Fairshare Model

The Fairshare Model

for Raising Venture Capital via a Crowdfunded Initial Public Offering

Highlights of a book under construction

by Karl M Sjogren

Coming in 2014

We Need Growth! We Need Jobs! Yes!

Yesterday!

Big Problem! Something ought to be done!

Where’s the leadership?

I’m worried about the future. Why isn’t it happening?

Occupy Wall Street! When will recession end?

How do I prepare for the future?

This recession is different—we need new solutions!

8/3/2013 Property of Karl M Sjogren 2

What’s the Solution?


More education!

Get rid of job-killing regulations!

Government – Business Partnerships!

Entrepreneurs!

Invest in the future!

Better education!

Strengthen bank regulation!

Throw the bums out!

Focus on and fix the problem!

Create opportunity!

Get government out of the way!

Better regulations!

Banks that lend

Crowdfunding!

Reduce the deficit

New Attitudes!

More venture capital!

Competent Government!

Fix the housing market!

Get ready for the new economy!

Yoga!

Healthy food!

There’s an app for that!

Encourage innovation!

Support job-creators!

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Tax Policy

Regulatory Reform

Restrict Imports

Promote Exports

Just Wait Out Cycle

Gov’t Spending

Education

Fiscal Policy

How to Spur Growth?

Labor Law

Environmental Regulations

Product Liability

Quotas

Tariffs

Financing

Trade Agreements

Rates Structure

Incentives

Money Supply

Interest Rates

Improve Access

Reform

Reduce Spending

Increase Spending

Any Other Ideas? Property of Karl M Sjogren 4

?

They identify four strategic initiatives : 1. Encourage immigration by high-

skilled foreigners 2. Improve access to capital for new

firms (subject of the Fairshare Model)

3. Speed up commercialization of innovations at universities

4. Regulatory reform

Many good ideas are being discussed. For example, those put forth in Better Capitalism by Robert Litan and Carl Schramm

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Link to Must-See video sketchbook for Better Capitalism (3 minutes long) http://www.kauffman.org/sketchbook.aspx?VideoId=1845640971001

Property of Karl M Sjogren 5

http://www.kauffman.org/sketchbook.aspx?VideoId=1845640971001





Pathways to Improve Access to Capital

Wealthy individuals (a.k.a. Angel Investors)

Private Sector

Equity

Accredited Investors Unaccredited

Investors (a/k/a general public)

Loan Guarantees

Government

Tax Incentives to spur equity

investment

Regulatory Reform (e.g. JOBS Act)

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Venture Capital & Private Equity firms

Fairshare Model target audience

Debt



Basic Securities Term Definition

Issuer Company selling securities (stocks, notes, bonds)

Accredited Investor

• Someone allowed to invest in start-ups and other private company transactions.

• Defined in Federal securities law. Criteria: Wealthy enough to absorb full loss of investment

• “Angel Investor” = accredited investor who invests their own money (not a fund)

Unaccredited Investor Anyone who is not accredited (general public)

Broker-Dealer Underwriter, investment bank, brokerage firm, etc. • Regulated by government securities agencies & by

self-governing organizations

Private offering Only Accredited Investors may invest

Public offering Anyone may invest • Issuer must first file disclosure documents (registration

statement) acceptable to securities agencies

ENTREPRENEUR: I have an idea but

need money

INVESTOR: How much of your

company do I get if I give you the money?

The Fairshare Model Begins Here


Fairshare Model Basics • Two classes of stock--“Investor Stock” & “Performance Stock”.

• Investor Stock can trade in the market. It is issued for capital.

• Performance Stock is not tradable.

• Issued to insiders, converts to Investor Stock based on performance. • Performance measured quarterly. • Measures = revenue, earnings, new raises of capital, Investor

Stock price appreciation, etc.

• As a class, Performance Stock controls has half voting control. • Like a stock option that votes, and vests with performance, not the

mere passage of time.


Target Companies Companies that adopt the Fairshare Model: • May have already raised 1-3 rounds from accredited investors.

• Want to raise $2 to $10 million in public venture capital.

• Can identify an affinity group of likely investors.

• See advantage in having stock broadly held by the public.

• Will use Performance Stock to attract and motivate talent.

Such a company will necessarily: • Be confident it will deliver performance that results in conversion of

Performance Stock to Investor Stock

• Let public investors invest at low valuation.

• Offer protections provided to venture capital funds.

• Embrace the concept of investor oversight.


Possible Outcomes for Issuers Some companies will fail (start-ups face long odds).

Some will be acquired by other companies.

• Performance Stock conversion will be determined by the holders of Investor Stock and Performance Stock. • Performance Stock deserves compensation if purchase price

delivers attractive return for Investor Stock.

Some will raise more capital & trade on an exchange (NASDAQ).

• The growth may involve acquiring other companies.

Some may convert to a conventional capital structure. • Tried it, did not like it. • A majority of each stock must agree on a new structure.

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Snapshot

Voting Control

Investor Stock

Performance Stock

Ability to Trade

Investor Stock

Performance Stock

• Performance Stock can never trade.

• Investor Stock is registered with SEC.

• Trading market likely to start off thin, then improve as company performs.

• Matters that would require approval from each class of stock:

• Board member election

• Change to conversion criteria.

• Compensation plans involving Investor Stock.

• Changes to capital structure.

• Acquisition matters.


Who Will Like What?

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Key Attributes of the Fairshare Model Investors Companies

Access to equity venture capital Pre-IPO angel investors have an exit Performance Stock is a POWERFUL competitive advantage for managing human capital Broadly distributed Investor Stock creates evangelists to promote the company’s interests

Insiders do not get rich just because there is an IPO To sell stock, must have bought it or earned it Investors and insiders share voting control Ability to acquire other companies with public stock


Fundamental Problem of a Conventional Capital Structure

Assessing an early–stage company is as difficult as divining the adult achievement of young child.

