[00:01:55] Intro: You are listening to The Investor’s Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected.

[00:02:15] Clay Finck: Welcome to The Investor’s Podcast. I’m your host, Clay Finck. Today I am very excited as I’m joined by my friend Daniel Gallancy, to cover private capital markets. Daniel, such a pleasure having you on the show today.

[00:02:29] Daniel Gallancy: Thanks for inviting me.

[00:02:31] Clay Finck: As I mentioned at the top of the show, we’re going to be chatting about the evolution of capital formation and how this gives individual investors the access-to-access new opportunities that traditionally haven’t been available.

[00:02:44] Clay Finck: To get this conversation kicked off, I think it would be super helpful, Daniel, to touch on your background and why this topic of private capital markets is so fascinating to you and essential to you as an entrepreneur and a business owner.

[00:02:58] Daniel Gallancy: Sure, absolutely. So, my background is sort of half tech, half finance, so I studied physics and electrical engineering, and then I was a trader for a little while, and then I was a hedge fund analyst for quite a while in the fundamental longshore equity hedge fund industry. I’m mostly covering tech, and then I discovered the Bitcoin world. Got excited about that. And then ultimately that got me interested in cryptography in general, right? Not the cryptography that the discipline and started my own cybersecurity company along the way.

[00:03:31] Daniel Gallancy: I dealt a lot with, you know, of course the public capital markets when I was a trader and when I was in the hedge fund world. And then subsequently as I started my own company, and also as I looked into other areas in the Bitcoin world, the private capital markets, you know, markets for, startups and how private capital operates.

[00:03:50] Daniel Gallancy: And then of course there were a lot of situations in the hedge fund world. Entities would have an IPO and they’d be coming out of some situation where they’re, potentially held by private equity or owned by venture capitalists among other people or among other groups prior to their IPO, right?

[00:04:08] Daniel Gallancy: So, there are a lot of these nexus. There have always been nexus to the private capital markets. You’ve kind of, whatever I’ve done, and it got me just increasingly interested in how they operate.

[00:04:18] Clay Finck: So, we’re going to be talking a lot about capital formation and some of these terms that are related to this, and I think a really good place to start here is venture capital, which is a term a lot of people are really familiar with.

[00:04:30] Clay Finck: How about we just start with, what venture capital is and how it came to be and how it fits into this capital formation picture.

[00:04:38] Daniel Gallancy: Maybe I should start by talking about capital formation, and perhaps defining the term a little bit. I sometimes find that when I’m discussing is people saying, what in the world is capital formation?

[00:04:49] Daniel Gallancy: And it’s a good place to start foundationally before we talk about the venture world. So capital formation is the process through which investors come together and provide capital to a new entity. So, if you want to start a brand-new company, right? If your uncle wants to start a new carwash and your uncle says, hey, I want to do this.

[00:05:12] Daniel Gallancy: And maybe your uncle doesn’t quite have the right amount of capital for it. Your uncle would inherently be involved in the process of capital formation. He may not go with that, as most people do not. But he would manage to go to friends and family and say, hey, I’m trying to put together this car wash.

[00:05:27] Daniel Gallancy: I’d like you to put in some money. And that could be in the form of equity. It could be in the form of debt; it could be a hybrid instrument. There are all sorts of formats in which that could happen, right? But the process of that new capital air quotes forming. And then the new venture, get it off the ground, be it a VC like venture.

[00:05:45] Daniel Gallancy: I use air quotes there where, you know, it can scale tremendously. Or a small business like a laundromat, right? All that stuff is capital formation. So, with that, as a prerequisite, your question was really about the venture world. So, venture capital is a very specific corner of the capital formation world.

[00:06:10] Daniel Gallancy: And VCs really look for businesses that will scale hugely. So, there’s nothing wrong with car washes. And by the way, they can be great businesses. They can generate a lot of cash. And there are private equity companies that are rolling up car washes and taking them public, right? So that’s happening too.

[00:06:26] Daniel Gallancy: But venture capitals are not really looking for car washes because it’s very difficult to scale. So, you know, VCs tend to be interesting. I would say, stereotypically, and I’ll use that word in businesses, like software companies, right? Or a biotech company. Something where you can put in, a modest amount of capital upfront and then get these really tremendous returns on capital.

[00:06:51] Daniel Gallancy: What you’re getting returns on tend to be, for example, network effects or intellectual property. Right. Or something where, and I know you covered this a lot in your podcast, something where there’s an important mult, right? Sort of from the foundation, from ground zero. And that’s where the venture industry really cares those sorts of businesses in terms of its history.

[00:07:12] Daniel Gallancy: It’s surprisingly new. So, we could talk about the regulatory background, which is actually is not boring. It’s actually really interesting and very important. But just in terms of timing, it didn’t really exist, you know, pre-World War II at all, right? It really emerged. It was a tiny, tiny little bit in the sixties, a little bit more in the seventies, and then really in the eighties.

[00:07:36] Daniel Gallancy: So, in, in the sixties it was, so small, it didn’t really matter. In the seventies, that’s when you had, groups like Sequoia and Kleiner Perkins start, and at the time, it was maybe a hundred-million-dollar industry, so pretty small. By the eighties it was like a single digit billion.

