Tapping the web

Entrepreneurs look online for startup equity

Published January 30, 2013 by Richard Foster

Alice Ning had a million-dollar idea: high-tech winter gloves that you didn’t have to take off in order to use your smartphone. There was just one problem: Other people had the same idea and brought it to market before she could patent it.
So the Washington, D.C.-based entrepreneur modified her idea. She decided to create touchscreen-friendly stickers that could be adhered to the fingertips of normal gloves. “I wanted to think of a way to reduce the waste and find something that could adapt to every glove on the market,” says Ning, who calls her invention TapCaps.

Ning needed a relatively small amount of capital — about $15,000 — to develop a working prototype. That amount wasn’t large enough to interest most venture capital investors, so Ning took her idea public on crowdfunding website Kickstarter. She raised her goal in just 22 days and is now working on her prototype.

Crowd funding “is an excellent way to be able to reach a number of different people, test out the market for an idea and quickly fund it,” says Ning, who was invited to speak at a series of statewide panels hosted by U.S. Sen.Mark War­­­­ner in fall 2012 to encourage crowd-funding. Warner says crowdfunding “is potentially an enormously powerful tool for people raising money not just in Northern Virginia or Richmond but in Southside Virginia or Southwest Virginia, where there’s not a natural angel [investor] network.” Entrepreneurs “suddenly have a much broader universe of potential investors if you can promote this over the Internet. It offers a great, great opportunity as much in rural areas as it does in quote-unquote high-tech areas.”

Crowdfunding harnesses the power of the Internet to bring together large groups of people to fund a project or idea. Sites like Kickstarter employ a sliding rewards-for-donations model similar to a public radio pledge drive. Your return on investment might range from a T-shirt or sticker for a $25 donation to a private performance by a band or naming rights for a large donation.

However, last April, Congress passed the 2012 federal JOBS Act, which makes it legal for entrepreneurs to raise investment capital and sell shares and securities to the public via crowdfunding.

“We now said, ‘We’re going to move beyond this not-for-profit and social-do-good model and use this tool for plain old equity fundraising,” Warner says. “If I was 23 again, this would be an area I would love to go into, because I think it offers enormous potential.”

It’s important, the senator says, because it will offer new lines of available equity for startups, and studies show that startup ventures have been responsible for the majority of net new jobs in America in the last 25 years.

When President Obama signed the legislation, he said, “For the first time, ordinary Americans will be able to go online and invest in entrepreneurs that they believe in.”

But you can’t invest just yet. Congress delayed implementation of the law until the Securities and Exchange Commission can develop regulations and guidelines for crowdfunding investments, and the SEC missed the December 2012 deadline. Now some industry analysts worry that it could take as long as 2014 until the SEC hands down crowdfunding regulations.

In the meantime, startup businesses are cropping up in anticipation of the new regulations coming online, and entrepreneurs and investors are watching closely. Warner’s statewide panels brought together a variety of investment and tech experts to share ideas and discuss possible roadblocks to crowdfunding investments.

One of the obstacles to be addressed by the SEC regulations is how to protect investors. “The concern, rightfully so,” Warner says, “is how do we make sure people are not scamming little old ladies … The idea that you can raise equity capital for a company online is an enormously powerful tool, but it’s also an area that could be ripe for scam artists.”

Kickstarter operates on an honor system, trusting that those who are raising money will follow through. The site warns potential investors to use their “Internet street smarts” if something doesn’t seem right.

One protection built into the law, Warner points out, is that ordinary people with annual incomes less than $200,000 will be limited to investing $5,000 in a crowdfunding enterprise. Wealthy qualified investors will be limited to $100,000.
However, some say it’s worth the risk to democratize investment opportunities to everyday people rather than just the privileged wealthy.

“People say that it’s going to be riskier, that there’s going to be more fraud, that people are going to be taken advantage of, and I guess I say, ‘Compared to what? Compared to having money in Lehman Brothers? Having money in Enron? Having money in WorldCom?’” asks Ben Miller, co-founder of Fundrise, a Washington, D.C.-based web portal that raises crowdfunding investment equity to rehab local commercial real estate properties. (Fundrise circumvents the crowdfunding law by raising money as Regulation A and Regulation D offerings under the SEC, which Miller says is a much more time-consuming and expensive process than the new streamlined crowdfunding regulations are expected to be.)

“It’s going to be bumpy,” Miller says, “but it’s the direction we should be pushed — pushing power down to the people. That’s what the Internet has done: pushed power back down to the people through social media … It would make sense to basically deregulate a little bit and see what happens and adjust the system to allow for innovation.”

Among other protections, it’s expected that the SEC will require crowdfunding equity-raising portals to vet entrepreneurs, and that process might fall to intermediary services.

Alexandria-based CrowdCheck hopes to fill that space. The company’s CEO and founder, Sara Hanks, is a former Wall Street securities lawyer who also has worked for the SEC. Hanks started CrowdCheck in early 2012, anticipating the passage of the new crowdfunding legislation.

CrowdCheck helps entrepreneurs prepare discovery and due diligence materials to create a “report that gives the investor everything that they need to know to make an informed investment decision.” This vetting process would also protect entrepreneurs and equity-raising portals by making sure they comply with the upcoming SEC regulations.

While they don’t know everything the SEC will decide, “We know what’s in the statute, and we are able to make some very informed guesses about what the rules might look like and, second, we know what good due diligence looks like,” Hanks says. “We know what information needs to be looked into in order to make an informed investment decision.”

Opening up equity fundraising to crowdfunding investment also means that “more startups will survive to the level where sophisticated investors will get to see them,” she says. “There are some companies that never get to that stage because they never get beyond family and friends because they just can’t raise enough money to survive.”

Still, equity crowdfunding may not be the best vehicle for every business or startup, particularly for very small businesses. CrowdCheck, for instance, expects that most of its clients will probably be startups seeking $200,000 to $400,000 in capital, and it expects fees to be in the range of less than 1 percent of the equity raised. For smaller businesses, the rewards-for-donation system may still make better sense.

A group of four University of Virginia students founded rewards-for-donations crowdfunding portal Seed-ville in 2012 to help Charlottesville small businesses raise capital.

“It’s focused very much on investing in local small businesses,” says co-founder Jessica Lee, 19, a sophomore at U.Va. “We’re not planning on moving into equity [fundraising] right now. That is a potential, but it’s just a lot of extra regulations.”

Seed-ville’s first client, organic doughnut bakery Carpe Donut, sought to raise $15,000 to start a food truck franchise in New York City. Donors received gifts such as free doughnuts and coffee. While Carpe Donut raised only $1,000 toward its goal, owner Matt Rohdie is encouraged and plans to try crowdfunding again.

A former social worker, Rohdie says that crowdfunding taught him that his loyal customer base is “an asset on your balance sheet. In the business world, it’s an asset you want to periodically take advant-age of,” he says, “the goodwill you have in the community.”