Startup Hero – Colette Courtion of Joylux

Colette Courtion founded Joylux (www.joylux.com) in 2016 after she became a mother and experienced both the joys of motherhood and the consequence of incontinence that results from childbearing. She had previously founded a skincare company and decided to apply some of the technologies that help skin look younger to a more intimate health problem—sexual health—that not only is the result of childbirth, but also menopause. Colette brought a meaningful change to the conversation of intimate women’s health—no small accomplishment for a startup.

Taking a page out of the playbook of Clarisonic and Sonicare (both from last-generation Startup Hero David Giuliani), she decided to go to market through a professional channel of doctors who performed vaginal rejuvenation procedures. With the usual problems facing a startup, there were ups and downs, but she persisted, building a great team and wonderful investor base. (Note: I am an investor, so not entirely unbiased!)

Joylux was recognized by the Angel Capital Association as last year’s most innovative company. Despite the many hurdles of starting a women’s health company, Joylux was beginning to get a lot of traction. Then came the pandemic. 

With the help of CFO Peter Weiss, they quickly strategized about what they would need to do. As Courtion shared, “There is an advantage of being an ‘older’ entrepreneur. I was there for the dot-com bust of early 2001 and saw what happened to Lehman Brothers during the 2008 crash. In order to survive, I knew that we needed to move early, fast, and make hard decisions.” Just like there is no immunity from the COVID-19 virus, there is no immunity to the economic result either.

She and Peter put together a plan and sat down with the management team to discuss. “We laid out the stark financial reality and shared the numbers. We asked that everyone first take a salary cut and then we discussed what roles we had to eliminate,” Courtion said. “We asked them to consider what they could do financially to help the business survive, gave them overnight to consider, and then we talked the next day. I’m proud to say the management team was thoughtful and creative. They came back with deep cuts—perhaps deeper than we might have done without their input. The key was that we came together as a team—everyone had ownership—for a plan to help the business remain strong.” 

The salary cuts were substantial. Senior management led the way with 50% cuts. But in one case, they recommended actually raising an employee’s salary. She was a phenomenal employee but would have suffered massively because her comp was commission-based, so they decided to change her comp model. “That brought us loyalty, as well as an even stronger commitment to the business.” 

Before COVID-19, Joylux had 15 employees; they cut to 9, and 2 contractors agreed to lower their number of hours. This was all done prior to PPP (Payroll Protection Act), which did not come through until more than a month later.

“After we cut expenses, I posed the following question to the team: If we could start over, what would you do differently?” Courtion said. “Each team/department went off and discussed what they thought we should do. A week later, they came back and presented what they would do, with the entire team participating.” Turned out to be more than just how the company should pivot in response to COVID-19—they implemented changes that had been put off because they were too busy, changes that made Joylux a stronger business. 

“The silver lining to COVID-19 is that it has given us a perfect opportunity to test things that might affect the near-term, top-line revenue, but will be better for us long term and make Joylux even stronger. We put in place a new way to do business, shifting from a wholesale business model with professional doctors to a more D2C business model,” Courtion said.

Like Sonicare Toothbrush and Clarisonic, the core strategy prior to the pandemic was to engage the professional channel, i.e. Ob-Gyns and urologists, for product validation and endorsements, but COVID-19 caused a pivot to a more direct-to-consumer focus. This was necessary while the pro channel was closed due to the quarantine. Courtion added, “The professional partner is still vital to our business, but how we engage with them changed. We quickly put in place a telehealth-like program to help them refer patients to the Joylux site for sales during the period their offices were closed. Being direct-to-consumer is allowing us to be much more creative. From telehealth opportunities to testing a membership business model, COVID-19 may turn out to be our catalyst for major growth.”

I asked Colette how she communicated the changes to her shareholders. First came shareholder Zoom calls to communicate the changes, followed by weekly email updates. She was particularly proud of her shareholders’ response. Although it was painful to do so, Joylux also decided to reopen the previous priced round from 2017. With the idea of raising $500K, they asked shareholders to each add $5,000 to their investment. In fact, most shareholders did more than their pro rata, and the company raised over $1.2M. That, along with another $200K from the PPP, gave them the cash cushion they needed.

“The business is doing very well. We lost 60% of our revenues overnight, but with the team’s quick shift to D2C, we have more than made up for it. We are seeing strong year-over-year growth, which is unprecedented for most businesses today. I am very proud of our team.” Asked about the future, Courtion added, “Even if the recovery is slow—12 to 18 months or longer—we are really optimistic about the future. We will attract new customers with a wider net.” Joylux has done best case/worst case modeling and believes that they are in a category (female sexual health) that will continue to grow. “COVID-19 will pass, but the need to treat these symptoms won’t,” she said, ending the discussion on an optimistic note.

