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Will Crowd-Funding Boost Small-Cap Real Estate?

June 12, 2012

Among the MarketBeat readers who have even heard of the crowd-funding concept, most of you probably consider it a new-age mechanism helping GenY-ers support artistic and charitable endeavors, or pre-order cool products soon to come from start-ups that haven’t otherwise attracted capital.

And you’d pretty much be on target.

But thanks to key provisions of the Jumpstart Our Business Startups (JOBS) Act that President Obama signed into law in April with bi-partisan support, crowd-funding appears positioned to become a driving force in small-business capitalization. In allowing as many as 2,000 "unaccredited" individual investors to collectively infuse up to $1 million in hard equity annually into a business seeking growth capital, the revised investment regulations appear destined to boost user demand for small-cap CRE properties.

And as crowd-funding veteran David Marlett is also quick to point out, dozens or hundreds of unaffiliated crowd investors will also be able to collectively buy, build, lend against or otherwise fund smallish income-property assets.

Crowd investors could conceivably buy into new ventures looking to develop commercial spaces that are in strong demand, acquire land lots opportunistically, share vacation-home intervals via timeshares, or maybe even purchase distressed or performing notes, says Marlett, an attorney and accountant involved in numerous non-equity, crowd-funding efforts – and head of the new National CrowdFunding Association.

Indeed now that small businesses will be able to tap into unaccredited investor equity without having to register extensive IPO or private-placement documentation with the Securities & Exchange Commission, crowd-funding ventures will arguably be limited only by American entrepreneurial imaginations, Marlett adds.

"There are just so many potential applications we haven’t even thought about yet," he adds. "So I expect crowd-funding equity will become an enourmously huge marketplace."

Amid the conservative debt-side small-business financing environment of recent years, crowd-funding has emerged to help jump-start new technology and media outfits in particular. But regulations being revised via the JOBS Act have heretofore limited unaccredited investor infusions to structures more akin to charitable contributions or loans than equity positions.

In fact the term often used to describe crowd-funding investments to date is the "donation model." In addition to supporting artistic and charitable endeavors of sponsors soliciting these contributions, crowd investors have also helped fund start-ups. But unaccredited investors in turn receive a company’s products or services as consideration, as sponsors can’t issue equity shares absent costly SEC registration.

But the JOBS Act appears to be a game-changer – or rather, it will be once SEC officials adopt corresponding new rules early next year. In opening up equity investments solicited through registered online portals to the 99 percent (probably closer to 98) of Americans who don’t qualify as accredited investors, the new rules will "throw the stock market out on the Internet," as Marlett puts it.

Crowd-funding equity investments could well hit "multiple billions" during the first year, and are almost certain to grow quickly thereafter, he adds. Indeed the popular portal Kickstarter, which links contributions to mostly creative-industries ventures, is expecting to manage some $700 million in non-equity crowd-funding this year alone, Marlett notes.

Prospective crowd-funding portal sponsors have quickly swelled to 300-some from 50-ish before the JOBS Act passed – presumably indicating the kind of impact the coming equity flood might have on the nation’s small-business real estate footprint.

Again, the concept is that start-up sponsors and other small-business entrepreneurs needing less than seven-figures in growth capital (annually), will be able to efficiently solicit equity investments from tens of millions of prospective investors. And if not enough of those prospects find terms attractive within limited offering periods (30-some days typically), sponsors can cancel and try again.

Presumably the new capital will improve balance-sheets and allow growth-minded operations to lease appropriate space, or alternatively buy facilities as owner-users. The structure entails no inherent conflicts with SBA small-business real estate lending programs – and provides solid equity business owners can leverage with conventional bank loans into property purchases and developments, Marlett relates.

He also suggests banks might be willing to provide commitments contingent on a crowd-funding effort’s success – perhaps in turn boosting prospects of the corresponding capital-raising. "Say you need $800,000 to complete a purchase or a development, and your bank says it will lend you $300,000 contingent on your ability to raise another $500,000 in equity. That contingency arrangement is something that would make crowd investors more comfortable."

Logically some skeptics question whether many fledgling small-business owners will be willing to take on dozens or even hundreds of shareholders and the governance responsibilities that come therewith – not to mention corresponding complications that might arise for tech-type start-ups in particular as they subsequently pursue initial venture-capital fundings.

But as Marlett points out, crowd-funding portal officials make it their business to act as investor relations representatives advising individuals on the benefits of shareholders speaking with "one voice." As for VC concerns, savvy sponsors and portal reps are able to structure securities – special classes, convertible debentures and the like – that don’t conflict with venture capital interests.

Perhaps boding well for entrepreneurs preparing to raise equity under the liberalized regulations, some start-ups have been overwhelmed with non-equity financial commitments.

One noteworthy, recent case is Pebble Technology, which has developed smart wristwatches that interface with smart phones. Principal Eric Migikovsky sought $100,000 through the Kickstarter portal – and received product order commitments totaling more than $1 million in one day, well over $4 million in barely a week, and ended up with $10.3 million by the time Pebble’s crowd-funding window closed May 18.

On a more typical scale – but likewise well beyond expectations – partners Ken Minn and Scott Hussa of HuMn Design tapped the crowd-funding market to support their fledgling manufacturing of scanner-secure aluminum and carbon-fiber wallets. The pair had hoped to raise $66,000 to finance mass-production, but ended up attracting commitments of almost $300,000 from nearly 4,000 individuals in March and April.

While SEC’s final rules are near-certain to restrict how much of a single investor’s net worth can be invested in a single entity, one attractive feature of the coming crowd-funding structure is that companies soliciting equity investments can continue raising up to $1 million each year as needed.

Marlett also identifies a "reciprocal effect" of crowd-funded small-business investments that bodes well for the small-cap commercial property space. If hundreds of locally based individual investors share stakes in a restaurant, plumbing supply outfit or the like, they’ll certainly be inclined to patronize the business and hence help ensure its profitability and growth – and ability to pay rent and/or service mortgages.

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