Crowdfunding for Startups
December 4, 2012
I just got back from a weekend in rainy Northern California. Some interesting articles from the SF Chronicle — one of the impediments to loan financing for startups is high risk/low reward for the lender. Ordinarily, that is offset by the lender either requesting very high interest or collateral/personal guarantees. Lenders may also become investors by obtaining an equity stake (shares) in the company as part of the loan package.
Ordinary people generally cannot invest in high-risk businesses, like startups, unless they can show they have the knowledge/financial ability to understand the risks involved. Membership in the Desert Angel investment group here in Tucson, for example, is limited to who the law calls “accredited investors.”
The new generation of entrepreneurs has become very creative with how they spend funds, and they have learned that they don’t need massive amounts of financing to build innovative services and scale them.
Earlier this year, President Obama signed into law the Jumpstart Our Business Startups Act which may allow ordinary people to invest in startups through crowdfunding sites.
More details in the article by Nick Leiber available here: http://www.sfgate.com/technology/article/Crowdfunding-firms-boost-startups-4082432.php#ixzz2E6ISdvj0
Crowdfunding firms boost startups
Updated 7:54 p.m., Friday, November 30, 2012
When Medigram, a Palo Alto startup that makes a messaging app for medical professionals, wanted to raise money this year, it enlisted the help of MicroVentures.
The online marketplace, also from the Silicon Valley, quickly lined up “hundreds of thousands” of dollars from about 20 individuals, says Medigram’s co-founder and chief executive officer, Michael Chiu. He credits the website, which connects investors to entrepreneurs, with making the fundraising process “a lot more streamlined” than having endless meetings with venture capitalists.
MicroVentures says it’s the first U.S. marketplace to use a crowdfunding model to sell equity stakes in private companies to wealthy investors. To do that, it had to register as a broker-dealer. Since closing its first deal in 2011, MicroVentures has handled more than $8 million in equity sales through 25 completed private placements and has six more in motion, according to CEO Tim Sullivan.
Other, far bigger sites such as Kickstarter and Indiegogo, which have raised hundreds of millions of dollars for creative projects and business ventures, don’t offer ownership positions or financial returns, though backers sometimes receive gifts or products.
MicroVentures will soon get some competition, thanks to the Jumpstart Our Business Startups Act, which President Obama signed in April. The law may permit almost anyone to buy shares in private companies advertised on crowdfunding sites. The Securities and Exchange Commission is drafting rules for the fledgling industry. Indiegogo co-founder and CEO Slava Rubin thinks the equity model could “complement” his “perks-based” model.
“When I started MicroVentures, I said, ‘Why isn’t anyone doing this?’ ” recalls founder and President Bill Clark.
His answer? Beyond the “hard work” involved in complying with securities laws, “if you’re doing a deal for $250,000, which is our average deal, there’s not a lot of meat left on the bone for a broker-dealer who is used to making $500,000” in fees per deal.
Another equity stakes crowdfunding site, CircleUp, launched in April in San Francisco and is partnered with broker-dealer WR Hambrecht. It’s done six deals averaging “around $1 million” and charges companies a commission “in line” with investment banks, says co-founder and CEO Ryan Caldbeck.
The SEC has been studying crowdfunding companies. The agency “has come in and asked us a lot of questions,” says MicroVentures’ Sullivan. Among other things, regulators are interested in the firm’s due diligence process, which screens out “fly-by-night operations.”
The securities industry regulator’s rules are due by year’s end, though many across the industry expect the agency to miss its deadline.
Stephen Graham, a managing partner at law firm Fenwick West, thinks it will be the crowdfunding sites themselves and fast-growing startups that will reap the biggest benefits from the new provisions. Once the regulations are in place, “you’re going to have a compliance regimen and a need for securities law expertise,” says Graham.
The additional financial burden will “shut out” Main Street businesses, “whether it’s a beauty parlor or a gas station,” he adds.
The potential for fraud remains the biggest concern for regulators.
“You’re going to have people investing in companies that weren’t able to get the VCs’ attention, that weren’t of the quality a VC was looking for,” says Lynn Turner, a former chief accountant at the SEC who opposed the legislation. “Then you’re going to let the leftovers go try to raise a lot of money via crowdfunding, and they can do it without putting up the necessary warnings and disclosures to investors. That’s really stupid.”