Crowdfunding Law

Let's Get Crowdfunding Right

Month: June, 2012

Bus Monitors, Killers and the Dangers of Donation-Based Crowdfunding

We all enjoyed the heartwarming story of Karen Klein who, after enduring relentless taunting by a group of middle school students, became the beneficiary of a crowdfunding campaign that raised more than $655,000 in only a few days to send her on “the vacation of her life.”  This is what crowdfunding is all about, right?  Many people, using the internet to rally behind a cause and make small contributions that aggregate to meaningful dollars.  Karen is not just going on vacation, she can now retire from riding school busses with miscreants.  That feels like justice.  But is anybody else getting a little nervous about the miscreants who will now have been impressed by the power of the tool and are no doubt working overtime to fake a similarly compelling cause or to benefit from someone else’s tragedy?

The Next Story Just Might be Fiction

I have written before that the donation-based crowdfunding that is practiced today is much more rife with opportunities for fraud than the much ballyhooed fraud fears involving investment crowdfunding under the JOBS Act.  While the SEC works on the rules to safeguard investors, I hope that local law enforcement officers are preparing for larceny investigations for those that take the much more direct path: faking the next Karen Klein story.  Why worry about SEC filings and investors that will complain about being ripped off when a good story will get you 3/4 of a million in a few days with no strings attached?  This game has been around for a long time before crowdfunding.  Who can forget the bride faking cancer for donations?  It took two years for her scam to result in an arrest.  But now crowdfunding provides a much more massive megaphone than that used by former scam artists who simply got their fake cause in the local newspaper.  The success of the Karen Klein crowdfunding campaign is likely to encourage less meritorious copycats.  In an era when “reality” TV is fake and staged, how long will it take for fraudsters to fake the next video and use it to try to raise funds?

The Next Real Tragedy Might Bring Out the Crooks

In addition to totally fake causes, what happens when third parties use crowdfunding to falsely benefit a real circumstance?  After all, Karen Klein never even asked for money.  The gentleman who started the campaign on Karen behalf seems legit.  IndieGoGo is intent on making sure Karen gets the money that was intended for her.  What about the fake supporter who converts the money intended for a legitimate tragic story and runs?  Campaigns such as this do not need to be done through a crowdfunding site such as IndieGoGo.  Just take George Zimmerman, the man who shot and killed a 17-year-old kid in Sanford.  Zimmerman apparently raised $200k for his legal defense and support of his family through his own website.  This is crowdfunding as well–only we later found out that Zimmerman’s attorney is working pro bono and Zimmerman and his wife were lying in court and attempting to hide the money raised.

Crowdfunding is getting explosive.  This brings with it the good and the bad.  It also brings a heavy burden on those of us who support crowdfunding and operate crowdfunding platforms to do what we can to keep out the bad.

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The New Big Three: Social Enterprises, Impact Investing and Crowdfunding

The crowdfunding securities exemption is going to make “impact investing” available to all Americans and I predict that this is going to create a great awakening for social enterprises.  Impact investment refers to the trend where investors use their investment dollars to achieve an impact that is broader than simply return on investment.  Institutional investors such as large pension funds, family offices and fund managers have focused investment allocations on sustainable business models, cleantech technologies, companies located in emerging countries or woman or minority owned or controlled businesses in order to both make money and make a broader impact.  These large investors have become more conscious of the broader impact of their investment dollars.  Limited partners and pensioners alike are also holding money managers more accountable for the indirect impacts of their investment activities.

Impact investing is not available to ordinary Americans.

Social enterprises are companies that have a designed business goal that achieves social good and/or environmental benefits.  Social enterprises are a natural fit for investment by impact investors because the very business models are predicated upon addressing a societal issue and making a broader impact.  It is a great fit.  Here is the problem: ordinary Americans cannot easily participate in many impact investing opportunities.  Social enterprises tend to be smaller companies or project related opportunities as opposed to large public companies and archaic U.S. securities laws make it difficult for those who are not wealthy to learn about or invest in small companies or projects.

Enter the crowdfunding securities exemption.