[00:07:51] Daniel Gallancy: I think the number I lasso was 3 billion in 1980. By 2000 it was more than a hundred billion. So, skip 20 years, skip another 20 years to 2020 slash 2021, and now we’re talking about 750 billion. So much larger. Now that seems very large, but just by way of comparison, if you look at the, the market caps of, you know, all US equities, right?

[00:08:20] Daniel Gallancy: Some tracked out ETFs and mutual funds ’cause you don’t want to double count. That’s, more than 40, somewhere between 40 and 45 trillion. Right? So, you know, 15, 16, 17 18, 19 x high teens X the size of the venture world, right? So even the venture world is big. It’s still small on a relative basis.

[00:08:43] Clay Finck: Traditionally, what have the returns of the venture space looked like relative to the public markets? Is that something you’re familiar with?

[00:08:51] Daniel Gallancy: So, it’s difficult to get precise data on this, but I have seen some data sets on this. So, first thing is that the data is skewed. The, and I, and I’ll explain why that is.

[00:09:07] Daniel Gallancy: So, when I say skewed, what do I mean? Certain venture capital groups will have tremendous, tremendous outperformance and they’ll be able to maintain that for quite some time. Whereas others will lag. So, you have this kind of odd distribution. Now, by the way, then you could say that that’s the case for equity fund managers, publicly traded equity fund managers.

[00:09:28] Daniel Gallancy: But I think that the skew here is going to be stronger. When I say here, I mean the venture world. Why the reason tends to be access to deal flow. So, the fancier, the better the prospects of the company. The more likely they are to be attracted by the likes of the top tier venture groups. Consequently, those venture groups, and it’s very clubby, those venture groups get access to these great deals and smaller venture groups tend to be a little bit more left out in the cold now.

[00:10:01] Daniel Gallancy: Now maybe changing a little bit, but if you look at historically, you know, certainly over the past 30, 40 years, it’s largely been the case. Now if you aggregate it all together, the last data set that I saw indicated that there’s actually a slight discount. So, if you look at the returns on venture capital, if you look across the board, so take the high performing ones and the less spectacularly performing ones and the aggregate performance is, a couple of coins below the S&P or the Russell over the same period.

[00:10:40] Daniel Gallancy: But I don’t think that’s quite the way to look at it, because you really want to be cognizant of the manager here and the big, a big difference between managers in the speeding of competitive advantage managers in the publicly traded equity markets. You’ll see these managers who will perform spectacularly and then it will go away, right?

[00:11:02] Daniel Gallancy: Not always, but often in the venture world, succes can create more success because they get bigger and they have access to better deals, and they get more connected, right? They get more entrenched in the top tier club and they get better access to better deals so they can create for themselves over time at increasingly powerful advantage.

[00:11:25] Daniel Gallancy: That has been the case historically. Whether that remains the case going forward, impossible to say, but I suspect that will continue to be the case.

[00:11:31] Clay Finck: It reminds me of a company like Airbnb when Sequoia decided they’re going to invest in Airbnb. That changed everything for them and, they got involved with Y Combinator and Y Combinator kind of got them access to this exclusive club that you’re talking about.

[00:11:46] Clay Finck: How about we talk a little bit about primary versus secondary markets and some of the rules around capital formation and general solicitations that go around this.

[00:11:57] Daniel Gallancy: Yeah, absolutely. Actually, before we do, I wanted to add to what you said about Airbnb. Airbnb is certainly not the only example of that. There are a handful of companies that actually won’t name names here, but one, one company in particular that’s in the digital asset space, let’s say its competitors, had suffered a lack of difficulty at the hands of incumbent banks.

[00:12:18] Daniel Gallancy: They didn’t, banks didn’t want to have relationships with the, you know, with a lot of these competitors. One company got together with the right VCs. The VCs called a particular bank and said, don’t shut this company’s accounts down. So, these VCs can all the sense drive their wrong returns. It’s really fascinating, but okay.

[00:12:35] Daniel Gallancy: To answer your question, your question was about primary markets, secondary markets, general solicitation. Let’s do the general solicitation part first. Your fictitious uncle with the fictitious car wash. If your fictitious uncle with the fictitious carwash, if he wanted to raise money for this carwash and he were to stand on the street corner and say, I am raising money at a sandwich board.

[00:12:56] Daniel Gallancy: I’m raising money for this carwash. Give me money and I will sell you shares in the carwash. Well, I will, will be a debt security, whatever it is. That would be considered what’s known as a general solicitation. He’s asking the world or capital general solicitations in the United States and in most other developed market countries are prohibited under securities regulations. I’m going to stick with mostly the US ’cause that’s what I’m, that’s where my familiarity is the greatest. But you can’t do that. Or historically you have not been able to do that. And that history goes all the way, all the way back to the Great Depression.

[00:13:31] Daniel Gallancy: So, before the Great Depression, you most certainly could do that. And people did. And there were a lot of scams and lots of kind of nonsense that would go on. And then, in the roaring twenties there were a lot of, you know, there were IPOs for companies that had no prospects at all. And then you had the bust in ’29 and people were angry as people always are during a bust.

[00:13:51] Daniel Gallancy: And now that anger sometimes gets directed properly and sometimes is misdirected. It really depends. I won’t say I do not. I’m not sufficiently adept as a historian. That’s not my point here. I won’t say whether or not the anger was appropriately directed in that case or not. But what came out of the crash in ’29, and the depression was three big cases of legislation in the United States, the Securities Act of ’33, the Exchange Act of ’34, and the Investment Advisor Act of ’40.