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A conventional capital structure requires a company to strike a valuation at each round of investment that pre-supposes performance.

Accredited investors are protected from overpaying for a private venture capital deal. A conventional model is NO PROBLEM for them.

Investors in a public venture capital deal are not protected from overpaying. A conventional model is a BIG PROBLEM for them. But most don’t realize it.

• Indicators are there, but can be wrong or misleading.

• Valuation = Value of an idea, of future performance • “The company is worth $100 million.”


Overpayment Protection: Who Has It

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Accredited Investors in a private venture

capital deal OVERPAYMENT PROTECTION

Know the deal valuation They know how to calculate the price to

buy the company, given the deal terms.

Get anti-dilution provisions Provide price protection by re-pricing investor shares lower if a subsequent financing is at a lower valuation than the round they bought into.

Investors in a public venture

capital deal NO OVERPAYMENT PROTECTION

Valuation-Unaware Unaccredited investors do not know how to calculate valuation nor its importance.

Issuers not obligated to disclose valuation, let alone discuss why its reasonable. Unable to invest earlier, small investors compete to pay “retail” for a “wholesale” deal; they invest with the zeal of “Black Friday” shoppers –but not for “deals”. They have no protection from overpaying


What is a “Venture-Stage” Company?

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• Market for its products/services is new/uncertain

• Unproven business model

• Uncertain timeline to profitable operations

• Negative cash flow from operations

• In other words, it requires investor cash to operate

• Little or no sustainable competitive advantage

• Execution risk; team may not build value for investors

A company with these risk factors:


Many public companies list such risk factors in their disclosure documents

Public Venture Capital

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capital provided to a venture-stage company

…is “venture capital”….

… whether its from accredited investors…

…or from public investors!

Same Girl, Different Dress

In substance, Private Venture

Capital Public Venture

Capital


What You Pay to Play…

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… venture capitalist…

… who you are!

Who R U?

…depends on….

Let’s explore how


Private Venture Capital Supply-Chain

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Some accredited investors invest only in the early rounds.

• Angel investors are early investors, but seek VC funds to for rounds over $1-2 million.

• VCs with operational expertise are the “lead institutional investor” (i.e., evaluate deal, serve on board of directors) for other investment funds that prefer to follow.

Others favor later rounds, after its apparent the company is on-track to have an IPO or be acquired (i.e. exits are visible).


Classic Conventional Valuation Trend

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The valuation for accredited investors begins low and increases over ensuing rounds to the price offered to “public venture capital” investors.

Example


What Best Explains the Trend?

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Risk reduction?

Performance?

What the Next Guy (the public or potential acquirer) may pay?

The Fairshare Model book will posit a Next Guy Theory for buyer behavior

• To a degree

• See Risk Factors in a IPO prospectus

• Guestimate: this explains 30-60% of the late pre-IPO valuation increase


Who is the Next Guy for Unaccredited Investors?

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There isn’t one…except other public investors

Downside Exposure Public investors at greater risk of overpaying for a venture stage deal than pre-IPO investors


Possibilities: Conventional Model

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Valuations between years 2-8 in this example are better explained… by who the Next Guy will be… than by what the company’s performance is.


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Possibilities: Fairshare Model Same example, but the valuation (aggregate of Investor Stock) is explained by performance, and it’s shared by investors and insiders, as Performance Stock converts to Investor Stock.

IPO valuation comparable to what a VC might pay.


How to Begin? Fairshare Model = disruptive innovation in the structure of securities.

– “Crowdfunding” is an innovation in the distribution of securities.

Innovations are challenging if they are not pushed by suppliers, demanded by customers or required by government.

– “Dutch Auction” approach to IPO pricing. Good idea! Not pushed by “suppliers” (issuers, investment banks), demanded by customers (those positioned to “flip” shares) nor required by government or the self governing organizations that oversee exchanges.

Fairshare Model does not benefit existing players. – Venture capital and private equity funds; investment bankers; Investors positioned to “flip”

hot IPO shares, or, IPO companies with a conventional capital structure

Issuers will not adopt it unless it helps them raise capital. – General investor interest must be there.

It’s beneficiaries don’t realize they get a bad deal now, or, feel helpless. – Valuation-unaware – Weak understanding of investor protections – More concerned with access to deals than with terms of deals


Concept Gap

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Where the Fairshare

Model is now

Concept Gap

Should Investor Interest be significant, some issuers will adopt it

If Early Issuers and Investors benefit, more issuers will

adopt it

Should it become popular, capitalism will have evolved

in interesting ways.

Better Capitalism!!!!


Help Narrow the Concept Gap If the model appeals to you, please create buzz .

• Talk about the Fairshare Model • Spread the word via social networking • Join the community at www.fairsharemodel.com

to hear what others have to say—favorable or not. I will publish a book on the Fairshare Model by Q4 2013.

• I seek critical input from attorneys, financial experts, angel investors, etc. while working on it.

Companies: my focus is to define a credible & attractive equity capital option for you; if investor interest is there, the next step will be to define “how-to” guidance. Email me at [email protected]

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The Fairshare Model Needs You!


http://www.fairsharemodel.com/

mailto:[email protected]

This is the construction of the Fairshare Model.

It’s mission: to explore new relationships between labor and capital,

to help entrepreneurs finance companies with public venture capital,

to boldly go where no capital structure has gone before.

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Better Capitalism…the new frontier


Fairshare Model

Economy & Finance

property of karl

access reform

better regulations

better education

government securities

bonds accredited investor

better capitalism

competent government