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Editor's Note: The following guest post comes to us from Thomas Vass of The Private Capital Market, a subscription-based crowdfunding website. Vass writes in to discuss the nexus of financial and political interests between crowdfunders and regional economic development professionals, using the concept of innovation economics. In this second half of the article, Vass expands on the concept of innovation economics, and puts it in context of intrastate crowdfunding regulations. The first half of the article is here; to read previous articles from Vass, click here.
Georgia state securities officials, and members of the Georgia General Assembly, got part of the new innovation infrastructure exactly right in their recent series of crowdfunding laws. They first passed the intrastate exemption, which looks much like the earlier legislation passed in Kansas.
But, Georgia went a step further in adding important capital market components, beyond crowdfunding.
According to Knox Massey, on April 29, 2013, Governor Nathan Deal signed into law House Bill 318 which enabled the creation of the Invest Georgia Fund. 1
Massey noted that, “the Invest Georgia Fund will be $100M in size and will be invested into Georgia companies over a five year period. Most likely, the Invest Georgia Fund will be funded in fiscal years 2014 – 2018.”
The Invest Georgia Fund will look like, and function like, a capital market mutual fund in Georgia, similar in intent to the Draper-Fisher MeVC fund.
Massey explained that he viewed crowdfunding as one important component to a much bigger capital market series of exchanges that he calls, “life cycle of funding for Georgia companies.”
Massey described the various stages or steps to raising capital that the Georgia legislation mirrors. The first step was creating an angel investor community that had organizational self-awareness to promote the big picture of innovation economics.
The second step was to align Georgia tax policy with the stages of innovation economics. The Angel Tax Credit legislation is intended to reduce the risk by lowering taxes of Georgia angel investors and to help forge a public/partnership between state government and private investors targeted to the goals of innovation economic development.
The third step in Massey’s conception of innovation economic policy is to continue to build that partnership, through the Invest Georgia legislation, between the public interests of the state and the private parties that invest “risk” capital and help grow Georgia companies.
His fourth step was to create a crowdfunding community that would fit between “friends and family” funding and angel investor funding. This part of his strategy was called Invest Georgia Exemption. That exemption allows Georgia-based, private companies to sell equity (shares of stock or debt) to Georgia based non-accredited residents of Georgia. For-profit Georgia companies can raise up to $1 million annually from non-accredited and accredited investors. Georgia-based companies can advertise (solicit) capital raises in Georgia to Georgia-based residents. Non-accredited Georgia residents can invest up to $10,000 per company.
Massey’s application of an innovation economic strategy reflects the chronology of events in raising capital for innovative companies and it is a big improvement over existing practice.
It would be better, though, if the state would adopt regional closed end mutual funds to supplement the centralized Invest Georgia Fund because most technological innovation is a local phenomena and requires local capital.
The Alliance of Merger & Acquisition Advisors® (AM&AA) was formed in 1998 to represent the professional interests of its 875 member firms. These investment banking firms engage in mergers and acquisitions, primarily of private firms, and the AM&AA is a potential ally for crowdfunders and economic developers.
The Alliance is currently promoting passage in the U. S. Congress of a law that serves the interests of all members of the entire private capital markets. In the logical chronology of capital market events, the merger and acquisition function occurs generally when growth companies obtain top line revenues of about $25 million.
So, their work occurs after the initial rounds of private equity have been made, but before the exit to public securities stock exchanges. Seen from an economic development perspective, the M&A function is crucial for regional economies who want to continue to reap the benefits of technological innovation by making certain that their home-grown firms continue to reside in the home regional economy, and not be lured to some other location, after an M&A transaction.
As noted by Joy Schoffler, founder of Leverage PR, “While crowdfunding provides a great opportunity for the small business community, it also brings additional liquidity opportunities and technology advancements that provide economies of scale to the middle market—companies with annual revenue between $5 and $500 million.”
