Crowdfunding rule change can boost regulation
MADISON, Wis. — A former Green Bay Packers player whose consulting business has connected 400 high school athletes with college teams got a lesson in federal securities law when he sought to raise money for a new smartphone app.
Videoscore owner Darryl Ingram decided to seek Wisconsin investors through a process called state crowdfunding, a relatively new and underused tool available to small businesses.
What he didn’t realize was that the system bans any ad that can be seen by an out-of-state resident, including solicitations through Facebook and Twitter, so his effort to raise $100,000 failed to land a single taker.
Modernized federal rules taking effect Thursday lift such restrictions on using social media for state crowdfunding, provided that the states incorporate the changes into their own laws.
Ingram says it will make it much easier for small businesses like his to raise money from in-state investors.
“If I’m setting up a crowdfunding site, I’d want it to reach as many people as possible,” he said. “That’s hard without social media.”
A measure former President Barack Obama signed into law in 2012 laid the groundwork for the new rules. The goal was to help startups raise money quickly when they couldn’t attract attention from traditional investors.
But as the Securities and Exchange Commission took three more years to finalize crowdfunding rules, more than 30 states grew impatient and created their own.
Under state crowdfunding, small businesses ranging from software companies to yoga studios can sell stock to residents of their own state without having to report the transactions to federal regulators. But if any ad reaches someone outside the state, the company could be found in violation of the arrangement and be forced to register with the SEC — a lengthy process that costs hundreds of thousands of dollars and subjects the company to additional scrutiny.
“State crowdfunding laws are the Wild West,” said Mitchell Lindstrom, a Milwaukee attorney who specializes in crowdfunding.
He said state crowdfunding is a young enough practice that many of the rules are not only untested but still being worked out.
Federal crowdfunding, on the other hand, allows companies to find investors in any state and advertise widely. Both forms of crowdfunding are risky for investors, given that about half of startups fail within the first five years.
But supporters of state crowdfunding say it’s easier to undertake and has particular appeal because local investors can help grow local companies.
The idea is that investors who help a neighborhood restaurant get off the ground not only make a small profit but also get the joy of seeing their investments at work.
Hatch Oregon, a nonprofit state crowdfunding platform based in Portland, calls new offerings on its site “CPOs” — community public offerings — instead of “IPOs.”
“It really is community-based,” said Finn Terdal, Hatch’s technology manager. “There’s nothing about federal crowdfunding that ensures it’s your neighbor.” Offerings listed on Hatch’s site have included a baseball bat maker, an artisanal ice cream company and a distillery.
Terdal said the biggest hurdle has been reaching both entrepreneurs and investors, which could be improved with the upcoming rule changes and by states marketing the option more widely.
Fewer than 200 companies in the country have tried raising capital through state crowdfunding, according to data from the North American Securities Administrators Association.
It doesn’t have information on how many of those companies actually raised money, but individual states’ results suggest success has been spotty:
≤ In Texas, 41 companies with in-state offerings raised on average less than a quarter of the money they asked for: just $56,000 of $312,000.
≤ In Oregon, all but six of 26 companies that tried state crowdfunding canceled their offerings for lack of interest.
≤ In Wisconsin, only three of nine companies that tried it raised any money, and almost all of that was for a single brewery.
Abe Chu is a co-founder of NextSeed, a crowdfunding portal based in Houston. Chu said the company started as a state crowdfunding platform in 2015 but late last year retooled itself as a solely federal platform to get better results.
But he’s still enthusiastic about state crowdfunding, especially with the upcoming change.
“A local restaurant, fitness studio or brew pub can benefit a by having a strong base of local investors who in turn can become advocates and customers,” Chu said.
Ingram, the Wisconsin entrepreneur who couldn’t raise a dime for his app via state crowdfunding, says he’s now focusing on face-to-face pitches of potential investors. But he says he might try state crowdfunding again after the change.
“I’ll throw a bunch of stuff against the wall and see what sticks,” he said.