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Sunday, 29 March 2015 22:00

Lost in the crowd? Startup West Michigan craft brewery abandons crowdfunding for traditional investment model

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The Loomans — Eric, Nick, Krista and Scott — in late 2014 signed up to a crowdfunding portal to raise capital for their startup business, Newaygo Brewing Co., after exhausting an initial $150,000 in SBA-backed loans and $135,000 from friends and family. But the company in February canceled its raise on Localstake to work directly with a private investor group. Executives cited the access to more money at better rates than offered by the portal as the main driver to abandon the crowdfunding campaign. The Loomans — Eric, Nick, Krista and Scott — in late 2014 signed up to a crowdfunding portal to raise capital for their startup business, Newaygo Brewing Co., after exhausting an initial $150,000 in SBA-backed loans and $135,000 from friends and family. But the company in February canceled its raise on Localstake to work directly with a private investor group. Executives cited the access to more money at better rates than offered by the portal as the main driver to abandon the crowdfunding campaign. COURTESY PHOTO: MATT PRATT

If two recent examples are any indication, companies in West Michigan seem attracted to the promise of securities-based crowdfunding, but often find better and more lucrative offers from traditional investment avenues.

Case in point: Newaygo Brewing Company LLC.

The startup garnered more than $80,000 in investments through the Localstake Marketplace LLC portal and had 60 days left in its crowdfunding campaign when it opted in late February to work directly with a single investor group.

Despite “soft commitments” in excess of its $145,000 goal, the executives at Newaygo Brewing said they could get more money at a lower interest rate and access to other crucial support services by tapping the private investors.

The company is among a handful of startups, particularly in the craft beverage and food-related industry, that have initiated a securities-backed crowdfunding raise only to cancel it and seek investors on their own, according to Brandon Smith, the founder of Indianapolis-based Localstake.

While Smith declined to disclose the number of companies that have canceled their campaigns on Localstake, he said the reasoning for the cancellations is clear: Preparing for and conducting a successful fundraising campaign often puts a company in an ideal position to be exposed to potential investors. Private investors can track the viability of a company’s business plan and potential following by examining its crowdfunding campaign, he added.

“I would characterize (private investments) as a function of that fundraising effort,” Smith said. “In a lot of cases, the prep work that a business is doing to facilitate a raise puts them in a position in general to be attractive to all funding sources.”

After pulling its campaign from Localstake, Newaygo Brewing signed a deal to sell a 30-percent equity stake in the business to 5 GI LLC, an investment company formed by five West Michigan executives in early 2015 to invest in local companies, said Nick Looman, the president of the brewery.

“It seemed like a good fit to us, so we hammered out a deal,” Looman said. “It basically became looking at the numbers. Localstake (funding) was almost guaranteed, but over the next three years, there was going to be a larger amount of interest paid out.”

Newaygo Brewing and a related company that it formed to buy the real estate for the microbrewery and pub raised a total of $100,000 from private investors, according to filings made with federal securities regulators.

5 GI LLC also offered Newaygo Brewing an additional line of credit for more than its potential raise through Localstake and at a lower interest rate, Looman said. The investors also plan to provide additional legal and marketing services for the startup microbrewery.

The influx of extra capital and credit allowed the company to upgrade the overall quality and design of its taproom and install a larger kitchen, Looman said. Newaygo Brewing plans to open by mid-April.

“We’re talking about a once-in-a-lifetime opportunity for locals with a bunch of money to seek us out and invest in us,” Looman said. “That’s not going to happen to every business and if it hadn’t happened to us, we would have followed through and had a fantastic (crowdfunding campaign).”

5 GI LLC, the company that invested in Newaygo Brewing, is located at 1991 12 Mile Road NW and lists Howard Veltman as its registered agent, according to Michigan Department of Licensing and Regulatory Affairs documents. Veltman is the vice president, COO and CFO of the Sparta-based Old Orchard Brands LLC, based at the same address.

CANCELLATIONS COMMONPLACE?

Intrastate securities-based crowdfunding was made possible by the Michigan Invests Locally Exemption (MILE) Act, which was signed into law in December 2013. The law allows Michigan-based companies to advertise a solicitation for investment from in-state investors without having to register with federal securities regulators. Under the law, accredited investors can make unlimited investments in small businesses, while non-accredited investors are capped at $10,000.

To date, very few companies have chosen to use the fundraising model, and fewer still have successfully completed a raise. Tecumseh Brewing Company LLC is the only Michigan-based small business to successfully raise funds via Localstake. Others, including Newaygo Brewing and Pilot Malt House LLC, a Byron Center-based company that supplies the craft brewing and distilling industry with malted grains, have started crowdfunding campaigns on the portal but eventually cancelled them in favor of working directly with fewer private investors.

