Netcapital Inc. 10-K

ITEM 1. BUSINESS. Overview Netcapital Inc. is a fintech company with a scalable technology platform that allows private companies to raise capital online from accredited and non-accredited investors. We give virtually all investors the opportunity to access investments in private companies. Our model is disruptive to traditional private equity investing and is based on Title III, Reg CF of the JOBS Act. We generate fees from listing private companies on our portal. Our consulting group, Netcapital Advisors, provides marketing and strategic advice in exchange for cash and equity positions. The Netcapital funding portal is registered with the SEC, is a member of the Financial Industry Regulatory Authority, or FINRA, a registered national securities association, and provides investors with opportunities to invest in private companies. Development of Business The Company was incorporated in Utah in 1984 as DBS Investments, Inc., or DBS. DBS merged with ValueSetters L.L.C. in December 2003 and changed its name to ValueSetters, Inc. In November 2020, the Company purchased Netcapital Funding Portal Inc. (the “Funding Portal”) and changed the name of the Company from ValueSetters, Inc. to Netcapital Inc. The Company has three operating subsidiaries. The Funding Portal provides private companies with access to investments from accredited and non-accredited retail investors through our online portal (www.netcapital.com). The Funding Portal charges a $5,000 to $10,000 engagement fee, a 4.9% success fee for capital raised at closing and sometimes is paid with equity from the issuer that has listed on the Funding Portal. In addition, the Funding Portal generates fees for other ancillary services, such as rolling closes. Netcapital Advisors Inc. generates fees and equity stakes from consulting in select portfolio and non-portfolio clients. MSG Development Corp. provides corporate valuation services to businesses and individuals. Funding Portal Netcapital.com is an SEC-registered funding portal that enables private companies to raise capital online, while investors are able to invest from almost anywhere in the world, at any time, with just a few clicks. Securities offerings on the portal are accessible through individual offering pages, where companies include product or service details, market size, competitive advantages, and financial documents. Companies can accept investment from virtually anyone, including friends, family, customers, employees, etc. Customer accounts on our platform are not permitted to hold digital securities. In addition to access to the Funding Portal, the Funding Portal provides the following services: ● a fully automated onboarding process; ● automated filing of required regulatory documents; ● compliance review; ● custom-built offering page on our portal website; ● third party transfer agent and custodial services; ● rolling closes, which provide potential access to liquidity before final close date of offering; ● assistance with annual filings; and ● direct access to our team for ongoing support. 6 Consulting Business Our consulting group, Netcapital Advisors helps companies at all stages to raise capital. Netcapital Advisors provides strategic advice, technology consulting and online marketing services to assist with fundraising campaigns on the Netcapital platform. We also act as an incubator and accelerator, taking equity stakes in select disruptive start-ups. Netcapital Advisors’ services include: ● incubation of technology start-ups; ● investor introductions; ● online marketing; ● website design, software and software development; ● message crafting, including pitch decks, offering pages, and ad creation; ● strategic advice; and ● technology consulting. Valuation Business Our valuation group, MSG Development Corp. prepares valuations. The valuation services include: ● business valuations; ● fairness and solvency opinions; ● ESOP feasibility and valuation; ● non-cash charitable contributions; ● economic analysis of damages; ● intellectual property appraisals; and ● compensation studies. Competition We compete with a number of public and private companies that provide assistance with capital raising, strategy, technology consulting, and digital marketing. Most of our competitors have significant financial resources and occupy entrenched positions in the market with name-brand recognition. The majority of our capital raising and digital marketing business is on the Internet. The barriers to entry into most Internet markets are relatively low, making them accessible to a large number of entities and individuals. We believe the principal competitive factors in our industry that create certain barriers to entry include but are not limited to reputation, technology, financial stability and resources, proven track record of successful operations, critical mass, and independent oversight and transparency of business practices. Obtaining approval from FINRA to operate as a funding portal is also a barrier to entry due to the significant internal control and