Crowdsourcing Equity Investment

14 January 2013

Tyler draws our attention to this piece recommending crowdsourcing of equity investment. I’ve watched people trying to raise equity on both sides of the Atlantic and the UK system does have its advantages. Much less legal worry, fewer restrictions, on who you can ask and for how much you can ask before you have to wade through mountains of very expensive paperwork.

In theory it should be easier to defraud people as well but then I’ve seen that happen to people in both countries too and I didn’t notice anyone finding that the US restrictions stopped very much of it (tell me, is that guy in Scottsdale still pushing low-energy nuclear transmutation?).

As a purely personal view I’d say that it’s easier to raise large sums of equity, investment or venture capital in the US. In the UK it’s easier to spread the fund raising out from the direct family and friends circles than it is in the US but more difficult to raise those large sums. As I’m convinced that it’s small business which makes the economy hum, not the few big break out successes, I tend to think the UK system is better. But that is purely personal prejudice.

From the piece:

One petition, prepared in 2010 by the Sustainable Economies Law Center and, fittingly, paid for by a grass-roots crowdfunding effort, asks the S.E.C. to permit entrepreneurs to raise up to $100 per individual and an aggregate of up to $100,000 without requiring expensive registration and disclosure.

President Obama, as part of his jobs act, advocates an exemption for sums totaling up to $1 million. Representative Patrick McHenry, a Republican from North Carolina, has drafted legislation that would allow companies to obtain up to $5 million from individuals through crowdfunded ventures, with a cap of $10,000 per investor, or 10 percent of their annual incomes, whichever is smaller.

There are real concerns. The S.E.C. must balance its dual mission of facilitating investment and protecting investors, and as we all know, snake-oil salesmen are alive and well on the Internet. Furthermore, Wall Street banks are likely to fight any efforts to encourage crowdfunding because it cuts them out of the equation.

I spoke at some length to Crowdcube a little while back, about whether they would be a suitable way to raise funds for one of my own adventures (disclosure, no, I have no relationship with them at all, just that one long phone call). It does seem to work, funds are being raised.

In the background though are a few rules that do make it work. You can’t just pitch any business idea (“an undertaking of Great Advantage but no-one to know what it is”), you’ve got to convince both Crowdcube and their financial advisors (who themselves, in another part of their business, prepare companies for IPOs on the junior London market).

But the bits that make their model work, and the bits suggested in that NYT piece that would not make them work are, to me, as follows.

1) There’s no hard and fast upper limit on how much can be raised. £250,000 is what they say they’re willing to go to but that’s all about baby steps, nothing more. There’s certainly no legal limit on what can be raised.

2) There are restrictions on how much an individual can invest. Up to £5,000 in any one venture with minimal checking (ie, is this a live human adult sort of level of checking) and above that, one must prove that the investor is a sophisticated investor. However, note that the burden of this proof is on the investor: it is not on the company at all.

3) Which is where that McHenry “10% of their incomes” becomes a problem. As soon as you insist that the company raising the funds do the check on the incomes of all the investors then you’re burdening them with great costs to raise what are, after all, small sums of money.

4) $100 per project per individual is way, waaaay, too low a number. These are equity investors, recall? They need to be informed, sent the annual reports, invited to the AGM: $100,000 might be the right amount to open up a deli these days (having been there and done that, it does sound about the right order of magnitude) and does anyone really think that a deli wants to have a shareholder list of 1,000 people?