Monday, December 9, 2013

The Next Big Thing: Where Crowdfunding and Investing Meet

written by Northwestern Mutual Voice - Forbes

It's what many investors dream about: getting in at the ground floor of the next Apple or Facebook. Thanks to the 2012 Jumpstart Our Business Startups (JOBS) Act and a recent decision by the Securities and Exchange Commission (SEC), some investors may be one step closer to uncovering such an opportunity through a new type of investing called equity-based crowd funding.
Crowd funding is part of a worldwide phenomenon that leverages the power of the Internet to pool the resources of people (the “crowd”) in support of a project. “There are two main models for crowd funding: donation- and equity-based,” said John Mroz, Investment Consultant for Northwestern Mutual Wealth Management Company. “Donation-based crowd funding (think websites like KickStarter and IndieGogo) is when people donate funds in exchange for tangible, non-monetary rewards, such as a copy of the company’s computer game or the promise of a future service or perk when the project is completed. In contrast, equity-based crowd funding is where investors contribute early-stage funding to a company in exchange for an equity stake in the business.”
Donation-based crowd funding has seen tremendous growth in the last few years. In fact, industry insider Massolution reported that crowd funding volumes are estimated to reach $5.1 billion in 2013, an increase of 89 percent from 2012. Many expect equity-based crowd funding also to take off.
Equity-based crowd funding took form with the 2012 passage of the JOBS Act, which expanded the ability of non accredited individuals to make direct investments in private companies at the earliest stage of their development through registered web-based portals. Up until this point, the only way to invest in these businesses was through a private equity group, an “angel” investor, or at the initial public offering (IPO) stage. However, before investors can access these web-based portals, the Securities and Exchange Commission still needs to approve final rules governing the operation of this newest capital market. Those rules are expected sometime in 2014.
A level of investor protection

As the proposed SEC rules stand now, entrepreneurs would be allowed to raise up to $1 million in a 12-month period either using a licensed broker-dealer or via a funding portal registered with the SEC. Investors with an annual net income or net worth of less than $100,000 would be allowed to invest up to 5 percent of that or $2,000, whichever is more, every 12 months. Investors with an annual income or net worth greater than $100,000 would be able to invest up to 10 percent of that every 12 months. Securities bought through crowd funding portals would have to be held at least a year before being sold.
Companies would be required to provide detailed information to investors so that they understand what they’re getting into; however, only those raising more than $500,000 would have to file more detailed information with the SEC. Even so, equity crowd funding isn’t without significant risks, including the chance that you could lose all or part of your investment.
Risks and barriers to success

“Equity-based crowd funding can offer investors the chance to own a piece of a fledgling company, but they’re often risky bets and can be more volatile than more established stocks because of how unproven these start ups tend to be,” said Mroz. “If the business succeeds, then its value goes up—and so does the value of that share of the business. But the converse also can be true. That’s why due diligence is key for investors.”
For many entrepreneurs, it can be easier to raise money for a project than it may be to make that project a success. Investors who are sold on a good idea but have no experience working with start ups could easily overlook a weak financial statement or a questionable business model.
“There are lots of examples of individuals who donated money to start ups that never managed to make the leap from concept to actual product,” concluded Mroz. “But even if the company had early success, investors may be surprised to find their original equity stake was diluted as more funding was required to take the business to the next level. What’s important to remember is that just a small number of these startups will be winners, leaving most investors holding stakes in companies that may end up having little or no value.”
For these and other reasons, Mroz suggests speaking with a professional advisor about equity crowd funding and its possible role as a speculative add-on to a sound financial plan. Specifically, he or she can explain prudent ways to invest in the broad opportunities this new and still untested investment opportunity may provide.
The Northwestern Mutual Voice Team is a group of professionals who share insights and opinions from experts and industry leaders across the enterprise. Our vision is to inspire others to take action and plan for their financial future through topics ranging from financial planning, retirement planning and distribution strategies, wealth accumulation and preservation, to leadership, philanthropy and innovation. 
To Learn More click Here

Sunday, December 8, 2013

Why Crowd Funding Rocks

By Hanaan Rosenthal Author, Founder and President of Custom Flow Solutions

There's no doubt that the Internet has changed the way we do many things. I cannot remember, for instance, the last time I visited my bank teller, bought a postage stamp or walked into a book store. While the use of the Internet has some unsavory social implications, such as IAD (Internet Addiction Disorder) to name one, it also has aspects that will forever displace the balance of power from a few at the top calling the shots, to the rest of us determining our own path.

