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Analysis

The future of crowdfunding and how it benefits the UK

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On Wednesday, 1st June, BICOM hosted a conference call for journalists with Jon Medved on the future of crowdfunding and how it benefits the UK. Medved is founder and CEO of OurCrowd, where he invested in over 100 Israeli start-ups, 12 of which have been valued at over US$100m. In three years since inception, OurCrowd has raised over US$220m for over 100 start-ups, six of which have secured a successful exit. In this phone briefing for BICOM, he discussed how tech investment has developed over the years, the growing status of crowdfunding, and why Israel is an attractive destination for British investors and entrepreneurs. Below is an edited transcript.

Opening a closed asset class

Clearly crowdfunding has become rather exciting worldwide. I think it represents a really interesting way to get people into a previously closed asset class.

I have been involved for almost four decades building start-ups as a serial entrepreneur and as a venture capitalist, rather addicted angel investor. And until now this whole area of innovation finance has really been sort of like esoteric law. It has not been one of those areas which are really open to most people; and that’s true because not only do you require capital to get involved, but you require connections and deep knowledge. When you look at the world of these great companies that have changed all of our lives – the Facebooks, the Apples, the Intels and the Googles – the people who invest in them are pretty much a closed circle. And this is true not just of Silicon Valley but also for New York, and for London – just a few hundred, maybe a few thousand.

Crowdfunding now represents an opportunity to get into these kinds of deals when it’s done right that would open this up to potentially millions of investors.  In the UK you have a couple of great sites already, people like CrowdCube and Seedrs and others, we’re based in Israel, there are many in U.S such as AngelList or CircleUp or FundersClub, and it’s becoming quite a big deal. We have now invested over US$230m in close to 100 start-ups. We’ve had six announced exits, so we are actually making money for our investors by not just investing their money, and our money as well, but realising profits in most cases on exit. I think the future is very, very rosy for this.

Today, an entrepreneur has only three choices in terms of seeking finance for his start-up. One is to go to Angels, two is to go to V.C. – venture capital, and three is then to go for corporate funding. I think that the ability now to harness potentially billions of dollars of new funds for these start-ups is great for entrepreneurs as well as great for investors.

The OurCrowd model and why it works

Investors realise that if they are not getting involved in investing in these companies when they are still private they are going to leave a lot of money on the table, especially in the age of unicorns when the valuations of the private companies get to be over a billion dollars plus. If you wait until they go public you are potentially waiting a little bit too long. So the question is if you can get in a crowdfunding platform that is great, but there are many differences among the platforms. And we are more of a hybrid between venture capital and classic crowdfunding.

We actually curate the deals that we put up at OurCrowd so that about 98 per cent of the deals that we look at, we reject. We accept two per cent. We have done about 100 deals so far. And when we accept a deal the first thing we do is to invest our own capital. Roughly about five per cent of the capital of each raise comes from us and our partners, and therefore we have skin in the game.

The other thing which we do is that we aggregate our investors into a single entity called the SPV, special purpose vehicle, which is essentially a limited partnership. It looks like a venture fund, but for a specific company. So when we have several hundred investors they are not buying shares directly in the company and then on their own after they make the investment. But we are taking all of this money, aggregating it and writing a single cheque to the company.

This is good for a bunch of reasons. One is it preserves the integrity of the cap table, the capitalisation table of the company, so that other venture capitalists or corporate investors will feel comfortable, and won’t feel uncomfortable with thousands of individual investors.

Number two is we get the same kind of rights and benefits that the big boys get. So we are typically buying what is called preferred stock with a whole bunch of special benefits such as anti-dilution rights, pre-emptive rights, information rights and we even do an old fashioned thing such as sit on companies’ boards. So OurCrowd appoints representatives where possible to sit on the board of directors of the companies we invest in to represent our investors. And we don’t take any money as a result of the placement of the investments from the companies, because we feel that by charging the companies’ fees you are going to get a negative feedback loop and get worse companies.

What we do is take management fees from the day of the investment going forward, as well carried interest or upside or success fee from the investors themselves. So the investors who invest we align our interests with them. They only pay us for post investment management and then success at exit, and we think that’s the right model.

It is again more like a hybrid of old fashioned sort of venture capital best practice mixed in with a little bit of new age crowdfunding opening up to instead of just big heavy institutional investors, individuals who can start from US$10k on up. It is not a couple of hundred dollars that you can find on sites like CrowdCube, so it is not quite so democratic. But it is democratic enough for our investor base which at the moment is about 13,000 people around the world.

