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

Thursday, October 24, 2013

Crowdfunding: Don't Start Your Engines Just Yet

Crowdfunding has landed with a thud! On Wednesday, the SEC issued 568 pages of proposed rules for Title III of the JOBS Act – aka crowdfunding. Embedded in it were 295 questions for interested parties and the public at large to comment on, ranging from how to calculate the $1 million per year limit on how much issuers can raise (ie. should that be net of fees? should other non-crowdfunded fundraising be included or exempted?) to the economic impact of the proposed rules (question #295). 

SEC commissioners weighed in on the historic moment, proclaiming it a step forward in a "bold experiment" that has "great potential" to unleash capital for the nation's small businesses, but one that will take some time to get right. Others interpreted the voluminous proposal as the SEC kicking the can further down the road while appearing to fulfill its duty to issue rules mandated in the JOBS Act (already more than ten months behind). 

While the details are sorted out, the broad outlines of crowdfunding remain the same: 

- Companies can raise a maximum of $1 million through crowdfunding in a 12-month period

- Investors whose income and net worth are less than $100,000 are limited to $2,000 or 5% of their income, whichever is greater, in aggregate crowdfunding investments over a 12-month period
- Investors whose annual income or net worth is greater than $100,000 may invest up to 10% of their income or net worth, not to exceed $100,000 in a 12-month period
- All crowdfunding transactions must take place on an SEC-registered intermediary - either a broker-dealer or a crowdfunding portal
- These intermediaries must take measures to educate investors and mitigate fraud
- Companies raising money on these platforms must provide basic financial information (the proposed rules require audited financials for offerings greater than $500,000)

So when can we expect mainstream investment crowdfunding to be ready for prime time? 

Not so fast. 

Wednesday's proposed rules kick off a 90-day comment period. At the end of the comment period, SEC staffers will study the comments and consider whether to recommend tweaks to the proposed rules to their bosses. Sara Hanks, an attorney and the CEO of CrowdCheck, notes that the end of the comment period does not imply any action on the part of the SEC – in fact, in practice, proposed rules often languish for many months. Given the controversy surrounding crowdfunding and the magnitude of the questions buried in the proposed Title III rules, this recommendation stage is likely to stretch on for at least three months, if not many more.

The next step would be for the SEC commissioners to formally adopt the rules (or reissue rules and start the process all over again, which is considered unlikely). Bottom line: final crowdfunding rules are not likely to be released until six months out, at the earliest. 

Add in some time for FINRA, the industry regulatory body, which must issue its own rules and guidance, and a registration period for crowdfunding portals, and mainstream crowdfunding will not be a reality until mid-2014 at best.

In the meantime, read the proposed rules here, and offer your own (constructive) comments here.

Wednesday, August 21, 2013

When Buying Local Doesn't Build Community Wealth

Buy local. Support local business. These are the rallying cries that community-boosters (including
myself) use all the time. When you spend money at a local business, the theory goes, more of that money circulates in the community, supporting other local businesses as well as charities and boosting the local tax base.

Except when it doesn't.

Maggie Anderson, the author of Our Black Year, opened my eyes to the fact that, in many neighborhoods—especially poorer Black ones—the 'local' businesses are not owned by people who live there, so the money spent at them flows right out of the community. African Americans account for 14% of the population, but they make up only 5% of business ownership in this country (and most of those businesses are sole proprietorships). The reasons are complex, but the reality is that, while African American buying power has surged, little of that spending is actually helping build wealth in Black communities. 

Anderson cites some startling statistics:

A dollar spent locally circulates nearly a month in an Asian American community before the money flows out.
In Jewish communities, it sticks around for about 20 days. 
White Anglo-Saxon Protestant neighborhoods enjoy a locally spent dollar for roughly 17 days. 
African American communities? Six hours
All neighborhoods have "leakage" — money that flows out of the community and into the hands of nonlocal business owners, chain stores, bankers, landlords, etc. But it's particularly acute in some Black neighborhoods. For every $100 spent in an "underserved Black community," about $95 leaves, says Anderson, citing a 2004 report. 

To call attention to the lack of Black-owned enterprises, she and her family spent a year trying to buy only from Black-owned businesses around their Chicago neighborhood. The results of this Empowerment Experiment, as they call it, are chronicled in her book. I won't be spoiling anything to say that it wasn't exactly a rousing success.  

Anderson's book is a reminder that not all neighborhoods are created equal, and that the 'local' movement must become more diverse (to its credit, the Business Alliance for Local Living Economies featured Anderson as a keynote speaker at its 2012 conference, where I found out about her project and book). 

