Equity crowdfunding (ECF)—also referred to as securities crowdfunding or investment crowdfunding—is an alternative finance model that was projected to become the leading source of funding for start-up companies by 2020 ahead of venture capital. To emphasize its economic impact, in previous scholarship we estimated that in 2018 alone, over $400 million was raised through ECF from just four countries: the US, the UK, Australia, and New Zealand. But the enabling ECF regimes are not commonly proclaimed as important contributors to financial inclusion and financial technology. Precise and ample association between ECF regimes and their advancement of these subjects is not often portrayed.
The concept of financial inclusion is aimed at enabling individuals and businesses to have meaningful and affordable access to financial products and services they need within a financial system. Among other financial services and products, an inclusive financial system typically enhances access for financial consumers to loans, insurance, pensions, bank accounts, financial advice, etc. Importantly, financial inclusion enables individuals and businesses to capitalize on business opportunities and access the securities market. This latter dimension is the primary purpose underlying ECF regimes.
ECF regimes improve the flow of capital by expanding access to fundraising and investment opportunities to individuals and businesses that were previously excluded or underserved. John Coffee observes how small businesses are increasingly shut out from access to the public equity markets. In previous scholarship, we discussed how ECF regimes permit small private businesses, like start-up or early-stage companies in almost any sector, to secure funding online from the public. Private companies usually have a regulated cap on the number of members they can have, but ECF regimes typically disapply this limitation for companies that rely on ECF. These companies are now able raise capital through the previously prohibited, now ECF-exempted, process of issuing shares that are not registered to the public in exchange for investments from the crowd of investors (crowdfunders). This is a significant shift because, historically, only an exclusive group of professional investors and close family and friends were usually able to invest in private companies. As a result, ECF regimes institute greater access to funding and equal opportunity for all types of investors to invest in companies at their early stage.
Another key thing to remember is that public fundraising through the issue of company shares is an activity that is subject to comprehensive and costly registration and disclosure obligations under securities law. But ECF regimes either fully exempt fundraising companies from mandatory securities disclosures or subject them to reduced disclosure obligations. This radically lowers the costs of obtaining funding for small private businesses, incentivizing them to use ECF to meet their funding needs. It is apparent that these exemptions increase the type and number of companies that can access equity investments and the number of people that can secure equity in start-ups and early-stage companies. Simultaneously, exemptions reduce the number of companies affected by the funding gap since almost any small private business in any sector can secure investments from any member of the public who is attracted to their business project. Research also shows that ECF attracts very diverse crowdfunders of different ethnicities, gender, age, expertise, or geography. What is more, there is evidence that entrepreneurs that use ECF are more gender and ethnically diverse.
Of course, the use of the internet and technology-enabled devices are critical to the functioning of the ECF model on both ends. Innovative FinTech business models usually provide financial products or services through automated meansusing the internet. ECF regimes require that offerings promoted by companies be conducted through a licensed intermediary and these intermediaries are, among other things, assessed on their technological capacity. ECF intermediaries operate online platforms where they intermediate the placement of shares and disintermediate stock exchanges. They make use of digital applications and procedures to match the need for capital by small private businesses with its supply from crowdfunders through information technology-driven platforms. The amounts being raised or invested in response to an ECF offering are available in real time on the online platform.
ECF regimes also require intermediaries to provide communication channels on their online platforms where crowdfunders can communicate and discuss with each other, with the fundraising business, and the intermediary. This contributes to the use of digital strategies to moderate the intrinsic financing problems of uncertainty, information asymmetry, and agency costs. Traditional monitoring methods for investors—like actively taking part in the business, sitting on boards, and having access to comprehensive disclosures—do not readily translate to ECF, but its online nature provides other monitoring strategies. These methods are predicated on the wisdom of the crowd, crowdsource investment analysis, online reputation, securities-based compensation, and digital monitoring.
Ultimately, ECF regimes advance a more accessible securities market that appeals to startups and early-stage businesses in the funding gap and individuals looking to invest in companies at their early stage. By enabling this beneficial relationship, albeit in an untraditional way and through a technology enabled process, ECF regimes accelerate satisfying the capital and investment needs of the previously underserved and excluded.
Jonathan Ande is a financial and corporate law academic and a Doctoral candidate at Deakin University Law School.
Parts of this post are adapted from the author’s forthcoming project on the governance issues of equity crowdfunding, and the article “Could New Zealand’s Equity Crowdfunding Regulations be the Model for the Developing World?” available on SSRN.
