New crowdfunding rules could boost Austin startups [Austin American-Statesman]
(Austin American-Statesman (TX) Via Acquire Media NewsEdge) Sept. 22--When Austin startup Grandma Lu's Spice Cabinet wanted to raise cash to expand its snack line of crunchy dried peas this summer, company founder Anish Sheth couldn't advertise or try other marketing techniques to look for investors. Federal securities rules wouldn't allow it.
But starting Monday, that all changes. Grandma Lu's and other companies will be able to expand their search for investors to a much wider field, as regulators end a decades-old ban that made it illegal for companies to publicly advertise as they seek investors.
Companies will now be able to use print ads, television and the Internet -- even highway billboards or banners flown over University of Texas football games -- to pitch themselves to investors who meet certain income or wealth criteria and can better afford the financial risk of new business ventures. Companies can even use Twitter, Facebook or blogs to promote an offering.
The rule change could have a significant impact in Austin, with its strong culture of startups and crop of young companies in search of funding to fuel growth.
"Now we can go out and find investors in the consumer product space, show what we're doing and hopefully get them interested," said Sheth, Grandma Lu's founder and CEO. "It's a new way to reach people who might want to back our company."
The change is part of the Jumpstart Our Business Startups Act. The so-called JOBS Act, passed in 2012, relaxes regulations that were put in place with the Securities Act of 1933 and makes it easier for startups to raise money and go public.
While some experts say the new freedoms will open key doors for startups, others say the changes go too far in removing regulatory oversight and could put inexperienced investors at risk by luring them into highly risky -- or entirely fraudulent -- investments.
"Unfortunately, there are just people in this world who are determined to steal money from the public, and securities offerings can be a very quick way to get that done," said John Morgan, chairman of the Texas State Securities Board.
"They don't care at all about the niceties of a (Securities and Exchange Commission) rule or taking steps to make sure purchasers are accredited," Morgan said. "They're going to see a green light to advertise to the public, and they're going to take off as soon as they can, as quickly as they can."
Under the new rules, securities advertised to the public don't have to undergo any federal or state review to ensure the documents are accurate and include the necessary disclosures to fully inform potential investors. That binds state securities regulators from providing many proactive investor protections outside of educational efforts.
"Investors will be on their own for this," Morgan said.
Casting a wider net
For Austin's startup community, there are hopes that the ability to promote a share offering could open new avenues to financial backing. It could also draw new investment here from other parts of the country and world.
"Austin has built a reputation as an up-and- coming startup center, but it can be hard for outside investors to find deals here," said Bill Clark, founder of Austin-based MicroVentures, which runs an equity crowdfunding website. "Now that very early-stage startups can tell the world that they're raising money, it will be easier for investors to connect with them."
That's especially helpful at a time when venture capitalists are continuing to pull back on investing in young, not yet established companies. As venture investors seek less risky deals, venture funding for "seed stage" companies is continuing to drop to historic lows, according to a recent MoneyTree Report released by the National Venture Capital Association.
Still, local securities attorneys say they don't expect to see a mad rush of quality investment opportunities showing up in public ads. The better investments, they said, will almost certainly go through traditional, private channels.
"It will help companies that are having a tougher time raising money, because they can cast a wider net," said Sam Zabaneh, a partner at DLA Piper's law offices in Austin. "But the stronger startups are going through sophisticated institutional investors and being very strategic about how they're getting funding."
The eventual combination of crowdfunding -- in which companies and organizations solicit large numbers of smaller investors, usually through online portals -- and public advertising for equity investments could help pull even more capital toward traditional high-tech and finance hubs, said Christian Catalini, a professor at the Massachusetts Institute of Technology's Sloan School of Management.
In June, Catalini and two colleagues from the University of Toronto published a National Bureau of Economic Research working paper in which they noted that current forms of crowdfunding tended to go toward places where money was already going.
For arts projects, they found, the crowd's funds largely went to the same places where the National Endowment for the Arts granted money. For tech projects, the crowd typically invested in areas with a strong base of venture capital.
"Places like (Silicon) Valley, New York and also Austin that have attracted technology and entrepreneurial activity in the past are receiving a disproportionate share of crowdfunding dollars," Catalini said. "That's where the human capital is, where the talent is, and people aggregate around that activity."
The JOBS Act, which was backed by Silicon Valley and the high-tech industry, is also expected to eventually open up more opportunities for crowdfunding.
