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Sunday, 07 June 2015 22:00

Despite slow start, experts predict crowdfunding to grow with time, education

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Despite an initial rush of publicity after it was passed in late 2013, entrepreneurs’ interest in securities-based crowdfunding under the Michigan Invests Locally Exemption (MILE) Act has waned throughout 2015.

To date, only a handful of Michigan companies have taken advantage of the nascent funding mechanism and even fewer have completed a successful raise. While the cooled interest among investors and businesses has prompted some critics to question crowdfunding’s viability as a method to raise capital, industry insiders are confident that it’s just a matter of time and education for crowdfunding to catch on.

“I don’t take (the low participation) as a negative at all,” said Paula Sorrell, the former vice president of entrepreneurship, innovation and venture capital at the Michigan Economic Development Corp. “I take that as encouraging that companies are considering it at all. (Crowdfunding) is one of many bullets in the holster. I like that it’s not been seen as a gold rush.”

Tecumseh Brewing Company LLC has completed one of the state’s only successful raises under the MILE Act, drawing in $175,000 from 21 investors.

Other craft beverage industry companies have looked into the fundraising model, but ultimately opted for more traditional financing. Earlier this year, Newaygo Brewing Company was on track to exceed its $145,000 goal, but the startup brewery later abandoned its raise in favor of private investors, as MiBiz previously reported. Byron Center-based Pilot Malt House LLC also turned to private investment after foregoing its securities-backed crowdfunding campaign in 2014.

Fewer than 10 companies in Michigan have filed raises under the MILE Act since it was created, said Angela Barbash, founder of Ypsilanti-based financial advisory firm Reconsider Inc.

“I think crowdfunding is still viable, but there are some long-term challenges that will take years to work through,” Barbash said.

MISCONCEPTIONS

In particular, the MILE Act’s lack of popularity can be tied to its mischaracterization as solely “equity-based” crowdfunding, which has driven away would-be principals who don’t want to see their equity be absorbed by numerous unsophisticated investors, Barbash said.

Most companies that choose to use the MILE Act have opted for a traditional debt or revenue-sharing model instead of giving up equity, she said.

“MILE is agnostic as far as deal structure,” Barbash said.

In part, the flagging interest in crowdfunding under the MILE Act is a result of how complicated the legislation is and the lack of interpretation and experts in the field, sources said.

“Crowdfunding is still very to-be-determined, and we don’t know how it’s going to play out,” Sorrell said. “It’s more complicated than people anticipated, and it’s not quite there yet.”

Despite the misperception, Rajesh Kothari, managing director of Cascade Partners LLC in Southfield, cites the openness of crowdfunding as a potential pitfall for unsophisticated investors.

Kothari said securities-based crowdfunding may be viable in small scales. But investing large sums of capital via crowdfunding portals into companies that may not have done all of the due diligence required for a large-scale raise could prove financially hazardous, he said.

“Where I get concerned and think there’s real risk is when someone is raising $1 million and people are putting real dollars in there,” Kothari said. “You have to have the diligence, thoughtfulness and the disclosure. Sometimes, it’s not a poor intention of the issuer — they just don’t know any better. But these systems foster that.”

ALTERNATIVES EXIST

While equity-based intrastate crowdfunding has not attracted the anticipated level of interest politicians proclaimed in passing the MILE Act, the initial premise of soliciting investment from a large group of people through crowdfunding remains, said Tom Coke, a former state securities regulator in Michigan and director of compliance at Chicago-based Crowdfund Connect Inc.

More companies have started to examine hybrid models of crowdfunding, including peer-to-peer lending, micro-lending and revenue sharing along with the traditional rewards-based model, Coke said.

“Is equity crowdfunding a magic bullet? Maybe not, but there’s some type of crowdfunding that will work for companies,” Coke said.

New legislation from federal regulators could be one of the driving forces that pushes crowdfunding back into the limelight, Coke said.

In early April, the U.S. Securities and Exchange Commission (SEC) increased from $5 million to $50 million the amount of money a company can raise under a federal Regulation A exemption before they need to undertake the costly process for a typical public offering. The new exemption, dubbed Regulation A+, offers two different tiers of offerings that allow for non-accredited individual investors to contribute to the raise.

“Regulation A+ has been deemed as a crowdfunding bill, but it’s really a securities raise,” Coke said. “But it’s been a benefit for crowdfunding that put it back into the public eye.”

While Regulation A+ will increase awareness around crowdfunding, Coke expects established companies seeking growth capital — not startups — will take advantage of the new regulation mostly because of the six-figure cost related to a so-called “mini IPO.”

PORTAL GROWTH

Beyond helping startups and other companies grow their organizations, the MILE Act has also yielded a potential growth market for those entrepreneurs offering investment portals, sources said.

That’s especially true for the increase in niche investment portals such as Grand Rapids-based Loquidity LLC, which specializes in debt- and equity-based real estate deals in the Midwest. Loquidity launched in June 2014.

While the majority of portals have received a moderate amount of initial interest, most have run into trouble with finding the correct volume of deals to keep the business sustainable, said Joe Elias, co-founder and COO at Loquidity.

“You need to build trust and part of doing that is putting out a lot of good, quality deals,” Elias said. “The big thing for us is to mitigate as much risk as possible.”

The platform is currently working on putting together a raise for a Detroit-based property under the MILE Act, though Elias could not disclose any other information about the project, citing regulatory reasons.

While more investment portals have continued to enter the market, there’s evidence that state regulators haven’t embraced the rush of new investment technology with open arms, Barbash said.

“Regulators are uncomfortable with how crowdfunding is being implemented using (portals),” Barbash said. “There have been cease-and-desist letters and random aches and pains for the portals from (the state). I think that until there is better dialogue from the portals and regulators, there’s going to be challenges.”

While all parties have struggled to sort through the new provisions in the MILE Act, Sorrell sees those challenges as a normal coming of age for the nascent crowdfunding industry. It’s likely that more companies will begin raises as they see successful examples and as the legislation continues to develop, she said.

“Funding is never an easy answer,” Sorrell said. “This method, in particular, is new legislation and is taking some time to learn.”

Read 3721 times Last modified on Sunday, 07 June 2015 23:23

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