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What the SEC Letters to FundersClub and AngelList Mean for Investment Crowdfunding

What the SEC Letters to FundersClub and AngelList Mean for Investment Crowdfunding

Editor's Note: The following comes exclusively to from contributing expert William Carleton, an attorney with the firm McNaul, Ebel, Nawrot & Helgren who has been keeping his eagle-eye on the SEC, the JOBS Act and crowdfunding for some time now. To read more of his thoughts on platforms like FundersClub and AngelList, visit his blog here. We welcome your thoughts and reactions in the comments section below.

"Looks like FundersClub and AngelList have both been given a blessing of sorts from the SEC."

So wrote's Managing Editor, Eric Mack, when asking for my reaction to the two, back-to-back "no-action" letters (click to see the letters to AngelList and FundersClub) released on the SEC website within the past week.

Eric's right.

These letters from SEC staff establish a green zone of legal calm in the ever escalating drama that is online startup investing.

- Three Things Broken in Investment Crowdfunding That SEC Regulations Won't Fix
- Does the Crowdfunding Portion of the JOBS Act Need a "Do-Over?"

But it's just that, a green zone. Plenty of room outside the confines or "walls" of the no-action letters for crowdfunding portals and other online investing platforms to get into trouble.

Keep that in mind as we consider the positive lessons. We'll come back to the limitations of the letters at the end of the post. At the outset, though, let's take a couple minutes to talk about the "no-action" process.

No-action letters are not laws or rules

When the SEC takes a "no-action" position in a letter to a company or individual, it isn't actually making a rule that has the force of law. In fact, technically speaking, the SEC itself isn't acting, or not acting. Instead, the letters express a sense of SEC staff, who, when the "no-action" request of a company is answered positively, say: "Based on the facts and representations set forth in your letter, and without necessarily agreeing with your conclusions and analysis, the Staff will not recommend enforcement action." That exact quote appears in both the FundersClub and AngelList no-action letters. 

No-action letters are always fact-specific and are always conditional. Indeed, both the FundersClub and AngelList letters expressly state that the SEC staff might modify or revoke the position "at any time the Staff determines that such modification or revocation is consistent with the public interest or the protection of investors."

Nevertheless, it is fair to say that lawyers consult the body of no-action letters published in a given area, to help advise clients on what is and isn't kosher. It's also true that, in setting out a statement of facts and making legal arguments to support a no-action request, companies reveal business models and strategies that can become models for others to imitate.

It's also fair to say that no-action letters are rarely, if ever, as high profile as these two. You have to infer that SEC staff went about preparing these letters carefully, knowing the attention they would get within the startup and venture investing community. Consider also the dates on the letters requesting no-action assurance, and the dates on the SEC staff's responses - a four day turnaround for FundersClub, and a two day turnaround for AngelList. The ostensibly quick turnaround suggests that we're seeing the end result of a negotiated back-and-forth.

FundersClub as retail VC

What FundersClub's no-action letter signals is that FundersClub can legitimately rely on the kind of legal exemptions that permit VCs to set up and manage venture capital funds without registering or being regulated as broker-dealers. All while conducting its business online and "crowdfunding" the investment dollars.

Unlike a typical VC firm, however, FundersClub stipulates that it will not charge a management fee for the investment funds its management arm will operate. Eschewing the typical "2 and 20," where a VC firm charges an annual fee equal to 2% of funds under management and takes a 20% backend carry (or interest in the profits of the fund), FundersClub tells the SEC staff that it will take only the backend carry. Moreover, FundersClub discloses that it may increase the size of the backend carry, on a case by case basis, to as much as 30% of a given fund's profits.

This is an admirable set up. The interests of investors placing money in FundersClub investment vehicles should be aligned with the interests of FundersClub, which itself only profits if and after investors in the fund see the return of their initial investment.

What's not said in the FundersClub no-action letter, neither in the statement of facts presented by FundersClub nor in the response from SEC staff, is how FundersClub itself is financed. According to CrunchBase, FundersClub has raised $7 million in angel and venture capital. It might be fair to think of that money as the FundersClub management fee, pre-paid, if indirectly, on investment funds to be specified later.

Put another way, FundersClub could be showing the way, not only for other upstarts to disrupt traditional VC firms, but also for VC firms to syndicate interests in their back-end carries by selling interests in fund management vehicles to investors.

AngelList and the power of curation

AngelList's request for a no-action position (contained within the AngelList no-action letter) lays out a model where AngelList might also facilitate the setup and management of startup-specific investment funds, not unlike the FundersClub vehicles. But in AngelList's proposed model, the attraction of the given investment opportunity would be in how it leverages the skills and experience of a "Lead Angel," who would pick the given startup and might structure and negotiate the terms of the deal. The Lead Angel might also provide hands on assistance to the startup, post-investment.