So when I heard about the Kingonomics conference taking place this week in Washington, DC, I was intrigued. Timed to commemorate the 50th anniversary of the March on Washington, where Martin Luther King gave his enduring "I Have a Dream" speech, it brings together entrepreneurs, innovators, civil rights leaders, businesses and investors inspired by the economic philosophies of Dr. King. Yes, economic philosophies. As Kingonomics author and conference organizer Rodney Sampson explains, many people don't realize that Dr. King was very focused on economic issues, believing that without economic opportunity, people do not have the chance to pursue happiness. Before his death, King campaigned for an "economic bill of rights" and called upon the government to invest in rebuilding American cities.

"The modern day civil rights movement has evolved into an economic rights movement for all to participate," writes Sampson. To that end, the conference entails two days of entrepreneur bootcamps, capital raising education, crowdfunding and pitch competitions for entrepreneurs, capped by an "Emancipation of Capital" gala. 

This is where I get excited about the potential for crowdfunding to help minorities, women and other entrepreneurs too often cut off from traditional funding sources. At its best, crowdfunding is about democratizing access to capital, so that ideas get funded based on their merits, not on powerful connections or where you went to school. So here's to MLK's dream, and the dreams of entrepreneurs everywhere, to make a difference in the world. We just have to give them a chance. 

Monday, May 20, 2013

Show your supply chain? No sweat.

Photo courtesy of The Sweatshop Project 
The recent collapse of a garment factory in Bangladesh, which killed or injured thousands of low-wage workers, shined a harsh light on how and where much of our clothing is made. And working conditions aren't the only problem:  fashion often comes at a high cost to our health and the environment, with finishes, fabrics and dyes that involve a laundry list of toxic chemicals. In fact, consumer goods of all kinds—whether clothing or cosmetics or processed food—are the retail equivalents of the global financial system, characterized by long, complex and opaque supply chains that are hard for companies, much less consumers, to keep track of. That is, until some tragedy, scandal or recall brings the details to the surface (horse meat, anyone?).  

In the wake of the Bangladesh incident, companies from Nordstrom to Walmart have indicated they would take steps to make their supply chains more transparent. We've heard that before. But corporations have been slow to back up their promises. In the meantime, a new generation of socially-minded companies is showing the way.  

In North Carolina, T.S. Designs makes organic cotton t-shirts "from dirt to shirt" in the state. The organic cotton is grown, spun, knit, finished, sewn and printed all within 700 miles—compared to the 16,000 miles that a typical globally-sourced t-shirt travels. The t-shirts are also printed with water-based ink and no harsh chemicals. When T.S. Designs president Eric Henry set out on this mission, there was no organic cotton being grown in the Carolinas. But with the help of a $30,000 loan from Slow Money NC, Henry was able to persuade (and pay up front) a handful of cotton farmers to make the switch to organic. In late 2011, the state's first organic cotton crop was harvested and ginned. Henry also helped found Cotton of the Carolinas, a collaboration of farmers and manufacturers dedicated to growing, making, and selling its t-shirts in the Carolinas. Each t-shirt from the Coalition comes with a tag that lets you track the entire supply chain, from farm to finish.  

I was recently introduced to another supply chain pioneer, S.W. Basics, a small but ambitious Brooklyn startup that makes a line of wonderfully simple skin care products, each with just five or fewer ingredients. No scary, unpronounceable names, chemical fragrances or fillers made in a lab. Just pure, ethically-sourced ingredients like shea butter, avocado oil, rosewater, coconut butter, and sea salt. S.W.'s founder, Adina Grigore, says all of the ingredients are either certified organic, Fair Trade, or sourced from small, family farms. And she wants you to know! Grigore and her team have launched a Kickstarter campaign to help the company film and document its suppliers, from the family that sustainably harvests its witch hazel in the Ozarks to the small Iowa firm that makes its lip balms and the women's cooperative in Ghana that suppliers its shea butter. 

The idea, says Grigore, is to celebrate S.W.'s suppliers and help them perhaps attract more business so that they can thrive. But it's also about creating new standards for doing business and encouraging people to be curious about how their products are made.

"For me, it's about being truthful to what we're doing, and not in a way that's token, like putting our ingredients on the front label, but in a way that is completely transparent," she says. In other words, "Proof, not just words." 

