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Crowdfunding Essentials : An Interview with Sherwood Neiss

In this exclusive interview with Sherwood Neiss, who co-authored the legislative framework for crowdfunding legislation passed in the US, explores critical aspects around crowdfunding and taking steps to see this new financing model legalized in Canada.

Crowdfunding Essentials : An Interview with Sherwood Neiss Transcript

JK:  So Sherwood thank you for being here today. Crowdfunding is a pretty big deal. You’ve just done some extraordinary stuff in the United States… helped move the legislation first through the house and then through the Senate. Can you just tell us in plain language what is crowdfunding.

SN: Crowd funding is where a group of people take small dollar amounts and they help fund a person with an idea, in its most basic form.

JK: And Canada has 13 different security regulations, and this is where things initially, I understand, got hung up a little bit in the States and we’re now going to be looking at what you did and possibly going through a change here. What did you experience and what do we need to tell our regulators so they don’t fear change.

SN: That’s a great question. Regulators are most concerned with disclosure. They are not necessarily concerned about people making investment decisions, they just want to make sure they have the amount of information they need to make the right decision. So in the States the Security’s Commission is overseen at a federal level and a state level. And at the state level they are the ones that oversee the actual fraud, so it’s important that you get the individual states associated and understanding what crowdfunding is and how it works. And until they actually play with the crowdfunding platform, I think they won’t understand the premise behind it or how the crowd can take over and not necessarily do their job, but help them do their job.

JK: And it’s not just the regulators that are new to this. A lot of entrepreneurs are as well, especially from some of the more traditional industries. Can you tell me, I’m a business owners, a small business owner. What is crowdfunding and how would I practically use it. What are the steps I would take to go raise some money.

SN: Oh, it’s a great question. So it used to be, if you had a great idea, you talked to your friends and family, they’d say yeah this is a great idea, lets go out and raise some capital for it. The sources of capital were really venture capital. So if you showed up in a VC’s office they would tell you to go out, build a proof of concept, get some customers, get some revenue and come back.

Crowdfunding actually turns the table around, and it lets you go to the community. And it lets the community decide if you should build it… and if they say yes they will actually help you build it, and they will fund it, and they will market it for you. So it sort of changes the game.

JK: And does this have to be - like we just heard about, you talked about, the Canadian company Pebble getting over $10 million - does this have to be a lot of money?

SN: No, it doesn’t. The funding void really, if you study small businesses and start-ups, is between zero and $250,000 dollars. So the whole part of crowdfunding is to help entrepreneurs and small businesses get access to that initial seed capital.

JK: And, okay, I’m a small business and I’ve had some success and raised some money with crowdfunding. Why am I going to go to the VC world, especially if my product is starting to take off? Is this going to impact angels and VC’s? Do you see that in 2-5 years?

SN: Crowdfunding plays an initial role in seed capital. It will not replace angel or Venture Capital. The great ideas will need to have an on-ramp to more sophisticated financing, and that’s where your angels and VCs are going to come in. Crowdfunding will take place for Main Street financing, for those companies that probably would never stand to gain in a capital from angels or venture capital.

JK: Ok, and if I’m a small business and I want to raise $10,000 to $20,000… how much of my business am I giving up? Am I giving up voting shares and is somebody else going to take control of my business… how do I value my business?

SN: That’s a great question, how do you value a business. That’s part of the secret sauce. Crowdfunding is based on all or nothing financing, so if you don’t hit 100% of your funding target, you don’t get any money. So the valuation part’s going to be really critical. Before you decide to go out and crowdfund money, it’s going to be really important that you socialize the idea with your community and see what they think is a good valuation for the business.

That will help you determine how successful you will be when you actually go out there and raise the capital.

JK: Are people afraid - you’ve got to tell me this – about revealing the books? I mean when you raise money you’ve got to tell people what’s going on in your business. Your competitors can find some of that information out potentially. Is there some fear amongst the smaller, less entrepreneurial / gazelle start-up crowd?

SN: Fear about disclosure I can see as an important thing because it keeps your competitive advantage intact, however crowdfunding is based on transparency, so if yu’re not comfortable with being completely transparent with who you are, your business idea, your revenue model, your financial statements, then crowdfunding is probably not for you because you need to have the transparency to build the credibility with the crowd to raise the capital that you need to grow.