Leadership for the Pandemic and the New Normal

The COVID-19 Pandemic has caused every startup to assess how to survive and plan to thrive in the “new normal.” No one knows what the new normal will look like, but based on other jolts to our economic system, we do know that life after this pandemic will be different than life before – at least for a while.  Just as there is no natural immunity to the Covid-19 virus, there will be no immunity to the economic disruption that results.

As I previously posted (see http://blog.drosenassoc.com/?p=140 and http://blog.drosenassoc.com/?p=145), startups need to act  while they can to survive, pivot (as appropriate), and figure out what unique things each business can do to solidify their future.

This is a test of leadership. 

Most angels cite the team as number one thing they look for in their investments.  The critical role of dynamic leadership is more important in this time of unprecedented upheaval and startup survival threat. 

Founders and CEOs must maintain team enthusiasm in the face of societal and personal hardships now more than ever.  While maintaining team cohesion, startup leaders also need to motivate their investors to stick with them and subscribe to their changing vision.  Both founders and their investors are in this to create great companies that lead to great exits.  Ultimately future investors and acquirers will judge and value the enterprise based on how well it adapts to this new normal.  But, of course, there is no company to value if it runs out of cash before it gets to an exit.

As I’ve spoken with many startup CEOs, I’m finding that they seem to fit into one or several of four categories.  These are:

  1. Immediate action.  These CEOs (generally guided by either their own experience or that of an experienced CFO who has experienced previous downturns) see that cash must be conserved with a potential path to becoming cash flow positive.  They tend to involve their entire employee team into the conversation and take rapid action to conserve cash.  They often have a company that already has some cash flow, so balance the reduced cash flow with cuts to stay alive and potentially thrive.  Given that cash balance is finite, early cuts have a bigger impact than later ones; this is similar to the response to Covid-19, where earlier actions seem to have more effect in preventing widespread infection.
  2. Benefit from the “New Normal”.  There truly are some business that will benefit from the disruption.  A clear example is Zoom, which is blossoming as we all need to move to videoconferencing.  Or, one of my portfolio companies, DocuSign that has enabled transactions to still be done virtually.  Some clever entrepreneurs have quickly pivoted to provide a piece of critical infrastructure for businesses to reopen safely. 
  3. Wait and see.  Some CEOs decide to wait to understand how bad their situation will be before taking action.  They might have considerable cash in the bank – they believe sufficient to weather the storm.  And, guided by their prior experience, believe that when cash get low, they will have achieved milestones that allow them to raise more cash.
  4. Denial.  These CEOs believe that, while things look bad right now, their business will turn around and go back to the way things were before.  In some cases, they were in the middle of raising institutional money and believe that the money will come (it might).  In some cases, there is a logic that says if every one of my competitors cuts back, but I continue to move forward, then I will be the biggest winner when the market does turn.  There are probably some businesses that will do well in the “new normal” but I doubt that it is as many as think that they will do well.

The purpose of the above discourse is to point out that there are many different paths to leadership in this tumultuous time.  No one path is always correct, and most leaders will use some elements of more than one.

Over the next few weeks, I will talk with leaders who I believe, through their actions, have demonstrated exceptional leadership in the face of what could have been a company destruction.  I believe that their examples will serve to illustrate why we invest in startups and be a guidepost for others to adopt best practices.

How Angel Investors Survive the COVID-19 Economic Crisis

Blakiston Owl: We need the wisdom of an owl in times like these. (c) Rosen Photo

Author: Dan Rosen

To: The Angel Community

After publishing my companion piece, “How Startups Survive the COVID-19 Economic Crisis,” I have received a number of comments about how this impacts angels and angel investing.  Here are my thoughts.

Unlike VCs, who have a fund to invest and collect a management fee for investing their fund, Angel Investors invest their own money and are under no pressure to invest in any company or at any time.  Our decisions to support a startup are totally our own.  As in previous market downturns, there will be some themes that help us through our investment decisions during the COVID-19 pandemic and the resulting economic crisis.

Angels have limited funds.  And many of us already have extensive portfolios.  We quickly will be (or already are) in the position of getting funding requests from many of our portfolio companies for new rounds of funding.  Some will make it, and some won’t – even great companies with fabulous ideas will fail when the cash dries up, and sometimes Angels alone can’t provide sufficient cash to carry them through.

For Angels, this is a good time for both investing and tough love.  Great companies are often started in market downturns.  I believe this is because only the most dedicated entrepreneurs (the ones that feel absolutely compelled to create their new company) will leave a stable, good-paying job in the middle of a downturn.