Grigore believes that if supply chains were more transparent, people might make different purchasing decisions. After all, would you knowingly buy cosmetics that have lead or endocrine disruptors in them? Or a t-shirt made in a sweat shop? No wonder the big conglomerates are so slow in responding to pressure.

As consumers, we have power. In addition to buying local and ethical, we can demand information from the retailers and manufacturers whose products we choose to buy. Or not buy, as the case may be. 

Friday, April 5, 2013

Happy Anniversary, JOBS Act!

In case you missed it, today marks the one-year anniversary of the JOBS Act. For those assembled in the Rose Garden for that momentous signing and for millions of entrepreneurs who would benefit from the law, hopes were high. A year later, we're still waiting for key provisions of the Act, notably crowdfunding and (Title III) and the lifting of the general solicitation ban (Title II).

There's been plenty written about that in the days leading up to the one-year anniversary (see links below) and several events today to commemorate the one-year mark (I participated in one in NYC yesterday). But I am reminded of the words of Bill Gates, who sagely observed that when it comes to disruptive technologies, we tend to overestimate the change that will occur in the next two years and underestimate the change that will occur in the next ten.  The revolution, apparently, will wait. 

Happy anniversary JOBS!

Tuesday, February 19, 2013

Crowdfunders to SEC: Bring it On

I was in the Rose Garden that exhilarating, giddy day last April, when President Obama signed the JOBS Act into law. And I can tell you with relative certainty that everyone present, including the President, thought that it would be implemented by now. Instead, as we approach the one-year anniversary, key pieces of the JOBS Act —namely Title II and III, which eliminate the restrictions on advertising private securities and allow for investment-based crowdfunding, respectively— are still just a rosy dream. That's because the SEC, the agency charged with writing the rules that will govern these new provisions, has been moving at the speed of molasses.

Here's a not-very-well-guarded secret: the proposed rules for crowdfunding have been written by the SEC staff and finished for some time. What's holding it up? Well, apparently the commissioners have been sitting on the rules for reasons spanning wariness of leaving themselves open to criticism from opponents of crowdfunding, to turmoil at the agency: former SEC chairwoman Mary Schapiro resigned late last year. Elisse Walter — one of four remaining commissioners, was named interim chairwoman. Then President Obama nominated Mary Jo White to head the agency, although she has yet to take over the role. In the meantime, it's a power vacuum. For crowdfunding advocates and startups, it's like waiting for Godot.

And that's a shame, because the delay is holding back regulatory progress that could deliver much needed relief to small businesses seeking capital and begin to bring the transformational power of the Internet and social networks to a broken financial system.

It's against this backdrop that some of the leaders of the nascent crowdfunding industry decided to take a stand. This morning, the Crowdfunding Professional Association staged a press conference at the National Press Club in Washington, before heading off to meet with various officials in the Office of Science & Technology Research, Treasury and, yes, SEC. Their aim, it seems, was to dispel some of the misperceptions about crowdfunding and put pressure on the SEC to act.

One of those misperceptions is that crowdfunding is about get-rich-quick schemes. Instead, speaker after speaker talked of helping Main Street businesses. Woody Neiss of Crowdfund Capital Advisors summed it up when he said that crowdfunding is not about "finding the next Facebook" — Silicon Valley does a robust job of that already. It's about finding and funding "the next 1 or 10 or 100,000 Main Street startups" that will create jobs and help build strong and prosperous communities. "It's social media meets community finance," he said.

Readers of this blog and my book will know that this is long what I have been preaching. To me, crowdfunding makes the most sense when there are social bonds and relationships that connect investors and entrepreneurs. As Warren Buffet has long advised: it makes sense to invest in what you know!

Crowdfunding is also an opportunity to take a broken financial system and make it better. To wit: Sarah Hanks, a former securities and corporate lawyer who is now the CEO of CrowdCheck, is offering a private market solution that addresses regulators' fraud and risk concerns. Her disclosure and due diligence system walks investors through the investment process, presenting them relevant information in plain understandable English. Compare that with the typical phone book-sized prospectus filled with legalese that no one in their right mind reads. "We've thrown that out the window," says Hanks. "The best disclosure is the kind that someone is actually reads and understands."

Crowdfunding is in its infancy and will continue to evolve to address market needs. As Chance Barnett, founder of pointed out, Crowdfunding 1.0 was about transactions, often undertaken on impulse. But with the JOBS Act, we're on the cusp of Crowdfunding 2.0, which will be based on building long term relationships and community ecosystems.

In a world of speculation and short term trading, that is something to celebrate. That is, if the SEC ever makes a move.