Big Red Car here.  Glorious day in the ATX (Austin, Texas for you Yankees).  Sunny and crisp.

The Boss was out early for a meeting and on the way back was mumbling about crowdfunding. The Boss has raised a lot of money in his business career and is intimately familiar with the process.  For every entrepreneur it is a baptism of fire.

The Boss wrote about it here and it is a good idea to review those comments.

The Rules as They Exist

Raising capital — particularly for a startup or a new company or a small business — has been a very highly regulated undertaking.  It is, at the end of the day, an issuance of securities whether in a public manner or privately.  The rules on the solicitation of investors have been very complex, intimidating and serious.  This is an area that spawns gobs of litigation.

Done right, it requires the involvement of lawyers, accountants, broker dealers and a lot of disclosures and documentation.  It is not easy.  It is not for the faint of heart.

If the money is being raised for a startup or a new business or a small business the first pragmatic problem is funding the undertaking itself.  You will find that those lawyers, accountants and broker dealers will not work for free.

In doing this on a private basis, there is the necessity to ensure that you offering is organized, well written and complete.

And it has to comply with a lot of securities law.  The Big Red Car is not giving anyone legal advice — ever — but you are going to want to sit with your lawyer and discuss Regulation D.  It can be done but it is not easy.


But there is a bit of change afoot.  America is in desperate need of jobs and start ups, new companies and small business may be one of the only bright spots on the horizon.  If we can get it done.

What Has Changed

In April 2012, the President signed the JOBS Act — Jumpstarting Our Business Startups Act — which provided for a number of changes.  The Big Red Car does not want to explain them all to you but the big ones were:

1.  Emerging growth companies can raise $1,000,000 per year to fund their growth.  This is in essence public venture capital.

2.  Changes were made to the public solicitation requirements of Regulation D.  Bit of arcane jargon here.

3.  The changes included the ability to publicly solicit — ON THE INTERNET — accredited investors rather than having to make private solicitations of accredited investors — generally folks with $1,000,000 net worth not including their residence and with incomes of $200,000 if single and $300,000 if married.

4.  In addition, you are not required to use a broker dealer (and pay their fee) if you are directly soliciting funds to be used by you or your company.

These are monumental changes and because of this the United States Securities and Exchange Commission has been wringing their hands with draft rules and has missed all of their deadlines to finalize the rules.  This is like a land rush waiting for the flag to go down and turn loose those ponies and wagons.

This is the future — Internet and social media — smashing into the Old Economy.  There will be a huge explosion and the fuse has been lit.

The BIG Buzzword

The big buzzword which encompasses these changes is CROWDFUNDING.  A word I have already begun to hate right up there with “spot on” and “the Millenials”.

Hate it, does the Big Red Car and The Boss.

1.  Crowdfunding suggests a crowd of investors who previously were shut out of the rigged game that is Wall Street.

2.  Crowdfunding suggests a new tier of portal companies who will facilitate this like investment banks raise money for large public companies.

They will be started by, owned by and operated by young Turks who cut their teeth as financial analysts at big investment banks.

You will not be able to swing a cat without hitting some young stud who spent a couple of years at JP Morgan crunching numbers for the big dogs.

3.  Crowdfunding suggests a crowd of startup companies who were unable to tap into venture capital or other pooled growth funds.  Maybe because their business model was crap.

4.  Crowdfunding suggests a venture capital competitor which would expose deals to the public which were previously the exclusive market of venture capitalists.

The real crowd should be experienced businessmen who are operating legitimate businesses or starting up legitimate businesses who will comply with the laws and will be stewards of the public’s money.  This could be a huge boon for small businesses.  This is where The Boss’s focus currently is.

How Will this Really Work?

Nobody really knows how it will work but the formative work has begun.  There are hundreds of portal companies out there just waiting for those SEC rules to be finalized.  They are lying in the weeds in wait for the land rush to begin.

In the meantime, the SEC is investigating about 200 of them who have allowed their youthful exuberance to get the better of them.  Rules?  We don’t need no stinking rules!  [pullquote]Rules?  We don’t need no stinking rules![/pullquote]

There is some good organizational work out there including from such organizations as:

The National Crowdfunding Association – follow the link; and,

Crowdfunding Professionals Association.

