One of the first funding portals to receive SEC approval was NextSeed. The company, founded by Youngro Lee, Abraham Chu and Bob Dunton (with team, above), had been quietly raising money for small businesses in Texas for a year. With the implementation of Title III of the JOBS Act, Houston-based NextSeed is now expanding to the national stage. We talked with Lee, who is NextSeed’s CEO, about his journey and what lies ahead for crowdfunding.
What’s the origin story of NextSeed?
I was a private equity lawyer. I did mostly corporate work and private equity fund work. When the JOBS Act was signed in 2012, instantly, I was like, this is the future—offering up securities to everyone. My specialty was offering private placements to accredited investors, and the idea that you could connect everybody without this arbitrary income limitation was something that I believe will really change the world.
Having said that, as a lawyer I also know how long this legal process takes. I knew it wasn’t going to happen overnight. When the proposed rules came out in October of 2013, I said, OK, now it’s getting serious. Right after that I began planning to move—in 2014 I left the firm I was working for in Hong Kong and came back to the U.S. There were still no final rules so there was some uncertainty, and that’s when the intrastate movement was starting. At the time there were ten states—Texas was the largest.
So the strategy was, Title III is not perfect but it’s going to come. Instead of waiting, why not start with intrastate and build a platform and learn how the process works? And as we were building the process, the Title III final rules came out last year. So we got our applications in and got approved by the SEC.
What differentiates NextSeed from other platforms?
We don’t do tech startups or equity. We focus on Main Street small business financing, especially in the form of debt. The reason is pretty simple: there’s been a lot of issues with traditional bank financing. They’re not bad businesses, they just can’t get funding because of the current financial system and the way it’s set up. So when I first heard about crowdfunding, in my mind it was an ideal way to connect small businesses with people around them looking for alternative investment opportunities.
We also have an investment account element. Just like a Fidelity of eTrade, you open up an investment account with NextSeed, which is held by or bank partner. You connect your personal account to your NextSeed account. We handle all the services, accounting tax forms, etc. So we’re the interface for both the investors and the businesses.
On a more personal level, we all have immigrant backgrounds and come from families that have been small business owners. We all left pretty good jobs to do this because we believe in it.
Tell me about your deals to date.
In Texas, we’ve completed seven companies successful campaigns. We’ve raised over $1.2 million for businesses, and we’ve returned $80,000 to investors so far. And we’ve launched our first Title III deal, a boutique luxury hostel in Austin.
What are your typical loan terms?
We offer two types: a term loan and a revenue share agreement. With the revenue share, there’s a total dollar amount payment requirement, and the businesses share a fixed percent of their revenues until they pay back the total amount, so there’s some variability. We’ve found that’s good for businesses with a solid track record but that don’t have a steady cash flow.
Our terms loan rates range from 8% to 18%. For the revenue sharing percentage, it’s between 15% to 20-25%.
So Title III is out, how do you feel about it and how will it will shake out between Title III and intrastate?
There are a lot of pieces to this and it’s hard to say how it will turn out, but it’s definitely exciting. Texas businesses are lucky—they have the option to choose. The national rules are a little more cumbersome. My initial sense is that businesses looking for national exposure will be attracted to Title III. Super local businesses might be willing to pursue intrastate because it’s a little simpler. The main difference is the marketing—until Rule 147 [the intrastate exemption] is amended, local businesses are still somewhat limited.
No matter how the rules turn out, this is the natural progression of how capital-raising should go.
What sort of challenges are you seeing issuers running into s the biggest challenge in your view for Title III?
The biggest issue for everybody is education about the process and what it entails. A lot of those small businesses don’t have experience with this stuff, whether its financials or legal disclosure. That’s the challenge we go through, educating the issuers that it’s not as easy as preparing a Kickstarter campaign. It comes down to cost of service providers, whether its lawyers or accountants or business advisors.
What do you charge?
Our business model is the same for Texas or national: we charge between 5-10% of the successful offering amount. Some businesses have everything ready and only need the platform, while some need more hand holding and support. So we work on case-by-case basis. We also charge 1% on the repayments that go back to investors.
NextSeed At A Glance
Type: Intrastate and Title III Funding Portal
Offering types: term loans and revenue share
Fees: 5% to 10% of successful offering
How do the platform economics work for small deals?
A common complaint you hear is that $1 million cap is too low. That may be true for certain types of business or real estate transactions, but small businesses aren’t looking for millions of dollars, they just need a $100,000 or $200,000. We designed our model around small deals. It will be very difficult if the portal has to do everything, and that’s why we’re trying to create a more efficient marketplace. We made an investment to create an infrastructure, and we believe that as the momentum picks up things will get better. Our process is relatively standardized—we offer term loans and revenue share. If an issuer wants to their own thing, we can’t work with them.
What do you think is motivating investors?
It’s some of the themes you talk about in your own work. People who want to do more with their money. The way the financial markets have worked, especially since the Great Recession, it’s very impersonal: you put money into the stock market and you have no idea why something goes up or down. The reality is, that was literally the only option people had. So now when we offer people an opportunity to invest in a business they can believe in, they can see or touch or visit, that’s very attractive to them.
We also have a higher proportion of Millennials—they are the early adopters. And I think that trend will continue.