[00:14:23] Daniel Gallancy: Basically, what the first two of those acts did was they said, no more of this general solicitation stuff, no more sandwich board. You cannot solicit, generally, you must go through various different proper channels. So, what ultimately is allowed and what ultimately is not allowed. So if you want to solicit capital for capital formation and you are a private individual, you have to go to what are known as accredited investors.

[00:14:52] Daniel Gallancy: And we can talk about the definition there if you like. You could do that. Right. And those are essentially people who have a certain amount of wealth or capital or a certain amount of income. They have to meet these thresholds for wealth or for income, which is a much tighter pool. And the assumption there, for better or for worse, is that those people are more sophisticated or perhaps that it will be less tumultuous if they lose some money.

[00:15:16] Daniel Gallancy: What the exact assumption is, I don’t, I actually can’t tell you. Right. But it’s somewhere in there. Now, is that assumption good or is it silly? It’s probably a little bit goofy because there are plenty of people who have plenty of money and don’t know what they’re doing. And there are plenty of people who don’t have that much money, who are very smart and don’t know what they’re, but you know, this is the way the world, this is the way the world is, and this is the way the regulations were set up.

[00:15:35] Daniel Gallancy: By the way, it’s 90 years ago, the Securities Act of ’33 is 90 years ago. So, you know, that’s a general solicitation. You can’t do it anymore. And then, you know, after that, of course, if a company wants to go public, you could do an IPO. And that’s a register with the SEC, but basically there are these exemptions. You need to be following one of the exemptions. One of the exemptions is known as Reg D, and Reg D is what enables accredited investors to provide capital to a new entity, right? Then there’s the IPO process. That’s another exemption, and there are, you know, a small handful of others, and then there are the ones that have emerged more recently, but that’s where you end up with what’s called primary capital, right?

[00:16:18] Daniel Gallancy: Primary capital is, I’m going to put new money into a venture, and the company itself is going to get that money distinct, very distinct from trading in the traditional capital markets, buying and selling shares of stock for your brokerage. That’s whole secondary market, right? In other words, if I invest in Google by buying shares of Google, I guess output, sorry, they don’t get my money.

[00:16:42] Daniel Gallancy: I’m just buying from someone else to the other side of the trade. That’s a secondary market to stick from the primary market. Primary market is if you were one of the VCs who invested in Google, and I believe that Sequoia was one of them. I’d have to look. Sequoia provided primary market capital. They did so under Regulation D, right?

[00:16:59] Daniel Gallancy: Because Sequoia is for sure accredited. So last but not least, and I’ll, I’ll stop. An accredited investor could be a human being, or it could be an entity like a venture capital.

[00:17:11] Clay Finck: I do think you mentioned a really good point there, ’cause I think you’re a common everyday person. Like you say, when they’re buying Alphabet stock, that money isn’t going to Alphabet, it’s going to whoever sold those shares.

[00:17:23] Clay Finck: Whereas when they go through that IPO process, that’s when they go into that secondary market and then when they issue those new shares, then that money, you know, the bank sells the shares and it goes to the company. Right?

[00:17:37] Daniel Gallancy: Yeah, that’s right. And by the way, it’s a common misconception that I hear all the time when people talk about ESG. ESG has become thematically important, right?

[00:17:46] Daniel Gallancy: People are talking about it all the time. And you have a lot of people who talk about ESG and say, I don’t want my money going to, for example, the petrochemical industry. But if they’re buying and selling shares of ExxonMobil on the stock exchange, whatever one thinks about ESG, put that aside.

[00:18:01] Daniel Gallancy: I take no view on that. What I think we need to avoid is the red herring that is in this context. My money is going to the company. It’s not going to the company unless it’s capital formation, unless it’s primary shares.

[00:18:14] Clay Finck: So how about we look a little bit more at the history of capital formation? Maybe you could discuss how some of these roles have changed over time, maybe in more recent years.

[00:18:26] Daniel Gallancy: So, after the depression and you had the, the acts of ’33, ’34, and ’40. You had a far more restricted landscape in terms of how capital’s formation could occur. And by the way, the SEC’s mission, I forget the exact mission statement, but in there are the words capital formation. So, you know, you could no longer stand in the middle of the street with a sandwich board and say, I want to take capital.

[00:18:48] Daniel Gallancy: Instead, you were, you know, if you were raising money for a new entity, you were approaching wealthy people. You were approaching other established entities that have money. And saying, I want to put this new entity together, or I want to put together a new company. And that was the process of capital formation.

[00:19:04] Daniel Gallancy: And that persisted for a very, very long time. Basically that there were exceedingly limited number of ways that you could do capital formation. And this is all outside the public markets. This is all private markets. An exceedingly limited number of ways in which you could do that process. Now, what changed here more recently?

[00:19:26] Daniel Gallancy: In 2012 was the Jobs Act. So, the Jobs Act had lots of stuff in it, but the thing that’s relevant, the piece of it that’s relevant to capital formation was the establishment of two new regulations. One was called, is called Reg A+, and the other is called Reg CF. What do they do?

[00:19:47] Daniel Gallancy: They allow for within certain confines, a general solicitation targeting investors who are not accredited and they enable capital formation from people who are not necessarily accredited investors. By the way, many investors turn out to be accredited and they don’t realize they are, but that’s another, we’ll come back to that. But with the establishment of those new regulations, it was a change.

