Small Business: Finding investors in 'crowdfunding'

Businesses will soon be able to harness the power of the "crowd" to raise equity funding via a large pool of small investors.

That's because the new federal JOBS Act (Jumpstart Our Business Startups) allows a new type of financing: equity "crowdfunding." The change could generate hundreds or thousands of new investors for start-ups and small entities via online funding portals, say experts.

"It creates a mass market for private equity investments and allows companies to solicit direct to the public for equity investments," explains Clifford Holekamp, senior lecturer in entrepreneurship at Washington University in St. Louis.

Previously, public solicitation and advertising of private equity investments to non-accredited investors was prohibited under Securities and Exchange Commission guidelines, he notes. This limited the pool to individuals with annual income above $200,000 or net worth above $1 million.

Equity elite: "It created a private equity elite," Holekamp says. "This is kind of chipping away at the door of the private equity club."

Crowdfunding sites such as Kickstarter.com existed before the JOBS Act, but contributors were prohibited from getting equity or ownership interest in the company, says Maurice Lopes, a director of the National Crowdfunding Association and chief executive of EarlyShares.com, a crowdfunding platform. Funders on those sites are essentially making a donation, not an investment.

Companies will now be able to solicit up to $1 million from the public at large within a 12-month period through SEC-approved online crowdfunding portals, Lopes says. There are some investor funding limits (see earlyshares.com).

The legislation also increases the number of shareholders a private company may have before an initial public offering is required from 500 to 2,000, eliminating some of the regulatory red tape, he says.

Details are being finalized, and the SEC has 270 days from when the act was signed on April 5 to create the oversight rules, says Lopes, who is also on the leadership council of the Crowdfund Intermediary Regulatory Association.

Applications are already pouring into his site, which is going through a careful vetting process, says Lopes.

"They have to meet a certain criteria," he says. "We're looking at management team, market size, do they have experience in what they're pitching?"

Treat this as seriously as you would if you were sitting in front of a major venture capitalist, he recommends. Investors still want to see that they're investing in a worthwhile company or concept.

"People are giving up their hard-earned money," says John Murcott, co-founder of Jericho-based Karma411.com, a crowdfunding site raising money for nonprofits. The site is collaborating on a new equity crowdfunding platform with investment partner Canrock Ventures.

Mini-investors: Be sure to think through your long-term fundraising strategy before applying to any site, advises Holekamp. If you're seeking more mature venture capital later on, he notes, some VCs may not want to invest in a company with hundreds or thousands of mini-investors or "unsophisticated partners" who might create conflict. Also, a high volume of "less savvy investors" would likely require more "hand holding."

Still, for some companies it may make sense.

David Crane, chief executive of Mobile Health One Inc. in Hauppauge, says it's part of his overall strategy. The start-up, developing a secure cloud-based communications and collaboration system for health care professionals and patients, has raised half of its $750,000 goal from accredited angel investors. He's looking at crowdfunding sites as another potential source.

"We don't expect to get a zillion investors on these sites," he notes. "It's going to be a while before you see the herd mentality moving to these sites."

CROWD EQUITY

Companies will be able to raise up to $1 million within a 12-month period using SEC-approved online crowdfunding sites.
Source: National Crowdfunding Association