The Wisdom of Crowdfunding

By L.A. LOREK
Founder Silicon Hills News
Crowdfunding will lead to an explosion in entrepreneurship, innovation and job creation in the U.S., according to its advocates.
“We’ll go from 60,000 angel investors to six million angel investors over the next decade,” said Chris Camillo, an angel investor and filmmaker producing a documentary “Crowd of Angels.”
“This will change the way investment is done in the U.S.,” said Trey Bowles, chair of Startup Texas, an affiliate of Startup America.
Lack of access to capital is the number one inhibitor to starting a business today, said Jason Best, principal of Crowdfund Capital Advisors and co-founder of the Crowdfunding Professional Association.
They all spoke at the first-ever Crowdfund Texas Conference in Austin on Tuesday, along with dozens of others involved in the emerging new industry, known as crowdfunding. Most of the industry pioneers attended and quite a few of them were featured in a recent New York Times article “The Crowdfunding Crowd Gets Anxious.” The article detailed how Candace Klein, founder of SoMoLend, and others looked for alternative revenue sources while waiting for U.S. Securities and Exchange Commission approval to go ahead with their equity-based crowdfunding portals that take investments from regular people and not wealthy accredited investors.
At the Crowdfund Texas Conference, Klein participated on two panels and had a table with information on her company in the hallway. SoMoLend, based in Cincinnati, partners with banks and offers low-interest loans to small businesses nationwide.
With equity-based crowdfunding, companies hope to tap into money that isn’t available to them right now.
“If Americans shifted just one percent of the $30 trillion they hold in long-term investments to small businesses, it would amount to more than 10 times the venture capital invested in all of 2011,” according to the Crowdfunding Professional Association.
Currently, crowdfunding allows individuals to invest in new ideas and projects. For the past five years, companies like Kickstarter, RocketHub and IndieGoGo, have allowed individuals to donate money in exchange for perks like a new pair of tennis shoes or a watch. Since the donors are not actually investing in the company, the practice is legal.
In the past few years, individuals have poured millions into new ideas through crowdfunding, which saw its investment rise 92 percent last year, according to Startups.co. And Kickstarter, founded in 1999, reported more than 2.2 million people pledged a total of $319.7 million to successfully fund 18,109 projects in 2012. Many of the projects supported the arts. Kickstarter doesn’t allow people to raise money for charity, a cause or “fund my life” ventures.
The projects-based funding on Kickstarter doesn’t work for some startup companies like a biotechnology company looking to create a new medical device. Best said.
That’s where startups hope to tap into equity-based Crowdfunding, which Congress approved as part of the Jumpstart Our Business Startups, known as the JOBS Act. That law allows companies to raise up to $1 million a year from small investors. It has already created new businesses like EarlyShares in Miami with 20 employees. But EarlyShares hasn’t been able to finance any companies yet through its online portal. The entire industry must wait for regulations from the U.S. Securities and Exchange Commission before they can begin to match companies with small investors. The SEC already missed its deadline for submitting the new rules and no one knows for certain when they might be issued.
But the demand for equity-based crowdfunding is there, said Hall T. Martin, director of Texas Entrepreneurs Networks.
“The angel groups just can’t keep up with the deal flow right now,” Martin said.
Texas Entrepreneurs Networks plans to launch an equity-based crowdfunding portal to augment the deals its already doing with accredited angel investors, Martin said.
“A huge amount of money is sitting on the sidelines right now looking for good investments,” Martin said. “This will substantially increase deal flow.”
Small businesses struggle to get loans especially in the wake of the financial crisis, said Heather Schwarz-Lopes, CEO of EarlyShares.
Small businesses and private companies get less than one percent of investment capital.
“There’s a huge opportunity out there,” she said.
Right now, EarlyShares focuses on investor education. Already, 60,000 users have registered on its site, including 2,000 companies. It’s doing traditional broker-dealer investments with accredited investors until it gets the go ahead to make equity-based investments with non-accredited investors. It’s going to make money by taking a 5 percent to 10 percent fee on each transaction, Schwarz-Lopes said.
“Crowdfunding is going to revolutionize financing for companies,” she said.
But some speculate the SEC has not yet released its rules because of worries about fraud. The fear is that investors will lose money. And some will, said Doug Ellenoff, partner at Ellenoff Grossman & Schole, a New York-based law firm. But that’s the inherent risk involved in financing startup companies, he said.
But the hope is that some of the investments will enable entrepreneurs to create the next Facebook or Microsoft, Bowles said.
So far, few cases of fraud have been reported. In a review of more than $250 million worth of crowdfunding transactions, Jonathan Sandlund, founder of TheCrowdCafé, didn’t find any cases of fraud. That’s not to say that failures don’t occur, he said. But a startup failure is not the same as fraud, he said.
Equity-based crowdfunding is already legal in the United Kingdom and Australia and it is working really well, said Best, who has travelled all over the world to learn about and promote crowdfunding.
Crowdcube in the United Kingdom launched in 2010 and finances, on average, $88,000 per company, said Sandlund. But only seven percent of the companies seeking investment are successful, he said. That shows that the crowd is pretty good at vetting the companies seeking funds and investing in only the best ideas and teams, he said.
“It’s not a financial trend, it’s a cultural shift,” Sandlund said.
Crowdfunding appeals to the millennial generation seeking locally based goods and services and something unique and cool, Sandlund said. They like to invest in startups and new ideas, he said. They also like to seek funding from a community of supporters, he said.
CircleUp, launched in mid-2012, and has already invested $7.5 million in eight deals into privately held consumer and retail companies. CircleUp, based in San Francisco, deals with accredited investors only and that’s why it’s able to do deals. It is the nation’s largest equity-based crowdfunding site.
Best also believes equity-based crowdfunding will provide investment stimulus to a variety of entrepreneurs in all areas of the country.
Currently, angel and venture capital investment is concentrated in a handful of cities: Boston, Austin, San Francisco and Silicon Valley, he said. Entrepreneurs often move to those areas to be close to sources of financing and support, he said. Imagine if an entrepreneur in Louisiana had access to investment capital, he said. They wouldn’t have to move and they could begin to expand their company and impact the local economy favorably, he said.
Crowdfunding can also take the bias out of investments, Best said. Many investors are white men who invest in ideas they feel comfortable with and people like them, he said. But crowdfunding allows people of all races and gender to tap into financing a variety of ideas, he said.
So a 40-year-old Asian woman in Topeka, Kansas who wants to launch a healthy snack food company for toddlers has as great a chance of getting financed as a white male 20-something in Austin with a software as a service company.
Already, a barista in Portland, Oregon had success with creating a new coffee filter. Best invested in the idea by buying his product on Kickstarter.
Keith Gehrke, owner of Able Brewing, raised $155,162, exceeding his $5,000 goal on Kickstarter to create a new coffee filter and ceramic brewer. He was four months late in delivering his product to Best, but he has constantly communicated with his donors and that’s Ok with Best. He’s been able to share in Gehrke’s entrepreneurial journey.
With crowdfunding, the secret sauce is in the person’s social network.
“You’re investing in an idea,” Best said. “You’re investing in a person.”
And crowdfunding allows investors to vet a person because no one knows them better than the people in their social networks, Best said.