Displacement The first such phenomenon in my mind, was YouTube. Before YouTube became popular, you were a star when Nickelodeon or Disney told you you were. Someone in those corporations would scout talent, made them up and then made them famous. Now take Fred , for example. He put some crazy-funny home-made videos up, and people liked him. He now has over a billion views and over 2 million subscribers. No one at Disney told him what to say or what to wear. Or Jenna Marbles, the hilarious inappropriate blond hottie, who's now sporting over 11 million subscribers and over 1.27 billion views. I dare Nickelodeon to sensor her rants. The web, in these cases, is all about displacement. Letting you and I decide what goes and what doesn't rather than having some suit decide for us. is another great equalizer -- not so much for book stores, but very much for authors. Anyone can write and publish book and get a chance to sell it along side the best sellers. I like that! Getting funded The next such form of displacement is another example of how the masses can grab control previously held by the wealthy few: Funding. Yes, rich people have more money, but take all us average Joes, and together we have a bundle.

And now, with crowdfunding, we can combine that money to decide what projects get funded. The traditional methods of funding meant that people with great ideas and creativity were actively looking for the few people with money to spare. Those few would then decide if we, the people, are or aren't interested in their idea. Crowdfunding skips that step altogether. Why ask one person what the rest of us want when you can just as the rest of us? With crowdfunding, anyone can invest as little as $1 in any project. Sometimes to buy advanced product, simply to be a part of the next big thing, or even buy shares of the company, as may be soon possible. The difference is that the company or individual that put the product together don't have to go begging. All they have to do is make a compelling video and convince you and I that helping them with $12 will be just too much fun to pass. 2013 is becoming a $5 Billion year for crowdfunding projects, up over 500 percent from 2010.

Next step When you have successful sites revolving around a new phenomenon, you start to see aggregator sites. While some of those are aimed towards the crowdfunders themselves, a new, unique site is emerging that aims to make projects across all crowdfunding sites more accessible to investors. By investors, of course, I mean you and I.

Meet A brilliantly designed new site that allows you to discover, rate and share crowdfunded project across all sites. Part of Betaspring, a startup incubator in Providence RI, founders Matt and James have something really cool going on. I caught up with founders Matt, James and Olivia, their social media marketing coordinator, to get a better idea of what they are up to.

Q: What is

Matt: Since Kickstarter was kickstarted in 2009, literally hundreds of crowdfunding websites have sprouted up, releasing thousands of projects every day. Today, we - the backers - simply can't find the campaigns we care about, let alone keep up with them. is the new tool for project supporters. It pulls together the projects from all major crowd funding platforms. Whether you're a fashionista or a gadget enthusiast, learns what you love, and recommends you the hot new projects you would never have found, as soon as they come out. For projects you've liked, it alerts you if you're about to miss an early bird discount or the closing date, so you don't end up kicking yourself once it's too late.

Q: How are you positioned relating to other sites?

Matt: There are a million and one tools and websites out there which help fundraisers get their campaign off the ground, but supporters are left to fend for themselves. We either have to trawl through projects across a dozen of our favourite sites every day, read an email on what the Kickstarter staff happen to like that week, or more often just miss out. We've been called 'the crowdfinding app' and 'the Kayak of Crowdfunding', but really our mission is to help crowdfunders find and back the projects they care about.

Q: What do you see the role of crowdfunding in the world economy?

Matt: Crowdfunding is a fundamentally new, more democratised flow of capital. $5 Billion this year will grow to more than $10 Billion next year. If you think this is a big deal, analysts estimate that crowdfunding will unlock as much as $1 Trillion in capital with the JOBS Act. The crowdfunding movement is enabling all of us to collaborate with a flood of inventors, creatives, entrepreneurs and altruists, to make their ideas a reality and the world that bit better. As a startup ourselves, we have seen so many world-changing projects fail because of a simple lack of capital. Making these new markets more efficient by bringing the right people together definitely gets us out of bed in the morning.

Q. Are you looking for funding yourselves?

Matt: Truth be told, if we were, we couldn't legally announce it right now. We'll be raising a seed round very soon though, and with the JOBS Act lifting the ban on public fundraising last September, everyone can now benefit from the same investments rich VCs have accessed for decades, through equity crowd funding sites.

