Finance 2.0: Anyone is a bank or an angel investor
Funding Community, Pave and Small Knot open the door to investing and lending by the crowd, despite the threat of looming regulation.
But the promise of crowdfunding has always been in the idea of financing: enabling small investors to put money into businesses in for equity, or loan money in exchange for interest payments.
While last year’s JOBS Act gave the green light to such crowdfunding ventures, the Securities and Exchange Commission has so far mostly blocked the operation of those sites, worried that small investors will get in over their heads. As of now, there’s no telling when the new regulations might be released, according to an SEC spokesman.
But a few platforms are beginning to emerge. They are finding ways to work around existing rules, without waiting for the SEC to develop specific regulations for equity crowdfunding. They are offering loans or stakes in ventures that just skirt the definition of a security, which would put them in the purview of the SEC.
“We’re not waiting for the JOBS Act,” said Alex Binkley, CEO of the just-launched small business lending site Funding Community. “It doesn’t change our business model.”
More than a year ago, the JOBS Act made it kosher to publicly solicit nonaccredited investors—people with less than $1 million in net worth—to buy a stake in a business. The law has spawned platforms across the country that are waiting to cash in when the rules are finalized. Most are standing by, but others, like Funding Community, have hit the ground running with new, creative models of finance.
Call from Treasury
Some sites, such as peer-to-peer lender SoMoLend, deal only with accredited investors. For others, it’s still a delicate dance. Two days after Funding Community launched, Mr. Binkley got a call from the Treasury Department.
“They’re definitely keeping their eyes on the industry and on what’s happening, and reaching out to people doing innovative things,” he said.
Calling itself the first portal in the U.S. to crowdfund small business loans, Funding Community makes small, short-term loans, which Mr. Binkley said are not considered securities and, thus, not subject to SEC regulation.
He lends mostly to Main Street, mom-and-pop outfits, which can borrow up to $10,000 for nine months. Funding Community posts their financials, decides on the loan terms and opens the deal to would-be backers, who can put up as little as $25 or as much as $1,000. The crowdfunding portal aggregates contributions into a single loan, charges a 2.5% origination fee and 7% to 9% interest, collects the payments and pays back the supporters. So far, it has four deals in the works, two of which have been funded.
As with many crowdfunding gigs, there’s mission as well as money in the mix.
“A key part of the model is turning lenders into customers and champions of the business,” said Mr. Binkley, a former lawyer for tech startups who left his position at WilmerHale five days before the JOBS Act became law. “[Backers] could be people down the street, really getting involved with shaping their community.”
Another site, SoHo-based Pave, has a more unusual take on small loans. It offers investors stakes in someone’s future earnings, an arrangement it calls a “social financial contract.” A glance at Pave’s home page shows mostly young borrowers looking for money to pay off student debt, finance mind-expanding travel, underwrite an Olympics dream or start a nonprofit. Pave takes an origination fee of 3% plus another 1.5% a year on the typical 10-year loan.
Most Pave investors—lawyers, consultants, financial types—are accredited but don’t earn interest on the loans, which conveniently means the loans are not securities. Unaccredited investors “pay forward,” or reinvest loan proceeds back into another prospect, another SEC workaround that Pave CEO Sal Lahoud said keeps deals from crossing regulatory lines. So far, Pave has staked eight “prospects” to $15,000 to $22,000 and has 15 more in the pipeline, plus a ton of interested participants—4,000 would-be borrowers and 800 potential investors, many of whom might also become long-term mentors.
“If you don’t do well and fail, you’ll pay nothing,” said Mr. Lahoud, who moved the firm from Silicon Valley to Manhattan last summer. “If you do better, you pay more. Literally, it’s an investment in a person.”
Jay Lee, a former securities lawyer and founder and CEO of Small Knot, has yet another model, providing capital to small businesses that return the favor with a product or service of greater value. Some of Small Knot’s crowdfunded loans provide capital for expansion, such as the vineyard seeking $5,000 to plant 2,000 new vines. Others become collateral for larger loans from lenders such as Accion. Small Knot, a Tech Stars accelerator graduate, takes a 3% fee on the money raised.
Even as these entrepreneurs work through SEC loopholes, others like Sang Lee, founder and CEO of Return on Change, are sitting it out, waiting for the new rules to be written. Mr. Lee started Return on Change 18 months ago to raise money for social entrepreneurs, but stayed in beta for most of that time. He recently launched and has four non-crowdfunded deals in the works. For the time being, he raises money only from accredited investors.
“As excited as we are for the rules to come out, we’ll take smaller steps,” said Mr. Lee.
It’s not clear right now whether or how the new rules might treat sites such as these.
“Expect an incremental, evolutionary approach toward [equity crowdfunding], rather than a swing-for-the-fences, revolutionary approach,” said Duncan Stewart, a partner in Deloitte’s technology, media and telecommunications practice.
Source: Crain’s New York Business – JUDITH MESSINA