JK: Ok, so I want to go out and I want to raise some money. You mentioned something, a really neat idea, which I wouldn’t have thought of, which was using it as a marketing strategy to compete against big brands. Can you explain that?

SN: Oh yeah, I mean the beauty about crowdfunding goes back to what I was talking about. I used to be, if you built it they might come, you hoped they would come. But with crowd funding the crowd’s going to tell you whether or not you should build it and if they get behind it and fund it they’re not just coming in with dollars, they’re coming in with marketing experience and knowledge. If they’ve got a vested interest in your success, they’re going to be going out there talking about that product or service that they’re a part of, because they actually want to get a return on that investment. And there’s no more power than having people with a vested interest in your business.

JK: Now we’re talking about the upsides, but there’s got to be some risks and downsides too. What are those risks and how do you mitigate them?

SN: There’s a lot of risks. If you are shady, you will be exposed.  If you are not transparent you will never be able to raise capital. If you do not communicate well, you will never be able to grow your business or get the future rounds of investment you are going to need. You need to learn to become a successful entrepreneur by watching people that have been successful entrepreneurs.

JK: I think it’s important to point out to people that crowdfunding doesn’t necessarily mean I’m going to give you 10% of my company and you’re going to give me $10,000 with that going out to a thousand investors. It can also be I’m going to buy your product early before you’ve even made it. Can you talk about some of the different models and how money can get raised?

SN: There’s two types of donation based crowd funding. There’s one that’s just donation based and pre-ordering product. If you’re going to pre-order product you can go out there and pitch your idea on a crowdfunding platform and actually presell your product. As long as you’re not offering a financial return that’s legal. The other one is saying listen I’ve got this idea for a movie or book I want to write and getting your community to sponsor it by coming in with donations, and in return you give them a t-shirt or a credit in the book.

JK: You’re talking about investments [in the work done to legalize crowdfunding in the US]. So is it traditional share? Do I need to go to my accountant and rework the structure of my company?

SN: Oh yes. You will have to hire accountants and lawyers to get this done. But the whole point about it is you might be thinking that’s going to be very costly, but the beauty about crowdfunding is that it standardizes the entire process, so that we’re coming up with both standardized forms and terms for both entrepreneurs and investors. So the investors are going to either be buying common stock most likely, or preferred stock with a dividend where they might be getting a loan from the business.

All of this in the United States right now is yet to be determined and that’s what the SEC is working on over the next 277 days.

JK: If a Canadian company can’t access crowdfunding in Canada right now, they can still legally go to the US?

SN: I’m not quite sure what all the rules are (laughs)… but I know that Pebble is Canadian and he went down to the United States and raised $10 million dollars. So I think it’s an important thing not just for America, but for all countries around the world, Canada in particular. There’s no reason why you need to leave your nation’s border to go out and get capital for your great idea. Most of the businesses will stay in your community, so why not raise capital in your community.

JK: And where would we be in 15 years? Do you see one day having crowd IPOs instead of the traditional Wall Street IPOs? Or do you think we’re still going to be going back to the traditional?

SN: No, I think we will have traditional IPOs. I think the next Facebook will be crowdfunded in the beginning.  But I think we’re going to see a lot more successes at the community level. Main Street financing, local-vesting, which is really is what crowdfund investing is all about, is going to transform what we see happening in our local communities.

JK: Great, well thank you very much. One last question. Is it only accessible to businesses, or are there ways – I guess it’s more donation based - if you want to start doing public-private partnerships?

SN: I think we’re going to see, probably in crowdfund investing 2.0 and 3.0, we’ll probably see what you’re talking about at a further level. But right now it’s only donation based and it’s soon to be investment based.

JK: Well thank you very much. This was Sherwood Neiss who has just passed – helped get the legislation for crowdfunding through the US House and Senate. Hopefully we’ll be able to learn from your experience and have that happen here in Canada as well.

SN: Well, if we can help we’d love to and I think this is a very important thing for the world, so let us know how we can help.

JK: Great, thanks very much Sherwood.

SN: Thank you.

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