As crowdfunding gathers speed, financial industry changes loom

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Benefits Canada by Yaldaz Sadakova | August 26, 2013

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Source: Benefits Canada

Lucrative deals might be just a click away for Canada’s pension funds and other institutional investors.

Unlike retail investors, the country’s institutional investors can now access a wider range of investment opportunities in a more immediate and transparent manner through institutional crowdfunding—a phenomenon that allows companies to raise capital from numerous investors via the Internet. This is thanks to the recent emergence of a Canadian online marketplace that matches institutional investors with issuers. This development could take away at least some business from investment banks, which are typically the intermediaries between big investors and issuers.

In early August, Optimize Capital Markets launched the first ever Internet portal in Canada, which connects institutional and accredited investors with public and private companies across the country that are seeking growth capital. On this platform, investors can either lend money to businesses or buy equity.

“Both the deals are much larger, as well as the investors, which are primarily institutions,” says Matthew McGrath, president and CEO of Optimize Capital Markets. While issuers have to pay fees to be listed on the virtual marketplace, there are no fees for the investors, who can sort through opportunities in the range of $2 million to $30 million, McGrath says. The portal expects to close its first transaction later this month for $2.57 million, he adds.

Optimize is an exempt market dealer, which means that it deals only with institutional and accredited investors, which, unlike individual investors, are able to buy securities that are exempt from disclosure requirements, according to the Ontario Securities Commission (OSC). Optimize is registered with the Ontario, Alberta, British Columbia and Quebec securities commissions.

Transparency
The main advantage of using Optimize compared to searching for deals offline is that it does a lot of initial due diligence on behalf of investors, increasing transparency, explains McGrath. The website offers a lot of data about each company listed—everything from informational videos to financial details and risk profiles.

But Avi Goldfarb, a professor of marketing at the University of Toronto’s Rotman School of Management, offers a word of caution. “It’s hard to verify the claims that you see on a website,” he says.

Optimize’s solution to this is that after investors go through the data posted on its portal, they can set up a meeting with representatives of the company they’re interested in. “Certainly, institutional investors that will be cutting checks will want to reach out to a senior director,” McGrath explains.

Risks
Apart from the potential for deceit, institutional crowdfunding poses another risk for investors. While it “might enable them to fund a wider set of projects,” many of these opportunities might be risky, says Goldfarb. The reason is that, generally, the companies listed on equity crowdfunding sites are early-stage projects, which are inherently risky. “They’re often projects that are not funded through other means,” he explains.

But Optimize says most companies listed on its portal are not new ventures. “The most typical companies looking for funding are well-established firms with skilled leadership and with good cash flow,” according to its website.

The future
So with the arrival of Optimize, what does the future hold for institutional crowdfunding in Canada? The reasonable expectation is that, over time, other institutional crowdfunding websites will spring up in the country.

But it’s unclear how many of them will survive, according to Goldfarb. “This is the kind of market that requires size,” he adds, explaining that, as the name crowdfunding implies, the success of these online venues depends on having many issuers and many investors.

“There’s likely to be some success; there’s likely to be some spectacular failures,” Goldfarb says. “How the market plays out is an open question.”

But one thing that is clear is that the growth of institutional crowdfunding will take away at least some deals from investment banks because crowdfunding platforms essentially act as investment banks, explains Goldfarb.

Some proponents of crowdfunding are even bolder in their prediction. “Let’s face it, crowdfunding is the new investment banker,” wrote Dan Levitan, co-founder of American venture capital firm Maveron, in a recent blog post.

No so fast, says Goldfarb. Investment banks will be able to keep certain deals because “expertise is still very valuable and most investors don’t have expertise at the level of investment banks,” he explains. “Institutional investors have expertise, but it’s still costly to search through opportunities.”

That’s why it is not clear whether institutional crowdfunding will be the next big thing in the financial industry, Goldfarb says—even though this is how many of its supporters describe it. “I have no idea,” Goldfarb admits. “I think anybody who says they know also has no idea.”

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