How does CrowdPal works
How does CrowdPal work?
CrowdPal is an equity crowdfunding platform creating a marketplace for individual investors to make equity investments in startup and early stage businesses with small amounts of capital. At CrowdPal, we conduct extensive due diligence on each investment before approving it on our platform, we only accept VC/Angel Investor Backed companies.
CrowdPal pools the funds from each of the investors into a single limited liability company (“LTD”). Each of the investors becomes a member of the LTD allocated based on their percentage participation in the pooled fund. CrowdPal then uses the aggregate funds in the LTD to make an investment in the company or venture featured in the offering. The LTD is issued equity, a convertible note or other investment securities.
As a result of this process, individual investors are able to gain exposure to venture capital investments, an asset class typically reserved for institutional investors, while investing as little as $5,000. Companies benefit from CrowdPal ’ process through the pooling of all investors into a single umbrella. This structure provides a clean addition to the capitalization table and allows for smooth capital structure transitions as companies move through various life-cycle stages. Essentially, CrowdPal is democratizing venture capital investing while maintaining the same level of expertise and diligence expected of an institutional venture capital fund.
Different stages of investments
What are the different stages of investments?
Investment opportunities available on the CrowdPal platform are typically private placements in startup companies at various points in their lifecycle. The startup lifecycle spans idea generation to an eventual exit through an acquisition or initial public offering with several inflection points throughout. Companies featured on the Crowd Pal platform can be categorized in the seed, early, and late stages of the startup lifecycle.
Seed and Early Stage Investments
Seed and early stage companies featured on the CrowdPal platform are seeking capital to invest in product development, building a team of employees, and formalizing customer acquisition strategies. While seed stage companies are focused on product development, early stage companies typically have a handful of users testing a beta product while fine-tuning their go-to-market strategy and building out sales channels.
• Focused on product development and preparing for a broader market launch.
• Product is usually in use by early beta customers for testing and feedback.
• Typically cash-constrained and seeking its first outside investors through family, friends, and angel investors.
When offered on the CrowdPal platform, seed and early stage investment opportunities are primary offerings meaning capital raised by CrowdPla is received by the company to invest in business development activities, additional employees, and user expansion. Investments within this stage typically take two forms: convertible notes and preferred equity. The form of investment is dependent on the company’s relative maturity with seed stage investments typically structured as convertible notes while early stage companies issue preferred equity in exchange for investor funds. In institutional venture capital terms these are known as Series Seed, Series A, and at times Series B.
• Officially launched and focused on customer acquisition.
• Implementing its sales channel strategy and attempting to reach breakeven cash flow.
• Generating revenue but pursing additional capital from institutional investors to invest in customer acquisition and business development.
LATE STAGE INVESTMENTS
Late stage companies have demonstrated viability as a going concern and generally have a well-known product with a strong market presence. Late stage companies have generally reached a point of positive cash flow generation and profitability and begin to experiment with expanding into tangential markets. Early investors in late stage companies start to search for sources of liquidity thus leading late stage companies to position for a liquidity event, usually in the form of an acquisition or initial public offering.
• Well-known product which has successfully penetrated its initial market and learned where and how to move next.
• Cash flow positive and introducing its product into tangential markets.
• Investors are seeking liquidity as the company begins to position itself for an acquisition or an initial public offering.
Investments made early in a company’s lifecycle typically require a long holding period and can be riskier relative to a late stage company with a well-known product on its way to market dominance. Understanding the lifecycle stage at which an investment will be made is paramount in accurately capturing the risks and return characteristics associated with that investment
Differences between debt vs equity
What is the difference between Debt vs Equity?
Generally, capital raised for new businesses takes one of two structures: debt or equity. Debt capital is raised in the form of a loan or promissory note to be paid back at some point in the future usually with interest. Conversely, equity is issued as stock in a company, representing a form of ownership with no defined maturity date. While hybrid financial products exist, they are outside the scope of this writing.
Projects and people who include pictures in their profiles help to build trust with other members on the service and sell the investment opportunities available.
Investing in debt
Investing in debt
In a debt financing, there are two parties to the transaction, the debtor and the creditor. In exchange for capital, the company (debtor) will issue a loan or promissory note to the investor (creditor). The documents governing and representing the loan will outline the complete provisions of the transaction, however, there are a handful of key terms investors should understand before investing in a debt product.
Principal: amount of capital originally invested in a debt product
Interest rate: the percentage rate, usually quoted annually, at which interest is paid by the debtor to the creditor while the loan is outstanding
Interest: the cash paid to the creditor by the debtor until loan maturity calculated as (interest rate ÷ payment frequency) * outstanding principal balance
Amortization: the act of paying the principal balance over time between the issuance of the loan and loan maturity
Maturity: the date at which the outstanding principal balance must be paid and returned to a creditor in full
Default: failure to make timely payments of principal or interest
An attractive aspect of debt financing is current income generated through interest payments over the life of the loan. Typically, interest is paid to creditors on a quarterly or monthly basis providing cash flow to investors while the principal is outstanding. Principal can be amortized, meaning paid in installments over the life of the loan, or paid in full at maturity, known as a bullet maturity.