My friend and colleague, John Huston of Ohio TechAngels, commented on the last two recessions: “One strong recollection I have of those periods is that CEOs (with a strong BOD) who most effectively & frequently communicated their parsimonious plans to use the emergency funding were helped and survived.”  An inexperienced entrepreneur might neither have the experience nor the tools to manage their impending company crisis; we as knowledgeable Angels and mentors and board members can draw on the experiences we have faced as investors in those previous cycles.  It is our hour to shine and help our startups survive and thrive!

Here are my rules for Angels during this downturn:

  1. Stay in the Game.  I know that our public equity portfolio is way down, but, most likely, you aren’t bailing out while the stock market is down.  Same is true of Angel investing.  Stay in the game.  Keep reviewing companies, meeting with entrepreneurs, etc.  And be prepared to invest in both some of your existing companies and some new ones.
  2. Be highly selective.  Most Angel investors are always selective, but this is the time to turn your filter even higher.  Funding is even more limited than it was a few weeks ago.  There will be lots of great opportunities, both in your existing portfolio and new ones.  So, take your time and invest with care.  The funding requests will vastly exceed your ability to invest!
  3. Work in a group or a team.  Angel groups (or groups of Angels) can help a lot, both in terms of assessing deals and in making sure that there is a sufficient pool of capital and expertise to help companies succeed and thrive.  In stressful times like these, this is even more important.  The Alliance of Angels has survived the 2000 (dot com crash) and 2008 (mortgage crisis) downturns, with a group IRR of over 20%.  Angels and the startups they support can really benefit from that institutional wisdom.
  4. Be ruthless.  All Angels investors have their favorite companies.  We want them to succeed.  This is the time to step back and realistically consider the probability of success with limited financing.  Advise your existing companies to conserve cash and focus on how to help their customers.  (See my companion piece.)  You may think you are helping by keeping a portfolio company alive, but make sure that their plan is reasonable to actually survive – tough love.  Some of your portfolio companies will not survive – even great companies will die from running out of cash and runway.  But it is likely that some good ones will come through this crisis even stronger and give a better return than you expected.
  5. Multiple financing rounds.  This is a time to avoid companies whose plans require multiple rounds of financing with large cash needs before they can turn cash-flow positive.  I’m not saying to sub-optimize the outcome of great companies.  But for at least quite a while, it is likely that cash will be tight, and it will be difficult to raise money.  Companies that are frugal and can make the most out of the Angel cash have a much higher probability of giving you a return.
  6. Deal terms matter.  This is a time for resets.  Both Angels and entrepreneurs need to reset expectations.  The world will recover, but it is likely to take a while, so make sure that the terms on which you invest are in synch with the market and the projected future.  Resetting valuations to match today’s reality is a must.  If you agree to too high a valuation, the company will have trouble both attracting enough investment now and, particularly, more investment at the high post-money valuation later.  Watch for other terms, like liquidation preferences, that can lower your return.  And, for a less experienced CEO, do not be afraid to have some protective provisions, e.g., the company can’t exceed its budget without the approval of the investors or investors’ rep.
  7. Be careful, but not greedy.  As Angel investors, we invest for the future and to give back.  It is OK to be careful, ensuring that the return you get is commensurate with the now higher risk you are taking.  But don’t be greedy and ask for large multiple liquidation preferences, too much of the company, or asking the entrepreneur to throw all their energy into the company without retaining a big enough stake.  This is a time when we want a “rising tide to raise all ships.”  We are in this together.
  8. Exits.  In the short term, not many exits are likely to occur.  Unlike VCs, Angels can do well with modest exit valuations (provided that the initial valuation was in line with reality).  Entrepreneurs can also do well with a modest exit.  Make sure the entrepreneurs in which you invest are on the same page – look for early exits, even if they are more modest.  You want entrepreneurs who want to be rich, rather than becoming a king!

We are in a challenging period.  It is natural to want to pull back.  As an Angel investor, this can be a good time to both maximize your current portfolio and find some new fantastic deals with fantastic teams at reasonable terms.

How Startups Survive the COVID-19 Economic Crisis

Iceland Sunrise and Sunset

Author: Dan Rosen

To: All angel investors and their portfolio CEOs

Being trained as a scientist, and having lived through several investment cycles, I’ve been asked to share my perspective on the financial impact of the COVID-19 pandemic on startups.

I firmly believe that the human and societal impact of COVID-19 will be extreme, even though we are at the early stage of this pandemic.  If we, as a society can pull together, enact social distancing and other means of delaying the spread of this virus, we can come out of the other end of the tunnel.  Most people really don’t understand the concept of exponentials – it is not in human nature to grasp what this means. 