Thursday, October 24, 2013

SEC Approves Crowdfunding Plan Allowing Internet Stock Sales

October 24, 2013  Bloomberg News
Start-ups and small businesses could sell ownership stakes in their companies by soliciting investors over the Internet under a proposal advanced by the Securities and Exchange Commission.
The plan would set rules for equity crowdfunding, which lawmakers said would spur growth by easing financing when they mandated it in the 2012 Jumpstart Our Business Startups Act. The rules, which the SEC voted 5-0 to release for public comment yesterday, may boost the nascent crowdfunding movement and help the agency through its backlog of regulations required by the JOBS Act and Dodd-Frank law.
Businesses and startups too small or risky to attract funding from banks or venture capitalists are expected to use equity crowdfunding. Regulators say they tried to address concerns that such fundraising will create a channel for fraud by allowing upstart companies to issue illiquid shares to retail investors.
“The proposal before us today appears to offer great promise for providing capital to small businesses so they can survive and hopefully thrive, but it may also provide great risks to investors,” Democratic SEC Commissioner Kara M. Stein said before the vote in Washington. “If we don’t get it right, I fear that the promise of crowdfunding will be lost.”

Advertising Allowed

The SEC’s proposal, open for public comment for 90 days, becomes the second regulation from the JOBS Act advanced under Chairman Mary Jo White. In July the agency approved a rule lifting the ban on advertising for investors outside of a public offering, which eased the ability to market directly to investors considered sophisticated and wealthy enough to understand the risks of investing and withstand a loss.
Crowdfunding has drawn wide interest because it will be open to any investor regardless of their income or net worth. Under the proposal, crowdfunding must be done online through an entity that provides investors with forums to ask questions and communicate about a deal.
“All investors, not just the so-called accredited investors, will have the opportunity to invest in entrepreneurs and their ideas at an earlier stage than ever before,” Republican SEC Commissioner Michael Piwowar said.
Businesses using crowdfunding could raise no more than $5,000 a year from someone whose income or net worth is less than $100,000. Investors with income or net worth greater than $100,000 could contribute as much as 10 percent of their annual income or net worth, to a maximum of $100,000 in one year.

No Verification

The proposal doesn’t require businesses or funding portals engaged in crowdfunding to verify compliance with those restrictions. Instead, a crowdfunding portal must ask investors to disclose their income or net worth as a means of determining compliance.
“It does make it easier for portals to operate with a large number of investors, which is within the spirit of the law,” said Rory Eakin, chief operating officer of CircleUp Network Inc.
The proposal creates a new regulatory regime for platforms such as CircleUp if they decide to engage in equity crowdfunding. The SEC estimates that 50 portals will initially participate in the market once the rules are adopted. Portals aren’t allowed to recommend deals or give investment advice.
Other portal operators that have shown interest in equity crowdfunding include Indiegogo Inc., EquityNet LLC, and RocketHub Inc. Kickstarter Inc., the most popular crowdfunding platform to date, has said it doesn’t intend to participate in equity crowdfunding.

Limits Imposed

A company using equity crowdfunding is limited to raising a maximum of $1 million per year. While companies raising smaller amounts would have to share financial statements and income-tax returns with investors, a business looking to raise more than $500,000 would have to provide audited financial statements. That requirement may deter some companies from participating in equity crowdfunding, Eakin said in a phone interview.
“It’s a very expensive process for early stage companies to spend $20,000 or $30,000 to have an audit,” Eakin said. “Venture firms historically don’t require those in Silicon Valley.”
Companies may intentionally limit their crowdfunding pitches to less than $500,000 to avoid having to hire an auditor, said Judd Hollas, chief executive of Fayetteville, Arkansas-based EquityNet.
“A formal audit is relatively rare and I’m a little bit surprised to see that is a requirement,” Hollas said.
To contact the reporter on this story: Dave Michaels in Washington at
To contact the editor responsible for this story: Maura Reynolds at

Thursday, October 17, 2013

SEC to Release Crowdfunding Rule Easing Investor Verification

October 17, 2013

Bloomberg News

Small businesses raising money by selling shares over the Internet wouldn’t have to verify that their backers comply with individual investment limits under a U.S. regulatory proposal set for a vote as soon as next week.
The plan, targeted for an Oct. 23 vote by the Securities and Exchange Commission, would allow such companies to use so-called equity crowdfunding without having to check that a person’s investment is a greater share of their income or net worth than allowed by law, according to two people with direct knowledge of the matter who asked not to be named because the proposal hasn’t been made public.
The crowdfunding rule, authorized as part of the 2012 Jumpstart Our Business Startups Act, is intended to benefit small businesses and startups too small to attract funding from banks or venture capitalists. It may also boost business for Internet funding portals such as Kickstarter Inc., IndieGoGo Inc., and CircleUp Network Inc. that are used by startups to raise money.
“Some of the verification requirements would effectively negate what Congress had in mind,” Harvey L. Pitt, a former SEC chairman and now chief executive officer of Kalorama Partners LLC, said in an interview. “It has to be done in a way that lets people raise money.”
Crowdfunding was a popular provision in the JOBS Act, with advocates saying it would unlock capital for small businesses and entrepreneurs. In implementing the law, the SEC has been trying to balance the need to protect ordinary investors from potential fraud with Congress’s goal of reducing regulations for small businesses.

