BY DARA ALBRIGHT
Hey, bootstrapped entrepreneurs and struggling small businesses, what’s all this lying around sh*t?
So what if the banks aren’t lending? Who cares if the public markets continue to exclude you? Boo hoo that the SEC is dragging its feet on implementing key components of the JOBS Act such as crowdfund investing? Are you going to let these factors impede you from accessing the funding that would allow your business grow? Hell no! Cue John Belushi’s famous “Animal House” rallying cry.
Entrepreneurs need not despair, for a wave of financial innovation is sweeping across Wall Street and leaving a number of preferable financing mechanisms in its wake. Some are so novel that many industry veterans aren’t even aware of them. Yet, these neoteric methods are reshaping the financial markets and forever changing the way companies capitalize their businesses. NowStreet, a company on the forefront of this revolution, is pleased to illustrate four cutting-edge financing techniques that can provide immediate funding to emerging businesses.
1. Perks-based aka reward-based Crowdfunding:
While it is not yet to legal to give funders securities in exchange for their money, it is perfectly permissible to reward them with other items such as a company’s products or even thoughtful souvenirs. If a business is providing value to its community or society at large, some funders are happy to simply receive a baseball hat in exchange for the capital. If you think that this altruistic funding approach will never succeed, think again. According to Crowdsourcing.org, the leading resource for crowdfunding analytics, “On Kickstarter alone, last year, 2,241,475 people pledged a total of $319,786,629 to campaigns on the platform. That’s $606.76 per minute, a 221 percent increase from 2011. Backers successfully funded 18,109 projects, which cumulatively raked in $274,391,721.”
COST OF CAPITAL:
In comparison to traditional financings, the company’s cost of capital with perks-based crowdfunding is pretty minuscule. A business could expect to pay, on average, a 5% success fee and a 4% credit card processing fee. Some crowdfunding portals may also charge fees for a campaign failing to meet its minimum goal. This “failure” fee can range approximately 8 or 9%.
This method is not only “in vogue”, it allows the company to retain 100% of its equity and maintain a clean, debt-free balance sheet.
Although it looks easy, you need more than a great product and vision to be triumphant. You need creativity, authenticity and ingenuity. Although it helps to possess an expansive social network, despite what many believe, it is not a prerequisite for success. NowStreet has featured a number of crowdfunding success stories at its industry events. Interestingly, they all possess one commonality: impassioned funders. Unlike many publicly-traded stocks that are artificially pumped with paid media placements and other disingenuous PR strategies, we have found that crowdfunders possess a sincere interest in the company’s products. In one instance, a notable gadget blogger from another continent, stumbled upon a cool device on Kickstarter called the Tiltpod which enables users to capture the perfect picture from any angle with any camera or phone. He wrote a blog about the product, not because he was being paid to, but because he genuinely liked it. Soon after, the Tiltpod’s funding campaign was six-times oversubscribed. Since most crowdfunding campaigns aren’t picked up by renowned bloggers, it would behoove capital raisers to constantly be strengthening the social presence of its company as well as its management. (See part I of NowStreet’s Capitalizing on Financial Innovation Series: Preparing for the Crowdfunding Revolution.)
2. Peer Lending, Social Lending, P2P Lending, P2B Lending
Peer Lending (peer-to-peer lending, peer-to-business lending) is the practice of allowing individuals to lend money directly to other individuals or businesses. Instead of using conventional intermediaries such as banks, the entire transaction occurs via online lending platforms. Miserly banking institutions are helping peer lending become the new normal. In an environment where interest rates are at all-time lows and banks are hording cash, the peer lending market is accelerating. In fact, Lending Club, the largest peer-to-peer lending company in the U.S., recently surpassed one billion dollars of loans funded. Additionally, many new peer-to-business lending platforms are beginning to propagate the marketplace.
COST OF CAPITAL:
Although interest rates vary based on credit scores, borrowers with better credit scores (720 or higher) can expect to pay somewhere between 7 and 13%. Other fees may also include success fees, unsuccessful payment fees, late fees and/or check processing fees.
The lender receives a much better return on his money than a traditional savings account or CD, and the borrower gets a lower interest rate than he would through a traditional bank loan or credit card. The process is fairly quick with many loans closing as early as 14 days.
Most lending portals require a minimum credit score in the mid-600s. As with conventional loans, late fees are charged to borrowers and default notices are sent to credit reporting bureaus. To avoid penalties and credit score reduction, loan payments should always be made on time.