capital requirements. While these barriers may limit those able to enter or compete effectively in the market, it is likely that new competitors as well as laws and regulations of governmental authority may be established in the future, in addition to our known current competitors. We face significant competition in every aspect of our business, including from companies that facilitate online capital formation and the sharing of content and information, companies that enable marketers to display advertising, companies that distribute video and other forms of media content, and companies that provide development platforms for applications developers. We compete to attract, engage, and retain customers, to attract and retain marketers, and to attract and retain developers to build compelling applications that integrate with our products. Increased competition from current and future competitors may in the future materially adversely affect our business, revenues, operating results and financial condition. 7 Industry Regulation In an effort to enhance economic growth and to democratize access to private investment opportunities, Congress finalized the Jumpstart Our Business Startups Act (JOBS Act) in 2016. Title III of the JOBS Act enabled early-stage companies to offer and sell securities to the general public for the first time. The SEC then adopted Regulation Crowdfunding, or Reg CF, in order to implement the JOBS Act’s crowdfunding provisions. Reg CF has several important features that changed the landscape for private capital raising and investment. For the first time, this regulation: ● Allowed the general public to invest in private companies, no longer limiting early-stage investment opportunities to less than 10% of the population; ● Enabled private companies to advertise their securities offerings to the public (general solicitation); and ● Conditionally exempted securities sold under Section 4(a)(6) from the registration requirements of the Securities and Exchange Act of 1934. We are subject, both directly and indirectly, to various laws and regulations relating to our business. If any of the laws are amended, compliance could become more expensive and directly affect our income. We intend to comply with such laws, but new restrictions may arise that could materially adversely affect our Company. Specifically, the SEC regulates our funding portal business, and our funding portal is also a member of FINRA and is regulated by FINRA. We are also subject to the USA Patriot Act of 2001, which contains anti-money laundering and financial transparency laws and mandates various regulations applicable to financial services companies, including standards for verifying client identification at account opening, and obligations to monitor client transactions and report suspicious activities. Anti-money laundering laws outside of the United States contain some similar provisions. Our failure to comply with these requirements as applicable to us could have a material adverse effect on us. Our Market The traditional funding model restricts access to capital, investments and liquidity. According to Harvard Business Review, venture capital firms, or VCs, invest in fewer than 1% of the companies they consider and only 10% of VC meetings are obtained through cold outreach. In addition, only 2% of VC funding went to women in 2022, according to PitchBook, while only 1% went to black-owned firms, according to TechCrunch. Furthermore, under the traditional model, the average investor lacked access to early-stage investments. Prior to the JOBS Act, almost 90% of U.S. households were precluded from investing in private deals, per dqydj.com. Liquidity has also been an issue, as private investments are generally locked up until IPO or takeout. The JOBS Act helped provide a solution to these issues by establishing the funding portal industry, which is currently in its infancy. Title III of the JOBS Act outlines Reg CF, which traditionally allowed private companies to raise up to $1.07 million from all Americans. In March 2021, regulatory enhancements by the SEC went into effect and increased the limit to $5 million. These amendments increased the offering limits for Reg CF, Regulation A and Regulation D, Rule 504 offerings as follows: Reg CF increased to $5 million; Regulation D, Rule 504 increased to $10 million from $5 million; and Regulation A Tier 2 increased to $75 million from $50 million. There was $494 million raised via Reg CF in 2022, according to Crowdwise. We believe a significant opportunity exists to disrupt private capital markets via the Netcapital funding portal. Private capital markets reached $12 trillion by the first half of 2022, per McKinsey. Within this market, private equity represents the largest share, with assets in excess of $3 trillion and a 10-year CAGR of 10%. Since 2000, global private equity, or PE, net asset value has increased almost tenfold, nearly three times faster than the size of the public equity market. Both McKinsey and Boston Consulting Group predict that this strong