Crowdfunding & the Future
It’s the darling of the investment world. But who’s using it? And how do you get in on the act?
Want to follow the crowd to entrepreneurial fame and investor fortune? Tread carefully, warns longtime Chicago business adviser and attorney Bill Hubbard of Hubbard Business Counsel
. “This is an important area of business growth and investment if it doesn’t get mucked up—and it could get mucked up,” says Hubbard, former chair of the Illinois CPA Society Mergers and Acquisitions Special Interest Group. “Yet if you really want to grow your business, this is a realistic growth opportunity for you to seriously explore.”
Although crowdfunding has been around in various forms for the last few years, recent law and rules changes in Illinois and nationally are likely to alter the business and investment landscape in the years ahead—both for entrepreneurial business owners and eager investors.
The evolving crowdfunding environment is also likely to mean more business opportunities for CPAs and finance professionals on both sides of the investment fence, as auditing, verification and solid financial and business plans and operations become critically necessary for entrepreneurs and investors alike.
While the mention of crowdfunding conjures a mélange of fundraising images, from the inspirational (helping Boston Marathon bombing victims recover) to the bizarre (Help Me Buy a 20pc McNugget Meal!), it’s actually big business and a big deal in the corporate world today. A report released last year by crowdfunding research firm Massolutions
found that global crowdfunding jumped from $6.1B in 2013 to $16.2B in 2014, with another more-than-double increase to $34.4B expected in 2015.
Crowdfunding is typically divided into four distinct types: donation-based (donors united behind a cause), reward-based (donors get a gift or reward from a company), lending-based (often called P2P or peer-to-peer business loans) and equity-based (donors receive financial shares in a business). Crowdfunding websites such as Kickstarter
—which focus on donation and reward-based programs—have garnered some of the earliest attention and funds.
But a combination of changes in federal and state regulation is expected to put a greater focus on—and more money into—debt- and equity-based crowdfunding. On a national level, May 16 marked the initiation of Title III of the Jumpstart Our Business Startups (JOBS) Act of 2012
, which opens the doors of business investment to non-accredited investors. Depending on income and net worth, they can invest up to $100K in any year in companies that use online FINRA-registered crowdfunding portals or broker-dealers to raise capital under the US crowdfunding regulation.
Dara Albright, an investment and finance professional, and early advocate of crowd-structured financial products, prefers to call this newest wave of investment “crowd financing.”
“It’s really not anything different than the regulated financial industry. Instead of money coming from large institutional investors, the capital is coming from ‘We, the People,’” she says. “It represents a first step in democratizing access to capital. We’re going to see an entirely new path for finance capitalization.”
Title III represents a significant shift for small and small middle-market businesses and startup owners, who previously tended to rely on generous family members, maxed-out credit cards, bank loans, and a limited number of ‘accredited’ investors who had to certify their own financial stability and wealth, says Hubbard.
“Any path to access investment capital for most entrepreneurs with a solid business and good operations and prospects has been significantly limited throughout my career,” he explains. “This change provides such business owners with their first realistic opportunity—one which has not, until now, existed in the United States. It’s likely, if done right, to be exceptionally useful for a substantial minority of businesses if structured correctly for the business and each prospective investor alike.”
This is also an opportunity for entrepreneurs to devote more time to growing their business operations and financial bases, says Lauren Leibowitz, membership administrator for the National Crowdfunding Association (NLCFA). “Now they can go out and market their business and convert their customers into investors.”
For businesses treading into the crowdfunding arena, there are four major advantages, according to Anthony Zeoli, the Chicago finance and crowdfunding attorney who wrote Illinois’ state-level crowdfunding law: Good public relations, building brand loyalty, a cheaper source of capital than borrowing, and more independence, since power is not concentrated among fewer shareholders with large stakes.
For Regular Joe investors, it’s a chance to use a relatively small amount of money to get ahead of the curve on a growing business or idea. “Regular people have never been able to do this. It’s always been a country club deal,” says Zeoli. “This is exciting. Now everyday investors will have the opportunity to invest in the types of ‘private company’ deals that were previously available only for high-net-worth and institutional investors.”
While the SEC has led federal crowdfunding regulations, more than 30 states have developed their own state-level crowdfunding-related legislation and rules, with Illinois becoming one of the latest entrants on January 1 of this year. Illinois HB 3420 permits unaccredited state residents to invest up to $5K per year (with no limits for accredited investors) in Illinois companies via online crowdfunding. The bill further allows companies to raise as much as $4M per year via online equity and lending-based crowdfunding.
Crowdfunding & the CPA
Whether the potential client is a neophyte investor or a regulatory minded entrepreneur, the crowdfunding rush is opening a growing market for CPAs and finance professionals. Mindful of the potential for fraud and overeager over-investors, the SEC and the State of Illinois have each put in multiple safeguards intended to protect investors. That translates into opportunities for accounting and financial experts to offer their input.
Among the requirements: Financial audits and reviews of financial statements performed by licensed accountants (depending on the amount of capital raised); compliance with Generally Accepted Account Principles (GAAP) if applicable; regular financial disclosures to investors, including an annual report and a business forecast; and third-party financial verification of accredited investors (required under an earlier section of the JOBS Act). In Illinois, companies raising $1M or more must have professionally audited financials, business plans and a determination of the company’s value. They must also provide quarterly or semi-annual financial statements to investors as applicable.
For many potential small businesses, preparing to go the crowdfunding route will require plenty of up-front work—and plenty more to follow, says Hubbard. “You might have to change your accounting operations, and it’s not going to happen overnight,” he explains.
As for investors, while limits are in place to reduce any potentially large losses, they’ll still have to do their homework, Hubbard and others say. And with many first-time investors expected to wade into the crowd, financial literacy and advice are key.
“I would hope that the crowd will go to their trusted CPAs or finance professionals,” says Leibowitz. “There’s a lot of consultation and advisement that can be done. They can ask them, ‘Do you see this as viable? Do you see this as appropriate for me?’ It really gives investors an opportunity to put professional eyes on things.”
Although anticipation among investors has been building for the launch of Title III—and possible further tweaks by the SEC and the states in the years ahead to grow equity-based crowdfunding—many observers say it could take some time for it to become an established part of business growth and investment. Albright expects that a generational shift will help speed the change, however.
“There will be a great transfer of wealth from the Baby Boomers to the Millennials. They don’t trust Wall Street. They don’t trust banks. But they do trust the Internet,” she says. “When it starts to scale up is when you see the industry tapping into the $14T in retail retirement accounts.”
“The faucet has been turned on,” says Leibowitz. “Now we’ll see what happens.”