Can Crowdfunding Help Save American Small Businesses?

Treefort Music Fest, a popular music and arts festival in Boise, Idaho, was set to open for its ninth annual event two weeks after the COVID-19 crisis hit full force. It was forced to postpone, initially until September 2020 and then until 2021. It could have meant the death of the iconic community event. But Treefort is still planning on moving forward next year, thanks in part to a crowdfunding campaign that has brought in more than $200,000 to date. 

Unlike the more well-known versions of crowdfunding—rewards-based or donation-based—Treefort is using “equity” or “investment” crowdfunding through the platform Wefunder to secure investment funding. 

Investors in Treefort are able to purchase preferred stock, with no dividends or voting rights. According to the investor Q&A section of Treefort’s campaign page, “Until the pandemic came, we were closing in on our best year yet and poised to take the next step of profitability to allow us to have more margin of cash flow for the rainy day fund, pay our team better living wages, and to expand on the business model.”

“We really liked that people get ownership,” says Eric Gilbert, co-founder and festival director. “We’ve always had a level of transparency with our community. This allowed us to up the transparency and involve more of the community.” 

3 reasons to consider Regulation Crowdfunding

Crowdfunding has been a bright spot in an otherwise challenging fundraising and small business lending landscape dominated lately by government loan programs such as Paycheck Protection Program (PPP) and Economic Injury Disaster Loans (EIDL). 

Even before the coronavirus crisis, many small businesses failed due to lack of access to capital and/or poor cash flow. “COVID has made it insanely difficult to access capital,” says Sherwood Neiss, cofounder of Crowdfund Capital Advisors, and maintains crowdfunding could be one of the best ways to get capital into the hands of small businesses that need it. 

There are several types of crowdfunding. While rewards-based crowdfunding (think Kickstarter) and donation-based crowdfunding (think GoFundMe) often get the most attention, Regulation Crowdfunding isn’t as well known or understood by small business owners. 

Regulation Crowdfunding allows eligible companies to offer and sell securities through SEC-registered intermediaries (a broker-dealer or funding portal). Currently, companies may raise a maximum aggregate amount of $1,070,000 through crowdfunding offerings in a 12-month period. “Regulation Crowdfunding allows startups and small businesses to raise capital by selling securities in their companies to the community” explains Abe Chu, co-founder and CMO of NextSeed. “Those securities could be in the form of equity, debt, convertible notes, and other types.”

Regulation Crowdfunding is gaining momentum. For example, July 2020, an historically low month for crowdfunding, “saw records for the highest number of offerings in a single month, the highest amount of commitments, as well as the highest number of investors,” according to Crowdfund Capital Advisors data. And “80% of (that) capital comes from friends, family, customers, and followers.”

1. Customers become advocates

One of the biggest advantages of Regulation Crowdfunding is the relationship founders build with supporters. 

Winner of MasterChef Season 3, Chef Christine Ha opened her first full restaurant space Xin Chao along with husband John Suh and Chef Tony J. Nguyen. Their campaign on NextSeed raised its targeted $107,000 from 93 investors within the first two hours. The money raised is in the form of a loan which they have started to repay, despite the challenging environment for restaurants.

“We’ve had to rethink what consumers are looking for these days,” Ha explains. The restaurant has a large patio, which helps, and they’re offering more affordable bar bites. “We’ve had to keep adapting and shifting, but our long-term vision is still the same.” 

When asked about her crowdfunding experience, Ha repeatedly points to the fact that backers want to see the business succeed. “I think the more intrinsic value is having the team of people who invest in your business to really want to help you foster that business and help you get the word out,” she says. 

Treefort’s Gilbert agrees. “These are going to be owners of our company,” he says. “I think this brings a higher level of commitment. They are going to be more apt to care about it deeply into the future.”

2. Its surprisingly diverse

As these examples have shown, Regulation Crowdfunding isn’t just for unique retail products or sophisticated biotech firms. A wide variety of businesses are raising money this way, too. 

Crowdfund Capital Advisors research found that the top industry groups in 2019 groups were “entertainment, application software, consumer packaged goods, restaurants, alcoholic beverages, real estate, biotechnology, computer hardware, education, utilities, personal services, advertising and marketing services, autos, consulting and banks.” 

That’s a pretty wide swath of businesses, many of which would be unlikely to land angel funding or venture capital. They also could have trouble getting traditional business financing without strong revenues, solid credit scores, and not being in business for at least two years.

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3. It can be cost effective

Raising money through a Regulation Crowdfunding campaign ends up costing, on average, about 5.3% of the amount raised, says Neiss. Costs may include the campaign video, company disclosures, marketing costs, plus legal and accounting fees. Once successful, a platform will take on average a 6% success fee.

In addition, investors will expect some sort of return. Some campaigns offer equity; others make loans or offer convertible notes. The Xin Chao campaign offered investors a gross annualized interest rate of 17% to be paid monthly over four years. 

Still, it can be less expensive than other types of fundraising and you won’t give up as much control as you would with angel funding or venture capital. “If you were to do a comparable offering via Regulation A, you could easily spend $100,000 on the same fees,” explains Neiss. “[Regulation Crowdfunding] scales down to the size of the offering. Other types of fundraising have fixed costs that are much higher.” 

With Regulation Crowdfunding, “Main Street businesses are raising around $100,000,” Neiss adds, and “the average amount across the board is about $250,000.”

Can the U.S. crowdfund the next stimulus?

At the end of August 2020, Yelp reports 163,735 total U.S. businesses on Yelp closed since the beginning of the pandemic (observed as of March 1, 2020), and 60% of those are permanent closures. That’s nearly 100,000 businesses on Yelp alone that have closed and do not plan to reopen. More businesses will likely join their ranks if there is not another round of stimulus. 

Several years ago, Neiss walked the halls of Congress to advocate for Regulation Crowdfunding, which became legal though the JOBS Act in 2012. Now he’s a driving force behind the proposed Main Street Recovery Co-Investment Fund, which would provide a model for the government to match 100% of funds (up to $250,000) raised from communities via these platforms. This approach would replicate a successful program in the U.K., and engages local communities to support businesses they believe in. 

“What is happening on Wall Street is not the same as Main Street,” Neiss warns. “Community businesses are facing the worst economic crisis in decades and are closing their doors. The stimulus programs the government has created for Main Street are failing. The money they allocated is still there. This program would allow the government to deploy capital immediately to businesses that need it to survive using policy and regulation that already exists, technology platforms that are ready to scale, and real-time data feedback that will allow the government to see how the program is working.”

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