RECOMMENDED LENDING PLATFORMS:
For a personal loan that can then be used to fund a startup, we recommend either Lending Club or Prosper – both provide a much more attractive alternative to using a credit card. For direct business loans, we suggest exploring niche P2B portals. SoMoLend is the platform with a big heart that caters to underserved small businesses such as women or minority led companies. SoMoLend is unique in that borrowers can leverage their social connections and personal relationships to secure additional funding from local community banks. We also really like Quarterspot, a P2B lending portal that enables businesses to obtain loans on the basis of its cash flow. Quarterspot, slated for launch in Q1, 2013, is ideal for both brick and mortar companies and online merchants, particularly those that have found traditional receivable financing structures too cost prohibitive.
3. Accredited Crowdfunding
Also known as “Reg D Crowdfunding”, Accredited Crowdfunding is essentially Reg D exempt securities (either equity or debt) that are offered only to accredited investors through a registered portal. Accredited Crowdfunding allows businesses to raise capital from like-minded qualified individuals.
COST OF CAPITAL:
Banking fees usually vary based on deal size; however, an issuer can expect to pay anywhere from 5 to 12% of the offering. Companies should also expect to pay additional due diligence fees and offering expenses which can range from a few hundred to multiple thousands of dollars.
Accredited Crowdfunding is far less expensive, timely and cumbersome than completing a registered offering. Furthermore, once the general solicitation ban is lifted, Reg D issuers will also have the ability to advertise their offering and reach new accredited investors.
It is important to note that Reg D investors WILL count toward the recently raised 2,000 investor threshold established under the amended Rule 12(g) under U.S. Exchange Act of 1934. Once a company exceeds 2,000 shareholders, it WILL be required to file with the S.E.C.
RECOMMENDED ACCREDITED PLATFORMS:
We suggest considering the following platforms:
- CircleUp: Offering securities through the legendary Bill Hambrecht’s WR Hambrecht + Co, CircleUp is the ideal platform for consumer companies.
- Crowdfunder: Crowdfunder offers securities through GATE US LLC, a New York based broker dealer and a member of FINRA and SIPC that is well-known in crowdfunding circles.
- EarlyShares: EarlyShares offers securities through FINRA regulated Point Capital Partners, a designated veteran-owned merchant bank that donates a portion of its revenue to military and veteran charitable organizations.
- MicroVentures: MicroVentures is an investment bank for startups that conducts its own due diligence prior to raising capital with its angel network.
- RockThePost is a crowdfunding portal catering to traditional VC-quality companies that no longer fit a changed VC paradigm. RockThePost offers securities through Bendigo Securities’ regulatory-compliant CrowdClear platform. CrowdClear provides a suite of back office solutions that enables funding portals to raise capital for entrepreneurs in a more efficient manner.
Another accredited crowdfunding alternative that is worth exploring is EquityNet’s crowdfunding marketplace. Instead of a commission, EquityNet receives a nominal annual fee to provide entrepreneurs with direct access to qualified angels as well as a suite of tools designed to capture investor attention.
4. Self-Directed IRAs
For the agoraphobic issuer who prefers to stay away from the crowds, here is an out-of-the-box financing strategy unbeknownst to most financial advisors. It essentially entails utilizing one’s retirement account to fund one’s own small business. A self-Directed IRA (SDIRA), or Rollover for Business Startups (“ROB”), is an individual 401k set up for one’s own startup company or business. As the Manager of the ROB, the business owner act as the Trustee for the Plan’s monies.
HOW IT WORKS:
First, an LLC or C Corp as well as Trust and Plan documents are created. Monies are then rolled over from a former 401K or IRA, and checking accounts for the plan are established. Direct investments can then be made into the entity by purchasing membership or stock in the business.
The start-up costs can range from $2,000 to 3,000. There are also annual fees of a few hundred dollars.
SDIRAs allow the business owner to maintain complete autonomy and control over investments as well as the checkbook. Since the investments reside within a title holding company, away from the rest of the business owner’s estate, litigation threats are reduced. Once the entity begins generating income, salaries can be paid and annual plan contributions of up to $50,000 can be made.
All proper IRS documents must be filed for the Plan both initially as well as annually. Prohibited transactions including receiving immediate personal benefits outside of the 401k can lead to total taxable distribution and penalties of the 401k. In order to avoid penalization, it is the imperative that the business owner’s administrator and custodian possess extensive experience in establishing and maintaining ROBs.
For assistance on ROB structuring or guidance on which alternative financing mechanism and/or portal would most appropriately serve your business, please contact email@example.com. To understand the tax implications of each structure, please contact Richard Salute at Richard.Salute@CohnReznick.com.