In this interview with Rod Turner, Chairman and Founder of Manhattan Street Capital, we discuss using Reg A+ for funding real estate ventures. Question we answer include:
- Why Real Estate is Succeeding with Reg A+ ($160 Million Raised To Date)?
- Is it Possible to Raise More Than $50 Mill Per Year?
- What are the Up Front Costs and Total Costs of a Reg A+ Offering?
- When Can We Do Our First Closing?
About Rod Turner:
Rod Turner is the Founder of Manhattan Street Capital, the #1 Growth Capital marketplace for the best mid sized US and Canadian companies. He has been the Senior Executive for two IPOs to NASDAQ (Ashton-Tate, Symantec). Rod was an Angel Investor in Ask Jeeves, INFN, AMRS, eASIC, Bloom Energy. He is a high energy strategic thinker with an engineering background and skills in all areas of business. He is also an experienced M&A expert. Rod is a contributing writer for Forbes. You can contact Rod at RodTurner@MahattanStreetCapital.com.
Patrick: This is Patrick Henry, the CEO of QuestFusion, with the Real Deal…What Matters. I’m here today with Rod Turner. We had a very successful webinar about Regulation A+. It was a general overview. There were a lot of questions after the webinar, specifically about Regulation A+ and as it relates to real estate transactions. There are some unique nuances associated with that.
Rod is the Chairman and President of Manhattan Street Capital. They are a leader in raising Regulation A+ financing for growth companies. I’ll let him give you more background and then we can jump into it.
Rod: Thank you, Patrick. I have had the good fortune to make a lot of real estate investments over time of various kinds. When it comes to Manhattan Street Capital, we’ve been doing this for two years, focused almost exclusively on Regulation A+.
I’ve had a key role in building six successful startups, two of which we took public to the NASDAQ. One of them was Symantec, the company behind Norton Antivirus, which my team introduced. I’ve had a lot of relevant experience.
I have financing experience based on a technology background in entrepreneurship. Manhattan Street Capital focuses on raising money for companies using Regulation A+ primarily. That’s our area of expertise.
Patrick: There is a rumor out there that Peter Norton still gets $1 a copy for every copy of Norton Antivirus.
Rod: I’m sure that’s true. Based on the original agreement, it’s substantially better. I imagine it may have been renegotiated five or six times.
Patrick: The first topic is learning how to make the most of Regulation A+ to raise capital for your real estate venture. Are these typically real estate investment trusts or other types of real estate investment vehicles?
Rod: They can be eREITs but they don’t have to be. That’s a valid mechanism to use.
Patrick: Maybe we can talk about that. We’ll explain the steps to take and the mistakes to avoid when planning and implementing your Reg A+ offering. Why is real estate succeeding with Reg A+? There has been $160 million raised to date. This is a relatively new vehicle for raising capital. Why the success with real estate?
Rod: To put that into perspective, that’s about 40% of the total capital raised in Reg A+ to date. It’s in real estate.
Patrick: That’s a single segment. There are probably a dozen or more segments.
Rod: Yes. It’s by far the leader. From an opportunity standpoint, consumer investors are primarily funding these companies and investing through Reg A+ at this stage in the process. Accredited investors and institutions are waiting for Reg A+ to be proven. We need to appeal to consumers.
Consumers can identify with real estate. A lot of Main Street investors would love the opportunity to go out and buy a building, but they don’t have the time or the capital. Being a part of such an investment when the terms are attractive is interesting.
Then you have the tangible asset of the real estate itself. Those are the fundamental reasons. I think the third one that matters greatly to people is that, most real estate transactions are paying a yield or preferred return. For the man on the street, when you’re getting a half percent, if you’re lucky, on your bank account, the idea of getting a 6% or 8% preferred return on your investment and having an upside as the project succeeds is very appealing. You have a combination of those factors, especially if you are looking at investing in real estate in a different country. Some people find this difficult, however, there are companies similar to Piermont Grand EC who might be able a good place to start with real estate investment.
Patrick: Then a lot of it is deal structure. Other verticals could duplicate this success rate, potentially, if they pay this high yield?
Rod: Yes. The high yield thing is something that I’ve been pursuing, and I’m suggesting that to some of our other companies that aren’t in real estate. There are entirely legitimate ways to do that.
