The concept of equity-based Crowdfund investing (CFI) is not a completely new one - investors in the U.S. began pooling their capital to invest in new businesses since the Industrial Revolution. Similarly, start-ups around the world frequently turn to the tried-and-true friends and family network for initial seed funding. Over the past few years, however, the global financial crisis and diminished access to bank loans has limited access to capital for start-ups and small businesses for early stage and advanced rounds of funding. Moreover, legislation enacted in response to past financial crises has had the unintended effect of placing both small-volume investors and start-ups without significant resources out of the capital markets. Several countries have already taken steps to open up capital markets through CFI. Crowdfunding becomes legal this year in the U.S. thanks to the JOBS Act passed by Congress and signed into law by President Obama last spring. This will allow businesses to raise investment capital from both small and large investors in exchange for equity. In an unprecedented era of social connectedness via the Internet and the rising availability of innovative, disruptive technologies, Crowdfunding will open the doors to investment opportunities for entrepreneurs, investors and incubators. A new era of transparency and collaboration is set to replace older, outdated investment models.

Unintended Consequences

In the early twentieth century, the decentralized regulation of financial markets in the U.S. enabled unscrupulous stockbrokers to issue stock in fictitious or worthless companies and sell them to investors in other states. In response to widespread securities fraud and the stock market crash of 1929, Congress passed the Securities Act of 1933 and the Securities Exchange Act of 1934. These laws were designed to increase public trust in the capital markets by requiring uniform disclosure of information about public securities and establishing rules for honest transactions. These regulations dictated the way capital markets would function in the U.S. for the following 50 years, until it became apparent they were inhibiting the flow of capital to smaller enterprises. In response, the SEC adopted "Regulation D" in 1982, which established certain exemptions from the registration requirements under the 1933 law for small businesses.

The failures of WorldCom and Enron in the early 2000s again brought about new financial regulations. Legislation passed in response to these scandals ushered in a wide range of corporate governance, accounting and financial reporting requirements. "The new rules effectively ensured that if your business was worth less than $100 million, going public through an IPO was not an option due to excessive costs," says Sherwood Neiss, co-founder and principal of Crowdfund Capital Advisors, the group that lobbied for the legalization of CFI in the U.S. The IPO market was closed off from all but the largest corporations and dramatically reduced small- and medium-sized businesses' access to capital.

Kickstarting Entrepreneurship

The Organisation for Economic Co-operation and Development (OECD) estimates that small- to medium-sized enterprises (SMEs) supply between 60 and 70 percent of all jobs in developed countries. Relatively high interest rates, disparities in access to private equity markets and regulatory burdens are the primary hurdles facing entrepreneurs, according to the organisation. In developing countries without well-developed private equity markets, securing early-stage investment is even more difficult.
By 2012, the concept of Crowdfunding was already commonplace due to websites like Kickstarter, which allows users to donate funds to a project in exchange for a "thank you" or a gift - but not equity in a new venture. The JOBS Act of 2012 lifted certain restrictions on soliciting unaccredited investors to purchase stock in the U.S. The country is certainly not the first to legalize equity-based CFI - some form of Crowdfunding has been operating in Australia and the UK for years with profound success. Italy joined their ranks last year, allowing start-ups to pursue Crowdfunded investment capital with the assistance of an angel investor.

New financing options could not have come at a better time for start-ups. In 2012, small business loans were difficult to secure in the face of the banking crises in several European countries and renewed fears of recession in the U.S.; venture capitalists seemed more apprehensive about riskier, early-stage ventures. Funding a start-up is "as difficult as ever," according to Kelly Hoey, founder of Women Innovate Mobile, an accelerator dedicated to fostering mobile technology projects headed by women. More start-ups compete for the same number of slots, and possibly less funding, even if they work with an incubator or accelerator. Even then, the success rate of even the most prestigious venture capital firms has come under scrutiny, as reportedly only half of start-ups backed by venture capital have generated a return in recent years.

"The world we know as 'Crowdfunding' will continue to grow," says Adam Draper, founder of Crowdfunding platform BoostFinder and San Mateo, California-based incubator Boost. "I believe that most venture and angel-backed deals will be done online in the next five years. The biggest issues with investing in start-ups are getting to know the companies and filing all the necessary legal documents after the decision has been made to invest. CFI platforms address these issues in an attempt to create a fast, easy process to invest in start-up companies."

Impact on Incubators

Crowdfund investing will create a new set of investors that Jason Best, co-principal with Neiss at Crowdfund Capital Advisors has called "micro-angel investors." Although some skeptics caution that Crowdfunding will compete for access with angel investors and venture capital firms, it is not intended as a direct alternative, but rather as an early-stage funding option for start-ups that may eventually pursue larger rounds of financing or want to attract the attention of an incubator or accelerator. In the U.S., companies will be able to raise up to $1 million annually through Crowdfunding. A business owner can use Crowdfunding to raise funds in small increments, and every investment can have a big impact on that business's success in the early stages. The potential for Crowdfunding to attract a significant number of new investors to the private capital markets raises new questions for incubators and private equity firms alike.

