Crowdfunding websites - Equity Crowdfunding: Next Generation of Angel Investors Is Not Sorry to Disrupt

posted May 6, 2013, 2:20 PM by David Khorram
Nikola Tesla wrote once, "The present is theirs; the future, for which I really worked, is mine." I can see this being quoted by any supporter of equity based crowdfunding (or crowdinvesting) -- an innovative online tool that would give you a legitimate right to own a stake in a company you choose to invest in. Just like angels investors do.

Now, if you think you can invest too, join the club and have a nice... fight.

There are several equity-based crowdfunding portals here in the U.S. that are already operational such asAngelListThe FundersClubEarlyShares orRealtyMogul. But since the private investors in the U.S. must fit an accredited investor profile (Rules 501, 505 and 506 of Regulation D) - there is only 1 percent of the population that is allowed to utilize such an option.

What is left for the remaining 99 percent? Everyone else can hold onto publicly traded stocks, real estate or commodities -- passive investments with no impact, in other words. Ah, there is also Vegas ($6 billion in revenues in 2012gross gaming revenues totaled $34.6 billion) and in fact, the online gambling has been legalized in three states. Bingo!

I spoke with a number of prominent angel investors. Dave Berkus invested in over 90 companies and 4 companies in his portfolio generated 97 percent of his new wealth. Amir Banifatemi made 34 investments and 4 of them were successful. Numbers game? Some of the investors confessed that it is. Even despite the fact that they spend up to 50 hours per company on due diligence, at the end of the day a rationality behind it is to hit a "jackpot" to cover prior losses.

What about non-professional investors then? One of the most successful serial-entrepreneurs-turned-angel-investor David Carter told me that "there are many private individuals that outperform the strongest hedge fund managers which will probably happen in equity based crowdfunding."

The saga with crowdinvesting officially started on April 5, 2012 when President Obama signed the JOBS Act into law, but the Security and Exchange Commission (SEC) dropped the ball, having not yet arrived with the anticipated regulations (you can add your comments for the SEC here). The JOBS Act's signature provision is the relaxation of an eighty-year old general solicitation rule which would allow everyone in the country to have a right to invest in the private companies, regardless of his or her economic class.

The main watchdog's concern is the investor's protections. As the SEC explains on its website, "to invest" is "to engage in any activity in which money is put at risk for the purpose of making a profit". Ironically, making a profit has become the wrong incentive for some folks like Goldman Sachs or Citigroup -- check out the list of the SEC enforcement actions.

But you might get even more surprised if you fancy reviewing the report by the North American Security Administrators Association (NASAA). In the report NASAA ranks the investments products involvement in enforcement actions and the most reported one is ... the notorious Rule 506 Offerings. As you might guess, NASAA is the most active organization that opposes crowdinvesting.

I've turned to my international colleagues including German, French, and Japanese conducting an "un-academic" survey. I've been wondering whether in their countries you have to fit a certain investor's profile too. The only country I spotted that imposes some limitations is France, where you would need to fit "investisseurs qualifiés." France has a skyrocketing unemployment rate of over 10 percent while, for example, Germany is doing quite well with the rate twice less than of France's. Coincidence?

Ronald Kleverlaan, co-founder of the European Crowdfunding Network, shared with me that 118 businesses have been financed in 2012 with the average investment of 360 Euro per investor and around 100 investors per campaign in Netherlands where the equity based crowdfunding has been operational for the past two years. Games as well as social and sustainable projects are the most popular choices in the "menu." No fraud has been reported.

I am all for the coherent investors' protections regulations and I am also for the equal rights even if it is a right to lose. The problem is that a lot of folks suspect that equity crowdfunding is just a harbor for another financial innovation with a flag hanging over a roof "this time it will be different." But what is more - they don't see the fact that we are dealing with a) the direct investments - the type of investments that create jobs and b) digital economy where a reputation of the participants prevents fraud and market manipulation.

If you agree with me that the Internet is based on trust, compassion and transparency (think Facebook, Wikipedia or Yelp), you will recognize that the crowd investors are not the investors in a traditional sense we are used to thinking of. These are the people who would make their due diligence from the customer or human point of view rather than from a pure financial return. They would like to get involved (how about becoming a shareholder of a new gym?). They would embrace a sense of fairness (dare to "like" the company that outsources its operations to some sweatshop in China? The Facebook troops are marching already).

Something very wrong happened when investing in private companies became available for very few people who would, in a way, eventually try to "crowdfund" their ventures by going public. Ultimately, it has all become about exit strategies instead of healthy cash flows (aka dividends) that healthy business would be capable to deliver to its shareholders.

I believe that by shifting the focus from solely financial wealth to the community wealth, crowdinvesting has a substantial promise to become that exact impact investment when commitment to long-term economic value would balance the risk of an investment strategy. The last one will be going hand to hand with a direct involvement and desire to make a difference.

The true disruption that is waiting to happen is actually not in this emerging financial tool, but in our way of thinking.

Posted from:

Victoria Silchenko

Founder & CEO, Metropole Capital Group