Popularized by online platforms such as Kickstarter and RocketHub, crowdfunding is becoming a first stop for a growing number of startups soliciting funds. There are now hundreds of crowdfunding platforms, and according to Los Angeles research firm Massolution, last year they channeled $2.7 billion to entrepreneurs, almost double the previous year's total.
Companies set the amount of money that they want to raise from crowdfunding and a time frame -- usually 30 days. The crowdfunding sites typically take a cut of the money raised; Kickstarter receives 5 percent.
As of now, however, crowdfunding backers aren't allowed to receive equity as a result of their investments. Instead, startups typically reward them with perks such as T-shirts, free samples or a chance to test a gaming company's new release.
Crowdfunding that will allow backers to receive equity for their investment was approved by Congress as part of the JOBS Act, but the SEC has missed the deadline for issuing a set of rules, and the final regulations might still be months away.
Grandma Lu's is an example of how the current crowdfunding model can give a tiny startup a boost.
Sheth, a former finance lawyer who started the company in 2010, wanted to add a new flavor to the company's World Peas snack line.
But the three-person company, which sells its peas at 3,000 retail locations including Whole Foods and H-E-B, is self-funded and didn't have the money.
So Sheth started a month-long Kickstarter campaign in July, raising $17,000 from friends, family and customers. This month, the company will debut its new wasabi flavor. In return, those who contributed will receive snack samples and T-shirts.
Now Sheth is looking forward to promoting the business to a wider set of accredited investors.
"It's very hard to find the right investors for food startups, especially in Austin, where they're very tech-focused," he said. "The rules have been very strict about solicitation. Now we can put our message out and reach a much broader audience, and hopefully find a new source of capital."
Buyer, seller beware
The relaxed regulations about advertising securities will probably have a greater local impact once the SEC finalizes the new crowdfunding rules, local experts said. But some local venture capitalists say Monday's eased regulations, on their own, could have big repercussions for inexperienced investors.
"This is the highest risk investment you can make, information and transparency is going to be minimal, and you have no control or influence," said Chris Shonk, managing director of Austin investment firm Liahona Ventures. "You also can't push a button and sell it, because there's no market. It's a really bad cocktail."
When venture investors put money into a company, they write the terms, get a board seat and have decision-making power. They are financially prepared for the fact that many, if not most, of their investments will fail.
Most Austin startups are expected to move cautiously when it comes to promoting their offerings. The new rules put the burden of verifying that investors are accredited on the firm selling the securities. In the past, accredited investors -- defined by law as individuals with a net worth of at least $1 million or an average annual income of $200,000 or more for the past two years -- were often taken at their word.
Joshua Baer, an Austin investor and founder of technology incubator Capital Factory, said he believes the more lenient rules are a good step, but he warns that "startups could face severe penalties -- such as not being able to raise money for a year -- for making mistakes in an already complicated process. Not being able to fundraise for a year equals death."
It's also possible that publicly soliciting investments could actually limit the number of investors interested in the securities, said Benette Zivley, a shareholder at the Munsch Hardt Kopf & Harr law offices in Austin and a former chairman of the Texas securities board. Asking for tax returns or statements of wealth and income from financial advisers might turn off many potential investors.
"That could have some detrimental effect," Zivley said. "At what point is it helpful for a company to use solicitation if you have these additional barriers?"
Bypass traditional players?
For Austin software startup Jumpshot, a crowdfunding campaign last year was a way to get early feedback on its new computer security application.
"We thought if we could raise $25,000, it would be a sign that we had something people wanted," said co-founder David Endler.
The company achieved its goal in two days and went on to raise $162,598 from 3,035 supporters -- an average of less than $55 apiece.
Backers were given gifts, including USB drives, T-shirts and early access to its first product, and the company used the funding to hire three interns and make tweaks to its software.
Endler says startups will benefit from easing crowdfunding rules and allowing companies to solicit investors directly.
"A venture capitalist might scoff at your idea," he said, "but if you have a compelling marketing message, you could potentially reach out to investors directly and bypass the traditional players."
Local business coverage
Lori Hawkins has reported on startups, entrepreneurs and venture capital investing in Central Texas since the mid-1990s. Dan Zehr focuses on the region's overall economic health and how that's affected by specific trends and industries.
(c)2013 Austin American-Statesman, Texas
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