growth will continue, as investors allocate increasing amounts to private equity, due to historically higher returns and lower volatility than public markets. In addition, Boston Consulting Group estimates that there are $42 trillion held in retail investment accounts, which we believe represents a large pool of potential account holders for us. 8 Our Technology The Netcapital platform is a scalable, real-time, transaction-processing engine that runs without human intervention, 24 hours a day, seven days a week. For companies raising capital, the technology provides fully automated onboarding with integrated regulatory filings. Funds are collected from investors and held in escrow until the offering closes. For entrepreneurs, the technology facilitates access to capital at low cost. For investors, the platform provides access to investments in private, early-stage companies that were previously unavailable to the general public. Both entrepreneurs and investors can track and view their investments through their dashboard on netcapital.com. The platform currently has more than 100,000 users. Scalability was demonstrated in November 2021, when the platform processed more than 2,000 investments in less than two hours, totaling more than $2 million. Our infrastructure is designed in a way that can horizontally scale to meet our capacity needs. Using Docker containers and Amazon Elastic Container Service, or Amazon ECS, we are able to automate the creation and launch of our production web and application programming interface, or API, endpoints in order to replicate them as needed behind Elastic Load Balancers (ELBs). Additionally, all of our public facing endpoints live behind CloudFlare to ensure protection from large scale traffic fluctuations (including DDoS attacks). Our main database layer is built on Amazon RDS and features a Multi-AZ deployment that can also be easily scaled up or down as needed. General queries are cached in our API layer, and we monitor to optimize very complex database queries that are generated by the API. Additionally, we cache the most complex queries (such as analytics data) in our NoSQL (Mongo) data store for improved performance. Most of our central processing unit, or CPU, intensive data processing happens asynchronously through a worker/jobs system managed by AWS ElastiCache’s Redis endpoint. This component can be easily fine-tuned for any scale necessary. The technology necessary to operate our funding portal is licensed from Netcapital Systems LLC, a Delaware limited liability company, of which Jason Frishman, Netcapital Founder, owns a 29% interest, under a license agreement with the Funding Portal. Payments under the licensing agreement amounted to $430,000 and $357,429 in the years ended April 30, 2023 and 2022, respectively. Proposed Alternative Trading System (“ATS”) Relationship On January 2, 2023, our wholly owned subsidiary, Netcapital Systems LLC entered into a software license and services agreement (“Templum License Agreement”) with Templum, Inc (“Templum”) to provide issuers and investors on the Netcapital funding portal with the potential for greater distribution and liquidity. Templum is a company that provides capital markets infrastructure for trading private equity securities and operates an ATS with approval in 53 U.S. states and territories for the trading of unregistered or private securities. The Templum License Agreement allows us to launch a customized marketplace for the trading of private securities issued under an exemption to the Securities Act of 1933, as amended. Templum operates an alternative trading system under the provisions of Regulation ATS. The Templum License Agreement is for an initial term of three (3) years and will automatically renew for consecutive terms of one (1) year unless (i) either party upon at least ninety (90) days prior to the expiration of the initial term or then-current renewal term, provides written notice to the other party of its intention not to renew, in which case the agreement and the applicable order and technology services and pricing outline will expire, as the case may be, at the end of the then current initial term or renewal term; or (ii) either party terminates the agreement pursuant to and in accordance with the terms and conditions set forth in the agreement. Netcapital Systems paid Templum an implementation fee upon signing of the Agreement. The Templum License Agreement grants Netcapital Systems a limited, revocable, non-exclusive, non-transferable, and non-sublicensable right and license to use Templum’s software and to provide its users access to the software. Notwithstanding the foregoing, Netcapital Systems shall be Templum’s exclusive registered crowdfunding platform partner and Templum shall not provide services to any third-party whose primary business is providing services as a registered crowdfunding platform except as noted in the agreement. Netcapital Systems agreed to pay Templum a discounted license fee in year 1, and a standard license fee in years 2 and 3. After conclusion