If you live in New York City, you might have spent money at a Smallknot boosted business. Smallknot is a funding platform for small, local companies. Last Friday, I spoke with Jay Lee, founder and CEO of Smallknot, about his company and the state of the American neighborhood.
How did you get the idea for Smallknot?
I was working as a securities lawyer on Wall Street, as was one of my co-founders. At the time we were enjoying Wall Street just after the collapse of Lehman Brothers so the credit crunch was in full force around the country, small businesses were having a really hard time getting capital. At the same time I was just sitting in a law firm working on billion dollar transactions. We were moving money around the country, around the world. It’s very easy to move a billion dollars from here to an oil well down in brazil or to a high fructose corn syrup factory out in Iowa or whatnot, so it seemed really interesting to us that there was no rail for capital to move directly from individuals to the communities, all the money just moved from here through the financial system out to a bunch of companies. It seemed crazy you could move money hundreds of thousands of miles with a click of a mouse but you couldn’t move money directly into your community, into the small businesses you’re actually engaged with, the places you live, the places you love, the places you go every single day. With that in mind, we set out to build a company to build that new rail to get capital from people to their communities and the small businesses in them.
Were you inspired at all by Kickstarter, or was the genesis of your idea independent?
The genesis was actually completely independent. I come from a securities law background—you look at financial flows—so my interest is building a more nourishing, more locally oriented financial system. The earlier models we worked with were more in the nature of building a local financial economy. We looked at the way mechanics worked for peer-to-peer lending, we looked at how crowdfunding worked, and we looked at how organizations like Kiva moved money around. When we looked at the needs of the business owners and what people in the communities actually wanted, it turns out the platform mechanics looked a lot like Kickstarter. Ultimately, our platform has some similarities in how payment is delivered and how the mechanism works. We ended up at a system that looked a little like Kickstarter, but we started with a completely different perspective and a completely different goal for what we wanted to build, which still is building local ecosystems for local finance.
In a world absent Smallknot, or the status quo before you founded Smallknot, what did financing look like for someone who wanted to, say, start a restaurant in his neighborhood?
It’s very, very difficult. If you look at restaurants as an example, banks often look at restaurants as very risky propositions. They actually have categories called restricted industries where they don’t make loans for certain industries like food, so the terms are pretty difficult to get capital. For a restaurant owner, if you want to get that loan, you often have to secure it with personal assets, so you have to put up your house to get that loan. With smaller amounts of capital you’re also subject to credit cards or merchant cash advances, and all those alternatives are very expensive. So they might be available, but they have very high interest rates and they’re very expensive and complicated for small business owners, so they’re often not used. There’s both the issue of access to capital and the issue of cost of capital and I think we’re trying to address both.
Can you outline the funding process for a Smallknot enterprise?
A business owner hears of Smallknot, they come to us, and we help them build a page for the fundraise. They give us other information about their business, they get to tell their story and what they want to use the funds for, and they get their own beautiful page and they can lay it out to tell their story and raise funds. The way it works is it takes their returns for their investors, so you don’t necessarily just get rewards, but they’re often more in the nature of repayment in kind. So you get repaid at a higher value than you put in. If a restaurant were to be on Smallknot and someone contributed $100, that person might get $120, $150, $200 or more back in value, so it might be a house account, it could be free meals, it could be events—there are a wide variety of ways that restaurant could repay the person in kind. They get to lay that out on the page as well. When they come on the site, they are able to raise funds from their networks in the communities, those first and second degree networks whether it’s the customers, the communities, their friends and family, keeping those people interested in the business engaged, reaching out to those people and offer returns for their investments. It’s an all or nothing model. The business only gets funded if it reaches the goal it sets out in about 45 days. The reason for that is if you’re buying a pizza oven you can’t really buy half a pizza oven. We want to make sure the project can be worth something, and it’s a way to maintain accountability in the community, that the community is able to speak up and say that this is something we think is worth funding and want to help you meet that goal.
Do the people providing the funding have to come from a certain geographical radius around the business that’s starting?
No, it’s not restricted to that geographic area at all.
People who are friends of the founder can put money in even if they don’t live in the neighborhood.