As a scientist (a biophysicist at that), this kind of modeling is something I was trained on early in my career.  At this point, suffice to say, that we cannot prevent COVID-19 from spreading and our best hope to minimize the impact is to (a) lengthen the time it takes to effect a substantial portion of the population; and (b) prepare for the impact that will have.  The key right now is to ensure that our medical system is not overwhelmed by this impact.

In 12-18 months, I expect that we will have a viable treatment for those with the disease, a working vaccine and that a large enough percentage of the population will have developed immunity through recovering from being exposed to the virus.  The combination of the herd immunity and a vaccine for the most vulnerable will potentiate the impact, provided that we can wait it out through mitigation measures in the meantime.

I went through this detail because the depth and timing of the disruption will have major impact on the startups we support and fund.  A deep and shorter disruption might actually be more severe for both our society and our companies, so let’s pray that our remediation response works.

For startups, this will be a particularly difficult time.  In the recessions of 1982, 2000, and 2008, funding for startups dried up. While many have heard me say that great startups are often created during market downturns – sometimes, easier said than done.  So here are my suggestions:

  1. Survive.  This is pretty obvious.  If you don’t survive, there is no upside.  So all of the strategies below are about survival.  It is time to put aside the wonderful plans to become a huge company with world-beating products.  None of this matters if you don’t survive.
  2. Cash is king.  Startups don’t generally die for a lack of ideas.  They die because they run out of cash.  Put in place a plan to conserve cash.  Be aggressive in this plan; early action will be much more impactful than later action.  Have at least 12 months of cash on hand, because it is likely that is what you will need.  Even if the COVID-19 crisis resolves itself much sooner than that, the turmoil left in its wake will persist, particularly for startup.
  3. Forget about raising money.  Angels will continue to invest, but expect smaller rounds, at lower valuation, in companies that don’t require large amounts of cash.  For existing portfolio companies, the sudden downturn in the market, coupled with the disruption of almost all business as usual will cause fundings to stall.  While VCs and angel investors might have cash to invest, the pullback will trigger a triage mode (as it did in previous downturns), where investments will be in select companies.  Even some good companies won’t get financed.  Assume that this pullback will last till after the COVID-19 crisis is over and add a few months to that for them to get back on their feet.   M&A will dry up; if you were in discussions last month, expect that nothing will happen until this crisis ends.  If you are lucky, you might get your existing angel investors to help carry you a bit, but expect it to be really costly and only if you have a plan to make the money last a long time.  And, as I believe is always prudent, communicate well with your shareholders, giving them the bad news and the good.
  4. Revenue is likely to be curtailed.  If you are counting on contracts in the pipeline to close, you shouldn’t.  Most big companies, government clients, and especially small and medium businesses will also go into survival mode.  Unless you are supplying a product or service that they consider absolutely mission-critical, you should expect that revenue will be deferred for at least 6 months and probably longer.  If you existing contracts have cancellation clauses, expect that some will be exercised. 
  5. Opportunities.  If you have a way to shift some or all of your business to be part of a solution to the COVID-19 problem, stay alert to do so.  For example, even as GM is closing plants, they are looking at how to make ventilators and respirators.  While there will be great economic dislocation that effects small and large businesses, there are still some opportunities, especially for direct to consumer businesses.  People are sheltering at home and online a lot.  If you are selling something that will make their lives better during this difficult period, there are opportunities.  Examples might be things like online learning or classes, online consulting, or even things that bring a smile in these difficult times.  Similarly, any product or service that makes working from home easier will have a ready market (if your customers can find you online).
  6. Downsize.  While this is a really difficult decision, survival is the single most important thing.  Many companies will have to pare back to the essential.  Salaries will need to be slashed (as they were in 2000 and 2008), if companies will survive.  I’ve already heard from several of my portfolio companies that they had company-wide meetings and agreed to 50% salary cuts, and cut non-essential staff.  While the pandemic will certainly curtail travel, make that a policy.  Cut all contract help that can be cut.  Cut marketing and sales spend until the your customers are back to work and buying once more.  Again, any step that cuts your burn early on, will have a lasting impact on the later cash balance and your cash horizon.
  7. Non-equity cash raise.  Look for sources of cash that are non-equity.  Think of ways to get government grants.   Explore the SBA programs that have been put in place to help small businesses.  Be creative about finding sources of cash to stay alive, including potentially doing some short-term deals that help the immediate crunch.  These are things that you would never have considered doing three months ago.
  8. Stay alert for the inflection point.  As with almost all things in life, this too will pass.  It is hard to tell what the country and market will look like when this is past, but if your company is alive and flexible, there will be great opportunities.  Watch for it, since none of us can predict when it will happen.