Verification Impractical

The proposal, overdue by nine months, will become the second regulatory item from the JOBS Act advanced under SEC Chairman Mary Jo White. Although the law imposes limits on investors based on the person’s income or net worth, the people said the SEC’s proposal won’t require companies or brokers to verify compliance with the limit, something Internet funders have argued is impractical.
Under the law, businesses using crowdfunding could raise no more than $5,000 a year from someone whose net worth is less than $100,000. Investors with a net worth greater than $100,000 could contribute as much as 10 percent of their annual income or net worth, up to a maximum of $100,000 in one year.

1 Million Projects

Crowdfunding platforms raised $2.7 billion in 2012 and funded more than 1 million projects, according to research firm Massolution. Crowdfunding has financed technology projects such as the Pebble smartwatch, which raised more than $10 million on Kickstarter to develop a watch that works with an iPhone or Android-powered device.
Equity crowdfunding, which is practiced legally in the U.K. and Australia, accounts for less than 5 percent of the market, according to Ethan Mollick, a professor of management at the University of Pennsylvania’s Wharton School of Business. Less than 1 percent of the money pledged through Kickstarter has gone to projects that may be fraudulent, according to Mollick, whose research has focused on the practice.
“What stops fraud is having a lot of eyeballs that look at a project,” Mollick said in a phone interview. “One thing I have advised both Kickstarter and lawmakers and policy makers to think about is you want what happens in crowdfunding to be as public as possible.”
To date, U.S. small businesses and nonprofits using Internet portals have offered perks or products in exchange for capital but so far haven’t been able to offer financial returns on equity.

Limits Imposed

Congress responded to such worries by putting restrictions on crowdfunding, including a $1 million limit on how much a company can raise in a year. Even small companies that use equity crowdfunding will have to, depending on their size, disclose their income-tax returns or financial statements and annual operating results.
“The commission is going to have to focus on enabling folks to raise funding easily and seamlessly, but at the same time the commission’s main preoccupation is investor protection,” Pitt said. “What they are worried about is trying to prevent swindle artists from getting their hands on public funding.”

Public Comment

If approved by the commission’s five members, the proposal will be open to public comment before the commission votes a second time on a final version.Once the SEC proposal is issued, the Financial Industry Regulatory Authority will propose detailed rules for funding portals that aren’t registered as brokerages.
The law “is very prescriptive about how crowdfunding needs to happen,” Thomas J. Kim, a former chief counsel in the SEC division writing the rule, said at an April conference sponsored by the Council of Institutional Investors. “It is not going to be as easy as going on the Internet to raise capital. It is going to be done in a highly regulated way.”
White took over the SEC in April saying she would push the agency to finish rules required under the JOBS Act. In July, the SEC finished the first rule authorized by the law, one that allows hedge funds, startups and other businesses to use advertising to raise money outside of a public offering.
Ending the ban on advertising opened the door to a more limited version of crowdfunding, allowing companies to pitch shares to accredited investors, or those considered wealthy enough to understand the risks of investing and withstand a loss.
To contact the reporter on this story: Dave Michaels in Washington at
To contact the editor responsible for this story: Maura Reynolds at

Wednesday, August 28, 2013

Looking for capital? There's a new way to crowd source it.

