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October 30, 2023

Here’s how online investors propelled one CT company’s growth

PHOTO | CONTRIBUTED Researchers at Bloomfield-based LiquidPiston are developing lightweight rotary engine technology that aims to create a super-efficient version of a diesel engine.

Business crowdsource funding is not a new concept, but financial regulation changes in recent years have opened new doors for entrepreneurs struggling to find early-stage investment, particularly in a challenging high interest rate environment.

Traditional crowdsource funding efforts, on such platforms as GoFundMe, might raise a few thousand dollars in small increments for charitable or other causes. But more platforms are emerging with a focus on helping kick-start small businesses or other ventures.

Bloomfield-based LiquidPiston Inc. has been one of the more active Connecticut companies leveraging crowdsource funding. It has raised $50 million since 2016, using multiple crowdsource options made possible by the 2012 federal JOBS Act.

LiquidPiston’s most recent funding round — conducted on the DealMaker platform and completed on Oct. 24 — raised $30 million. The funds will help further develop the company’s lightweight rotary engine technology that aims to create a super-efficient version of a diesel engine, said CEO Alec Shkolnik.

Alec Shkolnik

It has taken a large amount of capital and time to develop the new technology, said Shkolnik, who has used other avenues to raise money, including venture and angel investor funding.

But he said he’s found many benefits of crowdfunding, including a strong base of small investors and the ability to maintain more company control.

Other businesses — including well-known names like Peloton and Oculus VR — have also embraced the capital-raising method.

The Wall Street Journal recently reported that even big companies — like GE Appliances — are using crowdfunding to gauge consumer interest in potential new products.

Limited funding options

Frank Milone

Amid rising interest rates and other challenging economic conditions, “access to capital has gotten harder,” said Frank Milone, CPA and founding partner of Glastonbury-based accounting and consulting firm Fiondella Milone & Lasaracina LLP.

A young startup company — especially in the technology, bioscience or manufacturing space — will often have limited or even no revenue, and need to raise money through non-traditional avenues, Milone said.

“A traditional bank is not a funding source for those companies because there are no real assets, no real revenue,” he said. “There’s no profit because those companies are generating losses from investing in technology and innovation.”

Until a company becomes profitable or well-funded, there are limited financing options, mainly venture capital, gifts or funding from angel investors, who provide capital to businesses, including startups, usually in exchange for convertible debt or ownership equity.

That leaves accredited investors, typically with net worths in the millions, in the position to fund such ventures in the private market.

However, the 2012 federal JOBS Act established provisions that allow early-stage businesses to offer and sell securities through crowdfunding. It also allowed non-accredited investors — who have a net worth under $1 million and make less than $200,000 a year — to invest in startups through crowdfunding and “mini-IPOs.”

Swami Venkat

“And that slowly started the trend that we see today, where smaller investors, unsophisticated investors, are dipping their feet into the market,” said Swami Venkat, who leads accounting and consulting firm CohnReznick’s CFO advisory practice.

Kickstarter is a popular crowdfunding site for aspiring businesses. Since its 2009 launch, investors using the service have pledged $7.6 billion to more than 247,000 projects, according to the company. Most successfully funded Kickstarter projects raise less than $10,000, but a growing number have reached six-, seven-, and even eight figures, the company said.

Other business crowdfunding websites include Indiegogo and SeedInvest.

Crowdfunding paths

The 2012 JOBS Act established several crowdfunding options for startups. Each comes with different levels of capital-raising limits and disclosure requirements.

LiquidPiston has used two crowdfunding methods since 2016, when it had to “recapitalize,” after two venture capital investments folded at the same time, Shkolnik said.

“... That presented a real challenge for us,” he said. “We went through a funding crisis and were exploring a number of different ways to fund.”

The company raised a total of $3 million from three separate Regulation CF (Reg CF) crowdfunding campaigns – in 2016 and 2018 using the Wefunder platform, then another in 2020 on StartEngine, raising the maximum allowed $1.07 million in nine hours from 1,963 investors.

Reg CF initially allowed companies to raise up to $1.07 million in a 12-month period from both credited and non-accredited investors. That limit was raised to $5 million in 2021.

Under Reg CF, there are fewer disclosure requirements with the SEC, which cuts down on compliance costs. However, companies must file an annual report and provide financial statements.

In its more recent capital-raising rounds, LiquidPiston used Regulation A+ crowdfunding, which allows companies to raise up to $75 million in a 12-month period from accredited and non-accredited investors.

The higher funding limit comes with increased disclosure requirements — Reg A+ companies must file an offering statement with the SEC, which includes audited financial statements.

LiquidPiston in 2021 conducted its first Reg A+ campaign, raising $16 million; its second funding round, which began in late 2022 and ended last month, raised $30 million from thousands of investors on the DealMaker platform, Shkolnik said.

Milone said campaigns like LiquidPiston’s have raised the bar for this new way of raising capital.

VC vs. CF

Like any financing option, there are pros and cons to crowdfunding for businesses and investors.

The failure rate of any startup is high, experts said, so investors face the inherent risk of losing their bet.

Using venture capital funding has its benefits, Shkolnik said, as it’s typically backed by professional investors and advisors who can help grow or scale an early-stage company. But venture investors often end up with board seats and an increasing ownership share.

“Within a few years, they usually end up controlling both the board and the shares of the company. And that can be very challenging for an entrepreneur,” Shkolnik said.

With crowdfunding, a company can have thousands of supporters and a base of loyal customers who want to be part of the business, while the founders maintain control.

LiquidPiston was recently awarded a three-year, $35 million contract to develop a 90-plus horsepower heavy-fueled rotary engine for the U.S. Air Force.

Milone said crowdfunding makes it impossible for all investors to have a seat at the table.

“Say 100,000 people gave you $100. If you had every one of those individuals at your table, as a holder of a share, it would become extremely hard to manage as a company that’s growing,” Milone said.

Meanwhile, crowdfunded companies aren’t doing initial public offerings, nor are they involving dozens of attorneys, so the cost of raising capital is much lower with just a one-time filing fee with the SEC, Venkat said.

Crowdfunding also opens the door to younger generations, which may not have accumulated enough wealth to become accredited investors, Milone added.

Younger crowdfunders are more likely to want to create a buzz around the technology or company they invest in, through social media or in other ways, Vankat said. They also may become a beta tester of the technology.

“So, the companies get two benefits: free testers of the product, and free marketing publicity,” Vankat said.

Paying less interest than a traditional loan is also a perk, but the success rate for startups remains low, experts said.

So far, LiquidPiston — which recorded $6.7 million in revenue last year and $5.75 million during the first half of 2023 — has defied those odds.

The company recently announced a three-year, $35 million contract to design and develop a 90-plus horsepower heavy-fueled rotary engine for the U.S. Air Force.

The lightweight and portable hybrid power system will potentially serve as a “power pack” for a variety of applications, the company said, including unmanned aerial systems propulsion, mobile operating bases and vehicle auxiliary power units.

The company, which has grown to 43 employees and recently expanded its Bloomfield headquarters, also has 82 patents issued or pending, Shkolnik said.

“This is a technology that is ripe for disruption,” he said.

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