After 4 years of experience across 37 countries, we have learned that there are recurring themes that impede optimal equity and debt crowdfunding development. This report breaks away from our traditional analysis of the ecosystem to suggest a path forward for regulators to consider that is based on lessons learned.
Although it is probably self-evident, the work we do with governments and financial regulators is sensitive and confidential, most of which we never discuss publicly. This is how we have built our business. We are a firm that U.S. and global government officials, regulators and policymakers can trust, to both provide solutions and to be discrete.
Recently, I had a call with an eager government organization exploring how to start integrating securities-based crowdfunding into their financial markets. However, based upon our years of experience, we believe they are pursuing a strategy that is not structurally sound. They see their concept as “a possible solution to their economic ailments.” But they don’t understand that it will require investing time and resources in technology, as well as policy, to understand the dynamics that will make it easier for companies to start and grow.
They are trying to do a good thing, but if they are not more responsive to previous global experiences, we fear that they will spend the next 12 months working on policy and regulation that will fail to gain the traction and success necessary to create the appropriate foundation.
If you are in a Financial Regulator, Finance Ministry, Treasury Department, Ministry of Economy or Trade, Stock Exchange or Economic or SME Development Organization, we encourage you to read this post.
We respect that you are experts in financial and economic policy and regulation, that you are dedicated and you want to make an impact on your country. We offer this perspective formed from working in 37 countries over the last 4 years on the issues of how to create access to capital for SMEs and startups.
These are 4 goals we hear over and over from government leaders:
- We need more jobs in our country
- To increase jobs, we must help existing SMEs to grow
- To increase jobs, we must help more entrepreneurs start businesses
- To increase innovation and job creation in our country we must help both existing SMEs and entrepreneurs to have easier access to capital (debt and equity financing)
The next predictable, expensive and difficult steps they embark on include:
- “New government program to create incubators, accelerators, grants and government investment vehicles”
- These are great and important. But on their own, these efforts usually fall into the category of “necessary but insufficient.” The problem is that eventually, the grant money runs out and there are no early stage investors in the country to step in with follow on funding. So while a country may now have full incubators and fledgling companies, the number of companies that can actually find follow-on investment from traditional private sector “angel investors” is usually limited.
- Then governments turn to banks in the country and ask or demand that they increase SME lending. Banks say “yes,” issue press releases, make some loans, but not enough to move the needle in the market. Reality sinks in. Their cost structures are high and they have bigger clients that are already profitable. So why should they burden themselves with new cost structures and unnecessary processes that increase their overhead and reduce their profitability?
And then, we come to the basis of my concern raised in my recent call with a regulator:
- Government official says, “We are taking our existing rules, requirements and processes for companies that want to go public on the main stock exchange or the “small board” stock exchange and creating ANOTHER way for SMEs to raise money in the public/private markets. But we want to do this without any new technology, services or solutions. We’ve been studying X, Y and Z countries (countries with regulation that looks to the past, rather than the future for creating online financial structures) as examples of online finance and crowdfunding.”
Here are the 5 serious concerns that we have with that strategy:
- It does not utilize the technologies (Web, Mobile or Social Media) that are a part of our daily lives, and enable everything to be faster, easier, cheaper and more transparent. All countries that we work with include new enabling technologies as a central part of their new rules. Additionally, we recommend that general solicitation for equity and debt crowdfunding be allowed.
- The regulatory and cost structures of public exchanges are just too heavy and expensive for SMEs. There is a reason that most “small board” stock exchanges have very low levels of activity – most do not enable new technology solutions to reduce regulatory oversight or transparency burdens.
- It does not utilize the technology that is being created for online finance and crowdfunding that is broadening participation, transparency and liquidity.
- It does not include real time data standardization, integration and analysis that follows the flow of investor’s capital and issuer’s needs and matches a global standard to create benchmarks and promote global best practices. And finally,
- It does not include offering documentation or disclosure standardization solutions that streamline processes, increase transparency and reduce costs.
Fundamental to any new initiative to save cost and time is the following strategic framework. (We use this in all countries as they work to reach the 4 goals mentioned earlier):
- Leverage the policy and regulatory expertise in your country in combination with 4 years of global best practices and knowledge in crowdfunding, to create a new path to capital formation for the 21st century. (Start by focusing on SMEs and startups, but that is just the starting point).
- Leverage technology created for crowdfunding to make other private capital market transactions more standards-based, transparent, lower friction and lower cost. (New efficient technologies + lower hurdles = more capital flows).
- Balance the needs of the 4 key stakeholders to create a policy and regulatory framework that works for everyone. It must provide:
- Protection for investors
- Ease of use for SMEs, Startups and Entrepreneurs
- Transparency for the regulator
- Opportunity for the crowdfunding industry
- Implement effective crowdfunding regulation to make diaspora and cross-border investment scalable.
- Train SMEs, startups and entrepreneurs with the skills they need to raise capital online.
- Leverage global standards for data standardization and documentation standardization to increase transparency, regulatory oversight and investor engagement.
While we do not profess to have all of the answers, we have personally seen both successes and failures when it comes to creating crowdfunding ecosystems, are constantly analyzing data in real time on a global basis, and we want to reduce the number of preventable issues going forward.
We welcome feedback and comments with differing perspectives. We share our experiences here to help those creating policy and regulation, save time, cost and frustration as they work to create much needed jobs, entrepreneurship and innovation globally.
*Thanks to Doug Ellenoff for his review of a draft of this post.
Our Sponsor, Ellenoff Grossman, has been an integral member of the
establishment of the crowdfunding industry and is the most active law firm focused on this space both domestically and worldwide. Its 10 member crowdfunding practice group represents funding platforms that cater to venture and real estate opportunities.