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.

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

General Solicitation

Once again, through inadvertent action, the federal government is about to threaten Angel Investing. This all started as a way to increase investment in startups, when congress passed, and the Obama signed the JOBS Act (see: http://blog.drosenassoc.com/?p=97). Title II of the JOBS Act allows “General Solicitation and Advertising” of private placements (like Angel deals). One would think this is good for two principal reasons: (1) it roughly brings current practice into compliance, since many angel groups post their deals on a web site (like Gust, which is used by many angel groups) or run events where companies present to their members and others; and (2) more and more angel deals are funded by many angel groups (usually called syndication), so there is an implicit solicitation. We liked this idea. It allows our companies to reach a broader audience of only accredited investors. All good, right?

Well, not so much. The legislation also asks that the SEC use “reasonable steps to verify” that they are accredited. Even with that, it seems pretty straightforward. The reasonable steps to verify have been around a long time (under Rule 506B). Every time angels (or other accredited investors) make an investment, the deal documents come with a short form that you fill out how you qualify as an accredited investor. The SEC has given “safe harbor” using this mechanism.

But the SEC is considering that this long-accepted method will not be acceptable if an issuer (a startup company raising money using Regulation D) uses the new General Solicitation rule (Rule 506C). Instead, the SEC originally proposed that investors would have to give the issuer copies of their tax returns. The Angel Capital Association (ACA) wrote a very strident response that this would severely diminish angel investing, since few angels would turn over their tax returns to a startup. And, of course, the startup would have to find a way to preserve these records and keep them confidential – a real mess, given that most startups don’t even have permanent offices.

The ACA Public Policy Committee fought hard to ensure that existing “quiet offerings” (Rule 506B). Therefore, if you don’t take advantage of the General Solicitation (“noisy offerings”), you still can take advantage of the existing rules.

If you do use a noisy offering, then you will need to follow new rules, which have not yet been written. But the preliminary rules (and discussions with SEC) show that the SEC is unlikely to allow “self certification” for these offerings. Therefore, one of two outcomes now looks likely: (1) issuers (or their attorneys) will have to collect a lot of information about their investors and investors will have to share a lot of personal information; or (2) new third-party certifiers will emerge to do this.

Is this really so bad? YES – this is bad. First and foremost, we all rely on the “safe harbor” on the Reg D investments. At this point, the rules don’t give this safe harbor for any particular mode of validating accreditation. This means that deals can be challenged and unwound. Very bad. Secondly, even using third party validation, will cause the costs of these deals to increase. Instead of money going to hire engineers and sales people, it will be used on deal overhead. Very bad. And lastly, most angels HATE extra paperwork. If the validation requires that you hunt through and list all of your deals for the last 5 years (it would take me hours to do this!) And, I would be generally unwilling to provide my tax returns to anyone. In the end, it would just mean a lot of extra paperwork and time. I would probably avoid any deal that used a noisy offering.

I think that the SEC (and the legislators who supported the JOBS Act) really needs to recognize that the angel investing arena has self-regulated very well and the current system has worked well. Extending the current process for noisy offerings makes a ton of sense. It is the right way forward.

After all, “if it ain’t broke, don’t fix it!”

Angel Investing and Job Creation

As you know, I chair the Public Policy Committee of the Angel Capital Association (http://www.angelcapitalassociation.org/). In that regard, I’ve spent a bunch of time in Washington, DC, meeting with legislators and executive branch people. I thought it would be useful to post a simplified version of the story we tell.

It still surprises me, being so immersed in Angel Investing, that there is so little understanding of what we do. Many confuse what we do with banking. Others confuse us with venture capitalists. And yet others confuse us with friends and family. The ACA Public Policy agenda, when stripped to its essence, is comprised of the following four items:

1) Educational. Angel investing (and therefore angel investors) are the wellspring of our economy; we are the true job creators. We are not Wall Street; we are Main Street. We invest our own money (not other peoples’ money) in virtually every community in the country to start high-growth, high-potential startups that transform the economy to the 21st Century. We do this knowing that (statistically) over half will fail and we will lose our money. When we back the winner, we plow the returns back into more startups. We are not looking for government protection. But encouragement will make a difference in the rate and amount we invest in these high-growth companies.

2) Do no harm. Sometimes there are unintended consequences of legislative actions. One good example of this were several provisions in the original draft of the Dodd-Frank Financial Reform act that would have eliminated over 70% of the eligible angels and made Reg D filings difficult or impossible. This would have severely hampered Angel Investing and curbed the companies we support. We take aggressive, but prudent, actions to ensure that such actions are understood and not taken.

