An Oregon real estate company and CEC client, Guerrilla Development, is focused on “creating inventive and experimental projects that use both hemispheres of the brain.” Coincidentally, earlier this month they have been busy engaging both “hemispheres” of investors: accredited investors (a.k.a. wealthy individuals) and non-accredited investors (a.k.a. the rest of us). They are using one of the newest legal strategies for ventures to “crowdfund” investment capital, Regulation A, through which they are offering $1.5 million of preferred equity in the Fair-Haired Dumbbell, an office building with ground floor retail in Portland, Oregon. The offering is open to residents of California, Oregon, Washington, Massachusetts, Virginia, and the District of Columbia. If you’re curious about Regulation A offerings, check out their campaign video for a great overview:
While the idea of raising capital from the “crowd” is catching on around the country with private enterprises seeking growth capital, the Guerrilla Development offering is different from other offerings in that it is part of a broader trend to use today’s investment crowdfunding tools for economic and community development purposes—specifically, downtown revitalization.
This approach marks a change from the way communities have typically sought funds for their improvement: through applying for state and federal redevelopment grants. This significant departure from the familiar approach presents a number of advantages for community-based ventures. For one, it allows for greater flexibility in the use of funds, which are often tightly regulated by grantmakers to specific types of community development projects. In the grant-driven approach, if the project or program doesn’t jive with the rigorous criteria of the grantmaker, there’s a good chance it will never see the light of day. Secondly, crowdfunding opens up a range of new possibilities for communities self-funding their own development. Now, rather than waiting for the state or federal government coming to the rescue of America’s urban cores and downtowns, communities can be empowered to raise their own capital to get projects done using these new tools.
We are working with other groups that are using Direct Public Offerings, or DPOs, to raise capital for downtown revitalization projects. As an example, one of the groups we are working with intends to raise $4.5 million for a real estate investment fund for the purpose of a major overhaul of downtown Fresno, through the purchase and rehabilitation of a number of properties for retail and other uses. Fresno, California, if you don’t already know, sits in one of the most productive agriculture regions on earth, and yet has some of the highest levels of poverty in California. Decades of disinvestment have led to a ghost town-like status in downtown Fresno, in sharp contrast to the abundant agriculture lands outside of the city. Through the use of a DPO, the group will give Fresno residents a chance to invest in the underlying real estate at the center of the revitalization plan, and be a part of the city’s success. The arrangement will ensure that the fund will never take on debt (which goes to the safety of the investments) and will be marketed specifically to local investors. Not having just one or two wealthy investors will allow the manager to make decisions based on the need for the revitalization of the area, without the typical shareholder primacy pressures. The offering is also devoid of the typical wiggle room that real estate developers typically add into their offerings that allows them to change the direction of the plan once it is funded.
Another group we’re working with, Our Katahdin, takes a broader approach to downtown revitalization, targeting the Kathadin region of Maine, which includes both small town and rural geographies. Seeing an opportunity to allow Maine residents to invest in the region’s development, this non-profit loan fund will cycle in capital from Maine residents through a DPO, before either loaning it out at a slightly higher interest rate to qualified ventures for their growth and development, or actually purchasing land for the non-profit to develop. In the process, everyone will benefit: Maine entrepreneurs will benefit from the access to capital; Maine investors (of the lending variety) will benefit from a modest return on investment; the region and its communities will benefit from enhanced economic activity; and the non-profit loan fund will benefit from the revenues for making it all happen.
We’re also excited to share that we’re in conversation with another real estate group, a non-profit Community Development Corporation in Rhode Island, which soon plans to pursue an innovative approach to real estate development in the state. Their approach centers on a public-private partnership with local municipalities to co-fund both the DPO and, if all goes according to plan, real estate development projects in Rhode Island’s distressed urban cores. They propose a fundamental rethink of housing development, bringing together spaces for living, co-working, and education, while also focusing on job creation, community revitalization, and “smart” growth in low to middle income neighborhoods. They, too, plan to use a DPO to engage a wide range of community stakeholders—and shareholders—in the success of the project.
We find a lot to like about this new trend toward greater democratization of investment in revitalization. Not only does it serve as a practical way to access capital for impactful projects that can breathe life into towns and urban cores, but it also serves to empower communities to take charge of their futures. When communities invest in themselves through local ventures, everybody wins.
