Crowd Funding Waiting on SEC Rules

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Back in December, two different early-stage entrepreneurs got in touch with me, both of whom were looking for equity funding for their projects.  One was marketing a beverage product, and the other was an innovative high tech product.  In both cases their questions revolved around how they could get equity funding, what was involved, what would make someone a good source, and what would determine how much ownership they had to sell to raise the funds they needed.

The bald truth is that pre-revenue companies are disadvantaged when it comes to trying to raise equity from anyone other than “friends and family.”   The lack of an in-market sales history leads any potential investor to demand a lower valuation then the owner typically will accept.  The potential investor needs that lower valuation in order to achieve a high return on his or her investment, to compensate for the risk of failure.  When investor and entrepreneur cannot agree on a valuation, the equity funding does not take place.   It is for this reason, more than any other, that the vast majority of successful start-ups are self-funded.   According to celebrated scholar Amar Bhide’s survey of business owners who made the Inc 500 list, 55% initially capitalized their business from personal savings, 6% from credit cards, 13% from friends and family, 7% from bank loans or mortgages, and only 7% from Angels or Venture Capitalists.

Kickstarter’s success in helping artists, musicians, film makers, game designers and the like fund their projects has captured the attention of those who would use crowd funding to do the same for entrepreneurs.  Kickstarter was founded in April of 2009, and through October of 2012, had led to pledges of $399 million for projects that went on to get funded for the full amount (on Kickstarter it’s all or nothing.)   Importantly, Kickstarter cannot be used to offer financial returns or equity.

Approximately 2/3’s of successfully funded Kickstarter projects have been in the range of $1,000 to $9,999.   Most entrepreneurs looking for initial equity funding for their business need considerably more funds than this.  If they have insufficient funds of their own, they can seek equity from friends and family.  Another alternative is to register with a portal such as CircleUp, which believes “great entrepreneurs deserve funding from passionate investors” and whose technology is “allowing accredited investors to find, vet and invest in companies in a new way.”

To be an “accredited investor” requires demonstrating net worth of at least $1,000,000 (excluding primary residence) or income of $200,000 (or $300,000 including spousal income), criteria which exclude most Americans.  Proponents of Crowd Funding believe that easing this restriction on non-accredited investors will lead to greater funding of entrepreneurial start-ups and faster job creation.

Enter North Carolina 10th District Congressman Patrick McHenry, currently serving his fifth term, who introduced legislation which evolved into the Crowd Funding provisions of the Jumpstart Our Business Startups (JOBS)  act (H.R. 3606)  which was signed into law by President Obama on 4/5/2012.  The Securities Exchange Commission (SEC) was tasked to create and implement regulations within 270 days, which they failed to do.  An SEC spokesman was quoted by the “NY Times” on 1/6/13 as saying they were “working very hard” on the new rules needed to implement the provisions of the JOBS act.

It is really not in the Security Exchange Commission’s DNA to be comfortable with the new Crowd Funding provisions in the JOBS act, as tightly controlling the exemptions to securities registration regulations has been one of their main lines of defense against securities fraud.  For example, the SEC website page titled “Risky Business: Pre-IPO Investing” cautions pre-IPO investors, “remember, if it’s neither registered nor an exemption, it’s probably illegal.”

With that as a backdrop, it should come as no surprise that the Securities Exchange Commission came out against the Crowd Funding provisions of the JOBS act.   Much to the chagrin of Congressman McHenry, the biggest push against the bill from the SEC came after the House had already passed it by a 390-23 margin on March 8th of 2012.  This opposition came in the form of a speech by SEC Commissioner Luis Agular, which was posted on the SEC website on March 16, 2012,  and a March 13th letter from Chairman Schapiro to Senator Tim Johnson of South Dakota and Senator Richard Shelby of Alabama, the Chairman and Ranking Member, respectively, of the Senate Committee on Banking, Housing and Urban Affairs.

The timing of the Security Exchange Commission opposition to the JOBS act Crowd Funding provisions, coming after the House had passed the bill, understandably rankled Congressman McHenry.  To get a flavor for this check this YouTube video of SEC Commissioner Mary Schapiro (now retired) testifying on June 28, 2012 before the House Committee on TARP, Financial Services, and Bailout of Public and Private Programs chaired by Congressman McHenry, starting at 36:40., leading up to 38:53 where Congressman McHenry complains about “being sideswiped by a regulatory body at the 11th hour” as well as asking Chairman Schapiro “do you have my [mailing] address?”  Despite the flurry of last-minute SEC objections to the Crowd Funding provisions in the JOBS act, the Senate went on to pass it by a 73-26 vote on March 26, 2012.

So what happens next?   Eventually the SEC will probably step forward and put regulations in place to enact the Crowd Funding provisions of the Jobs Act, although this may not happen until 2014.  Sites like CircleUp, which are already well established, and working within the current regulations, possess the infrastructure and market presence to accommodate the additional (non-accredited) investors who will be eligible to invest under the new JOBS act provision once the SEC completes the rules-writing process.   Potential investors and entrepreneurs will still often disagree on valuations, especially for pre-revenue companies, but broadening the pool of potential investors in start-ups should be a good thing for the U.S. economy, provided the proper safeguards are put in place to implement this new law without opening the doors for scam artists.