Patrick: That’s really interesting.
Rod: It broadens the investor base.
Patrick: There are some people who don’t invest in stocks unless they’re dividend-bearing, including big mutual funds. They have certain funds where, unless you pay a dividend, they won’t invest, no matter how good your company is. This was a key catalyst when Intel first started paying a dividend. They’ve been paying it a long time. It was the same with Microsoft and Cisco.
Rod: Everyone in the US knows that real estate is on an uptrend. Just ask professionals like Eddie Yan if you want to find out about real estate.
Most people would say that interest rates are not going to go up to high levels anytime soon. In this environment, one can feel like this is going to be a good place to be. Real estate is going through a very positive phase. But people are frustrated that they can’t do more.
Patrick: Interest rates are so low that, even if they went up by 50%, they would still be massively low. Getting financing is a different story, but that is a topic for a different day.
Rod: That is gradually normalizing, one is led to believe.
Patrick: Is it possible to raise more than $50 million in a real estate investment using Regulation A+? I know there is a $50 million cap. Are there ways to deal with that?
Rod: The SEC is happy to approve certain transactions. When a business is raising money, that money can be distributed and invested in different geographic regions. In the US, you might divide the US into six regions, where you would attempt to make each one of them about the same size, from an invested capital standpoint. Then each of them can raise $50 million for each of its territories. If you have six regions within the US, you could raise $50 million for each one in parallel, and then do the same thing next year for each one.
Patrick: You can do it every year?
Rod: Yes, every year, you can do a secondary with Reg A+. There is this $50 million limit but it doesn’t apply to real estate transactions and some others where you can divide a geography into different regions. You can divide Southern California into different geographic regions and have a fund for each.
Patrick: There is no set rule that says, “We’re going to break the US into the 12 territories or 50 states?”
Patrick: Is there something special that you need to do in your filings that allow you to do something like that?
Rod: Yes, but it’s not difficult to do. The challenge is that you might start off with one offering for $50 million but you would carve out one territory, knowing that you’re thinking of another five, in the example that I gave.
Patrick: In your filings, you would say, “This is specifically for Los Angeles County?”
Rod: Yes. That would be the test case scenario. When you like the model, you roll with that. When you negotiate with the service provider that does the legal filing, you would want to get a package deal. Each one of them is a replica of the others with very few changes.
Patrick: Are they different limited partnerships or different LLCs for each of these? Are they each a different entity?
Rod: No, that’s the point. You don’t need to have separate entities. You could, but you don’t need to. That’s a huge plus. The two other areas that I see for that are private equity funds, dividing up a region geographically, and venture capital firms where there is a limit. Up to 40% of their holdings can be in equity. Then, a minimum of up to 60% have to be in debt. That’s not a regular venture fund. It’s a debt-based venture fund.
Patrick: What are the up-front costs and total costs of a Reg A+ offering?
Rod: For a sizeable transaction, Reg A+ is appealing for real estate, and in many instances, for larger sums. Then there is a slight increase in the fees. You need to have an audit first. That will vary depending on if it’s a brand new entity that you set up. If that is the case, it might be $4,000 for an audit that is a part of the filing.
Then the legal service provider would be $50K minimum per Reg A+ offering. Then there is the marketing preparation prior to going live with a marketing agency. These would be things like creating videos and graphical content, testing messages, and building social media presence in order to launch and have rapid success to bring in investors. The largest expense of that is the agency. The low end of the range is $100K. The higher end is $200K of up-front expenses for a much larger raise.
Patrick: These are specialized PR agencies that are working in this area or have a specialization in this area?
Rod: Yes. I like to call them 360-degree agencies. They’re covering PR and advertising in a traditional digital sense as well as social media advertising and creating videos. You have content creation, designing a very attractive offering page and a short compelling video.
There is a lot in common with donation crowdfunding at this stage because we’re appealing to consumers, just like they do in Kickstarter. It doesn’t compare to a whole raft of smaller offerings that are doing music. But on Kickstarter, a company that has a gadget that’s raising millions of dollars of donations as pre-purchases, you’re appealing to consumers who love what you do.
Patrick: It’s about running Facebook ads, SEO work on Google, content creation, all of the traditional digital marketing stuff that you would do, but this is targeted and specialized towards equity crowdfunding offerings.