Foundations, Families and Funds can play a very important role in helping to redirect capitalism toward a more fair and just application, while also finding the right social enterprises to support.
By playing a more comprehensive role in the creation and support of Community Capital Markets, these funding sources can build impact into a systemic approach. In addition to investments they make into the social enterprises either directly or through other intermediaries, they can also facilitate opportunities for the 90% of households that are prevented from participating in the private capital markets by investing in the structures that form alternative capital markets open to everyone.
We are better informed today than ever before about the rapidly expanding wealth and income gaps. Many recent studies show the top 10% of U.S. households now have over 75% of all the wealth in America. The next 24% of American households make up almost all the rest of all the wealth, leaving the bottom 40% with 0% wealth, and the bottom 60% with a whopping 3%! And the gap is growing fast, not shrinking, which portends many new challenges to our society.
Clearly we need to think about whether the current approaches are working, and if not, shift the paradigm.
As economists like Thomas Piketty have thoughtfully surmised, this growing gap will not improve without either government intervention or opportunities similar to what the wealthy have had – i.e. the same chances to invest and to begin to grow some wealth of their own. For anyone out there who follows the current dysfunctional state of our government, I would not hold out much hope for the first option anytime soon.
Regardless of the causes, our current state of affairs seems to point toward us having to right this very serious problem ourselves, and right it we must.
In the U.S., our government actually limits 90% of households from having any access to the private capital markets, leaving their investment options only in either the public capital markets, or alternatives that I’ve written about here, via Direct Public Offerings, or perhaps through the new state and federal crowdfunding options.
The irony is that, in the interests of protecting the 90%, only the very wealthy 10% continue growing their wealth. They have access to opportunities that far surpass anything found in the public capital markets. The 10%er’s may also use the public capital markets to hedge, speculate, or even arbitrage if they like, but their real wealth generation comes mostly from those private markets. But neither of these kinds of markets helps us to form the systemic structure we need to build healthier communities.
Which leads me back to how Foundations, Families and Funds can help.
The list of impact investors is growing every day, and we will all continue to work toward better identification of who is truly acting as a social enterprise, e.g. companies building business models to tackle some of the most difficult and seemingly intractable social and environmental problems, including climate change, poverty, water, energy and real estate, etc.
I refer to the entrepreneurs above as our new community of social enterprises, which includes those with a clearly defined mission, who are focusing on achieving impact at scale for all stakeholders (workers, customers, community, environment), but who also understand the importance of connecting via deep impact into their local populations. These kinds of entrepreneurs place a high degree of importance on the generation of mission aligned revenues (from clients or others who’s mission is aligned), and tracking/publicly reporting on their impact on a regular basis (transparency).
It’s encouraging to know that many investing organizations are now looking to make real impact via their investments by seeking out these entrepreneurs, even if we’re still in the nascent stages of trying to square that with the goal of getting back “market rate returns.” Leslie Christian just posted a great blog on this conflict here.
However, supporting those entrepreneurs with an investment is only one of two key components we need to have a healthy Community Capital Market. Focus also needs to be provided to the 90% of households so they can participate as well, even if half or more of them currently have no wealth to employ as investments into a market. These households need opportunity, which they are now starting to see with the alternative investment vehicles mentioned above, but even more important, they need experience, education and understanding in terms of what it means to be an impact investor – one that may not need those “market based returns,” whatever that means.
We need a whole system approach in place for community investors and community entrepreneurs to be able to find each other, which is what a Community Capital Market can be.
10 years ago, my good friend Don Shaffer (now at RSF Social Finance) and I embarked on a project to develop Local Stock Exchanges. I wrote about the need for these in several publications and even took a position at the Boston Stock Exchange to mirror a national exchange at a local level. But looking back, there is one critical element I got wrong. We don’t need to replicate the public capital markets with a lively secondary trading component that fosters speculation and arbitrage (using the need for liquidity to justify the madness they have become). We need a much more simple system in place that allows for the efficient transfer of individual’s savings into socially responsible companies, allowing for modest healthy returns, and some reasonable offerings of an exit if necessary. We need to power it with the right tools, education and mentors to help guide the ones that have not had access until now. We also need to reconsider what a capital market needs to be today, and not fall for the trap of manic returns and unlimited growth.
Foundations, Families and Funds can get behind this new kind of capital market by funding the system that can facilitate the Impact we need, and if they desire, they can also play a member-based role in how we operate it – much like exchanges used to be structured, before they turned into the same shareholder primacy driven entities that list on them today.
