Creating a vehicle for investors to be able to sell their shares in small businesses could help drive interest in equity crowdfunding in Michigan, although experts say it may take a few years for a viable market to emerge.
A new state law, passed unanimously by the Michigan House and Senate and signed last week by Gov. Rick Snyder, would allow licensed broker-dealers who handle the sale of securities to set up a web-based
“Michigan investment market” to connect buyers and sellers of shares in small businesses. The investment market would handle intrastate transactions for Michigan-based investors who want to dispose of the shares they acquired in Michigan-based small businesses.
The law provides another key piece of what’s needed to drive the flow of capital to local small businesses through crowdfunding and essentially gives investors an exit strategy for their investments.
“If someone needs to be liquid, it gives them a comfort zone that they can get out of their investment,” said Joe Elias, chief operating officer at Grand Rapids-based Loquidity.com, a crowdfunding platform launched this past summer for real estate investing.
“We can potentially get a lot more investors if it’s done right,” Elias said. “I can buy into this property, and I know I can potentially sell it in one or two years and make some money and get my capital back.”
Elias and others who followed the legislation and are enthused by the emergence of crowdfunding as an investment tool, but they say steady deal flow likely will not come soon. While the law to create a secondary market was needed, the industry needs to figure out a lot of issues before equity crowdfunding takes off.
Among them: “How do they evaluate what the share price (of a company) should be at that time?” Elias said.
“It’s important to have that (secondary market), but how it’s managed is wide open,” he said. “What are the buyer’s expectations and what are the seller’s expectations? How we manage that secondary market will be interesting.”
The state’s Securities and Commercial Licensing Bureau within the Department of Licensing and Regulatory Affairs will need to write rules and regulations to implement the law, which provides a legal framework for a Michigan investment market and penalties for violations.Until state regulators can craft and issue rules, deal flow for equity crowdfunding likely won’t emerge.
“There’s a fair amount of thinking to get into this that is going to take some time,” said attorney Shane Hansen, partner and co-chair of the funds and investment services practice at Warner Norcross & Judd LLP in Grand Rapids. “There is going to be some kind of lead time to make this effective.”
Under the law, dealer-brokers would pay a $500 fee to register to handle intrastate transactions, then a $250 annual renewal fee.
The legislation to create a secondary market to sell shares follows adoption late last year of the Michigan Invests Locally Exemption (MILE) Act that allows companies based in the state to solicit investments from Michigan-based investors without having to register with federal securities regulators.
Reconciling how shares are priced is one of the key remaining questions in equity crowdfunding. State regulators will have to put some guidelines around that issue, given the relatively light trading volume and the lack of third-party analysis of a small company’s shares, experts say.
“What’s a fair price?” Hansen said. “Fair valuation is going to be a risk for the investor.”
The federal JOBS Act of 2012 opened crowdfunding to equity offerings. As the U.S. Securities and Exchange Commission drags out final adoption of rules for equity crowdfunding, lawmakers in Michigan and other states enacted laws to take advantage of an exemption in federal securities regulations that allows intrastate offerings.
To date, Michigan has seen only a handful of crowdfunding campaigns under the MILE Act. They have used a model where financial supporters receive a reward for their investment or a revenue-based model where the company commits a percentage of sales to pay back investors.
Despite a need to create a secondary market to accommodate equity crowdfunding, Thomas Coke of CrowdFundConnect sees a limited number of broker-dealers jumping into the market at the onset. Equity crowdfunding is in its infancy and Coke believes it will take two years or so for the market to develop.
Deal flow needs to emerge first on the front end before demand activity begins for the secondary market, Coke said.
“I think someone will do it. I don’t know that there will be a lot,” Coke said. “There just are not enough crowdfunding offerings today — and there aren’t enough intrastate offerings — to really create a huge market, but there are going to be people to step up and register. As crowdfunding becomes more prevalent, I think you’ll see more people get into this game just because there’ll be reason to.
“There’ll be slow growth, but there will be growth over time.”
CrowdFundConnect is a new Chicago-based virtual company that develops websites for broker-dealers to use for transactions. Soon, the company plans to launch a crowdfunding site for accredited investors. A former state securities regulator for Michigan, Coke serves as the company’s director of compliance services, working out of Grand Rapids.
Elias of Loquidity.com sees deal flow taking two to three years to pick up. For now, there remains an education process to go through about equity crowdfunding.
“Our job mainly every day is educating new investors about what crowdfunding is and how they can benefit from investing in real estate using crowdfunding,” Elias said. “We’re still getting people over that hurdle every day. To say that, ‘Hey, now you can sell that on the secondary market,’ and trust that secondary market — that’s another uphill battle.
“They just need to trust crowdfunding first, and then they will be able to trust the secondary market, presuming it will have some type of governance around it,” Elias said.
Equity crowdfunding itself, either through a securities offering or a debt offering, also can have limited appeal to entrepreneurs, Coke said.
Not every startup and growing company needing capital is open to an equity campaign, he said. If they opt to do a crowdfunding campaign to raise capital, using a reward or revenue-sharing model may prove a better avenue, Coke said.
The first crowdfunding campaign conducted under the MILE Act was completed by Southeast Michigan-based Tecumseh Brewing Co. LLC, which raised $175,000 in startup capital from investors that it matched with private investments and a commercial bank loan. Partners in the microbrewery used a revenue-sharing model for the campaign, which they listed on LocalStake.com.
“A lot of entrepreneurs are not necessarily ready for equity,” Coke said. “(When) they sit down and talk to their attorney, talk to their accountant and talk to people who are in the know, they have hesitation and (say), ‘You know I’m just not prepared for equity at this point, so it’s just not a good option for me.’”
Despite those issues, legislation to create a secondary market in Michigan was needed now to accommodate what may come down the road, Coke said.
“It’s a great opportunity for Michigan to further become a pioneer in this space,” he said. “That’s one of the concerns a lot of people have had. ‘If I buy shares in one of these intrastate crowdfunding offerings, how do I ever get out of that?’ If I need to get my money back and sell my shares, there’s really no good way to do that.”
A small online survey conducted last spring by Ypsilanti financial advisory firm Reconsider Inc. found an emerging interest in equity crowdfunding in Michigan. Of the 151 people in 20 counties who answered the online survey, 86 percent said they were willing to put up $50,000 or less for equity investments made through crowdfunding — if they felt confident and comfortable in the investment they were making.
The survey shows an emerging interest in equity crowdfunding in Michigan, said Angela Barbash, a financial adviser and the founder and CEO of Reconsider Inc. Moving that interest into action requires a large outreach to investors across the state, Barbash said.
“Bottom line — it’s education, education, education,” she said.
In particular, business owners who are retiring and selling their companies can put their money to work by investing locally through crowdfunding, Barbash said.
“We need to reach out to that community and say, ‘Hey, how about you investing that or a portion of that into the local market?’” Barbash said. “It’s a huge opportunity.”
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