The other element I think we are a little different on is that we are highly global. About half of our money comes from North America. The other half is pretty evenly distributed among a 110 different countries in the planet. Our company base is about 70 per cent Israeli. So we are very focused on our home market in terms of bringing money to the StartUp nation. But we are also investing all over the world in U.S start-ups, we have a UK start-up, we have some in Australia and we are looking all over the world. We are also doing partnerships now: we have announced one with the UOB Bank of Singapore. We will be making further announcements about additional global expansion. But we are much focussed on not only democratising this asset class through opening serious investing from accredited investors and qualified investors [is how] I guess you call them in the UK, but also in terms of making this a global activity.

Why is it good? I think it is good because it encourages innovation. I think it builds ties between countries, and I think the future of innovation is about linking disparate investors around the world to global opportunities and in particular mobilising the crowd not just to raise money but actually act as force multiplier for the companies. So we spend a lot of time [talking] about how we are mobilising our 13,000 investors on behalf of our companies to help them raise additional funds, to make connections with distribution, to find hires etc. So this is crowdsourcing essentially of the company building process and not just the investment process.

The Israeli venture capital ecosystem

It’s been quite a good couple of years. It turns out over the last two years since 2013; the amount of venture dollars invested in Israeli start-ups has more than doubled. It has gone up over 100 per cent. In 2013, the dollar amount was about $2.2bn; last year it was about $4.5bn; and this year, so far the first quarter was up 10 per cent from last year. So it looks like we’re going to do, if we continue these trends, actually more. And this is a little different. We are bucking the trend globally. Where venture investing has gone down – equity crowdfunding has gone up all over the place – but venture investment has gone down in the 10-20 per cent range depending on which country you are in. But here in Israel venture investment is still up.

Question: You have got that high minimum, relatively speaking this is, because on CrowdCube over here in the UK, as I’m sure you know, we have a £10/£20 minimum.

Medved: It’s a wonderful thing, a great thing.

Question: And often on Seedrs it is similar as well, and I would say that their approach to due diligence isn’t quite as high a bar as you have on your platform, if I can put it that way, in terms of over 90 per cent of people being turned away. So can you tell me why you have chosen that model? Why did you want to set the bar quite high? Why do you take that quite curated approach rather than just letting it be, for want of a better phrase, kind of like a dumb platform and people can make their own minds up about the quality of the investment?

Medved: First of all, I think it is cool that there are multiple models out there in the market. And I have a lot of respect for those UK companies and for the extent to which the UK has really pioneered this kind of crowdfunding. In the U.S, where a big chunk of our investors come from, the kind of £10 crowdfunding was not available until two weeks ago, literally the laws just changed – you know, Title III. You are now seeing the emergence of a couple dozen portals that will do that in the U.S with a small amount for any investor who wants to get into it. I think that’s great and wonderful, and most of those platforms will also not be curated. I think that they have their place and there will be companies that will go there. There are issues, however, with them in many of these cases – and I can’t really comment specifically about the CrowdCube or Seedrs – but in many of these cases people are buying non-voting stock. They are buying common shares. They have no representation on the board. There is no one there to manage their investment after. They are basically investing, yes. But it is like you’re watching a horse race and there is nothing you can do. You might have made a very informed decision based on jockey performance, good breeding of the horse, but there is a bunch of guys in this race and you have to hope that yours is going to win. Ours is a little different. We want to fix the race.

We want to influence the outcome. We think that it is extraordinarily important to help these companies. These companies don’t just need cash, they need help. Not that they need to be told what to do or they need to be managed, because we don’t do that, but we want to be active investors. And we want to sit on their board, we want to help them with strategy, we want to mobilise OurCrowd to provide added value. We want to give them global reach. We think it is a process of at least our model of crowd investing is not just the funding part but is the crowd building. And it starts literally the day that we write the cheque. It doesn’t end the day that the money has been invested. And I think that’s a very different model than many of these other companies who are raising larger sums per company but smaller amount of companies.

So I think that overall we are pretty much neck and neck with people like the CrowdCube in terms of total capital deployed. I think they’re something at the £160m level, and we are about US$230m. So it is really uncannily close in terms of where we are. But we have done this on literally less than 100 companies, so the amounts we are investing average out to be a little over US$2m per deal.

