The crowdfunding crowd is anxious

Amy Cortese / New York Times News Service /

Ryan Caldbeck was stumped. A director at a private equity firm, he was taking part in a panel discussion at a consumer goods conference last summer in New York when an entrepreneur raised his hand with a question: Where could a young company with just a few million dollars in sales go for money to grow?

Caldbeck and his peers on the panel fumbled for a response. The fact is, most private equity investors and venture capitalists won’t touch a consumer products company until it has surpassed $10 million in sales — anything else is too small to bother with.

The best advice the panel could offer was for the entrepreneur to tap his credit cards.

“The purpose of the panel was to help entrepreneurs raise money, but we had no answers,” Caldbeck remembers. “That’s when I knew that there is a big issue here.”

That big issue caused Caldbeck to leave his job to start CircleUp, a company that aims to connect up-and-coming consumer products companies with investors.

Right now, the people allowed to invest through CircleUp must be accredited, meaning they have a high net worth. CircleUp hopes that soon not just the wealthy few, but the general public — whether friends, family members, customers, Facebook friends, or even total strangers — will be able to invest in deserving companies through a hot new area of finance known as crowdfunding.

To its advocates, crowdfunding is a way for capital-starved entrepreneurs to receive financing that neither big investors nor lenders are willing or able to provide. To others, it represents a potential minefield that could help bad businesses get off the ground before they eventually fail, and in some cases could even ensnare unsophisticated investors in outright fraud.

Those fears are partly why the Securities and Exchange Commission has delayed rules allowing crowdfunding that were supposed to take effect this month as part of the JOBS Act (Jump-start Our Business Startups), signed by President Barack Obama last April. The SEC is wary of loosening investor protections that have been in place since the 1930s.

Despite the uncertainty, the outlines of a new industry are emerging as a few crowdfunding startups have found ways to raise money within current rules. They include companies like CircleUp and SoMoLend, which lends money to small businesses that typically wouldn’t interest private investors.

By themselves, of course, a few startups can’t completely democratize finance. But they begin to illuminate what the future of crowdfunding could look like, as the debate continues over a vast widening of the private investor pool.

Caldbeck formed CircleUp last fall along with Rory Eakin, a former business school classmate who was working for a philanthropic foundation. Through their startup, the two men seek to finance food, personal care, apparel and pet-related companies, often with an environmental or social bent.

CircleUp considers applications from companies with $1 million to $10 million in revenue. Companies whose applications are accepted make their pitches to investors behind a firewall on the CircleUp website, offering equity stakes in return for capital. CircleUp, which helps companies raise up to $3 million, takes a small cut of the money.

Under current federal regulations, CircleUp wouldn’t be able to arrange such deals on its own. But it struck a partnership with W.R. Hambrecht, a registered broker-dealer that can handle investments from accredited, or high-net-worth, individuals whom the SEC considers sophisticated enough to invest in private companies.

“Living here in Silicon Valley, a lot of people don’t understand the need,” Caldbeck says. “If you’re a tech company with a good idea, you can raise money. But it’s a different story for food, agriculture, retail and other consumer- oriented businesses.”

Caldbeck sees a big opportunity. Consumer goods companies account for a sizable portion of the nation’s businesses, yet very little capital — from private equity funds or from accredited investors — flows to them, he says.

What’s more, only a tiny percentage of those who qualify as accredited investors actually invest in private companies, he says. (These are people with a net worth of at least $1 million, not including their primary residence, or who have earned more than $200,000 — $300,000 for couples — in each of the last two years.)

CircleUp is aiming to simplify the process so that more accredited investors take the plunge and more startups can get financing. And it wants to expand its business to unaccredited investors when the rules for crowdfunding are completed.

Bringing more than money

So far, CircleUp has helped seven companies raise money on its site. They include Episencial, a children’s organic skin-care line based in Los Angeles; Laloo’s, a maker of goat milk ice cream in Petaluma, Calif.; and Little Duck Organics, a children’s snack producer in Brooklyn, N.Y.

Zak Normandin, 26, the tousled-haired founder of Little Duck Organics, got the money to start his business the way many small businesses do: By maxing out credit cards. He ran the company out of his basement and distributed products himself to local stores before winning his first big client: Whole Foods.

Two years later, he and nine employees operate out of offices in a brick warehouse in the Greenpoint area of Brooklyn. His goal has been to create healthy snacks and cereals that he would serve to his own three children.

“There’s no healthy fun alternative for kids,” Normandin says.

The company’s first product — Tiny Fruits, a line of no- sugar-added organic fruit snacks — can be found in 6,000 retail outlets, including Whole Foods and Stop & Shop stores and on . Mighty Oats, a new cereal line packaged in compostable containers, will hit stores this month. There are juices, fruit purées and other products in the works, he says.

