“You’re either a high-net worth sophisticated investor, or a complete idiot and you need the state to hold your hand” – that’s how most people view securities law, says Jeff Lynn, co-founder and CEO of the equity-based crowdfunding platform Seedrs.
Having secured Financial Services Authority (FSA) approval, new crowdfunding player Seedrs is stepping out into the market. Despite not having launched yet, having FSA approval makes Seedrs stand out of the crowd. Lynn believes it’s time to challenge the “wealthy versus idiot” perception.
Seedrs was the winner of the London Web Summit start-up competition, which Lynn says has been more important for him than seeing crowdfunding become legal in the US, under the JOBS Act.
As a qualified lawyer himself – with experience ranging from corporate law to early-stage businesses in London and New York – Lynn always keeps an eye on regulatory changes in the US: “What’s going on in the US is very interesting, but it isn’t necessarily a good thing.”
According to Lynn, just because the amounts involved through crowdfunding are small, financial laws should not disappear altogether: “In the US, it seems that people have forgotten that investor protections were there for a reason. And it’s not just protecting the investors; it’s protecting the integrity of the market. If it’s too much of a Wild West, if there is a feeling that the providers, the people operating the space, aren’t sufficiently supervised and act like cowboys, there will be fraud. But more importantly, investors will just stay away.”
The “crowd funding bill” that President Barack Obama signed on April 5 is significantly better than the original proposal by the House, comments Lynn. The Securities and Exchange Commission is drafting further regulations, which will determine not only whether or not Seedrs will enter the American market, but also the success of crowdfunding in general. “The US passage is great publicity. It’s a great focus on the news, but we’re substantially concerned with what’s in there,” says Lynn.
European laws are more open to innovation, believes Lynn: “One of the great things about the British and European systems in general is that it’s actually quite flexible. It took a lot of work to figure out how to use it correctly, but it’s designed to be flexible, to accommodate new forms of financial services and so that’s very much what we have done. We built a system that complies with the Financial Services and Capital Markets framework and complies with FSA regulations. We think that adds tremendous value to the overall market place by protecting investors and by encouraging investors to know that while it is a high risk investment, it is safe in a sense that we are not going to run off with their money or being stupid to lose it.”
It took two years for Lynn and his team to build a regulatory framework before they went to the FSA. “We did a lot of pioneering work,” he says. “While the law works, it doesn’t mean it’s obvious.” It then took another year for the FSA to finish the application.
Lynn says there are three key aspects on how Seedrs is going to work: “One is that we review the entrepreneurs’ disclosures before they are made available to the investors, when we come to the conclusion that they’re fair, clear and not misleading.
“The second thing that we do is structure the investment agreement. It’s boring stuff, but it’s actually very important. If you think that you’re buying 20 per cent of shares of the company, I don’t believe that you have to do a heck of a lot of detailed technical business due diligence, but you need to know that the company has been properly formed, that it actually owns the business, that there isn’t another separate company on the side that runs the business, that the shares are what you think they are. We come in and do the due diligence and enter into a contract with the underlined business.
“The third part is that we monitor investor rights under the contract, right through to the exit. We hold the shares as nominee investor and we make sure that we receive information that the business has promised to provide and that the business complies with the other governance that is undertaken to comply with.”
Having Seedrs involved in these three ways has been essential to getting FSA approval, he adds: “You’re still fully exposed to the risk of the business. That’s absolutely fine, that’s what investing in a start-up is. But what you’re not exposed to is some legal nicety where you lose your entire investment because it wasn’t properly structured.”
However, in scenarios where you lose your investment, it isn’t just the entrepreneurs fault. An investor needs to be smart enough not to bet on a bad business. Hence why, until now, in the US it was illegal for unsophisticated investors to invest in ventures.
To reduce the risk, Seedrs does due-diligence on start-ups, but it also screens the crowd using a quiz. “When investors come onto the platform they have to do two things. One is to answer the questions about their professional educational background; we’re looking at whether they have a degree, whether they have some form of managerial or professional experience, or if they’ve worked with start-ups before. Most importantly, we have a quiz asking about the risks of investing in start-ups and you have to show that you actually understand that most start-ups fail. That was an important part for the FSA, of how we insure that this is a sensible grown-up category that invests,” explains Lynn.
Because the crowdfunding business model is so new, it’s quite a challenge to define what a potential investor looks like. In the US, there were some attempts in the media to promote crowdfunding as a great opportunity for mom-and-pop investors, but Lynn isn’t overly excited about that: “I’m not a big fan of the mom and pop thing. Traditionally, the way people view the law is just to have two categories of people. You’re either a high-net worth sophisticated investor, or a complete idiot and you need the state to hold your hand. But we think there’s another group: sensible grown-up adults. Call it mass affluence: from young professionals to small business owners, middle managers, academics, civil servants even some very skilled tradesman.”
Seedrs, therefore, expects to offer a wide variety of investment opportunities for a wide range of crowd investors: from tech to retail start-ups, from restaurants to trade businesses. “We’re focused on any pre-revenue businesses, seeking £100 000 or less to take their first step. We’d be thrilled to have any business that needs such money to do something meaningful. I think we’ll be less useful to capital intensive business, like oil exploration, mining or even bio-tech.”
The European crowd
Crowdfunding is more than screening and matching business ideas with investors. To work, it needs a crowd. Seedrs thinks internationally: “We would like to be Europe-wide. We’re in the very early stage of looking into the regulatory framework of each country. Broadly speaking, we should be able to get an FSA passport which, in principle, allows us to do business throughout Europe. What we shouldn’t do, unless things go very wrong, is to need to be regulated by the IMF or various local regulators. Hopefully, we’ll continue to be supervised and regulated solely by the FSA.”
Does it really matter that any sensible grown-up in the UK can invest in a viable business idea; is it really worth trying to make equity crowdfunding work in Europe? Maybe the majority of Europeans don’t have the right mindset to get involved in ventures.
Jeff Lynn is optimistic: “I do think that there’s a bit more of a tradition of investing in America. But I actually think that Brits in particular – Europeans maybe a little bit less – understand start-ups and entrepreneurship. Napoleon referred to Britain as a nation of small shopkeepers. It’s something Britain is proud of. We have a tradition here of a small business creation and I think that people get what it means to back a small business.”