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The Fall of the Muni Startup That Wanted to Upend Wall Street

The Fall of the Muni Startup That Wanted to Upend Wall Street

(Bloomberg) -- In early 2017, a San Francisco startup backed by billionaire Laurene Powell Jobs and actor Ashton Kutcher scored the first victory in its campaign to shake up a $400 billion-a-year business dominated by Wall Street’s biggest banks.

The firm, Neighborly Corp., underwrote a $2 million debt sale for Cambridge, Massachusetts -- the home of Harvard University and the Massachusetts Institute of Technology -- by selling the securities in $1,000 lots to residents who wanted to invest in their own community. The company didn’t earn a penny in fees. But the successful experiment in the prestigious Boston suburb lent valuable publicity to Neighborly’s quixotic quest to make a technological end-run around big mutual funds, insurers and banks by peddling municipal bonds directly to the people.

So employees went to Maui to celebrate.

The costly junket would provide an early glimpse of problems that two years later would leave it among the ranks of startups that tried -- and failed -- to dislodge the goliaths of American finance: profligate spending, an unclear route to turning a profit and erratic leadership. Last week, the company ran out of cash to pay employees after failing to raise more funds, according to a memo seen by Bloomberg News.

Despite the millions of dollars in venture-capital money, big-name hires, talented engineers and flashy marketing, Neighborly still couldn’t overcome the obstacles of a more than century-old market built on ties between public officials and the bankers handling taxpayer money. It also proved to be a difficult time to break into municipal-bond underwriting, an industry that’s been under pressure as declining fees prompt a wave of banks to pull out of the business or merge with rivals.

The Cambridge bond deal was one of just a handful the company won before shifting to other trendy businesses, including efforts to start a social-impact investing arm and allow cities to float a kind of cryptocurrency. It’s now planning to focus on extending high-speed Internet service to communities without it.

The Fall of the Muni Startup That Wanted to Upend Wall Street

Jase Wilson, who founded Neighborly, said the company chose to leave the municipal-bond market after deciding it was “solving the wrong problem.”

“Even if we made it as efficient as it could possibly be, it’d be still structurally incapable of delivering information infrastructure, which is what our nation’s communities need more than anything,” Wilson said in a Sept. 25 interview.

Eva Arevuo, spokeswoman for Neighborly, declined to comment for this story, which is based on interviews with more than a dozen current and former employees who spoke on the condition of anonymity because they weren’t authorized to discuss internal company affairs. Wilson didn’t respond to emails seeking additional comment after his interview.

Wilson formed the company in 2012 after getting a master’s degree in city design and development at MIT. In a 2016 video, he said he got the idea after talking with a municipal-bond trader and realizing that many debt-financed projects weren’t in the best interests of the communities they served. Maybe if the investors were locals, that would change.

So Neighborly sought to bring the crowdfunding approach popularized by Kickstarter to the $3.8 trillion municipal-securities market. Instead of selling bonds in minimum lots of $5,000, it would sell them in tiny amounts so local residents could buy them, expanding the market beyond the wealthy buyers and big investment firms who currently dominate it. To do that, Neighborly would help advertise the sale, hold town halls to answer questions and manage brokerage accounts.

“If people knew they could invest in a street or school down the street, they would do that in a heartbeat,” Wilson told MIT News in 2016. “They don’t because the market has been made very, very complicated by a handful of global banks who make a profit off making it as complicated as it can be.”

With tousled hair, a yen for guided meditation and workdays that start at 3 a.m., the frequently sweatshirt-clad Wilson fit the bill for a tech executive. Neighborly raised over $30 million from backers including Kutcher’s Sound Ventures and Powell Jobs’s Emerson Collective, according to data compiled by Bloomberg.

The money allowed Neighborly to hire bankers from marquee firms, including Lindsey Brannon from JPMorgan Chase & Co. as its head of public finance and Morgan Stanley’s Homero Radway as head of underwriting and trading.

Yet as the funding came in, Wilson’s management style became increasingly erratic and employees began doubting his vision, according to former employees.

