Why crowdfunding will fail in some countries

Recently, I had a call with an eager government organization exploring how to start integrating securities-based crowdfunding into their financial markets. Unfortunately, I believe they are pursuing a strategy that is not structurally sound. They see crowdfunding/online finance as a possible solution to their economic ailments. But they don’t understand that it will require investing time and resources in technology and training as well as policy, to successfully reach their goals.

This is what I hear frequently from government leaders and financial regulators about why they are considering debt and equity crowdfunding:

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• 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 and expensive/difficult steps they embark on are new government programs to create incubators, accelerators, and various grants and government investments. 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/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. They have clients that are already profitable. So why should they burden themselves with new cost structures and processes they are not required to and whose overhead makes them unprofitable?

Next, when regulators/officials begin to consider adopting online finance/crowdfunding rules, government officials say, “We are taking our existing rules/requirements/processes for companies that want to go public on the main stock exchange or the “small board” stock exchange and create ANOTHER way for SMEs to raise money in the public/private markets. But we want to do this without any new technology services/solutions.” In addition, the three countries they were benchmarking for regulation were far from “global best practices” examples.

I have five serious concerns with this kind of “change in policy only” strategy:

1. It does not use the technologies (web/mobile/social media) that are a part of our daily lives and enable everything to be faster, easier, cheaper, and more transparent. All countries that I work with include new enabling technologies as a central part of their new rules. Additionally, I recommend that solicitation for equity and debt crowdfunding be allowed.

2. The regulatory/cost structures of public exchanges are just too heavy/expensive for SMEs. There is a reason why most “small board” stock exchanges have very low levels of activity – most do not enable new technology solutions to reduce regulatory oversight/transparency burdens.

3. It does not use the technology that is being created for online finance/crowdfunding that is broadening participation, transparency and liquidity.

4. It does not include real time data standardization, integration, and analysis that follows the flow of investor capital and issuer needs and matches a global standard to create benchmarks and leverage global best practices.

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5. It does not offer documentation/disclosure standardization solutions that streamline process, increase transparency, and reduce costs.

The need for a proper framework

The countries that are succeeding at kickstarting entrepreneurship through crowdfunding and other means have strategic frameworks in place. These are the cornerstones of that framework:

1. Leverage the policy and regulatory expertise in your country in combination with four 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).

2. Leverage technology created for crowdfunding to make other private capital market transactions more standards-based, transparent, lower friction, and lower cost.

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3. Balance the needs of the four 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
• Transparency for the regulator
• Opportunity for the crowdfunding industry to succeed

4. Implement effective crowdfunding regulation to make diaspora/cross-border investment scalable.

5. Train SMEs and startups with the skills they need to raise capital online.

6. Leverage global best practices for data standardization and documentation standardization to increase transparency, regulatory oversight, and investor engagement.

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While I do not profess to have all of the answers, there are certainly a number of examples of both successes and failures when it comes to creating crowdfunding ecosystems. A good understanding of likely pitfalls and best practices will help reduce the number of preventable policy and implementation issues going forward.

Jason W. Best is a partner at Crowdfund Capital Advisors. The firm provides strategy and investment advisory services to professional investors, governments, innovators, and financial institutions. Jason and CCA principal Sherwood Neiss are credited as the creators of the regulatory framework used in Title III of the JOBS Act and have now worked in 30 countries to improve financial technology and access to capital. Jason  also co-authored The World Bank’s Research on Crowdfunding and Crowdfund Investing for Dummies. You can follow him on Twitter @CrowdCapAdvisor.