Rod: Yes, exactly. There are a limited number of agencies that are good at that. We have selected four of them.
Patrick: What makes them good?
Rod: Practice and project management. You’re juggling so many different components and they all have to work at the right time. Cost efficiency is also important. If you were to take these tasks to a traditional marketing agency, they are on a whole different wavelength. They’re thinking six months to a year to build a brand. This is very different in terms of those things. Project management and cost efficiency are important.
Patrick: How does Manhattan Street Capital get paid? There is a cost associated with that as well.
Rod: Because we’re not a broker dealer, which enables us to charge lower fees, we are not allowed to do the marketing. We’re not allowed to promote our offerings as Manhattan Street Capital. The agencies are. We introduce the agencies and stay engaged to help baby the process and consult with the company along the way to maximize the likelihood of a successful ad and maximize the cost efficiency of it.
Patrick: You take a percentage?
Rod: No, we can’t do that. Because we’re not a broker dealer, we charge $50 for each investor and $50 of warrant coverage, which are like stock options.
Patrick: There is a requirement for a broker dealer in a Reg A+ offering transaction. From taking Entropic public, that is a huge expense. You have to be with broker dealers because they have the relationships and training. It’s really essential. On the legal, PR, the audit and agency side, this is a massively lower cost way to raise large sums of money versus an IPO.
Rod: Yes. When you involve a broker dealer, it’s around 10% of the capital raised, in this form in Reg A+ when the amounts are smaller. You wouldn’t really be able to raise the money at all in the past. It was a private placement and there is only $1 billion a year of that happening in the whole US. It is cost effective for the size of the offering relative to an IPO, that you couldn’t do anyway.
I want to mention some important aspects of the broker dealer conversation. They can add an intense amount of value once the retail transaction is already successful. Then they will bring in their clients. This will happen once it’s a no brainer and low risk for them with their client relationships.
They open up some “problem states.” It’s difficult for companies to sell shares into Texas and Florida in particular because they are not cooperating with the SEC. Then you’re talking about 14% of the US investing public. You get access to them easily with a broker dealer. Having a broker dealer on is great. But there are some complications that have to do with FINRA at the moment where the process of getting the deal approved by FINRA can be unpredictable and sometimes very slow.
Patrick: Whether you use a broker dealer or not?
Rod: No, only with a broker dealer. By having one, then the terms the company has negotiated with the broker dealer have to be approved by FINRA, which is entirely appropriate. That process is not as smooth and predictable as we want it to be.
Patrick: Does this deal with things like liability and having a fairness opinion? What are the hold ups with that kind of approach?
Rod: It’s that each dealer is generally a little different. Then you’re dealing with different examiners at FINRA. It would be neat if they had more employees doing this.
Patrick: It might be like the patent office where things are bottlenecked?
Rod: Yes. But then you hear about transactions getting through very smoothly, too. It’s that inconsistency. If you’re dedicated to having a broker dealer, then you can do it. The terms can be very reasonable. They have their up-front fee. They have the percentages they charge, which most companies are happy to pay. The primary issue is what I mentioned with this FINRA process. If you get far enough down the process and it’s still delaying, then you can choose to remove the broker from the transaction. Or, it might go great and there’s no problem. It’s a double-edged sword at the moment.
Patrick: As I understand, you can do multiple closings. Is that right? When can you do a first closing?
Rod: If you’re buying a building, for example, and the price is $20 million that you have to raise, then you cannot do a closing until you hit $20 million. If you are doing a “grow the business” strategy where you are going to buy buildings, then you do not need to have any particular buildings in mind when you start.
You don’t need to have a minimum. You can have zero minimum. That’s the normal process for most Reg A offerings at the moment. Unless you’re buying a business or some other asset, in which case, you can do the first closing after five days or two weeks, depending on how much capital you’ve raised.
Patrick: Do you have to state that in your up-front filing?
Rod: No. The zero minimum states it. It says that, if we were silly, we could close when we have $1,000 of invested capital. No one would do it because there are transaction costs for every closing you do. They aren’t excessive but they’re there.
Patrick: You still have an open ended deal up to the maximum that you state in your offering.
Rod: Yes. You end up waiting until there is enough money to justify doing a closing. You wait until everything is clarified and there are no issues. If there is some concern about a couple of investors then you would not close on those investors. You would close on the others. You can do that closing and then move on to the next one.