As does FundersClub with respect to its model, AngelList stipulates that its new, Lead Angel-centric fund model will not involve a management fee, but instead will restrict compensation to a backend carry. In AngelList's case, the carry would be shared between an affiliated AngelList company, AngelList Advisors, which will register as an investment adviser, and the Lead Angel.

The secret sauce of the alternative model AngelList proposes is in the selection of Lead Angels and potential portfolio companies. Both angels and companies would have to pass muster with AngelList Advisors. Here's a description of the process from the AngelList letter to the SEC:

"Each Lead Angel will be subject to the diligence and approval of AngelList Advisors, and must generally be a well known, experienced venture capital investor with demonstrated experience investing in and working with start-up companies. Likewise, each Portfolio Company will be subject to AngelList Advisor's diligence and approval process, and must meet certain established guidelines prior to being approved for investment."

AngelList's request letter goes on to give examples of the standards that might be imposed, including an evaluation of "the likelihood that the Lead Angel will be able to add significant value and assistance to the Portfolio Company."

It's important to add that Naval Ravikant of AngelList has publicly stated that the business model outlined in the no-action request is not necessarily indicative of any change of emphasis in how AngelList currently operates. As quoted by Danielle Morrill on her blog, Ravikant states that the no-action response from the SEC staff "lets us know the legal boundaries of what’s possible in the space and will inform our future products," but that the company is currently satisfied with the relationship it has with SecondMarket, a registered broker-dealer. SecondMarket, Ravikant explains to Morrill, "vets investors for sophistication, companies for background, and provides Broker-Dealer level protection and compliance."

The strings attached

What are the limits of the FundersClub and AngelList no-action letters as precedent for other platforms?

First and foremost, neither AngelList nor FundersClub are relying on investment crowdfunding under Title III of the JOBS Act, the implementation of which true believers in the democratization of private financing are anticipating with high hopes (in vain, in this writer's opinion). No, FundersClub and AngelList restrict the investment opportunities they facilitate to accredited investors, angels, in order that their startups may rely on the Rule 506 exemption that has been the legal linchpin for angel investing in America for decades.

What's more - and this is surprising - AngelList did not, and FundersClub effectively did not, make their respective cases dependent on Section 201(c) of the JOBS Act, a legal reform that is already on the books (unlike Title III crowdfunding, which is waiting on rules for implementation) and that expressly permits angel groups to maintain "a platform or mechanism that permits the offer, sale, purchase, or negotiation of or with respect to securities" (in all cases where deals are limited to accredited investors, a limitation FundersClub and AngelList currently follow).

Instead, FundersClub and AngelList went to great lengths to describe business models that, while innovative to be sure, squeeze into existing legal precedent for exemptions from broker-dealer requirements.

This meant that each had to stipulate it would take no commission on sales, no finder's fees, no success fees, nor even (as noted above) management fees. They had to agree that the only compensation for advising (in the case of AngelList) or managing (in the case of FundersClub) the investment vehicles formed would be a carried interest.

What's more, each had to come to terms with the prospect of investment adviser status. In AngelList's case, registration as an investment adviser is prospective, to occur if and when AngelList Advisors is formed. In FundersClub's case, it has already made a filing as an "exempt reporting adviser." (Thanks to Doug Cornelius, the excellent legal blogger, for pinning down FundersClub's filing status.)

What's next for everyone else?

Committing to take only a carry is a true kind of co-investment - if in time and opportunity, rather than cash - and, as I said above, it is admirable. But a 100% dependence on a carry can't be the only model for all angel crowdfunding platforms, and the nascent industry is going to need to see other precedent develop around the shiny new exemption provided by Section 201(c) of the JOBS Act.

Moreover, given all the restrictions imposed by Title III of the JOBS Act for crowdfunding platforms that desire to be open for non-accredited investors, there may be very, very little in the FundersClub and AngelList models to imitate. (Aside: I think the future for non-accredited investment crowdfunding law is in pressing state legislatures to pass simpler, straightforward intrastate exemptions. See this crowdfunding bill introduced in Washington State by Representative Cyrus Habib, inspired by a post in GeekWire by Seattle startup attorney Joe Wallin.)

My thanks to Eric and the editorial staff for inviting me to write this post. I follow this subject closely on my daily blog, Counselor @ Law, under the category "Angel platforms." Much more is going to happen in the next couple of years, so, if you have a keen interest in this subject, please join the discussion threads on my blog as well.

