Background

Signed into law by President Obama on April 5, 2012 the JOBS Act (Jumpstart Our Business Startups Act),  created a framework to allow smaller business and startups to access capital from non-accredited investors without having to go public.  “This is a very complex change in the way the SEC thought about itself and its duty to protect the unsophisticated consumer”, said Corey Schwartz of Loanatik.com, a company that will crowdfund residential mortgages.  It took the Commission just over 4 years to write the rules and approve them.  They worked diligently to make crowdfunding easier for the people trying to get businesses going.  A few examples of their efforts to make crowdfunding easy include:

• Not requiring companies doing less than $100,000 of fund raising to get audited financial statements.  This saves companies at least $5,000 in accounting fees.
• Allowing crowdfunding portals to vet the companies they list on their platforms
• Allowing funding portals, subject to conditions and prominent disclosure, to receive securities offered in a transaction as compensation on the same terms offered to investors

This vote begins a new era of allowing the public to fund early stage companies, an area that was once confined to the hallowed halls of Palo Alto. Yet it is not without its pitfalls.  For example, the new rules require that Crowdfunding Portals register with FINRA. Funding portals must register with the SEC and become members of FINRA or another registered national securities association. They are not broker-dealers, but they must comply with the separate requirements that apply to funding portals.  This isn’t a free ride.  In tomorrow’s post, I’ll start to detail the good, the bad, and the ugly of these Title III crowdfunding rules as we understand them today.  For those of you that enjoy reading, here are just under 700 pages of rules, regulations and forms to pour through until tomorrow’s post:

Title III Crowdfunding: What the Jobs Act Rules Require

1. SR-FINRA-2015-040:
a. Adopt Funding Portal Rules 100,110,200, 300, 800,900 and 1200 and related forms.
b. Adopt FINRA rule 4518: Notification to FINRA in Connection with the JOBS Act.

2. SR-FINRA-2015-041: Adopt Section 15 of Schedule A to the FINRA By-Laws governing fees for funding portals that are FINRA Members.

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I have been part of the Phoenix startup ecosystem for nearly 30 years. While the change has been dramatic, it hasn’t changed much at all.

Having a background in computer programming, I approach life in a structured manner. I break complex tasks into manageable pieces, then methodically evaluate, note, consider, research, and keep or discard each piece. That’s how I approached finding a city where my company could thrive.

Just out of college in the mid 1980’s and living in Princeton, NJ, I was running Programmer’s Warehouse, a software publishing and distribution company that I founded. I would never be happy living in a cold weather place and decided that my future did not include the 99% humidity, year round gray skies or damp snow that NJ so abundantly offered. That condition ruled out everything north of Georgia. Growing up in the New York metro area, coming of age on St. Marx Place and working in the world trade center meant that I was a city boy at heart. I would always be drawn to the culture of a big city, its nightlife and massive support system. Aside from a good lifestyle, I needed affordable, high quality employees, low rent, a university, great transportation, good infrastructure (electricity, telephone & internet), direct flights to all the major airports, good lawyers and a dozen other basic necessities. Considering those constraints, I set out to find the best place to run a fledgling business.

My additional criteria reduced the universe to Atlanta, Orlando, Dallas, Houston, Phoenix, San Diego and Los Angeles. I evaluated each city looking at their startup ecosystem: schools, capital, employee quality, transportation, telephony and lifestyle/culture. In the mid 1980’s I visited Atlanta several times and found that there was a lot of racial tension. I didn’t feel safe walking the streets at night. Atlanta was out. Next on the list Florida.

I really enjoyed visiting my grandparents in Florida, but, hanging out in south beach before it was cool, well, just wasn’t cool.  Given the large retiree population, we lovingly called it Heaven’s front door. As a teenager, I sat with them in rocking chairs on the front porch of the Surfcomber Hotel. Bubbe and Savta complained about their husband’s flatulence while Zayde and Saba farted – a lot. Three hours north to Orlando didn’t improve my view of Florida very much: hot, humid and full of bugs that needed landing lights and air traffic control. I wasn’t moving to Orlando. Houston and Dallas were eliminated because I could not identify with being a Texan and Austin, with a population hovering around 300,000, was still in diapers. Texas was out.

That left San Diego, Los Angeles and Phoenix. Based on preconceptions, I thought I would end up in LA. I had contracts with both Ashton Tate and Nantucket Corporation to develop source level debugger technology for their popular dBase and Clipper products respectively. I was in LA often and had lots of friends and a support network there. The Nantucket development center was a condemned house in Malibu on the ocean side of PCH. We would turn up somewhere in the early evening  ,program until the sun came up and discuss how to make object oriented database programming acceptable to the masses. Seemed like a good choice until I started house hunting.