Another advantage to debt from an investor’s vantage point is security. In most cases, debt sits at the very top of the capital structure and in scenarios of liquidation or bankruptcy is first to be repaid with the assets of the debtor. Debt transactions can also include security features tied to certain assets of a debtor providing an even greater level of security to creditors in the event of default or bankruptcy. Given the seniority of debt within the capital structure, the rate of return for debt investments is typically lower than its equity investment counterpart.
Debt can be (and often is) a very complex financing structure. The discussion above barely scratches the surface of the mechanics of a debt investment. Other important facets of debt investments include any covenants required of the debtor, events of default, recourse, prepayment provisions, fraudulent conveyance, underlying security, and many others. Additionally, debt can take on multiple structures including but not limited to senior secured, mortgage, unsecured, convertible, zero-coupon, payment-in-kind, revolvers, floating-rate, and structured products among countless others. The most common debt product in a venture capital context is a convertible note, the properties of which we discuss extensively in our Convertible Note Whitepaper.
In summary, debt investments can provide investors with current income and security not afforded to equity investors. Given the relative position in the capital structure and security surrounding debt investments, the rate of return for creditors of a given company is typically lower than the company’s equity holders. Moreover, debt investments have a finite life and an investor’s relationship with the company ends upon maturity and repayment of the debt capping the potential upside afforded to equity investments.
Investing in equity
Investing in equity
When an investor makes an equity investment, he or she is issued shares in exchange for capital and becomes a shareholder, or owner, of the company. There are two types of equity securities routinely used in financing new businesses: preferred and common. As owners of a company, both common and preferred shareholders have voting rights related to the board of directors, ultimately influencing control over the company’s activities and direction.
While the equity portion of a publicly traded company’s capital structure will more heavily lean towards common, venture capital investors typically utilize a preferred equity structure due to certain rights and privileges afforded preferred shareholders, most notably a liquidation preference. Prior to making an investment in preferred equity it’s important to understand the additional features attached to preferred shares.
Preferred shareholders are typically entitled to a dividend, if and when declared by the board of directors, before any dividends are paid to common shareholders. Dividends for preferred shareholders are established at a percent of the principal, similar to an interest paying debt product, usually between 4% and 10% annually.
A liquidation preference ensures that in the event of a liquidation or winding up of the company, preferred shareholders receive back at least the original investment value and often times a multiple thereof before any distributions are made to common shareholders. A liquidation preference of 1x is typical, although a preference of 3x is not uncommon. In addition to a multiple preference, some preferred equity structures include participating provisions whereby preferred shareholders will receive a multiple of the original purchase price and then participate ratably on an as-converted basis in the remaining proceeds of the liquidity event. As-converted simply refers to the preferred shareholders participation if each preferred share was converted into a common share.
Most always, preferred shares are convertible into common shares at the option of the preferred shareholder at a 1:1 conversion ratio. There are several instances where conversion into common could be advantageous to a preferred shareholder including an acquisition of the company at a value well exceeding the liquidation preferences, where common shareholders receive a greater amount of the acquisition proceeds. Some preferred structures include automatic conversion provisions where if the company is executing a Qualified Initial Public Offering above a certain valuation threshold, preferred shares are converted into common to enable selling in the secondary market following a public offering.
Pay-to-play provisions are used to incentivize early investors to participate in future financing rounds. Essentially, if an investor subject to a pay-to-play provision does not participate in a future financing round of the company, the investor could lose certain rights and privileges associated with preferred stock. In a stricter construct, if an investor does not participate in his or her pro rata participation in a future financing round, the preferred stock could be converted to common. Pay-to-play provisions can be helpful to both entrepreneurs and investors.
Board of Directors
In a preferred equity investment, investors will negotiate for the ability to join the board of directors in order to influence company direction and serve as a proxy for preferred shareholders. By taking a board seat, investors can actively monitor activities of the company, ensuring the company’s actions are in the best interest of investors and employees.
While additional terms are found in a typical preferred equity financing, the few listed above serve as the primary reasoning behind venture capital investors pursuing a preferred stock structure when making an equity investment. As implied earlier, another advantage to preferred stock is its seniority to common stock.
Common stock ranks as the lowest priority in a company’s capital structure, and consequently, is often the class of stock held by company founders and employees. While common stockholders are afforded certain voting rights, economic participation in the event of a liquidity event or declaration of dividends is subordinate to creditor and preferred shareholder cash distributions. Given its relative rank in the capital structure, common stockholders often assume the most risk of any investor class in a given company, while potentially reaping the greatest rewards.
While debt investments can provide a stable cash flow stream and security for investors, participation in value expansion, and return on investment, is capped at the interest and principal payments outlined in the financing documents. By taking on more risk as an equity investor, one can economically participate in a company’s value creation activities providing an enhanced return profile relative to a company’s debt offerings. Given this dynamic, several early stage venture capital investors utilize a convertible note structure, a financial product that begins as a debt instrument and converts into equity at a future date. To learn more about the convertible debt financing structure, download our Convertible Note White Paper
When sourcing capital for a new business venture, entrepreneurs utilize one of two basic structures: debt or equity. Debt is a capital source with a finite life and clearly defined return profile known at the initial investment. With debt financing, a company is required to pay interest throughout the term of the loan with principal repaid at maturity. Conversely, equity investors are issued shares representing ownership in an enterprise. While equity does not require repayment over a defined time period, an entrepreneur’s stake in his or her company is diluted through the issuance of equity to outside investors.
