Recent Changes in Crowdfunding—Business Fuel Podcast #56
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The idea of crowdfunding has changed a lot in the last few months. Judd Hollas, founder and CEO of EquityNet.com, talks about how new SEC rules have changed the way investors can participate in crowdfunding and what this might mean for small business owners. Is crowdfunding a good way for you to get your small business funded? It could be. Check out today’s podcast to see if it’s right for you.
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Patrick Wiscombe: Serving 327,000 plus people, this is The Business Fuel Podcast. I’m Patrick Wiscombe. Thank you for tuning us in and taking us along wherever and however you are accessing the podcast today. Coming up on today’s podcast, we’re going to be speaking with Judd Hollas who is the founder and CEO of Equity Net. We’ll bring him on in just a second, but first let’s say hello to Ty Kiisel. He is the producer and co-host of the podcast and he is the Director of Content at Lendio. Hello.
Ty Kiisel: How are you doing today Patrick?
Patrick Wiscombe: Doing alright. Let’s talk about your Forbes article.
Ty Kiisel: There are lots of reasons why your credit score might be bad or nonexistent. I’m doing a profile of a very successful immigrant from Scotland. But he had no credit score when he came here and started with local banks. He pretty much bootstrapped his business when he started. So we’re talking about some of the things he did to get his business off the ground.
Patrick: Let’s go ahead and bring in the founder and CEO of Equity Net, Judd Hollas. If memory serves, I think you’re the original and only patented crowdfunding platform. Where are you this morning?
Judd Hollas: I’m in northwest Arkansas, specifically in Fayetteville. That’s where Equity Net was founded. Of course we now have offices in Austin and Denver. Our company demonstrates that web based companies do not need to be located in northern California or New York.
Patrick: Let’s go crowdfunding 101. If people don’t know what that is, let’s explain that for a second then we’ll get into the SEC rulings.
Judd: That’s an interesting question. If you ask 10 different industry experts, you’ll get 10 different answers. We view it as a principle; of using the internet to access a much greater community of investors. Funding from a crowd of people rather than funding from 1 or 2 people.
Patrick: What does the crowd get out of it?
Judd: There are actually 4 different types of funding in terms of the type of capital. If you think about the public markets, you have equity capital in the public market. You also have a bond market publically. The same kind of segmentation exists in the crowdfunding industry. You have debt based crowdfunding where investors provide returns in the form of principal and interest. You have equity based crowdfunding where investors providing capital obtain a percentage of the company. Then you have other forms such as donation based and niche based.
Patrick: What is your background? How or why did you start Equity Net?
Judd: My background is probably not what you would expect. My background is in chemical engineering and finance. But actually through meeting someone on a plane, I got involved in the private equity industry. It became very clear to me that there was an enormous number of businesses seeking capital and an enormous amount of capital held by investors. But there was a small amount of activity between those two parties. There was not a good mechanism for capital to get from the hands of the investors to the businesses. The epiphany came when back in 2004, you look at LendingTree, eHarmony, Monster.com and things like that which bring large communities of people together. They all grew very fast and revolutionized their industries. I asked myself, “Why can’t that happen in the funding world?” So that’s how it all began.
Ty: I think it’s interesting that you talk about eHarmony and Monster. Those are completely different from what you’re doing. Yet you were able to learn from those models and come up with an idea to start Equity Net.
Judd: Funding online, at least when it’s peer to peer, is a human to human interaction. And actually there is a lot to gleen from the enormous dating industry. Not only in how their marketplaces work, but also how they’ve scaled up to compete with each other. I know it sounds a little “apples to oranges,” but in terms of the mechanisms, there’s a lot to learn from those examples.
Ty: Equity Net has been pretty darn successful. Since 2005, you have raised over $200 million in capital for small businesses. Is that the right number?
Patrick: And let me add something, that was during the worst economic downturn.
Judd: Yes. And it took a couple of years to get a fully functioning marketplace. So most of that $200 million has occurred over 4 or 5 years, more or less in the last 18 to 24 months. Because once the Jobs Act was passed, the general public started learning about crowdfunding. We’re seeing a dramatic increase in entrepreneurs coming and wanting to sign up.
Patrick: Was Kickstarter a good thing? Did it help your business because they were the public face of crowdfunding?
