Sunday, December 14, 2014

Can Crowdfunding Revive Local Stocks Markets?

Back in October, I wrote an op-ed that appeared in the New York Times about local stock markets. Specifically, it was about the passage of Michigan's Investment Markets bill, a novel new law that allows the creation of intrastate stock markets that would let Michigan-based residents buy and sell shares of Michigan-based securities. The idea of a Michigan-only stock market harkens back to the local stock markets that once thrived across the country, and helped their regional economies thrive as well. The Detroit Stock Exchange (pictured left) raised money for fledgling automakers, for example, while the The Honolulu Stock Exchange capitalized Hawaii's banking, communications and power infrastructure in the early 1900s.

In a strange coincidence, just days before my op-ed ran, a Pennsylvania paper ran a story about LanX, a proposed local stock market for an eight-country region in western Pennsylvania. I wrote about LanX and its creator, Trexler Proffitt, then an assistant professor of business at Franklin & Marshall College, in my book (as well as well as in the New York Times Magazine in the weeks after the financial meltdown of 2008).

At Franklin & Marshall, Proffitt had done some of the only real research examining the role of local exchanges in American economic development. He and a fellow researcher counted 28 regional exchanges created between 1830 and 1930, from Richmond to Milwaukee to Los Angeles. The number of exchanges rose in lockstep with U.S. industrial production. But their research showed that regions with newly established exchanges had a 175% increase in manufacturing jobs—the dominant employer category at the time and a proxy for economic growth, That compared to 76% growth for the nation as a whole. So the local markets clearly helped their local economies.

Most of those markets have since merged or closed. Today, many promising regional growth companies can no longer access the public markets, which cater to very large corporations (the average IPO size is around $140 million, up from $10 million or so twenty years ago).

Proffitt believed that a Lancaster area stock market could help provide capital to small but growing companies in the Lancaster area and add as much as $10 annually to the local economy. It was also a way to forge connections. As he explained it: "The idea was to let investors see the social impact of the company they were supporting, a sort of “Buy Local” approach to investing."

The news out of Lancaster, however, was that Proffitt, now a professor at Emory University, was throwing in the towel on LanX. The reason? Crowdfunding had made the idea moot.

“Since the energy went in that direction, I thought this is too much of an uphill battle,” Proffitt told the paper.

The purpose of a stock market is twofold: to help companies to raise money through initial public offerings, and then to provide liquidity to share owners by providing a place to trade those shares.

As Proffitt notes, companies can now raise money through crowdfunding as well as other alternative capital-raising methods, such as direct public offerings. Today crowdfunding is limited to offering non-financial rewards to contributors, as Kickstarter does, or "equity" (including stock, debt or revenue-sharing) to wealthy individual investors. While we wait (and wait) for federal regulators to finalize the rules that will open up crowdfunding to the general public, more than a dozen states have adopted their own state crowdfunding rules.

Michigan is one of those states. It's Michigan Invests Locally Exemption, or MILE, allows Michigan-based ventures to raise money by selling securities to residents of the state through crowdfunding. Michigan lawmakers see it as a way to rev up their state economy and encourage a new generation of homegrown companies.

But for investors to really warm up to crowdfunding, they need to feel comfortable that they'll be able to sell their shares should they need to cash out. As Proffitt told me in an email recently, "All those equity shares have to go someplace and if there is no way to do that, investors are stuck. They may not care, because the limits keep their amounts small, but sometimes we all need our money back."
That's why Michigan followed up its crowfunding law with the Michigan Investment Markets law: to give Michigan investors the comfort of knowing they have liquidity. 

It will be interesting to see where this leads. Could crowdfunding platforms, in addition to raising money, also be a mechanism for secondary trading? If so, crowdfunding platforms could turn into a sort of stock market for local, small and mid-sized companies that don't have the wherewithal—or maybe the desire—to go public on the New York Stock Exchange or NASDAQ. The hope is that these new age stock markets, at least at the local level, might provide a platform for long term investment and a sense of place, rather than flipping shares to make a quick buck. 

Saturday, April 5, 2014

Move Over JOBS Act: States Are the Real Laboratories for Crowdfunding

Today marks two years since the passage of the JOBS Act—the landmark legislation that was supposed to open up gushers of capital for the nation's small businesses and create jobs. But as the law inches closer to implementation, it's becoming clear to even (or especially) the law's most ardent supporters that it will fall short of those lofty goals. If the SEC's 600 pages of proposed crowdfunding rules are adopted as laid out, the complexities and requirements they entail will likely make it too expensive and onerous for most of the small businesses the law was originally intended to help. 

For example, the SEC estimates that companies raising less than $100,000 could pay up to 15% in legal and other fees. For companies raising $1 million (which requires audited financials), the costs could be as much as $250,000.

As that reality sets in, a number of states impatient to spur job creation and entrepreneurship are crafting laws that allow investment crowdfunding within their own borders. Kansas was the first, with its Invest Kansas Exemption (IKE), followed by Georgia. In late 2013, Wisconsin and Michigan joined in with laws of their own. 

Already this year, Maine, Alabama, Washington, Indiana and Maryland have passed their own mini-JOBS Acts, and many more are likely to follow. Why? Because they see it as pragmatic economic development, a way to strengthen their local economies. 

“I hope that IKE can serve as a model for all fifty states,” one Kansas state regulator told me. (Fittingly, Kansas was the first state in the country to regulate securities, in 1911. The argument—to keep "Kansas money in Kansas" and help local farmers and businesses rather than enriching "New York Stock Exchange speculators and gamblers"—rings as true now as it did then. (See chapter 2 of my book for more on these genesis of the Blue Sky laws) 

Although the state laws vary, generally they allow any business based in the state to raise money from any resident of the state, without all of the red tape and restrictions entailed that come with JOBS Act crowdfunding. In Kansas and Georgia, for example, companies raising money submit a simple one-page form to state regulators, and there are no audited financials required. Unlike the JOBS Act, transactions in those two states don't even need to take place on a portal (although I think portals can provide clear value). 

Because companies are restricted to raising money from residents of their state, intrastate crowdfunding may not appeal to high-flying firms that can attract a national or global audience of investors. But then, those companies typically do not have problems raising capital—unlike thousands of smaller or less sexy businesses that the JOBS Act was expected to boost.

So where does state crowdfunding stand? It's been slow to take off so far, mainly because it is so new and much education needs to be done. In Kansas and Georgia, there have been just a handful of deals so far, and many residents still don't know the laws exist. I'm most impressed with Michigan, which is taking a more hands on approach to promote the Michigan Invest Local Exemption (MILE). The Michigan Municipal League, a well respected organization that represents counties and towns throughout the state, has taken the lead in educating businesses and investors, and has partnered with two crowdfunding platforms- Localstake and Fundrise - to encourage MILE deals. The first Michigan state crowdfunding campaign - for the Tecumseh Brewery - is now live on Localstake. 

I still hold out hope for a workable JOBS Act someday. But, as with so many things these days, states are becoming the true laboratories for crowdfunding. They have an opportunity to show how crowdfunding—or in this case, communityfunding—can be done. 

Me & Patrick McHenry at the Rose Garden signing ceremony April 5, 2012