of the initial 3-year term, the annual license fee will increase by the greater of CPI+3% or 5% for each renewal term. A beta testing platform has been established and the functionality is currently being tested. Additional milestones required to launch the platform to the public include, but are not limited to, development of the know-your-customer (KYC) and anti-money laundering (AML) functionality as well as a launch of the beta version to a closed group of users, which is currently expected in the fourth quarter of 2023. Currently, we do not know when, or if, this platform will be fully completed and launched, as there are many details that remain to be completed as well as certain regulatory matters that are required to be satisfied regarding the proposed operation of the ATS. Any regulatory delays or objections will result in delays in our ability to launch the proposed platform. It is currently contemplated that the Templum ATS will be integrated with the Netcapital funding platform, and that issuers and investors will not be able to directly access the Templum ATS. Rather, we will be responsible for collecting and delivering any required information to the Templum ATS. Once an order request has been submitted and the Templum ATS has identified two-order (bid/ask) matching at the price level, it will inform us so that we can initiate the process of wallet reconciliation between the two proposed parties in the transaction. Competitive Advantages We believe we provide a low-cost solution for online capital raising versus our peer group (StartEngine Crowdfunding, Inc., Wefunder Inc. and Republic Core LLC). We also believe that our access and onboarding of new clients are superior due to our facilitated technology platforms. Our network is expanding as a result of our enhanced marketing and broad distribution to reach new investors. Given the rapid growth in the industry and its potential to disrupt the multi-billion dollar private capital market, we believe there is sufficient room for multiple players. Our Strategy Two major tailwinds are driving accelerated growth in the shift to the use of online funding portals: (i) the COVID-19 pandemic; and (ii) the increase in funding limits under Reg CF. The pandemic drove a rapid need to bring as many processes as possible online. With travel restrictions in place and most people in lockdown, entrepreneurs were no longer able to fundraise in person and have increasingly turned to online capital raising through funding portals. 9 There are numerous industry drivers and tailwinds that complement investor demand for access to investments in private companies. To capitalize on these, our strategy is to: ● Generate New Investor Accounts. Growing the number of investor accounts on our platform is a top priority. Investment dollars continuing to flow through our platform is a key revenue driver. When issuers advertise their offerings, they are generating new investor accounts for us at no cost to Netcapital. We plan to supplement our issuers’ spend on advertising by increasing our online marketing spend as well, which may include virtual conferences going forward. ● Hire Additional Business Development Staff. We seek to hire additional business development staff that is technology and financially passionate about capital markets to handle our growing backlog of potential customers. ● Increase the Number of Companies on Our Platform via Marketing. When a new company lists on our platform, they bring their customers, supporters, and brand ambassadors as new investors to Netcapital. We plan to increase our marketing budget to help grow our portal and advisory clients. ● Invest in Technology. Technology is critical to everything that we do. We plan to invest in developing innovative technologies that enhance our platform and allow us to pursue additional service offerings. For example, we plan on offering the ability to purchase securities sold under Regulation A. ● Incubate and Accelerate Our Advisory Portfolio Clients. The advisory portfolio and our equity interests in select advisory clients represent potential upside for our shareholders. We seek to grow this model of advisory clients. ● Expand Internationally. We believe there is a significant opportunity to expand into Europe and Asia as an appetite abroad grows for U.S. stocks. ● Open ATS/Secondary Transfer Feature. Lack of liquidity is a key issue for investors in private companies as private markets lack a liquidity feature in our targeted market. In January 2023, we entered into software license and services agreement with Templum Markets LLC, operator of an ATS with approval in 53 U.S. states and territories, for the trading of unregistered or private securities to provide issuers and investors on the Netcapital funding portal with the potential for greater distribution and liquidity. A beta testing platform has been established and the functionality is currently being tested. ● New Verticals Represent a Compelling Opportunity. We operate in a regulated market supported by the JOBS Act. We may