What’s more real-life is that you can set a maximum of $50 million, raise the $12 million you need now, and then pause the offering. Don’t close it, but pause it. Come back three months later at a higher valuation because the business has moved on. You have assets now and real estate that is performing. It’s entirely reasonable to turn it off and turn it back on. You can say, “We’ve taken enough capital right now. Let’s pause it.”
Companies like Realty Mogul and Fundrise is the best example so far. Once they had proven themselves, they opened one of their funds and raised $5 million in a few hours because they already had a lot of pent-up enthusiasm for it. They’ve raised about $140 million on Fundrise on three funds geographically divided.
Patrick: Over what period of time?
Rod: Approximately one year. They raised money and then paused it. Then they raised money again and paused it. This is real life. In a way, I think it’s what investors want to see. It’s real. You’re not trying to get all the money now just in case you can use it. You’re taking as much as you can deploy. You deploy that, and then come back and reopen. That’s fair enough. That’s more sensible.
Patrick: It allows you to establish a track record, which is very important for a lot of investors.
Patrick: An interesting thing that you brought up was about the broker dealers. Do the broker dealers see the Manhattan Street Capitals of the world, these fundraising platforms, as being competitive with what they do?
Rod: It’s a mixed bag. Some of them think it’s a concept, that you can never raise money online of any significant amount. Obviously, that’s been disproven. Some are still of that mindset. Some of them, we’re working with. We have arrangements in formal partnerships with them. We’re helping each other.
There are others that I refer companies to that are a misfit for us. I partner with them for our companies. There is a handful of great broker dealers in Reg A+. We work with them and are pleased to do so. I hope over time that some of the broker dealers, as they get attracted to the idea of building their own platform, will realize how difficult it is and then partner with us. I would like for us to get a significant amount of that kind of business, where they’ve done the tire kicking. They know the principles. They may have worked with them for years. Let’s work together. We already have a validated business. It helps both parties.
Patrick: How long does it typically take to complete a Reg A+ offering?
Rod: You’re allowed to continue raising money theoretically for two years. It’s really one year, and then you have to refile. Up to 12 months is the total amount of time from when the SEC qualifies the offering first.
Once the audit is done, then the marketing preparation and filing with the SEC is approximately 60 days. It’s two months to get ready after the audit. You can be raising money the first day after that. Let’s say that month one is when you make a substantial closing.
Maybe that would be 10% of the raise, enough to make it interesting and pay for the ongoing marketing costs. Maybe an offering where it’s gangbusters and we’re trying to raise the money all at once, if it’s a bigger number and a more challenging offer, it might take six months of live offering, after two months of preparation.
If we’re very lucky and it’s really a no brainer and it’s not only a good investment but you say, “I want that place. Can I get a deal to buy one?” then that’s going to happen faster. Maybe you have 60 days of raising capital. It’s all adjustable. You don’t start out with a huge marketing spend in the first weeks because you’re tweaking it, adjusting it and setting the parameters correctly.
When you have it working at maximum efficiency is when you turn up the burners. Then you know what’s working and it will work consistently for some time unless you tap out of the market, which would be hard to do with real estate.
Patrick: Now that you’ve done some of these deals, are you seeing any patterns or trends develop? I’m especially referring to the real estate segment where you say, “This is how it looks with best practices and what typically happens.”
Rod: Yes. There are two things that I want to make clear. One is that you are allowed to contribute, as an investment, a piece of real estate that you own. Some companies are interested in this. They raise money typically in a Reg D transaction or they have a pool of investors.
Then they borrow money, buy a facility, upgrade it and improve upon it. Then it’s ready for sale. It’s producing at a higher rate. They will sell it into the marketplace. Now you have the option to set up a Reg A fund that will buy that building and other buildings that have been through your first process.
You can stay involved and make money on them thereafter. Using that method of contributing those assets at fair value is a totally legitimate thing to do. It opens up a new avenue for companies already successful in real estate that otherwise would have had to let them go. There’s a limit to how much capital you can lay your hands on at any given time.
Patrick: That’s a tricky proposition. Fair value is typically determined by some type of arm’s length transaction. If I’m getting an appraisal on a building, that isn’t necessarily what’s reflective of the market. I might say, “I’m going to sell it. I’m going to cash out but I will contribute on the upside with an arm’s length transaction.” How is that regulated?
