CircleUp Brings Crowdfunding, Of a Sort, to Non-Tech Firms

7/2/12Follow @wroush

A common complaint among technology entrepreneurs back in the mid-2000s was that there weren’t enough angel investors willing to help small startups get off the ground. Bootstrapping and “friends-and-family” funding would only take you so far, and if you didn’t already have a couple million in annual revenue, the venture funds just weren’t interested, creating an early-stage funding gap.

This problem has largely gone away in the tech world, thanks to three big changes: A huge increase in the number of individual investors happy to put $25,000 or $50,000 into a startup, especially in Silicon Valley; the proliferation of startup accelerator programs like Y Combinator and TechStars; and a new willingness at many venture funds to invest in early-stage startups.

But the funding gap has definitely not gone away outside the technology world. If you’re building a company in an area like food, beverages, personal care, pet products, sporting goods, apparel, or restaurants—and you’ve got between $1 million and $10 million in annual revenue—you’re probably too big for friends-and-family funding. And the banks, private equity funds, and venture firms won’t touch you either.

That’s the gap CircleUp hopes to fill. It’s a Web-based crowdfunding platform where early- to mid-stage consumer products companies can turn to angel investors for the equity-based funding they need to get to the next level, where they’ll presumably be able to attract institutional investors.

It’s a little bit like Kickstarter, Indiegogo, Rally.org, and other crowdfunding services in that companies have profile pages with videos and other enticements, and they raise money by aggregating lots of small investments. But the San Francisco-based startup is different in the sense that it carefully screens the companies it wants to feature. Also, the companies are selling actual shares, which means, under current SEC regulations, that only qualified investors are allowed to use the platform, which is password-protected. (A qualified or “accredited” investor is one with $200,000 of annual income per individual or $300,000 per household or a net worth of at least $1 million excluding real estate.)

Ryan Caldbeck, CEO of CircleUp

CircleUp debuted in April and is featuring only about 10 companies in its marketplace so far—but it has big ambitions. Co-founder and CEO Ryan Caldbeck notes that there are somewhere between 750,000 and 1.2 million consumer products companies in the U.S. in CircleUp’s target market—that is, the $1 million to $10 million revenue range. Consumer products “may not be as sexy as mobile apps, but they account for 20 percent of our economy and receive only 4 percent of the angel investing,” he says.

Caldbeck founded CircleUp with former Stanford Business School classmate Rory Eakin, the company’s chief operating officer, after the two saw how inefficient it was for companies below the venture and private-equity threshold to raise money. “Rory and I started kicking around ideas to help solve that problem, and we realized that there are a lot of great companies that are doing very well, and also investors out there who want access to a new asset class. So marrying those two made a lot of sense.”

The very first company to complete a funding round on CircleUp is Episencial, a Los Angeles-based maker of natural skincare products for infants. The company had raised $6 million in the past from angel groups, but on CircleUp it was able to collect about half of a recent top-off round of $500,000 in just 14 days, with far less time spent briefing individual investors, according to founder and CEO Kim Wells. “It costs time and money to raise money,” Wells says. “To be able to raise money in days instead of months and do it with conversations that last minutes instead of hours is an incredible benefit for a company with limited bandwidth.”

Both CircleUp co-founders come from the financial world: Caldbeck was formerly with TSG Consumer Partners, a private equity fund focused on consumer products and retail, and Eakin was at Humanity United, the social-enterprise wing of eBay tycoon Pierre Omidyar’s investing empire. To get the operation off the ground, they’ve raised $1.5 million of their own from Maveron, Triple Point Investors, and angel investors such as David Topper, a JP Morgan veteran. Like investment bankers, they keep a percentage of each fundraising round as a commission. “We don’t disclose publicly what the percentage is, but it’s consistent with what companies would pay an investment bank in the offline world,” says Caldbeck.

While they wait for their own broker-dealer license, the CircleUp team is operating under the aegis of financial services firm W.R. Hambrecht + Co., which is best known for helping companies like Google go public through online auctions. They’re also renting space inside Hambrecht’s swanky Pier One offices in San Francisco.

