‘Crowdfunding’ trend poised to make mark on U.S. investing landscape

WestMill Capital Partners - The tan building in the middle of the frame is 1351 H Street NE, where the plans for the restaurant Maketto are being drawn up.

For $100, Micah Lubens bought a share of a vacant, two-story brick building that was promoted as the next up-and-coming hot spot along D.C.’s bustling H Street corridor.

Through food blogs, Lubens learned of plans to transform 1351 H Street NE into a mini-replica of Asian night markets, with food stalls and at least one clothing shop. The developers were offering shares of the property online for $100 a pop. In return, investors would get a cut of the profits and rent generated by the market, called Maketto.

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“I figured I easily spend $100 a month on silly things, so why not try this?” said Lubens, 25, a project manager at a District communications firm. “I don’t have a ton of money to invest, but I’m into the food scene and this intrigued me.”

Gathering small sums of money from a large number of people online — known as “crowdfunding” — is poised to take off in the investing world, with backing from Washington policymakers who see it as a chance to involve the masses in an arena dominated by big Wall Street firms and the super-wealthy.

A law signed by President Obama a year ago enables small businesses to offer a stake in their firms via the Web to anyone who wants one, a “game changer” that gives them “access to a big, new pool of investors — namely, the American people,” as he put it. Companies can raise up to $1 million a year this way once the law is implemented.

But given its potential to upend the nation’s investment landscape, critics are worried that crowdfunding will leave unsophisticated investors vulnerable to fraud or big losses, especially since small businesses generally suffer high failure rates and the firms involved in crowdfunding will have to make only limited financial disclosures.

Those fears have played a role in delaying new regulations from the Securities and Exchange Commission, which was supposed to adopt rules nearly a year ago to put the crowdfunding law into effect. Now, all eyes are on Mary Jo White, the agency’s new chairman, who has come under pressure by lawmakers to crank out a plan. During her confirmation hearings, White suggested that the rules are high on her priority list.

Agency observers expect them to come out soon, though no timeline has been set for their consideration. Meanwhile, as the SEC hashes out the details, investors and businesses are racing to get a piece of the action.

Several state legislatures have proposed allowing this type of crowdfunding within their borders. Internet domains with “crowdfunding” in their names are getting snatched up. And businesses are moving forward with their own plans, using exemptions in existing regulations that allow for some limited crowdfunding.

Among them is WestMill Capital Partners, the developer behind the H Street Project.

The firm’s co-founders, Ben and David Miller, had bought several vacant storefronts in Northeast Washington in the past three years with plans to develop them for retail use. They dug into their own pockets, took out loans and tapped wealthy people to fund the deals.

But they were frustrated by what Ben Miller described as a “disconnect.”

“The people most excited about what we were doing, the ones in the neighborhood, weren’t allowed by law to invest,” said Miller, 36. “We started thinking: How do we close the loop? Is there a new way?”

Since the early 1930s, a firm that wants to sell securities to the general public had to register with the SEC, a process that is too costly and time consuming for many small firms. But the law has a few exceptions, and the Millers discovered one of them.

They learned they could raise money from anyone as long they qualified with the SEC and registered with the localities in which they wanted to raise cash — the District and Virginia, in their case. Nearly a year later, they got the necessary approvals.

Online launch

In August, they launched the Web site ­Fundrise and began offering shares in the H Street property, which they had purchased for close to $1 million, Miller said. Within three months, they raised their $325,000 target from 175 investors.

The company has since used the Web site to gauge interest in a deal at 1539 7th St. NW, and they plan to use it again to raise money for a D.C. government parcel they are developing at 1300 H St. NE.

This concept is not entirely new. For years, crowdfunding has been a popular way to seek financial support for a new album, a smartphone app or even a worthy cause. Contributors get a token reward — maybe a T-shirt — or nothing at all for their donations.

But they have not been allowed to earn a profit or buy a security unless a company gets approval from the SEC or the states.

A few states have passed regulations to allow crowdfunding, and others have proposed doing so in recent months — including North Carolina, Washington and Nebraska. A state can set its own crowdfunding rules within its borders, with certain restrictions. Targeted investors, for instance, must reside within the state.

This month, California upped the ante. It allowed Oakland-based Mosaic to raise money online from California residents interested in funding solar projects — $100 million worth of them.

Under this arrangement, investors lend money at a fixed rate and get paid back monthly based on the project’s revenue. Investors ponied up $152,700 in less than six hours to pay for solar panels on the roof of San Diego’s Ronald McDonald House.

“It took us awhile to set up the regulatory structure,” said Billy Parish, a Mosaic founder. “We’ve been tracking what [the SEC] is doing. But in hindsight, it was a good decision to not base our business model on that. We pursued a strategy that allows us to get out ahead while the federal rules are being put together.”

Still, federal regulators will ultimately shape the crowdfunding space.

Jobs Act details

The law Obama signed, called the Jobs Act, limits how much people can invest in a crowdfunded project based on their net worth and income. The funds would have to be raised through a regulated portal that would make sure the income limits are observed and that investors receive educational materials about the company. It’s up to the SEC to flesh out the details of how it will all work.

Heath Abshure, head of the North American Securities Administrators Association, said there is more to worry about than exposing unsophisticated investors to outright fraud. He is also concerned about the lack of an exit strategy for investors who want out.

“Very few of these small companies succeed, and the securities themselves are extremely speculative and highly illiquid, meaning that once you buy them, you may not be able to sell them,” Abshure said. “How will you sell a security in a cupcake store or a hardware shop?”

Meanwhile, some industry observers say the restrictions Congress has built into the crowdfunding law may simply be too costly and onerous for many small businesses.

Under the law, companies must hire firms to audit their operations, depending on how much they intend to raise, a huge expense for a small business, said Steve Bradford, a professor at the University of Nebraska College of Law. The firms must also issue reports to investors and the SEC, which significantly adds to costs, he said.

And top company officials can be held liable for false statements or other lapses, even if they are not intentional, a departure from the norm, Bradford said.

“Given the lack of sophistication that most [company officials] will have as they enter the crowdfunding arena and given how complicated the disclosures are, that’s a real risk,” he said.

Lubens is not worried about the broader policy debate.

Last week, he received his first dividend: a mere 50 cents. When Maketto opens, he expects the dividend to grow. Until then, he is enjoying the psychic rewards.

“Last weekend, my mother and brother were in town and we were having dinner on H Street,” Lubens said. “It was just so cool to point out the building and say: ‘I own that.’ ”

 
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