Illinois law paves way to business ‘crowdfunding’
By DENNIS GRUBAUGH
A retooled “crowdfunding” law is giving Illinois companies and communities a new means to grow businesses via local investment, and more participants are expected as awareness of the measure spreads.
So says Anthony J. Zeoli, the Chicago attorney who wrote the original law and revisions to it and who is now helping companies navigate the specifics.
The law is in essence a new type of investment-based crowdfunding that allows small businesses to seek out the capital needed to do much bigger things with their companies. It’s being used in a growing number of states.
Crowdfunding has been around several years. Smaller-scale platforms like Go Fund Me allow people to seek donations for a variety of personal uses, while Kickstarter and Indiegogo offer rewards in return for donations toward an idea, charity or startup business.
However, the new law in Illinois deals with specifically investing in a company, in ways that average people have not been able to do until now.
“You’re either getting equity or you’re loaning money and getting interest and debt,” Zeoli said. “In 80 years of securities law, this is the first time that ‘normal, everyday people’ have been able to participate in this market.”
People looking for investments are generally frustrated by a market dominated by bigger players. Thirty years ago, IPOs had the potential of return of 20 or more percent and it was easier to get in on the action.
Now, a company’s equity is held in private for so long that by the time a company hits the public market, new investors “are lucky to get 5 percent over 10 years. All the money is just eaten up in this private market. You can’t touch it. You have no access to those types of investments,” Zeoli said.
Most investment in breakout companies like Uber or Airbnb is private investment.
“This (new law) actually starts to break down those barriers where normal people have access to those investments, and the companies can find customers and funding for less money than they would be paying otherwise.”
“Mainstream crowdfunding was only made legal in Illinois last year but (a 2012 federal) act paved the way,” Zeoli said. “Once the federal government allowed that kind of contract to exist, we were able to do it on the state level.”
Zeoli’s work has brought him recognition. He is a transactional attorney with a national practice and specializes in securities, commercial finance, real estate and general corporate law.
“I have a background in all the areas that crowdfunding touches on, everything from corporate work to lending to real estate to securities transactions. What was normally your private securities transaction and your fund formation I was already doing,” he said.
Years ago, he said, he could see where the evolution of business financing was headed.
“It kind of became a passion of mine over the past four years. A lot of it was a self-hobby, to get involved and get in front of this industry. One, because I think this is where this industry is going and, two, because I really have substantive input into the laws and the ways things are done and can put my unique spin on things.”
At the time he drafted the original Illinois law, about 16 other states had crowdfunding laws. Now there are 32.
“I saw the issues with the other states, and nobody here was looking into it,” he told the Illinois Business Journal. “In my naiveté I figured if I wrote it, I could get it passed. Luckily, the Small Business Advocacy Council (in Chicago) was able to lobby it and get it passed.”
Initially, Zeoli drafted what he called a “very progressive” version of the legislation.
“We had to sit in a room with the Illinois secretary of state for about nine or 10 hours and hammered out all the details, but in the end I think we have a very balanced law and certainly one of the most, if not the most, useful crowdfunding laws in the country,” he said.
The law was approved in the end of 2015 and made effective in 2016. However, the Secretary of State took eight or nine months to finalize the rules.
“So, we really didn’t have the criteria to put an offering out until October of last year,” he said. Three or four more offerings came in January this year.
“A lot of businesses have shown interest in using it. It’s been more an issue of trying to educate investors and the people living in the community about how it works. It’s not just giving money to a company and getting nothing in return,” he said.
Only a handful of businesses have pursued offerings so far, Zeoli said. One company floated a six-year debt offering, with investors getting 6 percent a year on the money they invested. Just like any other loan, there was a promissory note. Investors also got extra benefits.
“It was a health club so they got free T-shirts and free training sessions,” he said.
Two other companies set up the offerings so that investors would share in the equity and the profits as they came in. The profits are to be distributed on a quarterly basis.
