Wall Street bounced back from its near-death experience in 2008, but there’s plenty for the Masters of the Universe to fret about: Industry-wide revenue and headcounts are down; regulators are threatening to reign in the megabanks; and bankers are about as popular as Congress.
Guess what? That’s not all.
The next great disruptive technology is aimed directly at Wall Street. It’s called crowdfunding. And whether you acknowledge it or not, crowdfunding is all about democratizing finance—and you can imagine where that leaves Wall Street.
By marrying online social networks with finance, crowdfunding offers a finance model in which individuals can directly fund entrepreneurs or businesses that they deem worthy—bypassing Wall Street middlemen and their exorbitant fees.
Although still in its infancy, crowdfunding has already attracted influential supporters, including Google, which this May led a $125 million investment in Lending Club, a peer-to-peer, crowdfunding-style financing network that allows members to borrow and lend to each other with no bankers involved. Since 2007, the site has made $1.8 billion with a ‘b’ in loans.
Google isn’t alone in seeing a future for crowdfunding. A year ago Clay Christensen, author of Innovator’s Dilemma and the godfather of “disruptive innovation,” joined with other early-stage venture capital funds, including Howard Schultz’s Maveron, to back CircleUp. This San Francisco-based startup connects investors with fledgling retail and consumer brands too small for private equity firms to bother with. CircleUp usually deals with companies with $1 million to $10 million in revenue.
Over the past 12 months, at least a dozen small companies, including Little Duck Organics, which makes organic kids’ snacks, and 18 Rabbits, a granola brand, have used the Circle Up platform to collectively raise more than $10 million. Corporations, such as General Mills and Procter & Gamble, have partnered with the site to get an early peek at up-and-comers they might someday acquire. Google Ventures participated in the latest funding round.
Crowdfunding is all about democratizing finance—and you can imagine where that leaves Wall Street.
How does crowdfunding work? Like crowdsourcing, where ideas or services are solicited from an Internet-connected community rather than an RFP to a handful of ‘experts,’ crowdfunding allows entrepreneurs to aggregate funds, often in small amounts, from interested investors via the Internet. The dollar figures may be small by Wall Street standards, but they are adding up quickly. Crowdfunding of all types generated $2.7 billion worldwide in 2012, according to research firm Massolution, a figure that is expected to balloon to more than $5 billion this year.
Individuals who are moved to fund a company often become its biggest supporters and ambassadors. And the crowdfunding campaign itself—typically involving an appealing video and heavy social media— can generate valuable publicity. Just ask the makers of Knix Wear, a women’s underwear maker based in Toronto that attracted an 18-store pre-order by the Hudson’s Bay Company, Canada’s largest department store and owner of Lord & Taylor, through its crowdfunding campaign on Indiegogo.com. In this way, crowdfunding is as much about marketing, branding and creating long term, engaged customers—the Holy Grail in the new social economy—as it is about financing.
To date, most crowdfunding has centered on donations to arts and entertainment ventures, many of which might otherwise not make it past industry gatekeepers or the banks. For instance, organizers of the storied Coney Island Mermaid Parade didn’t have funds to put on the annual free spectacle following the hammering the Brooklyn seaside community took from Superstorm Sandy. So they turned to Kickstarter, a popular “crowdfunding” site that lets people donate money to creative projects in return for rewards. Give $13 and get a temporary mermaid tattoo; larger outlays were rewarded with VIP seating or custom-made mermaid costumes. By the end of four weeks, nearly 2,500 enthusiasts had chipped in more than $117,000. The parade, which attracts as many as 750,000 revelers each spring, took over the boardwalk and Surf Avenue June 22.
Crowdfunding is about to get its own kickstart from the Jumpstart Our Business Startup (JOBS) Act, which was signed into law by President Obama in April 2011 and is aimed at making it easier for small companies to go directly to everyday investors to raise money. (Currently, only wealthy, “accredited” investors can easily put money into private companies.) The Securities and Exchange Commission is still writing the rules, but many expect crowdfunding to take off once they are released.
Meanwhile, a few crowdfunding startups have found ways to get around the lack of clear-cut regulation. For example, Fundrise, a Washington DC-based startup founded by two young brothers with real estate backgrounds, uses legal loopholes to offer ordinary investors the opportunity to invest in local commercial real estate projects.
Fundrise offers a great example of how crowdfunding can get rid of the intermediaries in investing and democratize the process. As Fundrise cofounders Dan and Ben Miller explain, most commercial real estate projects are financed by private equity investors who don’t live in the neighborhood and are solely interested in returns. As a result, neighborhoods end up with strip malls and bland office towers that they may not want or need. By allowing the people who live in a neighborhood—its natural stakeholders—to fund local projects, Fundrise has been able to develop quirky projects that wouldn’t fly with private equity investors, such as the Taiwanese noodle house-cum-indie boutique set to lease space in D.C.’s emerging H Street N.E. neighborhood—with the help of $325,000 investment from 175 local investors.
In a typical commercial real estate deal, fees can strip out 20 to 40 percent of the value, Ben Miller explains. By offering shares directly to the public, Fundrise cuts out those fees and passes the savings along to investors. (Its deals typically promise yields of 7 percent to 10 percent on top of the property’s appreciation.)
So far, crowdfunding has stirred interest among small businesses that have a harder time obtaining capital. But could it be long before large companies embrace it as well? Corporations, such as General Electric and Dell, are already using crowdsourcing to solicit ideas and improve products. While big firms may not have trouble obtaining funds, crowdfunding offers new opportunities to generate social buzz and customer buy-in. And besides, who wouldn’t want to ditch their banker?
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