When a Wall Street veteran with 30 years of experience says “In the last 12 months, I’ve done more private transactions via the JOBS Act than I have done in the 29 previous years,” it is worth digging in to learn what that really means.
Company: North Capital
Sector: Platforms and Secondary Markets
Location: San Francisco / Salt Lake City
Summary on North Capital:
In the United States, and many parts of the world, securities crowdfunding can either be conducted on a funding portal or via a broker-dealer. What is the difference? Funding portals in the United States are limited in their activities (no vetting, no escrow, no promotion). So when both issuers and investors want to engage in those activities, they must find a broker dealer where these activities are included as part of their regulated activities. Historically, using a broker-dealer for small offerings wasn’t an option because the costs were prohibitive for the issuer and margins weren’t there for the broker. With the introduction of technology and new crowdfunding laws this changes for those broker-dealers (aka BDs) that want to innovate and grow their businesses. One BD we know has not only attacked this margin challenge but created a private-label solution for funding portals that need a technology and BD partner that can also give them access to a larger network of investors, deals and referral fees.
What problem is North Capital solving?
North Capital is a leading provider of prime brokerage and technology application services to power financial marketplaces. They empower existing intermediaries (deal teams) with platform technology to leverage North Capital’s investment deal origination and deal distribution efforts. They also support new platforms with brokerage sponsorship and oversight to conduct their regulated placement business.
Why is this service necessary?
Engaging in securities placements as an intermediary is a highly-regulated activity. Most funding platforms are required by law to conduct their securities business under the auspices of a broker-dealer, unless they are eligible for one of the limited exemptions from registration. But most broker-dealers either do not understand, are not equipped or do not want to work with funding platforms, and the barriers to establishing a de novo broker-dealer are significant in terms of time, money, and expertise. In the United States, North Capital is focused on exempt offerings (aka those offerings that do not require registration with the Securities & Exchange Commission (SEC) like Reg D, Reg S, Reg A+, and Reg CF), and they have structured their firm specifically to support the high transaction volume and fast ramp-up of funding platforms.
North Capital developed a proprietary transaction platform called TransactCloud. It allows deal groups to get to market quickly with a white-label solution, or to integrate North Capital’s transaction engine directly into their own platform technology. In addition to enabling funding platforms through the affiliation with their broker-dealer, North Capital leverages their network to expand distribution for their platform partners. It is still early, but North Capital believes that “our ability to syndicate deals across our network, and our relationships with and knowledge of the traditional financial services business, offer compelling reasons for our partners to work with us even if they decide to establish their own broker-dealer, as some have.” This is interesting because North Capital is explicitly supporting 2 models: A long-term partnership model and a “rent-to-own” model.
How do North Capital’s services work?
On the brokerage side, North Capital sponsors individuals from their platform partners who will be engaged in securities activities as associated persons (registered representatives) of North Capital. All securities activity is conducted through the broker-dealer, under their compliance oversight, and while the funding platform itself is not directly subject to their control, North Capital provides guidance to facilitate regulatory compliance. Funding platforms are thereby able to participate indirectly in the transaction-based compensation from deals transacted through the platform by the dual-affiliated registered representatives, who can receive transaction-based commissions. The funding platforms receive due diligence fees, licensing payments and other eligible payments from North Capital. “Because they operate in association with and under the oversight of our broker-dealer, they have more flexibility to monetize both origination and distribution relationships,” says founder Jim Dowd.
Who are the founders?
Jim Dowd, founder and CEO, is a 30-year veteran of Wall Street, most recently a Senior Managing Director at Bear Stearns focused on alternative investments. He is a CFA charter holder and a CPA who considers himself lucky to have spent most of his career in some of the most innovative areas of finance: derivative products in the 80s, international markets in the 90s (he ran businesses in London, Tokyo, and Hong Kong) and hedge funds after that. Soon after starting North Capital, Dowd was joined by Craig Goos, who worked with Dowd at Bear Stearns before leaving to head the alternative investment group at UBS Private Clients Group. The company now has over a dozen employees including four full-time registered principals (supervisory personnel).
What can North Capital share about early traction/user experience?
When the JOBS Act first passed, it was extremely difficult to get anyone to focus on the possible need for, or benefits of, affiliating with a broker-dealer. Over the past four years (and as funding portals saw the liability flaw of not being able to vet deals properly in the United States) the market has come North Capital’s way: most funding platforms now operate in association with a broker-dealer, and many of the ones that do not, acknowledge that they will need to in the future. North Capital has forty deal groups that are currently clients, with a growing pipeline of prospective partners. Says Dowd, “We have done more private deals in the past twelve months than in the previous 30 years of my career. The JOBS Act is clearly having an impact, whether or not the established Wall Street firms realize it.”
What does North Capital believe are the risks (regulatory, operational, other) to North Capital or the industry?
There are a wide range of risks that include issuer risk, market risk, operational risk, litigation risk and regulatory risk. North Capital “spends a tremendous amount of time and money trying to dimension and mitigate these risks. Our firm is very process-driven — and sometimes we are criticized by start-ups that are eager to move quickly. We try to engineer processes and systems that provide for scale while addressing the exposure in a thoughtful way,” says Dowd.
What is CCV’s Perspective?
When we went to Washington, DC to legalize securities-based crowdfunding we promoted the idea of funding portals because large, traditional broker-dealers were “driving via the rearview mirror” and had no interest in what they said was “low margin, high touch deals.” In addition, issuers had no need to use the services broker-dealers provided to public companies, or large private companies, that come with high costs and long transaction cycles. This is one of the reasons that “friends and family finance” is so large and opaque…there were no effective capital formation tools for SMEs/Startups….hence the need for the JOBS Act.
Unfortunately, the final rules for Regulation Crowdfunding place a liability standard on funding portals that put them at risk for any material misstatements by an issuer without giving them the ability (or financial model) to properly diligence and account for those misstatements. This has forced many funding portals to align with broker-dealers to leverage their liability safe harbors. Since North Capital has created a technology driven solution that de-risks the offering for funding portals without burdening them with excessive costs, it represents both an attractive opportunity for funding portals and growth potential for North Capital as a broker-dealer. We also believe that this is a great way for small and middle market BDs (especially those not in Silicon Valley and New York City) to build their businesses in new ways.