With crowdfunding, experts urge caution before businesses raise funds
When President Obama signed the JOBS Act in April, it opened the door for entrepreneurs to fund their businesses via crowdfunding websites, a digital-age first.
It also cut out lots of red tape, as the act provides crowdfunded business and investors with exemptions to the Securities Act of 1933, which prohibited anyone with a net worth below $1 million from investing in private companies.
But that doesn't mean Congress and the President have given a free pass to startups that want to raise money online. Experts anticipate that once the Securities and Exchange Commission approves a new set of rules and requirements—sometime in January 2013—it's going to take lots of homework for entrepreneurs to wrap their heads around the legalities and intricacies of the crowdfunding process.
"Although this opens up investment to the general public for equity in small companies, it is still a complicated process," said Karl F. Buhl, a managing member of Navocate, a business sales and acquisitions firm based in Tampa, Florida.
Navocate recently hosted a "Get Funded Through Crowdfunding" webinar, where a panel of experts talked about the expected hurdles, and to put crowdfunding under the JOBS Act in perspective. "The SEC sees crowdfunding as somewhere between raising money from friends and family, and raising money from an angel investor or VC firm," said Paul Winkle, an emerging companies specialist with Navocate.
Prior to the JOBS Act, only donation-based crowdfunding projects had been allowed by federal regulation. And while businesses have used sites such as Kickstarter and Indiegogo to gather working capital, they have generally offered pre-sales or other swag, not equity, to raise funds.
So what changes will come in the start of 2013? To begin with, it's expected that all companies pursuing a crowdfunding path will need to have their financial statements in order, certified by an accountant if seeking more than $100,000, and audited and prepared by an accountant if raising in excess $500,000. "These statements are very critical," said Ruth Hedges, founder and CEO of CrowdfundingRoadmap.com.
The creation of a business plan to raise capital is crucial as well, which is why Hedges' website will use multiple-choice question prompts to walk entrepreneurs through details of a plan, and the due diligence reporting that applies for equity crowdfunding.
"We created a reporting system on the cloud where you can answer all of those questions and create a placeholder," Hedges said. That's a huge, huge part of this process because there's a lot of information you have to get together."
That message was echoed by Maurice Lopes, founder and CEO of EarlyShares.com, an equity-based crowdfunding platform. "The more organized you can get with your documentation, the better," Lopes said. "The biggest challenge people will have with crowdfunding will be transparency, and the more transparent you can be, the easier your process will be, from getting it started to getting it funded."
In advising transparency, Lopes and others anticipate that the SEC—now collecting feedback from businesses and case studies from non-equity arts crowdfunders such as Indiegogo—will try to weed out scammers from the get-go. Naysayers of the JOBS Act, for example, fear that its streamlined path to capital could open a new avenue for stock scams and highly speculative investing.
But supporters say equity crowdfunding will do something altogether different, giving everyday people a chance to back the next Google or Facebook. "It changes the face of venture capitalism," says Kristie Arslan, president and CEO of the National Association for the Self-Employed. "It will no longer have to be the very rich who invest in these new inventions or new businesses any longer. It's a new stream, a new American Dream."
It also comes at a time where small business loan approvals dipped to 10.2 percent for May, according to the Biz2Credit Small Business Lending Index. That's not as dismal as the 9.8 percent approval rating of a year ago, but it's bad enough to have many entrepreneurs swearing off banks and looking forward to future crowdfunding opportunities.
Entrepreneurs can pre-register on Lopes' site; about 500 have already done so. EarlyShares plans to use social media and search engine optimization as web-centric tactics to attract investors to business ventures.
Lopes is also boundlessly optimistic, citing "Localvesting" author Amy Cortese—who estimates that if Americans shift just 1 percent of their $30 trillion in long-term investments to small businesses, it would equal more than 10 times the venture capital invested in all of 2011.
To that end, Lopes says that crowdfunding is more like the kind of networking that occurs on Twitter, where users multiply their reach and muscle until they have thousands and thousands of followers.
"You'll be able communicate with your crowd or following as an entrepreneur," Lopes said. "That's important, because if you have 2000 to 5000 people in your ownership base, you'll also have 2000 to 5000 people with great contacts who want to see your business succeed. That's where you can get the same kind of value as working with a private investor of VC firm that provides mentoring or contacts."
(The author is a Reuters contributor)