from wall street to main street: will equity-based crowdfunding help to grow ohio startups?

Thanks to the Internet, everyone’s an entrepreneur these days. Creating a new company – or for that matter, cursing if someone else has already beaten you to the punch – may only be a click away.

And now, thanks to the Jumpstart Our Business Startups (JOBS) Act that recently received bipartisan support in Congress and was just signed into law by President Obama, anyone can invest in one, too.

That's because the JOBS Act, which aims to make it easier for small businesses to raise startup capital, includes a provision which allows equity-based crowdfunding. For the first time, anyone will be able to purchase equity shares in startups. Whether those shares are worth $100 or $10,000, their cumulative impact will likely become an important source of early-stage capital for entrepreneurs.

Previously, only accredited investors (high net worth individuals) could make equity investments in our nation’s newest, most innovative companies. Such rules from the Securities and Exchange Commission (SEC) were written to protect small investors – most startups fold before they turn a profit, after all – yet they also discouraged the sort of micro-investments that give startups early momentum.

So far, the reviews of crowdfunding from investors have been mixed. Some say that it represents the radical democratization of startup capital, while others say its potential may be overstated and it could lead to more fraud, loss and litigation. 

“Historically, investors have been categorized as friends, family, founders and fools,” says Richard Miller, Senior Vice President of the National Association of Seed and Venture Funds (NASVF), a nonprofit group that recently relocated its headquarters to the Innovation Center at Lorain County Community College. “Crowdfunding falls under one of these, but I’m not sure which one yet.”

Yet for Ohio, a state that has sometimes been viewed as "flyover country" by venture capitalists on their way to join the crowds in Silicon Valley, crowdfunding could offer an opportunity to attract new capital as well as educate and empower local investors.

There are plenty of risks and uncertainties, of course. The new law tries to address these by limiting how much an investor can put into a deal (based upon a percentage of his or her income) and requiring disclosures (buyers must be made aware of risks).

While not everyone is sold on the value of crowdfunding, most would agree that accessing startup capital remains a vexing problem for small businesses. Equity-based crowdfunding could become a major new way to help Ohio-based startup businesses get off the ground and propel innovation and job creation across the state, advocates say.

“In the past few years, bank loans to small businesses have become all but extinct,” says Candace Klein, a Cincinnati attorney who started the crowdfunding website SoMoLend (Social Mobile Lending). Klein also founded Bad Girl Ventures, a nonprofit group that focuses on helping women entrepreneurs. “Of the 260,000 small businesses in Ohio, about 70 percent are probably unable to get bank financing. Crowdfunding opens up a new channel for getting funds to small businesses.”

Despite his skepticism, Miller also says that crowdfunding could help create startup businesses across Ohio.  "We have an opportunity to educate investors about how to invest in good deals and broaden our capital base," he says. "Just as we’ve grown entrepreneurs in Ohio, we can now grow investors.”

Although we're no Silicon Valley, venture capital in Ohio is actually fairly strong. In fact, during the recession, Ohio actually increased its seed and early stage investments while, on average, the rest of the nation declined. Now, equity-based crowdfunding presents an opportunity to engage a new group of investors.

“The collaborative nature of Ohio Third Frontier and its partners has built a strong entrepreneurial ecosystem in Ohio,” says Lisa Delp, Executive Director of Ohio Third Frontier. “We need to help new investors make good decisions.”

For startups, the new crowdfunding legislation couldn’t have arrived at a better time. Studies have shown that most new jobs are created by startups, not existing businesses. Yet raising money can be a full-time job, and most new companies face long odds at becoming successful. As the economy heats up, crowdfunding could offer a viable new way for founders to accelerate their growth curve.

“People will be able to take control of their investments and put them towards companies that hold their values,” says Stacey Shiring, owner of the Cincinnati-based startup Bridal Divas Ink, an ecommerce platform that links artists and designers with brides seeking custom-designed wedding invitations. "Entrepreneurs love this idea because it's so difficult to raise capital."

Bridal Divas Ink launched last year with the help of a $25,000 startup loan from Bad Girl Ventures and $15,000 in debt-based crowdfunding from SoMoLend. Debt-based crowdfunding, which comes in the form of a loan, was allowed under the previous rules. The support of these groups -- along with an interest rate and loan terms that were more favorable than what her bank could offer -- were invaluable in giving her business just the push that it needed, Shiring says. Ultimately, the loan she secured through SoMoLend came from Key Bank.

Now, the fledgling company is going through a growth spurt. Shiring is launching a new brick-and-mortar store to complement her growing ecommerce site, changing the company name to Creative Invites and Events, and entering new markets.

“I started my company after my sister got laid off when she was three months pregnant and I lost my job at a design firm due to downsizing,” says Shiring, who received her undergraduate degree from the College of Design, Architecture, Art and Planning at the University of Cincinnati. “So when I started Bridal Divas Ink, I wanted to build something that couldn’t be outsourced. I also wanted to show people they can use their purchasing power to improve the community.”

Bridal Divas Ink uses Cincinnati-based artists and designers and requires that they complete volunteer work in the community to be considered for the site.

Overall, Shiring advises business owners to make sure they educate themselves about crowdfunding opportunities before plunging into the market. “The reason why I liked the SoMoLend platform and Bad Girl Ventures is they combine training and lending. We have to make sure people know how to grow a business.”

Freeman White, who created the crowdfunding site Launcht.com, says there are potentially many more entrepreneurs like Shiring. The new crowdfunding law could open up big opportunities for underserved markets like Ohio, he says.

“Many people are looking at crowdfunding as a way to boost economic development,” says White, whose Philadelphia-based company creates custom crowdfunding websites and also assists startups with raising money. “It’s a natural fit. The beauty of crowdfunding is that it is easier to get started with a local network that knows your business and knows you.”

While the number of crowdfunding websites will probably soar as the law takes effect in 2013, the stronger players will emerge victorious from the fray over time, White says. Despite criticism, he also believes the new law does a decent job of protecting investors. When the legislation was being debated in the Senate, new measures were added, including regulation of how crowdfunding sites market investments so that they remain neutral in promoting such opportunities.

The fee structure could also prove advantageous to small businesses. With an average fee load of around 7-10 percent, crowdfunding is competitive with commercial lending, White says. Investors also have a potential for upside if they get in on the ground floor with a successful company. After a certain period of time, they'll be able to sell their shares on the secondary market.

White and other crowdfunding experts caution that startups should give ample thought to how they structure investor relationships. The wrong deal structure could hamper a company’s ability to attract venture capital down the line.

Chance Barnett, an Internet entrepreneur based in Los Angeles who created crowdfunder.com, also says the new legislation has the potential to help Midwest cities attract a broader, deeper group of investors. “For better or worse, there is a ‘follow the herd’ mentality among investors,” he says. “One of the most powerful aspects of the web is that it offers what I like to call ‘social proof.’ If there are 400 smart people who support an idea, I’m very likely to take a big interest.”

For Ohio leaders charged with growing the entrepreneurial ecosystem statewide, crowdfunding offers both a challenge and a big opportunity to educate investors and expand the seed capital that is available to entrepreneurs and startups.

“We’re creating investor education programs that we plan to roll out statewide and make available through distance learning,” says Delp. “We'll offer investor boot camps that will help people to understand how to invest in good deals.”