Imagine that you log onto your Facebook account one day and see an ad for your favorite bagel shop. They’ve got two locations, the staff is friendly, the store graphics and design are smart, and the bagels are the best. You’re a loyal customer and so are your neighbors — the shops are always packed.
The ad announces plans for a third store, with an unusual twist — an invitation to help the micro-chain fund its growth by buying shares in the company. The minimum investment is only a few hundred dollars. You spend close to a thousand a year on their bagels. Given the choice, why not invest where you shop? It’s like paying yourself.
In a nutshell, that describes some of what’s already happening as a result of changes in the securities laws. For the past several years, those new rules have been quietly revolutionizing the ability of small companies to raise equity capital and for small investors to get in on the ground floor of promising ventures.
Meet crowdfunding 2.0, a sophisticated, regulated, entrepreneurial version of platforms like GoFundMe that facilitate donations for people and projects. Instead of donating to a fund to help a local employer whose business was flooded out, it’s now possible for that employer to sell stock which could become more valuable as the firm recovers.
The new rules emerged from a provision in the 2012 JOBS Act (Jumpstart Our Business Startups), passed in response to the Great Recession, and were aimed at making it easier for individuals to invest in small businesses that otherwise lack access to investment capital. Among the first companies to take the equity crowdfunding plunge in 2015 were Elio Motors and Med-X, Inc. What happened to each of these very different companies sheds some light on the advantages and pitfalls.
Elio Motors made a splash in 2015 with its design for a new kind of sports car — a bullet-shaped, three-wheeled, two-seater, available in bright red. Very sexy. At a base price of $7,000, it wasn’t long before the company had deposits for 50,000 orders. It just needed the money to finish the engineering and build the factory.
The company took advantage of the new rules to test the market for its stock. The campaign was so successful that after raising $16 million the company felt confident enough to list the shares for trading on the OTC market, traditionally where stocks trade that fail to qualify for exchange listing.
Elio Motors’ haste in tapping into the larger public market quickly became a self-inflicted wound. Elio shares [ELIO] debuted in February 2016 at $40, plunged to $20, and for the past several years have been slowly bleeding out. The company has been promising for years that production would start soon, but it hasn’t. A plan to raise $100 million in an IPO fell apart last year and recent quotes on the OTC have the shares trading at $1.30. Elio Motors now has about 65,000 unfilled orders and no way to build the cars.
Med-X Inc., a California-based green technology firm, has been the tortoise to Elio’s hare. Founder Matthew Mills had for years been interested in finding alternatives to everyday products like industrial pesticides that require special handling and build up in the ecosystem. With a partner he developed a line of non-toxic pest control products under the brand Nature-Cide and had been testing them out, refining the recipe of harmless essential oils, like cedar and clove, that kill various insects and repel rodents and reptiles.
By the time the new investment rules went into effect in 2016, Mills was ready to take the plunge under Regulation A, or “Reg A+,” as the crowdfunding community refers to it. There are two basic levels of crowdfunding that the SEC governs. According to Max Crawford, an executive with crowdfunding platform StartEngine.com, to be able to sell shares directly to investors under Reg A requires an investment of between $50,000 and $100,000 in legal, auditing, and filing costs. Once approved, companies can raise up to $50 million. A light version, called Regulation Crowdfunding, allows companies to raise up to $1,000,000 with minimal expense—companies that choose this route are allowed to self-audit.
Med-X first sold stock in 2016 using Regulation A+ but the effort began in earnest in late 2017. The company is in the middle of a campaign now to raise $15 million with more than $7 million raised to date from approximately 2,500 investors, according to StartEngine.com. Although it doesn’t yet look like a cannabis company, Mills says Med-X is developing cannabis-based health products and it plans to be positioned when all the regulatory issues have been resolved. Meanwhile, Nature-Cide got a big boost when the agriculture departments in Colorado, Washington, and Oregon listed the product as safe for use on cannabis cultivation.
Mills is a big fan of Reg A. Based on the company’s most recent regulatory filings, Mills says the total market capitalization of Med-X, Inc. could be about $80 million by the end of 2019. He is most enthusiastic about the unique relationship that develops between the company and individual investors, many of whom become missionaries for its products. A number of investors who made the minimum initial investment of $420 have become repeat investors, he says, with a few having passed the $100,000 mark.
Besides getting ahead of themselves, as Elio Motors apparently did, crowdfunding isn’t for all eligible businesses. One aspect that gives people pause is the fact that their financials become public. Twice a year they have to report all of the financial details of their companies in SEC Audits. “Some businesses are uncomfortable with that level of transparency,” says StartEngine’s Crawford.
At the other end of the spectrum, he says one of the platform’s happiest listing companies, a fitness apparel brand, calculates that on average its investors become such loyal customers and brand ambassadors that they generate many times their investment in revenue.
For now, at least, equity crowdfunding doesn’t show up on the radar of most businesses and investors and may not until a secondary market becomes established.