Friday, November 09, 2012

The Wonderful World of Crowdfunding

Crowdfunding is here to stay.  This is the brand new way for startups to raise capital in small increments from many sources online.  The National Crowdfunding Association has some basic information on this growing market.  I'm pleased they're developing a certification credential for crowdfunding advisors and have programs for underrepresented business owners.

Crowdfunding is related to microfinance in that it funds small projects, but the difference is that a microfinanced transaction is sourced from a single institution like Grameen Bank.  It also differs from peer-to-peer (P2P) lending, which enables loans from a single nonfinancial private lender to a private borrower through online portals that enable credit checks.  I am intrigued by the possibility that some crowdfunding platforms may become so successful that they can expand their brand into a one-stop shop that includes microfinance and P2P lending.

I had the chance to hear from crowdfunding pioneers at last August's Money Show in San Francisco, and my interpretation of what they discussed is intended more for entrepreneurs than charities.  The key element for entrepreneurs to consider is how much to raise.  Raising more than a few million will probably have to go to angel investor clubs and then VCs, but startups that only need a million or two can use crowdfunding portals once they've exhausted the friends and family route.

Some crowdfunding portals use a pledge system for non-profit clients, so if a startup doesn't raise the full amount of its proposed total it must return the balance to donors.  I have a hard time believing whether that would be viable for a for-profit startup, because investors would have to read the startup's prospectus online and understand they are contributing a legal form of consideration (a cash investment) in exchange for a security representing ownership.

The JOBS Act will be a tremendous enabler of crowdfunding by lowering barriers to raising capital that previously allowed only accredited investors to subscribe to an offering prospectus.  The SEC is formulating rules for implementing the JOBS Act but they need to hurry it up before state regulators start issuing their own legal opinions.  Once the SEC has its complete rules in place, the crowdfunding portals that adhere to them and attract investors stand a good chance of being acquired by broker-dealers.

I challenge the conventional wisdom that a secondary market isn't likely for securities sold in crowdfunding.  Facebook's lengthy pre-IPO drama broke the mold on trading private shares in a secondary market.  Crowdfunding a hot startup that later grows into a Facebook-type behemoth will force a secondary market into existence whether the SEC is ready for it or not.  Mutual fund companies will see the value in crowdfunded shares on the secondary market, and they will probably launch actively managed funds that invest in first-round capital raises on crowdfunding platforms and shares available in the secondary market.  I don't foresee an index fund or ETF ever developing for the crowdfunding sector because the potential universe of enterprises to track is simply too large to be worth pursuing.

Crowdfunding can test an idea (a tech startup, a film project, a non-profit fundraising campaign) to see if it has a catchy theme that will go viral.  Reaching beyond friends and family for investors will IMHO require a social media campaign to get the word out.

Let's do a quick run-down of some crowdfunding platforms.  IMHO the most successful platforms will allow potential investors to view a startup's full business plan, prospectus, and term sheet online without requiring them to sign a non-disclosure agreement (NDA).
Kiva is early name that merged microfinance with peer-to-peer lending.
Kickstarter is getting a lot of attention and credibility in Silicon Valley, and is a portal for film finance.
Indiegogo is making a name for itself in non-profit funding.
Health Tech Hatch focuses on raising capital for the biotech sector.
CircleUp enables consumer products startups to raise equity capital. adds CRM data mining and mobile apps to its portal (a smart value-adding move IMHO!)
Streetfunder is focused on equity raises.
Launcht has platforms for non-profits and social entrepreneurs.
Funding Launchpad enables offers that include a complex capital structure (equity, debt, and other options).

Crowdsourcing explains the whole phenomenon of mass-generated online content.  I am convinced that crowdfunding can fund human-scale enterprises like makerspacesbiohacking laboratories, and permaculture installations that will enable resilient communities.  This is the future of finance.   Capital markets were originally intended to raise money for productive enterprises, but in recent years they have degenerated into massive gambling parlors that waste capital in high-speed trading.  Crowdfunding and its related concepts will hit the reset button and return finance to its role as servant of product enterprise.  This is the future of civilization.

Full disclosure:  The author has no ownership interest in any of the crowdfunding platforms mentioned in this article, although he reserves the right to use any and all of them as an investor in enterprises and/or donor to causes.