The experimental arrangement creates a structure more often seen on Wall Street than in Silicon Valley, with a single company having to manage potentially conflicting interests.
Seed Equity Ventures
An experimental new strategy for startups to raise money is gaining adherents in Silicon Valley.
A handful of technology dealmakers have adopted a twist on equity crowdfunding — in which a large group of investors back a startup through a private fundraising round — by introducing funds that offer exposure to a range of startups instead of just one at a time.
The latest company to take this step is Seed Equity Ventures, a broker in Salt Lake City, that operates a crowdfunding platform for startups. It is expected to announce today that it is seeking to raise $10 million for a venture capital fund. The new fund, Seed Equity Capital Partners, which will charge management fees and cut of profits, will invest in tech startups alongside other investors using the Seed Equity Ventures crowdfunding platform.
The arrangement creates at least the appearance of a conflict of interest. Seed Equity Ventures, a registered broker that was launched last year by Todd Crosland, earns fees from startups based on the amount of money it helps them raise. The new Capital Partners fund, which includes $1 million of Crosland's own money, will be participating in those same funding rounds and should try to get the best deal possible for its investors. That could, in theory, mean sending less in fees to the broker. Or, it could mean trying to maximize the broker's fees at investors' expense.
But Crosland, who previously founded Interbank FX, an online currency broker, said he would be able to keep the two parts of his business separate. He added that having a venture capital fund would more closely align his interests with those of the investors on the broker platform.
“It's really an arm's length transaction,” Crosland told BuzzFeed News. Startups, he added, “will have a set of expectations as far as valuation and terms for a deal. And then we'll negotiate with that company for what we feel are the best terms for both ourselves and our investors.”
Crosland is not the first financier to try to combine elements of venture capital with equity crowdfunding, a business that took off after the passage of the JOBS Act of 2012. That law made it legal for privately held startups to ask for capital in public, expanding the universe of potential investors beyond those who have contacts in the tech industry. (For now, only wealthy “accredited investors” are allowed to participate.)
Some equity crowdfunding pioneers argue that certain investors would rather own part of a diversified fund than individual stakes in startups. A fund, they say, can reduce the hassle of vetting companies and can increase the chances of betting on a winner.
Another crowdfunding firm, CircleUp, which launched in 2012, quietly introduced a fund at the beginning of this year that commits capital to startups alongside investors on the platform, according to Rory Eakin, the CircleUp co-founder. Compared with the Seed Equity fund, however, the CircleUp fund is more passive, automatically following other investors in certain deals and matching their commitments.
Perhaps the best known equity crowdfunding platform, AngelList, has since 2013 offered funds that allow investors to commit capital to startups alongside prominent angel investors. Unlike the other two, AngelList is not a broker, so it does not get paid by startups that raise money.
The new Seed Equity fund creates a structure more commonly seen on Wall Street than in Silicon Valley, in which a single company has to manage potentially conflicting interests. Crosland even drew a comparison to Goldman Sachs, which has lots of experience managing conflicts.
But onlookers worry about the implications for investors. “Everything about the crowdfunding industry suggests that conflicts of interest will be rampant and that the insiders will be playing fast and loose with investors' funds. This is but one case in point,” John C. Coffee Jr., a securities law professor at Columbia University, told BuzzFeed News in an email. Still, he said, “if appropriate disclosures are made, a conflict of interest does not make the transaction illegal.”
Crosland argued that getting a good deal for the investors on the platform would also benefit the startup selling the equity, by encouraging the investors to come back for more at a later date. His fund already has three startups in its portfolio, he said.
“We want the best deal for our investors,” Crosland said. “The better the investors do, when this company goes to raise the next round at a higher price, they'll feel that they were dealt with fairly. And then they'll be interested in investing in the series A or B round.”