Crowdfunding is the practice of leveraging small amounts of money from many individuals as capital for funding a project, business or cause. It is a nascent industry that is at the threshold of discovering its vast potential to transform global financial systems.
David Drake is one visionary leader among others in this burgeoning industry. Through The Soho Loft, he advances education and strategic collaboration in angel investing, venture capital, crowdfunding and other forms of innovative investing and entrepreneurship.
In this interview David shares his insights and knowledge of crowdfunding and its impact from a global perspective, as he is on a world tour that over the past six months has taken him to 20 countries. He also writes regularly for 30 magazines, including Forbes and Thomson Reuters.
How did equity crowdfunding begin?
Crowdfunding for equity began with Symbid in Holland, which claims to have started working on the regulatory framework as early as 2006. Meanwhile, Jenny Kassan and Danae Ringelmann broached the topic in the United States during the summer of 2010, before anyone else in the country. In retrospect, ASSOB in Australia started in 2007, but as we deconstruct its marketplace, we find that it is only allowed 20 unaccredited investors (earning less than AU$250,000 per year or having AU$5 million net worth, including a home) per deal. That is not crowdfunding for the real “crowd” – the non-accredited – as intended. Ideally, crowdfunding for equity is when you can raise capital from people over the Internet regardless of their income and without limits on the amount each person can invest.
What’s the most successful case you’ve seen?
For me, crowdfunding for equity is when you can invest an unlimited amount regardless of what your income is, and when more than two people submit money online toward a project. In this sense, the restaurant group Rushmore Group in the UK was the most successful, raising $1,579,550 from its patrons for a new restaurant in fall 2011.
Why isn’t equity allowed in United States? Why doesn’t the Jumpstart Our Business Startups (JOBS) Act support equity crowdfunding?
We are still waiting for the SEC to finalize the rules for the implementation of the JOBS Act in the United States. These rules are expected to remove the ban on general solicitation by companies seeking to sell their shares for capital. I wrote an article outlining the SEC process to implement the law.
How is crowdfunding for equity legislation going in the United States?
The process from the time the proposal is submitted to the Commissioners of the SEC takes about eight months, and then FINRA has to go through a similar process. Crowdfunding for equity is facing SEC legacy challenges from the 1933, 1934 and 1940 Acts that likely will delay the law’s implementation until 2015. Chairman White has just come into the position (see my article 10 Steps Needed by SEC, November 2012, outlining why) and she has to catch up and handle more important issues, like the Dodd-Frank legislation that is still not concluded after three years. She has committed to address the crowdfunding issue, but cannot consider submitting a proposal until this fall at the earliest. The law may be in place 12-18 months later.
What is the biggest challenge of equity crowdfunding?
Really, the only challenge that remains is the law itself, which is preventing practically everyone who has a little money to invest from becoming an investor. The technology that is necessary to transform traditional complex processes into simple automated processes is already right here, right now. The SEC-equivalent authorities and legacy laws in the various countries are the biggest challenges for this. Italy is closest, with a proposal that has been implemented. No country in the world has passed a law specifically for crowdfunding, so a country like Brazil could take the lead if legislative innovation and momentum exit. We are advising a dozen countries globally and writing on this topic in more than 30 countries.
What is the impact of equity crowdfunding on economics? Is there a significant impact or do you think it is still too early to analyze that?
When equity crowdfunding becomes legal there will be both an avalanche of investors looking for small companies into which to put their money, and an avalanche of small companies seeking investors to whom to sell their shares. The challenge we are seeing in Europe is that the industry lacks scale. We advise a couple of funds with global strategies on how to scale crowdfunding for equity today under existing laws; our writing and speaking engagements give us global insight into fund and company regulatory structures and regulations. The future is very promising, as this impacts jobs in small companies globally.
When analyzing the impact of crowdfunding, it´s possible to that it is changing the way people think about economics. How do you think equity crowdfunding has changed the ability to invest and raise money?
Ideally, equity crowdfunding will open up the financial markets to a horde of new investors all looking to put their money into the next big things. The hedge fund managers and angel networks I advise all indicate they want to invest small amounts of capital, to either monitor firms’ growth or to make sure they can buy the last 25% of stock outstanding if a firm gains momentum. Yes, crowdfunding for equity is allowing the non-rich to invest in early-stage firms, and not just the rich.
