Crowdfunding Could Save My Island’s Only Bookstore

Written by Co-Founder Arthur Hardy-Doubleday 

Today’s independent book stores are having a hard time surviving.  The growing popularity of E-Books has crushed the book store’s traditional business model.   I have watched as Martha’s Vineyard has gone from three book stores down to just one.

Last week, the owner of the last surviving bookstore, Bunch of Grapes, announced that she would be moving her store across the street to downsize and save money.  Many islanders commented in the Martha’s Vineyard Times  about the planned move and whether it was the right strategy.   Judging by the number of comments, Bunch of Grapes has a deep base of support that wants to see it survive.  How does a loyal consumer base translate into better revenue?  Equity Crowdfunding.
Perusing through the comments sections of the MVTimes article covering the move, there were a number of different supporters that questioned the book store’s business model.  While they support this flagship store of Tisbury’s main street, they don’t necessarily agree with how it’s presently being operated.

Equity Crowdfunding could save the store from eventual closure.

There has been a lot of coverage about how equity crowdfunding could help startups.  However, startups will not be the only beneficiaries of the recently signed Jobs Act.  Small Business will also benefit from this new way of raising capital.  They can increase working capital without increasing fixed term debt.

Bunch of Grapes has an active fan base.  Many people shop there because they want the store to survive.  I count myself among them.   The downsizing of the store signifies the need for the store to re-think its business model.

Once equity crowdfunding is allowed (expected early 2013), the owner could create an equity crowdfunding transaction where in exchange for equity, her fan base could provide capital.  Part of the process would include the owner publishing a business model online using a crowdfunding platform.   The contents of that document would disclose how she would use the capital to improve operations.

Over the course of her equity offering (let’s say 90 day period) she could field questions in an online forum about assumption she made in her model.  Foreseeably, there would be individuals that might have suggestions on how she could improve her business.

Islanders who know how important Bunch of Grapes is to the Tisbury businesses district might consider buying equity because they want to see the bookstore survive.  In turn, the owner would get debt free capital that would help her stabilize her operation.

The underlining assumption in the purchase of equity is that it will be worth more tomorrow than what it is today.  The owner would need to prove how this capital could improve her operation, stabilize her business. and help it grow.

The entire process opens a dialogue between business owner and investor/consumer.  The owner thinks through her business model and the community validates her assumption through buying equity.

If the Bookstore raises its goal, it survives.  Islanders keep their coveted bookstore.  The owner now has a base of equity owners who will shop at the book store to help their equity investment increase in value.

While startups will defiantly play a huge role in validating equity crowdfunding, they won’t be the only beneficiaries.  Main Street America stands to benefit from this new form of “local vesting.”

Valuing Equity in a Crowdfunded Company

On Thursday, President Obama is set to sign the Jobs Act into law.  The SEC will then take 6-9 months to write regulations.  Presumably, by early 2013, the first companies utilizing crowdfunding in exchange for equity will be going through their first rounds of funding.  Investors who don’t have a million dollars in assets will be able to invest in small growing companies for the first time since the great depression.  The question for many investors will be, what is a small company worth and how should one approach valuing its equity?  Here are two simple approaches.  There are many, but think of these as back of the napkin quick and dirty approaches to valuation.

Price to Earnings (“PE”)

A classic approach is to look at the price relative to the earnings.  For Example let’s value a hypothetical company named Acme. Acme has annual earnings of $100/year and is selling 100 shares at a $1 each it has a PE of 1

P/E = Stock Price / EPS

In the public market, technology companies have a higher PE relative to utility companies.  For example, as of today Amazon (AMZN) has a PE of 144.56 while American Electric Power Co. (AEP) has a PE of 9.66.  Presumably, the same rules will apply to smaller crowdfunded companies.

Why the difference in PE valuation?

The market is looking at a number of factors but the short answer would be growth.  AEP likely has a stable market with little room to grow.  Amazon, an online store that has experience double digit growth since in inception, could continue to grow at break neck speed for the foreseeable future.

Applying this logic to Acme Co.

If Acme is a demonstrated revenue generating company in a stable market with single digit year over year growth, it will probably have a low PE.  If Acme is a technology start up with demonstrated double digit growth or the potential for double digit growth it will likely have a high PE.

Hence, if Acme is a midsize landscaping company that is offering equity to expand into a neighboring town, it would likely have a low PE because the market is likely not going to grow at a break neck speed.  However, if Acme is Boston based tech startup creating a transformative new app or technology, it will likely have a higher PE and command a higher share price.

Annual Revenue Valuation

A very simple approach to valuing a company’s equity is to annual revenue valuation.

Annual Revenue x Industry accepted multiple = company value

The industry accepted multiple is the number by which other company’s multiply their revenue to come to a valuation.  Going back to the Acme example.  If the company is a landscaping company and has $100 in revenue each year and five companies sold at a median price of 2x their revenue the industry accepted multiple would be 2x.  Hence $100 x 2 =$200.  The company’s total value is $200, with 100 shares that would be $2 share.

If the company is a tech start up with unproven revenue but with projections of $500 of annual revenue in 3 years, one could value the projected revenue in 3 years today.  We could apply a present value discount, but lest save that for another blog post.

Hence in 3 years the projected revenue is $500.  This similar companies sold between 4x and 6x their annual revenue given a median multiple of 5x.  $500 x 5 = $2,500.  The company’s total value is $2,500 or $25 a share ($2,500 / 100 = $25).

Conclusion

Equity valuation is relative.  Equity or any asset is only worth how much someone else will pay for it.  Given that crowdfunding is a new method of capital raising with many questions to be answered about the liquidly of crowdfunded equity, likely at first the market will apply a discount to that equity.  However, as crowdfunding becomes accepted with wider adoption, that discount may disappear.

For any potential investor in a crowdfunded company, they must ask the right questions about how that company makes a profit or foresees making a profit.   From there, the investors can apply whatever valuation method they feel comfortable with.