Judd: Yes it was very good. They spent their capital and marketed themselves to help popularize the principle of crowdfunding. And since they don’t directly compete with us, they’re in donations, it generated interest in our industry.
Ty: I don’t think it’s an overstatement to say the world has changed since the end of September, is it? With Title 2 and Title 3, maybe we should talk about that a little. Why is crowdfunding different today than it was 18 months ago?
Judd: I should preface this by saying the donation part of crowdfunding is quite simplistic. The government doesn’t regulate it. The debt area is more complex. But it too is less regulated and has been an early success story in this domain. The equity area has the fastest growth rate currently, but is also smaller than the debt area because it has to deal with so much regulation. There’s actually 3 different forms of equity crowdfunding. The first form predates September and the SEC rule. It actually goes back to 1996 with a no action letter issued by the SEC back then, called the IPO.net no action letter. That means if a platform, like Equity Net, put everything behind a password firewall, and if all those investors who looked at that were accredited investors, it was allowed. That’s rather restrictive if you think about it. So that’s what changed in September. On September 23, a new rule went into effect which created a second form of equity crowdfunding. For the first time in 80 years, the SEC is going to lift the ban on you advertising your need for funding. A lot of business owners don’t understand it, so let me explain it. For 80 years, if you were trying to raise equity capital, you could not publicly advertise that need. You could not put out a newspaper ad, a billboard, or go on LinkEdIn or Facebook that said, “Hey, I need a million dollars.”
Patrick: Maybe I’m getting into the weeds, but why would the SEC care?
Judd: It’s a great question. If you look back at The Great Depression and the stock market crash, there were a lot of susceptible people who were taken advantage of. You had some grandmother who put her life savings into some start up and lost everything. So they created two main rules in 1933. #1 – You can’t advertise your need for funding publically. #2 – If you were going to invest in these companies, you had to be a high networth individual. The reasoning being that if you had a million dollars net worth, you should know what you’re doing with your capital. Those rules have persisted ever since. So in September, Title 2 went into effect. Now companies can advertise their need for funding anywhere. If you go to Equity Net right now, you will see profiles of companies and their requests for funding. We were one of only two companies that launched that capability on the day it was allowed. We’ve seen a dramatic uptake. People are quite interested in using the new rule even though it comes with some new requirements. The number one requirement being that if you accept money from someone, you have to verify they are indeed an accredited investor.
Ty: What does type 3 do to the scenario?
Judd: Type1 and type 2 crowdfunding allow you to only raise funding from an accredited investor. There’s only about 2 million Americans who are accredited investors, who have a million dollars net worth or make $200,000 a year. That’s the requirements. That’s a relatively small number of people to go after. What type 3, or Title 3, does is allows you to raise money from pretty much anybody. To put that in perspective, that raises the pool of potential investors from 2 million to about 50 million. It becomes mass market. You can reach a much wider audience, but there are more requirements that come with it. I look at it as pent up demand. All of it was unleashed.
Ty: When does Title 3 go into effect?
Judd: Most industry experts are thinking Spring of 2014.
Ty: Crowdfunding is not a one size fits all deal. If you’re an entrepreneur looking to tie into this, what do you need to know? What kinds of questions should you be asking?
Judd: Business owners are probably overwhelmed and there’s going to need to be a lot of education. The first decision is what type of capital is best for them. Do they want to pursue debt capital where they pay back interest and principal? Or do they want to not have the cash flow requirements and raise equity capital? That would be the first question they would have to answer for themselves. Then it would be choosing the right platform.
Ty: Do you think a lot of entrepreneurs are investigating crowdfunding because of the capital that’s available or because they like the idea of the crowdfunding concept? And I guess the same question applies to the investors.
Judd: Let me address the entrepreneur/business owner side first. We did some research this year and dissected 1,000 companies that have actually used Equity Net. We looked at their characteristics. For example, what’s their geographical location? What are their industry sectors? How much capital are they seeking? Are they generating revenue or not? When do they expect to be profitable? Do they have a technology based product? It was amazing what we found. The major conclusion from that was the early adopters were the ones that were previously underserved by this industry. It makes complete sense if you think about it. This information is available publicly on our blog at https://www.equitynet.com/blog/us-equity-crowdfunding-activity-infographic/. The geographic distribution was pretty much even. It was not based in California and New York as venture capital has been for years. It was spread throughout the country evenly. The two largest industry sectors using it were consumer products and services and business product and services. Historically, they made up 10% of venture capital. They were left out in the cold for the most part. So those are the types of companies who were the early adopters with this because they were the ones who felt the biggest deficiency.