New Twist on Crowdfunding for Startups



Looking for capital? There's a new way to crowd source it.
A pair of online platforms are offering a new twist on the usual crowdfunding model for small businesses. Entrepreneurs can post their vitals, their business ideas and how much cash they need—and then solicit donations from interested backers.
So far, that's familiar. The twist is in what backers get in return. The entrepreneurs agree to give backers a small percentage of their earnings each month for a certain period. In effect, they're selling a temporary equity stake in themselves.
Getting a Boost
The sites, Upstart and Pave, aren't designed to completely fund a business idea or cover all of an entrepreneur's expenses—just to provide some breathing room, such as paying down some outstanding school debt.
And they come with caveats. They don't have long track records, and it isn't clear how the model will play out over time. It also isn't clear how much investors can expect to gain—both sites say something in the ballpark of an 8% return is feasible, but it obviously depends on how much the entrepreneur earns.
Lawrence Cann
A TEAM EFFORT Lawrence Cann used crowdfunding to manage expenses while running a nonprofit
And there are restrictions on who can use the services. Backers must be well-heeled "accredited" investors, and the sites are either explicitly or implicitly targeted at a very specific demographic: recent graduates.
Consider Trina Spear, a 29-year-old graduate of Harvard Business School. Confronted with a $170,000 debt when she got out of school in 2011, the Miami native put her entrepreneurial dreams on the back burner and got a job.
Then she heard about Upstart, a platform that launched last November and is open to people who completed college or grad school between 2010 and 2013. Ms. Spear raised $20,000 from 13 investors—which she says will help defray her living expenses and let her focus on Figs Scrubs, the medical-apparel company she co-founded in February. Half of her backers also offered mentorship opportunities.
For her part, she will share 1% of her future earnings with backers for 10 years. The site sets the percentage based on each applicant's earnings potential, using the same process Google GOOG -1.91% does to assess the success potential of young hires, says co-founder Dave Girouard, former president of Google Enterprise.
The Freedom to Focus
A similar site, Pave, is open to U.S. citizens 18 and over who meet certain qualifications, but is focusing on recent grads and soon-to-be grads because that's where it's seeing the greatest demand from backers. One user: Lawrence Cann, the 34-year-old founder and CEO of Street Soccer USA, a nonprofit initiative that works with homeless youth and adults. He's using Pave, which launched in December, to manage the near-$150,000 cost of an executive M.B.A. program at Columbia University.
Within a month of filling out a profile, Mr. Cann raised $40,000 from 11 backers. Once he receives his degree at the end of the summer, he's expected to start paying his investors 3.5% of "an adjusted income" for 10 years. The funding is a boon for Mr. Cann. "It gives me the freedom to focus on my business and also earn money to pay back [my investors]," he says.
Ms. Dorbian is a writer in New York. She can be reached at

Tuesday, August 27, 2013

BrewDog taps beer drinkers for £4m to fund expansion plan

Fast-growing company which trumpets its 

punk credentials will offer 

42,000 shares to the public

The Guardian

BrewDog Punk IPA Beer
Brewer and bar owner BrewDog wants beer drinkers to
crowdfund its expansion. Photograph: Keith Erskine/Alamy
Brewer and bar owner BrewDog is hoping to raise
£4m from beerdrinkers to fund its expansion plans.
The fast-growing company, which trumpets its punk
credentials, will make 42,000 shares available to
the public at £95 each, to fund a sevenfold increase
in production at its Ellon brewery near Aberdeen
and open its first shops, starting in London.
James Watt, BrewDog co-founder, claimed the
so-called "equity for punks" scheme was the
world's largest crowdfunding initiative. The share
sale underscores how many entrepreneurs are
turning to the public to raise money, rather
than use banks or venture capital funding.
"As we need funds for more growth plans,
we never considered a bank or an investment
group," Watt said. "[Equity for punks] proves
that there is a viable alternative to the
financial establishment. As the self-interested
banks continue to stunt economic growth,
people are looking for better places to put
their money
This is the third time BrewDog has sold
shares direct to the public, after hitting
targets to raise £2.2m in 2011 and
£750,000 in 2009, through similar
crowdfunding schemes.
The Aberdeen-based company has
recorded average annual growth of
167% over the last five year and hopes
 to hit turnover of £20m this year. The
owner of 12 bars in the UK and one
in Stockholm, it is also planning bars
in São Paulo and Tokyo.
BrewDog shareholders will get a
lifetime discount on the company's
portfolio of more than 30 beers,
which include its top-selling Punk IPA ,
as well Dead Pony Club and Hardcore IPA.
Founded in 2007, BrewDog revels in
pitting itself against what it calls
"the status quo of fizzy mass-produced
tasteless lagers". At its annual meeting
on Saturday existing shareholders will
enjoy beer tastings and punk rock.

EBay-Style Peer Loans Spur Wall Street Asset Craze

Bloomberg Markets Magazine

On a June morning in midtown Manhattan, more than 300 investors cram into a conference room at the Convene Innovation Center, nibbling on pastries and waiting for Renaud Laplanche to take the stage. As founder and chief executive officer of LendingClub Corp., Laplanche has rock star status at this inaugural LendIt conference, where Wall Street investment managers clamor for insight into the world of peer-to-peer lending. Laplanche, 42, a French securities lawyer turned Silicon Valley entrepreneur, expects San Francisco-based LendingClub to originate $2 billion in loans this year and double that in 2014. As he takes the stage, he’s fresh off a $125 million investment led by Google Inc., Bloomberg Markets magazine will report in its October issue.
Armed with a muscular board that includes former Morgan Stanley CEO John Mack and former U.S. Treasury SecretaryLawrence Summers, Laplanche aspires to create the go-to Internet site for borrowers in need of funds for credit card consolidation, home improvement and small-business expansion.
When Laplanche leaves the stage, he is mobbed by money managers and clients, who spend two hours grilling him about LendingClub’s loan programs.
LendingClub is one of a dozen firms in the U.S., Europe andAustralia whose model is to create a marketplace for loans similar to EBay Inc. (EBAY)’s market for goods and services, with ordinary people lending money to other ordinary people via an online platform.