When the rules are finalized (and keep in mind this is not likely to happen this year), the crowdfunding exemption will allow ordinary Americans to invest into small social enterprises and everyone can elect to become an impact investor.  Want to invest in a solar project in your area to support clean energy?  You will be able to do that.  Interested in supporting a local independent bookstore because you cannot stand another Barnes & Noble?  Invest in the local bookstore.  You decide the impact you want to make.  Everyone will be able to decide the impact that they want to make.  When crowdfunding investment becomes a reality in America, this is going to be a game changer for social enterprises.  Internet portals will develop around specific sectors such as clean energy, local/organic food movements and religious affiliations.   I believe investment clubs will form around these interests.  Crowdfunding, Social Enterprises and Impact Investing will be attached at the hip.  The result will be a dramatic increase in funding for social enterprises.  Many people are focused on how crowdfunding may fund the next Facebook.  That would be great.  I am personally more interested in seeing the cultivation of a garden of social enterprises–not social networks.

Will the Crowd Follow the Herd?

Venture capital investors have a long history of moving as a herd. In other words, they invest in similar areas and sectors at the same time. Whether internet, telecom, biotech, cleantech, internet again, well, you get the point–sectors get hot and VCs flock to get in on the action. Angel investor groups tend to wander in or behind those herds. This is a natural and in many ways beneficial phenomenon. As noted by VC and general deep thinker Neal Dikeman, investment “herds aren’t all bad.” The bad side is that many “investable” companies do not get funded when a sector is not in vogue. Once crowdfunding investment opens angel investing to everyone regardless of wealth, will the crowd follow the herd? I predict the answer is more “no” than “yes.”

At a high level, it is easy to see how the crowd will follow the investment herd. Crowdfunding portals will try to find and feature companies in the “hot” sectors. For those portals that develop a following and related traffic, featuring these hot sectors will help focus crowdfunding investment activity. I envision that crowdfunding clubs will be formed much in the same way that angel investment groups exist today. Those groups that focus mostly on pure investment returns will probably be influenced by the investment herd just like other angel groups and VCs.

However, I think that one of the great opportunities with the crowdfunding investment exemption is that it will not be stuck in the herd. Crowdfunding portals should develop around more specific interests and specializations. Just like VC funds are sometimes limited to specific sectors, portals would do well to specialize behind specific industries. I hope that crowdfunding investment clubs, whether official or unofficial, will form around industry expertise. Maybe they will become “farms” that stay within their sectors whether the sector is “hot” to not rather than herds that move from area to area.  I can envision investment groups that consist of investors with highly specialized knowledge–telecom engineers, aerospace and software engineers. Unlike angel groups, these crowdfunding investment clubs would not be limited to retired angel investors with sufficient net worth but could include working professionals. This is enabled for the first time by the JOBS Act because members would not need to be “accredited” for securities laws purposes. These industry specific groups will have a level of sophistication within their sectors that accredited and institutional investors will seldom share.

Perhaps these crowdfunding investment clubs can exist within large companies. Imagine the impact that a crowdfunding investment by members of a Google Employees Crowdfunding Club would have on others who decide to invest in a startup internet company. More importantly, imagine the influence outside of the “hot” sectors. What impact would an investment by members of a Cleveland Clinic Crowdfunding Club have on a nascent biotech startup? Think of the power of an incubator area like RTP for life science investment clubs or even Boulder for tech companies. A crowdfunding club of RTP professionals who identify a life sciences company as investment grade would be an immeasurable endorsement for that new company.

The typical crowdfunding investor will also likely not be as short-term or pure ROI based as the typical herd investor. The bigger crowdfunding issuances that are over-subscribed and meet the million dollar annual cap will grab the headlines but I think the more common funded round will be for the companies that you never hear about.  It will be the company that gets funded by people who directly or indirectly know the founders that I find most appealing. Part of the excitement will be the companies that would not have been funded at all prior to the crowdfunding securities exemption. This is the traditional realm of “friends and family” (“friends, family and fools” to some my more cynical colleagues) but the internet and social media tools will make these companies known to supporters that would not even be considered acquaintances under traditional definitions. Local businesses will raise capital from local citizens because the business is one that the community wants in the area or is started by local high school kids. The herd mentality that is evidenced by this type of local investment has its roots in our more traditional senses of community–not ROI.

The possibilities are endless. This is what has so many of us excited about crowdfunding investment when it becomes a reality in the U.S. It isn’t an expanded herd of traditional investment, it is the potential for non-migrating crowds to form outside of any investment herd.

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