[00:20:13] Daniel Gallancy: You’re changing the landscape, you know, 80 years of history. Change. Right. You know, I don’t want to say overnight because it took the SEC to actually, to actually put those regulations into action, right? So they, they were legislated in 2012, but then it took until 2015 and 2015 for Regulation A+ and 2016 for Regulation CF for them to actually be put into force.

[00:20:36] Daniel Gallancy: The wheels of godland do not move quickly. Once they were put into force, the rules were different. So, under Regulation A+. A company can solicit from the general public, they have to file this sort of kind of mini prospectus, right? It’s not quite the same as what you’d file in a traditional IPO, but it contains a lot of the same information.

[00:20:59] Daniel Gallancy: Once the company has filed that the company can go out and raise up to 75 million dollars from anybody. From anybody. That number, that 75 number used to be smaller, but it got, it was increased. Reg CF is a slightly lighter weight regulation. So instead of having to put together this mini prospectus, you need to put together an even more miniature one.

[00:21:21] Daniel Gallancy: It’s like it’s less onerous and the subsequent recording requirements are less onerous, and that lets you raise up to 5 million dollars again from the general public. That’s an increase from the original, approximately 1 million. So started as you could raise up to a million bucks. Now you can raise up to 5 bucks.

[00:21:39] Daniel Gallancy: And people are using it. Companies are using it with some fairly successfully, some a lot less successfully, but it’s definitely in use and it’s a huge change because now your uncle can say, I want to open that carwash. And you might not need 75 million bucks for it, but maybe he needs 2 million bucks for it.

[00:21:57] Daniel Gallancy: And he can go how on the screen with a sandwich board and say, I want to raise some money. Now, he can’t actually take the money and put in his, put it in his pockets. He needs to use an intermediary. The intermediary charges fees. There’s a whole racket there. There’s always a racket to these things, but the fact that he can do it, the fact that he can go into his own community and say, hey, I want to raise money for this carwash is really important and here’s why.

[00:22:24] Daniel Gallancy: Well, there are, there are many reasons why, but I want to focus on one. Outsiders, you know, wealthy individuals who don’t live near your uncle. They may not understand the need for that carwash in that community. They may say, is there really demand for this? Do people really care? But if you live in that community, people who live in that community with your uncle, they will have a sense perhaps as to whether or not there’s demand for that carwash.

[00:22:49] Daniel Gallancy: And maybe the, you know, Royal will say it. And so, you know what? There’s tons of demand for this. I really want a car wash. Not just because I want to be able to wash my car, but also because I think it will generate good returns. There are no other car washes in a 50-mile radius, and there are a tons of cars here.

[00:23:06] Daniel Gallancy: And I happen to know that because I’m in the community. Well, great. Now your uncle connects directly with this. You know, this individual, the individual can put any 500 bucks, a hundred bucks. It’s not going to necessarily be the fastest process if everyone’s putting in a hundred bucks, but the ability to get involved in the capital formation process, when you have an insight as to the value proposition of that business, where others might not, that’s what’s so important here. That’s what’s so important here. That’s a big change.

[00:23:40] Clay Finck: You mentioned these Reg A+ and Reg CF that was, you know, first proposed in 2012. Why do you think this came about? Is it something with the internet, you know, making information so much more available and much more accessible? Or why do you think all of a sudden now non-accredited investors can invest in companies like this?

[00:23:59] Daniel Gallancy: For a very long time, there have been complaints about the inability to conduct a general solicitation.

[00:24:08] Daniel Gallancy: I can’t tell you the exact catalyst that led to the legislation in 2012, but what I can tell you is that the desire for a three-year form of capital formation has existed for a very long time. At the time, 80 years of, you know, pent up demand. Now it’s 90 years later, at the time was 80 years, right? 80 years of pent-up demand for people to have easier access to capital formation.

[00:24:30] Daniel Gallancy: And I would say that Reg A+ and Reg CF have had certainly not fully solved the problem. They solved it, a little bit, but you can tell that there continues to be significant demand for capital formation through mechanisms outside of Reg D, outside of the venture world, based on a lot of things that you see around you. So, if you look back to, for example, 2017, ’18, there was a whole ICO craze.

[00:25:00] Daniel Gallancy: What is that? That’s a form of capital formation. Now, does it violate regulations? So many regulators would say yes, right? But people were saying, hey, this is a way to conduct capital formation. There were tons of scams, there was tons of bad stuff going on there, good stuff too. But people were doing it outside of the framework of Reg A and Reg CF.

[00:25:18] Daniel Gallancy: Some people actually tried to embrace Reg A and kind of meld the two together. I don’t know how well that went. I think some of those weren’t okay. But the point is it occurred in this sort of big rush and people were like, you know what? Here’s a great way to, here’s a great way to raise money. And it worked.

[00:25:33] Daniel Gallancy: And you continue to see situations in which individuals and companies will have interesting ideas and they have trouble forming capital to create a new entity. Right? To create a new venture to affect those ideas. I think Reg A and Reg CF are a great starting point. Clearly more needs to be done. It’s still too onerous overall.

[00:25:57] Daniel Gallancy: And if you look at, for example, just some of the fees that exist, if you’re involved in Reg CF, those fees can hit, you know, 10-ish percent, which is a gargantuan amount of money. Imagine you’re raising, $5 million dollars, half a million dollars going to intermediaries. It’s a lot of money. You know, I would say that the reform process remains incomplete here.