Rod: The SEC looks at that. They say that it has to be fair. It cannot be a conflicted transaction. Then it’s up to the company to determine a fair system. We will help advise them to the extent that we’re allowed to. We’re not valuation experts. There are professionals that are great at that. A chap I spoke with yesterday had a very successful real estate company. He said, “We’ll get five valuations and we’ll discard one. We’ll take the average of the remaining four.”
Patrick: That’s going to be their justification and they will hope that it holds up if it’s challenged.
Rod: Yes. I discussed that with one of my favorite expert attorneys that deals with the SEC. They were not concerned that it’s possible to construct a fair system that will pass muster. Of course, anything is a risk.
Patrick: All of that is disclosed in the offering?
Patrick: Someone will see the red herring and say, “This is what’s going on here.”
Rod: Yes. It all has to be above board. Writing those disclaimers properly is key. The other aspect was about nuances of these transactions. People tend to be confused about how you do Reg A. Think of it is a plugin investment engine. All the rest of the structure that companies are used to can remain. You have an advisor selecting buildings.
They don’t have to be part of the Reg A entity. As is the case now, if you’re doing a Reg D raising money, the advisors do not have to be a part of that. You structure a very similar mirror image of what you are already doing, except you’re using Reg A+ to raise money, potentially at larger amounts.
Given that Fundrise exists and is doing such a good job, I think it’s attractive for small real estate developers to go to them and see what their terms are. In that space, they’re offering good deals.
For companies that are regularly doing larger transactions, then it makes much more sense to do your own Reg A+ offerings that have control and don’t have two sets of fees. You want to be able to charge fees yourself. You don’t want to pay two sets of fees.
Patrick: Talk a little bit about eREIT that you mentioned. How does that work with Reg A+?
Rod: An eREIT is the same as a regular REIT that you see publicly traded. I’m going to use Fundrise as an example again here. Even though Reg A+ shares are liquid post transaction, as far as the SEC is concerned, Fundrise has wisely locked the shares so that they’re not liquid. Then they provide quarterly liquidity, which is limited because it’s a REIT. It’s limited anyway.
Whilst you are raising money, you can’t be liquidating investments simultaneously. That would cause a conflict. That amount is microscopic whilst you’re raising money. It goes up from there when you have raised money. The point is, you’re providing a reasonable liquidity path that exists.
It isn’t dependent on new marketplaces evolving. That structure of the REIT is defined and known. The differences are that you are not using brokers as a part of the buying transaction. You save a lot of fees there. That’s probably the biggest thing. When it comes down to the minimum investment amount, then you’re going to tune that according to your experience and preferences.
Some people have found in real estate that enabling very small investment amounts isn’t wise. People don’t think of it as an investment. They put $200 into something and you need them to sign a document and get it back to you promptly for an audit, they don’t even remember making the investment.
It’s not interesting enough for them to act. Setting a minimum that’s a little higher on some of these real estate deals is a better idea, like $1,000. I wouldn’t say this for a consumer-based company that has a gadget. That may be a smaller number.
Patrick: There isn’t a requirement for a broker dealer being involved.
Patrick: But you do have to provide liquidity. You don’t have a network of people making a market in that stock. How is that done?
Rod: You are not required to provide liquidity. It’s advisable to make the investment more attractive to the investors. If you say, “This is a 10-year project. You’re stuck and there’s no way out,” that’s going to turn off a lot of investors. That’s the reason to do it. What’s interesting here about Reg A+ is that I believe the SEC crafted a really sensible set of rules for reality. Some companies are raising smaller sums and they don’t want to list anywhere.
They will be really happy when it’s easy for their investors to transact sales of their shares. There are marketplaces coming along that will do that for non-listed shares. That’s one option. The other option that I just mentioned is locking the shares altogether. Those options exist.
You don’t necessarily have the performance right now that you want to justify big fluctuations in share price. Then there are companies that will choose to list on OTCQB, which if you do a successful Reg A+ transaction Tier II, you can list automatically. It’s $6,000. They raised the price for a new ticker symbol. Now you need market research. You need a research analyst service, which we’re building to make that cost effective.
