eShares issues electronic shares for private companies and then acts as the registration agent for those companies. To use the service, a company sets up an account and designates certain people who can issue and sign certificates. eShares then manages the workflow of getting existing shares entered into the system. Once that is complete, everyone with shares or options receives a notice saying that their paper certificates have been replaced with electronic shares, which they can see in their eShares portfolio. AIMkts likes the concept because it seems to put the responsibility of tracking who owns what percentage of a company into the hands of a presumably neutral third party expert. This seems to us to be an advantage for the investor. We recently sat down with eShares CEO, Henry Ward to learn more.
It seems counter intuitive, but most high-end attorneys don’t like managing cap tables or processing stock certificate and option grant paperwork. The work generates revenue, but it is mostly lower margin paralegal revenue and insignificant to a firm’s top line. The problem is that it is high-risk for the attorneys. One attorney described the dilemma well when he said “I’m in a client services business. No client has ever said to me ‘Great job not screwing up my cap table!’ But screwing up a cap table is usually how you lose clients.” It is a high-risk and low-reward activity for most attorneys and the early adopters were very excited to help us solve this problem for them.
The original idea was to replace paper stock certificates and pass them around for signature like Docusign and deposit them in an investor’s Dropbox folder. That would have made us a document workflow company and it was not an interesting market or problem to solve for me personally. It wasn’t until we looked at how this is handled in public markets that the idea became interesting.
In public markets, the Depository Trust Corporation (DTC) was established as the master database of shareholder ownership and the clearinghouse for public transactions. And the prerequisite to building exchanges, brokerages, market makers, and everything else we take for granted in public markets is a centralized electronic clearing system. Our “Ah-ha!” moment was the decision to build the DTC for private companies. And if we did that, we could provide the same financial services to private companies that is currently only available for public companies. To do this, we first had to vacuum up all the paper stock certificates, and their derivatives, laying around, i.e., solve the paper certificate problem. Once we looked at the idea through this lens, the market size question was no longer a question.
Definitely. The JOBS Act is a tailwind for eShares because we naturally solve a number of problems that the JOBS Act creates – like managing large-scale transactions, Title II and Title III securities, and employee liquidity programs, but it is not a requirement.
Most of our customers today are not affected at all by the JOBS Act – at least not yet.
Sure. My last company did not survive its funding round and I made the tough decision to wind it down. Afterwards, I was an entrepreneur without an idea, figuring out what to do next. Manu invited me to lunch to describe his paper certificate problem, which was an entirely new concept to me. We talked for over an hour and he asked if I’d be interested in starting a company on the idea. I initially rejected the idea because I didn’t want to do a document workflow company, but when we had the insight to build the master repository of shareholder registration, I got excited about it and the rest is history.
I’m not sure why eShares would introduce any new concerns for investors. I’m actually quite surprised that investors accepted the current system for so long. Before eShares, company cap tables were stored on Excel spreadsheets by paralegals who represented the issuer. They passed these sheets around via email without any protections. One over-write mistake or malicious change in the cap table could cause an investor to be completely wiped out from the cap table. The only recourse an investor had would be to prove they owned shares by sending their certificate to the company and hope the company would honor it, but most of the time the investor would never even know he or she was incorrectly recorded in the cap table.
We saw a company about to close a new round that completely forgot about an investor who had a convertible note. It sounds crazy, but they simply forgot they did this note a couple of years ago and at the 11th hour realized they had to redo the proforma for the new financing. That investor was very lucky they remembered.
I’m quite surprised at how long the current system has lasted and my educated guess is that investors and employees have lost significant amounts of money because of it.
We have invested heavily in product. Our R&D group is eight engineers and designers and we are pushing new features every two weeks. We are making a big bet that we will win this space by having the best product and we are investing accordingly. That may seem obvious, but it isn’t. Historically, the winners in this space, like CapMX, have won by having the best distribution rather than having the best product. We have zero sales people. It is a risky bet, but so far it seems to be paying off.
Capshare has been around for a while and I put them in the same bucket as the many other “more powerful spreadsheet” companies. They build good tools for managing a cap table, but they don’t solve the underlying double-entry paper problem.
Recently, we have seen companies copying us and announcing they are working on electronic share issuance, although we haven’t seen anybody go live with it yet. That trend is not surprising and I think we will see more copy cats in the next 12 months.
It is pretty simple. Because we issue electronic shares for an issuer, anytime shares change hands in a new round or a secondary transaction, we know about it, so we can push that information directly to investors that have information rights to that issuer.
Yes, but it will look very different than the vision of those companies. We believe secondary markets will evolve from scalable employee liquidity programs. For example, a company today might want to do an employee liquidity program where employees can sell 5% of their vested options to existing, approved institutional shareholders at a price set by the company. Today, this costs $50K – $100K and is a two to three month project.
eShares will do this with a click of a button. We call this “Scalable Controlled Liquidity” – where a company has complete control over the liquidity program and can throttle that liquidity, as desired, every month, every quarter or every year. It will be a long time before a liquid retail market for private shares exists, but there are concrete steps to get there and that is what we are working on.
I was pitching my previous company at an Orrick pitch competition and afterwards he invited me to chat further at his office. I guess pitch competitions do work sometimes!
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