Iowa small business startups seeking capital will have a new way to connect with investors beginning in January: through new crowdfunding rules that are now being finalized by state regulators. 

The Iowa Insurance Division is currently developing rules for intrastate crowdfunding, which will allow startup companies in Iowa to advertise share offerings in their companies to non-accredited investors through online portals. 

The new rules could provide a great tool for a potential Main Street business needing a single infusion of capital, but they appear less suited for high-growth-potential startup companies that will want to attract angel or venture capital funding down the line, said the director of a Des Moines-based business accelerator. 

Under the intrastate crowdfunding bill signed by Gov. Terry Branstad in July, Iowa companies could raise up to $1 million in capital from Iowa investors through the online portals, which would be operated by third-party intermediaries. The legislation, House File 632, limits individual non-accredited investors to no more than $5,000 in any single investment; accredited high-wealth investors would not be subject to an individual investment cap. 

The state regulations — which limit investments strictly to Iowa companies by Iowa investors — are separate from federal rules approved Oct. 30 by the Securities and Exchange Commission that will open up equity investing in startups nationwide to people who don’t meet the high-wealth requirements of accredited investors. 

“The goal is to make it easier for companies to raise money,” said Gary Marquett, assistant bureau chief for the Securities Bureau of the Iowa Insurance Division. Although transactions will be limited to sales of shares in Iowa-based companies by Iowa investors, there are no restrictions on advertising of the offerings on the online portals, and the required level of disclosure to investors will be much lower than they are with other types of state-regulated investments, he said. 

“In many ways this goes around the traditional brokerage firm, to less-traditional investors,” he said. 

At last count, Iowa is among 29 states that have enacted legislation allowing an exemption in state securities law to permit equity investments through crowdfunding. The state-by-state approach was in response to the slowness of the SEC in approving federal rules to allow interstate crowdfunding under Title III of the Jumpstart Our Business Startups (JOBS) Act enacted by Congress in 2012. 

“I think the SEC’s hesitancy to adopt final rules probably show its concern that if you liberalize these laws too much, you lose some of the protections that these laws were designed to provide,” said Chris Sackett, an attorney with the BrownWinick law firm whose specialties include securities law. “I applaud the (Iowa) Securities Bureau for trying to allow crowdfunding in a controlled and regulated manner.” 

The types of businesses that have taken advantage of intrastate crowdfunding in other states range from small grocery stores, hair salons, nightclubs and exercise studios to microbrewers, software companies and senior care facilities, according to data compiled by the North American Securities Administrators Association.

As of Aug. 1, the association found only 118 equity crowdfunding deals that had been cumulatively submitted through state regulators across the country, with 102 of those deals approved. 

Whether the process even gets off the ground in Iowa will depend largely upon interest by private entities in forming one or more online portals, which will be the vehicle for investments as well for regulating the process. Once a portal is set up, all investors will be directed to that crowdfunding portal. Funds that are raised by the issuers will be put in escrow, and once they’re at a target amount, the funds can be released from escrow by the company. 

“Whether it will be successful or not, we don’t know,” said Tom Alberts, an attorney with the Iowa Insurance Division who is involved in writing the regulations for Iowa. “We know that some states, like Texas, have a number of crowdfunding portals and have had a number of offers. Kansas, on the other hand, I don’t think has had more than one or two (deals), and they were the first to have crowdfunding.”

Few organizations that work with startups and small businesses in Iowa appeared to be aware of the intrastate crowdfunding law. The legislation was not on the Iowa Small Business Development Centers’ radar, said Lisa Shimkat, state SBDC director, though it’s going to be something her offices will look at as a potential funding tool, she said. 

“We do have several areas across the state that have angel investors, as well as some low-interest revolving loan funds,” Shimkat said. “(Equity crowdfunding) definitely could be something (to look at) in the future.”  

Equity crowdfunding represents a new avenue for investors and entrepreneurs to connect, but it comes with many caveats for both parties, said Mike Colwell, executive director of small business accelerator Square One DSM. Colwell said he was unfamiliar with the state’s initiative before he was contacted by the Business Record. 

The largest crowdfunding sites such as Kickstarter and Indiegogo, which do not offer equity stakes in startups, can be a great way for a startup to quickly determine if there’s a market for its product, Colwell said. 

“If you can create a two-minute video and can convince 5,000 people to back your idea, this isn’t just an idea now,” he said. However, those type of crowdfunded companies aren’t required or even expected to return any money to their backers. 

Equity crowdfunding by a small business may be a good option, provided it’s the only financing that will be needed, Otherwise, having dozens of crowdfunding investors can seriously complicate or eliminate future capital-raising options, he said. 

“I think that for anybody that’s thinking of going on to angel or venture capital-level funding, and most companies in the accelerator are thinking like that, crowdfunding creates more challenges (than benefits),” he said. 

BrownWinick’s Sackett agreed that small companies should approach equity crowdfunding cautiously. 