pursue expansion to our model to include Regulation A and Regulation D offerings. Industry Tailwinds Two major tailwinds are driving accelerated growth in the shift to digital fundraising: the COVID-19 pandemic and regulatory enhancements to the Jobs Act. The pandemic drove a rapid need to bring as many processes as possible online. With travel restrictions in place and most people in lockdown, entrepreneurs were no longer able to fundraise in person and have increasingly turned to online capital raising through funding portals. In addition, exempt offering regulatory enhancements proposed by the SEC in 2020 went into effect in March 2021. These amendments increased the offering limits for Reg CF, Regulation A and Rule 504 of Regulation D offerings as follows: the Reg CF limit increased to $5 million from $1.07 million, every twelve months. Rule 504 of Regulation D moved to $10 million from $5 million and Regulation A Tier 2 rose to $75 million from $50 million. Investment Portfolio A key part of our story involves the potential value creation driven by our portfolio companies. In our portfolio, we focus on companies with emerging, disruptive technologies. A partial list of our investment portfolio is described below: 10 KingsCrowd Industry: Fintech Trusted by over 300,000 investors to vet startup investments, KingsCrowd, Inc. is a leader in ratings and analytics for online private markets. The company aggregates, analyzes, and rates companies raising on platforms like Netcapital to help investors make more informed decisions. ChipBrain Industry: AI Effective communicators close more deals. ChipBrain LLC’s emotionally intelligent AI assistant provides real-time emotion, tone, and facial expression feedback in live conversations across text, voice, and video. Taking the guesswork out of identifying conversational cues, the company’s technology enables sales professionals to see at a glance how they are coming across to customers. ScanHash LLC Industry: AI With the click of a button and the wallet owner’s permission, ScanHash’s innovative program launches and immediately integrates with customers' technology systems to search for clues and traces of their private key, digital wallets and other crypto-enabling logs and records. Thanks to ScanHash’s proprietary digital forensics technology, recovering lost cryptocurrency is affordable, accessible, and safe. Zelgor Industry: Mobile Games Backed by famous venture capitalist Tim Draper, napster founder, Shawn Fanning, and co-creator of Guitar Hero, Kai Huang, Zelgor Inc. is an interactive entertainment company featuring a new species of rambunctious alien characters called The Noobs. The Noobs are a unique and original intellectual property introduced to the world through mobile games, multimedia content, and strategic partnerships. MustWatch Industry: Technology MustWatch LLC brings your friends and favorite shows together all in one place. The Watch Party app makes it easy to find new shows, see what your friends are watching, and recommend great shows to each other. The company’s platform delivers targeted show recommendations based on the television viewing tastes of users’ friends and family. It’s not a single streaming platform’s media catalog, but a cross-platform television guide, crowdsourced from your friends and family. C-Reveal Therapeutics Industry: Cancer Immunotherapy C-Reveal Therapeutics’s proprietary technology, developed at Massachusetts General Hospital and Harvard University, helps the body's immune system to identify and destroy cancer cells by inhibiting key enzymes that conceal the disease. This patent pending approach is designed to improve the efficacy of treating a broad range of cancers. Hiveskill LLC 11 Industry: AI The product is an AI-powered database and CRM hybrid that uses data and emotionally intelligent AI to boost direct one-to-one marketing efforts. It also provides specialized experts who know how to leverage your company’s data. Caesar Media Group Inc. Industry: Marketing Caesar Media Group, Inc. is an advanced marketing and technology solutions provider. Caesar Media Group is designed to leverage its technology and data to provide lead generation, search engine optimization (SEO) website development, project development, digital marketing, content management, customer service, and sales management. Although each of the above companies possesses potential to be a valuable liquid asset for our Company, they are subject to swings in their valuation and on a quarter-to-quarter basis, may create extreme volatility in our earnings report, as we mark the value of the investment to the most recent observable price. Some of our investments may decrease to a value of zero dollars. Major Customers For the year ended April 30, 2023, the Company had one customer that constituted 25% of its revenues, and four customers that each constituted 14% of its revenues. For the year ended April 30, 2022, the Company had one customer that constituted 22% of its revenues, a second customer that constituted 22% of its revenues, and