No one will be talking about crowdfunding in five years.
The term is inherently flawed; it focuses on the wrong side of any investment: the donor/investor. And it’s become too broad to be meaningful. The missions of the leading players are widely misunderstood, even by their own users.
“Crowdfunding” conflates a variety of very different business models, the most prominent being donation-based platforms like Kickstarter and investment marketplaces like Lending Club and CircleUp. To be clear, equity crowdfunding does not encompass Kickstarter. Kickstarter is a tremendous platform, bringing creative projects to life, many of which would never exist otherwise.
It’s equity crowdfunding that is dead in the water. Not because individual investors won’t continue to invest, but because equity crowdfunding is a confusing and misleading term.
Individual investors are and will remain an important part of CircleUp — they make up almost half of the capital in our marketplace. I expect that to continue as we grow. In fact, I hope individual investors only increase in importance because of the private markets becoming more accessible and efficient for more people. That said, the term crowdfunding is incorrect for us, and for the financial industry.
I say this knowing that advocates and policymakers will widely celebrate the launch of equity crowdfunding when new rules open up that permit equity investing for all Americans, not just the wealthy. These rules come four years after the JOBS Act, and finally complete the promise of the regulation celebrated by so many. Unfortunately, because of the way the law is designed, and because of the way the industry is heading, “crowdfunding” won’t matter.
Investment-based “crowdfunding” — both equity and debt — has existed in limited forms for several years through online sites that allow investors to invest in private companies. Some of those sites have turned into online VC firms, while some are now marketplaces. All are similarly misunderstood, as they imply a “crowd” is needed, or desired, to fund companies.
Marketplaces in finance exist to move capital in a more efficient, cheaper way — for investors, companies and individuals. In a digital-first world, that means creating a transparent, open process where entrepreneurs can choose which investors to take on when raising funds. For some entrepreneurs, that will mean finding support from “the crowd,” while for others it will mean seeking a specific few investors with relevant experience. In many cases, entrepreneurs choose to raise from institutional investors that use the marketplace to more efficiently find deals.
A diverse set of investors — diverse in size, geography, investment thesis and more — provide entrepreneurs more choice. On many platforms, larger institutional investors are joining the marketplace. For example, JP Morgan is a partner of Lending Club, while General Mills’ venture arm invests directly on CircleUp.
This isn’t “crowdfunding” because there needn’t be any “crowd” — the marketplace is a conduit for the right investors and entrepreneurs to come together. Individual investors can invest alongside institutional investors in these marketplaces. To me, that’s a more exciting vision of marketplace investing than the original contemplation of “crowdfunding.”
Technology forces the best legacy players to differentiate themselves from the new better, faster, cheaper alternatives.
So, we should we call this new form of online capital raising by its proper name: marketplace investing.
The common thread in marketplace investing is the use of technology to reduce costs and friction for both entrepreneurs and investors, and create a transparent process. Investments are made in a data-rich context, where both parties see relevant comparison data for valuation and competition, not unlike what happens in public markets.
Widespread adoption of marketplace investing will lead to dramatic change for all parties in private equity. Individuals can participate, funds can participate. Traditional Limited Partners can become direct investors and bypass funds. Traditional General Partners can focus on value-add to their portfolio, and spend less time sourcing.
The latter marks an important shift, as for decades, thousands of General Partners have tried to convince Limited Partners — their investors — that they’re good at all three parts of private equity: 1) sourcing strong new deals, 2) executing transactions (making good decisions) and 3) adding value post-close.
It’s a lie. Some are good at No. 1, a few are good at No. 2 and a few of the best are good at No. 3. Almost none are good at all three. Now that firms are starting to leverage the sourcing power of the marketplace, they can focus their time where their value-add matters most — No. 2 and No. 3 — while streamlining No. 1.
This transition won’t be painless. As we’ve seen in the past, offline intermediaries tend not to do well when faced with competition from online marketplaces. Think retail (Amazon), transportation (Uber), hospitality (Airbnb). Technology forces the best legacy players to differentiate themselves from the new better, faster, cheaper alternatives while squeezing out the intermediaries that can’t innovate. Private equity will be no different.
Here’s another prediction: The fees charged by private equity firms will go down because of marketplace investing. That’s an easy one — just look at the analog in public markets. In the past 40 years, fees have gone down 70-90 percent for public market investors, driven by new technologies and marketplaces. Fees haven’t changed at all in private equity — for decades. Today there is no product more expensive in all of financial services than the private equity fund that gobbles a 2-3 percent annual management fee and 20-30 percent of profits.
Then there are far too many GPs only good at sourcing, who will no longer be relevant and get squeezed from the equation. When it’s dramatically easier to source deals and for investors to share their qualifications with entrepreneurs looking for capital, GPs will differentiate where their impact is felt most, which is strong support post-close. So marketplace investing will reward the best funds — but only the best.
Yes, it is time to name the issue. Equity crowdfunding is dead. But I have never been more optimistic about the potential for marketplaces to create value for entrepreneurs all across the country, bring transparency to private equity and streamline sourcing for investors. Investment marketplaces will see greater adoption from individual investors and institutional investors alike – which will only benefit entrepreneurs.
Let’s stop calling this process crowdfunding. We are seeing the rise of marketplace investing.Featured Image: Dirk van der Walt/Shutterstock