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Friday, December 14, 2012

Crowdfunding Is Not an F-word

This op-ed by Victoria Silchenko, founder and CEO of the U.S.-based Metropole Capital Group and a member of Marchmont's Advisory Board, was first published at Huffington Post.

What is the five-letter word sure to strike fear into the hearts of investors everywhere? Fraud.

But what I can't understand is why this particular f-word keeps being associated with equity crowdfunding. Sure, the involvement of large crowds statistically does increase the probability of a fraud in any industry. The National Retail Federation, for example, reports that 4.6 percent of holiday returns are fraudulent and cost retailers billions of dollars every year; an estimated $8.9 billion to return fraud will be lost by the retailers this year alone. Another example with rather limited number of people involved: a hedge fund industry with its non-transparent investment vehicles -- one of which happened to be managed by Bernie Madoff.

Historically, "every positive value has its price in negative terms. The genius of Einstein leads to Hiroshima," wrote Pablo Picasso, known for his wit and wisdom. And theories about an "efficient" economic outcome require many assumptions -- there is only groping in the dark.

So the big question is -- why do we keep hearing "fraud" about an as yet nonexistent industry? Just Google "fraud crowdfunding" and you can find that:

Experts are concerned that crowdfunding as a means of selling securities allows for more abuse and increases the potential for fraud... Experts are concerned that the internet will be used to cheat individuals out of their money by asking them to fund illegitimate businesses.

I suddenly feel a sense of deja-vu -- I heard angry warnings about PayPal, eBay and Wikipedia in the old days that could be summed up in the "Who Let the Dogs Out?" rap.

So, let's keep in mind that equity crowdfunding (or crowdfund investing) is not operational and not legitimate in the United States yet and for those who are growing comfortable with the concept, there are three essential facts to remember:

1. The equity crowdfunding regulations are tight.

The Senate has already added a substantial number of filing, disclosure and registration requirements that should make it harder for illegitimate businesses to get in the game. One major restriction imposed on equity crowdfunding is that the crowdfunding portals must be registered with the SEC and receive the license of a broker-dealer. Another safeguard tool is that companies seeking equity crowdfunding should disclosure a considerable amount of information, including financial statements and prior year tax returns. Finally, the companies are restricted to raise not more than $1,000,000 per year; for a round of over $500,000 audited financials are required.

2. The investment risks are limited.

The equity crowdfunding law limits private investments to 5 percent for individuals with annual income of less than $100,000 and 10 percent for those who make over $100,000. The United States isn't going to become like Russia of 1998 when people invested everything they had and ended up losing their life savings.

3. The world is small -- and visible.

The UK, Australia, and the Netherlands have all implemented an equity-based crowdfunding model and so far the world hasn't heard about one single case of fraud. I asked a colleague of mine, Simon Dixon, the founder of Bank To The Future (the equity-based crowdfunding platform in the UK endorsed by Richard Branson) why there are only 12 companies listed on their platform and he revealed that they spend a lot of time screening companies and making sure that they are "investment ready."

After all -- this is a new industry in the era of an unprecedented power of social media and equity crowdfunding portals want to be known for healthy business and healthy deals.

The story with equity based crowdfunding goes back to April 5th, 2012 when President Obama signed the Jumpstart Our Business Startups Act (JOBS Act) into law which contains a crowdfunding provision that allows entrepreneurs to raise small amounts of first round capital from the public. The U.S. Securities and Exchange Commission (SEC) had 270 days to issue rules before equity crowdfunding becomes legitimate but has failed to meet the deadline although admirably managed to create on-line forum to involve the public to assist with the decision. Mary Schapiro officially steps down as the head of the SEC on December 14, 2012 leaving everyone to wonder if the regulation will be ready in 2013. Or ever.

By the way, interestingly the American Gaming Association (AGA) launched on December 3 its own campaign urging the U.S. Congress to legalize online poker . I am wondering what their timeline looks like. May I just add that the amount lost gambling by Americans has a pretty significant impact on household finances already -- a chart from The Economist shows the USA has around $375 in losses per year per adult.

The fact above tells me one thing -- people don't care about probability when they have a freedom of choice. And when it comes to equity crowdfunding, I have a sense that it is not about fraud -- it is about changes. And who likes the changes? Not the old financial world. The new law would empower everyone with a right to invest regardless of his/her economic class breaking the old rule when only people with an annual income of at least $200K are allowed into the club.

Equity crowdfunding presents an attractive proposition for people who can choose to back up the project they believe in and attain a sense of pride at becoming a shareholder and making a difference even with a tiny amount of capital. I bet it is more rewarding than gambling.

Then again, with crowdfund investing entrepreneurs and innovators will no longer be limited to conventional financing sources and are inspired with the possibility of being heard and supported by the community -- here's where Facebook comes in handy.

While the future of the new industry is in the hands of SEC, there is something hopeful hanging in the air. Crowdfund investing won't be the death of the financial world -- instead, it may just be its savior.