-- William Carleton is with the firm of McNaul, Ebel, Nawrot & Helgren. He also has experience as a startup lawyer and angel investor. Follow him on Twitter @wac6, and check out his previous articles here

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  • Guest Alexander Davie Apr 02, 2013 08:18 pm GMT


    Very nice article and summary of this development.

    I guess I'd question how revolutionary these no-action letters are. Essentially these angel investment platforms are acting as investment advisers in that they are receiving their carried interest for what is essentially monitoring an investment for the investing entity. It seems no different than what private equity, venture capital, and hedge funds have been doing for years, without registration as a broker-dealer.

    I have seen some on the ABA Private Equity list-serve suggest that receiving equity in a deal in the form of a carried interest is a form of transaction based compensation which requires registration as a broker-dealer. But I've always disagreed with that conclusion and I guess in some ways this confirms the thinking that I and many other lawyers that carried interests have never been broker-dealer activity but rather advisory activity.


  • Kiran Lingam Kiran Lingam Apr 02, 2013 09:33 pm GMT

    Great post. Why would AngelList go forward with registering as an investment advisor and not rely on the venture capital exemption (thus filing as an exempt reporting adviser like FundersClub)? If they register, AngelList would be limited to taking a carry from only "qualified clients." Any thoughts on the rationale here?

  • William Carleton William Carleton Apr 03, 2013 10:16 pm GMT

    Just seeing Alexander's and Kiran's comments. Thank you both for the compliments. Alexander, I take your point that these no-action letters are in line with what might be said to be settled doctrine. Perhaps what's different here is that prior rationales are being extended to overlay activity taking place quite publicly, and online, in a way that looks very much like crowdfunding (I maintain that it is, in fact, crowdfunding). What's curious - and this is not something we had room within the post to explore - is that by using existing broker-dealer exemptions by analogy, and bypassing Section 201(c) of the JOBS Act, ostensible concern over general solicitation and heightened scrutiny of accredited investor verification seems to have fallen away. Kiran, good question, but I can't say I have my finger on that rationale.

  • John Myer John Myer Apr 05, 2013 03:06 pm GMT

    Great post, Bill. By way of background for non-lawyers reading your post and the comments, the problem with angel platforms has always been the need to avoid broker-dealer (BD) registration. Exemptions prior to the JOBS Act were (and apparently still are) helpful, but Section 201(c) is broad and states that platforms that sell to accredited investors under Rule 506 need not register as BDs as long as they don't take commissions. But the statute also says they can't provide investment advice,and that is a problem. It is also the likely reason why AngelList and FundersClub did not want to rely on Section 201(c). BD registration needs to be avoided because all BDs are members of FINRA, and FINRA's rules do not permit a BD from doing anything less than underwriter's due diligence, which is financially infeasible for angel deals. As far as registering as an Investment Adviser (IA), while Kiran Lingam is correct that it is tempting to rely on the VC exemption, that only applies to large platforms (with $100 million under management). The states have no such exemption (NASAA, get cracking, please) and very few platforms will be able to come out of the gate with that sort of book of business. So if an angel platform tries to rely on Section 201(c), it will run afoul of state laws, which have a broad, catch-all definition of investment advice. Interestingly, while IAs are not FINRA members, since so many banks are both BDs and IAs, FINRA administers the test (Series 65) required to becomes an IA. That test, of course, deals exclusively with investing in public securities, and totally ignores start-up finance. If none of this makes sense, then you probably understood this comment perfectly.

  • none none Apr 06, 2013 12:27 am GMT

    Hi Bill,
    Thank you for sharing your insights on this matter. I am a little bit puzzled about one of the points you make in your piece, and I have a couple of follow-up questions too.

    You point out that "AngelList did not, and FundersClub effectively did not, make their respective cases dependent on Section 201(c) of the JOBS Act" -- why do think that is? As you note, both no-action requests seem to be testing the limits of current VC regulation. Do you think that there is as signal hidden here?

    Regarding carried interest without management fees or similar;
    Wouldn't such a compensation model induce the platform/advisor to promote (or host) only highly volatile ventures? And do you think carried interest compensation (for funding portals) would be workable under the JOBS Act?

  • Kiran Lingam Kiran Lingam Apr 08, 2013 08:34 pm GMT

    Thanks John. Interestingly, California (where AngelList and FundersClub both operate) does in fact have a venture capital exemption, which also exempts them from the "Qualified Client" limitation. See Do you have any thoughts on why AngelList would choose this course given the availability of a state exemption?

  • Guest Josh Maher Apr 09, 2013 10:35 pm GMT

    This is a great article John, I wonder if a state specific fund would change the dynamics here. For example, if the funds were raised in Washington State and invested only in Washington State.

  • Guest David Nov 25, 2013 07:58 pm GMT

    Thank you for doing the work and analysis behind this very helpful post.

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