Dispelling Myths #3 and #4: “Extraordinary popular delusions and the madness of crowdfunding”

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NCFA Canada | Posted on August 8, 2013

dispelling myths

Note to readers: This post is part of a series of posts written on behalf of Canada’s leading industry crowdfunding association, NCFA Canada, its members, and affiliates. Special thanks to our sponsors Joi Media (Katipult), FundRazr, Amplifi, CNW, and Wires Law, and the following contributing thought leaders including Craig Asano (NCFA Canada), John Wires (Wires Law), Christopher Charlesworth and Asier Ania (HiveWire), and Heri Rakotomalala (Seeding Factory).

On July 31, 2013 an opinion post article in the Financial Post’s comment section highlights the wide disparity in thinking between the established finance industry insiders and the rest of the world (view article).

It appears the world can be divided into two camps:

Camp A: Those that feel the general public or ‘crowd’ should have little or no participation in private market placements because they are thought unfit or incapable of adding value to the process, and the regulations required to protect them would duly outweigh the benefits they may receive from participating in the first place. Further, investing in start-up or growth capital investments is a risky game that should be left to professional VCs and sophisticated investors alone.

Camp B: Those that feel the general public or ‘crowd’ should have the choice to participate in private market placements in a regulated capacity, and that the general public is motivated to seek returns that go beyond financial incentives alone, such as supporting innovation, regional job creation and social impact goals. Equity crowdfunding markets globally have demonstrated that crowds can play a significant role in helping small to mid-sized enterprises (SMEs) access start-up capital and the necessary support to achieve business goals that would otherwise be unavailable to them in traditional capital markets.

To assist readers in making their own unbiased conclusions, NCFA Canada offers readers a response to the myths or one-sided beliefs that were conveyed in the FP article:

Myth 3: VCs and wealthy angels will not invest in companies with ownership structures that have many minor investors in them

RESPONSE 3:  Legal co-operatives and nominee structures can support crowdfunding transactions

Canada can learn from legal structures being used overseas to successfully facilitate equity crowdfunding

  • legal structuresIn the Netherlands, Symbid, a leading equity portal bundles all crowd investors of each successfully funded business into an investor co-operative, which acts as a single shareholder within the legal entity of the entrepreneur.
  • With this model, VCs that participate in follow-on investment rounds only deal with a single elected Board member.
  • This offers the best of both worlds:  the benefits of wide resources and crowd participation combined with streamlined decision making capabilities.
  • In the UK, Seedrs, a leading equity crowdfunding portal, uses a nominee structure where crowd investors appoint the platform itself to hold legal title of the securities on behalf of crowd investors who are still able to vote but are relieved of the burden of investment administration such as tracking corporate events, attending meetings and following investment performance.

Many VCs openly support equity crowdfunding as a means to fund early stage businesses that feed into wide venture capital markets

  • There are many venture capitalists in Canada that openly support the inevitability of equity crowdfunding (e.g., Chris Arsenault's blog) as a way to fund high risk earlier stage of start-up businesses to the point that they have demonstrated sufficient traction and management ability before getting snapped up by a VC in a future round.
  • They indicate that crowd investors are already participating in deals through angel investment matching networks, such as Angel List in the US.
  • Crowdfunding is a feeder system to a much wider venture capital network, and we can only expect to see more partnerships forming as more fundraising activities are moved online.

