By Andrew McIntyre Law360, New York (January 20, 2015, 3: 10 PM ET) -- Following the success of Denver's recent sale of minibonds directly to Colorado residents through an Internet portal, state and local governments are considering crowdfunding - which has become a popular means of raising capital among companies - as a way to reach investors, lawyers say.
In October, Denver offered $12 million in bonds directly to Colorado investors, as opposed to going through a bank, and set the minimum barrier to investment at $500, just a tenth of the typical $5,000 threshold for such offerings, according to Lewis G. Feldman of Goodwin Procter LLP.
And the success of that offering, which sold out almost immediately, as well as a similar offering by the commonwealth of Massachusetts last year, is causing governments to consider crowdfunding, both as a potential means of saving money and as a way to connect investors with local projects.
"People are following this and knowing that the inevitability of online distribution, which has been continuing for some time, is now making its way into the municipal market," said Feldman. "We're seeing ... cities looking at ways to create more efficient approaches."
The increasing interest in these types of offerings among cities and states is, on the one hand, a reaction to Denver's success. But it's also a reaction to the broader success of crowdfunding itself, which pools large numbers of investors, each of whom contributes a small amount of capital.
"I think this is sort of a natural evolution of the crowdfunding space and the continued manifestation of disintermediation by the Internet," said Gregory J. Nowak of Pepper Hamilton LLP. "If you're going to go that route, you need to have the capability to do it yourself."
In the case of Denver's offering, residents could purchase as much as $20,000 in bonds. Although Denver had done similar issuances before, this was the first time the city had made an offering directly to residents through the Internet, Feldman said.
Massachusetts also did a similar issuance last year, selling bonds for as little as $5,000 and allowing investors to buy as much as $500,000. That offering, said Rudy Salo of Nixon Peabody LLP, has also generated interest among state and local governments.
Part of what's driving cities to look to the Internet for fundraising is price. Cash-strapped cities and states are looking to save money by eliminating the cost of paying banks or other third parties and instead offering bonds directly to the public through online portals, lawyers say.
And there are other considerations. Part of the appeal of crowdfunding is that investors come to feel a connection with the project, unlike what they would feel if they had invested in a traditional securities offering, said Aron Izower of Reed Smith LLP.
"The issue is getting that connection to the investors and telling the story," Izower said. "With crowdfunding anything, you're trying to relate it to a specific project or proposal. Something so people can really understand, 'My dollars are going towards this.' It's different from general securities sale."
Of course, for a municipality that has never raised a cent through the Internet, taking the leap into crowdfunding is no small task.
"The No.1 challenge in municipal financing is, 'Well, we've never done it before,' " Salo said. "I think there needs to be more innovation in the market."
What makes such programs particularly tricky for cities is not knowing exactly how selling bonds over the Internet will work or ultimately play out. Cities also often lack the infrastructure or resources needed to set up such an offering.
The view of some is, Nowak said, is: "Yes, I could do it myself. Yes, I could do it without having to pay the banks the fees. But do I have the confidence to do that?"
"There is still a significant effort in underwriting an offering like this. That function still needs to happen. It's just priced a different way," Nowak added.
But despite the various complications and unknowns, deals are in the works, including an infrastructure project in the Southeast for which direct intrastate placement is being contemplated, according to Feldman.
And the California Statewide Communities Development Authority, a body set up in 1988 and tasked with helping local governments find financing for their projects, has its sights set on some sort of crowdfunding model, Feldman added.
"They are trying to create a menu of programs for raising money for local governments. It seems like it's heading very close to 'fill out this form, here's the online application, fill it out, and then we'll look at doing your deal,' " Feldman said.
"And I know that they're starting to work around the notion that people could sell direct through these kinds of portals," he added.
Given the growing popularity of crowdfunding and the perennial need for cities to find ways to cut costs, lawyers expect to see more of such offerings in the near future.
"There is a lot of money that courses through the books of municipalities. Just like every business, they have a need to smooth out cash flow," Nowak said. "If the Internet allows them to do that more effectively, I think the industry will have to respond."
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