NextSeed is one of a handful of FINRA approved Reg CF crowdfunding portals that is successfully providing access to growth capital for small businesses across the US. It is the only platform in operation that focuses solely on debt financing as most other platforms are more equity focused.
Empowered by the JOBS Act of 2012, NextSeed is a bank loan replacement for SMEs that need financing to operate and grow their business. These same businesses are too frequently denied access to money as banks simply do not want to shoulder the risk of lending to many SMEs. Due to crushing regulatory burdens, the banking industry has moved away from lending to small business. It simply costs to much – so why do it? Yet SMEs are the lifeblood of the economy. SMEs generate most all jobs and economic prosperity. Myopic policymakers have unduly harmed the economy with their law making zealotry but NextSeed is there to fill this funding gap.
By matching investors to viable small businesses, NextSeed has created value for both sides of the equation. The business is able to raise the money they need on a regulated platform and the investor can earn a solid risk adjusted return. While still relatively small, NextSeed may be the future of small business lending as it disintermediates the dwindling number of community banks.
Youngro Lee is the founder and CEO of NextSeed. He swapped a promising career as a global private equity attorney to pursue a mission of helping small businesses to survive and thrive. But while NextSeed benefits from new investment crowdfunding laws, more could be done if policymakers improved the rules.
Recently, Crowdfund Insider caught up with Lee to learn about NextSeed’s perspective in providing online capital to small businesses across the US.
During a meeting of the SEC Small Business Capital Formation Forum in Texas, you said that businesses have difficulty accessing small bank loans. Can you share what you are seeing in the marketplace?
Youngro Lee: Obtaining a bank loan is generally a very difficult process for small businesses. All things being equal, commercial bankers generally prefer to make larger business loans (e.g., $1 million+) considering that the amount of time and effort necessary for diligence and processing business loans is similar regardless of loan size, but larger loans generate larger fees.
As a result, small businesses looking for loans under $250,000 often have a difficult time getting such. Banks’ heightened lending requirements and preferences also mean that certain industries and entrepreneurs are left behind.
Most businesses in food & beverage (or other consumer-facing retail businesses) don’t meet the criteria, younger entrepreneurs who might not have a long history of credit or significant personal assets can’t catch up, and even seasoned entrepreneurs trying to open a brand-new concept, may not be able to obtain traditional bank financing. As a result, many entrepreneurs seek alternative financing.
Even more worrisome is that as more time passes, due to systemic and regulatory constraints, the banking industry will continue to move away from small business financing. Community banks will also continue to suffer and dwindle in numbers, while fewer banks open for business. In my opinion, the irony of Dodd-Frank’s desire to reduce the influences of “too big to fail” banks is that these big banks have now become even bigger. From these banks’ perspective, investing in small business lending is simply not an efficient allocation of their resources compared to other opportunities. As a result, we’ve seen many non-bank entities entering this vacuum including many Fintech lending startups. Nonetheless, new solutions aren’t necessarily the best solutions.
[clickToTweet tweet=”As more time passes, due to systemic and regulatory constraints, the banking industry will continue to move away from small business financing #Fintech” quote=”As more time passes, due to systemic and regulatory constraints, the banking industry will continue to move away from small business financing #Fintech”]
You mentioned the alternative for many small businesses is MCA (merchant cash advance) financing. How big is this problem?
Youngro Lee: MCA is akin to payday lending for small businesses. The effective interest rates of MCA can become extremely high (in some cases over 100% APR), but the true costs are hard to understand since MCA costs are not expressed as an effective APR (they are not required to). Many online and marketplace lenders that probably wouldn’t describe themselves as MCA lenders are also effectively offering similar financial products to potential business borrowers. In many instances, there are also various layers of brokers who facilitate these transactions which can drive up costs tremendously.
I don’t necessarily think that MCA as a financial product is itself the main problem. Short-term financing that can be disbursed quickly can be very helpful in certain situations if it is utilized properly and strategically – e.g., when a business just needs to access a small amount of capital quickly to address a temporary gap in cash flow.
The bigger problem is that small businesses can’t easily identify and access the type of capital that would truly benefit their situation. Many business owners don’t know where to go if they can’t get bank loans, and they often take the first financing option they see. In this context, many MCA brokers and providers (and similar capital providers) are great at getting in front of small business owners with the promise of fast access to cash. When that happens, it is difficult for small business owners to truly understand how much they are paying for this type of financing, which could come back later to hurt their businesses.
Can you quantify the difference for small businesses between raising debt capital on NextSeed vs seeking MCA or taking out loans from alternative lenders?
Youngro Lee: NextSeed debt crowdfunding is a brand new type of value-add and cost-effective fundraising mechanism to small businesses. We do this by offering the opportunity to invest in private debt issued by small businesses to everyday investors in their community who are interested in investing locally.
The main difference between raising debt capital on NextSeed and obtaining alternative loans is that a NextSeed offering process is much more than a purely financial transaction, as issuers can directly engage their community on NextSeed through their offering. We believe this active engagement process will help businesses build meaningful relationships with potential customers and ultimately improve their financial bottom line.