Ty: That makes perfect sense.
Judd: Now Equity Net has a great diversity of companies. We have everything from coffee shops to spinal fusion technology. It’s interesting to see this result because it makes you feel a certain level of good will for what you’re doing for the business community. It also tells me the politicians’ intention with the Jobs Act was to get people working.
Ty: Before you jump into the investor side, you brought something we need to mention. I noticed on your web site you help put together a package for small businesses so they are ready for investors. What I’m driving at is that the thought that getting crowdfunding is easy, is not entirely true. You still have to present a case and give a reason for an investor to invest in you, correct?
Judd: It is not easy, nor should it be easy. Raising capital for a high risk venture will never be what you would call easy. We do our best to streamline it and make it as efficient and easy as possible. Unfortunately some business owners and entrepreneurs have unrealistic expectations about how much time and work it will take to raise capital. One of our distinctions in the industry, for which we have patents, is having a platform with advanced tools that help the entrepreneurs engage investors. Likewise, it helps the investors review the companies in an efficient and empowering manner. Entrepreneurs on Equity Net have a great profiling ability where they can create a multi-media profile, then they can publish that within Equity Net for investors to see. They can also use the new Title 2 rule where they can publish it publicly. There’s also a patented business planning and evaluating software. It’s a 10 step guided process that will get you ready to seek funding. So those are the tools we think are key to making equity crowdfunding successful.
Ty: Let’s wrap up with understanding why the investor would want to get involved. Maybe understanding the mind of an investor would help and entrepreneur help figure out how to best pitch their story.
Judd: When I began my investing career in the mid 90’s, I used Merrill Lynch. You had a broker with enormous commissions to pay. When eTrade and AmeriTrade came out, they were the pioneers of the self directed investment. There was a lot of skepticism in the Merrill Lynch world. They said, “That will never last. People will never leave my advice.” But that’s exactly what happened and it happened swiftly. People moved to these other platforms in droves that allowed them to do their own decision making and save a lot of money at the same time. I look at that as a predictive analogy of what’s happening with crowdfunding.
Ty: Thank you very much. This has been a really interesting discussion. I’m excited for Title 3 to come out in the spring. It does provide a wider availability of capital for small business. And I’m personally of the opinion that anything that helps fund small business is a good thing.
Judd: I agree. It is the number one cause of business failure in the United States. So if you can address capitalization, then you can address the number one cause of business failure and all the economic growth and employment that comes from it. So maybe that’s a good note to end on. I appreciate the opportunity to interact with you Patrick and Ty.
Ty: Thank you. Let’s make sure people know how to get in touch with Equity Net. Where can we find you Judd?
Judd: It’s simple, www.equitynet.com. If you type in crowfunding or Equity Net on google, you’ll find us also. Our phone number is 866-542-3638. And the wonderful thing about Equity Net is a human answers when you call.
Patrick: I’ve noticed lately how many business go to an automated system when you call, or they just don’t pick up. I’m amazed. I don’t know how businesses survive if you don’t pick up the phone.
Judd: I don’t think you can do that with crowdfunding. It requires that human touch.
Patrick: Judd Hollas our guest for today. Check him out at www.equitynet.com. Thanks for coming on Judd.
Judd: Thank you very much.
Patrick: Is there anything else you need to throw in Ty?
Ty: No. Just thanks to Judd. This was a really interesting conversation and keep up the good work.
Patrick: Ok, we’ll go ahead and wrap up today’s edition of The Business Fuel Podcast. Remember you can download us on Lendio.com/blog. We’ve got 2 years worth of content you can access. So for Judd Hollas, Ty Kiisel, I’m Patrick Wiscombe. Thanks for listening. We’ll talk to you again next Tuesday.
Bringing you interviews with top business professionals and business financing tips to help fuel your American dream. This has been the Business Fuel podcast, with your hosts, Ty Kiisel and Patrick Wiscombe, heard exclusively on Lendio.com