I was looking at houses I couldn’t afford at around a million bucks. That got me 1,000 square feet of house, one room wide and ready to slide off the hill with the next mud slide. You could almost see the ocean if you stuck your head out the window and contorted your body. You might catch a glimpse of the water if the smog wasn’t too thick that day. Other parts of the LA area weren’t much better. San Diego, while beautiful, was also horrifically expensive.  If I couldn’t afford employees, how could I sustain, let alone grow, a young business? Cali was out. That left Phoenix.

As I dug in, I really liked the late 1980’s startup ecosystem. The city was in a bad downturn and Motorola had massive layoffs. I could hire well educated engineers for about $5/hr. because, it was better than being on the dole. They didn’t stay very long, but, they worked really hard, my customers loved them, and there was always someone else that was qualified and looking for work. Property values were very depressed. $300,000 bought a mountainside mansion with over an acre of land in Phoenix with a pool, Jacuzzi and city lights views. My office rent was $7/psf for brand new office warehouse space in the Scottsdale airpark. That compared favorably to the $25/psf that I was paying for similar space in Princeton. (If you are navigating the tax side of running an early-stage company today, the IRS Small Business and Self-Employed Tax Center is worth a look: irs.gov/businesses/small-businesses-self-employed.)

The Phoenix Startup Ecosystem Takes Off

By the early nineties there was a thriving startup ecosystem. There were software legends like Pat Sullivan, Ed Nusbaum, and Francine Hardaway constantly promoting the Valley of the Sun as the next Silicon Valley. There were great lawyers and law firms, like Bill Harden at Osborne Maledon, who handled the sale of Programmer’s Warehouse to two venture firms. There were shared office spaces and piles of wealthy real estate investors who joined angel groups. Convincing them to invest in anything but dirt was an uphill battle. The profile of a real estate investor is dramatically different from that of an equity investor.

I moved to Arizona in 1989 and I’m writing this in 2015. There’s more of everything I liked in the 80’s and I can’t think of a place that I’d rather live. The office spaces are better and co-working spaces are a great addition to the office landscape. But it’s just office space. Access to facilities (high quality fiber running to the majority of buildings) has gone from good to great.

The gastronomy and nightlife have improved dramatically. Success attracts success, and it is exactly why the Phoenix startup ecosystem keeps growing.  Better housing, shopping, and 300+ days of sunshine have attracted skilled people to Arizona who are as good as their counterparts in New York, Los Angeles, or San Francisco. The AZ investment community is tight knit. A small but active core of investors/friends will back high quality startups, much like they did in the 1990s. The Valley is also home to technology companies that grew up here and went public: GoDaddy and Carvana in Tempe, Axon in Scottsdale. They are established public companies rather than unicorns — a unicorn is specifically a private company valued above $1 billion — but they anchor the local talent pool that early-stage startups hire from. My opinion hasn’t changed. The Phoenix startup ecosystem is a fantastic place to run any business from early stage on.

But, let us not fool ourselves: being in any startup ecosystem outside of Silicon Valley has a high cost associated with it. Using the Wasabi Ventures definition of a startup, we’re talking specifically about a high growth tech company. That company requires high quality intellectual, technical and financial resources that are not plentiful outside of Silicon Valley.

As far as Silicon Valley, the center of the startup/internet/fintech/.com world is concerned, Phoenix hardly exists. ASU isn’t Stanford. The Desert Angels aren’t Sandhill Road and Godaddy doesn’t hold a match to Google, Facebook, Uber, etc…

If your startup has outgrown what the Phoenix startup ecosystem can offer and will need significant capital for global expansion, it would be prudent to start thinking about relocating when the timing is right

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Once thought to be “Too Large To Fail” firms such as Bank of America, Morgan Stanley, and Goldman Sachs, find themselves under attack.  These attacks aren’t being mounted by rivals, but by young, agile startups.  Nimble and fiercely innovative, these fintech startups are taking bites out of banking industry profit centers.  These fintech startups are eliminating inefficiencies and outdated operations, enabling them to win customers from entrenched institutions.

Anand Sanwal, CEO of CB Insights, describes the phenomenon as “death by a thousand cuts”.  None of the FinTech firms take more than a rounding error of profit from a large organization’s income statement.  Collectively, they have Wall Street shaking in its boots. Venture capitalists are fueling the onslaught, investing over $12B in FinTech startups in 2014 alone, a 201% increase over the prior year’s investment volume. For a look at how regulators are engaging directly with fintech startups, the CFPB maintains an Office of Competition and Innovation.  At the time, venture investors showed strong interest in fintech companies, although funding and valuation outcomes remained uncertain.