Hope this is helpful.  Comments appreciated.

Jet.com – Not ready for Prime time

I really wanted Jet.Com to work. When they announced the service as an alternative to Amazon, I thought that a new kind of competition would be good for the industry. Unfortunately, my experience shows that great ideas and intentions that are not ready for prime time = just a terrible customer experience that appears doomed.

Jet.com offers a membership service with what they believe to be prices 10-15% below the competition. As Costco has proven, a membership purchasing concept can be great for both customers and business. With free shipping on purchases over $35, the offer seems attractive.

I was pleasantly surprised to find a wide array of products on Jet.Com. Their UI is simple and straightforward – well suited to the task. Graphics are good and their purple theme interesting.

Given that I am a photographer, as well as techie, I first went to cameras. I was astonished to see a Nikon pro camera (D4S) in their listings. I immediately added it to my cart and the savings were indeed substantial enough to convince me to upgrade from my three-year-old D4.

Then the fun started. I clicked check out, entered my shipping and credit card info, and clicked purchase. They seems to process my order. Then a message popped up that they had a problem and please retry or call a “Jet Head.” I tried again. And again. No luck.

I called and Auli’i was really pleasant. Saw the item in my cart, confirmed that they had it, confirmed the price, confirmed that it was indeed a US sourced item, but got the same error. She put me on hold (with my permission) and talked with support who acknowledged that they were having problems. I was asked to try a different browser – I tried two more. Same result. She said that she would work with support to get my order through the system, process it and I would receive an email acknowledgement.

Two days later – not received. So, I called again. Brandon acknowledged that they were have some problems. (Can you say “not ready for prime time?” Yes.. pun intended) When he looked at my account, there were no items on order, nothing in my shopping cart, even though my account still showed the Nikon camera. He asked me to re-purchase. I did and there was no such product.

He told me that they had some issues with items that they priced too low and then removed from the system and that was probably what happened. They would not honor the price for an item that had already been ordered. And then, repeated the part line about service and price.

After I hung up, I got even angrier. Clearly this is amateur hour! They post items and prices to attract you to the site, don’t have them at that price, let you add them to your cart, and then have the “cart fail” so that they don’t have to honor their commitments.

And then, two days later, got an email response, again apologizing and asking for patience while they worked through technical issues. So, I checked and the same item was reposted, with the same price. Added to my cart, clicked purchase and got exactly the same error. And was informed, that the customer service staff had no ability to do a work around.

Intolerable policy and service. Chalk this up as another startup that doesn’t get it.

 

Trophy Hunting – I just don’t understand

Like many animal lovers, my first reaction was outrage at the senseless death of Cecil the lion by Walter Palmer. I let my first draft post that reflected my outrage subside into thought – I just couldn’t understand why a successful American dentist would feel the need to take the life of a beautiful African creature. Then I learned that he has done it many times in the past and that big-game hunting has supported the imperiled species to be taken to the brink of extinction, where the lion population has decreased from over 100,000 in the early 1990s to between 15,000-47,000 currently (ref: Wikipedia). The justification is that “trophy hunting” is a smaller factor than poaching. To me that is a specious argument, since it exacerbates the rapid decline of these magnificent creatures. Paying $50,000 to slaughter, behead, and skin a lion is unfathomable and should be condemned.

Our society has moved beyond this! We should not tolerate this. 2000 years ago, hunting and killing humans was considered acceptable. Army’s would plunder captured villages, beheading humans and displaying their heads on spikes or hanging them from walls. As our society matured and became more civilized, this was condemned and is considered abhorrent. ISIS still maintains this practice in their conquered territory – they considered conquered people trophies and not deserving of any compassion.
Are big-game trophy hunters, like Walter Palmer, very different from them? Future generations of humanity will look back on the barbaric practice of trophy hunting with disgust, just as we should now.

So, what should we do?
1) Clearly, the first step if for all civilized countries (led by the US) should put in place a permanent ban on Trophy Hunting; no part of a threatened or endangered species should be allowed to be brought back into the US or any other country.
2) Social pressure, like that shown to Walter Palmer, must be ferocious. We should shun anyone who does Trophy Hunting. Peer pressure should be massive. They should understand that this is as unacceptable as being taken to a remote location to hunt a human.
3) Economic stick. The countries that allow Trophy Hunting should face economic sanctions if they continue to do so. These include not just Zimbabwe, but also South Africa, Namibia, etc.
4) Economic carrot. We need to support non-destructive ways to preserve wildlife and their environments in the affected countries. I am a photographer and love photographing animals in their natural habitat. Photo trips like these are expensive and support the local economy. I also contribute to wildlife conservation. As a society, we need to make sure that preserving these natural habitats and their wild inhabitants is a high priority.

