Reading articles in the news and on crowdfunding forums can seem like sifting through advertisements and scary stories. A lot of content is either announcements of new crowdfunding campaigns or interviews with traditional investment organizations arguing that it is too scary to invest in private companies without an investment manager by your side. Much of this content has recently resurfaced with the release of the Securities and Exchange Commission’s proposed rules for implementing Title III of the Jumpstart Our Business Startups Act (JOBS Act) and regulating public crowdfunding in the United States. The scary stories are just that – “stories” – but when they are repeated often enough they become the stuff of myth.
The website of the National Crowdfunding Association of Canada (NCFA) is running a series of articles to address the most common myths being perpetrated against the crowdfunding industry. We recommend that you read this excellent series in its entirety. We have shortened and summarized some of the myths discussed in the NCFA series for use here:
- The crowd is made out of dangerous fools
- Crowdfunding cannot possibly work
- Traditional funding sources will not touch crowdfunded companies for subsequent rounds
- Den of Thieves (fraud and failure)
- There is no reason to make equity crowdfunding available to the general public
These “myths” make for harrowing headlines and great talking points, but none of them hold up to much scrutiny. We have addressed each of them in turn, providing analysis and examples. Read on to learn more.
Myth 4: Den of thieves (fraud and failure)
The most common complaint against crowdfunding – the threat of fraud – appears over and over in the press. This view is repeated by the securities administration lobby and venture capitalist bloggers. This myth begins and ends with the assertion that crowdfunding will be some sort of “Wild West” of lawless and unscrupulous actors conning ‘unsophisticated’ investors out of their nest eggs. Without diminishing the real threat posed by fraud to all investors, the impression of crowdfunding as uniquely dangerous is unfounded.
Fraud is a threat across all levels of and vehicles for investment and is not in any way unique to crowdfunding. Fraud committed by Enron, MCI Worldcom, Sino-Forest, Stratton Oakmont, Bernie Madoffand Fabrice Tourre affected millions of people and cost trillions of dollars, and the graft represented by these examples in no way reflects the vast majority of players in the traditional funding market. Since no single investment vehicle is fraud-proof, the investment community’s primary focus should be eliminating or minimizing fraud throughout all levels of business rather than finger-pointing at any one type of investment platform or vehicle.
The SEC’s regulations regarding the implementation of the JOBS Act were slow in coming because the 585 page document is so heavily weighted with rules and requirements to protect investors from fraud. This proposal includes specific requirements for crowdfunding portals to educate investors and potential investors to help them avoid making poor decisions, know what limits the law places on their investing activities and understand the process involved with investing through the portal.
In fact, the most dangerous threat to investors is not fraud but ignorance. Fortunately, as the SEC and several industry leaders acknowledge, there are multiple tools available to help protect and educate potential investors who want to use crowdfunding portals, including, but not limited to: educational content and disclaimers, online testing for investor comprehension, cooling off periods and wait times, as well as double opt-in consent for any online activity.
Indeed, crowdfunding represents a powerful new anti-fraud tool. When the crowd pokes and prods companies – that is, when thousands of individuals actively examine potential investment opportunities (like those on crowdfunding portals), these individuals are helping the market to more quickly identify and report potential fraud before it can do damage.
Rather than fraud, the more credible threat to the future of crowdfunding is the potential for companies to fail. Companies will fail. Companies will fail no matter what vehicle is used to fund them. Since failure is a recognized concern among entrepreneurs and early-stage investors alike, reputable crowdfunding organizations communicate the risk of company failure clearly. Moreover, investors are urged – by investment professionals as well as crowdfunding platforms themselves – to diversify their portfolios to minimize the impact of a single company’s failure. A balanced investment portfolio spreads risk across many investments to diminish the damage when a single investment fails.
Ultimately, there is risk to investing in early-stage businesses. In the early days of crowdfunding, it is likely that there will be several crowdfunded companies and crowdfunding portals that fail. This is part of the growing pains for any industry, but the net result will be the same kind of improvement and innovation (drawn from the crowd) driving the best entrepreneurs to succeed. The crowdfunding portals that do survive these growing pains will be those providing the best resources, showcase the best companies, and do the best job of aiding their investors and entrepreneurs to make the best decisions possible. The responsibility owed to investors by crowdfunding portals is to provide enough education to help investors make informed decisions as they consider different investment options.
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