Some companies will list on the QX. Now they have to report quarterly instead of once every six months. It’s still an annual audit. That zone, whether it’s on the OTC markets or others that don’t really exist right now, you have a very low reporting obligation relative to being a public company on the NASDAQ.
Patrick: You mentioned Tier II. What’s the difference between Tier I and Tier II?
Rod: Tier I is where you do not have any exemption from filing with every state that you raise money from in order to get their approval. That is a very expensive and time consuming process with some states. You wouldn’t want to raise money in Tier I from 20 states because it would probably cost you so much money for the legal services to file in each state.
Some of them are going to bog you down. Some of them are doing a merit-based review where they decide if this is a good risk. There are banks that have dominated Tier I. These are community banks that are generally local. They have some exemptions from state regulation when it comes to raising money.
Patrick: These are banks raising money as a bank?
Rod: Yes. That’s the most common use of Tier I, about 90%. Tier I is very attractive to companies outside the US if they’re not going to raise money inside the US. Now you don’t have to worry about the states. That’s an extreme and unusual case. They both start at zero and Tier II goes up to $50 million.
Tier I goes up to $20 million. Tier II has the disadvantage that there’s a reporting obligation of an annual audit and six monthly profit and revenue reporting. Tier I doesn’t have that obligation. That’s the reason why Tier I is exciting. You don’t need to have an audit to do Tier I, but it just doesn’t fly many times.
Patrick: There’s no requirement to take your company public if you do a Reg A+ offering?
Patrick: How do you organize a real estate offering?
Rod: Do you mean the Reg A+ aspect of it?
Rod: Testing the waters, for those that aren’t aware, is an aspect of Reg A+ where companies are allowed to put their offering up in a test mode in order to find out how much interest there is from investors. It’s been used up until now as part of a rollout. You’re spending the money.
You have all of the service providers locked in. You’re moving ahead. You do the “test the waters” thing as a way of getting reservations and prepping the market. In my view, it turns out to be a remarkably expensive way to do that. Once someone has made the reservation, now you have to go back to them later when you open for investing and persuade them to come back and sign up. That happens, but it’s expensive.
I personally recommend against doing test the waters in that form. Last week, we introduced a thing called Reg A+ audition, which is test the waters by another name. We package marketing services with this test on a low budget. Companies can do a two-month test. We’re not trying to shoot the lights out. We don’t have all of the other service providers already on board. We’re evaluating it to do a Reg A+.
Patrick: Do you have to have completed your audit?
Rod: No. Nothing is required up front except that we stick within the rules of no hype in the marketing. You can’t say, “This building will revolutionize habitation on the planet.” Our Reg A+ audition is a package of listing the offering on our site on Manhattan Street Capital and marketing services to inexpensively test the offering and engage our community, which is not an overnight thing.
People can find out easily and inexpensively if they should do this. You don’t need to have the big budget marketing plan to find out if it’s going to fly. It’s a matter of percentages. When you have the marketing experience, these days, digital marketing can be done very cost effectively.
Patrick: You can get a lot of data. You can get some statistically significant stuff. You can learn how to structure things properly. You can do a lot of A/B testing and see what messages resonate with audiences.
We do have a question. “What are the total costs and the breakdown for a $5 million fundraise for REIT on Reg A with about 100 investors, Manhattan’s fees, PR fees, NCC costs, legal and audit?
Rod: I touched on part of this. With a broker dealer, the total cash costs will amount to approximately 10% of the amount raised. It could be higher on a smaller raise. You wouldn’t raise $2 million. I say that $4 million is the minimum where you should use Reg A+. If you don’t use a broker dealer, then the cash costs will be about 6%. That is a very low total cost, plus warrants. We’re talking cash costs.
In terms of upfront costs, $100K is at the low end of the range. For a $5 million raise, it’s getting a little tight. The percentages might be a little higher with a $5 million raise. The cost of the audit will depend upon how long the business has been around. It’s the same with the cost of the legal services. That doesn’t change with the size.
The cost of marketing preparation will be less. The total cost of marketing tends to be 2% to 4% of the total raised. It’s not charged as a percentage, but I’m just giving you a broad strokes idea. How it will turn out with the mix of the fees depends on the minimum investment amount and the nature of the investor mix.
