Crowdfunding & The Great Decentralisation of Investing

26 July, 2021
Investing

When you think of crowdfunding, what comes to mind? Kickstarter? GoFundMe?

The term crowdfunding, for good or bad, invokes a miscellany of interpretations. But in this article, I’m talking about the adult in the room — equity crowdfunding.

So what is equity crowdfunding, and why is it important?

The great decentralisation of investing

Rewind 60 years from today to when Warren Buffet and Benjamin Graham first started investing. The investment industry was nascent and unpopular and information was extremely hard to come by.

Even until the 1990s, one still had to mail for annual reports.

But fast forward to today, and individuals now have access similar to institutions.

Indeed, looking beyond the memes and mania, the Wall St Bets saga tells us something about the structural changes in the market. It points to a deep secular trend: the frictionless of markets and the rise of retail investing.

Retail investors now make up 25% of trading volume in US equity markets. That’s up from 10% in 2019!

Robinhood, one of the spearheads of this trend, has its IPO next month for circa $40B USD.

Markets for real estate, artwork and even classic cars have similarly been democratised through fractional ownership and secondary markets.

Private venture capital is the natural next step and equity crowdfunding is the path to get there.

 

But, there is bound to be pushback.

Venture capitalists will exhort that their technical know-how and networks are vital for helping startups succeed.

And while this might sound like an excuse reminiscent of anxious mutual funds decrying the rise of retail investors in equities, there is some truth here: venture capitalists do matter.

But venture capital and crowdfunding are not mutually exclusive; they are complementary.

Venture capitalists provide credibility, know-how and networks and lead the round.  Crowdfunding then adds several other benefits.



Benefits of crowdfunding

1: Crowdfunding as a distribution channel

Angels and VCs bring expertise but the crowd brings customers and fans. — Naval

The nirvana of B2C, social media and marketplace distribution is exponential organic growth.

For example, imagine this:

You’ve just invested in an awesome company. Let’s say TikTok or the Whoop band. What’s the first thing you go and do? You get your friends on board.

Crowdfunding campaigns often have >1,000 investors — that’s 1,000 mini-evangelists for your product. Not only that, but 1,000s more investors will probably look at your crowdfunding campaign.

Raising money via crowdfunding is a viral distribution method.

2: Cheap and in control

Normally, VCs control the terms of the funding round. They often demand preferred shares with significant liquidation preferences and board seats. Having to give away 20-25% equity is common, and 20-40% of founders do not remain in their original role through exit.

On equity crowdfunding platforms, the founder sets the terms of the raise.

Crowdfunding can alleviate the startup from the pressure VCs place for a quick exit.

3: Social Capital

When angel investors invest, they buy part future cash flows, part social status.

Crowdfunding platforms therefore provide Status as a Service. It works a bit like this:

  1. Angel investing gives you the opportunity to invest in mega deals like Robinhood
  2. Saying you were an angel investor in Robinhood gives you big-boy status
  3. This big-boy status helps you build social capital in the investment community – you can attract more deals, land better jobs, and garner trust from others.

Status as a service will provide tailwinds for these platforms as they allow investors to earn both financial returns and meaningful signals. This also means that startups might be able to raise more money than they could otherwise raise.

4: Quicker, easier and more efficient

Convenience is the maxim of the 21st Century. Crowdfunding platforms make the raising process quicker and easy for startups by intermediating the process. They allow startups to get funding without breaking into the VC’s inner circle. Also, crowdfunding allows startups to always be raising, matching the source of funds to their uses to enhance efficiency in the use of capital.

In a world where convenience is a driver of adoption, crowdfunding will gather momentum.


The players

At present, the crowdfunding market in Europe and the US is $5B jointly. We predict the crowdfunding market to be worth between $12B and $25B in 2025. Currently, 3 players dominate the market:

I have small investments in both WeFunder and StartEngine. You can read my investment thesis for WeFunder here.

Conclusion

The composition of markets is fundamentally changing. What consumers invest in and how they do so is a directional arrow of progress that points towards the democratisation of investing.

In 2011 Marc Andreessen said that software is eating the world.

I say software will eat financial markets. It will disaggregate intermediaries and turn investing into a consumer pastime. Still, the wealthy have a monopoly over markets, but technology is breaking this down by increasing access and participation.

There are early signs of a larger secular trend. And crowdfunding is a step to get there.