Myth 4:  High Risk of Business Failure and Fraud

RESPONSE 4: The crowd will help to detect and report fraud.  Businesses will fail but some will iterate and achieve tremendous innovation through failure

fraudFraud and business risks can be identified and mitigated with education and technology

  • Fraud in any area of the financial system should not be tolerated, and crowdfunding is no different.  Industry stakeholders, government and academic partners need to collaborate to actively identify, report and prevent fraudulent activity and develop the appropriate safeguards to protect and advance the industry full stop.
  • Fraud and business failure isn’t limited to private companies.  Look at Sino Forest for example, where sophisticated financial and legal professionals performed reams of expensive due diligence to the tune of a $6 billion market cap only for the entire organization to collapse as a ‘ponzi’ scheme.   Canada isn’t a ‘nanny state’ nor is it anti-business, so while public market activity marches, what about crowdfunding?
  • The larger issue facing consumers is the risk of failure inherent with any new business venture, however this is expected risk and the crowdfunding industry will play a strong part in educating consumers by advising them of the various risks to their capital.  There are over 60+ Canadian portals and a growing list of providers looking to help and NCFA Canada is working to provide best practice education for SME issuers, investors and industry stakeholders with partnering sponsors.
  • Tools such as duration based page-timing, online testing, cooling off periods, and double opt-in consent provisions can be employed to educate participants of risk and maintain a verifiable record that investors were informed and consented to bearing that risk.

Innovation is an iterative process that requires effort and failure to germinate success, increase productivity and affect breakthrough change

  • Innovation doesn't occur in a vacuum yet CAMP A would have us believe that failure is a bad thing.  For the rest of us in CAMP B, we support innovation and understand that crowdfunding will help more projects and ideas get funded than traditional financing allows, thus allowing innovation to iterate and in some cases flourish.  Some of those projects will most certainly fail, but some will grow wildly successful in unexpected and rewarding ways.
  • Although Canada has world class education and thought leaders our ability to innovate and commercialize locally grown businesses is limited, and thus so is Canada's ability to compete on the global stage.
  • Abraham Lincoln once said, "My great concern is not whether you have failed but whether you are content with your failure".  In many ways, our current capital markets and securities laws are failing to provide SMEs with sufficient access to capital resulting in a well documented 'funding gap' (STDC report).  Collectively, are we content with this failure?

WHAT CAMP DO YOU SUPPORT?

innovation

Crowdfunding is about providing capital to the rest of us - to that broad swath of the Canadian public that doesn’t have friends on bay street, isn’t connected to VC’s from the valley, and doesn’t have their private banker on speed dial. In fact, CAMP A sentiments simply underscore the reality that capital is constrained, and primarily accessible to a very small and select group of people.

Innovation is happening everywhere, and in every group, including those that are typically overlooked by the traditional financiers. However it is often occurring at a small and incremental level, rather than at the ‘home run’ level that CAMP A refers to.

Crowdfunding is certainly not going to be looked favourably upon by ‘wheezy old securities lawyers’ disinterested in rolling up their sleeves to innovate and change the currently expensive process that seems to benefit their practices in the first place. Change requires hard work and effort, and in this case, the beneficiary is the public and small to mid-sized businesses asking for help.

Who’s going to rescue them? Wheezy old securities lawyers; or new, dynamic online investment communities powered by crowdfunding markets and new technologies.  You know which camp gets NCFA Canada's vote.  How about you?

Resources and Links:

View Dispelling Myths #1 and #2

Stay tuned for Dispelling Myths #5 and #6!

 

The National Crowdfunding Association of Canada (NCFA Canada) is a cross-Canada crowdfunding hub providing education, advocacy and networking opportunities in the rapidly evolving crowdfunding industry. NCFA Canada is a community-based, membership-driven entity that was formed at the grass roots level to fill a national need in the market place. Join our growing network of industry stakeholders, fundraisers and investors. Increase your organization's profile and gain access to a dynamic group of industry front runners. Learn more eBrochure | Prezi or contact us at casano@ncfacanada.org.

