Crowdfunding Investments Start Slow, But Could Gain Momentum

By Dan Zehr
Austin American-Statesman.

From drones to mushroom farms, hair salons to snoring treatment centers, it’s a colorful crowdfunding world.

What it’s not — at least not yet — is an especially crowded one.

Nearly a year after the Texas State Securities Board adopted regulations for investment crowdfunding within the Lone Star borders, only 15 companies have launched campaigns to raise capital through such a platform.

Of those, only three hit their minimum investment target, according to data the board provided the American-Statesman.

Yet despite the slow uptake, backers say investment crowdfunding in Texas started to build momentum as the year progressed, and the pipeline for new deals has started to swell.

Furthermore, the rising potential could receive another boost in early 2016 when federal crowdfunding regulations, approved last week by the Securities and Exchange Commission, open up these relatively new investment platforms to everyday investors nationwide.

“We still have a long way to go in education,” said Nathan Roach, head of MassVenture, one of 10 online investment-crowdfunding portals approved in Texas. “I’m very optimistic, in the medium term over the next couple years, this is going to continue to build momentum. The SEC rules will bring more attention to it.”

Unlike the rules adopted in Texas and 27 other states, which allow in-state companies to use online portals to raise debt or equity investments from almost every in-state adult, the long-awaited federal regulations open up those offerings to investors and firms anywhere in the country.

However, the SEC’s guidelines come with tighter restrictions on both companies and investors. For example, Texas allows less-wealthy residents to invest no more than $5,000 in any single offering — but it doesn’t limit the number of firms in which they can invest that amount.

The federal rules, on the other hand, set caps at 5 percent or 10 percent of an investor’s annual income or net worth, depending on their earnings and assets. Unlike Texas, though, the caps apply to the total annual investment, not just what’s put in individual offerings.

Companies seeking to raise capital through approved portals will also find different advantages and disadvantages in the federal and state mechanisms. Small, local businesses that don’t want to deal with the reporting requirements of the federal rules might prefer an offering in Texas, while a fast-growing tech startup might accept heightened federal requirements so it can tap a more far-flung investor network.

“We want the Texas exemption to provide a good alternative to the federal exemption,” said Texas Securities Commissioner John Morgan.

Few, if any, crowdfunding officials expect a huge wave of new deals to sweep across the country as soon as the federal rules go into effect. As participants in Texas and other states have found, it takes time to build the infrastructure, iron out the kinks, build a flow of good offerings and, especially, raise awareness among everyday investors.

“We’re off to a fairly slow start, and that’s been the experience generally nationwide,” Morgan said. “But this is Texas, and we have a very good environment for startups and small businesses here.”

Little running room
The true believers talk about investment crowdfunding as nothing short of a revolution in raising money.

Companies that couldn’t access existing debt or equity sources would now have an avenue to raise money and grow. Meanwhile, the everyday investor would have access to the high-risk, high-reward startup investments that were previously available only to wealthier investors.

In reality, the process has moved far more slowly than the most ardent proponents hoped. The SEC dragged its feet on the crowdfunding portion of the federal Jumpstart Our Business Startups Act of 2012. And while states moved to fill the void with their own local rules, they didn’t exactly unleash a wave of crowdfunded investments.

Kansas passed the first intrastate regulations in August 2011. Since then, 27 other states, including Texas, have adopted similar platforms. Yet across all of those, only 102 offerings have been approved or cleared by state agencies, according to data compiled by the North American Securities Administrators Association.

Compared with the national batting average — less than four per state — Texas has actually done quite well with its 15 live offerings since last November, when the state’s securities board adopted its investment-crowdfunding structure.

However, the success rate of funding those deals won’t blow anyone away. Only a hair salon ($25,000), a snoring treatment firm ($100,000) and an oil-and-gas firm ($169,000) hit their minimum targets as of Oct. 22.

Collectively, the live deals have a maximum offering amount of almost $4 million, but have only raised $342,572 — about 8.6 percent, according to securities board data.

Several factors contributed to the sluggish start. It took some time after the board’s approval to build out the infrastructure. Offers have to go through state-approved online portals, and any funds raised have to be held in an escrow account until targets are met.

MassVenture got its portal license in February. And while the first offering it hosted came in April, it has only posted two deals since, both of which didn’t go live until September. However, Roach said, about 1,000 investors have signed up on the portal to date and it’s currently readying new deals for them.

“We didn’t have as much running room in 2015 as we would’ve liked,” he said, “but things have picked up now that everything’s up and running.”

Microbreweries and mushroom farms
Regulators and participants readily acknowledge they still face some growing pains, but they follow up those admissions with the same admonition: it’s still early.

“It’s really hard to understate how much we’ve learned in the past year,” said Josh Duckworth, director of marketing at Goldstar Trust Co., the escrow agent for all but one of Texas’ 15 deals to date. “We’re all from different sectors and trying to come up with a working model in uncharted territory.”

For example, Goldstar’s requirements and fees have caught some companies off guard. The firm, a subsidiary of Happy State Bank south of Amarillo, asks companies for specific documentation and disclosures.

Some potential issuers failed to provide adequate information, Duckworth said, while others blanched at its fees — 0.25 percent of the offering amount, with a minimum of $500. For smaller deals, a $500 fee can tip the scales.

“A lot of people in this market have more or less expected the escrow and payment function to be pennies on the dollar compared with what the reality is,” Duckworth said.

Texas securities regulators have looked at what other states have done with escrow requirements, said Morgan, the commissioner. While the board has yet to revise its rules, he said, it could consider options to lighten escrow requirements for smaller deals.

Regardless, he said, the staff has received a lot of feedback from participants and almost certainly will tweak the Texas crowdfunding rules in the months to come. In the meantime, the agency has worked proactively with companies and portals to guide them through the new process.

“We’re not doing merit reviews, but just making sure they’re disclosing all the information an investor would think is important,” Morgan said. “We’re taking extra steps to get issuers into compliance so you don’t have those problems you’d have on the back end, after an offering has taken place.”

The same goes for the crowdfunding portals, which have to be approved by Morgan’s agency. Hall Martin said the board staff rejected his first proposal but now has his second,, nearing its launch.

As founder of the Texas Entrepreneur Networks, Martin jumped at the idea of investment crowdfunding as a way for startups and entrepreneurs to raise capital. He sees the platforms filling the gap between the $50,000 or so an entrepreneur can raise from friends and family and the $250,000 minimum investment most formal angel networks consider.

“It’s hard to raise $1 million, $5,000 at a time,” he said. “If you’re raising $50,000 to $100,000, you can do that, but after that it gets really tough.”

But now, particularly once interstate portals get up and running, a startup can reach out to its customer and supplier base to help fund its growth, Martin said. He said he already has three deals ready to go live once he launches the portal, hopefully next week or shortly thereafter.

“We have two microbreweries and a mushroom farm,” he said. “They’re Texas deals that have a good customer base that wants to invest in their business.”

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