Let’s make sure that Cecil’s senseless killing was not in vain. #CecilMattered

Note to the SEC on Accredited Investor Definition

8 June 2014

 

The Honorable Mary Jo White, Chairman

US Securities and Exchange Commission

100 F St. NE

Washington, DC  20549

 

RE:  Accredited Investor Definition

 

Dear Chairman White:

 

As a board member of the Angel Capital Association (ACA) and the Chair of the Seattle Alliance of Angels, I urge the Commission to protect angel funding to ensure the health of the startup economy we support, by retaining the existing financial thresholds in the current accredited investor definition.  These thresholds — $1 million in net worth or $200,000 in income — have worked well for decades, creating a vital accredited angel investor sector that is the primary source of funds for early-stage companies that drive the innovation economy and job-creation nationwide, and with very little fraud.

I have been an active angel investor for over 25 years, founded and chair the Alliance of Angels (the largest angel network in the Pacific Northwest that has invested over $80M in almost 200 companies during the last 18 years), and have helped start many companies, leading several to IPOs.  During this period, I have come to know many entrepreneurs and even more angel investors.  I have yet to encounter even one investor who said that they would benefit from changing the accredited investor threshold.

Angel investors are sophisticated.  Unlike bankers or VCs, we invest our own money – not someone else’s.  We are not in just the financial centers of New York, Boston, and San Francisco, but are in every major city and town in the country.  We invest not just our own money, but also our time, energy, expertise, and reputation in helping startups get off the ground, thrive, and become major forces in the economy.  We do this because many of us have been entrepreneurs and benefited from the innovation ecosystem.  And we do this knowing that a large percentage of the investments we make will not succeed.  But some will and what successes they can become!

 

If financial limits were sharply increased, angel investment in early-stage companies would suffer.  An increase in the net worth threshold to $2.5 million, advocated by some, could cut upwards of 60 percent of current accredited investors out of the market.  The startup ecosystem would be devastated by such a dramatic shrinkage of this vital investor pool, especially in regions where venture capital is not prevalent. A contraction in angel investing could stall local economic development, university technology initiatives, and stem innovation and job growth. At the same time, millions of Americans would instantly lose the opportunity to participate in the innovation economy that is largely the purview of companies raising funds privately from accredited investors.

 

It is important to consider investor protection, the public interest and our current economy.  However, the SEC should note that, as more accredited individuals have engaged in angel investing, direct investment in startups has remained largely free of fraud.  This is a result of concerted due diligence, negotiated terms, and ongoing entrepreneur support and mentoring that are the hallmark of angel investing.

 

Given the importance of the innovation economy to the nation, the need for capital formation in the early-stage sector, and the need to balance access to investment opportunity with investor protection, I urge the Commission to adopt the following approach to the accredited investor definition:

 

  • Maintain the current financial thresholds of $200,000 income per individual; $300,000 for joint filers, or $1 million net worth not including primary residence for individuals to qualify as accredited investors.
  • Incorporate the concept of “sophistication” for individuals who do not meet the above thresholds to prudently expand the accredited investor pool, using a detailed questionnaire to identify qualitative information about knowledge and experience with this type of investment.

 

Such an approach will continue to provide investor protection while also recognizing the growing role and importance of accredited investor investment in innovation and growth that are essential to serve the public interest and sustain our nation’s economy.

 

I believe that raising the limits will have a chilling effect on the angel investment ecosystem, with adverse effects on the entire economy for a generation.  At a time when risk capital is exceedingly hard for entrepreneurs with great ideas to obtain, any action to place further limitations on angel investors is likely to cause a further retraction of the highest growth segment of our economy.  While I understand that is not your intent, it will be an unintended consequence.  In the strongest possible terms, I urge you not to take such an unwarranted action that will have deep repercussions for years to come with no real upside benefit.

 

Thank you for your consideration.

 

Sincerely,

Daniel Rosen

Chair, Alliance of Angels (Seattle)

Member of the Board, Angel Capital Association

 

Comment to the SEC

November 4, 2013

Elizabeth Murphy, Secretary

U.S. Securities and Exchange Commission

100 F Street NE

Washington, DC 20549

 

Re: File No. S7‐06‐13, Amendments to Regulation D, Form D and Rule 156

Dear Ms. Murphy:

Thank you for the opportunity to provide comments to the Commission on your proposed amendments to Regulation D and Form D.  Many others have provided you detailed comments on why the proposed rules are neither suitable to current market conditions nor aligned with the goals of the JOBS Act that they were supposed to support.  I am not a securities attorney, and recognize that many of the legal arguments in these other comments will have more sway with the commission, so rather than pile on to those already exhaustive and accurate comments, I would like to take a more personal approach.