The Securities and Exchange Commission has recently estimated that approximately 10% of all U.S. Households are now in the “Accredited Investor“ category (for individuals, that means $1m in net worth not counting primary residence, or $200k of income). Assuming that’s accurate, there are now over 12 million households in the U.S. that meet the definition of Accredited Investor (“AI”).
The SEC defines the AI to determine their eligibility to invest in Private Placement offerings (i.e. funding rounds of securities that are sold not through a public offering (IPO), but rather through a private offering, and mostly to a small number of chosen investors). And as the private placement market edges toward $60 billion of deals a year, that may seem to most people as a sizable amount to participate in, with lots of opportunities to get in on the next big home run deal.
Some of those AIs, however, have begun to look for more than just a company swinging for the fences, but rather companies that look out for profits, people andthe planet. The rise of socially responsible or impact investing has now begun to take hold. And there are now more financial advisors becoming familiar with these kinds of investments, and helping their clients to find such deals.
Unfortunately, financial advisors feels constrained (for good reasons) to only show their clients deal opportunities of a certain size and nature. Many even limit their scope to only companies traded on public markets so that they reduce the risk of breaching their fiduciary duty to their clients. Other more adventurous advisors will brave the private investment landscape, where, with the right amount of due diligence, they can recommend impact deals to their clients that will also provide something close to market returns (whatever that really means).
But there’s another opportunity for AIs to make a significant impact. They can invest AND play an essential role in the stabilization, growth and resilience of the communities they live in or relate to. They can do this by participating alongside of the rest of the non-accredited investor community into investments offered by community entrepreneurs.
The kinds of investments I refer to here are Direct Public Offerings and certain state securities crowdfunding opportunities, both of which allow for investors to directly interact and engage with the entrepreneur/issuer. I wrote recently about this in previous blogs here, and also earlier today in a Locavesting article. As these crowdfunding offerings and the platforms they list on become more populated, investors will begin to find it easier to find offerings. Also, as we help clients obtain their approvals for DPOs, we post the offerings up on our CEX site so that investors can more easily find the issues and link to their sites.
The role AIs can play to support these much needed community enterprises cannot be emphasized enough. For one thing, as companies begin to turn more to using tools like DPOs to raise their funds, the size of the raise is going to increase well above the $1 million limit that the state or federal crowdfunding laws impose. DPOs, if done via the Intrastate exemption, are typically unlimited, as long as the state regulators approve them, and we are starting to see many more offerings in the $5-10 million range. Companies offering stock will want to limit the number of non-accredited investors to 500, and the total number of investors to 2,000, or face becoming “publicly reporting,” which is expensive to maintain. This means the offerings truly need the AIs to meet their targets.
Another key reason is the experience AIs may be bringing to these offerings. Clearly just because one is an AI does not mean one has the financial expertise of a typical VC or Angel who do this for a living or hobby. But there is no doubt that many AIs have some experience with investments, and likely more than their non-accredited counterparts. This can be very important when a company is even considering how to structure their offering, if they can learn beforehand what an AI will want to see before they participate.
And then there is, of course, the leverage an AI can bring to the offering, just by signing on and showing up. Some AIs provide the “prime to the pump“ so that the offering can take hold. Some even offer a matching approach. It can be an important signal to the non-accredited investors that they don’t have to shoulder the offering alone. Also, regardless of the wealth divide that exists, every member of the community can come together to make an offering successful. AIs can be an important kind of hero to this movement, while still obtaining enough of a return. Their participation can also lend the right kind of pressure to the entrepreneur to keep them on their toes, and striving to meet their mark.
AIs might do their own homework (due diligence), as they look at these investments, or they may be able to find a new breed of financial advisor who are willing to help analyze the offering, even if they stop short of making recommendations and risk their duty. And there are also new pioneers, like Marco Vangelisti, who has taken it upon himself to begin offering daylong workshops for community investors.
Marco is a veteran of global finance who walked away from the industry in 2009 after a 25-year career, and is now helping communities around the country understand the role investors can play in support of community. He created Essential Knowledge for Transition – an initiative to empower communities with a basic understanding of the large systems affecting our lives. Marco’s next workshop will be in Irvine CA the 7th of May, and after that, we intend to try cloning him so that we can help ALL kinds of investors, AIs and non-accrediteds alike, everywhere, to align their investments with their values, and create the world we want, and need.