San Francisco Startups

The other large U.S. peer-to-peer lender is Prosper Marketplace Inc., headquartered two blocks away from LendingClub in San Francisco’s South of Market district.
Prosper expects to originate more than $500 million in loans next year.
“What we’ve done is radically transform the way consumer lending operates,” Laplanche says in his speech. He says that LendingClub keeps staffing low by using algorithms to screen prospective borrowers for risk -- rejecting 90 percent of them - - and has no physical branches like banks. “The savings can be passed on to more borrowers in terms of lower interest rates and investors in terms of attractive returns.”
Prospective borrowers go to the firms’ websites to sign up. If they’re accepted, they pay interest rates ranging from 6.7 percent to 35 percent a year, depending on their credit history, on three- to five-year loans of as much as $35,000. They pay that interest directly to a group of lender-investors, with LendingClub and Prosper acting as underwriters and taking a fee from each transaction. Lenders scan the websites, read over prospective borrowers’ plans for using the money and buy pieces of individual loans.

Bypassing Banks

Masood Raja, an English professor at the University of North Texas in Denton, took out a three-year $3,500 loan from LendingClub early this year to purchase a Vespa motor scooter on eBay. He was assigned a rate of just over 10 percent.
“I liked that I didn’t have to go to a bank,” says Raja, 48. “The idea that small investors would be able to invest in this loan was very enticing.”
Raja says that 72 lenders put money into the loan, buying chunks of as little as $25.
LendingClub says that from June 2007 to July 31 of this year lender-investors earned an average annualized return of 9.5 percent, compared with 0.1 to 1.5 percent in a bank savings account. Prosper’s average return for the period from July 2009 to June 2013 was 9 percent.

Big Money

The new debt category’s high returns have brought Wall Street money managers running, along with pension funds, sovereign wealth funds and family offices desperate for higher yields at a time when 10-year U.S. Treasuries generate less than 3 percent. They’ve offered to take over all of the loans the peer-to-peer lenders can gather in.
The outside investors are now bundling the small loans into much larger pools so they can be more easily sold to big institutions. LendingClub itself runs a subsidiary called LC Advisors, which sells funds made up of LendingClub loans to high-net-worth individuals.
LendingClub is also working with a Massachusetts-based investment firm called Arcadia LLC, which has proposed to up the ante by applying leverage -- that is, take bank loans to fund more loan purchases.
“This is without doubt an emerging asset class,” says Andrew Hallowell, an Arcadia founder.

High Risk

Peer-to-peer loans can be high risk. When they were first introduced, default rates topped 17 percent. The loans remain unrated because the asset class is still too new for Moody’s Investors Service and Standard & Poor’s to take notice.
“The big problem is the whole issue of credit risk,” says Bert Ely, a banking consultant in Alexandria, Virginia. “To the extent the person putting up the money is relying on someone else to do the screening, you have to ask whether this is an appropriate investment for some.”
Peer-to-peer lenders issue their loans through Salt Lake City-based WebBank. They’re regulated by the U.S. Securities and Exchange Commission. Although LendingClub and Prosper recruit borrowers in more than 40 states, in at least 20 of them lender-investors are not allowed to be part of the process.
“If you are going to be a lender in this state, you have to be licensed,” says Ed Novak, a spokesman for the Pennsylvania Department of Banking and Securities. That rule, he says, applies to both banks and individuals.

Online Boom

By 2016, peer-to-peer lenders in the U.S. will be originating $20 billion in loans annually, according to Jason Jones, an organizer of the LendIt conference and partner at New York-based Disruption Credit, an investment firm focused on online lending. That doesn’t include online loan programs not available to retail investors, led by San Francisco-based Social Finance Inc., or SoFi, which may hand out as much as $1 billion in education loans this year.
Brooklyn, New York-based CommonBond LLC is also in the student loan business, while Montreal-based IOU Financial Inc. (IOU) lends online to small businesses.
David Schuette, a 50-year-old network engineer in Lakewood, Colorado, took out a $10,000 LendingClub loan this year to consolidate credit card debt, on some of which he was paying 30 percent interest. LendingClub approved a three-year loan at 9 percent.
“It’s a great idea to have the little guys helping the little guys,” Schuette says.

