We were happy to have crowdfunding attorney Mark Roderick speak at our Philadelphia Real Estate Council meeting in February. He spewed some spot-on knowledge regarding the industry, legal aspects of crowdfunding and why many investors and developers shouldn’t fear it as much as they do. I wanted to get a deeper look into the landscape of crowdfunding for all of our readers, so here it is!
Mark Roderick concentrates his practice on the representation of entrepreneurs and their businesses. He represents companies across a wide range of industries, including technology, real estate, and healthcare. Expanding on his in-depth knowledge of capital raising and securities law, Roderick is spearheading Flaster Greenberg’s Crowdfunding Practice and is one of the leading Crowdfunding lawyers in the United States. For more information on Crowdfunding, including news, updates and links to important information pertaining to the JOBS Act and how Crowdfunding may affect your business, follow Mark’s blog or his twitter handle: @CrowdfundAttny.
Crowdfunding has really gained traction only within the last few years. How did you form an interest in it?
I started practicing law around 1840. Ever since, I’ve been helping real estate developers and other entrepreneurs raise capital.
When the JOBS Act of 2012 was on the horizon, I realized that if entrepreneurs could reach prospective investors using the the Internet – and that’s what Crowdfunding is all about – it could reenergize American capitalism, eliminating the inefficiencies that have made raising capital so difficult since the 1930s. Think what the Internet has done to the retail industry, the travel industry, the hospitality industry, the transportation industry. . . .I realized that if you could bring the same changes to the capital formation industry it would be the most important change in the last 85 years. And I wanted to be a part of it.
Whom do you represent and what kinds of challenges are your clients currently facing?
Mostly, I represent two groups of people:
- Crowdfunding portals
- Real estate developers and other entrepreneurs raising money through Crowdfunding portals
The challenge in Crowdfunding today is simply that the market is still very small. Think of Amazon in 1996, selling only CDs. Of the eight and a half million accredited investors in the U.S. only 100,000 or so have made investments; and of the 120 million or so non-accredited investors almost nobody has made an investment. The numbers are growing exponentially, but the industry has a long way to go in terms of investor education.
You can think of Crowdfunding portals as retail stores, which happen to be selling securities rather than shoes. Developers and other entrepreneurs are the suppliers and investors are the customers. Today, there aren’t very many stores and they don’t sell very much stuff. It’s like the American West in 1850, with a few General Stores dotting the landscape. Before long we’re going to have big, crowded malls, but not yet.
Does Crowdfunding have a strong presence in one geographical region over another. If so, to what do you attribute the difference?
The top three geographical regions for Crowdfunding are California, California, and California. Texas, Florida, and New York also have strong markets.
New York, Austin, Houston, and San Francisco enjoy vibrant entrepreneurial ecosystems, so it’s no surprise they would embrace Crowdfunding, But California as a whole is a special case. Californians seem to have a thirst for change that is unmatched anywhere in the world. If raising capital using the Internet is the destination, Californians want to be in the driver’ seat. I helped a farmer in California create a Crowdfunding portal for agricultural property.
What is the regulatory landscape in terms of Crowdfunding like today?
There are three flavors of Crowdfunding, named for the sections of the JOBS Act in which they appear:
- Title II Crowdfunding, which is limited to accredited investors but subject to very light regulation otherwise.
- Title III Crowdfunding, which allows an issuer to raise up to $1 million per year with very extensive regulation.
- Title IV Crowdfunding, which allows an issuer to raise up to $50 million per year in what amounts to a mini-public offering.
For its part, the Securities & Exchange Commission has been great for the industry. The SEC is in the business of protecting investors and the integrity of our capital markets, but time after time has made decisions that allow the Crowdfunding industry to flourish.
How do these platforms make money? Is there a fee taken from investors or developers? If so, what does the fee look like?
There is no one revenue model used across the industry – not yet. Platforms might incorporate one or more of the following models:
- Flat listing fees
- Commissions based on capital raised
- Acquisition fees
- Carried interests
- Asset management fees
- Per-investor charges
- Investment management fees
A platform’s revenue model is closely tied to an important legal question: whether the platform must register as, or be affiliated with, a broker-dealer.
A lot of investors and developers have reservations about Crowdfunding? Why do you think that is?
For many years one of my partners wouldn’t deposit checks in an ATM. Fear of the unknown is very powerful.
Understand, also, that for the same reasons Crowdfunding represents such an opportunity, it also represents a threat. Just to throw a number around, suppose that allowing entrepreneurs to engage directly with investors via the Internet, rather than through layers of middlemen, reduces the cost of capital by 100 basis points. Apply that to the volume of real estate transactions in the United States and you’re talking about real money. Some of that money goes into the pocket of the entrepreneur and some into the pockets of investors, but all of its comes out of the pocket of the middlemen. Like the Barnes & Noble executives who told one another that consumers really should buy books in brick-and-mortar stores, those middlemen are going to believe that Crowdfunding is in some way wrong, or dangerous, or something.
Most of the hesitation is from lack of information. On the other hand, if you’re a developer trying to raise $50 million of equity today, you’re not going to raise much of it through Crowdfunding simply because the market is too small. For that developer, Crowdfunding is about the future, not the present.
As the industry matures, do you think more companies will form their own eREITS like Fundrise did?
Absolutely. In fact, it’s happening already, driven by three factors:
- Most retail investors (myself included) have neither the skill nor the desire to select individual real estate projects. Just as retail investors prefer mutual funds to picking individual stocks, they will prefer to invest in pools of assets that have been chosen by a professional.
- Theoretically, thousands of retail investors could invest in a traditional limited liability company. But when you own equity in an LLC you receive a K-1 each year. For someone who’s invested $1,000, the cost of adding a K-1 to her tax return at H&R Block could be prohibitive. In a REIT you receive a 1099, not a K-1.
- Privately-traded REITs have a very bad reputation, plagued by high fees and sales commissions. But if light is the best disinfectant, the Internet is like a spotlight, relentlessly driving down costs and providing investors with instantly-accessible information.
You’ll continue to see individual projects on Crowdfunding sites, but in terms of volume I believe REITs are the future of real estate Crowdfunding.
You’re very active on social media. How has this impacted your business?
You mean my Match.com account?
Crowdfunding is the Internet. Social media is the Internet. They go together like peas in a pod.
I began my Crowdfunding blog way back when, with the goal of providing legal resources for the industry. It turns out that just as people shop for clothes on the Internet and shop for vacation packages on the Internet and search (shop?) for significant others on the Internet, they also shop for lawyers on the Internet – at least they shop for Crowdfunding lawyers. Every day, I receive emails from people around the world who found my blog on Google.
Just as investors can search for the best real estate investment with the click of a mouse, so they can search for the best Crowdfunding lawyer. That’s great for the industry.
Other than growth, can you give us some predictions for the Crowdfunding space? What will it look like in 2027?
Crowdfunding is just the Internet, and I believe it will follow the trajectory of other Internet-driven industries. I believe Crowdfunding will capture a greater and greater share of the market, providing financing for larger and larger projects and more and more industry sectors. Long before 2027 I believe that any entrepreneur seeking capital will look first to Crowdfunding, just as we look first to the Internet to make travel plans or check the weather.
As the industry grows and middlemen are pushed to the side, I expect political pushback, especially from Wall Street. I expect that as entrepreneurs find success with Crowdfunding the legal rules will be liberalized, and when ordinary investors lose money they will be tightened.
I expect that as Crowdfunding becomes the new normal in the capital markets, the very word “Crowdfunding” will fall out of use. That’s when we’ll know the future has arrived.