The first image that comes to mind when someone mentions the word “crowdfunding” is of flash mobs dancing in public squares, with their minders taking donations only a few steps away. Other unwitting readers may imagine that crowdfunding is the practice of mobilizing masses of people in the streets through financial contributors to movements such as #Occupy. The actual truth of the matter is that while crowdfunding is indeed related to mobilizing masses – usually through Internet campaigns – this practice is actually a successful financial tool that is quickly gaining traction by offering interest from the success of big projects to “small investors”.
Crowdfunding is a relatively simple idea, and it operates upon the premise that people donate directly to social causes without the use of an intermediary agent such as a charity. In the world of corporate business, the practice works in the exact same way, except instead of crowdfunders donating to a charitable cause, they make investments in various enterprises and they expect returns. While crowdfunding equity investments is said to be the “most contentious” form of this practice – partly because of its formerly illegal status in the United States (that has since been discarded by the new JOBS Act) – this tool is undeniably successful in uniting entrepreneurs with huge numbers of potential investors – and capital.
The advent of social media networks such Facebook, Twitter, Reddit, DIGG, and others, means that a myriad of online communities are now available for entrepreneurs to advertise their campaigns to potentially millions of individuals – usually free of charge. Social media platforms and the Internet have made it possible to tap into huge pools of investors, offering them equity and interest on their investments in corporate ventures for the tiniest contributions known to Wall Street. In this way, crowdfunding schemes have raised more than $1.5 billion in over one million projects in 2011, and according to Forbes those numbers are bound to double by the end of this year. Crowdfunding project such as Indiegogo make it possible for those soliciting financial contributions to reach out to potential contributors interested in “entrepreneurial, cause-related, or creative ideas to generate funding online.”
Crowdfunding is increasingly gaining increasing traction as a popular and remarkably efficient method to connect entrepreneurs with investors and allow them to raise capital thanks to the widespread popularity of social media – especially in Canada. It is not without its fair share of detractors though, including top financial regulators such as the US Securities and Exchange Commission (SEC) and the North American Securities Administrators Association (NASAA). In fact, it was only in the last few months that the SEC removed legal challenges to crowdfunding, including “a ban on general marketing of such securities as private company stock,” following closely on the heels of the JOBS Act legislation coming into force.
Legal obstacles aside, the practice of crowdfunding is also sure to be a hit with scammers and fraudsters around the globe. Securities regulators like NASAA have recently warned about the threats posed to investors by crowdfunding ventures, with fraud and abuse of funds being two main concerns. William Galvin, Massachusetts Secretary of the Commonwealth, stated that “longstanding problems in the markets for small and speculative stocks show the pitfalls of relying on the wisdom of crowds.” Other threats noted by NASAA include (but are not limited to) “precious metals sales and investment pitches; fraudulent investment in distressed real estate; abuse of promissory notes, which are often linked to Ponzi schemes; scams related to self-directed Individual Retirement Accounts; investment-for-visa schemes” and many more.
For Canadians, one would think that the absence of a national securities regulator would loosen the restrictions on crowdfunding efforts, but in reality this is not the case. In fact, entrepreneurs looking to establish the practice in Canada would have to individually go through the independent securities regulators in each and every one of Canada’s thirteen provinces and territories, which would no doubt be more time-consuming than in the US with the SEC. For many investors, entrepreneurs, and venture capitalists, at this point it’s just too much of a hassle to try and establish crowdfunding in Canada without one clear set of rules to govern securities across the nation.
With crowdfunding still in its infancy and subject to a whole phalanx of legal obstacles in the United States and Canada, it is clear to see why investors and companies are still wary about adopting the practice as a new tool in the socially responsible investment toolkit. However, despite all the concern over fraud and all-around bad guys trying to take advantage of ethical investors, it may well be that these fears are unfounded – or at the very least, overblown.
One blogger astutely notes that critics of crowdfunding ignore fundamental “investor safeguards that exist in the [JOBS Act] legislation” and that they furthermore assume that the target audience of crowdfunding schemes “cannot possibly be smart enough to a) identify a good idea, b) determine who is a credible individual, or c) make an informed decision about an investment that they decide to make with their hard-earned dollars.” I’ve personally heard that argument emerge from within the ranks of the SEC and NASAA recently, and it begs the question that if people aren’t wise enough to know where to invest – according to this line of thinking – then how can they possibly be intelligent enough to elect a government which itself appoints the regulators who call these investors’ competencies into account?