The liquidity events that Schoffler mentions have an important innovation economic function because at this stage of company growth, the middle market liquidity event occurs right at the same time that the exponential increase in jobs for the company occurs. Metro regional elected leaders have a clearly defined constitutional public purpose in using their new capital market infrastructure resources to keep the company in the home community.
Their new Congressional bill will help local economic development agencies service the public purpose of economic development. On Wednesday, June 6, 2013, Congressman Bill Huizenga’s (R-MI) introduced H.R. 2274, THE SMALL BUSINESS MERGERS, ACQUISITIONS, SALES AND BROKERAGE SIMPLIFICATION ACT OF 2013, A Bill to Reduce Regulatory Costs and Burdens on the Sale of Privately Owned Businesses, which was immediately referred to the House Financial Services Committee (HFSC).
The provisions of the bill affect companies with earnings before interest, taxes, depreciation, and amortization that are less than $25,000,000. This would be considered the small business “sweet spot” of regional economic growth.
The intent of the bill is to amend the Securities Exchange Act of 1934 to provide an exemption for merger and acquisition brokers performing services in connection with the transfer of ownership of smaller privately held companies and to provide for regulation appropriate to the limited scope of the activities of such brokers.
Just like the case of the JOBS Act of 2012, the new M&A act would create opportunities for states to enact their own state-level M&A legislation. So, for instance, the state of Georgia would consider adding a new piece of legislation aimed at keeping homegrown companies down home in Georgia by complementing their new Invest Georgia fund with authority to engage in intrastate M&A transactions.
Much of the public commentary about the JOBS Act has focused on Title III, but the more significant provisions of the JOBS Act for economic development are buried inside Title IV and Title VI of the Act that contain the provisions for a new easier access for private companies to enter small public stock exchanges.
If local economic development agencies are successful in keeping home grown small companies at home at the M&A stage of growth, rather than being recruited with industrial recruitment incentives to some other region, then an important component of the innovation strategy will be the pathway from private to public markets.
Title IV and Title VI act in combination to exempt small companies from certain burdensome regulations contained in the 1933 Securities Act, and the 1934 Securities Market Act, making it easier for small companies to issue securities on small public stock exchanges.
For example, if Georgia wanted to keep Georgia companies at home, then Atlanta would serve as the location for the Georgia state stock exchange. The Atlanta public stock exchange, as envisioned under Title IV and Title VI, would primarily serve Georgia investors who had made the early risky commitment to invest in local companies by giving those investors an exit path.
The statewide stock exchange in Atlanta would be complemented by regional stock exchanges in Savannah, Athens, Columbus, and Valdosta. The regional stock exchanges are essential to promote state economic growth because those regions have their own unique industrial clusters and their own unique cultures (especially Savannah).
In their research on the causes of success in biotech ventures, entitled “Towards an Evolutionary Model of the Entrepreneurial Financing Process: Insights from Biotechnology Startups,” Tom Vanacker, Sophie Manigart, and Miguel Meuleman (VMM), described two reasons why “close” counts for innovation economics.
“Using multiple longitudinal case studies of young biotechnology firms,” they wrote, “we study differences in the financing process between high and low performing firms. Findings suggest that initial differences in the specialization of the investors with whom entrepreneurs affiliate early on, affect the ease with which firms attract (specialized) follow-on financing and firm performance. We demonstrate the role of the social context in shaping initial financing outcomes, as entrepreneurs limit their search for financing to one or a few investors with whom they have pre-existing ties.”
The transitional path between private and regional capital markets needs much better coordination to enhance the rate of deal flow, as the evidence from VMM describe. The new regional capital stock markets in the U. S. would probably look much like the Junior Toronto Exchange (TSVX), but would be local in each metro region, harkening back to the days when America had many smaller regional stock exchanges.
The New York Private Placement Exchange (NYPPE) was an idea way, way ahead of its time, and would have benefited from a more extensive capital market ecosystem that supported its financial viability. Like the case of industrial clusters never gaining traction, NYPPE never developed the political alliances it needed within the entire capital market system, nor in the economic development community, to demonstrate the validity of a private exchange mechanism for private securities.
