There’s a contradiction at the core of securities crowdfunding, a form of Internet-based public stock market modelled on Kickstarter and its ilk. On the one hand, crowdfunding seeks to create an inclusive system where entrepreneurs, regardless of where they are or whom they know, are invited to pitch their company directly to “the crowd” (the broad public). On the other hand, crowdfunding is supposed to be an efficient system that allows startups and small businesses to be financed so that they can grow, create jobs, and contribute to the economy. Unfortunately, these policy goals of inclusivity and efficiency are in tension.
A completely inclusive system would require crowdfunding platforms—websites that act like online stock exchanges—to accept every company that wants to list on their site. Reward crowdfunding generally follows this model: Kickstarter does not screen, curate, or vet the projects before presenting them to the crowd; anyone with an idea can take a shot. But crowdfunding platforms have a clear business need to exclude at least some of the companies that seek to participate, in order to establish a reputation as a reliable place for people to invest. As with traditional securities markets, some sort of gatekeeping mechanism seems vital for the system to function. Yet gatekeeping necessarily implies including some companies and excluding others, a direct affront to the goal of inclusivity and unmediated access to the crowd.
The Securities and Exchange Commission has struggled to resolve this tension from the earliest days. The SEC’s initial version of Regulation Crowdfunding, proposed in 2013, adopted an extreme version of inclusivity that would have required online crowdfunding platforms to list any company that asked to be included, regardless of the platform’s view of that company’s prospects or the price of its securities. Public commenters, however, pilloried that proposal as being unreasonably inefficient. In the end, the SEC relented, and the final version of Regulation Crowdfunding (operative since 2016) allows platforms to pick and choose which companies to list.
Securities crowdfunding, while born in the United States, has become a worldwide phenomenon, with New Zealand leading the charge. That country was one of the earliest jurisdictions with a functioning legal regime for crowdfunding, having launched its equity crowdfunding market in 2014, two full years ahead of the United States. Since then, New Zealand has become an international leader in the field, making it an ideal destination for an academic study of this emerging area in securities regulation.
I spent the first half of 2017 in New Zealand studying its crowdfunding law and marketplace, conducting local research, and interviewing entrepreneurs, platform operators, investors, lawyers, academics, and government officials (including the minister of commerce). In The Gatekeepers of Crowdfunding, I use this original research to compare the United States and New Zealand crowdfunding markets in terms of inclusivity and efficiency.
In my research, I found that New Zealand never had to grapple with the tension between inclusivity and efficiency, because its statutes and regulations were designed to promote only efficiency—sometimes at the expense of inclusivity. Platforms are empowered to, and do, take their role as gatekeepers very seriously and have always had the clear authority to exclude any company. As a practical matter, they have turned out to be rather exclusive, especially the largest platform, Snowball Effect, which lists only 2 percent of the hundreds of companies that ask to be included on the site.
With a laser-like focus on efficiency, New Zealand has established a crowdfunding market that is orders of magnitude more financially successful than its American counterpart. Data presented in my article compares the first year of crowdfunding in New Zealand (2014–15) with the first year of crowdfunding in the United States (2016–17), and reports numbers that are truly astounding: Scaled for the size of its economy, and focusing on the first year in each jurisdiction, New Zealand had 13 times as many crowdfunding campaigns which collectively raised about 30 times as much capital, and 80 percent of New Zealand crowdfunding campaigns were fully funded, compared with 50 percent in the United States.
The United States, by contrast, has succeeded in making crowdfunding inclusive. As shown in my article, very young startups that lack revenue and pre-existing supporters are not screened out but often given a chance—for better or worse—to pitch their ideas to the crowd. The average age of an American crowdfunding company is just two years, and almost none have previous investors. In New Zealand, however, the average age is eight years, and it is common to have pre-existing investors. In terms of demographic inclusiveness, the picture is mixed. Finally, the notably lower success rate for crowdfunding campaigns in the United States (50 percent) compared with those in New Zealand (80 percent) also indicates that the American system is more open and inclusive of entrepreneurs, and more likely to let a highly speculative startup at least try to convince the crowd.
The difference in approach to crowdfunding in America and New Zealand appears to stem from the difference in the amount and type of startup capital available in each country. The United States has long had the largest and most mature system of venture capital and angel financing in the world, and could afford to view crowdfunding as a complementary system focused on inclusive opportunities for entrepreneurs. New Zealand has long had much less venture capital and angel financing, even for its size, and crowdfunding helps make up for that shortfall. It could not afford to be distracted by the secondary goal of inclusivity.
This comparison between the United States and New Zealand offers a broader lesson for other countries drafting (or reforming) crowdfunding laws: Inclusive crowdfunding is a luxury. Jurisdictions with low levels of venture capital and angel financing (e.g., Italy and Spain) may wish to ignore inclusivity and just focus on creating an efficient system for crowdfunding. Jurisdictions that already have abundant venture capital and angel financing (e.g., Israel and the United States) can afford to employ crowdfunding as a way to promote entrepreneurial participation across a broad segment of society.
This post comes to us from Professor Andrew Abraham Schwartz at the University of Colorado Law School. It is based on his recent article, “The Gatekeepers of Crowdfunding” (Washington and Lee Law Review), available here.