All of that takes capital — lots of it. Yet fundraising takes valuable time away from running the business.

CircleUp has given entrepreneurs like Normandin a streamlined way to raise money while providing investors with opportunities they may not otherwise hear about. In seven weeks, Little Duck raised nearly $900,000 from about a dozen investors on the site.

“Pre-CircleUp, 80 percent of my time during fundraising was spent with investors,” Normandin says.

And the CircleUp fundraising brought more than money. A few investors with experience in building and marketing consumer brands have become informal advisers to Normandin. “To have that kind of experience to leverage has been extremely helpful,” he says.

Another draw is that CircleUp has partnered with corporations like General Mills, which get an early look at new brands they might want to acquire down the road.

CircleUp itself has attracted $1.5 million from big-name investors including Howard Schultz, the Starbucks chairman, through his Maveron venture fund.

Another supporter is Clayton Christensen, the Harvard Business School professor known for his work on what is called disruptive innovation; he invested in CircleUp through his Rose Park Advisors investment firm. (Christensen says that seemingly simple innovations can disrupt and displace mainstays in a market the way the personal computer disrupted the mainframe market and smartphones are now disrupting PCs.)

Focusing on the little guy

CircleUp, and crowdfunding in general, have “the potential to be disruptive,” Christensen says, by opening up financing to companies that have traditionally struggled to raise capital and to investors who have been excluded from the market.

SoMoLend, a crowdfunding startup based in Cincinnati with offices in New York City, is focused on a more modest, but ultimately larger, market: the millions of small businesses that dot the nation’s Main Streets.

These businesses usually rely on financing from friends and family, home equity loans, credit cards and bank loans. Yet all of those financing sources suffered greatly during the financial crisis and in many cases have not yet recovered. While overall commercial lending has rebounded, bank lending to small businesses is still down significantly from 2008.

Much of the crowdfunding focus has been on equity — selling shares in startups — but SoMoLend is betting that loans to expanding small businesses are a bigger opportunity. Equity crowdfunding will be “minuscule compared to the impact crowdfunding will have on debt financing,” says Candace Klein, SoMoLend’s founder and chief executive. “We think this is literally going to change the banking system.”

Citing a recent Federal Reserve report, Klein says that nearly a third of small businesses don’t apply for bank loans for fear of rejection. Of those that do apply, two-thirds are turned down, leaving them in need of capital.

That is the market that SoMoLend — short for Social Mobile Local Lending — was created to serve. Klein’s experience with her first startup, a Cincinnati-based firm that mentors and makes microloans to entrepreneurial women, made her clearly aware of the need, she said. But how to serve that market as crowdfunding worked its way through the legislative — and now the regulatory — process? Klein had an idea: instead of raising money from a group of individual investors, she would seek out institutions to serve as lenders.

Her first partner was KeyBank, a regional bank based in Cleveland, which helped test the site and develop an underwriting algorithm. Today, SoMoLend counts more than 40 institutions among its lenders, including Fifth Third Bank, the Emery Federal Credit Union, the Bank of Kentucky and Justine Petersen, a nonprofit microlender.

Klein says she offers an efficient way for lenders to find loan candidates and to team up so they can reduce their risk.

With SoMoLend, “we can query and filter the types of businesses we’re interested in” and “only take on the risk that we are comfortable with,” says Britt Scearce, a business development officer at Emery. In addition, local governments like the City of Cincinnati and St. Louis County, Mo., have signed on, seeing the service as a way to spur economic development.

Since SoMoLend started about a year ago, it has eased the way for $3.4 million in loans to 89 small-business borrowers, typically retailers, restaurants, salons and other concerns that have inventory and equipment that can be used as collateral.

Borrowers have included Candice Peters, who raised $9,000 from three lenders to help with working capital for her 2-year-old Hyde Park Body Boutique, a workout studio in the Hyde Park section of Cincinnati. She now employs six instructors and says she hopes to open a second studio in another part of town.

And there’s Stacey Shiring, owner of Creative Invites and Events, a Cincinnati shop that creates custom stationery and invitations from designs by local artists.

Shiring, who is 34, obtained a $15,000 loan, at 6 percent interest, from Key Bank through SoMoLend. She used the loan to develop software that will allow customers to design stationery online; she plans to license the software to other stationers. As she began building a history of loan repayment on SoMoLend, she was able to secure a $50,000 line of credit from her bank.

Shiring says her business is profitable, and she now employs five full-time and two part-time employees. “It’s hard to open a small business, and SoMoLend has made it a little easier for us,” she says.

Crowdfunding sites like SoMoLend aim to act as a kind of financial launching pad. “Crowdfunding can get companies started to the point where they can get bank financing down the road,” says Scearce of Emery Credit Union. “We’re excited about what this can do for the economy — it can get a lot of companies up and running. And we’re excited to be in on the ground floor.”

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