NYPPE provides a wide variety of liquidity solutions for interests in private funds, special purpose vehicles, trusts, etc. (e.g. buyout, venture, funds of funds, distressed debt, leveraged loans, real estate, natural resources, hedge funds), unregistered securities in private companies and their respective derivative instruments.
Liquidity transactions occur before the M&A exchanges, but after the third round of private equity transactions in the life cycle of funding innovation.
This same type of public indifference affects asset based lending models, like the innovative Receivables Exchange.
The Receivables Exchange offers a more cost-effective and flexible financing option to asset-based lending. Asset-based lenders make secured loans against certain business assets, such as accounts receivable, equipment, and inventory, which are offered on the internet platform as collateral for loans.
Lenders compete on the platform for making asset based loans to companies that need capital. The company is in control of the process and can select the best deal from the wide variety of lenders.
Both the NYPPE and the Receivables Exchange are global in scope and scale. In order to become effective tools of economic development and to be integrated with crowdfunding, both models of providing liquidity would need to be implemented at the state level.
So, for example, Georgia would have its own NYPPE, but it would be called something else.
The reason for the regional geographic emphasis on liquidity concerns how the companies who raised capital, via crowdfunding, offer those local investors an exit strategy that does not destroy the company in the process. Early investors need a way out of their private investments, and require local capital market liquidity mechanisms to trade their securities with other local investors.
NYPPE and the Receivables Exchange are natural political allies to both crowdfunders and economic development professionals, but crowdfunders and developers will need to reach out to the secondary market members to describe how they can work together to promote more deal flow, and finally, more job creation.
The new-new innovation economic theory is not a version of Rostow Stage Theory. It is not an alien offshoot of Economic Base Theory, and it most assuredly is not related to cluster-based industrial recruitment strategy.
The new innovation economic theory has five easy-to-understand premises.
Both Leontief and Schumpeter explained this theory many years ago, so it may be more accurate to say that the new-new innovation economic strategy is really a couple of old dogs trying to teach young economic development policy whipper-snappers new tricks.
For crowdfunders, the new-new innovation economic theory offers a great opportunity to get the economic development potential of crowdfunding right from the start. Crowdfunders need to see themselves as a part of a much bigger capital market community, and they need innovation economics to explain their role in economic development.
Georgia, Kansas, North Carolina, and Washington are all on the right innovation economic pathway with their adoption of intra-state crowdfunding legislation, and their efforts to opt-out of the dysfunctional Federal government crowdfunding mess is exactly the right path.
Georgia is the best example for other states to follow, but the Georgia model could be strengthened by adding more to the intellectual front end of their innovation economic policy. The new components of that policy include:
Using Feser’s model of technological affinities, in conjunction with both with regional closed end funds and and a greater political focus on protecting homegrown firms from outside M&A activities.
Combining the operation of multiple regional stock exchanges with many different regional crowdfunding business network events, that look like re-invented angel investor forums, that occur all over the State of Georgia.
Of course, the secret sauce for crowdfunders and economic developers in promoting regional job growth has absolutely nothing to do with capital markets or economic development policy tools. The secret sauce is new product ideas that eventually find their way into the regional deal flow.
Creating new ideas for products requires an entirely new organizational structure in each region called the Regional Product Design and Product Development Infrastructure, which no one in Georgia has quite figured out how to create.
The best advice for the folks in Georgia is to hurry on down the road in creating it, before the Federal government bureaucrats decide that this is an idea that can be managed from Washington.
1. The Basis of Legal Crowdfunding in Georgia, May, 2013.
Vass is the owner and manager of The Private Capital Market, Inc., a fee-based subscription crowdfunding website. He is the author of Predicting Technology, (2007), that explains his theory of technology evolution, and is the holder of a patent on how to select technology stocks for inclusion into an investment account.