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Venture Capital Dispatch

Crowdfunding 101: ‘Reg-D’ vs. ‘Rewards’

By Lora Kolodny
Pebble Technology Corp. founder Eric Migicovsky wears the Pebble, a smartphone-enabled watch. Last year his company raised $10.3 million from donors on crowdfunding site Kickstarter.

Small U.S. investors can donate money to a startup on a crowdfunding site such as Kickstarter, but they won’t get a stake in the company in exchange.

Despite changes in federal law, Americans can’t yet legally put money into a startup in an “equity crowdfunding,” an investment method that is open to ”accredited investors” only.

The Jumpstart Our Business Startups Act, enacted and signed into law in April last year, was meant to enable this. It eased accounting and disclosure requirements on smaller companies to help them go public, aiming to spur growth and create jobs.

The idea was that eventually, investors of every kind would be able to find startups or small businesses that they want to back online, hammer out deal terms and complete the transaction, all digitally.

Under the new leadership of Chairman Elisse B. Walter, the Securities and Exchange Commission is overdue in delivering the rules that will make it possible for startups to attain crowdfunding for equity from “ordinary Americans” (to borrow a phrase from President Obama).

Here’s a quick guide to the two main types of crowdfunding out there right now:

‘Reg-D’ Crowdfunding

For now, only broker-dealers licensed by the Financial Industry Regulatory Authority, and those regulated by the SEC and FINRA can legally conduct these transactions between startups and investors online in the U.S. Likewise, only accredited investors–as defined by the SEC–can use those sites to invest.

This subset of equity crowdfunding is referred to as “Reg-D” crowdfunding, a nod to the SEC’s existing Regulation D and the forms that a privately held company must fill out and file when it sells its securities.

Some sites offering Reg-D crowdfunding in the U.S. today are: AngelList in partnership with SecondMarket; Microventures; FundersClub in partnership with a large national bank that the company declined to name; CircleUp in partnership with W.R. Hambrecht; and Fundroom with securities offered through Wealthforge.

With Reg-D crowdfunding, accredited investors pool their money to provide a seed- or venture-capital round to a promising startup. In exchange, the investors get some stake in that company’s business of course.

The deals done through Reg-D crowdfunding sites may be convertible debt or equity deals, as with early-stage funds from venture firms and angel groups.

‘Rewards-Based’ Crowdfunding

Equity and Reg-D crowdfunding are different than the already mainstream variety of crowdfunding seen on sites like Kickstarter and Indiegogo.

Those more popular (and less regulated) sites offer “rewards-based” crowdfunding. They let almost anyone–not just accredited investors–contribute a few bucks (instead of thousands) to a project or person they like on the site.

Almost anyone can post a project for funders’ consideration, too.

In return for their money, project backers there get a reward, like a logo T-shirt, or a ticket to an event where they can meet the project’s creators.

Write to Lora Kolodny at lora.kolodny@dowjones.com. Follow her on Twitter at @lorakolodny

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Fabrice Grinda on Bloomberg TV Interview about his Angel Investing and one of his favorite companies:

Spotflux   http://spotflux.com

Please see Interview below – Spotflux around 5 minute 30 second mark towards end of interview

http://www.fabricegrinda.com/entrepreneurship/bloomberg-tv-interview-about-my-angel-investing-heuristics/

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Article from SFGate.

It’s suddenly a lot harder for venture capitalists and startups to raise funds, as investors fed up with low returns turn their backs on the sector.

Most industry observers agree that lots of young firms will simply not be able to raise their next round of funding, commencing a period of belt tightening, consolidation and closures. At a minimum, it seems to mark the beginning of a more level-headed investment climate in Silicon Valley, after years of insatiable lust for all things mobile and social.

But if the drop-off is too sudden and steep, this new austerity could spill over into an economy highly dependent on the tech sector. Indeed, as The Chronicle reported last week, the industry has an enormous impact, with each tech job creating 4.3 indirect jobs in the community, according to a Bay Area Council Economic Institute report.