[00:26:20] Daniel Gallancy: And you see a lot of areas in which there is innovation based upon these reforms, right? Based upon those new regulations. So for example, if you see a real estate venture, a real estate opportunity advertised to you on social media or factual ownership in a car, or a collectible or fragile ownership in our work, all of these things are being done via Reg A and Reg CF.

[00:26:48] Daniel Gallancy: So, you’ve had a lot of innovation as a consequence of these regulations emerging. You couldn’t have done that. Forget the social media part. You couldn’t have done that before the Jobs Act. Now you can and it goes to show that innovation will persist, and you end up the caps on that are often but not always, but are often a regulatory framework.

[00:27:13] Daniel Gallancy: And if you loosen those caps, you’ll probably see more innovation emerge.

[00:27:20] Clay Finck: I think this brings to question things like equity crowdfunding and maybe some of the other crowdfunding opportunities you might see on something like Kickstarter. How about you talk about equity crowdfunding, what it is and how this sort of fits into the picture as well?

[00:27:35] Daniel Gallancy: So, Reg A+ at Reg CF are, the equity crowdfunding regulations, and I think it’s really important to talk about equity crowdfunding versus traditional crowdfunding, you look, the type of crowdfunding you get on the likes of Kickstarter, you’re not getting any equity ownership in the entity that’s raising capital.

[00:27:52] Daniel Gallancy: What you’re doing is you’re effectively providing that company with working capital or potentially some R&D money to develop a new product. Then you’re kind of pre-buying the product. You don’t own the company. That’s, by the way, that does not, as far as I know, does not run afoul of the general solicitation rules because you don’t, you’re not getting any securities, right?

[00:28:11] Daniel Gallancy: You’re just pre-buying a product. Equity crowdfunding is different. You’re doing the same thing in terms of asking the crowd for money, but the crowd in return for its capital, gets an ownership interest in the company conducting the offering. So, equity crowdfundings are very, very different from old school crowdfunding.

[00:28:32] Clay Finck: So, for the traditional crowdfunding, you said they’re providing capital for, the working capital needs of the company. So, what are they actually purchasing then? And if they’re not getting equity?

[00:28:43] Daniel Gallancy: In regular crowdfunding, you’re generally getting access to a product, perhaps before it’s released to the general public.

[00:28:48] Daniel Gallancy: That’s generally what you’re getting. Versus in equity crowdfunding, you are getting either share of stock or some other security interest in the target company. So, with irregular crowdfunding, you’re getting a one-time thing. You’re getting the widget that they make. With equity crowdfunding, you get shares of stock of the company, which you could own into perpetuity.

[00:29:06] Daniel Gallancy: And to the extent that you know, ultimately those shares pay a dividend or ultimately there’s an acquisition, you have the opportunity to make money, not just receive a product.

[00:29:16] Clay Finck: Now, when I look at your background and your experience, you know, working at a hedge fund, you have a finance background. You started your own Bitcoin company in the 2010s, how do you see equity crowdfunding playing a part in an individual’s portfolio, then?

[00:29:31] Daniel Gallancy: I think this is an interesting topic. There are at this point an abundance of equity crowdfunding opportunities. You can go on websites like, Wefunder or Republic or Start Engine. There are a bunch of these things out there, and you can see these companies that are raising capital.

[00:29:46] Daniel Gallancy: Now, question, should you put capital into one of these companies? I’m not here to answer that. What I can talk to you about is, so I think this is your question, some of the frameworks for analysis here, so certainly, you know, one approach is to take a portfolio approach and say, okay, I don’t know which ones to pick, but I’m going to pick A and B and C and D and E and F and 10 of them, right?

[00:30:09] Daniel Gallancy: And put, you know, an equal amount of capital in each sort of, hedge your risk that way. Second way to do it is if you have some specific familiarity. This goes back to the car wash example. If you lived in the town where your uncle is raising money for the car wash and you know, there is a need for a car wash there, and you think that there will be demand and you think that that car washer will make money, then you have some information on which you can make potentially a reasonable decision.

[00:30:40] Daniel Gallancy: Right? And, you know, an outsider wouldn’t know one way or the other necessarily. Right? So maybe you have information as a community insider that would enable you to put capital into an entity because you have a sense for upcoming demand, and that doesn’t have to be a carwash, right? Maybe you are a physician.

[00:30:58] Daniel Gallancy: And what’s being proposed is a medical device and you understand that area particularly well, or you’re not a position, maybe you’re just a, like a biologist who knows. You understand some particular area. That can be interesting. Those are interesting opportunities. So that’s the second way.

[00:31:12] Daniel Gallancy: So, first way, portfolio. Second way is you have some sense for what’s going on with NEP Land Street. Third way is you can certainly follow along with others. There are, you know, newsletters and all sorts of kind of publications that we’ll talk about these things and compare them and I think that’s a good way to do it.

[00:31:29] Daniel Gallancy: There are websites that will also, where you can kind of compare and contrast, you know, conceptually similar to a screening tool for stocks, right? Where you know you can screen based on earnings grove or revenue, some particular. So there are a bunch of ways for a person to get informed about this stuff.

[00:31:46] Daniel Gallancy: Certainly, do your homework. What’s nice here is the fact that these opportunities are no longer limited to venture capitalists. It’s not that VCs can’t invest in these things, and often they do by the way. Some of these opportunities are led by venture capitalists and they’re taking money from the crowd anyway, right?

