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February 9, 2015 Expert Corner

Crowdfunding is democratizing capital for small business

Anthony Price

Today is an exciting time to be an entrepreneur. With a computer, mobile phone, email address, website, and social media, a small business can compete with anyone. Although the playing field is nearly level, sourcing capital remains skewed toward big business. Luckily, there are ways around traditional capital sources, allowing entrepreneurs to stay in the game.

The Jumpstart Our Business Startups Act (JOBS Act), which President Obama signed into law on April 5, 2012, is a reason to be optimistic. Over time, this legislation will change how small businesses raise capital as the U.S. Securities & Exchange Commission (SEC) figures out how to implement the crowdfunding aspect of the act.

Crowdfunding allows businesses to raise small amounts of capital from the general public.

To avoid the costly step of registering a private offering with the SEC, companies traditionally could only raise capital from accredited investors (they also must be in compliance with applicable state securities laws). To be accredited, an individual had to earn $200,000 annually ($300,000 per couple) or have a net worth of $1 million, excluding the value of a home.

Such requirements prevented an estimated 98 percent of the American public from investing in local business, according to Amy Cortese, author of the book “Locavesting.” Prior to 2012, raising equity from investors — apart from friends and family — was out of the question for most small businesses due to the complexity and cost involved in registering the offering with the SEC.

Crowdfunding aims to allow small businesses to raise funds from non-accredited investors. And states are not waiting for the SEC to implement crowdfunding regulations.

Maryland, for example, passed a new crowdfunding law allowing residents to lend up to $100 per year and businesses to raise up to $100,000 annually. Connecticut legislators proposed a bill during the 2014 session that would have tasked the Connecticut Department of Banking with researching how a crowdfunding law could work in the state. This bill passed the House but died in the Senate.

Meantime, 13 states have intrastate crowdfunding exemption laws, with 14 states considering legislation.

Public solicitation is legal in Connecticut, if the offering is registered with the state. Under federal law, an exemption from the SEC registration can be granted to a business using Rule 504 or the Intrastate Exemption, or both. In this scenario, a Connecticut business or nonprofit can raise up to $1 million annually through a direct public offering (DPO).

A DPO is a powerful financial tool for creating an offering directly to the public; it eliminates the need for an underwriter, attorney, and other intermediaries as well as the expense. Ben & Jerry's, Annie's Homegrown, and Desserts by David Glass have used DPOs to raise capital. Yet many small businesses don't use it. Cynthia Antanaitis, assistant director with the Securities and Business Investments Division in the Connecticut Banking Department, said, “We are lucky if we see one a year.”

Jenny Kassan, a Yale Law School graduate and CEO of Cutting Edge Capital, a consulting firm based in Oakland, Calif., helps train businesses to use DPOs. Kassan's first DPO was Workers Diner, a startup family-style diner that planned to locate in Brooklyn, N.Y. The goal was to raise $500,000, priced at $25 per share, from investors in New York, New Jersey, and Connecticut, but Workers Diner ultimately decided not to move forward after failing to raise sufficient capital.

Kassan identified the two primary parts of a DPO: compliance and marketing. Once the offering is approved through the compliance process, the business must begin marketing the offering. Without a strategy to promote and market the offering, success will not be forthcoming. 

Kassan explained, “You have to do the selling. The selling is not easy, especially when you're a startup. You have to go out and find the right people to invest.”

Capital remains the Achilles' heel for small businesses. Options do exist, and more will follow as capital innovation evolves. Crowdfunding is democratizing capital for small business by making every American a potential investor.

Anthony Price is an economic development executive in Connecticut.

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