The investors and venture capitalists I spoke to insisted that we’re not on the verge of anything like the dot-com meltdown, characterizing the shift as a minor and healthy correction, or a “rationalization.” One suggested it was little more than the usual process of separating good and bad ideas in the marketplace.

But the numbers suggest something new is afoot. In the third quarter, the amount that U.S. companies raised in venture capital dropped 32 percent from the prior year, according to Dow Jones VentureSource. Venture capital funds themselves raised 17 percent fewer dollars from the second to third quarter, even as the number of funds grew, according to a joint report from Thomson Reuters and the National Venture Capital Association.

Economic uncertainty

Some partially blame the economic uncertainty surrounding the outcome of the election and the “fiscal cliff.” But the main problem seems to be that many of the “limited partners” that fund venture capital are pulling back after years of frustration.

Ever since a brief period in the late 1990s when venture capital burned bright, the industry has been delivering consistently weak returns on the whole.

In fact, despite requiring greater risks and larger capital outlays, venture capital has been underperforming the stock market over the past decade, according to a report this year by the Ewing Marion Kauffman Foundation.

Joe Dear, chief investment officer for CalPERS, told Reuters this summer that venture capital “has been the most disappointing asset class over the past 10 years as far as returns.” The huge pension fund for California’s public employees didn’t return repeated calls from The Chronicle.

Investment horizons have steadily spread out, from five to 10 to sometimes 15 years, as exit opportunities like acquisitions and initial public offerings fail to materialize. This has sometimes forced investors to put in more money to protect their initial funds.

‘Pretty grumpy’

“The industry definitely, for the last decade, has been a tough place to be,” said Ray Rothrock of Palo Alto venture capital firm Venrock. “We’re all pretty grumpy right now.”

Some of this is due to macroeconomic conditions outside the control of venture capitalists, notably the housing and banking crises. But at least some of it has to do with poor picks and herd mentality, funding companies with few real prospects and driving up the entry price for legitimately promising companies beyond what they could pay off.

“The market overfunded the number of companies in the system,” said Hans Swildens, founder of Industry Ventures in San Francisco. “There’s a glut.”

Even the grand promise of Web 2.0 companies that lured so much recent money hasn’t generated the hoped-for returns. The ones that managed to go public were often disappointments, including Facebook, Zynga and Groupon, in some cases leaving late-stage investors underwater on their holdings.

That was a final straw for some.

Last week, Forbes dug up figures from CB Insights that highlighted a wide and growing gap between the number of companies that raised initial funding and companies securing the follow-on investments, known as a Series A, generally necessary to keep going. This year, there have been 1,747 seed or angel rounds but only 688 Series A deals, underscoring the coming crunch.

Bad businesses

Based on as scientific a survey as the PR pitches in my inbox, there’s a tremendous number of silly, redundant and poorly executed companies out there that don’t warrant additional funding. The real problem isn’t that many of these companies won’t raise more money; it’s that they raised money in the first place.

For the venture capital industry to get back on track, it needs to embrace a renewed sense of discipline – on company picks, deal terms and total spending.

But hope springs eternal in Silicon Valley.

Rothrock stresses that the industry’s trend-line averages mask very strong results and ongoing investment at top firms, as well as growing venture capital activity among corporations like Google. Companies are just being more selective and looking beyond consumer Internet opportunities.

“We’re steady as she goes in terms of funding enterprise,” he said.

Secondary opportunity

Swildens oversees a secondary fund that buys shares from limited partners and venture firms looking to liquidate part of their holdings. He sees this period as a ripe opportunity for bold investors to get into promising companies at suddenly reasonable rates.

“Ours is one of the few firms aggressively putting money into these funds,” he said.

Mark Heesen, president of National Venture Capital Association, is similarly optimistic. He says the industry could be primed for a strong comeback in 2013, as long as the broader economy strengthens.

Above all, what the industry needs are some wins – acquisitions or initial public offerings that put investors clearly in the black and start to restore some lost confidence.