Most people don’t have the ability, flexibility or funds to invest like a professional, and a more common approach for ‘investing in what you know’ takes the form of how well you can follow a company, mainly by looking at what you (or others who you trust) know about the company, or what the company has disclosed or reported about itself.
In the public markets, this means what a company publicly reports, and we (or the analysts) will read their “Form 10-Qs” and “10-Ks,” which publicly reporting companies must file with the SEC every quarter and year, respectively. We might also listen in on their webcasts, track their progress in the news, and even monitor their competition as a comparison.
The SEC reporting is still based mainly around financial information, with much less attention devoted to other material actions and impacts, but this is starting to change. There’s a lot of great work underway by organizations such as the Global Reporting Initiative (GRI), and Sustainable Accounting Standards Board (SASB), who are creating sustainability performance measures for these publicly reporting companies, and then monitoring and reporting on them separately. The largest database of corporate sustainability reports is still the UN Global Compact Initiative, which they publish on their website.
For private companies, there are also some new approaches, such as the GIIRS rating system for companies or funds, allowing companies to voluntarily report measurements on social and environmental impacts. B-Lab’s “B Corporation” label allows a company to do a self-assessment, which they claim leads to “B Analytics to help investors consider whether a company is properly managing its socially responsible impacts, with as much rigor as their profits.”
While these new reporting approaches try to help investors assess whether companies are meeting certain “sustainability” standards, trying to define these standards are can be a daunting task, especially as the definitions are too murky or continue to change and new reporting tools are created.
We first saw screening tools applied to companies (e.g. no oil, weapons or bad actor sovereignties) in an attempt to label the good ones as “socially responsible investments.” Then came the dawn of “sustainability,” which sounds good, but has many different definitions. Nor has “triple bottom line,” “ESG” (environmental, social, governance), or even “Impact” given us clarity in terms of a definitive metrics-based idea for understanding whether a company is really contributing to our world in a positive and replenishing way, or simply another extractor of resources leading us closer to the demise of our species.
Even if the definitions or surveys are well thought out, is a company’s reporting enough for us to rely on to know that they are really making the kind of “impact” we want to see? When a company receives a “good company” sort of label, in whatever new socially responsible format we like, does that mean that the label was strict enough to ferret out all of its behaviors? Can companies fudge, omit, or cleverly interpret the ratings questions so that the answers fit the right frame they want to display?
While the efforts to bolster transparency about private companies is a great step in the right direction, reliance on only the reporting approach to make investment decision poses meaningful risks. Borrowing the famous quote from Albert Einstein, I would refer to this as the investment equivalent of Spooky Action at a Distance. A potential investment candidate may have received high marks from an outside rating group, and only later might we find them to be acting in ways we deem distasteful. Maybe we didn’t realize they were hoarding revenues offshore to avoid paying U.S. taxes, or providing their services to any kind of planet damaging company while espousing high-minded values, or grabbing federal funds while really only focusing on driving profits to its shareholders.
How do we know from a label whether a company truly practices all of the values they received high ratings on? Similarly, how do we know from a report whether they might be making certain private compromises to what they publicly report in order to bolster their bottom line?
If we don’t know the people behind the company, we may be left with only our faith in the reports, provided mainly or only from information supplied by the company itself, with little if any recourse for misrepresentations or omissions (except possibly a future rescission of their seal of approval, or being publicly shamed for their hypocrisy). Unfortunately, there are likely as many forms of greenwashing today as there are new efforts to heighten transparency, so relying only on modern internet-based tools or chat groups should be done at every investor’s peril.
Some who work directly in the area of socially responsible investment advising have seemingly given up on trying to identify the right term or the right actions, now hoping they can simply determine whether a company is behaving “responsibly.” And perhaps it really may be more meaningful to apply a “smell test” than to blindly rely on a label or a report. To paraphrase SCOTUS Justice Potter’s famous line from the Jacobellis pornography case…trying to define terms like Sustainability, Impact, or Socially Responsible using shorthand descriptions can quickly become unintelligible. But, like Justice Potter, perhaps we can apply that same personal test… I know it when I see it!
