Among the most disruptive changes introduced in 2016 by the Jumpstart Our Business Startups (JOBS) Act is the opportunity for small, private businesses to raise capital via crowdfunding, adding yet another avenue to capital to the long list of traditional and alternative finance options available to small to medium-sized businesses (SMBs) today.
It’s an opportunity for FinTechs, too, to develop new platforms through which SMBs can access a new form of capital without facing some of the drawbacks of other financing processes. Indeed, experts agree that the JOBS Act will gradually forge new paths as FinTechs explore how to wield the legislation and promote SMBs’ access to capital.
But awareness of how SMBs can take advantage of these opportunities provided under the JOBS Act remains limited — with some entrepreneurs remaining skeptical of the fundraising strategy.
Ben Lozano, CEO and co-founder of SMB bond marketplace SMBX, told PYMNTS that many SMBs might be initially unenthused about the prospect of giving up ownership in their businesses to individual unaccredited investors. But, as he told PYMNTS in a recent interview, the JOBS Act opened up an opportunity for a new interpretation of the legislation, with benefits for both investors and SMBs.
Diverging From Equity Crowdfunding
While the JOBS Act unlocks a swath of investment opportunities, the prospect of selling equity may not be the right fit for all SMBs.
A 2018 report in Forbes cited research from the Journal of Business Venturing, which found that equity crowdfunding is often a last resort for SMBs when traditional and internal funding options run dry.
“The empirical evidence shows that firms listed on equity crowdfunding platforms are less profitable, more often have excessive debt levels, and have more intangible assets,” the report found.
Lozano said some SMB owners will express doubt at this model, lamenting, “‘I don’t want 500 people on my cap table.’”
That challenge is what led to the development of SMBX, a marketplace that labeled a new asset class, the SMBs bond, which Lozano explained is essentially an SMB loan that can be bought and sold, with investors able to participate by investing as little as $10 directly into the company.
While this strategy can address the challenges SMBs may view in equity crowdfunding, Lozano said it also tackles the friction many SMB owners face in seeking more traditional forms of financing, including Small Business Administration (SBA) loans, which have historically been viewed as among the most affordable options for SMBs.
“SBA loans take too long and cost too much because of regulatory fees that get worked into the private lending process,” he said. “Now, with the JOBS Act, for the first time a private company can remain private but issue a public security without having to comply with the expensive compliance requirements that locked them out of public finance.”
Crowdfunding platforms are an attractive option for individual investors who are often new to the process and aren’t ready to invest large sums of their personal funds. According to Lozano, an SMB bond marketplace offers similar investor benefits, particularly as a new generation of investors steps into the market.
“There is a growing class of individuals, who tend to be millennials, who have a subtle but general aversion to legacy finance,” he said. “They’re doing finance differently than their parents’ generation. They don’t want to invest in the same instruments their parents did.”
As this generation steps away from life as cash-strapped college students, there is a growing pile of cash sitting in no- or low-interest savings accounts. While these funds are being used by banks to fuel their own profit-generating lending strategies, little is gained by those account owners, noted Lozano.
“These aren’t cash-poor college kids anymore,” he explained. “They’re doctors, attorneys, entrepreneurs. They have investible wealth. The problem is, where do they put it?”
Investing in local SMBs can be an impactful way of unlocking value from those savings accounts, the same way Airbnb unlocked value in spare bedrooms, or Uber unlocked value in personal cars, he said, adding that local SMBs can be an attractive investment target for individuals able to actually visit a business in which they invest.
Emerging Risk Strategies
The JOBS Act’s impact on opportunities for SMBs to raise money (and individual investors to participate) is only one of several disruptions in the SMB funding arena to have surfaced in recent years as SMBs demand digital, fast and easy avenues to capital.
The FinTech community has jumped on many of these opportunities to connect investors to SMBs, and Lozano said more disruption is ahead for these platforms — particularly in the underwriting arena.
He pointed to blockchain and smart contract technology as especially promising in data integration and data sharing between a platform like SMBX and third-party partners without having to open up an entire back-office infrastructure. And as data integrations become more prominent in the financial services arena, opportunities for technology like machine learning to enhance and accelerate the underwriting process will also proliferate.
They’re trends that have the potential to disrupt all areas of SMB finance, from bank lending to alternative online finance. But as the face of SMB investors continues to shift, Lozano said the SMB bond market offers an opportunity to address the market’s changing needs.