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A Look at Smart Money Entrepreneurs' Crowdfunding Model [Part II]
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A Look at Smart Money Entrepreneurs' Crowdfunding Model [Part II]

Crowdfunding will not be legal under federal law until the SEC works out all the appropriate rules around it, as mandated by the JOBS Act. But that doesn’t mean entrepreneurs have to wait until then to crowdfund their businesses, says Jeremy Andrews, founder and CEO of Smart Money Entrepreneurs [SME]. SME is an equity- and debt-based crowdfunding platform that is creating a streamlined process for entrepreneurs to raise cash from the crowd by complying with state securities laws. Recently, we spoke with Andrews about his platform and how it will help entrepreneurs to raise money. Part two of the interview is below, and the first half can be found here.

Anton Root, Crowdsourcing.org: I wanted to ask how you guys make money on your platform. Is it the standard, take a fee off a successful raise model? Or is there another revenue stream?

Jeremy Andrews, Smart Money Entrepreneurs founder and CEO: We actually have seven revenue drivers. I mentioned my experience – I’m a big cash guy. When I talk to entrepreneurs, and I ask them how they will make money, sometimes there is a blank stare. So that’s a good question.

We have built seven revenue drivers into this company, just because you never know when a revenue driver is going to fall short. Having said that, the $25 application fee for entrepreneurs – we make no money off it and it’s actually a loss for us. The other platforms have several hundred dollar fees, and probably will continue to do that, until the SEC releases regulations around the JOBS Act. $100 or $200 may not sound like a lot to start your business, but we want to make sure there aren’t any barriers. So the $25 is a loss for us, but technically it’s a revenue driver because entrepreneurs are paying money. Another revenue driver is the back-end success fees, where we charge a percentage. Kickstarter charges around 10 percent, five for [its services] and five for payment processing. It’ll be similar – the industry standard is around 10 percent across the board.

Other than that, there are other value-added services that come into play. That is where the bulk of our revenue comes from. Investors actually pay a small fee to invest in the companies online and they’re doing that because they have access to all the entrepreneurs’ information, as well as being able to track an entrepreneur’s progress. So investors pay a little bit of a premium to access those deals, but they are of higher quality than what you would get on another platform.

Obviously there are a lot of things in the JOBS Act that funding portals must do – ensure that every unaccredited investor is educated, making sure that they don’t pass investment limits, etc. – I assume you do that on your platform, as well?

We do, and that’s actually something I can’t disclose 100 percent, it’s one of our secrets here. We don’t actually do it manually. If you tell me you’re accredited online, you could be lying. How could you check? What we’ve done is actually partner with a few firms that do this automatically. We can’t go into a ton of details, but we’ve made the process automated. Our system is actually able to access certain bits of information in order to tell whether you’re an accredited or unaccredited investor. All you’re doing is filling in information like social security number, as you would on a job application, and then we can tell whether you’re unaccredited or accredited.

You said something that got me thinking about something we discussed at a recent meeting, accredited versus sophisticated investors. I say this over and over again: there is a difference between a sophisticated and accredited investor. Say I’m an executive, which is one of the groups we’re targeting, or a banker, or a trader, or I’ve worked for Nabisco for ten years and I have retirement money that I’m going to use. Say you have $600,000 saved in your bank account, and you make an annual salary of $125,000; you’re still not an accredited investor. You still can’t invest in startups. We see a problem with that, because the person can invest $10,000 without it affecting his or her lifestyle that much. Most likely, if you’ve accumulated that much wealth, you’ve made good investment decisions. So for the government to say, you’re accredited if you make over a certain amount and unaccredited if you don’t – over the course of the years, I’ve met lots of investors who lost lots of money. They had a lot of money, but just because you have a lot of money doesn’t mean you make good investment decisions. Therefore, for us, it’s about being sophisticated over being accredited. It’s the sophistication we’re after – that’s our target market.

Let’s say I’m an investor and I’ve put the money in – how do I get it back?

Right, the payout. As I mentioned, after you invest in a company, you can track your investment. The SEC has stated you cannot sell the stock you’ve bought in the company for twelve months, which makes sense because you don’t want people coming in and out all the time, at a stage when a company is trying to build its business.

We actually have two forms. If you’re coming in as a debt investor, after month three, your debt starts to be paid back. So let’s say you loan a company $50,000. It’s almost like a deferred loan. Essentially, the investors would get a principal and interest payment, just like a bank would. So, it’s more familiar: I’ve loaned you $100,000, I know what my principal and interest payments are going to be every month, and it’s a safer vehicle. I don’t have equity, so if it becomes a billion-dollar company, all I get is $100,000 plus the interest payments, but at least I’m safe. I’m not a risky investor and I know I’m protected – I prefer to be safe rather than sorry.