[clickToTweet tweet=”NextSeed debt #crowdfunding is a brand new type of value-add and cost-effective fundraising mechanism to small businesses #SMEs #Entrepreneurship” quote=”NextSeed debt #crowdfunding is a brand new type of value-add and cost-effective fundraising mechanism to small businesses #SMEs #Entrepreneurship”]
Cost-wise, we seek to facilitate financing at rates competitive to the market (and certainly a lot better than typical MCA terms). This is possible because the typical MCA or alternative lender generally has to earn a certain rate of return via interest payments in order to pay for their own cost of capital, or to be able to sell their originated loans to institutional investors. In contrast, NextSeed does not receive ongoing interest payments from the debt offerings completed on our platform. We’re focused on how to optimize the cost of financing for small businesses at a level that the public is willing to invest in. In other words, we are not incentivized to increase the interest rates for businesses just so that we can profit more, or to cover a spread on the internal cost of capital.
Would you like to see a new security class (perhaps under Reg CF) for debt? What do you envision?
Youngro Lee: Definitely. In retrospect, many provisions and legal requirements under Reg CF (and Reg A for that matter) were clearly drafted with equity financing in mind, given the various investor protections and structural issues that are relevant in the context of equity transactions.
For example, there are extensive disclosure and reporting requirements that were intended to address the prospect of secondary trading which the SEC and FINRA care about deeply but have little relevance to debt financing or debt holders.
I think a more practical and simpler approach to regulating debt offerings under the JOBS Act would be very beneficial for both small businesses and non-accredited investors that would like to have easier access to private business debt in a transparent way.
How would this help small business? Why does this not exist now?
Youngro Lee: The vast majority of small businesses in the US are family-owned, lifestyle, cash flow businesses that support the day-to-day livelihoods of the owners and their employees. From an investment perspective, most brick-and-mortar small businesses are not like tech startups that are trying to build scale and increase their enterprise value over time in order to provide an exit to their investors upon an acquisition. This means that as a practical matter, most local small businesses would likely be better off maintaining control & ownership of their business rather than having to sell equity to third parties, and instead be able to grow via debt financing that they can reasonably pay off over time. In turn, investors in such debt products would benefit by receiving cash-on-cash returns in an alternative asset that they otherwise cannot access on their own.
I think the fact that we experience these fundamental economic problems today is simply a reflection of how society evolves rapidly, but laws and regulations can’t keep up on a real-time basis. Historically, community banks have generally provided the necessary debt capital for small businesses and communities across America. The world has changed dramatically over the past several decades as a result of globalization and incredible technology innovations, which naturally necessitate different types of financial services for businesses and individuals. However, since the financial industry has always been heavily regulated (i.e., it’s never been easy to set up a bank), the industry as a whole has not had much incentives to adapt to the needs of the market or their customers. As a result, one of the unintended consequences of all the legal and regulatory actions in the financial and banking industry (or lack thereof) over the past several decades has been that small businesses and small investors were left behind.
[clickToTweet tweet=”One of the unintended consequences of all the legal and regulatory actions in the financial and banking industry (or lack thereof) over the past several decades has been that small businesses and small investors were left behind #Fintech #Crowdfunding” quote=”One of the unintended consequences of all the legal and regulatory actions in the financial and banking industry (or lack thereof) over the past several decades has been that small businesses and small investors were left behind #Fintech #Crowdfunding”]
Nevertheless, for every action there’s always a reaction, and I am optimistic about the future precisely because of developments such as the JOBS Act. In my opinion, the JOBS Act is the silver lining of the 2008-09 global financial crisis – as devastating as that period was for the finance and banking industry, the JOBS Act would have never been passed by Congress otherwise. Because it did, new incentives and structures were created for the financial industry, entrepreneurs and other market participants. Frankly, it’s the reason why companies like NextSeed exist and why we are trying so hard to develop new solutions to address these fundamental problems.
[clickToTweet tweet=”the JOBS Act is the silver lining of the 2008-09 global financial crisis – as devastating as that period was for the finance and banking industry, the JOBS Act would have never been passed by Congress otherwise #Crowdfunding” quote=”the JOBS Act is the silver lining of the 2008-09 global financial crisis – as devastating as that period was for the finance and banking industry, the JOBS Act would have never been passed by Congress otherwise #Crowdfunding”]
Can you share progress at NextSeed? And future expansion plans?
Youngro Lee: Every day is a challenge at a startup, but we at NextSeed are very optimistic about the future. More and more small businesses and individuals are becoming familiar with the nuances of investment crowdfunding for debt capital, and when they do, they realize how it can help achieve their goals. As more issuers raise funds via NextSeed to grow their businesses and their investors start to see payments, our members are seeing for themselves what it feels like to invest in their community.
In 2017, over $4 million was raised on our platform for 18 businesses, and 17 businesses that had previously raised on our Reg CF platform and our TX intrastate platform paid over $1 million back to their investors.
Regardless of anything else that may be happening around us, we continue to focus intensely on our mission – connecting businesses and individuals to build vibrant communities – and we believe that the public adoption of this new way of fundraising and investing will accelerate.
In the near term, we are refining our business processes to improve our services and product offerings. At the same time, we’re also working on our long-term plan to establish NextSeed communities in various other markets and serve additional industries.
There is no doubt in our minds that in 10 years, small business financing and investing will look nothing like what it is today. We just want to help guide this evolution in a way that will benefit as many people as possible along the way.
[clickToTweet tweet=”There is no doubt in our minds that in 10 years, small business financing and investing will look nothing like what it is today #Fintech” quote=”There is no doubt in our minds that in 10 years, small business financing and investing will look nothing like what it is today #Fintech”]