Hoey is undecided about Crowdfunding's role during the incubation period, raising a key question many in the field are also asking: how will Crowdfunding affect start-ups that pursue angel or venture capital investment in the future? Crowdfunded start-ups "may come with a lot of baggage," she explains, citing the potential of having dozens or even hundreds of smaller investors to manage in a second or third round. As a mentor to the entrepreneurs in her programme, she is dedicated to educating start-ups about the myriad funding options available to them. She says among the potential advantages of Crowdfunding include "proof of market validation - people want this because they were prepared to Crowdfund it." While detailed rulings from the SEC have yet to come out at the time of writing, it is important for incubators and accelerators to think about the effect of expanding capital markets and prepare to work with Crowdfunded start-ups in the future.

Jeff Burton, president of SkyDeck, an incubator at the University of California, Berkeley, seems to agree. Crowdfunding is "still finding its appropriate fit in the world of investing… its terms, methods and sums vary widely and require a knowledgeable advisor to gauge the appropriateness [of it] for any specific start-up." Still, Crowdfund investing could have an immediate impact for "certain, specifically attuned 'crowd segments'" in the business-to-consumer product marketplace.

Mitch Gordon, a SkyDeck graduate and founder of GoOverseas.com, studied Crowdfunding during his MBA programme at UC Berkeley. "For a lot of companies, the most viable [funding] option is the one that gets them the money they need. Crowdfunding has the potential to do this, so I'm sure many more entrepreneurs will start looking in this direction," he says. "Accepting money from investors is a serious decision - it changes the way you run your business. Bringing on the large number of investors through a CFI service can be a challenge. If you focus [investors] the right way, this can be an amazing tool: they can be your first customers and brand evangelists."

Incubators will have to educate their start-ups on the specific legal requirements and regulations in their respective countries, and determine whether or not seed financing through Crowdfunding makes sense for their start-ups. Most Crowdfunding platforms will perform some level of due diligence on their investors - hopefully allaying some fears of a supposed legal quagmire for institutional investors. According to a November 2012 interview with Paul Niederer, CEO of the Australian Small Scale Offerings Board (ASSOB), the world's largest equity crowdfunding platform, where Crowdfund investing has been legal since 2005, there have been no reported instances of fraud, another concern regarding Crowdfunding.

From Microfinance to Crowdfunding

"Access to capital is not just an American problem, it's a global problem," says Best. He has been an active supporter of CFI, travelling all over the world to work with investors and policy makers in implementing Crowdfunding structures. Best and Neiss worked in a number of countries including Italy, Colombia, Mexico, Canada, Turkey and Sweden to provide policy consulting and investor training for building effective angel networks and Crowdfund investing platforms.

CFI "is perfect for a country like Colombia that doesn't have a strong history of venture capital or angel investors," says Jennifer Jordan of Mass Ventures, an early-stage venture fund in the high tech space in Massachusetts. There is a significant funding gap between early seed investment and more formal investment structures for many start-ups in the developing world, according to Jordan. She predicts that Crowdfunding will become a part of entrepreneurs' repertoire of financing options - just like angels and venture capital - but it may be more suitable for some organisations than others, like the Massachusetts Institute of Technology's Accelerating Information Technology Information (MITAITI) global incubator. MITAITI's alumni are successfully launching mobile technology and other ventures in their home countries, such as Hehe, a mobile services company in Rwanda. CFI could be a critical financing avenue for start-ups in developing countries that participate in MITAITI. "Lots of people can receive some amount of seed funding," but private equity funding in these countries tends to focus on growth-stage enterprises instead of early-stage start-ups.

Microfinance advocates encountered similar criticisms as those facing Crowdfunding before microloans became popular in the developing world. Today, not only do microloans have a lower default rate than many other loan structures (less than five percent), the size of the market has grown substantially, to everyone's benefit. Apprehension about a new form of technology, even a potentially disruptive one, should not deter the investment community from taking Crowdfunding seriously.

Conclusion
With the introduction of Crowdfund investing, the average small investor can sit in his or her living room anywhere in the world, study a multitude of business plans from global entrepreneurs and fund them with merely a few clicks. Crowdfunding platforms will screen both the investor and entrepreneur to avoid fraud - and the investor can feel assured that the funds are directly supporting the individual making the pitch. Instead of viewing Crowdfund investing as a direct competitor, angel investors and venture capitalists should accept it as a viable funding channel. Incubators are an incredibly important driver of innovation - Crowdfunding merely provides their programme participants with another financing option to overcome what is viewed as the primary hurdle facing early-stage start-ups: finding money to power their growth and success.

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Judy Robinett is a business thought leader actively involved in venture capital and private equity. With more than 30 years of experience as an entrepreneur and corporate leader, Judy has served as CEO of public and private companies and in management roles at Fortune 500 companies. She is currently a partner at Crowdfund Capital Advisors, on the advisory board of Illuminate VC and Pereg Ventures, and is a mentor at Pipeline Foundation, where she counsels high net-worth women on angel investing. She has given more than 300 speeches worldwide and is author of the upcoming book, Strategic Relationship Mastery: How to Build High-Value Connections for Business Success.