Polymathica Home

Polymathica

Refined.. Erudite.. Visionary

NOTE: Nothing in this article should be construed as an offer to sell or solicitation to buy any security. This article describes methods of capitalization and is not to be interpreted as legal advice. Prior to offering securities for sale, either publicly or privately, qualified legal counsel should be engaged.

Capitalizing the Information Age

A great Transformation is upon us. Future historians will identify the period from 2010 to 2030 as the heart of the Information Revolution. During this time, nearly all institutions, that heretofore have undergone moderate change, will be eradicated and replaced by Information Age institutions. The geopolitical and socioeconomic structures of civilization twenty years from now will be nearly unrecognizable. Those who understand the likely outcomes stand to profit economically, politically, professionally and socially. Here we consider the implications of the Transformation as it applies to the capitalization of the many enterprises it will spawn.

Through The Future 101, the Polymathica Institute has a compelling story to tell about The Transformation. Through the Institute, the Fellows of Polymathica will tell this story professionally to their collective benefit. However, it must be told carefully. A superior knowledge of futurity can only exist within the context of a generally inferior knowledge of futurity. So, we will tell the story. But in general terms, to all who will listen. However, we will discuss the details and specifics only within the Fellowship of the Polymathica Institute, itself.

Those individuals of intelligence, drive and vision who aggressively engage the Transformation and the opportunities it will present can expect to join the ranks of a new Information age elite with characteristic incomes in excess of $500K per year. However, those who ponder, muse, mull and/or dither will be left behind. Those risk takers with a bias toward action will reap the benefits. One of the important chapters in the story is an explanation of how ideas will turn into enterprises in the Information Age.

A General Plan for Bootstrapping Ventures

Suppose a person wants to capitalize a project. The Polymathica Institute and The Future 101 will provide the opportunities for many such projects. Parenthetically, we will be discussing this within the context of a U.S. offering, since most of our readers are functioning under those SEC laws and regulations. Clearly, step one is to obtain seed money. In some cases the person who capitalizes the project may have sufficient funds, generally in the range of $35K to $50K. In other cases, they either may not have such funds available or are reluctant to commit such funds. Also, one should not discount the importance of an initial group of committed founders with some ‘skin in the game’ in raising the funds necessary to begin operations.

An initial small and very private offering will provide the liquidity necessary for a Regulation A or Regulation D offering of larger size. While laws and regulations vary from state to state and among the various types of offerings, it is generally more difficult to raise funds when the amount being raised is more than ten times the existing capitalization. In some circumstances it is not allowed. However, even if it is allowed, the new investors also will want the founders to have some ‘skin in the game.’

Capitalization can be increased legitimately through the fruits of sweat equity. For example, an e-mail list can legitimately have a market value of $1.00 per name or more. A Real Estate project may have plans, drawings, etc. that can be capitalized at prevailing cost to produce. There are well established costs to website design that can be undertaken by a founder and then contributed in exchange for stock. Creativity in this realm is a valuable contributor to success. Remember, the more the substantial capital of the enterprise, the more that can be raised or the less that will need to be sold to raise the required capital.

In the U.S. and many other developed nations, there are strict regulations prohibiting unregistered public offerings. In the U.S. there is a general safe harbor Private Placement rule that exempts a company from registration if there are fewer than 35 non-accredited investors and any number of accredited investors. So, the first step in a bootstrapped venture is to create a group of enthusiastic people that is private. You can publicly discuss your dreams and plans to your heart’s content. However, when you invite people to the private group, you must clarify that they are joining for the purposes of discussion and education and that the purpose of limiting membership is to assure that, if any conversations that take place within the group may be construed as an offer to sell or solicitation to buy an unregistered security, that the safe harbor requirements are met. You are being honest in this regard because until you have gathered the group and gauged their interest, you do not know if you will incorporate and capitalize a project entity.

Generally speaking, you will need to acquire a minimum of $1,000 in cash and accumulate intangible assets from each founding investor in order to meet the requirements of the first step. Every person who joins the group should be asked whether they qualify as an accredited investor. You will probably be surprised that many of them do qualify. If they sign a certification, they will not count against the 35 person limit. This will improve your chances of success, first because you can raise capital from more people and secondly because they will likely be useful on second and third rounds of financing.

Up until the time that you actually offer securities privately within the group, you may ask people to leave if they do not appear to be sufficiently interested and invite new people in. As a general rule, you should never have more than 150 people in the group and you should stop adding people once offerings commence. The reason for this is to assure that any offering will be considered a private offering. However, once you are ready to incorporate and offer securities for sale, you should immediately engage legal counsel with securities experience. Your legal counsel may require you to approach each member individually. This, however, makes good marketing sense as well.

