The Democratization of Capital Raising

Bob Sargent had worked for Computer Tech for ten years. The company  has flourished and its stock soared. Billions were raked-in and employees were experiencing outside-gains in their 401Ks stuffed with Computer Tech stock. But Bob was feeling confined to their corporate daily duties.

No matter how many times management had praised him, “Bob, there will always be a place for you at Computer Tech.”, Bob knew that he would not be fulfilled by his mundane duties.   He had aspirations and dreams for his own product he has been developing with several other coworkers.They enjoyed the stability and security of a corporate job but it lacked the creativity and self-fulfillment.

That’s why Bob and a group of fellow Computer Tech friends built a prototype piece of hardware that would change the world as he knew it. Well, that’s an exaggeration, but it was a nifty piece of hardware. The group had prepared a business plan and maxed out their funding sources to get to this point. They each had established relationships with banks, but quickly found out the banks would not let go of their money. Each bank was fearful of the economy and just couldn’t take a chance on a startup. Besides there were all those maxed credit cards.

They had romanced Venture Capitalists (VCs) and were due to hear today if they were going to get the money they desperately needed.

“Hey, Bob, phone call on line 2.”

“Bob, its George Went here. Bob, I’m calling to tell you our investors made a decision. We are not going to be funding your company.”

“What is the stumbling block George?”

“Bob, it’s the same problem we’ve talked about. The board doesn’t believe you can build the product that cheaply. If you do, they think your customers will think it shoddy. If you build it more expensively, we don’t think you can meet minimum margins needed by our investors. I’m sorry, Bob.”

At the annual block party, the residents on 32nd Avenue gathered once again around Joe’s pool, and sipped their favorite beverages on this 90 degree day. Bob Sargent was sitting on the bottom, feeling like his dreams of pursuing his own company have been drowned by VCs. Bob was breathing and thinking, “What are we going to do now? I know we can make the product and still make a great margin. All our families are depending on us. We are tapped out and I can’t touch my 401k. What are we going to do? I wish there was a way.”

After a while Bob came up to the surface to join the party. As he emerged from the pool, and grabbed a beer, young 19 year old Beatty, leaned in close. “I saw you in the pool and heard the VCs turned you down. You are probably feeling hopeless right now. I have just one word of advice for you.” Beatty leaned in even closer and in a conspiratorial voice whispered “Crowdfunding!”

Spreading the Opportunity

Crowdfunding is the collection of capital from “the crowd,” traditionally a large group of people who pool their money to support efforts initiated by other people or organizations. Reward Crowdfunding is available today, while equity crowdfunding is still pending while the SEC releases the final rules.

Project creators typically create “…a profile containing a short video, an introduction to their project, the amount of money sought, a list of rewards per donation, and some images to elaborate.” The hope is the video goes viral. Once the project receives 25% to 40% of the goal, the project often crosses a threshold and non-related or “professional” investors step up. The percentage of the funding achieved is a good indicator to these non-related “professional” investors if the idea has achieved proof of concept.

  shutterstock_123710611
  The Statue of Liberty

Crowdfunding, historically, is huge. The Statue of Liberty is a great example that small amounts of funding were contributed for the cost of the base of the lady. Also compare this new way of venture capital investing to the printing of the Guttenberg Bible which was the first major book printed in the West using movable type. It marked the start of the “Gutenberg Revolution” and the age of the printed book in the West.

Prior to the printing of the Bible in 1450, there were only a few Bibles, they were laborious to produce, but owned only by the churches and interpreted by the elites of the church. After the Guttenberg Bible was printed, in theory everyone could have their own Bible and interpret the words for themselves.

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vellum copy of the Gutenberg Bible owned by the U.S. Library of Congress

With crowdfunding, suddenly everyone can be a venture capitalist. Just as everyone can have a Bible, everyone who has internet access now can fund or seek funding from everyone. Crowdfunding and the use of funding platforms will expand the distribution of new ideas and investment opportunities to support those companies. The gatekeepers of capital like the Banks and Venture Capitalists no longer have the keys to what company gets funding. It’s the great democratization.

