By Cliff Ennico
Last week my new book, The Crowdfunding Handbook, was officially released.
Three years in the making, this book is the first of many you will be seeing about “equity crowdfunding”–how a business can raise capital online from its social media followers and fans using crowdfunding websites such as kickstarter.com.
On May 16, 2016, new federal regulations go into effect that will kick start (sorry, couldn’t resist that) a new wave of Web-based financing that promoters say will overwhelm the more traditional sources of startup funding, such as bank loans, wealthy “angels” and venture capital.
But will it really?
So far comments on the new rules have been mixed. While many pundits view the new rules as revolutionary, just about as many say that the market for crowdfunded investments is years or even decades away.
The naysayers are not without some valid arguments. The U.S. Securities and Exchange Commission (SEC) – the federal government agency that regulates offerings of securities among other things – hasn’t made it easy for companies to raise capital via crowdfunding. The new rules impose fairly severe limitations on companies. For example:
- All such offerings must take place on a “funding portal” registered with the SEC and the federal banking authorities, subject to a gazillion regulations that will likely lead them to impose high fees on their startup clients;
- Companies looking to raise more than $100,000 via crowdfunding must include “reviewed” financial statements prepared by an independent accounting firm in their offering documents;
- People who are not “accredited investors” (high net worth individuals for whom the restrictions don’t apply) can invest only small amounts of money in crowdfunded offerings; and
- Companies cannot advertise or promote their offerings outside of the funding portal except for a modest “tombstone ad” on the company website.
A number of securities law experts I’ve spoken to predict that advisers to startup companies will discourage their clients from taking advance of crowdfunding. Among their reasons:
- Bringing in a lot of unsophisticated investors early on will discourage “angels,” venture capitalists and other more serious investors from participating in later rounds of financing; and
- It will be difficult for most startup founders to handle a large, unruly group of crowdfunded investors who may make unreasonable demands on management time and resources.
Understandably, the SEC doesn’t want to allow unscrupulous promoters of bogus startups to take advantage of naïve, unsuspecting people. But have the regulators gone too far the other way – imposing so many hurdles to crowdfunding that a healthy, thriving market will fail to develop?
A number of commentators say “yes,” but I disagree.
I do agree that most early stage technology companies will probably forego crowdfunding for the reasons discussed above. The only exception, I think, will be so-called “concept companies” – startups that have little more than an idea for a new product, service or technology who need small amounts of money ($50,000 to $150,000) to do basic marketing research, develop a prototype and patent their invention. Such companies are considered too risky for traditional venture financing and as such are likely candidates for crowdfunding.
But there are many other types of business, and two in particular would, I think, be excellent candidates for crowdfunding under the new rules.
Retail and Service Businesses With Huge Followings on Social Media. Let’s say, for example, that a world-famous restaurant, such as Fraunces Tavern (www.frauncestavern.com) in New York City, is looking to raise money. Restaurants, like most retail and service businesses, are low margin and unscalable, making them unattractive to venture investors. Historically, they have had to rely on bank loans to raise the capital they need to grow, or sometimes just refurbish. Bank loans are rigid and inflexible, because they must be repaid with interest. Banks also require their borrowers to operate their businesses within a narrow range of “restrictive covenants” that often prevent them from taking necessary business risks.
But if a restaurant has a huge following on social media (Fraunces Tavern has hundreds of “likes” on Facebook and thousands of followers on Twitter), it might be able to raise the money it needs through crowdfunding. Many people would want the “bragging rights” of being able to say they “own a piece” of Fraunces Tavern, and if the restaurant offers a discount coupon or a free entrée for larger investments, voila!
“Project” Businesses. Businesses that have traditionally relied on project or limited partnership financing – such as real estate developments, oil and gas drilling, movie and Broadway theater productions – I think will benefit from crowdfunding, especially if investors receive something tangible (such as free tickets to the Broadway show or licensed merchandise) in addition to their shares.
My prediction: the businesses most likely to benefit from equity crowdfunding are those that have traditionally relied on bank loans or project financing, have a large social media following (and perhaps a touch of glamour), and who can offer investors something other than a “piece of the action”.
Cliff Ennico (cennico@legalcareer.com) is a syndicated columnist, author and host of the PBS television series ‘Money Hunt’. This column is no substitute for legal, tax or financial advice, which can be furnished only by a qualified professional licensed in your state. To find out more about Cliff Ennico and other Creators Syndicate writers and cartoonists, visit our Web page at www.creators.com. COPYRIGHT 2016 CLIFFORD R. ENNICO. DISTRIBUTED BY CREATORS SYNDICATE, INC. @CliffEnnico.
