by Irwin Stein
I received year end 2017 reports from quite a few equity crowdfunding platforms and consultants. All were glowing with their accomplishments. Several reported the number of offerings that had successfully raised money. None spoke of the offerings that paid the listing fees and failed to get funding.
Overall the equity crowdfunding industry continues to grow and become more popular with both issuers and investors. Still, no one wants to look at the significant problems that still plague this industry.
There is absolutely no reason why any company that lists on a crowdfunding platform should not raise the money that it seeks. There is no reason that investors should be offered the opportunity to invest in scams or in businesses that are unlikely to succeed. The amount of effort that the crowdfunding industry expends to protect investors from scams and losses is virtually nil. The crowdfunding industry cannot expect to succeed if it does not get its act together and begin to address these issues.
Equity crowdfunding allows a company to sell its shares, bonds or notes directly to investors through a website rather than through a licensed stockbroker. That can save a company a lot of money. It also allows start-ups and companies that are too small for most stockbrokers to handle efficiently to raise capital.
A stockbrokerage firm provides two specific and necessary tasks to any stock offering. First it provides investment banking services to the company to assist properly structuring the offering so that it will be accepted by investors. Second, the brokerage firm provides the sales and marketing efforts that attract the investors, close the sales, and raise the money. Both tasks are necessary. Offering a new issue of securities without either being done well is like changing a tire without a jack.
The platforms are remarkably passive as regards the structure and sales of any offering. They are content to accept listing fees from any company that wants to list. They do not care if the offering is successful. They do not care if the company is a good investment or if the investors will make a profit. These are the crowdfunding industry’s biggest mistakes. For the crowdfunding industry to succeed it must reduce the risks to its investors.
The largest beneficiary from equity crowdfunding has certainly been the real estate industry. There are established real estate syndicators in this market offering investors participation in single properties and in public and private REITs. Several have set up their own proprietary platforms to showcase their own offerings; others use public platforms where their offerings compete with other properties.
Many of these syndicators have always used private placements as a source of equity funding. Crowdfunding has enabled real estate syndicators to save the 10% -15% that stockbrokerage firms charge to fund their projects. This lower cost usually provides more cash flow for investors.
Most of the platforms are using Regulation D private placements because there is no reason for an income producing property to be “public.” Real estate is easy for investors to understand. Investors trust real estate not just as an asset class, but as an investment.
Start-ups have a more difficult time raising funds on crowdfunding platforms. And before you say that is to be expected, when you compare most start-up offerings with real estate offerings it should become obvious that most of the deficiencies with start-ups are correctable.
If you are investing in the equity of a commercial real estate offering there is usually a bank that has done an appraisal of the property and a physical inspection. With start-ups the valuations are often off the charts. Rarely has anyone actually tested the product to see if it is viable or conducted a patent search to determine if the product infringes on someone else’s patent.
With a commercial real estate offering there is usually a seasoned property manager to handle the day to day business affairs. With many start-ups the management is often less experienced than it should be. Asking for investors to fund your business if you have never run a business, or do not have good managers or advisors in place becomes an up-hill fight.
Real estate offerings are most often structured to provide income to investors. Simply stating that the property will be sold after 7-10 years is all the exit strategy most investors need. Many start-ups would have a much easier time raising funds if they structured the offering as preferred shares or provided income through revenue sharing or royalty payments.
When I advise a start-up seeking to raise capital I always offer my sense of what they should do prior to the offering to strengthen the company. I advise them how they should structure their offering to increase the chance of success. This is the advice that the crowdfunding platforms should offer to every start-up that is paying for the privilege of listing, but do not.
My hope for 2018 is that the crowdfunding platforms get on board and do the same. The platforms handling start-ups just need to become more proactive. There is no reason that every offering that lists on a crowdfunding platform should not be funded.
When the JOBS Act was passed there was a lot of discussion about small investors being able to invest. Millennials, especially, were arguing that they were being denied the opportunity to invest in the next Facebook. So at the end of 2015, the SEC promulgated changes in Regulation A allowing a slimmed down registration process for smaller offerings of up to $50 million. By any standards Reg. A has been an abject failure.
It takes a lot more money and a lot more time to prepare and complete a Reg. A offering than a Reg. D offering. I will advise any company seeking funding to use the latter instead of the former. A company that spends an additional 6 months and $200,000 to reach small investors is usually telegraphing that the more sophisticated accredited investors do not want to invest.
Reg. A has been used to raise a fair amount of money, but the issuers themselves have not prospered. Several of the most hyped offerings, such as Elio Motors, have crashed and burned taking the investors with them. The share price of most of the other companies that used Reg. A to raise capital have not been able to maintain the original offering price. And this is in the middle of an historic bull market.
The Reg.A platforms and advisors do not support the price, after the shares have been issued,the way a stockbrokerage firm would. Again, my hope for 2018 is that they get their act together and provide all the services that a company issuing shares to the public needs, both before and after the offering.
Perhaps the most disappointing aspect of the crowdfunding market has been the lack of attention to the Reg. CF portals. These handle the smallest offerings of up to $1,000,000 that cater start-ups in need of seed capital. They represent the very essence of what crowdfunding should be about; small investors helping small companies.
Unfortunately, only about 35 Reg. CF portals are operating. Those that are operating also take a passive role. They fail to assist the companies with the structuring of the offering. They fail to assist with marketing. The simple fact is that if you are going to raise $1,000,000 by taking one or two hundred dollars from a lot of small investors, then you need to reach out to tens of thousands of investors before you find enough who are willing to invest. That takes both marketing money and muscle.
It is pretty clear that most start-ups will fail within 24 months and these investors will lose their money. It is these small start-ups that need the most help and these small investors who need the most protection from loss. But again, the crowdfunding industry has just not provided that help in any meaningful way.
I hope to make a contribution to the crowdfunding industry in 2018. I am working with a group that wants to provide a measure of protection to small investors that are investing in these small offerings. They are discussing starting a new Reg. CF portal where small companies can raise $500,000-$1,000,000.
They intend to offer a program to buy back any shares of any offering that lists on their Reg. CF portal if the company fails within 24 months. You know that they can only do this if they offer only companies that they think will survive and succeed.
This type of vetting is missing in the crowdfunding industry and I am pleased to be part of the team that is putting this together. Besides me the team includes people with years of investment and commercial banking experience and a young, dynamic marketing team. The goal is to select only the best companies to offer to investors, help those companies get the funding they need and help them succeed thereafter.
Right now, the group is seeking a very small number of investors to help fund the platform itself. It is using a revenue sharing model so these investors can expect their investment returned quickly with significant return thereafter. If you have an interest in participating with an investment, contact me and I will put you in touch with the CEO.