Uber transformed an industry more than a century old in just a few years. It did this while facing staunch opposition from a decades-old, unforgiving, regulatory web.

Airbnb, conceived as a temporary means to an end, is triumphing over forceful governmental pushback. It continues to have a paradigm-shifting effect on the hospitality industry.

FinTech firms such as mobile credit card processor Square emerged from the shadows taking their place alongside industry disruptors like PayPal.  These newcomers are revolutionizing consumer banking and finance by applying technology to a myriad of financial services.   FinTech companies automate processes that trained employees used to handle. This lets them provide customers with the streamlined user experience they have come to expect from modern ecommerce, while simultaneously reducing costs. The companies were poised to use their innovations to lead a dramatic transformation. That transformation was expected to be felt from Silicon Valley to Wall Street.

Big banks have long enjoyed a regulatory moat. But these Bay Area disruptors are persistently proving that technology trumps tradition.  JPMorgan Chase Chairman and CEO Jamie Dimon recognized how FinTech is poised to disrupt even the biggest players. He announced this in a letter to shareholders, writing that, “Silicon Valley is coming”.

Even Goldman Sachs has acknowledged that these firms threaten to take control of $4.7 trillion in revenue and upwards of $470B in profits from traditional Wall Street mainstays.

Venture capital funds have been responding to the “buy” signal by flooding money into over 700 fintech startups at every stage from seed to IPO, and at every corner of the industry from payment processing (Stripe, Braintree) to peer-to-peer lending (Lending Club, Prosper) to wealth management services (Wealthfront, Betterment).  While these startups are focused on narrower niches of the financial services industry, a crop of young companies is taking a different approach. They are going after entire sections of the industry, from the way we bank to the way we borrow.

Two Fintech Startups Reimagining Mortgages

Two of these companies have targeted the bread and butter “A” paper mortgage origination market.  Sindeo and Loanatik are two early-stage FinTech firms reimagining how mortgages are originated.   Analysis of the two companies diverges quickly as they solve the problem with different approaches.  Sindeo is staking out a “modern mortgage marketplace” hinged on 35 select lenders and offering the guidance of locally-based, full-service mortgage advisors that are paid based on client satisfaction.

Loanatik is a fully-licensed mortgage bank taking a more direct, top-down approach. It is re-thinking the path to getting a loan.  Loanatik has retooled and reinvigorated the entire mortgage process from the time a user applies, to approval, and through secondary marketing.  Loanatik founder and CEO Corey Schwartz, says that the company has been in stealth mode since early 2014, carefully planning its entry into the market.  “Loans aren’t fundamentally different than they were a thousand years ago, and they won’t be much different a thousand years from now.  The only thing that has truly changed over time is the process.  While technology has made life simpler and easier, the process of getting a loan has gotten more complicated, more difficult, and more stressful.  We’re humbly setting out to prove that it doesn’t have to be that way any longer.”

Loanatik is leveraging technology to empower consumers, while streamlining processes and saving costs.  By simplifying the application process, Loanatik reduces a paper-heavy, manual process. The result is a clear and simple channel of communication with the borrower.  CTO Glenn Jimerson explains further that “Loanatik streamlines the application process from a painful interrogation to a few simple questions that enable our technology to do the heavy lifting.” When you look at the documentation and questions that bankers typically demand of their borrowers, it quickly becomes clear that a refined process has real appeal. That appeal reaches both millennials and older generations alike.

“The technology relevant to the industry has evolved to the point where the market naturally provides disruptors with the tools they require to make seismic changes,” said Loanatik’s Chief Marketing Officer Michael Jacoby.  “We are really past the point where people are still wondering if legacy and sheer size is enough to keep you in the game.  Recent history has shown that without question, no industry is safe from a complete reboot – as long as the idea is good enough and it works, and people like it.  People like summoning a car on their phone, they like saving money by sleeping on a couch… when is the last time you’ve heard anyone say they liked anything about their bank?”

Both Sindeo and Loanatik had closed seed rounds of funding, increased valuations and started to attract additional investment capital.  Schwartz, said that “investors, both large and small recognize that FinTech investments hold the same promise as early stage investments in Ebay, Amazon and Microsoft.  Vast amounts of wealth will change hands throughout the sector.”

Contact: Corey Schwartz, 1-602-739-7060, cschwartz@loanatik.com

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