A blog on financial markets and their regulation
Regulating Equity Crowdfunding Redux
July 11, 2015Posted by on
In response to my blog post of a few days back on regulating crowd funding, my colleague Prof. Joshy Jacob writes in the comments:
I agree broadly with all the arguments in the blog post. I would like to add the following.
- If tapping the crowd wisdom on the product potential is the essence of crowdfunding, substituting that substantially with equity crowdfunding may not be a very good idea. While the donation based crowdfunding generates a sense of the product potential by way of the backings, the equity crowdfunding by financiers would not give the same, as their judgments still need to be based on the crowd wisdom. Is it possible to create a sequential structure involving donation based crowdfunding and equity based crowdfunding?
Unlike most other forms of financing, the judgement in crowdfunding is often done sitting far away, without meeting the founders, devoid of financial numbers, and therefore almost entirely based on the campaign material posted. This intimately links the central role of the campaign success to the nature of the promotional material and endorsements by influential individuals. Evolving a role model for the multimedia campaigns would be appropriate, given the ample evidences on behavioral biases in retail investor decision making.
Both these are valid points that the regulator should take into account. However, I would worry a bit about people gaming the system. For example, if the regulator says that a successful donation crowdfunding is a prerequisite for equity crowdfunding, there is a risk that entrepreneurs will get their friends and relatives to back the project in a donation campaign. It is true that angels and venture capitalists rely on crowdfunding campaign success as a metric of project viability, but I presume that they would have a slightly greater ability to detect such gaming than the crowd.