Published on March 23, 2012
By Lisa Allen, The Deal Pipeline
As Congress readies to send a package of measures promoting capital formation by startup companies to President Obama, proponents of a provision allowing Internet crowdfunding suggest it will revolutionize capital-raising for smaller companies.
The crowdfunding measure is part of a bill that among other things would raise the shareholder trigger requiring companies to register with the Securities and Exchange Commission from 500 to 2,000.
They say that the new procedure allowing companies to raise up to $2 million annually through online appeals conducted through brokers or Web portals could be especially helpful to potential IPO candidates that aren’t yet of interest to venture capital firms or angel investors, who typically aren’t interested in firms with annual revenues under $20 million.
“This most definitely impacts the startups and small businesses that do not have capital from traditional business sources,” said Frank Knapp Jr., vice chairman of the American Sustainable Business Council and president and CEO of the Georgia Small Business Chamber of Commerce. “It would enable them to secure the investment funding that they have been locked out from to date.”
Ryan Caldbeck, CEO and founder of CircleUp Inc., which targets accredited investors — those with family incomes of $250,000 and more than $1 million in net worth not including a home — said the new avenue for raising funds could be especially valuable for consumer product companies that have gained national distribution but are nevertheless starved for conventional funding for expansion.
“Smaller companies that are underserved by institutional investors and certain industries will especially benefit,” he said.
Caldbeck said that while high-tech companies catch the eyes of angel investors and venture capital firms, young consumer products companies don’t. Even companies whose products are distributed nationally are generally forced to raise funds from founders and friends.
“You can be national and selling in Whole Foods and have more than $1 million in sales, but no private equity firm in the country is interested. You have to go to your uncle for money,” Caldbeck said
He suggested the legislation will offer more capital for those companies that are underserved. Caldbeck said young companies were another provision that makes it easier to use advertising to reach accredited investors.
The crowdfunding provision in the legislation is similar to one that the U.K. launched last year. The original crowdfunding measure in the House package was amended in the Senate to add more consumer protections.
One addition limits how much individuals can contribute according to their income. Investors earning less than $100,000 can invest $2,000, or 5% of their annual income. Investors earning more than $100,000 annually can invest 10% of their income or $100,000. Companies using crowdfunding must provide financial statements to investors, and companies seeking to raise more than $1 million annually have to provide audited financial statements.
Crowdfunding had bipartisan support in both the House and the Senate, with the only concerns being the need for some oversight to cut down opportunities for scams.
Maurice Lopes, president and co-founder of EarlyShares.com LLC, which is readying a site targeted at general and accredited investors, predicts that the path will appeal to tech companies as well as more general companies and may even attract the interest of venture capital firms. “If you’ve tapped out your friends and family, it allows you to share your concept. Instead of hitting up Uncle Joe, you pitch your existing business,” Lopes said.
Lopes said his company will screen the offers it presents.
“Don’t come to me with a new napkin idea. We may not be making an investment, but we are treating it like we are a VC, looking at the management and reputation,” he said.
Among the founders of EarlyShares is Steve Temes, the founder and managing director of Lincoln Capital LLC.
Some critics of crowdfunding have expressed concern that getting a large number of small investors could create problems as successful companies expand and seek private equity capital. The large number of investors could force premature initial public offerings or make it more difficult to sell equity stake shares.
Lopes said his company is structuring its crowdfunding to avoid that issue. He said crowdfunding investors will be part of a single investor — a limited liability company that owns a percentage share.