There seems to exist in certain regulatory circles, particularly at the state level, a perception that Crowdfund Investing (CFI), when it comes on-line, will be rife with fraud. But this sky-is-falling mentality is unfounded and points to no structural or design problems with Title III and no data to support this conclusion. Contrary, the available data in markets where equity and debt crowdfunding currently exist (for example, Australia and the UK) supports the national imperative for crowdfunding and undermines their conclusion. The reason for this is that crowdfunding is based on one of the most powerful tools today for weeding out fraud, social media.
With the advent of the Internet, social media has gained prominence through websites like Facebook, Twitter, Google+ and LinkedIn. It allows anyone to share any information in a social network and allow others to comment on that information. Comments lead to further discussions and in many cases uncover nuances. It is one of the main reasons for the Arab Spring and successful political campaigns. Social media also drives consumer-buying patterns as people use it to rate products on Amazon.com and rate sellers on eBay.com. It allows individuals who cannot otherwise see each other to have a mechanism to develop trust while making buying decisions. This ‘circle of trust’ comes from the many-to-many interaction that takes place on these platforms.
This paper is meant to show how equity and debt crowdfunding, already in existence in other parts of the world has been operating fraud free for the past 7 years.
Case One: Australia – Equity Crowdfunding
The Australian Small Scale Offerings Board (www.ASSOB.com.au), founded in 2007, is the largest investment crowdfunding platform in Australia and one of the largest in the world. It is an equity crowdfunding platform that has successfully served both accredited and non-accredited investors since its inception over 5 years ago, raising $130,409,669 since 2007. 132 companies have been funded to date and not a single case of fraud has been reported. ASSOB operates within the current securities structure in Australia.
ASSOB uses a three-stage fundraising model (each stage is held at different valuations). Companies must be vetted prior to going on their platform. There have been 176 pitches funded since inception. 83% of companies funded are still operational (compare this to 50% of US companies that fail within one year according to the Small Business Administration). Subscribers have grown 26% annually, from 7,444 in 2007 to 23,859 in 2012.
Businesses can raise between $50,000 and $5M. (The limit in the US Legislation is $1M. Much lower than the upper cap in Australia). A wide range of businesses have been served, from seed to established, across most industry verticals. The average equity raised is $522,915 and the average equity offered is 21%. The average number of investors per issue is 14. The average size of investment is $38,023. This is comparable to a 2012 Study performed by the Crowdfunding Professional Association that found that Accredited investors in the USA will deploy approximately $30,000 into Crowdfunded opportunities. (Unaccredited investors will deploy approximately $4,000).
Issuers are required to choose a “Sponsor” to help with the fundraising process (preparing documents, due diligence, financials, etc.). These "Sponsors" provide an ecosystem of professional service providers to help guide businesses through the fundraising process. Sponsor fees range, averaging ~$5,000. ASSOB’s Business Model includes an on-boarding application fee of $990, a $3,960 one-time admission fee; monthly maintenance fee of $458 and a success fee of ~1.5% of funds raised). The true cost of capital in the USA has yet to be determined.
Once ideas are approved they go live on ASSOB’s platform. An issuer uses social media (email, Twitter, Facebook, etc) to reach out to their social network to attract investors. Investors are allowed to comment on pitches. Issuers must defend comments on platform in an open dialog. Transparent Issuers that meet the confidence of the crowd with sound business models are funded. No fraud has been reported.
Case Two: UK – Equity Crowdfunding
Crowdcube (www.crowdcube.com) is the largest equity-based crowdfunding platform in the UK has been operating since February 15, 2011 with no reported fraud. Crowdcube operates within the current securities framework within the UK and allows issuers to raise equity capital using an online portal.
29 pitches have been funded with £4.25M. Average raise is £146,552. Average equity given up is 16%. Average numbers of investors is 63. Average days to fund are 51. Average age of entrepreneur is 40 and total number of registered investors is 24,023. No fraud has been reported.
Case Three: UK – Debt Crowdfunding
UK based, Funding Circle (www.fundingcircle.com) was founded in 2010. It is an online marketplace enabling savers and investors to sidestep banks and directly lend to small businesses. Funding Circle differs from other lending platforms in that it facilitates loans to businesses, rather than consumers while also proving easy access to investors’ money at any time. It provides low cost finance for small, UK firms frustrated by the loan terms offered by the banks.
The monthly repayment loans available are for one, three or five years and for between £5,000 and £250,000. Each loan is comprised of small amounts of borrowing from many different people who compete to lend to the business in question, enabling it to borrow at a better rate. With no bank in the middle, both investors and borrowers achieve a better deal.
Funding Circle investors receive 8.4% interest on average. Some investor specific statistics: 27,000+ investors registered with Funding Circle. The average amount an active investor has in their account is £5,000. Average gross yield is 9.1%. Investors recently exceeded a total lending of £63 million. Average loan amount approximately £60,000. Approximately 1.5% bad debt ratio. Business borrower statistics: 1200 + businesses have borrowed via Funding Circle. More than £1 million lent to small businesses every week. Similarly, there have been no reports of fraud. (Additional statistics can be found https://www.fundingcircle.com/statistics).
Case Four: US - Fraud Derailed
An example of fraud that was derailed on a portal is a campaign on Kickstarter called Mythic. From Techdirt.com:
“A recent video game project on Kickstarter that turned out to be fake. As BetaBeat reports, the crowdsourcing scam was exposed by a crowdsourced investigation:
... a campaign for an action video game, MYTHIC: The Story Of Gods and Men, has just been busted by forum users at Reddit, SomethingAwful and Rock, Paper, Shotgun. The creators claimed to be an independent studio, “Little Monster Productions,” of 12 industry veterans in Hollywood. “Our team has done a significant amount of work on the World of Warcraft series as well as Diablo 2 and the original Starcraft,” says the project page.
Bull____, said the Internet. Turns out the art was cribbed, the text for backer rewards was copied and pasted from another Kickstarter project, and even the office photos were from another game studio, Burton Design Group.
When people brought their accusations to the Kickstarter comments, the developers made a few weak attempts at deflection then quietly shut down having raised just under $5,000 (far short of their goal, so that money won't actually be released). With Kickstarter gaining more attention every day, we're sure to see more attempts at scams—and maybe even some successes—but with a savvy community that polices itself like this, the scammers face an uphill battle.”
Technology has become a common component in our daily decision making process. Using the feedback from the community has also become a common way in which we further analyze our decision. In today’s technology driven world, if you want to know about a new restaurant, you may well consult Yelp.com, if you want to buy a product you look at the Amazon.com ratings or if you wish to purchase a something from someone you don’t know on ebay.com you check out the seller ratings. This is the new crowdsourced diligence paradigm. There was little transparency in the Venture Capital world, until the site TheFunded.com emerged, and became the "Yelp of Venture Capital" by having the portfolio companies rate the VCs. What is the equivalent site for rating entrepreneurs? Essentially, it doesn't exist, because there are no major crowdfunding platforms to support it. Title III will fill this void. Knowing that social media has helped provide transparency in these other markets can also help provide the same transparency and credibility to the crowdfund investing market.