Bank Credit Slumps

The online lenders owe a debt of their own to the commercial banks, which have cut back on consumer lending. Americans had borrowed $854 billion in open-ended or revolving debt, such as credit card loans, as of the end of June, a decline of almost $170 billion over the July 2008 peak, according to Federal Reserve data.
“The banks are not interested in expanding their business, and they’re bogged down from a regulatory standpoint,” SoFi CEO Mike Cagney says.
Prosper Marketplace, founded in 2005 by Silicon Valley entrepreneur Chris Larsen, was the first U.S. peer-to-peer lender. Laplanche started up LendingClub a year later.
Larsen’s notion was to create an enterprise in which individual borrowers and lenders could negotiate loans, take the risk and keep the profits. His business was just beginning to take off when, in October 2008, under pressure from the SEC, he voluntarily shut down.
A cease-and-desist order followed a month later, alleging that Larsen was selling unregistered securities -- meaning the online loans retail investors were buying. Larsen suspended operations for nine months while he made his company SEC compliant. He left the firm in March 2012.

SEC Action

LendingClub had anticipated SEC action and had been working with the agency since April 2008, when it stopped taking money from retail investors. Six months later, it restarted as an SEC-registered company. To gain that registration, it agreed to automatically file with the federal agency every loan it made as a separate security.
Prosper mimicked LendingClub’s process to gain compliance, yet it wasn’t until July 2009 that its registration was completed. In addition to filing every loan, both companies report quarterly and annual results, as though they were publicly traded.
“We have a regulatory reporting burden that’s unlike just about any private company in existence,” says Jeff Crowe, a LendingClub board member and partner at Palo Alto, California-based Norwest Venture Partners.

Class-Action Suit

LendingClub used the time it gained in the battle with the SEC to jet past Prosper, which made $153 million in loans in 2012 compared with LendingClub’s $718 million.
Prosper was also hampered by a class-action lawsuit, filed in San Francisco Superior Court days after the SEC cease-and-desist order by a group of disgruntled Prosper investors. The suit alleged that because Prosper was selling securities illegally, lenders who had lost money were entitled to be compensated.
The suit was settled on July 19, with Prosper agreeing to pay $10 million over a period of years to the plaintiff class. The company settled without admitting liability or wrongdoing.
Prosper and LendingClub now thoroughly check the credit history of all applicants, they say. Borrowers accepted by LendingClub as of early July had an average credit rating score of 704 out of 850.
Prosper’s annualized default rate for July of this year was 5.8 percent, down from 12.3 percent three years earlier. LendingClub’s aggregate rate of defaults and charge-offs dropped to 2.5 percent at the end of the first quarter of this year from 6.7 percent at the end of 2009.

Revenue, Profits

LendingClub recorded $20.8 million in revenue in the second quarter and profit of $1.7 million. Prosper lost $5.7 million, not including the $10 million legal settlement.
The influx of institutional interest has changed the game.
Hallowell, of Arcadia, has a five-person team in Burlington, Massachusetts, recruiting institutional investors for LendingClub loans through an entity called Cirrix Capital LP. Cirrix is developing quantitative models to determine how the loans will perform in a variety of economic scenarios. Hallowell says Santa Clara, California-based Silicon Valley Bank has agreed to lend Cirrix approximately three times the amount of the capital it raises from investors to buy more LendingClub loans. The bank’s rate: about 4.5 percent.
Prosper has also been pursuing institutional investors since a new management team took over in January. The firm’s board brought in Stephan and Aaron Vermut, a father-son tandem, as CEO and president. They previously ran Merlin Securities LLC, a prime brokerage acquired last year by San Francisco-based Wells Fargo & Co.

Sequoia Invests

The Vermuts brought with them $20 million of fresh equity for Prosper, with venture firmSequoia Capital, known for early investments in Apple Inc. and Google, leading the financing.
After the Vermuts arrived, monthly loan originations tripled to $30.3 million in July from less than $10 million in February.
“We created awareness by selling our business, leaving Wells Fargo and coming here,” Aaron Vermut, 40, says in the company’s new 15th-floor office overlooking downtown San Francisco. “So you’ve got a bunch of Wall Street guys now in the p-to-p business. That’s generated attention, and people said, ‘Look, this thing’s for real.’”

