It is a fairly fascinating proposition to have projects funded not by
a commercial lender but by prospective customers or by the general public.
Crowdfunding collects equity from stakeholders of all sorts in the global
village. It brings manufacturers and consumers closer. Almost any purpose can
be served – and financed: innovative e-products, free software, movies,
records, video games, scholarly research, social projects, journalistic
projects, political campaigns, start-up funding, disaster relief and other
charities, to name just a few.
Crowdfunding platforms are mushrooming, differentiated by project
categories, target groups, or geographical regions. One platform does not fit
all: some finance creative projects, others fundamental research, another
category offers social causes. Kickstarter.com, for
example, one of over 500 known crowdfunding platforms, has worked well for
projects launched from the U.S., the U.K. and Canada, such as the digital watch
Pebble that interacts with iPhones and Android phones: it sought to raise
$100,000 and got over $10,200,000.
Other successful crowdfundings include Amanda Palmer (sought to raise
$100,000 funding for an album, raised $1,200,000), Spike Lee (raised $1,250,000
for a movie), or Chris Roberts (raised $2,000,000 to revive space simulation in
videogames). Chris Roberts and Cloud Imperium Games also hold the record now pegged at
over $17.6 million.
As a method, crowd funding is still in its nascent stage and virtually
unregulated in many if not most jurisdictions, with the early exception of the
U.S. Jumpstart Our Business Startups Act (JOBS Act) that requires platforms for investment
crowdfunding to register as broker-dealers with the SEC. Therefore it is protected
only by conventional securities laws, such as the Howey test (Securities and Exchange Commission
v. W. J. Howey Co., 328 U.S. 293 (1946)) and general
concepts of fraud. Intellectual property protection for ideas disclosed to the
public in the course of a crowdfunding effort is lacking as well, unless
patent, copyright and trademark applications are filed early. The World
Intellectual Property Organisation (WIPO) promotes a novel standard of protection embedded in
creative works under the concept of a “creative bar code.”
To avoid the staggering and often suffocating cost of compliance with
securities regulation, crowdfunding that does not serve conventional investment
purposes needs to devote particular attention to devising its reward structure
not to fall under the Howey test for
an “expectation of profits” that “depends solely on the efforts” of a promoter
or third party. This is relatively easy in the case of charitable funding or
rewards through the enjoyment of completed creative artwork such as motion
pictures, video games or records.
Typical of crowdfunding are intense media campaigns, typically through
social media channels. Communication with backers (investors) including
response to their feedback and a constant stream of updates is essential. The
generally small amount of funds provided per backer results in a significant
increase in communication intensity per dollar raised. Crowdfunding is
service-intensive because it is not based on ratings and purely passive major
investors content with quarterly or annual reports are rare. The learning curve
with successful projects is often described as steep.
However, the operating model is just the latest high-tech based
application of a classic: the “low-margin, high volume” idea. Although the high
volume aspect is still debatable by comparison with institutionally-raised
finance, it is not low with regard to the needs of projects for which it has
been tested thus far. This is largely because it has primarily been used for
purposes that had previously not been thought of as “bankable” in the first
place or that could not be expected to provide an adequate monetary reward.
One of the important advantages of crowdfunding may be its lack of
need for investor protection, since contributions can often be structured in
ways different from traditional equity investments whenever rewards can be
demonstrated to avoid the Howey test.
While most backers would disagree that their contributions, often borne by
enthusiasm or emotional interest, are a fool’s tax paid with no expectation of
reward, they are often, and indeed typically, made in amounts the loss of which
they may safely be expected to be able to absorb, just like in the case of mass
charitable donations.
But precisely because typical projects are often best described as
innovative or cutting-edge, their traditional profitability almost always is in
a gray zone. Relative lack of regulatory burdens may be key to getting such
projects funded in the first place, and it will be important to avoid the
stifling burden of “protective safeguards” that have been designed to stop
fraud and abuse but that also hobble the viability of many projects. Especially
outside crowdfunded equity investment, this classical dilemma may be
sidestepped by relying on the speed by which news of mishaps travel in the
internet community and by a combination of user sophistication and improvement
of diligence by digestible losses. It is the price to be paid by people who
wish to “fund what matters
to you” outside conventional profit expectations as their only variable to
maximize. It expands democracy in the financial sector by removing the power of
large financial institutions, industry associations and government sponsors to
decide what does or does not get funded. It will be up to consumers in their
capacity as voters to determine whether they will be deprived of this tool
under the pretext of “investor protection” for the sole benefit of the monopoly
held traditionally by institutional finance – turning business into a domain
reserved for entities “too large to fail,” a code word for being a
taxpayer-protected part of the establishment.