I have been an accredited investor who has been an active angel investor for over 20 years.  As such, I’ve made well over 50 investments in startups and have chaired the largest angel group in the Pacific Northwest that has made over 200 such investments.

Angel investing has moved from a curiosity to an asset class.  Angel Investors are individuals, scattered across the country in every major city and town in the US, who invest their own money (unlike banks or VCs).  And, to make their companies succeed, they must also invest their time, knowledge, experience, and networks.  We do this willingly, giving back to the communities that help us become successful, knowing that on the average over 50% of these startups will fail and not return the investment capital we have contributed.  Occasionally, one or our companies succeeds wildly, creating many jobs and sometimes a whole new industry.

Here in the Pacific Northwest, as in many other areas of the country, the amount of venture capital financing has diminished.  Angel Investors have often stepped into the breach, investing both more and for longer than in the past.  These private investments are not liquid; we know that going in.  We know that we typically have to hold our investments for over 7 years from time of first investment and often over 10 years.  These are risky investments.

Since we operate on our own, we do not have the infrastructure of a large firm.  Typically, our individual investments are small – in the range of $25,000 to $100,000 – and the companies are at their very earliest stages (when we can add the most value to help them succeed), raising only a few hundred thousand dollars to get going.  More often than not, we invest in a small technology team with a good idea, who have not yet hired any real “business people,” have no infrastructure and are working out of a temporary office.  It is our hope that the capital and time we contribute (we are not paid; just equity) will help these companies become the next Microsoft, Google, or Facebook, creating thousands of high-paying jobs.

In order to get these companies going, simplicity is required in financing and deal structure.  Having travelled and worked in many countries, the US system has been the envy of the world.  Simple Reg D financings have been the cornerstone of the entire asset class and ecosystem.  We learn of a small team, help them get up and running, do a simple and quick financing, and then help them grow.  The SEC deserves a lot of credit for their foresight in this asset class and the Federal preemption that has allowed it to grow and create jobs and companies.

However, your latest rule-making has put all of that in jeopardy.  You have proposed a set of rules that would at best make these financings difficult and at worst completely crippled the asset class.  By asking the proverbial 2 guys in the garage to take on the same responsibilities that you would require of an established company with on-staff legal departments and millions in revenue is the definition of insanity.  Requiring potential investors to turn over personal financial information to a company that has no real ability to keep it secure is ridiculous.  But most of all, it strikes me that you are trying to fix a problem that doesn’t exist – angel investors know each other and the risks they are taking.  There is little or no fraud in this asset class.

If you do impose a host of restrictions and limitations on the asset class that is working well and is not suffering from any problem other than, perhaps, needing even more capital, you risk causing the capital to dry up for these fragile companies that have driven the US economy.

This is exactly opposite the intent of the JOBS Act.  And, in my humble opinion, contrary to our national interest.  We need more capital going into angel deals, not less.

Please resist the temptation to cripple angel investing.

Respectfully,

Daniel Rosen, CEO

Dan Rosen & Associates

Kirkland, WA

Too Much Complexity, so Tell the SEC

As a rule I live by, “if it ain’t broke, don’t fix it!” The new SEC rules violate that basic principle (see: http://www.startuplawblog.com/ or my previous posts). There is virtually no fraud in the Angel Investing asset class, but the SEC has decided to impose (without a Congressional mandate) stringent new rules that will cripple angel investing.

Let me use an analogy. Let’s say that you are a wine connoisseur. You buy a superb bottle of wine each month from a new small winery, knowing full-well that it will be expensive. But you really like supporting small, unknown vineyards and hope that the wine will mature into on that is exceptional in 5-10 years. You have been doing this for years and find that it is worthwhile.

All of sudden you are told by the federal government that before you are allowed to buy a new wine from any small, new vineyard that has announced their new wine, that winery must verify that you can afford to buy this wine.

The winemaker must verify that the purchaser is allowed to buy this expensive new wine or lose the license to sell wine at all. The winemaker says: “I’m just a wine maker and don’t have any ability to check or store financial records.” So she asks his distributor, who says: “I can do that for you, but it will be time-consuming and expensive.” The winemaker is befuddled, since she knows that, unless she can sell his wine in a timely fashion, her business will flounder, so she agrees to pay the distributor, even though the winemaker has always sold directly. She learns that if she never announced that she had a new winery to customers or was a large, established winery these rules would not apply.

So the distributer calls you and says, “give me your financial records, so that I can verify that you can afford to buy this wine.” You really want to buy the wine, since you have done hours or days of research finding the winemaker and studying how she makes great wine. Getting the financial information together is another time-consuming task that has nothing to do with studying wine. You decide it’s just not worth it, so don’t buy the wine.

