The new “Jumpstart Our Business Startups” Act (JOBS), signed by President Obama in April, has expanded the concept of “crowdfunding” to include direct investment in a small business.
Previously — and currently until regulations are completed by the Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission (SEC) — crowdfunding by entrepreneurs has been limited to either a donation model in which people donate money to a business or to a prepurchase model whereby people give money in exchange for a future product that the business is in the process of developing.
But people began to see these models as unnecessarily limiting. “What they realized was that it would be beneficial to give the person contributing an actual role as an investor and allow them to purchase an interest and be able to get a return, or get money plus interest, or sell at a later date and get money,” says Freeman White, chief executive officer and cofounder of Launcht, a New York-based company that enables crowdfunding via a stand-alone Web presence or as a supporting feature to a company’s or organization’s existing website.
The changes will allow for the transformation of what has been a donation or presale crowdfunding model into an investment model, under the name “investment” or “equity crowdfunding.”
White will speak on crowdfunding as part of at the New Jersey Entrepreneurial Network’s presentation on “Where’s the Money? Crowdfunding and Other New Financing Alternatives,” on Wednesday, October 10, from noon to 3 p.m. at the Princeton Marriott Hotel and Conference Center at Forrestal, 100 College Road East.
Other topics include the EB5 program that encourages foreign investors to invest in growing United States businesses; the New Jersey Economic Development Authority’s low-interest financing through bonds, loan participations/guarantees, grants, and tax incentives; and creative bank financing via “venture debt” and using intellectual property as collateral. Speakers will also be available for one-on-one discussions. Cost: $55, includes lunch. To register, go to www.njen.com. For more information, call 973-451-1100 or 609-688-9252.
Under the JOBS Act, companies will be allowed to raise no more than $1 million a year through a crowdfunding mechanism, which, says White, is a relatively small injection of capital compared to other rounds of financing that startups go through. And probably the capital goal would be $100,000, simply given the economics of doing such an offering.
“Everyone needs to benefit: the person raising the money needs enough so it is worth their time; the intermediary or broker has to make enough through fees; the investor must invest enough so that the payout is worth their time to do due diligence and do the investment. If the scale is too small, the value chain doesn’t really work out,” says White.
Eventually, suggests White, crowdfunding may take the place of going through traditional banks for loans in an early or growth-stage investment model.
The new law also provides limits intended to give investors some protection. For example, they will only be allowed to invest up to a certain amount each year to limit their exposure. From the startup’s side, the financial claims by the company raising money must be reviewed by an accountant or audited, depending on how much money the company is looking to raise. The principals of the business are also subject to security and criminal background checks by established third-party providers.
But White is not overly concerned with protection for investors; he maintains that the fact that crowdfunding takes place in the public domain limits the possibilities of fraud.
“One of the greatest ways fraud is perpetrated is in backroom deals where a person is given a hard sell and convinced to do something before they can check,” he says. With the new law, the offering by the small business has to be live and viewable by the public for 20 days.
Launcht’s experience offers a look into some of the clients for crowdfunding thus far as well as who the JOBS act encourage to try it out.
Socially responsible businesses. Crowdfunding has helped these businesses whose mission is to improve the environment, public health, and society to raise relatively small amounts of money, in the $5 to $10,000 range. These businesses often have a double or triple bottom line approach, which measures their impact on society and the environment as well as traditional profit measures.
“They will build in metrics for things like carbon and how much of the economic activity of the business benefits the local community,” says White. “We work with them and provide a platform where they can raise some of the seed capital, and encourage them to tell their story and perhaps offer a product or service that people can pay for now and receive later after it is developed.” This can allow the business to develop a customer base using a crowdfunding platform, he adds.
One of Launcht’s clients was a woman in Brooklyn who raised money for her composting service. Another was weBike in Washington, DC, which is creating a stationless bike-sharing program using a mobile application to help people track where bikes are. “The funders in this case primarily were reached out to by a business raising money,” says White.
Launcht provides companies and organization with a platform and a medium for exchange, and it promotes the platform through traditional public relations and news and media outreach to try to draw traffic to the site; in its newsletter it encourages people to review its current projects.
Larger institutions that want to create a platform for their niche. Universities, for example, can use crowdfunding to help on-campus student entrepreneurs to raise money for their start-up ideas, as did the University of Vermont, or, what is more common, to reach out to alumni.
“We provide the technology and allow the university to brand the platform to meet their look and feel and their logo,” says White. The student entrepreneurs, for example, would be invited to create a page to tell about what they are doing and also perhaps offer a product or service for sale.
Nonprofits. Social fundraising uses an organization’s emotional and moral connections with donors to focus them on specific initiatives. Or, for organizations that work in many different areas, for example, water projects in Africa, infrastructure projects in Asia, and health initiatives at home, using one online fundraising interface can expose donors to the diversity of the organization’s activities. This type of system can also be used effectively to rapidly collect funds for disaster relief.
Small business incubators. In the future when the regulations are completed, incubators might bring in Launcht’s crowdfunding service to offer as a service to entrepreneurs who would be able to use the platform to raise money for their business ideas.
Broker dealers. Many people decide to invest through a broker who is licensed by FINRA to broker securities transactions. This person serves as their agent in purchasing securities, and crowdfunding would become a new type of security that brokers might offer to their clients.
Startups raising capital with the investment crowdfunding model. They cannot make the online website an extension of their own website; it must be freestanding. They can only link to it. Launcht expects to provide the software for the crowdfunding platforms where the connection is made between the investment opportunity and the investor.
Although the crowdfunding model is expected to change on January 1, 2013, in the wake of the new law, White suggests that August, 2013, is a more likely timeframe. When this happens, Launcht will have to make sure its platform reflects the new regulatory requirements. It will also need to enable a higher threshold of due diligence, for example, allowing for the upload of more documents and information so that investors can do their own due diligence.
Launcht is currently reaching out to other folks in the industry to make sure its software development will meet the needs of the industry.
White grew up in Vermont and California, where his father held a number of jobs and his mother taught English in middle school. He majored in theater and biology at Middlebury College. The trajectory that landed him in the computer business began with an early job at New Leaders for New Schools, an educational reform organization in New York City.
He started building software systems for schools to track their donor base and maintain information online to track grants and find out how many students they were helping and how many principals they were training.
After three years, he struck out on his own as a consultant helping nonprofits and social enterprises to deploy systems like these by tailoring salesforce.com.
Four years later he got the idea for Launcht, and he started to build the software in the fall of 2010. The company is about to break even for the first time and is paying bills off revenue as opposed to financing. It has two employees on payroll, two 1099 contractors, and one intern.
But despite White’s enthusiasm for the possibilities that the JOBS act will generate for startups to raise money through crowdfunding, he warns that investing in startups is a risky business. Angel investors and venture capitalists recognize this and know that many of their investments will fail.
“The danger is for the general public, who may not understand the difference between failure and fraud,” says White. “Many small businesses fail even when they try hard and did exactly what they said they were going to do.”
People will need to understand just how risky this type of investment is and realize that it should constitute part, not all, of one’s investment portfolio. “There are risks, and the risks are very real,” says White. “I think the highest risk is not fraud but the nature of investing in startup businesses.”