a third customer that constituted 18% of its revenues. Recent Developments May 2023 Registered Direct Offering On May 23, 2023, we entered into a securities purchase agreement with certain institutional investors, pursuant to which we agreed to issue and sell to such investors, in a registered direct offering (the “Offering”), 1,100,000 shares (the “Shares”) of our common stock at a price of $1.55 per Share, for aggregate gross proceeds of $1,705,000, before deducting the placement agent's fees and other offering expenses payable by the Company. The Offering closed on May 25, 2023 and we received aggregate net proceeds of $1,468,700. The Shares were offered and issued and sold pursuant to the Company’s shelf registration statement on Form S-3 (File 333-267921) filed by the Company with the SEC under the Securities Act of 1933, as amended (the “Securities Act”), on October 18, 2022 and declared effective on October 26, 2022. We used approximately $365,000 of the net proceeds from the Offering to repay certain indebtedness, and the remainder of net proceeds for working capital and general corporate purposes. Also in connection with the Offering, on May 23, 2023, we entered into a placement agency agreement with ThinkEquity (the “Placement Agent”), pursuant to which (i) the Placement Agent agreed to act as placement agent on a “best efforts” basis in connection with the Offering, (ii) we agreed to pay the Placement Agent an aggregate fee equal to 8.0% of the gross proceeds raised in the Offering, and to reimburse the Placement Agent for certain expenses, and (iii) we agreed to issue to the Placement Agent warrants to purchase up to 55,000 shares of Common Stock at an exercise price of $1.94 (the “Placement Agent Warrants”), which were issued on May 25, 2023. The Placement Agent Warrants (and the shares of Common Stock issuable upon the exercise of the Placement Agent Warrants) were not registered under the Securities Act, and were offered pursuant to an exemption from the registration requirements of the Securities Act provided in Section 4(a)(2) of the Securities Act and Rule 506(b) promulgated thereunder. Repayment of Secured Debt On May 25, 2023, we paid $367,167 to our secured lender, Vaxstar LLC, to pay off the remaining $350,000 principal balance and $17,167 in interest, using a portion of the net proceeds of the Offering. Following repayment to Vaxstar LLC the facility was closed and all related agreements were terminated in accordance with their terms. Recent Common Stock Issuances. 12 In April and May 2023, we issued an aggregate of 450,000 shares of common stock to consultants in consideration of services rendered. In addition, in July 2023, we issued 49,855 shares of common stock to an unrelated third party, in consideration of a release from such third party related to settlement of an outstanding debt between such third-party and Netcapital DE LLC. We did not receive any proceeds from these issuances. Such shares were issued as restricted securities and were issued pursuant to the exemption provided by Section 4(a)(2) of the Securities Act of 1933, as amended. July 2023 Public Offering On July 24, 2023 the Company completed an underwritten public offering of 1,725,000 shares of the Company’s common stock, at a price to the public of $0.70 per share for aggregate gross proceeds of $1,207,500, before deducting underwriting discounts and offering expenses payable by the Company. In conjunction with this offering, the Company issued the underwriter and its designees warrants to purchase 86,250 shares of our common stock at an exercise price of $0.875. Corporate Information Our principal executive offices are located at State Street Financial Center, One Lincoln Street, Boston, Massachusetts and our telephone number is 781-925-1700. We maintain a corporate website with the address http://www.netcapitalinc.com, our funding portal maintains a website with the address http://www.netcapital.com, Netcapital Advisors maintains a website at http://www.netcapitaladvisors.com and our valuation business maintains a website at https://valucorp.com/. We have not incorporated by reference into this Report on Form 10-K the information on any of our websites and you should not consider any of such information to be a part of this document. Our website addresses are included in this document for reference only. We make available free of charge through our corporate website our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and amendments to these reports through a link to the EDGAR database as soon as reasonably practicable after we electronically file such material with, or furnish such material to the SEC. You can also read and copy any materials we file with the SEC at the SEC's Public Reference Room at 100 F Street, NE, Washington, DC 20549. You can obtain additional information about the operation of the Public Reference Room by calling the SEC at 1.800.SEC.0330. In addition, the SEC maintains a website (www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, including all of our filings. 13