Is equity crowdfunding the next channel capital source?

Rules around equity crowdfunding are still being hammered out, but industry experts say it's a good fit for channel companies looking to raise money.

Kirill Bensonoff, founder of ComputerSupport.com, is investigating a nontraditional source of capital as his IT services company gears up for expansion: crowdfunding.

Bensonoff plans to meet with Fundable.com, a crowdfunding site that lets young companies raise funds via its online platform. He suggested that his company's crowdfunding campaign could kick off in the next couple of weeks. ComputerSupport.com, based in Boston, offers managed IT services, cloud hosting services, consulting and support.

"We are an IT services company looking to do some acquisitions and basically looking at crowdfunding ... as a way to raise capital to do that, rather than going the traditional route," Bensonoff explained.

Setting up a new cloud business is capital-intensive. The smart ones will take advantage of [crowdfunding].

Michael Kraner,
director, MSPCFO

Bensonoff suggested that crowdfunding could prove easier than working with banks to obtain capital.

With crowdfunding, he said, "you just market yourself to the world through a platform like Fundable, or another, and hope that people like what they see."

A fit for the channel?

Crowdfunding has made its mark as a tool for raising money for charitable causes, independent artists and their projects, and consumer-oriented technology products.

People who find a particular campaign worthy donate their dollars and, in return, receive a reward or perk of some kind. A participant, for instance, might receive beta access to software in return for his or her financial support.

Some campaigns have raised tidy sums. Star Citizen, a space simulation video game currently in development, has raised more than $37 million through crowdfunding.

The question for the channel is whether the crowdfunding stream will prove viable for VARs, MSPs, cloud service providers and other IT services firms. Industry executives contend that traditional rewards-based, donation-oriented crowdfunding -- exemplified by sites such as Kickstarter.com -- may not prove a good fit.

"While I think the crowdfunding model, as seen with Kickstarter, Indiegogo and others, is a great model for certain business types, I have a hard time thinking a services-based business could be successful on this platform," said Michael Cohn, senior vice president of marketing at Cloud Sherpas, an Atlanta-based cloud services brokerage.

"These crowdfunding sources seem to be better suited for product-based businesses that need capital to manufacture a first-run of a new product," Cohn said.

"I'm not aware of any MSPs, cloud providers and IT service providers using crowdfunding as a technique to raise capital," added Jeff Kaplan, managing director at THINKstrategies, a cloud consulting firm based in Wellesley, Mass.

"I don't think people who are willing to participate and contribute to a crowdfunding campaign would be attracted to this type of company as a recipient of their investment."

Spencer Taylor, chief of business development and co-founder of Launcht, a white-label crowdfunding solution provider, said the issue for crowdfunding initiatives boils down to motivation. People need to connect emotionally with a good cause or see value in a tangible benefit they can receive, he noted. He cited the example of a video game developer offering a pre-sale of a new product in return for a donation.

"For those who don't have a social mission ... or don't have a gadget to give away, the ability for them to leverage pre-sales is pretty limited," Taylor said.

Kendall Almerico, CEO of ClickStartMe, a crowdfunding site, said rewards-based crowdfunding works best with a tangible product.

"In the IT services space, like any other services space, the challenge with rewards-based crowdfunding is that you do not always have something of value to give away as a reward to a donor," Almerico said.

But he said an IT services company with a sufficiently creative reward in mind could potentially use rewards-based crowdfunding. For example, a company offering cloud services could launch a campaign offering one year of services for the price of six months, he said.

Equity crowdfunding

Some market watchers, however, see a closer channel fit with the emerging equity crowdfunding model. Equity crowdfunding replaces the lure of perks inherent in basic crowdfunding with the opportunity to a purchase stock in a business venture. The Jumpstart Our Business Startups (JOBS) Act, which became law in the United States in April 2012, contains provisions related to this flavor of crowdfunding. In response to the law, the Securities and Exchange Commission (SEC) has been putting regulations in place to govern equity crowdfunding.

The SEC's first move was to greenlight crowdfunding for accredited investors, which the agency defines as banks, registered investment companies or individuals with a net worth in excess of $1 million or having an annual income of more than $200,000. That limited form of equity crowdfunding has been available since September.

The next step is to open equity crowdfunding to any interested individual, regardless of wealth. The SEC regulatory framework covering this type of crowdfunding, described in Title III of the JOBS Act, is expected to emerge this year.

Sherwood Neiss, co-founder of Crowdfund Capital Advisors, a consulting and advisory firm, said the SEC is working on the final rules governing Title III, noting that crowdfunding for nonaccredited investors is expected to go live around mid-2014. He said crowdfunding under Title III will expand the scope of the friends-and-family investment round. The friends-and-family round is the typical source of a tech startup's first investment.

Companies tapping equity crowdfunding platforms and social networks will "reach a broader friends-and-family community than they could before," Neiss said.

The potential impact on channel partners could prove significant.

"This will be a game changer, and managed services providers, cloud services providers, systems integrators and VARs/resellers would be able to raise money through equity crowdfunding, as long as they have a viable business model that is attractive to potential investors," Almerico said.

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Bensonoff said his company plans to offer equity as part of its crowdfunding campaign, offering investors the opportunity to get a return on their money once an acquisition is successful.

Michael Kraner, director at MSPCFO, an Englewood, N.J., financial services management firm focusing on MSPs and VARs, said crowdsourcing may eventually become a popular platform for service providers that are growing their businesses and expanding into new areas.

"Setting up a new cloud business is capital-intensive," Kraner said. "The smart ones will take advantage of [crowdfunding]," he said.

Equity crowdfunding could prove particularly critical for early-stage companies lacking access to more typical funding sources.

"Since 2007, banks no longer lend to startup businesses without collateral," Almerico said. "Angel investors have moved out of the startup funding arena for the most part. Venture capital firms are nowhere near this space. If you do not have friends or family to finance your new business, crowdfunding is sometimes the only option."

Challenges

The equity crowdfunding spigot won't be completely open until the SEC releases its final rulemaking on Title III. So there will be some uncertainty until that document emerges.

"The fear is the SEC is going to make the reporting requirements for issuers so onerous that it will take it out of existence," Taylor said. "We will see what shakes out."

Investors, meanwhile, must get up to speed on equity crowdfunding.

"Investors need to understand that this is a ... new form of investment, a high-risk asset class," Neiss said.

He emphasized that investors should invest in businesses they understand and in people they trust. They also need to recognize the potential for loss.

"We don't want people thinking this is a lottery and you are going to win," Neiss said. "No investment comes with a guarantee."

This was first published in February 2014

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