Let us assume now that you have completed the above and have a corporate bank account with a $50K balance and an additional $50K of contributed sweat equity assets. You are prepared to undertake a Reg A or Reg D Direct Public Offering for up to $1,000,000. However, having the funds to cover the legal and registration fees is somewhat different than having a pool of people willing to invest $1,000,000. In order to accomplish this, a realistic capitalization strategy must be prepared. Actually, it should be prepared before incorporating and collecting funds and assets.

Before we continue discussing the process of offerings, we should discuss the very important concepts of valuation. Suppose an entrepreneur brings $10K of assets to the table and issues himself 500 shares. Then, suppose 35 founding investors bring $1,000 each and receive 500 shares. The total capital of the company is $45K and consequently, every share has a book value of $45. In other words, the entrepreneur has 500 shares X $45 = $22,500 for which he paid only $10,000. The founding investors have 500 X $45 = $22,500 for which they paid $35,000. They have lost about 35.6% of their investment. This is due to a “promote” by the entrepreneur and is normal. However, suppose the group now raises $1,000,000 for which they issue 1,000 shares. The stock price is now $1,045,000/2,000= $522.50 per share. The entrepreneur is now worth 500 X 522.50 = 261,250. However, the founding shareholders now have stock worth $261,250 for which they paid $45,000 for a 581% appreciation. The second round investors paid $1,000,000 for stock now worth $522,500 and lost 47.7% of their investment. They essentially enriched the original stockholder for ‘getting on board first.’

The above is possible because Economic Value of a company is often greater than the Stockholders’ Equity on the Balance Sheet. Suppose in the above example, the risk adjusted expectation of the Economic Value of the company five years from now is $100,000,000 with no more equity infusions. The second round investors have 50% of the company, so their portion is $50,000,000 or a fifty-fold increase in their investment over five years. That equates to more than a doubling of their investment each year, which will motivate most investors. Basically, the original investors, by funding the start-up have improved the probability of success and therefore increased the risk adjusted expectation. They are, in essence, being rewarded for their vision.

This is normal. Each round of financing pays more per share, diluting their investment and enriching the investment of those who came before them. Because of this, in most private placements the early round investors are restricted from selling their stock for two years. This is intended to dissuade middle round investors from profiting from the dilution alone at the expense of later round purchasers.

The Investors’ Lounge

Once you have qualified for an offering, most likely a Regulation D, Rule 504, Form U-7 SCOR Direct Public Offering, you can move your group from private to public, create a website and begin to offer your stock. In theory, each of your 35 stockholders could bring 28 $1,000 investors into the deal and it would be fully subscribed. In practice, that is very unlikely. In fact, without a large base of enthusiastic fans, the process of Direct Public Offering is mostly likely doomed to failure. That is why, if you google Direct Public Offering, you will see much more about the opportunity than examples of success. In order to understand why alone you will fail, but as a Fellow of Polymathica Institute you may, indeed, succeed, we need to consider an example.

Imagine that you go out to find investors to finance a Polymathica entertainment venture. The first prospective investor you find is interested in Real Estate Development deals. The next invests in high tech Internet start-ups. The next invests in medical technologies. Because you are working on an entertainment deal, you have found three people interested in investing in start-ups - just not yours. Now, there are real estate development entrepreneurs, Internet start-ups and medical technology start-ups going through exactly the same process as you and experiencing exactly the same problem. Furthermore, each of you has an educational process that includes both general information about the future of your industry and specific information about your particular opportunity. Clearly, there is a benefit to pooling the funding efforts of all the Polymathica enterprises. Additionally, there is a clear benefit to the risk tolerant investor, once they understand the future described in The Future 101, to have direct access to all entrepreneurs who are attempting to capitalize upon the opportunities of the emerging Information Age civilization.

In the Industrial Age, the relationship between entrepreneur and investor was generally mediated by an Investment Banker who introduced the two parties for a fee. In small offerings, the Investment Banker typically took between 5% and 10%. A million dollar offering, in addition to the $50K to $100K of offering expenses may have had as much as another $100K of commissions. With the Investors’ Lounge the relationship between entrepreneur is more direct. The entrepreneur may wish to pursue endorsements and the investor may want professional advice, but generally, they are free to engage one another directly, allowing a larger share of proceeds directed to the enterprise, not funds acquisition.

For a visionary and risk tolerant investors, Fellowship is bargain. It will allow them to immerse themselves in a central node of Informatin Age transformation. As enterprises mature and net worths increase, the amount available for investment will grow – slowly at first, but as with exponential growth, dramatically over time. The Investors’ Lounge will have moderators who will be both knowledgeable Polymaths and competent New Ventures Analysts. Taken in total, it is far more cost effective, with a much greater probability that good projects will get funded.