CircleUp works like this: Companies selected by Caldbeck and Eakin create an online profile, with separate tabs for a company overview, a rundown of the founding team members and their backgrounds, a gallery of products, and an interactive forum for questions from investors. The overview section usually consist of a 10- to 30-page presentation describing the industry landscape, the companies’ unique products and who’s buying them, and their financial performance—in other words, the same stuff you’d find in the pitch deck of any Silicon Valley startup. “It’s not a coincidence,” says Caldbeck. “As former investors, this is what we would like to see.”

To help keep the total number of investors under control, companies set a minimum investment. (Episencial, for example, set its minimum at $5,000.) As on Kickstarter and other popular crowdfunding platforms, there’s a status bar on each profile page showing how close the company is getting to its fundraising goal. But Caldbeck describes the forum area as one of CircleUp’s biggest innovations; he says it speeds up the due-diligence process for both sides. “When you’re going out meeting with individual investors, you get the same questions over and over,” he says. “If you deal with those questions in the context an online forum, you only have to answer them once. By the same token, if an investor asks a really tough question that the company can’t answer, the other investors want to know that.

Rory Eakin, co-founder and chief operating officer at CircleUp

Once a CircleUp member decides to they want to back a company, there’s a simple, automated process to complete the deal. The investor enters in the amount they want to invest—say, $10,000—and CircleUp tells them how many shares they’ll get. (There’s typically no negotiation around valuation, share prices, or terms; all of that is dictated by the companies.) The site creates standardized investor-rights and purchase agreements, which are e-mailed to the investor for their electronic signature. Then the investor wires the money to a third-party escrow service. Once the fundraising target is reached and all the paperwork is signed, the money is released to the company.

Wells, at Episencial, says listing her company on CircleUp led to four big surprises: “How fast it was, how easy it was, how much interest there was, and the quality of the investors we ended up getting. Some of these people have fantastic connections that we didn’t have, such as Catamount. [Catamount Ventures is a San Francisco-based firm that makes seed-stage technology investments; individual partners from Catamount put money into Episencial through the CircleUp round.] I believe our next growth round will be easier to get because we are in front of more people now.”

But while crowdfunding is clearly the latest hot trend in the startup and investing worlds, the big questions are whether it can be scaled up in a responsible way, and whether CircleUp can build up a big lead before competitors enter the market.

Caldbeck says the five-man firm is being extremely selective to start. It does extensive background checks on each company, and so far it has agreed to help fewer than 2 percent of the more than 350 companies who have applied to be listed in the marketplace. “That’s because are trying to stay focused on providing really great investment opportunities,” Caldbeck says.

Whether that level of screening and curation will be sustainable as the marketplace grows remains to be seen. Meanwhile, the very rules around crowdfunding are in flux. The JOBS Act, passed by Congress in April, includes provisions that will allow companies to use registered Internet “funding portals” to raise money from unaccredited investors as well as accredited investors, subject to certain caps based on investors’ income. The exact rules that will govern this process are still being written by the SEC, but they could go into effect as soon as January. When they do, it’s likely to unleash a flood of CircleUp lookalikes; even Kickstarter could, in theory, start selling shares in the companies it promotes.

“It’s clear that there will be a lot of players in the market,” says Eakin. “We are seeing a lot of people indicating that they are coming in as soon as the rules change. And that is somewhat concerning.” After all, it defies human nature to think that this coming wave of crowdfunding wave won’t produce its share of fly-by-night schemes, creating whole new ways for gullible investors to lose money.

Fortunately, CircleUp has a lawyer—Richard Rosenfeld, a securities litigation expert at D.C.-based Mayer Brown—who is part of a committee advising the SEC on crowdfunding. Caldbeck says Rosenfeld has helped the company “develop a legal strategy to make sure we are doing everything right,” and he thinks the SEC’s final rules will include appropriate restrictions on the way companies can market themselves through crowdfunding platforms.

“We think in the end, crowdfunding will only be successful to the extent that investors and companies are finding good outcomes through the platforms they are using,” says Eakin.

And if the early outcomes are good enough—a big if, at the moment—it could even help fuel an era of consumer-product innovation to match the ferment in areas like mobile and social computing. “In industry after industry you see innovation percolating up from the bottom,” says Eakin. “One of the benefits you will see over time from CircleUp is small companies getting the traction they need to grow.”

Wade Roush is a contributing editor at Xconomy. Follow @wroush

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