As small businesses come to grips with the impact of the Pandemic and their ability to survive, some will determine a need to raise funding. However, many of the usual sources of risk capital are sitting on the sidelines until they are certain that the market has bottomed out. And, after throwing band-aids of money haphazardly at the small business community, the federal government is locked in partisan politics that provide no insight as to where, when or how economic recovery programs may be funded. That places a small business in the position of considering equity crowdfunding as a possible source of money.
Equity crowdfunding came into existence during the Great Recession as a belated effort by the federal government to restart the economy by making capital more accessible to entrepreneurs and innovators. However, legislation authorizing Reg CF capital campaigns was not passed until 2012 and the very bureaucratic and Wall Street biased SEC did not approve rules for its implementation until 2016 (four years ago this month). In educational programs I presented on crowdfunding, I used to joke that the time it took for the federal government to respond to the last economic downturn might be in time for the next one - now a prophetic observation.
As a refresher on ‘what is equity crowdfunding’, the key value of equity crowdfunding legislation is to enable selling securities to many ‘non-accredited’ investors without massive regulatory oversight and associated costs. The SEC views the world as being divided between the wealthy (defined has having $200,000 a year in income or $1 million net worth – representing 3% of the population) and the non-wealthy (everyone else – representing 97% of the population). The non-wealthy, labeled ‘non-accredited’ investors, are presumed by the SEC to be unqualified to make investment decisions in the amount of $100 when these same people commonly buy $25,000+ cars and $250,000+ houses.
I could get into a social justice examination of the SEC’s multi-decade failure to fix the definition of an ‘accredited investor’ or the gross incongruity in the minimal regulatory requirements of a simple Reg D 506C (accredited investors only) filing when compared with the regulatory hoops and costs of a REG CF filing, but that would take additional time and may only lead to greater frustration, so I won’t do that now.
By all accounts, investment crowdfunding has fallen far, far short of its potential. Although opening the gates to 97% of the population as possible investors, nearly all businesses found that it takes too much time, money and knowledge to successfully conduct a capital campaign that may require hundreds, if not thousands, of investors to successfully attain a capital campaign goal.
At the federal level (which is different from many state crowdfunding laws), a small business must work with a SEC licensed crowdfunding platform. This platform can charge the small business a commission representing a percentage of the total money raised. Commission fees commonly range from 5% to 7%. However, platforms rarely provide any value greater than an online shopping cart where small businesses are left with the cost and responsibility to recruit investors and point them to the platform website. Worse yet, platforms commonly charge a payment processing fee as high as 5% (bringing total costs to 12% of money raised) for moving money from the bank account of the investor to the an escrow account where the money is held until reaching minimum capital goals.
When crowdfunding laws were passed at the federal and state levels, it was assumed that anyone with money would simply step up and invest in small businesses whenever requested. This assumption ignored common sense and cultural investing norms that no one invests in a business that they do not know. This assumption also ignored the fact that few small businesses generate large profits that support angel investments focused solely upon return on investment (ROI). As a result, successful crowdfunding campaigns have been few and far between and the dollar amounts have been small.
There is currently a proposal advanced by Crowdfund Capital Advisors (theccagroup.com) to include crowdfunding in federal economic recovery programs by providing matching federal money up to $250,000 and paying most of the 7% commission charged by crowdfunding platforms. Although I agree with the concept of supporting small business capital campaigns, the proposal does nothing to address the problems described above. The federal government would be better off financing the cost of conducting the capital campaign, however completed, with the loan repaid out of money raised or forgiven if the campaign is not successful.
With all that said, I still advocate for crowdfunding as a tool in the toolbox of small businesses. It is a specialty tool that will only work for raising capital in certain situations. To be successful in crowdfunding, a small business must focus the campaign on its customers and community members and set its dollar expectations accordingly. The campaign must bundle product/service discounts with profit or revenue sharing as a package to provide a certain and tangible possibility of benefit to the investor. Otherwise, why would any person put their scarce money at risk for an uncertain outcome in the future?
The capital campaign will likely be limited to residents of a single state and therefore qualify under state crowdfunding laws that are less complicated and costly for the small business than federal laws. As an example, in Colorado, a small business can raise up to $500,000 without requirement of engaging a crowdfunding platform and is not allowed to pay a commission – only administrative fees. This DIY capability avoids unnecessary costs but the small business will still need to design, stage and conduct a capital campaign to many, many people.
One segment to which a small business may look for crowdfunding investors are the members of its local community who benefit from the jobs, taxes and purchasing from other businesses by the small business within the community. However, with the Pandemic, a single small business capital campaign may be lost in the noise of the economic downturn or be ignored as everyone looks to their own survival. Raising money today may be better accomplished by teaming with other businesses, local governments and community organizations on a larger, community project into which they can sell their products and services.
Crowdfunding as a source of capital will be the principal topic of the next free Small Business Pandemic Survival & Recovery Webinar presented by Karl Dakin and produced by the Capital Innovation & Technology Institute that will be held at 9 am MDST (Denver) on Tuesday, May 19 at Knowledge Avatars in a Virbela virtual office platform. You may register now at https://knowledgeavatars.com/Pandemic_Survival_and_Recovery_Webinars.
Karl Dakin
Capital Innovation & Technology Institute LLC kdakin@capitalinnovation.institute http://www.capitalinnovation.institute
The Capital Innovation & Technology Institute now offers for sale the Small Business Pandemic Survival & Recovery Kit with information on development of a capital strategy and accessing funding from government disaster relief programs. https://knowledgeavatars.com/small_bz_pandemic_survival_kit
This article was first published on May 15, 2020 at https://www.linkedin.com/pulse/equity- crowdfunding-during-pandemic-karl-dakin/