 

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6 Responses to Dispelling Myths #3 and #4: “Extraordinary popular delusions and the madness of crowdfunding”

  1. Antonio (Tony) Arias says:

    Myth No 4 – crowdfunding or not, whether we use the public capital market or the private capital market, business fails at most times because of bad management, not because of fraud. As an entrepreneur and a professional manager, I am armed with more education and experience than most, but I also had my bouts of failure. Check out Richard Branson, Elon Musk, Steve Jobs, or Donald Trump. It is all part of value creating process. The US is more successful than most countries because it encourages a culture of risk takers and innovators. They are creators and makers, not takers. Business is like team sports. We score when we have the right coach (directors/advisors) and players (management) in the right positions, matched with the right game plan (business plan). If one player is hurt or fouled, get substitute. If the first string does not deliver, bring in the next string (reorganization/restructuring). Sometimes you fire the players or the coach. Running a business is extreme sports. Players and spectators can get hurt but we wear protective outfits and keep the spectators at a distance.

    What makes crowdfunding or crowdsourcing a game changer is technology that the old SEC rules of 1930s did not envision when rules were made. It is technology that will pacify the worry warts. Think big data. Think predictive analytics. Think algorithm. We did not have them in the 1930s.

    The Sarbanes Oxley and Dodd Frank Reform are overreactions for the flaws and commercial crimes of the system. Treating a sick patient does not have to mean killing the patient (capital markets). We all have so much work to do reinvent the broken system. That is not through over-regulation but through innovative solutions brought about by technology. #HealthyCrowdfunder http://www.healthycrowdfunder.wordpress.com

    • NCFACanada says:

      Thanks for sharing your thoughts, Tony! In your opinion, what area of ‘game changing’ crowdsourcing technology will have the greatest impact on healthy crowdfunder and the health industry?

      • Antonio (Tony) Arias says:

        Stay tuned for the forthcoming launch of our platform. One can gain insight about our mission and values by going through our blogs http://www.healthycrowdfunder.wordpress.com Crowdsourcing technology is just a means to an end.We are high tech merchant bankers using our expertise to co-finance and co-develop health solutions. We are in the midst of recruiting co-managers/ co-founders/partners while raising capital. Accredited or qualified investors may contact me for a private presentation of our plans [tarias@alamidascapital.com]. In it, we demonstrate our game changing solutions including how we will protect investors as well as provide business management tools to our client-investees. Follow us at AngelList https://angel.co/healthy-crowdfunder-corp-1

  2. Tom McLellan says:

    Great post. Given the power and interests of the CAMP A crowd, it seems like Canada may become a laggard in embracing equity crowdfunding.

    That’s an inconvenience for Canadian entrepreneurs but hardly a showstopper. Canadian entrepreneurs are some of the brightest and most resourceful people on the planet. If Canadian provinces are slow to step up to crowdfunding (relative to the US and UK), then many entrepreneurs will simply locate their companies elsewhere.

    Whether you’re in Camp A or B, the reality is that we’re moving to a trust and talent based economy. The market and crowd are increasingly global, and it will invest in the ideas of talented entrepreneurs. It’s not about Canada or provincial legislation. It’s about bringing great ideas to market and building great companies, and doing what’s necessary to make that happen while ensuring legal compliance and minimizing administrative costs.

    The related question here is which countries and platforms will allow equity-based crowdfunding from citizens who are outside that country? Seedups.com for example lets investors who “self-certify” as sophisticated investors to make investments if they are based in the UK, Ireland, or the US. I’ve inquired whether they allow Canadian investors.

    The question to Canadian entrepreneurs who want to tap into equity crowdfunding may soon be: Where will you and your co-founders locate your company? Preferably in Canada.

    Eventually there will probably be platforms that allow equity investing between Canadian investors and Canadian entrepreneurs. I hope the platforms (and the registered companies) will be based in Canada.

    • NCFACanada says:

      Hi Tom, great comments and thanks for sharing. ASSOB (http://www.assob.com.au/) an equity portal in Australia allows Canadian accredited investors to participate in their deals. We will confirm the requirements (e.g., self-certification process) and revert back.

      Best, CA

      • NCFACanada says:

        Hi Tom, directly from Paul Niederer, CEO-ASSOB…
        “Foreign investors are their own category. There is no limitation or restriction on their investment. ASIC our regulators only have a mandate to protect Australians.” I guess that means ‘game on’….

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