My own interest in Crowdfunding goes back only about one year but there are few old timers like me in this now exploding corner of the capital markets. By now I have now read hundreds of articles and studies, spoken and corresponded with people who were instrumental in getting the JOBS Act passed and people who work in the Crowdfunding market every day.
I admit that I am fascinated by Crowdfunding. I see it as especially beneficial to smaller companies who can now raise capital in a regulated environment. Much of the literature focuses on the benefits of that capital to those companies and the benefits of those small companies to the general economy.
Very little seems to have been written on how this market will attract investors. If anything, there seems to be an attitude that suggests that ”if we build it, investors will come”.
Up until now, Crowdfunded offerings could only be purchased by “accredited investors”, wealthier people who are supposedly sophisticated enough to evaluate a private offering themselves and who are presumed to be wealthy enough to accept a loss if the investment tanked.
Before Crowdfunding accredited investors were sought out for private placements offered under Regulation D. Reg. D offerings are generally made through regulated brokerage firms where professional salespeople sell them to investors and are sometimes motivated by high commissions.
Crowdfunding is attempting to compete with these live salespeople using mostly passive portals and social media. It is not the same. Social media is just a tool. What Crowdfunding needs to embrace is a message that these investors want to hear.
A significant number of Reg. D offerings are real estate or oil and gas production syndications. In a great many of these offerings investors are promised a share of the rents or royalties or some other monthly or quarterly income stream. Some of these offerings offer tax benefits that are attractive to wealthy investors.
There are many established sponsors in the Reg. D market. These companies fund project after project through private placements. The larger sponsors can often point to a track record of success. By success I mean that prior investors were able to cash out for more than they invested.
Crowdfunding is too young for any company to post a similar track record. Crowdfunding counts its successes by how many companies get funded. As Crowdfunding matures it needs to judge its success by how many investors make money.
Only a small portion of the people who qualify as accredited investors actually invest in private placements. What exactly is the Crowdfunding industry doing to lure these private placement investors to Crowdfunding websites? The short answer is: not nearly enough.
The Securities and Exchange Commission (SEC) has recently opened Crowdfunding to all investors. Many smaller investors will be restricted to investing no more than $2000 on Crowdfunding portals each year. The SEC understands that with any Crowdfunded offering there is a high risk that the investors will could lose their entire investment.
Since we are speaking of only $2000 of non-essential income, it would seem more logical that people might opt to take that amount money to Las Vegas and put one dollar at a time into a slot machine. Statistically, slot machines pay out about 97% of the money that people put into them. Whether you ultimately win or lose has a lot do with when you stop. If you play a slot machine for long enough the casino is likely to buy you a beverage.
Investing that same $2000 in a small business through a Crowdfunding portal would have a significantly higher risk of loss and demonstrably less entertainment value. I see a lot of ads for Crowdfunded offerings and to date none has included a drink coupon.
The allure of Crowdfunding to any investor is the chance to cash out big. For the vast majority of Crowdfunded businesses that is very unlikely to happen even if the funded company is successful.
To date, there is no meaningful secondary market for Crowdfunded offerings. An investor who invests in a company that does well may still not get their money back to spend or invest in other offerings.
What will the Crowdfunding portals offer to entice any investor to bring money?
There is a lot in the Crowdfunding literature regarding the use of social media campaigns to sell offerings. This reliance upon social media actually highlights a weakness in the Crowdfunding system.
Investors who are solicited by a single company because they are suppliers or customers of that company or friends of the management have no reason to evaluate any other offering on the same portal or other portals. The portals should not expect these investors to become repeat customers.
If an investor does not get interest or a regular share of the profits, cannot cash out and has worse odds of success than at a slot machine, it is easy to see that the Crowdfunding industry still has will have some work to do. Once the “newness” of Crowdfunding wears off investors will need better deals and better incentives for investors.