“If we see these exit markets start to generate good returns, I think you’ll see limited partners look at this asset class again,” he said.

James Temple is a San Francisco Chronicle columnist. E-mail: jtemple@sfchronicle.com Twitter: @jtemple

Read more here.

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Article from NYTimes.

Few investors have ridden the recent Internet boomlet like the GSV Capital Corporation.

After GSV announced in June 2011 that it was buying a stake in the privately held Facebook, the closed-end mutual fund surged 42 percent that day. Capitalizing on the euphoria, GSV sold another $247 million of its shares, using the money to expand its portfolio of hot start-ups like Groupon and Zynga.

Now, GSV is feeling the Facebook blues.

When the public offering of the social network flopped, GSV fell hard, and it still has not recovered. Shares of GSV, which were sold for an average of $15.35, are trading at $8.54.

“We probably benefited from our stake in Facebook more than we deserved on the way up,” said GSV’s chief executive, Michael T. Moe, “and were certainly punished more than we deserved on the way down.”

GSV, short for Global Silicon Valley, is the largest of several closed-end mutual funds that offer ordinary investors a chance to own stakes in privately held companies, at least indirectly. Closed-end funds like GSV typically sell a set number of shares, and their managers invest the proceeds. In essence, such portfolios operate like small venture capital funds, taking stakes in start-ups and betting they will turn a profit if the companies are sold or go public.

“I think GSV was really innovative in creating a kind of publicly traded venture capital fund,” said Jason Jones, founder of HighStep Capital, which also invests in private companies.

But the shares of closed-end funds trade on investor demand – and can go significantly higher or lower than the value of the underlying portfolios. The entire category has been hit by Facebook’s troubles, with GSV trading at a 38 percent discount to its so-called net asset value.

Mr. Moe, 49, has previously experienced the wild ups and downs of popular stocks.

A backup quarterback at the University of Minnesota, he started out as a stockbroker at the Minneapolis-based Dain Bosworth, where he wrote a stock-market newsletter called “Mike Moe’s Market Minutes.” He met the chief executive of Starbucks, Howard Schultz, on a visit to Seattle in 1992, and he began covering the coffee chain after its initial public offering.

“I left believing I had just met the next Ray Kroc,” Mr. Moe wrote in his 2006 book, “Finding the Next Starbucks,” referring to the executive who built the McDonald’s empire.

After stints at two other brokerage firms, Mr. Moe became the director of global growth research in San Francisco at Merrill Lynch in 1998. There he ran a group of a dozen analysts at a time when mere business models “were going public at billion-dollar valuations,” he said.

Shortly after the dot-com bubble burst, he founded a banking boutique now called ThinkEquity. At the time, he expected the I.P.O. market to shrug off the weakness and recover in a couple of years. Instead, it went into a decade-long slump.

“Market timing is not my best skill,” Mr. Moe said. In 2007, he sold ThinkEquity.

The next year, he started a new firm to provide research on private companies, NeXt Up Research. He later expanded into asset management, eventually changing the name to GSV. Within two months of starting his own fund, he bought the shares in Facebook through SecondMarket, a marketplace for private shares.

GSV soon raised additional funds from investors and put the money into start-ups in education, cloud computing, Internet commerce, social media and clean technology. Along with Groupon and Zynga, he bought Twitter, Gilt Groupe and Spotify Technology. The goal is finding “the fastest-growing companies in the world,” he said.

But Mr. Moe has paid a high price, picking up several start-ups at high valuations on the private market. He bought Facebook at $29.92 a share. That stock is now trading at $19.10. He purchased Groupon in August 2011 for $26.61 a share, well above its eventual public offering price of $20. It currently sells at $4.31.

Max Wolff, who tracks pre-I.P.O. stocks at GreenCrest Capital Management, said GSV sometimes bought “popular names to please investors.”

“This is such a sentiment-sensitive space, the stocks don’t trade on fundamentals,” Mr. Wolff said, adding, “If there’s a loss of faith, they fall without a net.”

