Why Crowdfunding is Disrupting Finance
It is truly remarkable to think about the disruption that has resulted from the creation of marketplaces in almost every industry over the last few years. Need a restaurant reservation? Open Table has it down to a science- compare that to your experience just 10 or 15 years ago. Hotel rooms? Enter Airbnb. Clothing? Enter Poshmark. Dog sitter while on vacation? There’s DogVacay. Even scientists can help enlist a global network of researchers in a marketplace called Science Exchange. In industry after industry, consumers are gaining more information and more choices to make better decisions. With so many different marketplaces undergoing disruptive innovation, it is astounding to me that until very recently, the marketplace for companies raising capital was the same as it was 30 years ago: entrepreneurs go on road shows, spend months (or years) traveling to places far and wide to meet with potential investors and hope that at the end of the road there is capital. All the while, the entrepreneur is distracted from her #1 job: making her business successful.
As the founder of an online marketplace, we recently raised our Series A Round. Through the process we answered a lot of questions from very smart investors. One of the easiest went like this: “Today we see the total amount invested by individual investors into private companies is about $50 billion. But in our research we see that this amount essentially hasn’t risen in 15 years. Aren’t you guys just entering into a stale industry?”
No. Think about an industry in which marketing is prohibited (General Solicitation prohibits companies from advertising their capital raise) and the buyers and sellers are spread out across the country – possibly the globe. An industry in which there has been essentially zero innovation in 80 years. Why would there be growth that outpaces the GDP? Even if investors wanted to make more investments, their approach to finding opportunities is not meaningfully different in 2013 than it was in 1953. It is an incredibly dispersed, difficult and inefficient market in which buyers (investors) and sellers (companies) have the best chance of connecting if they both attend long angel meetings just as they would have pre-Internet. At least they might get free shrimp along the way.
These inefficiencies exist in fundraising for almost all small businesses, but they are even more pronounced in some non-tech industries, like consumer products. Consumer accounts for nearly 20% of U.S. GDP, yet less than 5% of venture capital investment, even though the Kauffman Foundation’s Angel Investment Performance Project found consumer investments produce cash-on-cash returns of 3.6x invested capital in 4.4 years. Why the lack of attention on non-tech? Silicon Valley and the venture capital firms ofSand Hill Road, by far the largest concentration of early-stage investors in theUS, grew up in the 70s, 80s and 90s investing in tech (then biotech) companies, and thus developed deep industry expertise in the tech space. This led these firms to pursue more tech investments and tech successes led to more promising tech firms seeking out these VCs—a virtuous cycle. Unfortunately, for non-tech companies, there is noSilicon Valleyand hardly any institutional investors who will write checks for companies with less than $10 million in revenue.
The colossal inefficiencies in the fundraising markets for small companies—particularly non-tech industries like consumer and retail—is why we founded our equity crowdfunding site last year.
This long-term transformation of private capital markets – from analog to digital – is what the ‘crowdfunding’ debate is all about. The internet does not treat offline intermediaries very well. Gatekeepers who extract a toll for hoarding information tend to get pushed aside as customers become empowered with the data and tools they need to make decisions themselves (think travel agents). For all the hyperbole (on both sides) of the debate around crowdfunding, the concept itself is hardly revolutionary: use technology to lower the cost to participate in the market, thereby expanding participation for both investors and companies.
So, what does the future look like? I foresee the increased use of digital technology to make it easier for investors to identify, diligence and complete investments in companies from all industries and sizes. As with the examples from other industries, value will be created by from the transparency. Both sides save time on networking, which can now be spent on diligence to make more informed investment decisions. Platforms that scale will provide investors, and companies, with more data and shared resources at lower costs – such as templates for companies to use in the capital raise, and background checks or data on in the industry overall for investors.
However, I do believe there will be many models for what we term ‘crowdfunding.’ For example, some platforms insist crowdfunding means all businesses should have an opportunity to raise capital. Others believe curation is critical to ensure quality control and provide some protection for investors- that the best marketplaces have standards. What type of companies (large/small/new/old), what types of investors (accredited/non-accredited), what security (equity/debt/donation), and what level of engagement post-investment (none/platform-driven/community-driven), are all business model choices for new operators.
The market will determine which specific models will survive, but the shift toward a more transparent, information rich and participatory private capital market will be unrelenting. As in the market for travel services, hotel rooms, clothing and dog sitters, with equity crowdfunding smart investors and worthy companies will be the beneficiaries.