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The Hidrate team.

Minnesota Venture Conference panel shares insights on alternative business financing

Today's entrepreneurs often "bootstrap" instead of following traditional financing models

By Brian Martucci
10-14-2015

Entrepreneurs know that securing adequate business financing isn’t as simple as walking into Wells Fargo and asking for an unsecured loan. (Want a laugh? Try it sometime.)

Instead, today’s entrepreneurs often “bootstrap” — they plow their own money, often the balance of their life savings, into their ventures. Others pitch their ideas to friends and family members, hoping that there’s enough dough in their private networks to get things off the ground.

But what about entrepreneurs who don’t have ample savings or generous personal connections? Thanks to some recent state and federal rule changes, cash-strapped business owners can tap a growing menu of options that don’t involve Powerball tickets.

Those options were the topic of discussion at Innovative Financing: Crowdfunding, Reg A+ and Alternative Forms of Raising Capital, one of several panel workshops held at last week’s Minnesota Venture Conference. 

One of the four panelists — Nadya Nguyen, young co-founder and CEO of smart water bottle manufacturer Hidrate — wouldn’t have been there without alternative financing: Her startup raised more than $600,000 on crowdfunding platform Kickstarter, besting its original fundraising goal by a factor of 20.

The other three panelists brought years of professional expertise and firsthand experience with entrepreneurial clients to bear. Attorneys Patrice Kloss and Pat Pazderka, both partners at Oppenheimer Wolff & Donnelly LLP, have built their careers around (among other things) connecting early-stage firms with startup and growth capital, and helping entrepreneurs avoid common legal and compliance pitfalls. Patrick Meenan, head of Fargo-based Arthur Ventures’ Minneapolis office (and previously a key employee at Microsoft and Piper Jaffray), has years of experience advising technology companies on mergers, acquisitions, strategic partnerships, divestments, and other activities.

TRADITIONAL VS. NONTRADITIONAL FINANCING

The workshop started off with a more precise definition of “nontraditional financing” — or at least what nontraditional financing isn’t. “Traditional” startup financing includes:

  • Equity investment by venture capital firms, which often occur after the initial financing phase
  • Equity investment by angel investors, which can occur earlier but aren’t suitable for many startups; Minnesota incentivizes angel investors with a 25% tax rebate on qualifying investments (Minnesota Angel Tax Credit)
  • Traditional investor debt, such as bridge loans, convertible debt and venture/term debt
  • Bank debt, which (as noted) is elusive for many early-stage firms

According to Kloss, raising capital through nontraditional means generally doesn’t have to involve a partnership with a fund or a highly complex securities registration, as is often the case with traditional capital raises. However, nontraditional financing always requires careful preparation and, in most cases, professional legal advice. 

CLASSIC CROWDFUNDING

Kickstarter and other crowdfunding platforms aren’t just for trivial pursuits or political statements. A surprising (and growing) number of for-profit companies raise capital through crowdfunding, too. Crowdfunding campaigns need to set a fundraising goal, which on most platforms must be met for the campaign to receive any funding at all. Instead of equity, campaigns attract contributions by offering early access to products or services, or singular experiences — Nguyen’s company offered a deep sea fishing excursion with the founders, for instance.

According to Nguyen, crowdfunding is all about preparation. “We interviewed lots of successful crowdfunders,” said Nguyen, “and some not so successful ones too.” She learned that successful campaigns generally:

  • Start preparing at least two months in advance
  • Build a list of early supporters and secure informal commitments in advance of the campaign’s launch
  • Invest in PR and media outreach, and develop a coherent brand message, early on
  • Secure intellectual property before publicly describing your idea on the crowdfunding platform — “We applied for a patent before doing pretty much anything else,” says Nguyen 

But Hidrate also hints at crowdfunding’s limitations. Nguyen’s team developed a great product and impeccably laid the groundwork for their campaign — in other words, things went about perfectly. And yet Hidrate still raised less than $700,000. Some runaway crowdfunding campaigns can raise in excess of $1 million, but they’re exceedingly rare.

“If you don’t need millions to get off the ground, crowdfunding is a very attractive option,” said Meenan. “If you’re hoping to secure venture capital down the road, it’s not as ideal.”

It’s increasingly common to offer equity to crowdfunding campaign participants, too. The federal government is currently finalizing regulations made possible by Title III of the JOBS Act, passed back in 2012; they’re expected to be ready sometime next year. These regulations could lessen restrictions on equity offerings to non-accredited investors; proposed rules prohibit companies from raising more than $1 million in a 12-month period. 

Meanwhile, recently passed MNvest legislation allows Minnesota-based companies that meet certain criteria (earning the vast majority of their income and housing the vast majority of their assets in Minnesota, for instance) to offer common stock to in-state crowdfunding investors, regardless of accreditation. According to Kloss and Pazderka, MNvest regulations will be ready in the first quarter of 2016, at the earliest.

“Investing in early-stage companies is currently only open to the wealthy,” remarked Meenan. “[These new regulations] level the playing field a bit.”

“It’s important to remember that accredited investors aren’t necessarily more sophisticated than non-accredited investors,” he added. 

Other Forms of Nontraditional Financing

Crowdfunding is probably the best-known, easiest to understand, and all-around “sexiest” form of nontraditional financing, but the Innovative Financing panel touched on several others:

  • General Solicitation Under Regulation D: Rule 506(c) of the Securities and Exchange Commission’s Regulation D “eliminates the prohibition on using general solicitation [i.e. publicly offering securities] where all purchasers of the securities are accredited investors and where the issuer takes reasonable steps to verify that the purchasers are accredited investors.”
  • SAFE Notes: SAFE stands for “Simple Agreement for Future Equity.” SAFE note holders have the right to convert the note into shares at a later date, often at a discount to market value.
  • Regulation A+: Made legal by the JOBS Act, “Reg A+” allows unregistered public equity offerings of up to $50 million, a 10-fold raise from the previous limit of $5 million.

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