At the Maui retreat, during a session in which anonymous employee comments were read aloud in an effort to foster better communication, Wilson became defensive and emotional after some voiced concerns with his spending, limits on bonuses and raises, changes in strategy and the lack of a human-resources representative, according to people who attended. Others felt the retreat itself was an unnecessary distraction because the company was in the middle of a new bond deal, a $654,000 offering for the city of Lawrence, Kansas.

Yet Neighborly intended to do much more than take on underwriters. It also had a vision for cutting out lawyers and advisers by allowing governments to post their own documents on its platform, according to a 2015 report by Joe Lonsdale, a venture capitalist who invested in Neighborly. It would also use machine-learning on the documents to see if a deal required more credit analysis, which would take “fewer resources” than ratings companies, he said.

But the crowdsourcing model was problematic for a market that needs billions of dollars each week.

Madison, Wisconsin, relied on Neighborly in October 2018 to raise $2.1 million for a botanical garden by selling debt in $500 chunks. But David Schmiedicke, the city’s finance director, said the deal had to be downsized to just $876,000 because orders fell short of expectations and it used a traditional debt sale to raise the rest of the money later.

Some government financial advisers were hesitant to work with the upstart, said one former employee. And there may have been a good reason for that: selling debt in such small amounts may be more costly. A University of Colorado Denver report released in 2016 found that when Denver sold so-called mini bonds, like those that later would be promoted by Neighborly, the cost as a share of principal raised was between 2.5 to 7.8 times higher than with traditional bond sales.

Even as it was just beginning with underwriting in 2017, the company started an impact investing arm, Neighborly Investments, emphasizing the effect that state and local debt can have on the environment and society. It hired Christine Todd, a president at Standish Mellon Asset Management, a traditional muni investor, to lead the investing effort in late 2017, only to shutter it less than two years later. It also generated buzz by pitching a plan for Berkeley, California, to float a cryptocurrency bond to raise money, though it never came to pass.

Employees’ concerns with company spending were consistent. In addition to the Maui junket, Neighborly held a conference at George Lucas’s Skywalker Ranch and an employee retreat at Lake Tahoe, according to people familiar with the matter.

The frequent shifts in businesses and strategies also annoyed some workers who would be pulled off projects for new ones. Such changes may have caused the company to miss out on underwriting work. Loveland, Colorado, planned to reserve a portion of a bond sale for Neighborly but the company ended up deciding not to pursue the deal, said Alan Krcmarik, the city’s chief financial officer. JPMorgan ended up underwriting the entire bond sale in April.

“To us, they appeared to be distracted by other opportunities,” Krcmarik said.

There are dozens of deactivated users on a company Slack channel, a sign of the high turnover there, according to a current employee. Three executives formerly named as Neighborly Securities board members in a regulatory filing are no longer with the company. Christopher Parrott, the longtime chief financial officer, and Kiran Jain, the chief operating officer, left recently, according to their LinkedIn profiles.

Radway, the head of underwriting and trading, was fired in June after he says he raised concerns about the “racially and sexually hostile environment” at Neighborly, according to a lawsuit he filed in July. He alleges he was racially discriminated against. The company denies the allegations and says he was let go as part of its exit from the underwriting business, when it reduced 25% of its staff.

Instead, the company is going to focus on “open access fiber networks,” according to their website. That involves a costly, capital-intensive effort to lay lines that would be leased to competing Internet providers.

Wilson said in the interview that the company has had its “fair share of experiments,” which he said is normal for a startup.

“Our current laser focus on delivering information infrastructure is very singular,” Wilson said. “It’s very easy to stay focused when there’s not all the aspects of a two-century old market. It’s simply -- execute.”

He told employees last week that a new entity was being developed and the company was moving forward with the “dissolution” of Neighborly, according to a memo seen by Bloomberg.

During an interview last month, Wilson said he was speaking in a car that had just driven over San Francisco’s Golden Gate Bridge, which was financed with municipal bonds in the 1930s. Even though he didn’t succeed in the business, Wilson said he thinks another startup could follow its path.

“I don’t know that it would be an easy journey for them,” he said.

To contact the reporter on this story: Amanda Albright in New York at aalbright4@bloomberg.net

To contact the editors responsible for this story: Elizabeth Campbell at ecampbell14@bloomberg.net, William Selway

©2019 Bloomberg L.P.