And we are also investing in technology companies by and large. We haven’t yet done a brewery, I won’t say that we won’t, we haven’t done food companies. And I am not saying we won’t. But we focus on chips and the internet of things, and big data and cyber security and optics and agricultural technology. So you look at our site and you will see things that are generally strong credentials in technology. And especially in those companies you just throw them up and let the crowd decide, that’s dangerous. You want some kind of a gatekeeper who has gone through it and has had experts look at it. Who has essentially looked at in and said ‘I believe this in enough to put my own money it’, and we will let you make a decision if we are right or wrong and we will work really hard after the money is raised to represent you and to manage this investment on your behalf. I think all the models are interesting and all I can say is that we have had some significant success already with our model. We have had a very successful IPO for a company called ReWalk which makes exoskeleton for paraplegics so that you can get up and out of your wheelchair. That was a very successful IPO in 2014.

Question: What was the return for your crowdfunding investors?

Medved: It depends when they came in, because they did two rounds, but they made between two and three times their capital. And it depends when they sold the shares because we were locked up for six months and then we distributed and some probably held and the stock went down and then the stock went roaring back. It is a very hard. At distribution it was between two and three times depending upon the round.

Then we sold a company recently, it was reported in the press, to Intel, a company called Replay Technology, which according to the press sold for US$175m. What was cool about this one was that it happened three months after we invested our money. And then recently we had a company bought by Oracle, a company called Crosswise, which is in the big data for identity management area. That was representative of a blended return of about 4 times the money. So we haven’t yet had a towering 50 or 100x, but I hope we do, kind of returns. But we are getting solid returns and a bunch of exits. Some of the sites are actually saying OurCrowd exit 5, OurCrowd exit 6. So I think that when you look at our site we probably have at least the highest percentage I would guess of exits of any other crowdfunding platform.

Question: In the UK there has only actually been two exits full stop, in the sector.

Medved: I guess we are doing pretty good then.

And we are focussed on that. Our whole sort of mantra is both curate on the front end and work our butts off as soon as you put the money and help them all the way through the process, and by the way, re-invest on the way up. About half of our companies have already gone back to our site to raise additional funds. That’s another difference between us  and other crowdfunding companies. The numbers of companies that raise more than one round in the same crowdfunding site are very, very small. But on our site literally half the companies have already done so.

Question: Obviously, it is a risky area investing in start-ups. How many failures have you had of the 100 or so companies that you have backed?

Medved: Well the question is: is it a total failure already? We have lost every penny? And so far the answer is zero, believe it or not. But we have at least a dozen that are deeply challenged and a few now that are exiting, in what I would call face saving… company being sold for its assets to another company at pennies on the dollar kind of thing, and those are now starting to occur. And by the way we’re proud of some of them because it is better than nothing. In other words, rather than a total blow up getting a dignified exit where you have a little piece of another start-up which may or may not return more is better than a poke in the eye. I would predict that we will have at least a quarter to a third of our companies fail in one way or another, or certainly fail to return capital, if not more.

Question: That would be pretty good, wouldn’t it, if it was that low?

Medved: That would be astounding.

If we pulled that off, we’re not there yet. People have said “oh wait a minute you haven’t had a complete total failure yet? What’s wrong with you?!” And I say “we’re working on it. We’re working on some total failures.”

So far so good. We have a lot of really exciting companies that are making us a lot of news. There’s a company we have called Consumer Physics which are the makers of Scio, which is a little tiny mass spectrometer that lets you scan everything. It’s sort of like Google for matter.  They were just featured on Bloomberg TV Hello World last week.

You can see a company called Syqe that is probably the leading medical grade cannabis delivery platform in the world. You can see a company called Medaware where we co-invested with General Electric.

So that’s another difference of ours. We co-invest I would say in 80-90 per cent of our deals with leading venture capitalists or corporations. So you will see the likes of Andreessen Horowitz, Sequoia, Excel, Bessemer, Battery, General Electric, Microsoft, they are in the same field as we are at the same rounds at the same prices. And that’s what is interesting about the deal flow because if you do curate and you are writing a big cheque and you are aggregating and you are buying preferred stock then you become an acceptable sort of member of the club. And yes, you have a weird way of finding your companies, at least weird in the traditional VC sense. And you are limited partners, you are not the big bank and pension funds, but that’s okay because you are managing it, you are sitting on the board and you are following your bets and they respect that. So this company Medaware is doing prescription malfeasance managements to prevent you from god forbid killing your patient in the hospital by mistake. There’s a company called Sight Diagnostics that has got the most exciting anti-malaria diagnostic platform in the world in my opinion. We are co-invested with Eric Schmidt.  We have Zebra Medical, which is doing deep learning for radiological images and we are co-invested there with Marc Benioff from SalesForce and Vinod Khosla from Khosla Ventures, and a host of other companies which look at what’s on the site right now. We have a company called Plastiq, which is a company extending credit card capabilities to pay your college tuition or your state or county taxes, or your mortgage even, and we are co-invested with Flybridge, Atlas and Khosla,  a company growing very fast. We have a company called WayUp which is a great new site for college students go to to get internships and jobs. We are co-invested there with Index Ventures and General Catalyst. We have HIL Medical up on the site which is a company doing proton beam therapy but much smaller machines instead of football field size. It uses desktop laser excitation of Nano targets. This company the co-investor is IBA (Ion Beam Applications), which was just featured in the Wall Street Journal about their leadership in the proton beam market.