2) Cap Gains. Reauthorizing the Section 1202 zero capital gains for Qualified Small Business, first through the extenders bill (making it retroactive to 1/1/12) and in place till the Congress has time to make it permanent. We need some structural changes (e.g. 2 year rather than 5 year holding period; LLCs as well as C corps; and changing the roll-over period to 1 year from 60 days) that we will work with staff to explain. And.. this needs to be permanent so that we can use it as an incentive; we look at lots of companies and the timing can’t be accurately predicted, so our members (and all angel investors) need to be able to plan on this or they won’t use it. When angels get an exit, they re-invest their proceeds in new deals; this is the flywheel upon which angel investing is based. If a substantial proportion of the proceeds are absorbed by taxes, the entire asset class looks much less attractive. And remember that Angels (unlike VCs who invest other people’s money and only make a return when they invest) don’t have to invest in these deals.

3) Angel Tax Credit. Other countries and lots of states have enacted an angel tax credit that has spurred investment in high-growth startups. Typically this is 25% in the year of investment. Zach has some wonderful data from WI. These tax credits do a great job in stimulating new investment.

More will follow.

At the Clinton Global Initiative – CGI America

I recently participated in the Clinton Global Initiative that was held in Chicago on June 7th and 8th. It really was a fascinating event in many respects. The agenda can be found at: http://www.cgiamerica.org/2012/agenda/. The basic thread was what specifically can be done to put America back to work. There were a slew of great speakers and breakouts. I was invited to help guide the Entrepreneurship sessions.

Dan Rosen & President Bill Clinton

It is impressive to see what former President Clinton can get companies and individuals to do – there were specific commitments to create programs, hire returning veterans, and great discussions and commentary about what has gone wrong and what can be done.

Several highlight comments:

  • Bill Clinton talked about the need for “creative cooperation” instead of the partisanship that is choking our political process.
  • He also talked about transforming our society to one that is sustainable, citing Costa Rica which has 26% national parks, is 51% forested, and has 92% of its energy (going to 100%) from renewables. He saw this model as a challenge model for the US.
  • Fareed Zakaria had a memorable quote, when saying he didn’t have a PowerPoint: “People who use PowerPoint rarely have power and never have a point.”
  • He then discussed the impact of two concurrent revolutions – globalization and technology – and how they are a “pincer movement” on American employment, where the American worker is stuck in a bad place, because we have had a divergence of capital and labor.
  • He cited that most countries have a cabinet level position to enhance tourism (“every tourist is a walking stimulus program”), where the US has a cabinet level position to prohibit tourism.
  • Rahm Emanuel, the new mayor of Chicago, cited the need for cities like Chicago to stop looking to Washington, DC or Springfield (the Illinois state capital) for help or answers; “the reinforcements aren’t coming.” He talked about programs he has done locally to help the city and employment in public-private partnerships and how he has gotten the cooperation of the unions.
  • He also made some interesting global comments about the economy. Apple, one of our most successful companies by any measure has over $100B in revenue, but only employs 40k people in the US. But, Foxcon, which make many of its products, employs over 1M people, primarily in China, to build Apple’s products.
  • Clinton: “I was just in Silicon Valley meeting with business leaders. I was told that, if we had the workers with the right skills, we would hire 3M people.” This was a segway to discussion about education.
  • I was really impressed by Ai-jen Poo, Director, National Domestic Workers Alliance. He spoke eloquently about the need to change both models and training in financial education. Paraphrased: “today the role models in disadvantaged communities are drug dealers and rap stars. They are successful and rich. We need new role models that bring financial dignity and literacy. Today, in these communities, you have liquor stores, pawn brokers, payday loans, and drug dealers. If you could raise the average credit score from 500 to 650, then you would transform them to convenience stores, credit unions and banks, and thriving businesses. This requires making “smart” sexy. And teaching and giving financial literacy and financial dignity.” Truly inspiring.
  • Clinton (in his second keynote) talked about Lincoln. In the teeth of the Civil War, he did the following:
    • Created the transcontinental railroad;
    • Created the National Science Foundation;
    • Chartered the land-grant universities
    • Others…
    • And wrote the Emancipation Proclamation.

    He was clearly in the “Future Business.” This is what we need now!

  • Kasim Reed, Mayor, City of Atlanta, said: “Being a mayor is where hope meets the street. It is a question of will – doing the right thing even when the cost is high.”
  • Another passionate and brilliant speaker was Neil deGrasse Tyson, Astrophysicist and Director, Hayden Planetarium, American Museum of Natural History. He said (paraphrase): “Getting students to study the hard STEM topics is more a question of inspiration than knowledge. We need to inspire our youth.”

The only downside for me was the seeming confusion between lending and equity. There was much discussion about helping small business and a lot of confusion about loans as investment. We angels have our work cut out for us.

JOBS Act – What does it mean for angels

I have been asked repeatedly over the last several weeks: “What does the JOBS Act mean for Angels?” In this and other future blog postings, I will give my perspective.