GSV’s peers have also struggled. Firsthand Technology Value Fund, which owns stakes in Facebook and solar power businesses like SolarCity and Intevac, is off 65 percent from its peak in April. “We paid too much” for Facebook, said Firsthand’s chief executive, Kevin Landis.

Two other funds with similar strategies have sidestepped the bulk of the pain. Harris & Harris Group owns 32 companies in microscale technology. Keating Capital, with $75 million in assets, owns pieces of 20 venture-backed companies. But neither Harris nor Keating owns Facebook, Groupon or Zynga, so shares in those companies have not fallen as steeply.

GSV is now dealing with the fallout.

In a conference call in August, Mr. Moe was confronted by one investor who said, “the recent public positions have been a disaster,” according to a transcript on Seeking Alpha, a stock market news Web site. While Mr. Moe expressed similar disappointment, he emphasized the companies’ fundamentals. Collectively, he said, their revenue was growing by more than 100 percent.

“We have been around this for quite some time, and we are going to be wrong from time to time,” Mr. Moe said in the call. “But we are focused on the batting average.”

In the same call, Mr. Moe remained enthusiastic – if not hyperbolic – about the group’s prospects. Many of GSV’s 40 holdings are in “game-changing companies” with the potential to drive outsize growth, he told the investors.

Twitter, the largest, “continues to just be a rocket ship in terms of growth, and we think value creation,” he said. The data analysis provider Palantir Technologies helps the Central Intelligence Agency “track terrorists and bad guys all over the world.” The flash memory maker Violin Memory “is experiencing hyper-growth,” he wrote in an e-mail.

But Mr. Moe was a bit more muted in recent interviews. While he says he still believes in giving public investors access to private company stocks, he recognizes the cloud over GSV. “We unfortunately have a social media segment that got tainted. I completely get why our stock is where it is. It’s going to be a show-me situation for a while.”

Acknowledging some regrets, Mr. Moe said he was angriest about overpaying for Groupon, saying, “Yeah, I blew Groupon.” He said that he also did not anticipate what he called a deceleration in Facebook’s growth rate, and that it was “kind of infuriating” that some of its early investors were allowed to exit before others. GSV often must hold its shares until six months after a public offering.

But the downturn in pre-I.P.O. shares has a silver lining, Mr. Moe said. Since the Facebook public offering, he has been able to put money to work “at better prices.” He recently bought shares of Spotify at a valuation of about $3 billion, roughly 25 percent below the target in its latest round of financing.

The I.P.O. market is also showing signs of life, he said, with the strong debuts of Palo Alto Networks and Kayak Software. And he still has faith in Facebook.

Whatever its current stock price, at least it is a “real company” with revenue and profit, Mr. Moe said, adding, “It’s not being valued off eyeballs and fairy dust.”

Read more here.

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Article from GigaOm.

Zscaler a four-year-old startup that has bootstrapped its business by providing a new form of security designed for a mobile and cloud-dependent workforce, has raised $38 million in first-time financing. The round was led by Lightspeed Venture Partners and an unnamed strategic investor.

Zscaler has been fairly successful in its four years building a significant base of clients including Crutchfield Corporation, La-Z-Boy and Telefonica. The company’s software as a service is hosted in more than 100 data centers around the world and essentially protects a company’s web traffic. It does this by routing requests through Zscaler’s software. But there’s no software for users to download on their clients and there’s also no appliance for corporate IT to worry about.

As the cloud and mobility do away with the perimeter model of security where a firewall may prevent harmful traffic from getting in and corporate secrets from getting out, Zscaler is one of several new companies trying to adapt security to a world where there is no perimeter. And even if the corporate IT thought it had a perimeter, the corporation may not own it or have a say in what runs on it. A perfect example of this might be the CEO’s iPad (a aapl).

