Yannis Pierrakis and Liam Collins
Over the last few years we've seen an explosion in the practice of crowdfunding, defined by Wikipedia as "the collective cooperation, attention and trust by people who network and pool their money and other resources together, usually via the internet, to support efforts initiated by other people or organizations".
The most common form of crowdfunding, soliciting donations from the crowd in exchange for rewards, is not a new concept. Back as far as the 1800s French and American organisations were part-crowdfunding the construction of the Statue of Liberty by offering donors miniature models of various sizes depending on the amount donated. However, the emergence of web 2.0 and the development of online social networks has created mechanisms that allow this sort of co-ordinated donation on a large scale and at far less cost. Other factors such as the restrictions in lending to businesses as a result of the recent financial crisis are creating greater demand for crowdfunded lending. And not just lending, we are also seeing this movement start to break through in investing for shares in young businesses by the crowd.
This area which, due to regulation had formerly been the preserve of accredited private and institutional investors is now also being considered for opening to the general public. Already in the US, a bill has been proposed that would allow individuals to invest up to the greater of $100,000 or 10% of their income into young companies in exchange for a share of the business. It would also remove the limit on the number of shareholders a private company can have, an issue that may force Facebook to go public in the coming year.
If the bill passes, which looks likely, it will no doubt lead to lobbying for similar changes on this side of the Atlantic in the year ahead. The potential benefits of allowing such investment are obvious; unlocking an enormous new source of potential capital for businesses struggling to get the finance they need to grow and create wealth and employment. It also offers investors a new, potentially lucrative asset class as well as giving them the chance to support businesses and entrepreneurs they care about.
As ever with the easing of regulation in such an area, there are many potential downsides too including the worry that investors will not be adequately protected and may lose their savings. Critics say changes will allow for fraud, that investors will be open to dilution of their shares in later funding rounds and that even sophisticated investors find it difficult to make money investing in young businesses so what chance will inexperienced investors have. Important questions in relation to these claims that are yet to be answered, including to what extent will there be co-investment through platforms of accredited investors and the crowd; will this be a mechanism to raise finance from just your personal network or will individuals invest in businesses they have no connection with; is the mechanism only suitable for certain businesses such as consumer facing firms or will the collective intelligence of the crowd allow them to invest in more technical ventures?
2012 will prove an important year as regulators, investors and businesses wrangle with the above issues and may be a landmark year in the further democratization of funding allowing you and me to get our piece of the next Facebook or Google.
This report looks at equity crowdfunding, where individuals receive small stakes in a privately owned young business in return for investment.
Download the report
This paper sums up the history of crowdfunding and includes examples of its different types.
Download the paper
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