After almost 4 years in action, Regulation Crowdfunding has not only proven to be a successful model for investing into startups and small businesses but how such investments can mitigate risk, invigorate local economies and provide critical jobs. Since May 2016, almost half a million individuals have invested over $360 million via Regulation Crowdfunding into 1,4000 businesses in over 80 industries across the United States. Despite the collapse of the public markets since the beginning of the Coronavirus pandemic, the private markets have been resilient. This is some positive news as now is the most critical time for small businesses that are struggling to stay afloat, are in a cash crunch and have nowhere to turn as government programs for small businesses run out of fuel. Crowdfunding platforms like Wefunder and Nextseed have created programs to leverage the power of the crowd to assist businesses during the COVID crisis. But there is more that our government can do … and not as a bailout but as a partner to small businesses. The government could leverage one of the tools in its tool chest, the Small Business Investment Company (SBIC) program, to develop a new $250 million co-investment fund that will invest alongside the crowd where campaigns hit their funding targets. If the government invested $1 for every dollar that was invested into local economies, that would be a half a billion dollar boost to regions of the country that are most impacted. Think about that in terms of economic activity and jobs.
Why the SBIC Program?
This isn’t about creating something new that the government is unfamiliar with. This is about finding something the government is already doing and expanding it to apply to the current crisis. It is also about layering on new methodologies (i.e. Regulation Crowdfunding) to existing practices such that the risk is less for the government. The SBIC is a program that helps finance small businesses. An SBIC is a private lending company which is licensed and regulated by the Small Business Association (SBA). SBICs offer venture capital financing to higher-risk small businesses and SBIC loans are guaranteed by the SBA. An added advantage of SBICs for small businesses is that, in addition to funding small business growth and more jobs, SBICs offer management expertise and assistance to companies. SBICs are privately owned and managed investment funds, licensed and regulated by the SBA. These companies use their own capital, along with funds borrowed with an SBA guarantee, to invest in qualifying small businesses. SBICs use a combination of funds raised from private sources and money raised through the use of SBA guarantees to make equity and capital investments in small businesses. The SBA matches SBIC funds at the rate of $2 for every $1 the SBIC puts in.
How Could this Work with Regulation Crowdfunding Platforms?
Crowdfunding platforms could apply with the SBA to be “Limited SBICs.” The approved platforms would have access to the $250 co-investment fund. In order for small businesses to qualify for co-investment funds they must meet certain criteria. For example, it might be required that a crowdfunding campaign hit its minimum funding target or a minimum dollar amount (like $50,000 from the crowd); that a certain number of investors be part of the offering, that those investors have a 1st or 2nd degree connection to the company, etc. Triggers like this will mitigate risk for the government by making sure there is an engaged group of investors looking out not just for the company but their investment as well. In a way, the crowd will act like the SBIC management company by providing capital and oversight.
Companies on the crowdfunding platforms could apply for matching funds from the “Limited SBIC COVID Co-Investment Fund.” Since the crowdfunding platforms don’t handle any funds (funds are held in escrow) they could notify the SBA when a company qualifies. Depending on how much the company has raised, the “Limited SBIC COVID Co-Investment Fund” would come in with a matching investment. This money would be automatically transferred to the company.
Since the crowd is “investing” in these offerings. The government would be investing as well. A popular type of investment vehicle that works well for cash flowing small businesses is a revenue share note. With a revenue sharing note, investors can earn a multiple on their principal, such as 1.2x (each deal has a different potential return). Businesses pay investors a small percent of their monthly revenue (for example 3-6%) over a set period of time (usually 4 years) or until the multiple is paid. Revenue sharing notes could work particularly well for businesses in crisis because when revenue is slow, paybacks (that are based on a percent of revenue) are lower as well. This eases the cash burn on these establishments. Then when business picks up, the note repayments pick up as well. Hence when these COVID affected businesses are back up and running, customers will be short-term investors, we will have saved local economies, businesses will have cash to survive and thrive, they will also be generating revenue and be able to repay their loans. Most importantly the money the government put up will be returned to the government with interest as opposed to all these current loan forgiveness programs.
Conclusion
The government could support startups and small businesses affected by COVID (and keep local economies invigorated as well as people employed), by creating a co-investment fund that matches (perhaps $1 dollar by US Government to every $1 by the crowd) into local businesses that raise funds to keep them going. A $250 million co-investment fund could then equate to $500 million invested into local economies. The government won’t be taking all the risk. The community is sharing in this risk. And because these local investors have a stake in the outcome of these local businesses, they will visit them and be marketing agents for them such that they thrive (and the investors get a return on their investment).
If this seems innovative, it isn’t. Right now, governments like Malaysia already do this with any company that is raising funds under their equivalent Regulation Crowdfunding regimes. Now is the time for fast acting solutions, this could be one of them.