Zscaler doesn’t solve all problems, but it’s certainly ahead of the pack in thinking about security in a forward-looking way. Other companies trying to address the changes in security required by BYOD and corporate access to the cloud applications are Bromium and CloudPassage. And by waiting to take on venture capital Zscaler’s CEO Jay Chaudhry has joined a select group of established companies who are finally succumbing to the lure of VC cash. For example Qualtrics, a ten-year-old company this year raised $70 million in its first round of outside investment. Another company, Code 42, avoided VC dollars for 11 years before this year raising $52.5 million.

Read more here.

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Article from GigaOm.

The Department of Energy’s program that gives grants to early-stage energy projects — called ARPA-E — has allocated another $43 million for 19 battery projects, including grants for futuristic batteries made of new chemical mixes, using brand new architectures and utilizing nanotechnology. The ARPA-E program has been aggressively funding next-generation battery technologies over the years, and though these are small grants, the amount of innovation happening is substantial.

The funds go to projects that are very early stage, and are supposed to help bring disruptive R&D closer to commercialization. While Japanese and Korean conglomerates dominate the industry of producing small format lithium ion batteries for laptops and cell phones, these next-gen batteries are mostly targeted for electric cars and the power grid. Some of these projects also aren’t strictly traditional batteries, and a couple are flow batteries, which are large tanks of chemicals that flow into a containerized system and provide energy storage for the power grid (see Primus Power’s flow battery pictured).

Notable winners of the funds include big companies like Ford, GE, and Eaton, small startups like Khosla Ventures-backed Pellion, and projects out of the labs of Oak Ridge National Laboratory, Battelle Memorial Institute, and Washington University in St. Louis.

Here’s some of the winners (for the full list of 19 go here):

  • Ford: $3.13 million for a very precise battery testing device that can improve forecasting of battery-life.
  • GE Global Research: $3.13 million for sensors thin-film sensors that can detect and monitor temperature and surface pressure for each cell within a battery pack.
  • Eaton: $2.50 million for a system that optimizes the power and operation of hybrid electric vehicles.
  • Pellion Technologies: $2.50 million for the startup’s long range battery for electric vehicles.
  • Sila Nanotechnologies: $1.73 million for the startup’s lithium ion electric car battery that it says has double the capacity of current lithium ion batteries.
  • Xilectric: $1.73 million to “reinvent Thomas Edison’s battery chemistries for today’s electric vehicles.”
  • Energy Storage Systems: $1.73 million for a flow battery for the grid, with an electrolyte made of low cost iron, and using a next-gen cell design.
  • Battelle Memorial Institute: $600K for a sensor to monitor the internal environment of a lithium-ion battery in real-time.

Read more here.

 

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Article from GigaOm.

Venture capital investments picked up significantly this quarter, with a 37 percent increase in funding and 3 percent increase in deals over the previous quarter. The period also saw strong emphasis on mobile investments and seed funding, according to a report released by CB Insights. There was a total of $8.1 billion in financing for 812 companies, the highest totals since Q2 of 2001.

About 13 percent of the activity — or 102 deals — was in the mobile sector, marking an all-time high, with 30 percent of those companies involved in photo or video technology.

“Without being too self-congratulatory, the Instagram Effect we speculated about in Q1 2012 seems to have taken shape as the mobile sector saw 102 deals, an all-time high… For skeptics, it may also be indicative of a VC herd mentality. Time will tell.”

Below is a breakdown of investments by dollar amounts in the different subsets of mobile and telecom industry:

Some other highlights from the report include:

  • Seed investing also hit an all-time high, with 22 percent of all deals happening at the seed stage this quarter, as compared to 12 percent from the same quarter in 2011.
  • The most successful sectors with respect to number of deals were internet companies with 46 percent, healthcare at 17 percent, and mobile and telecommunications at 13 percent. With respect to dollars in funding, the top sectors were internet at 38 percent and healthcare and “other” each at 19 percent.
  • 50 percent of deals occurred at either seed funding or Series A rounds, although they made up only 19 percent of funding dollars.
  • California took the most number of deals per state at 45 percent of deals, up from 40 percent in Q1. New York remained in second place with 10 percent of deals, and Massachusetts in third place with 9 percent.

Read more here.

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