So it is a different beast. It is more like a democratic venture fund if you will in terms of where we are. And we are well aware that the $10k is a high bar. We figured that since we want to deploy large sums of money and we are operating under regulatory regimes where we need to deal at the moment with either qualified sophisticated or accredited investors, wherever your country calls them. We would then raise the bar and it seems to have worked for us.

Question Is that how the Israeli regulation on this area works then? It has to be sophisticated in that sense?

Medved: That’s correct. In Israel the regs are really Draconian. They require US$2m of net assets outside of your house or a US$250k annual income.

Question: Wow. Do you have some UK investors coming onto the site to back these companies?

Medved: We do, thank God. And we hope to have more, and we would love to do more [in the UK]. Look, I think that the UK is now a spectacular place for innovation. There are some cases in the UK where there is more innovation and less money, meaning that there is too little money chasing too many good deals. That’s great. I think your EIS schemes are wonderful and I think that the UK is on an absolutely a clear upswing and if anything I am a little bit sorry that we haven’t been as active there as we would like. I hope to correct that over time. We are going to be at the Wired Money Conference in a couple weeks, I’ll be speaking there. And we want to do more than we have done today in terms of building… the UK-Israel ties, I think, have huge potential. I think it is all about linking up different ecosystems and working together and using different skillsets. The Israelis are really good at getting hard tech prototypes done quickly. You guys are much better at marketing and making the consumer and the customer happy, and scale up. Bringing those two skillsets together by opening our offices in your country for little Israeli start-ups, we are very keen on this.

Question: Can I just ask, Jon, do you see that as the main place where Israel and the UK come together on tech in that way. Are there any other areas? It is quite an interesting way of framing it: this kind of the hard tech plus the marketing. Are there any other areas where you think [that the two can come together]?

Medved: I think there is a lot going on in terms of healthcare and medical technology. We are particularly focused on digital health. We just made an investment in Sweetch which is a pre diabetes management platform and we co-invested in the seed round together with Phillips Corporation of Holland. And I think that healthcare, in the Internet of Things, in self-driving cars and cyber security. We have a lot of companies in our cybersecurity platforms, including seven companies that are aggressively working, aggressively in the good sense, with UK banking organisations because the city is so incredibly out there focused on how to secure all of our money. I think it is a whole slew of collaboration. What is interesting, though, is that there really isn’t a way for global investors to connect to especially tech start-ups. While you will see an occasional tech company on CrowdCube or Seedrs you don’t see a lot of them. You will see mostly consumer oriented plays it seems to me, which is fine, and those are very interesting companies and great, but I think that there is a lot of interesting tech companies coming out of the UK and I think people want to invest in them and we hope that we can get some of them to list in our platform.

Question:  I just wanted to know of that US$230 million that you guys have done, what proportion of that has come directly through the platform if you like. This has been an area we kind of discussed a bit in the UK where a platform quotes a headline number but actually when you look at it we are not actually sure how much money has been…

Medved: If you take the number of dollars which has been invested in the companies we have invested in it is well over US$1bn.

Question: So that US$230m is purely through the platform?

Medved: This is purely through the platform. I have got a lot chutzpah but that much chutzpah I don’t have. That much cheek?

Question: The way it works in the UK, so the money on CrowdCube or whatever, a lot of that will have been lined up for and come from Angel investors or whatever and then it is put in the platform.

Medved: This is fee-bearing. I think in the financial world we call it FPAUM: Fee producing assets under management. This is when someone is investing through us and we are taking management fees and carried interest on it.

All the money, the millions of dollars that are coming along side of us by venture capitalists or other Angel investors who got to the company before we did. I mean, I don’t have the cheek to add that to my numbers. I’d love to!

Question: You think they shouldn’t be adding that to their numbers, would be a polite way of putting it?

Medved:  Look, I don’t understand what your numbers mean if you are quoting all the money that the company has raised through other methods. We quote specifically the amount of money we have raised for the company, period.