“So why did you leave law to pursue crowdfunding?”
Over the past couple years, I’ve received this question more than any other. Prior to starting NextSeed in 2014, I was a lawyer for over 7 years specializing in private equity fund formation and private investments. I left my legal practice, and my amazingly talented colleagues left their established careers in law, finance, marketing and technology because we all believed that investment crowdfunding can fundamentally change how the private capital markets work for small businesses and small investors.
We came together to try to build our crowdfunding platform into a sustainable small business investment marketplace, where we could help connect businesses with people in their community to create opportunities for everyone.
The 28 million small businesses in the US drive the US economy, accounting for 54% of all US sales volume and creating 66% of all new US jobs since the 1970s. Despite serving as the backbone of every community and the literal grounds upon which people congregate and share their life stories, small business financing has largely been restricted to institutional or wealthy private investors.
On the flip side, 97% of all Americans are non-accredited investors who have had limited investment options to plan their future. We believe investment crowdfunding can change this reality for the better. In the first 90 days since Regulation Crowdfunding went live, there’s already been tremendous activity and interest across various Reg CF funding portals. We’ve seen increasing demand on NextSeed as well – over the past year 11 businesses crowdfunded over $2 million in debt through our debt crowdfunding platforms (prior to launching our national funding portal, we had launched a Texas-only portal in 2015 pursuant to Texas intrastate crowdfunding rules), and substantial repayments have already been made back to the investors on our platforms.
During my legal career in private equity, I witnessed first-hand the immeasurable power of information and capital when PE firms were able to act upon them quickly. The global PE industry has grown into a multi-trillion-dollar market today because it solved real problems for businesses (lack of access to capital) and investors (lack of access to sufficient investment opportunities) that weren’t being fully addressed by the public markets.
However, the PE industry was limited to Accredited Investors only and therefore the focus was on the capital needs of large or hyper growth-oriented companies that can satisfy the return expectations of large investors. As a result, the vast majority of small businesses and small investors in the US are woefully underserved by our current financial system.
So when the JOBS Act was announced in April 2012, I was genuinely blown away. Theoretically, small businesses could now leverage technology and the internet to raise capital directly from anyone, and small investors could access many more investment options than the stock market.
My ultimate eureka moment occurred in December 2012 when I had the opportunity to visit Bangladesh to see microfinancing in action.
By any measure, Bangladesh is a developing nation. Children walked barefoot on dirt roads and rusted sheet metal mounted on wooden posts passed for roofs on family homes. And yet, I saw with my own eyes how an innovative alternative financing structure like microfinancing was creating opportunities for local entrepreneurs and growing their local economy, supported by other members in their community and the microfinancing lender who kept account of the borrower’s success by pen and paper. Even without a sophisticated banking system or regulatory structure, community-based microfinancing has proven to be a viable mechanism to fuel local economic growth in many developing countries.
So if this simple system works in unsophisticated markets, just what might be possible in the US if community-based financing could be structured, regulated and administered using the latest technology? The JOBS Act legally provided the framework to test these ideas for the first time in US history, and we were determined to find out.
After carefully contemplating how the proposed JOBS Act provisions could be effectively utilized in practice, we started our platform with a focus on debt financing for Main Street small businesses (restaurants, cafes, hospitality businesses, etc.). Many of these businesses are not typically looking to raise massive amounts of capital by selling equity, but need relatively small amounts to expand or establish their business. For many of these small businesses, however, traditional financing has been getting more difficult to access in the aftermath of the Great Recession.
Ironically, big banks have become even bigger (the top 6 banks now control over 67% of the entire US banking industry assets). Due to increased compliance and operational costs, many big banks are focusing on more profitable capital allocation from their balance sheets than making small business loans. A multitude of alternative lenders and merchant cash advance services have swooped in to fill the void, sometimes causing more harm than good for the small businesses that utilize these services.
In this context, debt crowdfunding allows small businesses to obtain flexible financing while showcasing their business to the public and establishing trust with their investors. Even the individuals who invest amounts as small as $100 can become loyal customers and brand ambassadors for the local businesses they invest in as they develop an emotional connection with the businesses they support. On NextSeed, businesses are also required to make monthly payments back to their investors, thereby reducing their overall risk profile (e.g., relative to equity investments that may not pay out until a liquidity event occurs years down the line). In turn, based on member feedback we now understand that our members are drawn to small business investing because it offers a level of transparency and simplicity unavailable in most other investment options.
The emerging investment crowdfunding industry is not without doubt. Some have suggested that the industry will become rampant with fraudsters that take advantage of unsophisticated investors, but this ignores the fact that Funding Portals are regulated by the SEC and FINRA and are required to conduct extensive background checks on all issuers. Others point to the inherent risks of early-stage investments in startups as evidence that investors will likely lose their entire investments, but this also ignores fundamental risk-reward calculations that any investors consider, as well as the wide universe of securities (e.g., small business debt).
Even the SEC implicitly assumed that all Reg CF offerings are equally risky, as it imposed an aggregate “one-size-fits-all” investment limit across all Reg CF investments regardless of the underlying securities or businesses (in contrast, many states with intrastate crowdfunding rules, including Texas, reject this general presumption and only set a maximum limit on a per-investment basis). In reality, by design and by law, investment crowdfunding leverages technology and the power of the crowd to provide better oversight and diligence in the private markets than ever before possible. Businesses seeking to crowdfund are legally required to provide very detailed information about their ownership and operations, there is an open Q&A forum for anyone to be able to ask questions, and the popularity of social media can quickly provide social validation for any offering (or not).
Progress in society is always incremental.
The current investment crowdfunding laws may not be perfect, but that’s ok. Laws can and do evolve over time as they are tested, interpreted, and modified to reflect the reality they operate under. We’re still in the earliest of days in this industry, but we are definitely seeing increased traction and demand from businesses and investors who want to become a part of this new financial system.
Ultimately, I believe Regulation Crowdfunding represents a revolutionary shift in the foundation of the US private capital markets that can and will create new opportunities for all of us. Despite the challenges and obstacles ahead, let’s remind ourselves that the future is literally up to us – we have the power to make investment crowdfunding “mainstream” by participating and growing this industry until it becomes the norm.
NextSeed is but a single voice in this enormous moment, but we feel incredibly blessed to play a role.
Youngro Lee, JD/LLM is Chief Executive Officer of NextSeed, the first Title III approved crowdfunding platform in the United States. A former private equity funds lawyer in the U.S., Europe and Asia, Youngro helped clients raise over $25 billion in aggregate to pursue various strategies. Youngro previously practiced law at Weil Gotshal, Kirkland & Ellis and Cleary Gottlieb. He is a graduate of Cornell University and Cornell Law School.