Crowd Funding, also known as Crowd Financing, is the latest evolution of the Crowd Sourcing concept. Crowd Sourcing in its purest form is leveraging the collective efforts of many collaborating volunteers, usually in the form of a forum, to collectively solve a problem. The concept being that if enough people participate, the correct answer will rise to the top, just as we have seen with the Wiki concept.
The Essence of Crowd Funding
Crowd Funding, in short, leverages this model to help organizations source the required funding they need in order to meet their project’s required capital needs. Instead of people volunteering information, now they offer relatively small monetary contributions to projects that they feel are interesting or worthwhile. This pooling of many contributions adds up and the power of the crowd takes effect. This model has been successfully leveraged by disaster relief organizations like Red Cross, political campaigns, scientific research, and even open source software development.
Kickstarter, The King Kong of Crowd Funding
Well, it wasn’t long until entrepreneurs started to realize the power of the Crowd Funding and platforms started to appear online that were positioned to help startups and creative minds source the funding they needed to get their project off the ground. The most notable example being www.kickstarter.com, which has had many success stories including the Pebble Smart Watch, who was looking for $100,000 and ended up raising over $10,000,000. OUYA Video Game Console was initially seeking $950,000 and ended up raising over $8,500,000. These are of course some of the most funded projects, but there are many others that have found success is raising growth capital via Crowd Funding.
Investment Without Equity
The common theme with these platforms is that organizations or individuals offer something in trade for the money they receive, but not equity… not in the United States anyway. It was not until April 5, 2012 that President Obama signed the JOBS Act, with legislation that allows for a wider pool of small investors with fewer restrictions than currently allowed. The U.S. Securities and Exchange Commission was, at that time, given approximately 270 days to set forth specific rules and guidelines that enact this legislation, while also ensuring the protection of investors.This means that on January 1, 2013, there will be some major shifts in our country’s investment landscape. The significance and impact of these are not totally comprehensible at this point in time, but I believe that the two most affected groups by this will be Non-Accredited Investors and Venture Capital / Angel Investment Companies and here’s how:
Ever since the passage of the Securities Act of 1933, the SEC has maintained that if a company offers to sell equity to the public in a private transaction, those individuals who purchase equity must be an ‘Accredited Investor’. This basically means that you would either have to have a net worth of $1 Million or who be making over $200,000 per year in order to participate in such offerings. The fact that investors considering an investment in a privately placed venture are required to be accredited investors limits the universe of potential investors. Until the rules and regulations set forth by the SEC for this new Act are announced, it is hard speak to how exactly this is going to change, but one thing is nearly guaranteed is that such investment opportunities will be available to more people than ever before, and that is exciting.
Venture Capital / Angel Investment Companies
There is industry chatter as to whether or not these changes will affect the VC companies. I say that change is inevitable and the only question is how it will change the VC landscape? I believe there will be three notable shifts;
- There will of course be a rush to market for new online Crowd Funding websites that structure themselves to allow for investors to get equity instead of the promise of discounts on future products or services. There are already a handful of ‘placeholder’ websites that are already launched and undergoing SEO strategies to be in poll position by the time the clock starts. There are also serious players across the pond like www.seedrs.com who are establishing themselves now so they can be in a position to move into the US if and when the laws allow for it.
- Likewise, established Crowd Funding sites like www.kickstarter.com and others that have, up to this point, only been able to facilitate goods and service offerings to investors. These platforms will need to evaluate the pros and cons of staying focused on their present model or adapting to equity investment offerings. After all there will still be demand for the current trend because it’s no secret that a new company would much rather fund itself on pre-sales than it would in shelling out equity, if it can. But at the end of the day no serious investor would want to have ‘kickstarted’ Facebook.
- Lastly, I foresee some forward thinking VC firms adapting to this new trend. Evolving to a hybrid model would allow for a firm to endorse certain ventures and allow for more of a ‘public’ placement in any or all of their funding rounds. Because they are established and they do bring executive clout to the table, a VC firm could quickly rally an investment community around the companies they endorse. The gap here will be that crowd funding may be better suited for seed funding than VC funding, but that is an unproven assumption. Also, there are many industries such as manufacturing or B2B technologies for example that may struggle in immediately having investors embrace their business models as they lack the consumer appeal that successful crowed funding campaigns have demonstrated thus far.
In either case, Crowd Funding in exchange for equity brings up the point of valuation. Now that the person investing is purchasing equity, the question of how much they get for how much they invest is front and center. This introduces the subjective theory of value and will it will be difficult to establish or even standardize these valuations, especially for young or start-up ventures.
I for one am looking forward to watching the development of this evolving industry and its effect on our investment landscape. Our current economic conditions are such that more and more entrepreneurial ventures need money and our country’s banks sure aren’t making it available. With this creative new concept and forthcoming legislation, I feel that it will provide a much needed breath of fresh air into our economy and help keep alive the entrepreneurial spirit on which this country thrives. The timing couldn’t be better to once more illustrate how technology and the internet continue to level the playing field and create more opportunity for growing businesses to thrive.