Congress just passed the most significant legislation affecting entrepreneurs and investors since the Glass–Steagall Act back in the Great Depression over 80 years ago. The groundbreaking Entrepreneurs Access to Capital Act, aka “Crowdfunding,” passed the House on March 8 and was included in the JOBS (Jumpstart Our Business Startups) Act that the Senate passed on March 22.
Crowdfunding connects large populations of entrepreneurs and investors in online marketplaces to offer businesses better access to investment capital. It is a real game-changer for an industry that controls trillions of dollars of investment capital and that is the lifeblood of every young U.S. business, as well as the economic and social benefits these businesses engender.
Reason for Crowdfunding Inadequate capital is the #1 cause of U.S. private business failure – and over 50% of startup businesses fail within 4 years. In addition, fewer than 1 in 20 firms succeed at obtaining investment capital from outside their close network of family and friends. As any seasoned entrepreneur will agree, raising capital is usually the most challenging, time-consuming, and limiting aspect of starting and running a young business.
While most entrepreneurs find it difficult to obtain capital, fewer than 10% of accredited investors who have the interest and wherewithal to invest are actually active each year in making investments. Why? Because most investors – particularly individuals – have very limited access to entrepreneurial investment opportunities and no standardized, confident process to enable them to make these high-risk investment decisions. Crowdfunding is intended to increase access to investment opportunities for investors and to expand the pool of available individual investors for entrepreneurs.
Impact of Crowdfunding Crowdfunding will bring big changes. It will expand the population of potential investors from 2 million to over 50 million people. It will increase the amount of potentially available capital from $1 trillion to over $5 trillion. If crowdfunding platforms are successful at bringing together large populations of entrepreneurs and investors like social networks, and if those platforms include the standardized, analytical capabilities of systems comparable to Morningstar, crowdfunding will indeed turn out to be the most significant financial innovation in decades.
Crowdfunding has the solid potential to address and dramatically improve the most limiting factor in modern capitalism – the capitalization of young businesses. Young businesses are responsible for generating a majority of employment growth and technological innovation, directly influencing our economy’s rate of productivity and our standard of living. It will accelerate the pace of business formation and better ensure that promising businesses do not fail due to undercapitalization.
Crowdfunding could also perpetuate one of the United States’ most significant economic advantages: its sophisticated financial markets. Other countries such as the United Kingdom have already embraced crowdfunding and have operating platforms, and it is essential that the U.S. also exploit crowdfunding innovation to maintain its current global economic position.
Challenge of Crowdfunding Crowdfunding creates an entirely new class of individual investors that are usually unfamiliar with the sophisticated risk and return analysis common in investment decisions of accredited, professional investors. The primary challenge is the high level of risk associated with young businesses seeking capital and a platform to empower this new class of individual investors with sound decision-making tools and capabilities. Without these, many investors will make unsound investment decisions, lose their capital, and cease to participate in crowdfunding.
The JOBS Act that the Senate passed includes several provisions to help investors avoid fraud and excessive investment losses. However, it does not go far enough to ensure the market success of crowdfunding. Crowdfunding platforms must also offer capabilities similar to those underlying self-directed investment decisions in the public markets – namely standardization, analytics, and comparable data. Morningstar, ETrade, and others enabled an analogous new class of self-directed individual investors in the 1990’s.
Success of Crowdfunding Standardization: Because they are Internet marketplaces, crowdfunding platforms will naturally seek to offer investors the largest possible population of investment opportunities via posted business plans. However, many notable studies have already found that traditional, non-standard business plans are an inefficient means of communication between an entrepreneur and an investor and that time constraints prevent investors from studying each plan in detail. A standardized view of each business will be essential so investors can screen, compare, and qualify each opportunity in a reasonable amount of time and in sufficient depth.
Analytics: Investment platforms in the public markets must offer self-directed investors risk, return, and other analytics on various asset classes (e.g., stocks, bonds, mutual funds) to enable their autonomous investment decision-making. In the relatively high-risk domain of crowdfunding, this necessity is even more acute. It is critical that crowdfunding platforms provide investors standardized risk and return analytics for each business. Investors can then sort and rank a large population of investment opportunities and focus their due diligence on a reasonable number of opportunities that meet their risk and return objective.
Comparable Data: Good investment decisions rely on choosing well from a large number of opportunities. Investors must therefore be able to compare many attributes of each investment opportunity in a particular asset class to the same attributes of other opportunities in that asset class. For example, Morningstar features dozens of attributes for each mutual fund and then compares them directly to the same attributes of peer mutual funds. In crowdfunding, investors will also need the capability to compare attributes of each business to that of other peer businesses, such as valuation, growth rates, profit margins, management experience, and many other informative business attributes.
About the Author Judd Hollas is founder and CEO of EquityNet, the original and only patented crowdfunding platform (www.equitynet.com). It is used by entrepreneurs, investors, government entities, business incubators, and other members of the entrepreneurial community to plan, analyze, and capitalize young, privately-held businesses. EquityNet was the first company to patent and develop an automated web-based business planning, analysis, and funding platform for enabling crowdfunding innovation.
Entrepreneurs use EquityNet’s business planning and analysis tools to efficiently plan their business and to prepare for raising capital. Business supporters use EquityNet to mentor and support entrepreneur clients and their business success. Investors use the advanced business analytics and comparison capabilities of EquityNet’s Enterprise Analyzer™ engine to streamline due diligence and enable confident decisions.
EquityNet’s patented analytical engine, Enterprise Analyzer™, produces standardized Business Plan Analysis™ reports that quantify business risk, estimate business return and valuation, and benchmark a wide range of business parameters based on EquityNet’s proprietary Knowledge Base of over 500,000 businesses.
Contact: EquityNet, LLC Judd Hollas 866.542.3638