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Crowded Field: How crowdfunding is changing the investment world

October 18, 2013

Used to be, not so very long ago—prior to 2008, in fact—you had few options for raising money if you were low on cash and wanted to make a film or album, write the Great American (or Australian or Lithuanian) Novel, launch a killer app, or start a catering service for dogs. If you had credit cards, you could max them out. Or you could ask mom and dad for a currency infusion.

Or you could…you could…well, that’s about it. With zip collateral, no bank was going to give you a loan. Venture capitalists or angel investors? Puh-leeze. You wouldn’t even register on their scopes.

Then Danae Ringelmann, an MBA candidate at the Haas School of Business, had an epiphany. And the world changed. Or at least, the world had a freshly–minted neologism—“crowdfunding” —and impecunious artists and inventors had a new way of securing funds.

Ringelmann launched Indiegogo as the first crowdfunding site five years ago. Her idea—using social media to raise capital via mass solicitations for small contributions or investments—propagated so rapidly it could be properly characterized as an explosion. Myriad crowdfunding platforms now exist.

Richard Swart, who heads crowdfunding research at Cal’s Fung Institute of Engineering Leadership, observes that the sector raised $4 billion last year globally, and is expected to log double that amount in 2013.

“Last year, more money was raised for creative projects by Kickstarter (now the world’s largest crowdfunding platform) than by the National Endowment for the Arts,” Swart tells us. “(Kickstarter) alone has accounted for more than 100,000 campaigns, and about 40 percent met their financing goals. Another platform—Crowdcube, which operates out of Britain—grew by 500 percent in the last quarter alone. And crowdfunding isn’t restricted to North America and Europe. It’s growing rapidly in developing countries in Asia, Africa and South America.”

Swart confirms that many of the campaigns solicit small amounts of money because “some parents want to send their kid to art camp, or somebody wants to finish a film.” But others are product or business pitches, and involve big bucks.

“Kickstarter has had more than 100 successful campaigns for $1 million, and their record is a $15 million campaign,” Swart says.

Which begs a question. Or three. Is crowdfunding the magic key that will unlock the golden gyves shackling capital? In other words, will it open the capital markets to everyone with a good (or even fair) idea, not just the few, connected and filthy rich? Will it supplant venture capitalists and angel investors?

Short answer: no.

“Crowdfunding will never disrupt the corporate funding structure,” opines Swart, “but it will function as a parallel mechanism. To a certain degree, it’s having an impact in the financial angel sector. Some angels aren’t enthusiastic about crowdfunding, because they see it as competitive. They worry that people will choose crowdfunding over them. But other angels are excited about it. They see crowdfunding as a due diligence tool. They can say to a prospect, ‘Let’s see how you sell and market—let’s see if people like your product or service. Raise $100,000 through crowdfunding, and we’ll give you $200,000.’ ”

As rapid as its growth has been to date, U.S. crowdfunding will likely be supercharged by last month’s implementation of key provisions in the 2012 JOBS Act that authorize general advertising for offerings of private investment and allow unaccredited investors to dally with online equity crowdfunding. These new rules could take crowdfunding from supporting art film final cuts and trans-global motorcycle expeditions to generating heavy money for ambitious start-ups.

But won’t they also open the door to fiscal shenanigans, leading to an alt-money reprise of the 2008 financial crash? When you let crowdfunding act like Wall Street, won’t it lead to Wall Street-style excesses?

To a point, says Swart. But the new rules also require companies to verify the income and wealth of potential investors.

“If you say you make a certain amount of money, you have to prove that before you get to invest,” Swart said. “All in all, (the new rules) are a great development. They basically reflect what’s already going on in other parts of the world. Europeans, for example, can’t understand why we’re so freaked out, why these restrictions were in place. Will there be scams? Yes. Will people go to jail? No doubt. But that happens with all investment securities. And the transparency of social media will make it very hard for the scamsters to hide. They will be outed.”

—Glen Martin

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