Given the dynamics of early-stage companies, venture capital investors use a hybrid funding mechanism, convertible debt. Convertible debt, in the context of a venture capital financing, is a funding structure that combines the benefits of debt and equity into a single capital source. Convertible debt, usually in the form of a convertible note, is essentially a loan which converts into equity at a later date.
A convertible note is a short-term loan with maturities ranging from 12 to 36 months. Instead of paying interest in the form of cash, which would deplete valuable resources of a young company, interest accrues until maturity or conversion. A conversion of the loan (plus accrued interest) into equity is triggered by a subsequent priced equity financing round, typically known as a Series A financing. To compensate convertible note holders for the additional risk assumed with investing at an early stage, most convertible notes feature a conversion price below that of the subsequent financing round through the use of a valuation cap or a discount on the purchase price. Importantly, a valuation cap and a discount are mutually exclusive conversion features thus cannot be applied simultaneously. The note holder will ultimately utilize the conversion feature resulting in the most advantageous purchase price. Below is a demonstration of how a convertible note functions in practice.
Numerical Example: $25k convertible note with $5M cap, 20% discount
a numerical example ignoring any accrued interest:
You invest $25k in a startup’s seed round using a convertible note with a $5M cap, 20% discount
If, at the Series A, the startup raises money from a venture capital firm that invests at a pre-money valuation of $10M with a per share price of $5.00 IF we apply the discount, the price per share would be $4.00/share ($5.00 times (1 minus 20%)) IF we apply the cap, the price per share would be $2.50/share ($5.00 times ($5M cap divided by $10M pre-money valuation)) THUS the cap would apply and the note would convert at $2.50/share which gives 10,000 shares of Series A Preferred Stock ($25,000 divided by $2.50/share). On paper, your 10,000 shares at $5.00/share are worth $50,000 which is an unrealized return of 100%.
If, at the Series A, the startup raises money from a venture capital firm that invests at a pre-money valuation of $6M with a per share price of $5.00 IF we apply the discount, the price per share would be $4.00/share ($5.00 times (1 minus 20%)) IF we apply the cap, the price per share would be $4.1667/share ($5.00 times ($5M cap divided by $6M pre-money valuation)) THUS the discount would apply and the note would convert at $4.00/share which gives 6,250 shares of Series A Preferred Stock ($25,000 divided by $4.00/share). On paper, your 6,250 shares at $5.00/share are worth $31,250 which is an unrealized return of 25%
What is warrant coverage in a convertible note?
Warrant coverage in a convertible note gives an investor the right to purchase additional shares of stock in a company. Typically, this is based on some percentage of the principal amount of the loan (plus any accrued interest) and this additional purchase option happens at the point of conversion of the note from debt into equity. The terms vary based on the note
Numerical example: $25k convertible note with 10% warrant coverage
Let’s do a numerical example ignoring any accrued interest, and assuming no valuation cap or discount in the convertible note:
You invest $25k in a startup’s seed round using a convertible note with 10% warrant coverage for shares of the next round at the price of the next round
At the Series A, the startup raises money from a venture capital firm that pays $5.00 per share of Series A Preferred Stock
Your $25k loan would convert into shares of Series A Preferred Stock at a price of $5.00 per share = 5,000 shares
Additionally, you would have the option to purchases shares from 10% warrant coverage or an additional 500 shares (($25,000 * 10%)/$5/share).
If purchase option is fully exercised, you would have a total of 5,500 shares in the new round, or 10% more than you would have otherwise had from the convertible note
When contemplating an investment in a new business venture, investors typically do not consider a private investment in a technology startup as a risk-minimizing activity. However, within a given portfolio, by diversifying among several uncorrelated asset classes an investor can maximize return for a given level of risk. Taken in this context, venture capital investing, while in isolation a risky investment style, can provide enhanced returns at a given level of risk.
Based on modern portfolio theory and the efficient frontier, return is maximized for a given level of risk through asset class diversification. Therefore, adding alternative investments, like private equity or hedge funds, to a traditional portfolio can provide enhanced returns for the same level of risk. The chart below illustrates how alternative investments can impact the efficient frontier. What results is an upward shift in the efficient frontier, providing an enhanced return for a given level of risk, or conversely, a similar return at a lower risk profile.
Diversification is equally important among assets within the same class and especially important when investing in technology startups. When contemplating a venture capital investment, it’s important to consider multiple investment opportunities in an effort to reduce risk across the portfolio. Ultimately, the goal for any investor is to maximize return at a desired level of risk. Diversification of and within asset classes, particularly alternative assets, can enhance portfolio returns while reducing portfolio concentration and risk.