Crowdfunding Distribution and Accessibility

Already, there are numerous reward crowdfunding platforms where companies can safely ask for or donate money such as, Kickstarter, Indiegogo, and RocketHub. Even YouTube is facilitating donation crowdfunding capabilities. A Crowdfundingplanning.com YouTube video informs us that $2.8 billion was raised by reward crowdfunding in 2012 and they expect to see $16.6 billion raised in 2014. They compare crowdfunding’s growth from 2009 to 2014 to the growth of the internet and see the same phenomenal, growth rate. Reward Crowdfunding is not investing since there is own financial return incentive in the transaction.   Today accredited investors can actually invest in Reg D Private Placements offered by FINRA Member Broker Dealers and receive a financial return. Certain Broker Dealers have developed funding platforms that offer Reg D 506(c) Private Placements to verified accredited investors.

Just as different countries have their own stock trading markets Crowdfunding is not just taking place in the U.S., but around the world. A 2013 World Bank report, featured in Forbes, predicts that crowdfunding in China, where there are 560 million web users, could reach $50 billion by 2025.

“Demohour, is China’s first—and now largest—platform only launched in 2011, but it’s already funded over 400 projects.”

Emerging economies like Brazil have Ideame. It is another platform that serves Brazil, Argentina, Mexico, Chile, Colombia, and Uruguay. Forbes wrote the platform “…is off to a slower start, but still has raised US$150,000 across 86 of their most successful campaigns.”

Comparing Crowdfunding Characteristics to Today’s Investing in the Available Markets.

In some ways raising capital today is a revolution and in other ways the same. Comparing the traditional stock market model to private placements and equity crowdfunding, we find in both cases that:

  • Companies need to show financials; they need to be transparent.
  • The number of investors/shareholders could number in the hundreds, thousands or millions
  • Investors in the stock market do not need to be a certain type of investor. They can be anyone over 18 and a dream. They don’t need to be accredited Investors in equity crowdfunding. It is for the crowd.

Differences:

  • In the stock market investors can purchase as many shares they want subject to SEC rules of disclosure
  • With Equity CrowdFunding, investors can participate but only up until their limit which is an amount calculated from their net income or wealth.
  • Companies raising capital via the exchanges must meet size and number of shareholders requirements to qualify to be listed, therefore they tend to be more established
  • With Equity Crowdfunding, companies are in the newer stages of their business life. Investors may feel they are getting in on the ground floor.
  • Commentary about exchange traded companies generates tons of information. Everything from published analytics, charts of trading, internet profiles, SEC filings, insider selling, etc. Investors really do their homework before investing.
  • With Equity CrowdFunding, all information to analyze companies may not be totally available.
  • Here’s the big difference: LIQUIDITY. The stock market is a secondary market. A place where you can readily buy or sell shares and thus you have instant liquidity. If you sell, you can get your money out immediately, after the trade settles.
  • With Equity crowdfunding, there is no liquidity and at this time, there is no secondary market. You go along for the ride.

TRUST, INFRINGEMENT, TRANSPARENCY

That means that there are some obstacles and risks to equity crowdfunding that a potential investor must understand. One of the biggest is TRUST. Is the project legitimate or a scam? China has weak intellectual property laws. How can a project owner protect against INFRINGEMENT?

SeedAsia co-founder Tom Russell noted that the TRANSPARENCY that’s become the hallmark of successful Western crowdfunding projects often presents challenges for many Chinese entrepreneurs. “There is no easy way for investors to find and screen interesting companies.”

Another obstacle, for example, is Brazil’s “custo Brasil” or the Brazil Cost, the hurdles by bureaucrats restricting international business. In the U.S the projects come under the scrutiny of the SEC restricting equity ownership to people who are able financially to take risks; accredited investors. The Wall Street Journal wrote, “A hallmark of the 2012 (JOBS Act) law, the equity crowdfunding provision isn’t expected to become effective until later this year or early next year because the SEC is still hashing out final rules allowing companies to sell equity stakes in businesses to everyday investors through social media and the Internet.”

One change in the JOBS Act would unleash the power of the individual “The Crowd”; that of allowing small investors to secure a financial return in a company. The JOBS Act now allows you to advertise your private offering, but only accredited investors can participate. Until equity crowdfunding is legal, others, with less financial resources, can only participate in reward crowdfunding contributing in exchange for rewards, such as coffee mugs and T-shirts.

What if the governments of the world just got out of the way of entrepreneurs? Wouldn’t we see a flowering of new business that might give every individuals a rush to leave behind their stable job to pursue riskier endeavors but contain self-fulfillment?

Contributed by Mike Landfair


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