My path to the Fairshare Model became clear in the early 1990’s, when I began to be a consulting chief financial officer for start-ups in the San Francisco Bay area.
Preceding that, I worked for manufacturing companies, mostly in the Midwest, then in Silicon Valley. The two I worked at before becoming a consultant were remarkable for different reasons. One had a strong performance-driven culture that had been established by a turnaround manager with a record of repeated success. The other was a start-up that failed, despite having every possible indicator of success one could hope for.
As a consultant, I saw promising companies that seemed deserving of venture capital that could not get the attention of venture capitalists. As I learned about the capital formation process for clients, I discovered it to be rift with inefficiencies and bias.
One client was an environmental technology start-up. It had licensed technology from the Lawrence Livermore National Laboratories to use an electron beam to transform certain toxics into harmless components. Environmental technologies were uninteresting to VCs, so, the company turned to angel investors. This worked, but it was inefficient. At some point, the company turned to a broker-dealer raise private rounds of convertible debt. For a company that needed equity capital, it was expensive money, in multiple respects.
As I discussed the challenges with another consultant, John G. Wilson, he described a long-standing vision he had for an alternative approach to raising equity capital. It involved legal public offerings, small investors, often organized into investment clubs, and a performance based capital structure.
It was fanciful in nearly every respect, but beguiling. We worked on technical aspects for months, aspiring to make it possible for investors to put as little as a hundred dollars in a given deal. We let it languish when I realized the cost for companies to print and mail offering documents was too high to make it work.
October 1995, the heavens parted. The SEC signaled it would adapt regulations to the emerging Internet Age. Electronic delivery of documents would be equivalent to the mail. Also, regulators would regulate the sale of securities, not an offer.
The economics became…feasible, potentially.
We formed a company, Fairshare, and worked to make John’s core ideas feasible; I was CEO. Before 2001, when Fairshare sank in in the wake of the dotcom and telecom busts, we had measures of success. There was significant investor interest in being able to invest in small companies using the Fairshare Model (i.e., a low valuation, performance-based capital structure and other investor protections).
We had 16,000 “opt-in members”, some of whom were enthusiastic enough to buy a paid membership ($50 or $100), and many more who elected for a free membership. Traffic on our site, which offered education on valuation and how to calculate it using the terms of a company’s offering, was a multiple of our membership.
We also learned we had underestimated the expense and difficulty of finding a place where securities regulators were reasonably comfortable.
Fairshare was positioned as a non-regulated entity. The creator of an Internet based community who, once it reached a critical mass, could attract companies who wanted to pitch a direct public offering (where the issuer does not hire a broker-dealer to sell the shares—the company does it itself).
Members would be able to pool due diligence. So long as the issuer adopted the Fairshare Model and agreed to let members invest as little as $100, we would provide free access to the membership. Fairshare would not handle investor cash or the issuer’s stock.
Within months of launching the membership program, the securities regulatory agency for California issued a “cease and desist order”, stopping us from offering memberships to California residents. It said a membership (even a free one) was a security, an investment contract. As such, Fairshare would have to file a registration statement and, presumably, hire a broker-dealer to offer them. An administrative law judge denied our appeal. The decision is a “precedent case” for the Department of Corporations. You can view it here http://www.corp.ca.gov/ENF/decisions/default.asp
Around the same time, we had enquires from regulators in Ohio, Colorado and Texas. A membership was not a security under their law (SEC staff members I presented the matter to felt similarly regarding federal law). These states did, however, want to see a regulated entity involved when an offering was discussed or allocations managed.
To quell this concern, we formed a subsidiary that registered as a regulated Investment Advisor with the SEC and all states, including California. Our intention was to explore if this would help remove the barrier to memberships in California, but we needed more capital, revised thinking on how to approach the business and more people.
I was tired. I kept consulting as my “day job” during this 3 year effort to preserve the capital we had for expenses and others who needed to be paid in order to work on Fairshare activity. I was also frustrated with the team dynamics.
As we explored options to raise more capital, the SEC notified our subsidiary that it was considering rescinding its investment advisor status. We did not qualify because we did not have customer accounts to manage nor were we being paid for advice!
The novel, Catch 22, came to mind.
We entered discussions with an investment group about buying the company. Two days before we were to close, we learned that the SEC was preparing an inquiry into Fairshare’s operations.
It took 4 months for the investigation to conclude—no action resulted. By this time, however, the potential buyer had moved onto other things. We ceased operations.
Twelve years later;
a) there is deep national anxiety about how to spur economic growth,
b) powerful social networks are redefining how online communities form and interact,
c) there is broad popular interest in crowdfunding as a vehicle to improve access to capital, and
d) publishing a book is much easier and less expensive,
so, I am going to reprise and contemporize the Fairshare Model.
A lot of people liked it. Some, like me, became obsessed with it.
It’s highly relevant to discussions about how to improve entrepreneurial access to capital as well as improve global competitiveness.
In a small way, it promises to help address concern about how to make the playing field more fair for people without wealth, influence and connections.
Maybe it was too early; the magnificent failure may yet fly.
I’m going to give it another try.