[00:32:06] Daniel Gallancy: Because they want a community building exercise, right? They have a product, and they want their users to get even more excited about the product. So, they’re taking money and hoping that the users get more excited than they already. There’s that as well. So, it’s not limiting to the venture capitalists, but what it does is it enables investors who happen not to be accredited to participate in these sorts of things.

[00:32:27] Clay Finck: Earlier you mentioned the venture space being around a 750 billion dollar market, I believe. So how does the crowdfunding piece kind of play into this? I’m curious if it’s sort of disrupted venture capital in a way, you know, now that you know there’s more access for investors, or how big is this crowdfunding piece of the puzzle.

[00:32:47] Daniel Gallancy: I have to get back to you with the exact numbers. There is data out there. It’s not even close to the 750B. It’s not even close to disrupting venture. What’s one of the reasons why I lead so interesting. We’re at the earliest stages. It’s not even close and there are many reasons why it’s not even close.

[00:33:02] Daniel Gallancy: You still have a lot of hot deals that know they can go straight to VCs and get the money, you know, get it done fairly quickly. Whereas the equity crowdfunding route is sometimes viewed as more of a long, you know, more of a slot, a longer process. It depends. It isn’t always, you know, when we did it, we, you know, filled around very, very quickly.

[00:33:22] Daniel Gallancy: But I think there’s certainly a perception that it can take a long time, and I think in many instances it does. So, it has not yet disrupted the venture capital world, and I don’t know when it will. It may never disrupt it per se. It may exist alongside it. I would be surprised if equity crowdfunding were to destroy venture capital.

[00:33:43] Daniel Gallancy: I do not expect that. What could be interesting is the coexistence of the two and the continued growth of equity crowdfunding and the ability for people who are not venture capitalists to get involved in opportunities where they otherwise would not have the chance. And I think that coexistence can actually be not just healthy, but beyond that, I would say symbiotic.

[00:34:05] Daniel Gallancy: And a good example of that is a situation in which there’s a consumer facing product and the users are excited about the product and they want to put in capital, right? And that can sit right alongside the VCs.

[00:34:17] Clay Finck: Now this whole topic really hits close to home for you because your team at Atakama is actually doing an equity crowdfunding around yourselves, which is quite unique for all the reasons we’ve discussed here.

[00:34:32] Clay Finck: How about you talk more specifically about Atakama, your company and the equity crowdfunding opportunity that your team has.

[00:34:40] Daniel Gallancy: So, Atakama is a cybersecurity company based in New York City and we started an equity crowdfunding round late last year under Reg CF and also Reg D. So, we did these two things simultaneously, and then also another reg called Reg S, which I can explain in a moment as well.

[00:34:58] Daniel Gallancy: The Reg CF portion sold very quickly, so between Reg CF and then Silver Credit Accreditors, we hit the $5 million in like five days. I said earlier that many companies find this to be a slog. We found it to be a very efficient and effective way of raising capital. We’re thrilled we did it. We think it was great.

[00:35:18] Daniel Gallancy: And you know, now I give these investor updates and it’s great. You know, I’ll give, I’ll do a webinar and I’ll have all these folks who are investors in the company and I’ll be able to tell them directly what they, you know, what’s going on, which I enjoy. And I hope they enjoy it too. I think they do.

[00:35:30] Daniel Gallancy: We’ve continued along with the equity crowdfunding route here. So right now, we have, for the time being exhausted our $5 million cap, it’s 5 million dollars every 12 months. So now, right now we’re still raising under what’s known as Reg D, so we can take money from accredited investors, but also under what’s known as Reg S.

[00:35:49] Daniel Gallancy: Reg S enables us to raise capital from anyone overseas, accredited or not accredited. Overseas relative to the United States. So anyone, SEC says, under Reg S you can raise capital from folks who are outside of the United States, regardless of their accreditation status. We look forward in the future to, if at all possible, we’ll see reopening the Reg CF piece and being able to deal with even more investors in the United States who are not accredited.

[00:36:18] Daniel Gallancy: I think that’s great, but for now it’s accredited us and not accredited slash accredited overseas.

[00:36:27] Clay Finck: I’d love for you to jump in on the product side as well because I find that aspect just so interesting because you are able to recognize this opportunity in the cybersecurity space and move along and, you know, work for a hedge fund, work in tech, and then start a Bitcoin company and kind of understand the technology and the cybersecurity aspect.

[00:36:45] Clay Finck: So, I’d love for you to talk a little bit more about the product side of Atakama.

[00:36:50] Daniel Gallancy: Absolutely. And I’ll give you the 22nd Genesis story, which will explain how we got the product piece. When I spent some time in the Bitcoin world, one of the most interesting aspects of that space in my mind had been various different mechanisms of storing cryptographic keys.

[00:37:07] Daniel Gallancy: So, without getting too mired in the underlying details, cryptographic key is what enables you to send Bitcoin crypto from party A to party B, you have that key. You can send it to another person. You better keep that key very well protected. And one of the really neat ways to do that is to split the key into pieces and the, I would say, most well-known mechanism for doing that cryptographically, assuming known as Shamir’s secret sharing scheme. So, using is, so Shamir’s secret sharing scheme is what’s known as an example of threshold cryptography. It’s a mechanism of splitting a piece of data, be it a cryptographic keyword or otherwise into multiple components. We saw this within the Bitcoin and crypto world, and we should wait a second.