In addition, there are a lot of portal firms who are standing up a website in anticipation of the SEC getting their Rules finalized.  A couple The Boss likes are:

1.  SeedInvest — just likes their website design and is otherwise completely random; and,

2.  Microventures in Austin, Texas run by Bill Clark who is a new friend of The Boss.  Good people.  Good businessman.

 Microventures is an Old School/New School broker dealer with the appropriate licenses to operate both pre- and post-JOBS Act.  The Boss listened to an investment offering earlier this week sponsored by Microventures and it was first rate.  Microventures has already proven their model and is way down the track.


So what does the Big Red Car and The Boss predict is going to happen?

1.  So The Boss predicts this is going to be a huge boon to established businesses who can present a story of stability and a track record.

2.  The Big Red Car predicts it is going to be the Wild West on the startup side as easily 75% of these companies will fail.

Remember that venture capital is a 1/3, 1/3, 1/3 business.  One third the VC loses everything — tackle, worm.  One third the VC gets his worm back.  One third the VC catches a whale.  That is if the VC is good.

These deals are going to initially be deals that the VC has passed on.  They will have a failure rate higher than what an established VC would experience.

3.  There will be a lot of happy horse hockey until the first returns start coming in and then the lawyers will have a field day.

4.  This will be the financial equivalent of the derivatives debacle.  After all, you have the same group of young suds with mousse in their hair as designed some of those obscene derivatives.

Big difference now is you have very little adult leadership and they are going to be allowed to harness the power of the Internet.

5.  There will be some not inconsiderable fraud and the naysayers will have a field day.

Brazilian bikini wax anyone?

But, hey, what the Hell do I know anyway?  I’m just a Big Red Car.

Be kind to yourself this weekend.  You deserve it.  Be safe.




14 thoughts on “Crowdfunding

  1. Microventures sounds like they’re in prime position to expand their business.

    I’ve had mix feelings on crowdfuning, at first I was incredibly excited by the prospect of community funded businesses, then after thinking it over these business models are already happening with revenue driven growth. I guess the big differentiator is the spark of initial capital. Where will it come from, who will lose it all, and who will win BIG?

    Here are the ramblings of a 3 years younger and more foolish version of me.

  2. I’m probably not qualified to discuss the regulatory changes, but to toss in a 6th prediction: A handful of startups will raise mountains of money based on little more than highly successful viral campaigns. They will then go on to be incredibly successful based on the awareness created by the fundraising campaign, and confirmation bias will keep the crowdfunding ball rolling for quite some time to come.

    • .
      Charles, you may well be right.

      At the end of the day, you have to make money and getting a lot of money is not always an indicator that you CAN make a lot of money.

      I really want it to succeed.

  3. The Boss and his Big Car nailed it. Tough to argue against this approach. I like these 2 portals.

    Here’s the key thing that must not happen. If there is failure, it shouldn’t propagate and destroy the whole system (which is what happened in the bubble of 2000).

    To do this, keep this in a very decentralized manner and ensure the stop losses and checks & balances are very tight, while greasing the wheels of funding. So, success makes the system stronger, and failures make it stronger too by not destroying it (you need to read Antifragility).

    • .
      The only way the system does not get totally polluted and corrupted is if the first transgressors are put immediately in jail and so thoroughly and completely punished — everyone involved including lawyers, accountants — that it puts the fear of the Lord into everyone else.

      These will initially be small time crooks and the rest of the lot can be scared straight if done with speed and fierceness.

      The industry itself is attempting to develop some guidelines but we shall see.

      This is something that you personally should look into as a means of funding your company. It would be very easy to do.

      The Reg D changes — general solicitation, using the Internet writ large, no broker-dealer — is the real story and not the $1MM per year on ramp.

      • Good points. But I was thinking about failures of the companies being funded. If they fail, that doesn’t mean the crowdfunding process failed. As you well know, in the venture business, only a small percentage of companies properly succeeds.