But if I’m going in equity, the payoff is different. On our platform, there are two options. You can either wait for an acquisition, which could come – companies get acquired, but not everyone does. Or, what we do is also provide preferred dividends on our platform. There are two types of investors, power and regular. If you’re a power investor, you have preferred dividends. What that means is that you are the first to get paid, as soon as the company is able to pay dividends. The company is actually forced to declare a dividend by year three of their existence. The more time a company takes to pay dividends, the less valuable the company becomes. Again, that’s the cash thing – generate revenue, generate profits to make everyone happy. If you don’t declare dividends first year, that’s fine, second year, that’s fine. Third year, if you’re not declaring dividends, what happens is that you’re forced to pay automatic dividends, or your company becomes less valuable because now it’s more expensive. The acquisition target that you’re maybe looking at actually becomes really expensive because now, you have to buy out the preferred investors before anyone else comes into the deal. That is, again, to protect investors.

Not every company will make it, companies do go bankrupt. That’s just a fact of numbers. But we’re actually trying to increase the success rate from the low-30 percent over the course of five years to maybe 60 or 70 percent. Ultimately, the crowd makes better investment decisions. We’re willing to bet, based on the track records of angels and VCs who actually have not made the best returns overall, that the crowd can make above-average returns.

What about a secondary market for crowdfunding – is that something you’re looking to build into your platform? And what are your thoughts in general on that topic?

We actually are building a secondary marketplace. If you’re an investor, you have the opportunity, after twelve months, to sell your shares on the secondary market. So there are actually three options [for equity investors to get money back]: acquisition, dividends, or selling shares on the secondary market. The secondary market is what we’re building for everyone else, all the other platforms. Nobody’s building it and I think they’re late to the game if they start now. We actually started speaking with a few people in the financial industry who really want this to come into play. If you use SME to invest money, you’re eventually going to have to come back to sell your shares. Or, SecondMarket, one of our competitors, may develop a secondary marketplace with some of the crowdfunding platforms. But we’re looking at building our own because we, again, are looking at being a full suite solution.

Is it fair to say that you guys are less affected by the JOBS Act and its delays?

Not affected at all. Which is good, because I’m a big believer of “Don’t let the government run your business.” If you’re relying on government regulation to do something, you may be waiting for quite a long time. There’s a new chairman, who knows when the rules will be passed, things get delayed all the time – building a business upon government regulation is never a good idea. In the very beginning, coming into the market, we asked how we could do this today, rather than waiting for regulations.

Being first to market with this process and our technology – and actually being able to build the second market – it’s really incredible we don’t have to wait for the JOBS Act to pass. But when it does, of course, it allows for everything to be a little bit less cumbersome in a way, because there is a standard that everyone accepts. As I mentioned, our process relies on individual states. Each state is different and has its own process, and we’ve done the hard work of making those processes streamlined and straightforward. But eventually, when the SEC does finally release rules, those processes will be much easier because there will be a national process.

When it comes to the “blue sky” – state securities – laws, have there been examples of the SEC cracking down on companies who raise money in a way that’s compliant with state but not federal laws?

A little bit, there has been [some of that]. It’s a fine line, because the states are saying that they’re allowing this; it’s very tricky. I think, generally, the federal government is not trying to police, but to protect. Obviously, they’re not trying to stifle innovation or progress, but they are trying to protect. Sometimes, they’re not going about it the right way, but taking a look at the blue sky laws when it comes to crowdfunding is something that the SEC is heavily considering, as well.

From our perspective, the processes I mentioned are really state-driven. In some states, as long as you comply with federal regulation, you’re okay – it all depends on your deal, what your company is doing, how much you’re raising. It’s really on a case by case basis, which is why it’s so complicated and why we’ve integrated the process into our system. Based upon a series of questions [we determine] whether you can raise, how much you can raise, and how much it will cost. That’s why when someone asks, “How much is this going to cost me?” it’s hard to give one single number because each state has its own costs, and the forms and the documentation you have to fill out are a little bit different for each state. But we’ve done the hard work for you.

You mentioned that some states ask companies to comply with federal regulations – does that mean your hands are tied in those states until the JOBS Act rules are finalized?

No, no. The states that have to comply with federal regulations, we do that process as well, it’s just filling in another form. There are some states that are not friendly to the process. For example, I love New York, but over the last 20 years, the state hasn’t been friendly to business startups. It’s been very corporate – if you’re a big business, great, if you’re a small business, you’re not really that much of a concern. It’s changing a little bit, but it still has a long way to go.

There are certain states that are less progressive on the process of allowing you to raise capital. Some states are really progressive and forward thinking. There are around 30 states that we’ve talked to and have been working with, and that will have this process ready to go. So when we launch, there are around 30 states that you can [use] our product in today. There are 20 or so that are not friendly to it. They do it, but you will probably be stifled, and going through a six to ten month process to raise $10,000 is not really worth it. We stick to the states that are friendly. Those states will be revealed once we come out on our platform. I’m sorry to say that I don’t think New York will be one of those states, but we’ll see.

And you said you’re looking to launch in the summer, right?

Yes, that’s correct. The reason being is that we want to make our platform secure. We want to have a platform that’s a safe and controlled environment. Personally, as the CEO of the company, I want to make sure things go correctly. You have to test, check, test again, test again – it’s not a normal tech product that you can launch in beta and ask people to test out and fix the bugs later. It’s not one of those systems. Fortunately, we have some time. We have a great team and have gotten ahead of a lot of our competitors.

Read the first half of the interview here

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