If we get 100 investors in for $5 million, that implies a large average investment amount. Our Manhattan Street Capital fee would be a low number at $50 per investor. That’s what we charge. If someone puts in $1 million, we get $50. We don’t have such a big return on that one. I think I’ve hit the numbers sufficiently.
Patrick: There’s no definitive answer. A lot of it depends upon your company. The audit could vary a lot. Have you had audited financial statements for the last three years? Are you doing a prep audit where you will go back and do forensic accounting?
Rod: It’s a two-year audit requirement, but you’re right. If you’ve already done that stuff repeatedly then it’s a much easier step. A lot of companies are setting up a new entity to keep life simple. That can be done in almost every case.
Patrick: I remember when we took Entropic public in December of 2007. At the end of 2006, it was clear that we had exceeded a valuation that an outside company was going to buy the company. There was a disconnect. We were going to be a higher valuation if we took the company public as opposed to an M&A transaction. I still felt like we were subscale.
We bought another company. Their shareholders had about a third of the company and we had two thirds of the company. That delayed the SEC process by three or four months. It was complicated. If you’re cobbling together a bunch of real estate firms, you’ve done M&A and you haven’t gone through a whole audit cycle related to that, it’s going to be more expensive and time consuming. These things can come up.
There is a part two to the question. “Does Manhattan Street Capital have direct access to its own investors or will Manhattan solicit from the open market?”
Rod: We have a small investor base because we’ve been primarily focused on bringing in companies over the last two years. We have only done one offering so far. We’ve been very selective as to what companies we want to work with. We want them to be successful in the aftermarket and their raise.
The truth is, all of the platforms have a small number of investors relative to the need. In an ideal world, when you have a large enough investor base that loves your business, that is the platform. When you put an offering up, then it would be lovely.
A lot of the investors will come because they love the reputation and the track record of the offerings we’ve already done. That is my aim. When that’s the case, then they will have a predisposition to look at any new offering we put up. That’s what we aim for. That’s the bottom line.
Today, in Reg A+, it’s new enough. No one has a critical mass of investors. We do not solicit investment because we are not a broker dealer. The agency does that. When we have more than one offering then we are able to market our list of offerings. We’re not allowed to say, “Go for this one. This one’s the best one. Put your money here.” We’re absolutely not allowed to do that.
Patrick: As you know, I recently used Kickstarter for my new book. If I went in there and said, “I’m going to plop my book on this site and expect it to generate,” it just doesn’t work that way in crowdfunding. Even in crowdfunding, the platform gives you access. But you have to do your own marketing. You have to build your own momentum.
This brings up an interesting point. A lot of what I did, the pre-work was a month before I launched on Kickstarter. Some of the other guys who have been massively successful on Kickstarter started six months ahead. This is pre-sales crowdfunding compared to equity crowdfunding.
What are the rules around that? It could be considered a general solicitation as soon as you blast out an email to 1,000 people and say, “I’m going to be on Manhattan Street Capital making an offering in six months.” What are the rules around that?
Rod: The test allows you to do that without a time limit. If you want to do that for six months to a year, you’re allowed to. Is it cost effective? When does the cost effectiveness peak and drop off a cliff? That’s a different issue. It depends on the nature of the offering.
There have been companies that went live with their Reg A filing, waited on their new audit for six months and then went back to the reservation holders. In one case, there were 22,000 of them. It was dead. The early adopters have blown. They’re on vacation. They’ve forgotten. They’ve changed their interests. They have a new hobby in six months.
Patrick: I’ve recently looked at some investment property for high net worth individuals using a hard money lender to be the broker. He said, “Until we get within 30 days, I can’t lock down an investor. Interest rates are changing and they have other investments that they’re making.”
Rod: It’s a mixed bag. On the audit front, be careful. There are some auditors who will take you all the way down to some pivotal point where it’s too late to switch, and then tell you it’s going to cost you an arm and a leg more, like 4X, and take a lot more time. You have to protect yourself against that. There aren’t many, but they do exist.
Patrick: The main point I want to make relative to comparing Kickstarter and Manhattan Street Capital is, you can have a platform. It can have a wide reach. It can have a good brand. It can have respectability and a strong reputation. That’s the kind of platform you want to be on. At the same time, you have to do your own marketing. If you expect to jump on there and it will happen on its own, I don’t think that’s realistic.