Crowdequity seems to be a risk investment. How would you convince someone to invest in a startup through an equity crowdfunding website?
Do your own due diligence and rely on investors with a track record on due diligence. I would also note the governance and transparency that an online crowdfunding for equity platform offers. You have easier access to information, executive team communication, governance and reporting. In addition, you can more easily find information, check backgrounds, and review previous jobs and successes of the principals, plus you can invest smaller amounts but benefit from higher returns, as fund raises are often much smaller.
How are the crowd equity initiatives doing in other countries?
The U.K. has the biggest momentum. Holland started working on equity platforms as early as 2007. Finland recently adjusted a law that allows for crowdfunding for equity in an unlimited amount, so Finnish nationals can invest as much as they want, up to a total maximum 1.5 million euro, without an offering memorandum being needed. However, we have not seen the expected momentum in Finland, as each investment has to be done individually and via the bank. Italy just passed the commenting period for a high-tech proposal of crowdfunding for equity, where investors would have no limit or restrictions based on their salary. I am speaking in Milano, Cambridge, Stockholm and London on these topics in the next few weeks.
Why did it develop so well in the U.K.?
It was the right time. Two conditions made the market ripe for crowdfunding: First, a lot of small entrepreneurs were desperately seeking at least £100,000 in seed capital and, unless they had wealthy family and friends, found it difficult to raise the capital they needed to get their businesses off the ground through traditional means. And second, a lot of small investors were looking to invest less than £10,000 in high-risk but high-growth businesses, and they, too, found it difficult (and costly) to do through traditional means. Crowdfunding provided the solution – a cost-effective, easier and faster way for small entrepreneurs to get funding and for small investors to provide that funding. It bridged that gap between small entrepreneurs and small investors. Also, the tax incentive SEIS program allows people to deduct 50% of their investment in a qualified startup against their ordinary income salary. That has spurred a deluge of small company investments and certainly is an incentive we must match in the U.S.
Italy will have a new equity crowdfunding law. How do you see the Italian market for crowd equity?
I have read the legal opinions of a dozen countries, and Italy is closest to my heart. I travel to Italy frequently; this year I will spend 45 days there over three or four trips. My love for Italy grows stronger each time I visit, and I try to visit Lake Como and Cinqueterre every time I go. But I digress. The Italian law that passed on Dec. 17, 2012, is powerful. Italy has surpassed the U.S. to take the lead in this space. It will be the first country in the world to implement a crowdfunding law. It says a company must be owned at least 5% by a financial institution to qualify to raise capital under crowdfunding, and then allows such companies to raise up to 5 million Euro. The limitation is that the firm has to be younger than four years and in the innovation, high-tech space. The law does not have the same red tape and restrictions of crowdfunding as the US JOBS Act. My firm is working closely with funds and institutional investors looking to strengthen partnerships with leading Italian banks and broker dealers. I am privy to information on when the Commissioners of Italy will sign the new law and will know in advance of its being publicized.
If you could forecast the future of equity what would you say?
I can see a country like Italy leapfrogging everyone’s expectations and implementing new crowdfunding laws. I also can see other nations like the U.K. jumping ahead and implementing new laws. This is a space that’s up for grabs right now, and countries are considering accelerating the democratization of investments in private offerings for all citizens.
What’s your projection for how much money crowd equity can move this year globally? How about in 2014?
Based on the $2.7 billion invested in all crowd funding in 2012, we estimate that equity crowdfunding will reach $166 million in 2013, and crowdfunding in general will bring close to $6 billion globally. So in percentages, crowdfunding for equity will retract until laws are passed to grant it more freedom. Please reach out to me if you want to see how venture capital funds are getting into this game and how the technology is applying to asset managers and wealth managers.
David Drake is an early-stage equity expert and the founder and chairman of LDJ Capital, a New York City private equity firm, and The Soho Loft, a global event-driven financial media company. He also writes regularly for Forbes and Thomson Reuters. You can reach him directly at [email protected] for comments.