[00:37:53] Daniel Gallancy: This is great security. Why isn’t anybody doing this for enterprise cyber securities? And we were shocked at how little of this sort of thing was actually going on in the enterprise cybersecurity world. So of course, we said, this is great. There’s a great opportunity. Everyone was running towards, you know, the white hot Bitcoin and crypto world.

[00:38:11] Daniel Gallancy: And we said, wait a second, wait a second. There’s something great here tech-wise, and we can take that and apply it someplace else. And people are not running into that area like they’re not all trying to do that same thing. So we’ve built out an encryption platform that enables the splitting of keys and the reassembly of those keys at the point of decryption.

[00:38:33] Daniel Gallancy: So you’ll have a piece on your laptop, a piece on your phone, and a piece on your iPad. You know, a piece could be on a server. And then when you want to decrypt that piece of data, you can on the fly, let the shards of the key be reassembled and you know, sort of tap approve. It’s got sort of a IU, UX user interface, user experience of what looks like two FA.

[00:38:54] Daniel Gallancy: You just tap a button on your phone and then shroom, your cryptographic key is reassembled. The file is decrypted and you’re ready. You’re ready to rock and roll. Meanwhile, if somebody manages to get access to the underlying encrypted data, all they have is a bunch of encrypted nonsense. They need to have the keys.

[00:39:13] Daniel Gallancy: So, in order to steal your data, it’s no longer just breaking into your Google Drive, breaking into the file server, breaking into Dropbox or whatever. It’s, yes, they have to do that, but they also have to get the piece of the key that’s on your phone, the piece of the key that’s on the server, the piece of the key that’s on the laptop.

[00:39:31] Daniel Gallancy: It’s much, much harder. So, you, you know, you’ve increased the difficulty of accessing data here in a gargantuan manner, right? So, if stealing one piece of a key is difficulty X, stealing two pieces is not 2X, it’s like X to the sum power, right? It’s very difficult to calculate, but it’s much, much more difficult.

[00:39:49] Daniel Gallancy: So, you end up with incredibly powerful protection. Again, what’s known as data exfiltration, exfiltration, meaning the theft and potential exposure of that data, right? Elsewhere. And it’s been great. And you know, we have more than 60 enterprise customers. 60 would be very, you know, 60 doesn’t necessarily sound impressive if you’re talking about, mom and pop.

[00:40:10] Daniel Gallancy: We’re talking about big companies, right? We’re getting big companies to buy this stuff with success, and they like it and they’re buying more. You know, if you look at just, you know, Q1 is not quite over as we’re recording this, it’s approaching over. By the end of Q1, we’ll probably have grown, you know, revenue on a year over year basis.

[00:40:29] Daniel Gallancy: Annual recurring revenues. The amount of like new customers that we get in of recurring revenue buy a similar between 30 and 40%. So, we love it. We’re thrilled and it’s super cool technology. It serves a really important purpose. Customers love it and we’re thrilled to be doing it.

[00:40:46] Clay Finck: Since we’re talking about Atakama, I just wanted to give a full disclosure that I have personally invested in your team’s crowdfunding round just a few months ago actually, and that was after researching and getting to know yourself and getting to know the great people on your team just to make the audience fully aware.

[00:41:03] Clay Finck: And regarding the cybersecurity space in particular, one of the things that amazed me with Atakama and the industry is just how massive it is. McKinsey released a study that showed that in 2021 organizations spent around 150 billion dollars on cybersecurity, and they estimate that this is really just beginning in that there’s only 10% penetration into this total opportunity for cybersecurity and the current growth rate I saw on that McKinsey study in spend was around 12.4% in 2021. So, you mentioned the growth in Atakama and your business, you’re growing very rapidly and adding new customers. I’m curious if you could talk a little bit about the valuation and how that works with the crowdfunding ground, and then maybe what sort of opportunity you see in the future for your company.

[00:41:55] Daniel Gallancy: I think the study that you referenced captures it quite well. The need for cybersecurity is only increasing and it’s increasing for a lot of different reasons. It’s increasing because, , the complexity of the internet is only increasing the places in which we keep our data. You know, that number of places, that’s only increasing the opportunities for attackers.

[00:42:17] Daniel Gallancy: That opportunity space, unfortunately, is increasing. You know, cybercrime is a new way of conducting criminal activity where you can hide behind something. Physical crime, it just certainly still happens today. Right. You know, but there are cameras everywhere. Sure. I don’t think, I don’t think it’s as appealing to be a mugger on the street.

[00:42:42] Daniel Gallancy: When you might get picked up by a camera as it is to be, you know, an attacker behind a keyboard, or, of course there are ways you can be caught, of course, but it’s much easier to cover your tracks besides your webcam, which you’ve probably put a piece of tape over if you’re at a hacker, there’s no camera to watch you do it.

[00:42:59] Daniel Gallancy: So lots of attacks going on and, businesses are the primary targets of these. Because they have, their opportunities to, to steal money or steal data or unfortunately extort businesses. And then of course, the underlying data is like your data and my data to data about us. So the attackers know that the attackers know that they can really do a lot of damage and they take advantage of that.