        • .
          Failure has two different buckets — companies who FAIL to secure funding and those that FAIL after securing funding.

          Every startup faces daunting odds to still be in business 5 years later just as a phenomenon of being a new business. Most new businesses fail. Harsh truth.

          The issue of crowdfunding essentially being “new money” for obviously risky new businesses seems to have been overlooked in the discussion thus far.

          That is why I personally believe that the Reg D implications for existing stable companies — companies who have escaped the teething process of new business generation or even old economy stable businesses — is the big play here.

          These businesses used to go to their local bank which is currently closed for renovation and is only investing in sure things.

          The Reg D stuff could completely replace the now MIA banks.

          • I get it. It fills that segment’s need. But the caveat is that it puts the business at risk at the same time. The minute you borrow and make a promise to grow to pay it back, you’ve already mortgaged your future to the borrower whether they are cheerful crowd-funders or badass bankers. I’m with you that it should work out at the end, as we see more successes than failures. But the difference between that and a startup’s funding is that a startup gets funded to allow them to search for their true north business model, whereas an existing stable company already has (supposedly) a repeatable business.

          • .
            Yes and no.

            If a business is sound, stable and generating cash, then the issue becomes simply what do they intend to do with their excess cash? Distribute it or plow it back into the business?

            If they decide to plow it back into the business — thereby avoiding double taxation of dividends — then they can leverage that cash flow to underpin appropriately priced debt.

            If they intend to grow by adding an operating unit and have sufficient cash flow to handle the debt without any contribution from the new unit, then all they have done is leverage their own cash flow.

            Then the issue really just becomes a “cost of capital” issue.

            With CD rates where they are today, I suspect a reasonably well run business with a 1.75 DCR (debt coverage ratio) — which used to be a AA credit once upon a time — would be able to borrow money very, very cheaply.

            Anything is cheap when you cannot borrow money from a commercial bank. Commercial banks used to fund growth for existing small businesses once upon a time — DOA now.


          • I agree with your analysis, and wanted to add that one possibly very big positive change to the current funding landscape is “non-scalable” businesses may finally be able to have a new funding source. I think this fits under you heading of “existing stable companies” that may not have the 100X business models that VC’s require and may also include startups with a viable idea and some early traction that are not going to be $100M/year businesses but are going to be solid small businesses that can repay their crowdfunding investors on terms that are good for the investors. I also agree that this is in many cases finally going to replace the bank debt/funding that has evaporated over the last 5 years.

          • .
            I agree more with you than you do with yourself.

            I think there two pieces of low hanging fruit that would be game changers:

            1. Fully funding the SBA; and,
            2. Making the banks lend money up to 85% of assets.

            The crowdfunding will surely replace the SBA — who runs out of money (guaranties really) at the end of Q1; and, will do exactly what you have so keenly observed — take the place of commercial banks who funded solid businesses which were not growing wildly but were providing jobs and a good living for numerous folks.

            People forget that crowdfunding can also be used for straight debt deals. Why should an investor in debt accept a deal brokered or otherwise channeled through a commercial bank when they could make that loan directly and get a substantially better rate. And take pride in funding their own neighborhood.

          • I like your analogy to the SBA! I think a company that creates standardized loan docs, underwriting and security, then funds with peer to peer loans (including syndication to limit individual investor losses on any one loan) would really do well for itself, borrowers and investors. I’m sure Prosper, Lending Club, et. al. have their eyes on this market. The only issue is their investor bases are used to re-funding consumer loan debt where the borrower is cutting interest from 18% to 11%. Investors will have to get used to 5-8% to get good quality borrowers to be interested, IMO. I like your angle on “funding their own neighborhood”. The affinity angle could work in lots of ways, whether geographic (as you point out), industry, type of product, etc. You have elements of Kickstarter at work there.

          • .
            I think we are looking at things from the same vantage point.

            I think the implications of Reg D changes — unlimited accredited investors, direct solicitation of accredited investors — are more important than the Emerging Growth Company deals.

            The EGC deals are going to be deals that could not get VC funding. Granted VCs are only funding 2% of deals leaving the other 98% available.

            Local could be huge.


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