First, what is the JOBS Act? It stands for Jumpstart Our Business Startups Act; it has nothing to do with earlier jobs stimulus efforts other than sharing an acronym. It is a regulatory reform act and does not have any tax elements. The full text can be found at: http://www.govtrack.us/congress/bills/112/hr3606/text (There are other pending legislations that address how to stimulate early-stage company investment through tax incentives.)

Broadly speaking, the JOBS Act is intended to provide more capital to startups that fuel the growth of our economy. It does the following:

  1. Removes some of the most onerous provisions of Sarbanes-Oxley Bill from emerging growth companies. The argument is that, while large, publicly traded companies needed the extra oversight and transparency, it was never intended to cripple the ability of high-growth startups from tapping the public markets.
  2. Brings the Securities Act of 1933 into the 21st century by recognizing that markets and communications have changed.
  3. Potentially allows for the revitalization of Reg A filings as a way for smaller companies to raise money from public markets.
  4. Enables “Crowdfunding” – a way that very early stage startups can get many small investors to stake their company early in the lifecycle of the company.

Much of the attention to the JOBS Act has been focused on the Crowdfunding part, so I’ll address this in this posting. However, the largest impact is likely to be from the other provisions, which will modernize and simplify the operations of Angel financings, small IPOs, etc. I’ll address those in future postings.

Crowdfunding (Title III of the JOBS Act)

In the past, startups were typically initially financed by “friends and family.” There are legendary stories of entrepreneurs mortgaging their homes to start their businesses, and then reaching out to their family, friends, and associates to get the company off the ground. As the original Senate bill said, the decline in home values has caused much of this source of early-stage capital to dry up.

Crowdfunding has precedence. People have contributed small amount of money (via the net) to charities, arts, etc. The music and theatre industries have tapped their fan base to ask for money for new works.

The difference with these precedents and Crowdfunding is the purchase of equity, which has been highly regulated. In the US, only accredited investors (a person with over $200k of annual income or over $1M in net worth; see http://www.sec.gov/answers/accred.htm for the full definition) could invest in highly-speculative private shares. The accredited investors were thought to be sophisticated investors, who could do appropriate diligence on the company and assess the risks. In general, Angels and VCs are the primary investors in this category.

There is still a raging debate on the advisability of allowing less sophisticated investors to enter this asset class. On one hand, the optimists say “why should only the very wealthy be allowed to buy early shares in a company like Facebook?” On the other hand, the pessimists would say, “this is a recipe for fraud; charismatic fraudsters will prey on the unsophisticated investors getting them to invest an amount of money that they can’t afford to lose in companies that don’t really exist.”

The devil will be (to some degree) in the details. The Act calls for a 270 day period for the SEC to write the rules. It also includes some safeguards:

  • A company may only raise $1M in a year from Crowdfunding;
  • No investor may invest more than $10,000 (or $2,000 if the investor has an income of less than $100k);
  • The investment can only be through a registered broker or funding portal;
  • A degree of public transparency by publishing the terms of the deal, the basis of the price, cap table, etc. that Angels would typically study;
  • Take steps to prohibit “bad actors” from issuing securities using Crowdfunding to help prevent fraud.

This is an experiment that marries the internet, social networking, and modern communications with selling private securities. It could work, it could fizzle, or it could be a great vehicle that tests the innovative spirit of fraudsters. If it works, it could cause thousands of flowers to bloom – startups in all parts of the US will have access to capital. If not, we can hope that the SEC regulations will limit the amount of fraud.

Impact on Angels

The simple answer is none of us know exactly. But there are certain things I believe to be absolutely true.

First and foremost, Crowdfunding will only INCREASE the need for angel financing. Very few of our high growth companies will get by on just Crowdfunding. If this is a successful experiment, then more companies will need follow-on financing from Angels.

But, the question is “will angels be willing to invest in a company with potentially hundreds of new, unsophisticated shareholders?” Will the cap table be screwed up? Any good, sophisticated angel knows that valuation is a key to success. My biggest fear is the following scenario:

  • Company X at the concept stage has a charismatic CEO with a great vision. He posts a plan and video on a funding portal asking for $1M with a $20M post for common stock at $1 per share. (We all know that it is possible to write a business plan the justifies this!)
  • The company then spends the money and makes progress toward a product. It now seeks angel financing for $2M.
  • We assess the company, like its prospects, and agree that it is a worthy investment, but assess the appropriate pre-money valuation to be $2M (not $20M) for preferred stock.
  • The previous Crowdfunding investor now see their shares valued at less than 10 cents on the dollar. They are very angry.
  • This is widely reported in the press and the entire asset class takes a hit.

We have a lot of work to do on Crowdfunding.

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