But being forced to do this EVERY time raises the complexity and difficulty of finding new winemakers. So you decide that buying from only large vineyards is good enough, since you won’t have to go through the hassle. It’s not as much fun, you aren’t supporting the new winemakers that move the industry, but it is less difficult.

This is a direct analogy of what the SEC is imposing on entrepreneurs, startups, and their angel investors. We are being told that we must add to the complexity, cost, and hassle of doing these risky, early-stage deals (where over half fail anyway), while assuming additional risk that the company will have violated a cumbersome and costly regulatory process. If they have made a mistake, then they can’t raise money for a year, which we all know is a death sentence of a startup.

Please contact the SEC, your Congressional Delegation, any anyone else who will listen and spread the word.

Why is the ACA making a big deal about the SEC proposed ruling?

I am being asked, why is the SEC proposed ruling such a big issue?

Unless you read the entire ruling and get to talk either directly or indirectly to SEC staff, it doesn’t seem like a big issue. 

Simply put, the proposed SEC ruling is (a) trying to fix a problem that doesn’t exist; (b) will increase risk in our early-stage deals by adding a dimension of regulatory risk that isn’t there now; (c) will increase the cost and time for getting deals done; and (d) violates the Congressional intent of the JOBS Act, which recognized that using angel investment to create more jobs in startup companies was good for the US.

Their proposed ruling is setting new policy by bureaucrats in an area where the policy should be set by legislators

There are several issues here:

  1. What constitutes a general solicitation?  One reason I welcomed the JOBS Act provision on general solicitation was that Angel groups hit that boundary many times.  My angel group, the AoA, was ultra-conservative. For example, we didn’t give our 2 page startup summary sheets to guests, who had not yet given us the accredited investor forms.  Other groups, like Zino Society, did big events (Zillionaire Forum) that are attended by many people who aren’t accredited.  While I think this is a great idea, since it exposes new people to startups and helps fund them, are the companies that present there using general solicitation?  When a company posts its plan to Gust (as the AoA requires), are we generally soliciting?  We live in a connected world, with social media being the norm, so the new rules should take that into account. But, the boundaries are murky and, if the proposed rules are adopted, the consequences of a mistake are draconian.
  2. When the JOBS Act passed (and remember I was an insider), Congressional intent was to help angels fund more companies.  The new SEC rules not only won’t achieve that intent, but will make it harder, because of the uncertainty.  I will likely avoid investing in any deal that uses general solicitation. If the startup company makes a mistake, I will lose my investment quickly, since they will have spent my money (as I want them to) and not be able to return it when the deal is rescinded. Even if the deal is not rescinded, they will be prohibited from raising money under Reg D for one year; that is a death sentence for a startup.
  3. The old rules provided a safe harbor to the companies (the investors were accredited if they said they were).  The new rules do not provide safe harbor.  The companies must verify that each investor is accredited and not a “bad actor.”  That responsibility is on the company and their board.  To get that degree of certainty, our advisors are saying that each issuer must do a background check with a third party, which will cost several thousand dollars per investor.
  4. I most certainly won’t give personal financial records of any type to a startup. Perhaps a third party verification industry of broker/dealers will emerge that will do so, but that will add cost and complexity. Furthermore, that will likely mean I will have to fill out additional myriad forms for each investment, attaching my tax returns, bank accounts, etc. each time. Again, I find myself asking “what problem are you trying to solve?” Public market equities don’t require me to jump through any hoops. Seems simpler.
  5. If you think you are not using general solicitation, but later it is determined that you did (e.g. presented at a public event, did a post on a social network, talked to a reporter, or potentially even told a customer who asked how you could ship your product), the impact is draconian.  You have 30 days to file an amended form D, allow your existing investors to rescind, and potentially face a one-year ban on fundraising. 
  6. Today, if you use Reg D, 506b (quiet), you can file after you raise the money (15 days).  If you do use 506c, then you must file an Advance Form D 15 days BEFORE the first time you generally solicit.  So, that would mean that you will need to file before you speak to your first investor and then file (an amended Form D) when you reach final terms.  And the Form D is posted to a web site that can be reviewed by the State Security Administrators.  We believe that this is the reason for this whole process – they want to do away with Federal preemption of Reg D filings.  They can then require a company to jump through myriad state hoops, as they have done in Alabama.
  7. The SEC is making the Reg D forms much more complex.  You can read that to mean that legal fees will be substantially higher.  This will make smaller deals (which we have been advocating) more problematic.

For a more thorough treatment of these issues, see: http://www.startuplawblog.com/

Hope this helps.

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