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Small business joins the crowdfunding crowd

Crowdfunding for investing in small business is a hot topic in the Michigan financial world.

May 16, 2014
| By Pete Daly |
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Small business joins the crowdfunding crowd

Crowdfunding, as spelled out under Michigan’s new MILE Act, is now a viable way for small businesses in the state to raise capital quickly and cheaply, and has been a hot topic at recent public meetings in Muskegon and Grand Rapids.

Crowdfunding is the generic buzzword for using the Internet to quickly reach lots of people willing to loan to or invest in a small business, or make cash donations to an organization or event.

In early May, the Tecumseh Brewing Co. became the first business to successfully use the Michigan Invests Locally Exemption Act, signed into law in December by Gov. Rick Snyder. It allows small investments in Michigan businesses, by Michigan residents, that are exempt from the rules and oversight of the federal Securities and Exchange Commission.

The Lenawee County craft brewery was only halfway through its planned 90-day crowdfunding campaign when it hit its goal of raising $175,000 in investments.

“It’s only a matter of time before we will start seeing a lot of these (small investment) opportunities come up,” said John Pridnia, principal of Rehmann accounting/financial consultants in Muskegon.

Pridnia said in early May that he had heard of at least three other small businesses in West Michigan that were planning to use crowdfunding to find people willing to invest in their companies.

Pridnia said there is a another form of crowdfunding often referred to as “value fundraising.” Rather than making a capital investment, individuals may buy the company’s products online or receive certificates for the product. He said a typical example might be a brewpub that offers memberships in which the purchaser may have a personalized mug and certain other privileges.

Pridnia was a featured speaker on the subject at Crowdcon, a public conference on the MILE Act in Muskegon in late April. It was sponsored by Grand Valley State University, the Small Business Development Center, the GVSU Johnson Center for Philanthropy, the Center for Entrepreneurship, Great Lakes Renewable Energy Association and GR Current.

A second MILE Act conference, also involving GVSU support, was held later in Grand Rapids.

“This could be a significant capital infusion into the state,” said attorney Thomas Coke, a securities lawyer, crowdfunding expert and business developer at VerifyValid in Grand Rapids. Coke, who was a presenter at the Muskegon conference, said there is still a difficult regulatory climate for banks willing to lend money to small, risky businesses.

However, he said the Michigan Banking Association supports crowdfunding under the MILE Act because it may open up a new avenue for the banks to potentially increase their business. That’s because crowdfunding revenue raised under the MILE Act must go electronically into an escrow account at a Michigan financial institution. (VerifyValid helps businesses set up a system for making and receiving electronic payments in place of paper checks.)

In other words, while the lending itself may be deemed too risky by bank regulators, holding the escrow accounts may be a way community banks can be involved in helping small businesses get started and grow.

A key to the legislation is its “intrastate” nature; it is restricted to only businesses in Michigan and Michigan investors, which allows the exemption from SEC rules.

Michigan’s MILE Act also differs from conventional forms of business investing in that it allows Michigan corporations and limited liability companies to sell a small share in its business to non-accredited investors, “without having to register these interests as securities,” according to Michigan Licensing and Regulatory Affairs.

Conventional venture capitalists are required to be accredited, meaning they must have significant income and financial assets, giving them the ability to risk investing in start-ups or small companies trying to expand.

“This is an exciting new way to raise capital, but investors and small businesses need to make sure they know and understand all of the federal and state requirements of raising capital through crowdfunding,” said LARA Deputy Director Shelly Edgerton. “It may also be prudent for investors and small businesses to seek the assistance of an attorney who specializes in securities law before participating in intrastate equity crowdfunding.”

Small businesses are advised to be aware of the requirements for qualifying for the exemption from SEC registration so they don’t run afoul of federal and state securities laws. Some important things to be aware of include the following:

  • A small business should be cautious when offering the sale of an interest over the Internet because they may no longer qualify for the exemption from registration if they offer or sell to anyone who is not a Michigan resident. This can have significant federal and state legal consequences.
  • A person operating a website, authorized under the new legislation, may be required to register with the SEC as a broker-dealer or a funding portal.

LARA said “crowdfunding does not make investing in a small business any less risky. Investors should understand the risk they are taking and understand that they could lose all of their investment. They should ask questions, know who they are dealing with, and verify all of the information they are told.”

“We are excited with all of the possibilities this new legislation may bring to Michigan and look forward to seeing new business development in Michigan,” said Edgerton. “However, we urge investors and small businesses to do their due diligence and comply with all federal and state laws.”

Crowdfunding is also being formally codified on a national basis. The federal Jumpstart Our Business Startups Act of 2012 (JOBS Act) requires the SEC to promulgate rules on crowdfunding, expected to be finalized in 2014.

The MILE Act has been praised as a “democratization” of investing, in that it allows “unaccredited” individuals to make small investments in a small business.

Coke said he believes the possibility of crowdfunding investors being defrauded is a consideration weighed by state regulators as the MILE Act was being planned.

“Securities fraud goes on today,” even in the established and highly regulated world of Wall Street, noted Coke, but he added that, by its nature, the MILE Act crowdfunding is largely local, “so you’re going to know” about the individual or company proposing to sell shares.

“At the end of the day, though, investors really need to do their due diligence.”

The MILE Act allows a crowdfunding campaign to attempt to raise up to $1 million; beyond that the campaign must be audited by CPAs, according to Pridnia, and is then limited to a total of $2 million raised by crowdfunding.

Pridnia said the cost to file for a LARA-authorized crowdfunding campaign is $100, and he noted there are already small companies in the business of handling the Internet campaign for clients. They can be found by doing an Internet search for “crowdfunding.”

The man — or woman — on the street can turn to crowdfunding, “if he or she has a good idea, a product, a service, and just needs that little extra kick to be able to raise money to be able to get it started,” said Pridnia.

“It’s a fantastic way of being able to do it and not having to spend years of getting paperwork pulled together to comply with the SEC,” he added.

Rehmann is among several accounting firms that have joined with Michigan banks and law firms to provide free advice to entrepreneurs through the Pure Michigan Business Connect program.

“Crowdfunding is a perfect fit for that Pure Michigan Business Connect,” added Pridnia.

He said anyone who is interested in investing in a crowdfunding campaign must be careful.

“You’ve got to do your due diligence. Don’t just think you can throw (your investment) out there and get a 10-times return on your money,” said Pridnia.

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