Rod: Right. There’s a lot of work involved.
Patrick: It’s huge. With my Kickstarter, I was doing outreach every single day. It was probably two to four hours a day during that 30-day period of the crowdfunding campaign. You’re smiling and dialing. You’re doing everything you can possibly do to get that thing going. When we took Entropic public, we were on the road for two and a half weeks for the IPO roadshow. We were flying all over the country and to Europe. Investors want to see you do that.
There is skepticism around, “Will the online platform work?” In real estate, it’s raised $160 million in a very short period of time. It does work. Those saying it doesn’t work are burying their head in the sand.
Rod: Right. People come from their own background with their biases and perspectives. The nature of raising money, when you’re doing it through equity crowdfunding, the size of the offerings are large enough with Reg A+ that you can afford to have the agency do a lot of work. This is not to say that it’s easy and you can sit back and go on remote control. But it’s better in that way.
Patrick: You do have to invest in an agency.
Rod: Absolutely. That’s cash cost. That’s the single biggest expense unless you have a broker dealer. Then you’re happy if it’s a big expense because you’re paying them a percentage. That means they’ve brought in a lot of investors.
Patrick: They’re doing the marketing as well as the brokering of the deal.
Rod: Yes. Again, only when we’re already made it a success at retail. When you think about the broker dealer rep who has clients, he is not going to go out on a limb and suggest that they invest in an offering until it’s already no risk. It already has to be successful. He doesn’t want to have the follow up discussion where it’s the other way around.
Patrick: Is Reg A+ available for companies whose operations are outside the US and Canada?
Rod: Yes, as long as they set up their legal headquarters in the US or Canada.
Patrick: Every company I’ve been involved in, including QuestFusion, we’re incorporated in Delaware. There is always a chance that you raise outside capital and the investors I’m dealing with are familiar with Delaware law.
We could have incorporated in California. A lot of companies still do that. Maybe they’re an S Corp. Maybe they’re not LLC in California. Because there is the potential for raising outside capital, do you have that same kind of situation with the companies that you’re dealing with?
Rod: Yes. Nevada is gaining popularity but Delaware is still the big name for the same reasons. You can raise money from anywhere in the world. You’re not restricted to the US.
I want to go back to the implied questions about the platform. There’s a lot of work in increasing the efficiency of the close rate. A marketing agency delivers a flow of interested investors. Some of them will look and come back. When they are ready and they start the investment process, making that process as smooth and easy as is humanly possible is huge. It’s massive.
You can see where it looks clunky and they have too many questions. Then they repeat the questions, and they’re invasive questions. You may get 10% convert. In our case, our conversion rate from entering the investment process to completing it with money in escrow was 50%.
Patrick: That’s very good.
Rod: Yes. I was ecstatic. There are more things we have to add. For example, Millennials don’t always have a checking account. Writing a check or ACH isn’t going to work for them. Debit cards are something that I’m working hard to build into the platform so that we can make it easy for Millennial investors.
Patrick: Are there any closing remarks you’d like to leave with the audience?
Rod: We’re at the early stages of Reg A+ as a whole. Bear that in mind in your considerations. Don’t just leap into it. As a segment, real estate is the best established segment. We’re getting to more investors that are active. The second sweet spot is people that are almost accredited.
They haven’t been able to do these deals forever and now they can. When you get a larger investment amount, it tends to be some accredited investors. Mostly, it’s the almost accredited. They say, “Wow, I can do this now?” Then there is a $20K investment. Whereas, the consumer who believes in the company might be putting in $1,000 or $2,000.
For Reg A+, the most established sector is clearly real estate. You have a lot less risk of failure because, by its nature, it appeals more to consumer investors and people who will put in a little more.
Patrick: This is Patrick Henry, the CEO of QuestFusion, with the Real Deal…What Matters. We are here with Rod Turner, the President and Founder of Manhattan Street Capital, an expert on Regulation A+. Make sure to check out the Manhattan Street Capital site. How can people get a hold of you, Rod?
Rod: My email is firstname.lastname@example.org. You can go to the website and click on any of the touch points there. Most companies will flow through to me at this stage in the game. Thank you.
Patrick: Thank you so much.
This is Patrick Henry, CEO of QuestFusion, with The Real Deal…What Matters.