[00:43:22] Daniel Gallancy: In terms of valuation. So, you know, our current equity crop running round is at a 29, 29-million-dollar valuation. How did we come up with that? We wanted something that wasn’t too high, wasn’t too low. You’ll see in the equity crowdfunding space that there are all sorts of ranges of valuations, and I would, by the way, you know, listener beware, right?

[00:43:43] Daniel Gallancy: You will see valuations that are egregious, and you know, just be aware of the fact that when you see oh $1 billion valuation, on a company that doesn’t have any revenue, think carefully about what you want to do there. The, the way crop lending is you sort of get to pick your own valuation and then people either invest or don’t invest.

[00:44:03] Daniel Gallancy: So, we wanted to pick something that was reasonable, right? You know, that’s based on, the fact that we have total contract value of about 2.3 million dollars right now. So, we felt like it was a reasonable number. And then if you look north towards some of the big exits. There are plenty of cybersecurity companies where, you know, the exits have been well north of a B, right?

[00:44:28] Daniel Gallancy: So obviously, and some that have been well over the 10 B, we would love to be able to provide our investors with these 30 x, 300 x like these, you know, these gargantuan fraternities that, you know, our job right now is to continue to, you know, bust our behinds to make that happen. My team, you know, credit to my team. I think my team is terrific.

[00:44:50] Daniel Gallancy: They’re doing an incredible job pushing us forward, but we wanted to pick a reasonable valuation where investors can participate. The founding team doesn’t get excessively diluted, but investors can participate and still make really great return and I think we’ve done that.

[00:45:06] Clay Finck: Now you really understand this equity crowdfunding venture capital.

[00:45:11] Clay Finck: Why did Atakama decide to go the equity crowdfunding route and not some of these other routes that are available to you?

[00:45:19] Daniel Gallancy: Biggest reason is that I have a personal proclivity towards enabling everybody to invest. I don’t think it should just be in the hands of venture capitalists. I’m not saying that they should be excluded.

[00:45:31] Daniel Gallancy: I’m not saying you should prohibit them for participating. They have their place. But there’s no reason why that guy and that woman and that person over there and that person over there shouldn’t be able to participate as well. Let them read about the company. Right. You know, get to know us, do their homework a little bit and you know, if they want to participate, there shouldn’t be any barriers to that.

[00:45:52] Daniel Gallancy: So, you know, once I discovered the equity crowdfunding space and I realized what’s possible, you know, the fact that anyone can invest. And there’s no longer these goofy restrictions just because you don’t have some threshold amount of income or some threshold amount of assets.

[00:46:07] Daniel Gallancy: I think once I discovered that, and I assume discovered that, it’s quite liberating. I really love the idea and it’s worked out nicely for us.

[00:46:15] Clay Finck: I’m also curious, you mentioned some of these cybersecurity companies have had very successful exits. So, someone invests today, if they decide to invest today, their money gets locked up.

[00:46:26] Clay Finck: They own equity in Atakama. And then what does the exit process look like and maybe what sort of timeline or general timeline investors can expect for when they can, or when they do exit can come into a variety of different sorts.

[00:46:42] Daniel Gallancy: You know, exit can be an acquisition by another cybersecurity company or another company in general.

[00:46:47] Daniel Gallancy: Oftentimes, cybersecurity companies will acquire other security companies. And exit can be in the form of an IPO and exit can be in the form of an acquisition, not by a cybersecurity company or other company, but rather by a financial sponsor, you know, by private equity. So those are three examples. And of course, we are not opposed to any of those three.

[00:47:04] Daniel Gallancy: You know, all three of those would be interesting ways, good ways of affecting an exit. Right now, the way we’re thinking about it is build the most powerful business we can build, grow revenue as powerfully as we can. Create a bunch of really happy customers who want to continue to spend, grow the product line.

[00:47:26] Daniel Gallancy: We do those things, and we do them well, and I’m confident that an appropriate exit will appear. So, I think it’s important to mention the ways in which exits can occur, but I think simultaneously it’s important to mention that the team at Atakama is focused on building the business and we have confidence that building a good business will ultimately result in a good exit in one of those forms or some other form.

[00:47:56] Clay Finck: Well, Daniel, I really, really appreciate you coming on the show. I know I learned so much from this one hour. You know, capital formation, venture capital equity, crowdfunding, and Atakama. There’s just so much in this episode and I got so much value from it, and I know that the audience will as well.

[00:48:12] Clay Finck: If anyone’s interested in investing in Atakama like I have, or learn more about your company, how can they get in touch with you and invest and check it out?

[00:48:22] Daniel Gallancy: Yeah. So first of all, Clay, we’re thrilled to have you as an investor. And for folks who are interested in investing, you can go to invest.atakama.com/wsb and Atakama is spelled Atakama.

[00:48:38] Daniel Gallancy: We’re named after the Atakama Desert in Chile, which is spelled with a C, but we spell our name of the K and at invest.atakama.com/wsb you’ll find tons of information about the company. You’ll find information about milestones that we’ve hit our success to date, you’ll find our investor presentation, the ability to talk to investor relations and a whole lot more.

[00:48:58] Daniel Gallancy: And we’d love to have you as investors.

[00:49:00] Clay Finck: Awesome. Well, Daniel, we’ll be sure to get that link in the show notes for anyone that’s interested. Thank you again for coming on the We Study Billionaires Podcast and providing so much value to our audience. We really do appreciate it.

[00:49:12] Daniel Gallancy: Thank you so much for having me.

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