Institutional Limits

Laplanche, a former French sailing champion whose 73-foot (22-meter) trimaran, “LendingClub,” won the Transpacific Yacht Race in July, is wary of the flood of institutional clients. To maintain a diversified investor base, he says that no single investor -- aside from LendingClub’s own LC Advisors funds -- will control more than 5 percent of the loans and that levered deals will fund no more than 15 percent of them.
“We’re trying to build a business for the long run that’s very sustainable and can grow through different credit rate environments,” he says. “We’re putting constraints on individual managers, on our own funds and on any large source of capital.”
The capital continues to flow in.
A corporate pension fund committed $25 million to LendingClub loans in June, a month after a sovereign wealth fund invested a similar sum, Laplanche says, declining to name the institutions. Oppenheimer Holdings Inc. (OPY) has recently started offering LendingClub’s funds to high-net-worth clients.
Mack, Morgan Stanley (MS)’s CEO from 2005 to 2009, joined LendingClub’s board last year and then encouraged the wealth management division of his former employer to sell the firm’s loans to its clients.

‘First Class’

“I saw a first-class product that consumers should have access to,” says Mack, who first put some of his own money into the loans.
As peer-to-peer lending balloons, Prosper founder Chris Larsen, who now runs an electronic currency provider called OpenCoin Inc., looks on with some sadness. His original notion was to democratize lending by taking the profits away from the banks and giving them to consumers.
“This is not an Occupy Wall Street solution,” he says of the takeover of peer-to-peer by big money. If the regulators had permitted him to pursue his original dream, he says, “maybe it could have been.”
To contact the reporters on this story: Ari Levy in San Francisco at; Dakin Campbell in New York at
To contact the editor responsible for this story: Michael Serrill at

Thursday, August 8, 2013




Technology probably isn't the first thing most people think of when they think of underwear.
Joanna Griffiths is not most people. While studying at INSEAD, one of the world's largest graduate business schools, Griffiths saw an opportunity to create a product that did more than the existing options on the market. "Thanks to technology, almost everything has evolved, everything but our underwear," she says. "We created a product truly designed with women's needs in mind: underwear that looks great, fits great, and has technology built in to eradicate odor and wick away and absorb moisture."

Griffiths needed a way to fund her new venture, Knix Wear. She had interviewed hundreds of women about the idea while doing her MBA, identifying demand for a stylish lingerie line for women who exercised intensely or experienced light incontinence, and she decided that crowd funding would be the ultimate test. "People had liked the idea, but would they actually pay for it?" says Griffiths. "I knew that it would also give us the opportunity to gain invaluable customer feedback--before the product had been made."
The campaign was a success, surpassing the $40,000 goal (by an extra $20,000). During the Indiegogo experience, Griffiths also learned some crucial crowd funding lessons.
1. Seek out best practices
Before you start your crowdfunding campaign, Griffiths suggests that it's important to study others who have done it well. For her, there were a handful of examples of how to do things right. She drew inspiration from how the Ministry of Supply men's shirtcampaign described their technology; she looked to the Saint Harridan campaign for its storytelling abilities; and she liked how the footwear project, Forus, positioned their wholesale packs.

2. Be prepared to hustle
No matter how much experience you have in the crowdfunding space, it requires a strategic approach to reach--and exceed--your goal. From media lists to ambassadors, Griffiths recommends that you plan ahead as much as possible. This means contacting your supporters before you launch to firm up their promotion and participation, and also developing a thorough marketing plan.
3. Adapt quickly to survive
For many in the crowdfunding world, there are no second chances. Griffiths shares how at just two weeks into their campaign they realized things weren't going as planned and they needed to adapt, quickly. "It was extremely difficult to let go of our preconceived notions and admit that we had launched incorrectly," she says. "But that is part of the beauty of crowdfunding," she explains. "Listen to your customers, as it could prevent you from making costly mistakes later on." Thanks to listening closely to feedback, they re-shot their promo video and repositioned their product to get better results.
4. Make your own rules
While it's key to study best practices, it's also important to seek out your own rules, as crowd funding is a relatively new space and many best practices are still being defined. During the Knix Wear campaign, Griffiths received an email from a major retailer, HBC, saying they wanted to be her first retail partner and were going to pre-purchase product via the Indiegogo campaign. "We were the first campaign to have a major retailer pre-order through crowd funding and we got them by thinking outside of the box. If we had only looked to what had been done before, we never would have reached that milestone." One of the perks that helped to seal this deal was the $800 retailer multi-pack featured as part of the campaign, which includes 48 pairs of Knix Wear high-tech knickers (retail value $1,600).
5. Get tactical and practical
Start your campaign on Monday and end your campaign on a Friday, says Griffiths. It will help you to maintain your momentum. She also recommends that you set your goal below the actual amount you want to reach. "It sounds counterintuitive but people like to contribute to winning campaigns, so if your goal is achievable and you hit it early on, you’ll be more likely to hit your stretch target."
KnixWear is now shipping product to its 518 pre-order supporters and planning for a future in stores around the world.

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