Crowdfunding an alternative for startups seeking capital

June 8th, 2012

News Coverage:

Crowdfunding an alternative for startups seeking capital


Friday, Jun. 08, 2012 at 5:40am

A powerful tool for raising business startup capital is expected to expand northeast Indiana’s investor pool within the next year, providing new opportunities for emerging growth companies to take root.

That is the impact area entrepreneurs and professionals hope to see from new crowdfunding legislation, the Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure (CROWDFUND) Act.

The act went into effect as part of the Jumpstart Our Business Startups (JOBS) Act, which was signed into law two months ago. Entrepreneurs will be able to start selling shares in their companies through crowdfunding after the federal Securities and Exchange Commission completes crowdfunding regulations early next year.

Dave Gross, a Fort Wayne entrepreneur and president of the local Inventor’s Club, believes many more products invented in the area would be available commercially if their inventors could find the funding needed to build a business around them.

“Some of them, all they need is the financial incentive to say, ‘Quit your day job and make this a real business.’ If they had $100,000 to knock out a prototype and start a new business, they would be a lot more likely to do that than just let their ideas languish in the back of their minds,” he said.

And for a startup that is struggling to develop a market for a promising new product, “cash flow is basically everything; even a small amount can keep a small business going for a relatively long period of time,” Gross said.

Crowdfunding “could be something that would allow businesses to incubate and take off before they die of cash flow starvation,” he said.

The concept of crowdfunding has been around for years and is best known as a means of raising funds for creative projects.

At the website, for example, visitors can back the “Zombie Fairytale Theater” Web series project in Goshen, the “Beginners Guide to Home Soap Making” nonfiction project in Bryan, Ohio, or the “Taylor Fredricks — Using a Heart as an Inanimate Object” rock project in Fort Wayne. They can pledge specific amounts toward fundraising goals in return for rewards that range from thank-you e-mails to a role as a featured zombie in a Web series episode.

Some emerging growth businesses have generated startup capital through crowdfunding websites by preselling products to fans of their latest creations. The CROWDFUND Act allows entrepreneurs to offer equity in their companies in exchange for small investments, without going through the more complicated and heavily regulated process of an initial public offering or private placement of stock.

Hedayeh Samavati, an economics professor at Indiana University-Purdue University Fort Wayne, said reducing the amount of work that is required of a small business to raise capital could prove to be an important feature of the new law.

With more heavily regulated approaches, “there’s the cost of understanding the regulation, of setting up (compliance) systems and getting the legal advice required to start an operation. It’s not only money, but the information gathering that could be substantial,” she said.

“If the benefits of starting a business are higher than the costs, then you should go ahead and start a business. When you lower the costs, you’re tipping the balance in favor of higher benefits, therefore, more people will find it beneficial to start a business.”

The CROWDFUND Act does include some investor safeguards. Entrepreneurs cannot use crowdfunding to raise more than $1 million a year, and they must describe how the proceeds will be used in a business plan that outlines risks as well as opportunities. Financial statements of the business must be reviewed by a public accountant when the amount ranges between $100,000 and $500,000, and audited when more than $500,000 is raised.

The money must be raised through a crowdfunding portal or intermediary registered with the SEC, and investments are capped based on an investor’s annual income. No individual crowdfunding investment can exceed $100,000.

“It’s one of those things where a lot of the benefits and a lot of the risks aren’t really predictable until a lot of people do it,” said Jeremy Gayed, a patent attorney with Barrett & McNagny LLP in Fort Wayne.

“You’re typically not going to get a prospectus. This is going to be a lot more about grassroots and a lot more about relationships and who people trust and what ideas resonate with them.”

Steve Franks, chief marketing officer for Vertical Leap in Fort Wayne and a former programming director for the Northeast Indiana Innovation Center, said he could see future entrepreneurs making a natural progression from borrowing money from family and friends to crowdfunding to working with angel investors.

“A lot of the angel investors who exist here today … may want to invest more than what people are looking for, and they’re looking for companies that are a little further along than some companies are when they’re first starting to raise money,” he said.

Developing a business with “smaller amounts of money raised through crowdfunding to prime the pump could lead them to be in a position to then go talk to angel investors,” Franks said.

Karl LaPan, president and chief executive officer for the Innovation Center, said less than 15 percent of ventures seeking funding obtain angel capital. Less than 1 percent receive venture capital.

“If we are going to grow high-quality jobs and high-potential companies we need to source early-stage funding to get good ideas off the ground. Today, a small number of serial angel investors control the early-stage deal flow,” LaPan said.

With crowdfunding, “I think the pace and rate of startup ventures will accelerate, and more non-venturable firms needing modest amounts of capital can get cost-effective access to capital without diluting their ownership materially or paying too much for the capital.”