A seat at the high-roller’s table
By MARK CALVEY for The San Francisco Business Times
Bay Area entrepreneurs are pursuing financial innovations that aim to give the middle class a piece of the action when it comes to startups, initial public offerings, real estate investments or private equity deals — for as little as $100.
San Francisco-based Loyal3 began as a means to allow investors to buy as little as $10 worth of stock in brand-name companies with no fees. But Loyal3 hit a rich vein with its service allowing small investors to buy into some initial public offerings, including last month’s GoPro IPO (see accompanying story) for $100.
“IPOs represent the last bastion of elitism. Loyal3 is a platform that provides access,” said Loyal3 CEO Barry Schneider, noting that only 18 percent of Americans own stock directly due to the cost and complexity of doing so. Many more Americans indirectly hold stocks via mutual funds and 401(k) plans.
“It was very clear to me that there’s a large, disenfranchised middle class. I felt if we could build a platform that would allow a large number of people to invest, it would be really important.”
Loyal3 offers fee-free investing to small investors by convincing companies that it’s in their interest to pick up the investment costs to turn loyal customers into shareholders. Loyal3 takes other steps to make it less costly for companies to communicate and service those small investors.
Companies see such shareholders as long-term investors who are likely to be loyal customers, given their pride of ownership in the company.
“If you own Coca-Cola stock, why would you ever drink Pepsi or let your friends drink Pepsi?” Schneider asked.
Targeting retirement dollars
Other Bay Area firms, such as San Francisco-based FundersClub and AngelList, have built online platforms featuring a broad range of investment opportunities in startups — but confine them to wealthier investors rather than the masses. Many such investors are seeing illiquid investments in real estate and private equity as ideal for the cash sitting in their tax-favored retirement accounts. San Francisco-based Pensco Trust Co. has teamed up with Bay Area angel networks Keiretsu Forum and CircleUp, among others, to allow investors to use retirement money with the push of a button.
“Our members are looking for this kind of opportunity to use their retirement dollars to fund startups they believe in,” said Randy Williams, founder and CEO of Keiretsu Forum, who has invested retirement funds in private equity to take advantage of the tax benefits these accounts provide while backing deals he likes.
Pensco sees 60 percent of new money flowing through its firm going into private companies. Half of Pensco’s assets under custody are in private equity, with real estate and notes against real estate accounting for much of the rest.
As the stock market hovers at record levels, some investors are eager to diversify away from publicly traded stocks. Others want to participate in the high risk and potentially high reward that comes with financing private companies, especially as many opt to remain private longer.
The clubby world of private equity investing creates an opportunity for the proliferation of startups providing access to these investments through new technology and regulations.
Chase for accredited investors
FundersClub and similar services target so-called accredited investors who have at least $1 million in net worth, excluding their primary residence, or have annual income of $200,000 individually or $300,000 as a couple. Regulators are considering new rules that would allow the average investor to participate in private companies through crowdfunding, but some entrepreneurs and angel groups have said they prefer working with investors of some means.
“It’s concerning to see inexperienced investors make small investments in private equity,” said Jon Merriman, CEO of San Francisco-based Merriman Capital, which operates Digital Capital Network, an online platform connecting institutional and accredited investors with investment opportunities in real estate and private equity.
Reflecting on millions of Americans who qualify for investing in startups but choose not to do so, FundersClub CEO Alex Mittal said, “There’s no reason why we should be putting up barriers that make it harder for people with money to invest in some of the most innovative companies.”
He says companies choosing to remain privately held instead of going public means substantial wealth creation that once occurred at fast-growing public companies is now only available to a smaller group of investors that can get in on private-equity deals. He points to Facebook’s valuation at its IPO vs. Microsoft’s in 1986. Some investors are picking up shares in private companies through SecondMarket and SharesPost, but even more investors are seeking avenues to invest in these businesses at an earlier stage of their growth.
It’s these angel investors that are being courted by startups such as FundersClub, which allows seed-stage investments to be made for a minimum of $3,000 vs. a traditional minimum angel investment of $25,000 or more.
Crowdfunding startups such as Sausalito-based Breakaway Funding are top of mind with restaurants and other businesses that dot Main Street. These companies hope to do well, but generally don’t have ambitions or growth trajectories to become the next Google or next Google acquisition that make fast-growing startups so attractive to angel investors and venture capitalists.