For Erik May, the CEO of Pilot Malt House, the decision to abandon the crowdfunding campaign came after a business partner backed out of the company and after he was approached by a small group of people looking to invest in his company, according to a previous report in MiBiz. He said having a small group of vetted investors proved to be more attractive as he started up the company since they brought both money and experience to the table.

Tom Coke, director of compliance at Crowdfund Connect Inc., said the recent cancellations are likely a factor of the relatively new technique’s failure to gain traction in the state versus any sort of issue with specific portals.

“In most of the states that have intrastate crowdfunding, it hasn’t taken off. It’s really been feast or famine,” Coke said. “If a company gets a large, single investor, it’s going to be better for them than having a hundred smaller investors.”

To hedge against possible cancellations in the future, Localstake is continuing to adapt its platform to deal with similar situations as they arise, said Smith, the portal’s founder.

Currently, Localstake requires companies using its services to inform them if they plan to pursue other funding options and may decide to cancel the raise if it conflicts with federal regulations, Smith said. Companies can also voluntarily cancel their raise.

In Newaygo Brewing’s case, the West Michigan-based company incurred a fee for canceling its raise, said Looman, who declined to disclose the amount of the charge.

MARKETING FOCUSED?

Critics of crowdfunding have taken aim at the notion that the platforms serve more as an effective marketing tool than as a viable source of funding. By its nature, crowdfunding spreads awareness of a startup to a wider audience — beyond what a typical marketing campaign would reach and regardless of how well the fundraiser performs, sources said.

“Most of the traditional crowdfunding is out there to get exposure and reach a broader base,” said Joe Infante, a Grand Rapids-based attorney who leads the alcoholic beverage regulation team at Miller, Canfield, Paddock and Stone PLC.

Coke of Crowdfund Connect sees the mounting examples of companies canceling their campaigns as evidence of a lack of awareness about equity crowdfunding in general, rather than a ploy by companies to garner attention from larger investors.

“I think it’s less of a marketing tool than it is investors sitting back because they don’t know about the companies or are waiting until they gain traction,” Coke said.

For its part, Newaygo Brewing turned to crowdfunding after tapping out its initial funding, which included $150,000 in U.S. Small Business Administration-backed loans and $135,000 from family members.

But even though the company canceled its crowdfunding campaign, the process directly contributed to the startup’s ability to attract outside investors, Looman said.

“We would not have been able to attract this investor without the pending success of the Localstake campaign,” Looman said. “That’s not to say (the campaign was) planned to be a marketing or advertising tool.”

While companies gain exposure from running the campaigns themselves, successful raises can also create a community of advocates and possible patrons before companies even open their doors. That was a factor cited by Tecumseh Brewing’s co-founder Kyle DeWitt in a previous MiBiz report at the time the Southeast Michigan microbrewery started its raise early last year. He likened the process to converting the brewery’s initial mug club members into investors.

Tecumseh Brewing received individual investments of as little as $250, but it met its goal of $175,000 largely because of a $122,000 contribution from an accredited investor from Ann Arbor, DeWitt said at the time.

Working through Localstake, the brewery structured the crowdfunding as a revenue-sharing loan, a type of debt security. It will use a percentage of sales each month to pay back the investors until each investor receives one and a half times his or her investment, if the company is successful. The funds also allowed Tecumseh Brewing to secure a $200,000 bank loan.

The company is currently hiring staff and now plans to open in April, according to its Facebook page.

David Ringler, a former financial executive and the owner of the startup Cedar Springs Brewing Company LLC, followed Tecumseh Brewing’s successful crowdfunding campaign, but never considered the process as an option for his company. In particular, Ringler said he was put off by the prevalence of unvetted investors that come with a crowdfunding campaign.

“The problem that you have is you’re dealing with unsophisticated investors,” Ringler said. “You could end up with some partners who don’t know their role and have the potential for interfering. I don’t think any of those are good things.”

Noting that no other companies have successfully completed a securities-based crowdfunding raise since Tecumseh Brewing, Ringler wonders whether the newness of the practice has worn off for investors.

“The first time out was a popularity thing and a new, fresh idea. Sometimes, the first company to try this will get funded,” Ringler said. “But the more people that jump on this and try to get funded, the less unique the idea is and you only have so many people willing to do that.”

Despite the seemingly cooled interest among local beer-related businesses and criticisms surrounding intrastate securities-based crowdfunding, the process is too young for advisers to determine whether or not it offers a sustainable funding mechanism for small businesses.

“I think it’s too early to say that (equity crowdfunding) is not a viable option,” Infante said. “If it gets to the point where there’s two or three more that start it and figure out it’s not for them, then maybe it isn’t (a viable method).”

Read 7250 times Last modified on Tuesday, 31 March 2015 18:56

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