To question the merits of crowdfunding seems a surefire means of being awarded an OC – Order of Curmudgeon. Millions of person hours have been devoted to introduce it to the world and more than a few forests consumed by its advocates. There is clearly some steak, $10 million of prepaid Pebble watches being an excellent case in point. One case in point, however, does not a society reshape. In this essay, our thrust is to discern over the years to come whether the highly audible sizzle is to be matched by steak in the founders’, then funders’ stomachs.

A little historical perspective seems warranted. Few now question that society’s realization of ubiquitous computing has reshaped industries in the last two decades. Even fewer question that one of society’s core functions, the allocation of savings, will or should be exempted, particularly post 2008. Those saying that there is both sizzle and steak in deployment of the hardware and software of the Internet and mobile phone to improve the allocation of capital in society are surely on the right side of history. We will get products that otherwise would not have seen the light of day, as Kickstarter so clearly demonstrated by being the means of financing the Pebble Watch when existing sources of funds choose not to invest. The watch was bought by 68,000 customers.

Nor is there doubt that opportunity for improvement exists, some would say abounds, in the capital market’s processes in respect of funding new entrants, a fount of new processes, products, and services. The creator of AngelList estimates that 20 per cent of the 700 new weekly listings requesting funds merit consideration. Given that an active angel group in Canada looks at 20 opportunities a year, and under the current rules invest in two or three, proponents of equity crowdfunding are again on the right side of history in arguing for more sources of capital. Equity crowdfunding advocates seek to implement their realization that it is technically well within our means to deploy the technologies underpinning crowdfunding and allow entrepreneurs to offer shares rather than products in exchange. We have decided on the latter. Should we do so for the former is the issue.

To gain insight into a response to the issue, our Capital Market Note looks at some probable impacts of the deployment of equity crowd sourcing on Founders, Funders and beyond, to the functioning of two core tasks of our society, allocation of capital and economic fraud.

Founders helped to ‘fail early and often’

Knowing that there is increased availability of funding would bring joy to the heart of any founder, at least initially. A key promise of equity crowdfunding is that anyone in the world can chip in a thousand or two: so raising a million takes less than a thousand people. Even if the idea is beyond the pale of most of us, funds are more likely to be made available through crowdfunding than currently used approaches because of the worldwide reach of crowdfunding platforms.

Many a founder’s joy would be quickly tempered by the realization that crowdfunding undermines the old complaint that that “investors don’t get it.” There is really no more hiding behind that reasoning. More reflective founders would also realize (as did Tracy Clark, founder of Bridgeheads chain of coffee shops) that lack of funds is not the only challenge to be met. She mused publicly that maintaining the Bridgehead culture could be imperiled were too much capital too readily available. Availability brings home to founders the other half of the capital raising equation, the responsibility to use other people’s money to create wealth, not destroy funders’ wealth and their own as well.

Adding to the founders’ burden will be that dispersed crowd funders cannot easily have a lunch or a coffee and come to a conclusion about the founder’s trust worthiness and capability by use of a face to face meeting. How will funders make the judgment call about the founders’ capacity to position and reposition the business over the years required to attain positive stable revenues? Look for someone who has already made the assessment? Seek third-party validations? Some founders will surely seek a competitive advantage by providing third-party validations as part and parcel of their offering to funders.

Another burden for founders will be to assure themselves that the funders’ incentives are well aligned with those of the founders. How will funders get a return of their capital and a return on capital is central to minimizing misalignment. Founders will learn to think this through clearly. Their starting point will be to estimate what the business model and projections show the firm can afford. Equity may simply be too expensive for many. So getting the right kind of money in the right quantities from the right kind of people for their business will remain a critical part of every founder’s preparations for the money chase. Expect to see the rise of investment banking functions to support equity crowdfunding in various platforms and possible as a classic fee for service investment banking organizations.

Use of crowdfunding, whether in exchange for equity or for goods such as a Pebble watch, brings with it burdens new and old: but one great advantage is generated. Achievement of the old dictum “fail early and fail often” on the road to success, becomes much easier, particularly for products. For many products, proof of market is built in to the process far earlier than the old “build it and they will come” model encrusted as it is with gate keepers. For founders, one of the pleasantest possibilities inherent in crowdfunding is that niche ideas will be economically feasible to a far greater extent than today. In turn this will allow more entrepreneurs to succeed. No small improvement given the failure rates for new firms.

Lastly, founders are bound to observe that if what they want is capital, they can offer goods or even services on a pre-paid basis and get it. Shades of Michel Dell in his dorm 30 years ago. The anticipated insight for founders will be to reason that the barrier to equity crowdfunding as a source of funds is that issuing shares or warrants falls under securities legislation. And it does for just one reason, it is the form used not the fact that consideration is offered.

We are left to speculate why the Michael Dells of the world would not simply offer two computers – one of which could be sold by the funder. Pebble allowed multiple purchases. It is only a small step to raise funds by offering to pay those providing cash a finance contract, for example a royalty on future sales, instead of a prepaid product contract. No corporate securities are issued: cash is obtained.

Tomorrow, Peter examines how crowdfunding could impact existing investors and society at large.

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  • http://twitter.com/cdlingHQ cdlingHQ

    Sorry – you lost me at “more than a few forests consumed”