Then there are long popular real estate investments, which also are attracting retirement-account dollars. Many new platforms providing small investors access to real estate deals aren’t based in the Bay Area, but still attract investors from the region. Fundrise in Washington, D.C. lets eligible investors put in as little as $100 in real estate projects. Then there’s Patch of Land, GroundFloor, RealCrowd and Realty Mogul Co., to name just a few.
Shakeout to come?
All these ventures have been conceived and launched against the backdrop of a stock market that’s risen to record highs, fueling both investor optimism and worries by those on the sidelines that they may be missing out.
It remains to be seen how they will fare in an eventual downturn. History shows investors’ appetite for risk can turn quickly when the market does.
“We’re seeing signs of extreme exuberance,” Merriman said. “One of thosesigns is everyone’s interest in early-stage companies.”
Investors who have built up sizable retirement accounts over the years are now looking for alternative investments that are commonly found in pension fund portfolios.
“There’s a lot of factors driving private equity investing using retirement funds,” said Kelly Rodriques, CEO of Pensco Trust Co. “Private equity is the highest-performing asset class of the last 10 to 20 years.”
Private equity in retirement accounts is also getting a boost from those making such investments more accessible to individual investors, including the proliferation of angel groups.
“There’s been a mainstreaming of angel investing,” Rodriques said. Rodriques hints that the firm has its sights set on crowdfunding as a new source of growth. That could involve a change of fees and marketing, but Rodriques isn’t tipping his hand. The average Pensco client is paying annual fees of $600 to have the firm serve as a custodian of assets held in IRAs and other qualified retirement accounts. Pensco and rivals, such as Equity Trust Co. in suburban Cleveland, assess whether an investment opportunity can be held in a tax-favored retirement plan but they don’t pass judgment on the merits of such investments.
FundersClub in San Francisco this month debuted its Partnerships service that allows accredited investors to participate in angel funds, or what the company prefers to call venture capital funds, without the time commitment and connections often needed to discover and conduct due diligence on startup opportunities.
The firm’s Partnerships, which typically represent a portfolio of startups, are usually available for a minimum investment of $25,000 but that could be higher at the fund manager’s discretion.
FundersClub carefully selects fund managers who can participate in Partnerships using its online platform, which began two years ago as a means for accredited investors to put money to work in startups.
“We had to build a lot of technology to run funds online and build a marketplace,” said FundersClub CEO Alex Mittal.
The company recently added a feature that lets the wealthy invest in startups using money from Individual Retirement Accounts. FundersClub charges investors a fee of 0.25 percent of the amount invested and a 1 percent carry fee on the fund.
The new service allows accredited investors to invest in startups more conveniently while making it easier for entrepreneurs to work with the fund’s manager rather than deal with a syndicate of investors, which even in the best of situations can feel like herding cats.
Loyal3 wants to turn the average American into a stockholder.
Loyal3, based in San Francisco’s financial district, has attracted big-name companies such as Facebook, Apple and Coca-Cola to its investing platform that lets small investors buy stock in these companies fee-free.
But the company ignited a new round of buzz with the recent IPO of San Mateo-based GoPro, the camera company that makes it easy for people to shoot video while skydiving and the like. Underwriters allotted 1.5 percent of GoPro’s shares in the IPO to Loyal3, which in turn let its customers invest from $100 to $10,000 in the IPO.
“At GoPro, we realize that it’s the people who love our products and what we do who are the real heroes here, and it just made sense for us to level the playing field and include them in our IPO,” GoPro CEO Nick Woodman said.
Loyal3 CEO Barry Schneider says every investor requesting an allocation in GoPro’s IPO got some shares, meaning that a “very large number” of investors participated, even though some were unhappy they didn’t get their full request.
“Most IPOs go to big institutions and the wealthiest people,” Schneider said. “I can tell you unequivocally, the size of someone’s wallet or the size of their account at Loyal3 had zero to do with our IPO allocation.”
Getting an IPO allocation at Loyal3 requires the investor to check a box acknowledging that the entire investment could be lost.
Loyal3 clients picking up GoPro shares at the $24 IPO price have profited.