SoundBoard Angel Fund Getting Closer to Launch Date

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Earlier today, I attended an informational meeting about SoundBoard Angel Fund, which is getting closer to its launch date.  The fund will build on the expertise of SoundBoard Consulting Group, whose members have extensive experience coaching entrepreneurial led companies.

Attorney Gregory Petroff, who is advising SoundBoard Ventures, told the meeting attendees that he believed that SoundBoard Angel Fund’s chances for success were strong, given its focus on a set of industries (i.e., consumer goods, education, health care services) that sets it apart from Arc Angel Fund, an extremely successful angel fund launched in August 2010.

NY City Supporting Food Manufacturers in Meaningful Way

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Mayor Michael Bloomberg and City Council Speaker Christine Quinn both emphasized the importance of New York City’s food manufacturers when speaking at Baruch College this morning, the site of the NYC Food Manufacturers Business Expo.

Mayor Bloomberg addressing the NYC Food Manufacturers Business Expo

Bloomberg mentioned that food  represents a $5 billion industry in New York City,  responsible for 19,000 jobs, and employment growing at 14%.   In her talk, Quinn mentioned that NY City exports 7% of its goods and services, vs. 12% export of goods and services across the U.S., and the city is getting behind its food processors to help close that gap.  Seth Pinsky head of the NYEDC spoke next, about how his organization is working to bolster the chances of immigrants to succeed as entrepreneurs, given that they often lack a national network of contacts.

As a further show of support and interest in the food industry, the city today launched a new website: NYC Food.

Exhibitors at the Expo included Brewla Bars, Esposito’s Fine Quality Sausage Products and Davidovich Bagels, but as Mayor Bloomberg discovered when he showed up to make his remarks, no coffee.    One of his aides went across 25th street to grab him a cup.

 

 

 

NY City Showing Support for Food Manufacturers

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Earlier this week, NY City announced 22 new initiatives to help small industrial businesses stay and grow in New York.   As reported by the NY Times, overall employment by manufacturers in NY City has declined by almost two-thirds since 1990, but the number of jobs in food-making increased by about 6 percent last year, running counter to that trend.

With that in mind, the city has contributed $1 million to a $10 million small business loan pool, intended to help finance the growth of some promising NY City food makers.  Goldman Sachs will contribute the balance of the $10 million, which will be managed by a small business lender to be chosen.

Recognizing that lack of affordable manufacturing space is also an acute problem for growing food makers based in NY City, the Economic Development Corporation is “revamping several spaces, including the former Federal Building in Sunset Park,” the NY Times reported.

Adam Friedman, the director of the Pratt Center for Community Development told the NY Times that businesses typically reach a tipping point when they need more than 30,000 square feet, and that is when they first start to think about leaving the city.   (As an aside, I do consulting work through the Industrial &  Technology Assistance Corporation (ITAC) which among its many services, helps NY City-based manufacturers implement Lean manufacturing techniques,  reducing cost, inventory investment, and space requirements)

It’s great that NY City is taking this step to help support manufacturers, including food makers, which often have a difficult time competing for equity investment with companies in faster growing industries.   $10 million is small compared to the need, but it may be a big help to a couple of small, promising companies.

Haagen-D’Azs was launched by Reuben and Rose Mattus in the Bronx in 1961, acquired by Pillsbury in 1983, and is no longer made in NY City.   I’m going to be attending the Fancy Food Show next month where I hope to visit the booths of NY City based businesses such as Wine Cellar Sorbets and Chozen all natural ice cream. If either of these brands becomes a huge success, it would be nice to think they could continue to  be economically manufactured in NY City.

 

Stylitics wins 2011 Wharton Business Plan Competition

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Stylitics won the Wharton 2011 Business Plan Competition, beating out seven other finalists for the grand prize of $30,000 in cash and $15,000 in legal and accounting services.   The competition, which is open to any student of the University of Pennsylvania, began in the fall of 2010, with 210 contestants.

Stylitics motivates customers (with gifts like reward cards) to log what they wear on a daily basis, thereby capturing up-to-the-minute insights that it hopes will make it the “Nielsen for clothing.”   The company has developed a “new generation” of tools that can track and analyze actual offline clothing and purchase behavior.

Stylitics was judged to have the “most viable business plan.”    Obviously  a business plan is needed to win a business plan competition, and is also typically required to raise capital from outside investors, but how about a company that is able to self-fund, is a business plan still important?

Using Stylitics as an example, they believe there are 50,000+ clients for their services in the United States, and that at an average revenue of $5,000 per client, they have the potential to be a $95 million revenue company by 2015.   In the process of creating a business plan for Stylitics, one of the key questions that would need to be answered is: “what marketing strategy and tactics, and at what cost, is needed to build awareness and trial of our site among these 50,000 potential clients, in order to put us on a growth curve that gets us to the $95 million revenue level by 2015?”   Estimating this early years’ marketing budget is key to estimating the needed initial capitalization.

Although a self-funded company would not need a formal 25 page business plan write-up, it would still need to know how much it has to self-fund.   Therefore, the problem solving, decision making and disciplined planning that goes into answering questions like this all can be essential elements of successful start-up businesses, even if the end result is not a 25 page comprehensive business plan.