That’s right. The returns are often structured in different ways to attract different kinds of people. For example, there’s a coffee shop we worked with park slope called Kos Kaffe, and they offered a variety of rewards, some were onsite, so they would close down the shop and serve you private dinner, and others would be more distant where you could order a coffee of the month club and they would send you a bag of coffee to your door for eight months. And so for those people who might be friends who are interested, who love the business but might not live in a four-block radius, they can still contribute and get meaningful returns back from the business. We do work with the business and make sure they have ways of rewarding all types of people, both in their communities and people they know in their networks who might be outside their communities.
What types of communities are you working with right now? Urban, rural, East Coast, West Coast?
In the short term we’re working in two markets primarily, the first is New York and Brooklyn, we’ve worked in a variety of neighborhoods from Williamsburg to Park Slope to Lower East Side and Greenpoint and people in between, and we’re also in Greenville, South Carolina, which happens to be my hometown, and we have a running campaign down there. That’s much less urban and much more suburban in nature. The communities are tightknit but they’re more spread out, not necessarily block-to-block, but a large community. We’re looking at other cities that might be interesting to expand into, but for the short term, that’s where we are.
What differences do you see between the suburban and urban settings for this kind of project?
The dynamics are really interesting. In some ways people who live in New York often get moved in, stay a couple years, and move out in a couple years, so it’s a much more transient nature for a lot of communities. But people really do love their neighborhoods, they love their street, they love their blocks, but oftentimes that’s restricted to a ten block radius around their apartment. But they’re still completely attached to it. When you look at suburban areas like Greenville, you have people who define their community as far out as 20 miles, so it’s not block-to-block, and they also usually value that whole area—it might not just be limited to a small radius.
Do you think that in the suburban setting there’s more or less of a community that’s structured around proximity? … It seems the entrenchedness of the suburbs has a very different effect on how committed people are to improving the immediate area they live in.
The suburbs are interesting, because in the suburbs lots of people do own homes, they raise families out there, they’re not necessarily young and transient, so they do feel much more of a connection to the places they live. And they often have more of stake in the places they live, they might be more active politically, they might send their kids to public school, they own their homes, they’ve lived there longer, so their sense of community is often built upon how long they’ve been there and how close they are to the places they live. We think that dynamic is really interesting because it looks very different from the ones you see in cities. And I think there’s something really powerful about that tapping into that in the communities, even if it might be a much broader segment than in an urban area.
There have been a lot of startups getting media attention over the last three months focused on different aspects of traditional neighborhood living in america. there’s one that’s a community watch program [Nextdoor] that just started up that tries to create social networks within only neighborhood spaces. Do you think there’s a reason why people are suddenly becoming interested in simulating the social bonds and economic bonds of neighborhood communities in these very tech oriented ways?
I do think that there’s a long arc in culture that’s happening, especially in our generation, where a lot of people like me grew up in places like South Carolina where everything was like strip malls. And everything got bigger and bigger: the stores got bigger, online retailers became more distant to them, and we became used to the fact that everything would become more homogenized, more big box, and more online retail focused. And then as we got older we realized that there’s a lot of value in the communities we live in, that all these bonds that are between people and their businesses in the community are actually very important, and these are the places we actually live in and engage with and they’re very important to us. And we realize how much value is in each of these interactions. We’re starting to realize that we don’t all want to live just for convenience and low prices and big box stores, but have places that we want to live in that offer character, the vibrant community, the diversity that are offered by small business in the places we care about. So I think it might be a generational shift. You see the ability for technology to make these connections in a way that’s more seamless and often more comfortable for people our age to connect with each other in a way that bridges the online and offline world. It makes it a lot easier to interact and build those connections.
What are the next steps for Smallknot?
We’re really excited, we just left the TechStars program about three weeks ago, and so now we’re back to focusing on the business. So we’re back to contacting business owners, getting a lot of interest from local shareholders, from people both in New York and around the country who are interested in what we’re doing. So we’re working closely with all those folks, trying to build the Smallknot system and make this platform successful for both investors and for the businesses, and try to recreate the Smallknot system built up in New York and Greenville and beyond.
How does it scale?
Automation will be built in over time. Now, we really enjoy the ability of being in contact with the small business owners, getting to know them better, getting to know how to make this process work well for them. We’re still engaging with them pretty actively, and over time we’re increasingly automating the process so they can take these tools and build their own campaign pages by themselves so we don’t have to be so involved. But for now, we really enjoy the process of learning and talking and engaging. We’ll take this process and move towards automation, but this is the fun part I guess.
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