How it can be used
“It can be used in so many different ways,” he said. A small business needing $50,000 to expand, for example, can pursue an offering that would allow both their customers and the community to get involved.
And communities can foster economic development by building interest in certain areas. If a town is looking to attract a certain restaurant, it might float the possibility of tax credits to the restaurant if the restaurant is willing to use local investment funds as part of the equation.
A big-box developer facing local opposition could build goodwill by seeking out local investors.
“You open up a small sliver to invest in that company, and I’m sure you’d see a lot more smiling faces at the zoning board,” Zeoli said.
Communities can also lure businesses to economically deprived areas by encouraging loans created by local investors.
“For example, you could use Illinois crowdfunding to raise $500,000 or a million dollars for a note and give Whole Foods or a Jewel (Osco) a low-interest loan to come into your area. Jewel doesn’t need the money but you’ve given them all the incentive they need to come there. You’ve written the story for them and given them a dedicated customer base. They’d be stupid to say no.”
It’s also a new way to invest in real estate without taking all the risks of a whole project, he said.
The crowdfunding process can be cheaper and easier to do than a traditional bank loan, he said, and it does not limit a business owner from running a company the way he wants to run it because his investors are silent, non-voting partners.
How to participate
To take advantage of the law, a participant would have to work with a business portal to access the necessary paperwork. Zeoli suggests VestLo, which operates an Illinois investment-based crowdfunding platform (vestlo.com).
“They’ll give you a document package to put together and show off what your company is about; what you’re trying to offer to other people; whether there’s equity or debt; and what kind of return they think there would be,” Zeoli said. “Once that’s all figured out, which should take anywhere from two to four weeks, they would engage (an attorney) to put together the offering packet. This will be like a 30-page investment packet. It shows what the business is, what the investment is, how it works, how you’re going to get paid back, the risks involved and things like that.”
Those documents get filed with the Secretary of State’s Office, along with a $100 fee.
Then, participants can start advertising their offering, through videos, marketing, pitchbooks, etc.
“Advertising is the key. If you’re a company with a good community relations or customer base or social media presence, you should be able to get these people amped up about investing in your product or your company,” he said.
The law isn’t designed to help new or fledgling startups. For that, entrepreneurs would need more of a Kickstarter approach where people are just looking for funds to get an idea off the ground. This is for businesses “with more potential,” he said.
“Even if you’re not revenue producing, you want to have a full business plan and show investors how you are going to use their money to expand and make them money,” Zeoli said.
Businesses considering an offering “are looking at paying anywhere from 7 percent to 9 percent all in, with your portal fee, your legal fees, your marketing budget, all that. It’s comparable if not less than what you would pay to some other broker trying to get you funding in the other way,” he said.
Countries like the United Kingdom, which is about four or five years ahead of the United States in this type of crowdfunding, have seen enormous success.
“In the U.K., it’s a completely functional market. Companies can easily find funds; investors can easily find things to invest in. There are virtually no instances of fraud. People are making money,” he said.
The new Illinois law has built-in antifraud measures to protect investments. Non-accredited investors (those who don’t make over $200,000 a year or have a million dollars in net worth) can only invest up to $5,000 per company per year.
“Unlike other states, (the Illinois law) doesn’t stop them from investing all their money; it just makes them diversify by putting the money into multiple companies,” he said.
Additionally, all the funds have to be held in a third-party escrow until the minimum amount of money that is required to be raised is raised. Until then, the company has no access to that capital.
If the money is not raised, the escrow agent will return all the money back to the investors.
Nationally, such crowdfunding generally takes 45 to 90 days.
“Here, it’s going a lot slower because we’re still getting people to understand that it exists,” Zeoli said.
Still, he’s certain it’s the future of business.
“This now gives people the chance to get into the private market, even if it’s not a big chunk of their investment portfolio. This allows you to be an armchair quarterback for startups.”
This year attempts were made in the Legislature to establish a tax credit for those who invest through crowdfunding. The measure did not pass but Zeoli expects it will be attempted again.