In a new book, I discuss “investment crowdfunding” (also known as “equity crowdfunding” or “securities crowdfunding”), an inclusive new type of online venture capital market – it’s like Kickstarter, except you get a share of stock. More formally, I define investment crowdfunding as the public offering of unregistered securities through an independent online platform. The book is a comparative work that covers the law of investment crowdfunding in the United States and five foreign jurisdictions: Canada, Australia, New Zealand, the UK, and the EU.
Most countries have followed the lead of the United States and adopted what I call the standard model of investment crowdfunding regulation, which relies on the usual methods of securities law and regulation, especially mandatory disclosure. Yet two countries, the UK and New Zealand, have adopted what I call the liberal model, meaning a very light-handed (de-regulatory) regulatory regime that relies primarily on economic incentives and private ordering to police and govern the investment crowdfunding market.
The liberal jurisdictions have developed larger investment crowdfunding markets than their standard brethren (measured on a per-capita basis), without any significant difference in the levels of fraud or other misbehavior. I suggest that this outperformance is a result, in part, of the lower compliance costs in liberal countries. Low costs are essential to the success of investment crowdfunding, because companies are only allowed to raise $5 million per year in this manner.
All countries, but especially the liberal ones, rely on private ordering mechanisms to efficiently protect investors and the integrity of the market. Some of the most important of these are gatekeeping, syndication, and wisdom-of-the-crowd. To give you a flavor, let me explain one private ordering mechanism in a bit of detail, one that I call brand ambassadors.
By brand ambassadors I mean loyal customers or clients, the type that a company can rely upon for word-of-mouth and social media advertising, beta testing, and such. They wear t-shirts with the company logo. When the company posts an announcement to social media, brand ambassadors will “like” or re-tweet it to their online friends. When the company has a new product, brand ambassadors will buy it and post a review.
Brand ambassadors are valuable to every type of company, but they are particularly vital for startups. By definition, they are not household names and need to market and promote the company to potential customers, clients, employees, and others. Most of the time, this sort of promotion costs the company money; advertisements are not free. But brand ambassadors promote the company just because they love it.
And, through investment crowdfunding, when the company wants to raise money, it can look to its brand ambassadors, who will be eager to invest because they know the products, believe in the company, and want to participate – after all, they’re brand ambassadors. The result is that a company with a loyal fanbase can likely raise money on attractive terms from their own customers – and this happens all the time, across jurisdictions.
Often, a company will raise money simultaneously from venture capitalists and from its brand ambassadors via investment crowdfunding. This is allowed under the regulations and benefits all concerned. The VC gets an additional quantum of capital invested in a company it believes in; the brand ambassadors get comfort that they are investing on the same terms as an experienced VC that has engaged in due diligence; and the company gets a marketing boost by energizing its brand ambassadors, as well as the benefit of expert advice from the VC, and more capital overall.
The value of brand ambassadors is clear. But there is danger as well. If they feel mistreated as investors, the brand ambassadors could boycott the company and encourage others to do the same. If a company were to mistreat their investors or customers through mis-valuation, agency costs, opportunistic exits, misleading behavior, or otherwise, these brand ambassadors could quickly turn into brand assassins. Instead of extolling the company on Twitter and Facebook, they could write angry missives, causing real damage to the company and its prospects.
The fear of such turnabout by a crowdfunding company’s investors or customers serves to protect them from misbehavior on the part of the founders and management. The larger and more passionate the army of brand ambassadors, the more power they hold over management. Thus, gathering a large group of investors through crowdfunding, at least for a consumer company, is a way for management to credibly commit to treating them fairly, minimizing agency costs, and avoiding fraud, all as a matter of private ordering.
Brand ambassadors are just one of many non-legal mechanisms discussed in the book, and together they create a strong web of governance and protection. My ultimate recommendation, therefore, is that investment crowdfunding policymakers should rely primarily on private ordering and keep the regulations as light as possible. They should, in short, follow the liberal approach.
This post comes to us from Professor Andrew A. Schwartz at the University of Colorado Law School. It is based on his new book, Investment Crowdfunding (Oxford University Press 2023), available here.