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What Does Crowdfinance Mean for the Future of Traditional Finance?

Crowdfinance is on the tip of everyone’s tongue these days, and it’s not hard to see why. With the new rules issued by the SEC, the world of corporate finance, previously cut off and

Crowdfinance is on the tip of everyone’s tongue these days, and it’s not hard to see why. With the new rules issued by the SEC, the world of corporate finance, previously cut off and limited to the wealthiest individuals, major brokers, and banks, has been opened up to the general public.

But what does this mean to big banks? With both the available investor pool as well as the means of pursuing it expanding, what lies ahead for the middle-men who used to control the faucet of business capital? It used to be that one had to be an accredited investor in order to throw money behind a start-up or small-cap, and one needed a broker to arrange any investment, but those walls appear to be coming down. So where does that leave the more traditional actors in the world of finance?

Crowdfinance a New Source of Money

Estimates of how crowdsourcing could increase the flow of capital into the small-cap and start-up market are considerable, with some speculating that the current venture capital market of $30 billion could be increased as much as ten-fold.

And the chance for this to change the very culture of finance is profound. A business with naught but a great idea can take its potential for success straight to the people, and an average American with limited capital but shrewd business sense now has the chance to get in on the ground floor of growing companies and make massive returns.

Traditional Finance Currently Relies on the Old Model

But this potential $300 billion in capital could prove much more difficult to take advantage of for more traditional actors. In this bold new future, neither company nor investor will hypothetically need to rely on a broker to bring them together anymore. Brokers and banks that previously relied on fewer, bigger deals to make commissions may find it more difficult to participate in this new type of capital raising process.

With small sums of money flowing in from hundreds or even thousands of people, start-ups could potentially be looking at a new way to interface with their investors. And the ability of big banks to take their cut may not be as clear anymore.

Suddenly, finance has the look of the Wild West, with too many different financiers and projects for any one entity to completely track or control.

A New Slate of Crowdfunding Platforms

Trailblazing this new landscape are a new slate of websites dedicated to crowdfinance. They’re designed to put investors in contact with investment opportunities. Companies post their profiles along with fundraising goals and business plans, and investors can peruse the available options before purchasing equity and/or debt from the companies that strike their fancy. Investors can even register as accredited investors on some sites.

These platforms are awash with potential, and it’s an exciting moment for many in the capital-raising sphere. To the optimist, these platforms look like egalitarian idea forums; Darwinistic, free-market meritocracies that offer the greatest advantage to those businesses and investors with the greatest mastery of their business faculties.

However, to the pessimist, these crowdfunding platforms could look like giant Petrie dishes growing seedy actors and snake oil salesmen if not outright fraud.

Brokers and Banks as Doorways Rather Than Walls

Precisely what the capital markets will look like moving forward is unclear, but it seems like, while crowdfunding is likely going to be a major part of the world of finance in the future, that won’t mean the traditional world of finance is going anywhere.

The new SEC rules were only issued on Oct. 23, so the entire segment is very new. It stands to reason that as the market expands, more banks, brokers, and other traditional actors will sit up and take notice. As such, it seems very possible that major banks like Bank of America (BAC) or Citigroup (C) will operate their own crowdfinance websites at some point in the future, harnessing this new inflow of capital to improve their own balance sheets. Or, we could see the most successful of these crowdfinance platforms start getting bought up by those actors in the not-so-distant future.

And crowdfinance platforms operated by major banks might be able to offer certain things that smaller platforms can’t. It remains entirely hypothetical, but traditional banks could bring brand-name recognition to their platforms. They can field a larger staff to vet potential projects, potentially allowing them to weed out unscrupulous companies and potential fraud. And, with less potential for bad investments, it’s possible that these platforms will be even more successful in attracting investors and convincing them to take a chance on a growing start-up.

All of this strikes at the real purpose of a broker in the classic sense. Not just as an institutionalized middle man, but as an expert using their specific knowledge to help guide non-experts through the landscape. With so many new opportunities and so many new people looking to take part, it only stands to reason that brokers will have more opportunity than they have had in the past, even if their role as gate-keeper starts to erode.

Banks May Also Stay Away

By that same token, the nature of brand names could be precisely what keeps major banks out of the space, as well. The potential for having one’s carefully constructed, responsible brand image sullied by association with shoddy investments smaller investors might make on your site could be what makes traditional banking institutions keep their distance.

Even if they do, opening up new capital doesn’t mean that the old forms of finance will disappear. Accredited investors and more structured equity and debt offerings will likely remain a presence no matter how much success crowdfinancing has. For any number of companies, the appeal of going the traditional route will remain, leaving a large piece of the pie for banks no matter what their decision on new opportunities.

Small Businesses, Entertainment Could Change with Crowdfunding

Finally, another area that could be affected is small business loans. An influx of smaller investors could already provide a lift to funding in certain industries that capture the public imagination, like green energy or entertainment ventures. However, is it also possible that local small businesses might be able to use crowdfunding to their advantage?

Imagine that local mom-and-pop Italian restaurant you love so much for its brilliant food. The owners are hoping to move to a bigger space, or open a second location. Previously, their only real option would have been to go to the bank for a small-business loan.

Now, it’s not out of the question to envision a future where the restaurant would have the option to go to its customers and sell its new debt piece by piece, or even open up the business to investment and sell equity. While many (if not most) small businesses may not want to deal with the paperwork and public filings that would be involved, others may see the opportunity to go straight to a loyal customer base to raise capital as a major opportunity.

The Small Business Association wrote guarantees for just under $30 billion in small business loans for the 12-months ending September, 2013. Even a small portion of that market shifting to the crowdfinance segment could be significant. Some small businesses have already found success raising money through reward-based crowdfunding platforms, so it's not a tremendous stretch to assume that others may see potential for raising the money they need to expand by offering people a shot an actual return on investment rather than just a T-shirt or a gift certificate.

Future Remains Bright if Unclear

Precisely how the future of finance will look is currently unclear, and no one can say for sure just how significant these new equity crowdfunding rules could prove. Major banks may not need to take any major actions to be ready, and they may also ultimately decide to aggressively move into the space.

While it’s unclear what the future will hold, it does seem clear that raising capital should be much easier in the future for a lot of people who previously lacked a diversity of options.

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