“I don’t think that we’ll see a lot of clients that will want to pursue this as an opportunity,” he said. “I think it’s suited for small companies with small aspirations and no need for additional rounds of capital. Most companies we’re dealing with are seeking $100,000 to $200,000, and then a larger round by bigger investors down the road. …  I do think some companies may look at this if they raise an early round and have a redemption option. That may be a way crowdfunding may work with more traditional means of raising capital.” 

From the investor side, an accredited investor is very unlikely to make a substantial investment in a crowdfunded company, Colwell said. 

“When a company has (a lot of crowdfunding investors), that gets a little messy,” he said. “And crowdfunding investors may drive a company into the ground because they don’t want to let (an entrepreneur they backed) go. … I think fundamentally (the question is,) why are you investing? Is it passion or a return on investment?” 

With equity crowdfunding, investors’ first priority can’t be getting their money back quickly, Colwell noted. 

“The only way (the owner) can pay us back probably is to sell the company,” he said. “If we start a small-town grocery store, we probably don’t want to flip it to a national chain. So you just have to make sure that the investor’s goals are in line with the business. 

“I’m a much bigger fan of crowdfunding that is loan-based, not true equity-based. I think a loan can be better than a security, because the investor has a clear knowledge of how they get their money back. And the entrepreneur has a clear understanding that he has to pay those loans back.”

Brewing up Crowdfunders in Wisconsin 

A crowdfunding portal in Wisconsin that specializes in facilitating deals for craft beer microbreweries in that state has attracted funding for two microbrewing startups to open their taps, with a third deal now in the works. 

“I’m a craft beer fan, and that’s what gave me the idea to do this when the crowdfunding law came out,” said David Dupee, founder and CEO of CraftFund LLC in Milwaukee, who describes himself as “an attorney with an entrepreneurial itch.” 

Dupee was the first to launch a crowdfunding portal in Wisconsin after the state approved intrastate crowdfunding in 2013. He has been operating CraftFund.com for the past year and now has approximately 90 Wisconsin companies — the majority 
of them craft brewers — that have posted profiles. 

The first craft brewery to launch was MobCraft, which bills itself as the “the world’s first completely crowdsourced brewery.” It received an initial commitment of $75,000 from about 55 investors. Using that equity, MobCraft was able to obtain a bank loan that will now enable it to expand to a new facility in Milwaukee, Dupee said. 

Another brewery that completed its funding — Common Man Brewery — raised $20,000 from nine investors, he said. 

As a portal, CraftFund has no stake in any of the companies whose profiles it hosts; it makes its money through a flat monthly listing fee of $400 to $500 per company. Dupee would prefer to be able to charge a commission of 5 to 7 percent, which is the way he believes the crowdfunding industry is headed. 

“We wish we would have had more deals in the first year,” he said. “But once the SEC rule comes out, we’ll see more of a business model emerge for portals where you’ll see a commission rather than a listing fee.”

Rules for Iowa crowdfunding issuers 

For a filing to be approved, the crowdfunding issuer must demonstrate: 
1. The crowdfunding issuer is an Iowa entity that has filed a certificate of formation with the Iowa secretary of state and is authorized to do business in Iowa.
2. The principal office of the issuer is located in Iowa.
3. At least 80 percent of the issuer’s gross revenue during its most recent fiscal year prior to the offering is derived from the operation of a business in Iowa.
4. At least 80 percent of the issuer’s assets at the end of its most recent semiannual period prior to the offering are located in Iowa.
5. At least 80 percent of the net proceeds of this offering will be used by the issuer in connection with the operation of its business within Iowa.

Source: Iowa Insurance Division

SEC ruling will ease some requirements for intrastate offerings

On Oct. 30, the Securities and Exchange Commission approved final rules that will allow equity crowdfunding on a national basis. Those rules, expected to be effective early next year, will allow individuals with annual incomes or net worth of $100,000 or less to invest up to $2,000 or 5 percent of the lesser of their income or net worth within a 12-month period. Those with an income or net worth of more than $100,000 will be permitted to invest 10 percent of the lesser of their annual income or net worth. 

The SEC also revised Securities Act Rule 147, the provision which provided the exemption for states to enact rules for intrastate crowdfunding. 

“In recognition of the transformative nature of the Internet and other technologies, the rule would, among other things, eliminate the existing intrastate restriction on offers, but — critically for the state-based nature of the offering and its regulation — continue to require that sales be made only to residents of the state or territory of the issuer’s principal place of business,” SEC Chair Mary Jo White said in a statement. “The proposal would also ease some of the issuer eligibility requirements to make the rule available to a greater number of businesses seeking financing in state, but ensure that such financing can only occur with a set of baseline investor protections and that issuers have a strong and identifiable presence within the state … “ 

By the Numbers:
29 – Number of states with crowdfunding rules
$5,000 – Individual investment maximum in Iowa
$1 Million – Iowa crowdfunding limit per company