And that then begs the question…how do you see it? One very well tested method is to invest in who you know, and that means being able to find and get to know the companies, and the team, before you invest. Community capital markets provide just that opportunity. Community capital markets enable companies and investors, connected geographically or in fellowship, to engage with each other on a personal level. These kinds of capital markets can take the spooky out of the action, by bringing a personal touch to our awareness, and engaging with each other in financial transactions that support each other.
There’s an old saying that you should “invest in what you know,” but what’s far more valuable is when you can “invest in who you know” as well. The new crowdfunding laws are not designed to nurture this; they are meant to prohibit investment conversations with the company insiders when the opposite has historically been the case.
Wealthy individual investors and funds (angels and VCs), will often do both, and it makes a lot of sense, when you have the time and the wherewithal to afford due diligence, apply your previous experiences, and meet with the founders or senior management to determine whether an investment is a good one. A secondary benefit to this approach is that you often get to insert your previous knowledge (i.e. what you know) into the equation, because you have invested enough to have a voice.
Aside from reading the company’s reports, the other main component to making an investment decision is the ability to get to know who you are investing in. This is arguably the more important component, especially for those with limited amounts to apply toward investing. But does this mean that all of the new opportunities to make investing available to everyone via crowdfunding helps us in this regard?
The last few years have been exciting ones for those following new crowdfunding laws at both the state and the national level. I am not speaking to donation-based crowdfunding here (such as Kickstarter, Indiegogo and the rest) but rather investment crowdfunding (that involves actual return on investment).
When the JOBS Act was passed and as we watched and waited to see what rules our federal government would create, the states took earlier actions to implement their own forms of state-based securities crowdfunding. However, many of the new rules are going in the exact opposite direction of how investing has historically been done, and those rules have created more barriers, not fewer, in terms of getting to know who you might invest in. For examples, the JOBS Act rules (and those of many states) that require a company to only post their offering onto a third-party “intermediary” platform, and that limit what a company can say directly to its potential investors, creates such a barrier.
Investing has almost always been more interaction than any reaction to data before a transaction is completed, where the personal aspects of the interaction weigh heavily in favor of any successful transaction. How many times have we used, heard or relied on the old adage that you need to look someone in the eye before you can do a deal with them? In this modern age of SEO, and the multitudes of interweb communications, there are still many dealmakers that need to meet, and should be able to meet, the other person first before any deal gets done. The same has held true for our investing in other businesses since the dawn of investments began, and still holds true today.
Consider most companies that raise funds privately, through a broker-dealer, or even those that go public via a IPO. In each and every case, the company or its representatives sell those offerings, and the investors only buy (invest) if they can get to know the team. With private offerings, the company goes directly out to the accredited investors that already know them, or to whom they have been introduced. Broker-dealers help companies with their offerings by introducing them to investors they know, and those investors then get to know the company. And broker-dealers are supposed to ensure that the deal is suitable for every investor they bring in. Even IPOs have a personal connection component. The main underwriter will take the company team out on a roadshow, and introduce the team to its potential syndicate of other dealers to bring them in to an IPO. Those potential dealers put a lot of weight into meeting that team, and likely would not consider investing without a chance to get to know them personally.
But not all securities crowdfunding takes the unfortunate approach that you need to separate the company from the investor and utilize technology platforms in the place of that person interaction. In addition to the Direct Public Offerings (DPO) that have been around for decades, there is also, for example, the new Oregon Community Public Offering (CPO). DPOs are federally exempt offerings that must be filed with any state in which the offering is conducted, either using a federal exemption that currently limits the raise to $1m (but allows you to file in multiple states), or what is known as the Intrastate Exemption that typically has no dollar limit but requires the company and all investors to be in just one state. The Oregon CPO, which was championed by Amy Pearl and Hatch Innovation, was designed to be a community capital raising tool, and companies are actually encouraged, not discouraged from raising those funds directly from their communities via meet-ups that actually allows people to look the CEOs in the eye.
Whether it’s a DPO, CPO, or another kind of offering that provides for and encourages direct and interpersonal connections, an investor is provided with a very valuable opportunity to meet the people behind the veil and to use their own personal assessments in addition to what a company states in its materials or ratings it’s received. And those personal connections then make a significant impact on those inside the company who are taking investments from people they now know. The decisions companies make are likely highly informed by how connected the investors are to them. And while we have not experienced DPO investors who have abused that personal connection, what we have seen is a deeper, richer and more connected community as a result – a community of investors and companies who actually know each other