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The Next Big Thing in Finance!

Freaking Heck's picture




 

By: Chris Tell at http://capitalistexploits.at/

That's what its being called. Crowdfinance or crowdfunding, is a space we've spoken about repeatedly on this site. Mainstream media have been a little slow to wake up to it, but wake up to it they will.

It is MASSIVELY DISRUPTIVE, and the implications for traditional brokers, investment bankers, venture capitalists and the numerous flow-on and related industries cannot be underestimated. 

For the last few years we've watched the crowdfunding space intently and have deep connections in the industry. 2013 landed up being a pivotal year for crowdfinance and 2014 looks even better.

In a regulatory environment that has appeared to be sleepwalking into high-vis misery, the SEC removal of the 80 year ban on general solicitation for private companies was a step in the opposite, yet right direction. Catalytic mainstream acceptance was further solidified, and a number of high profile investments were made. Google led a $125 million deal buying a stake in Lending Club, valuing the world's largest p2p lending platform at $1.55 billion. Blackrock came in as a strategic investor to Prosper, to name but two.

Our friend Dara Albright, Co-founder of NowStreet Wire, has 4 predictions for 2014. Incidentally we don't disagree.

1. CAPITAL WILL BE REALLOCATED FROM TRADITIONAL FIXED INCOME PRODUCTS INTO PEER-TO-PEER (P2P) LOANS
2013 was an extraordinary year for p2p lending. The domestic market grew 177%, the global market exceeded $8B, and the industry began winning over an initially skeptical media. As the financial press increasingly draws attention to p2p’s greater and more stable returns, we should experience an exodus from bond funds into p2p. This past year, many active bond managers underperformed their benchmarks, and investors began withdrawing money from bond funds at record paces. According to Lipper US Fund Flows data, over $60B has been pulled from municipal bond funds alone in 2013 – the most since 1992. With p2p garnering mainstream attention, conventional fixed income asset classes languishing, and wealth managers becoming more knowledgeable about p2p investing, more capital is likely to find its way into a diversified portfolio of p2p loans.

2. EQUITIES CROWDFINANCE WILL GERMINATE THROUGH SELL SIDE CHANNELS

Whereas p2p lending sprouted from the yield-hungry investing public before being chased by the institutional buy-side, the equity side of crowdfinance is more likely to germinate through sell-side channels such as boutique investment banks and small cap underwriters who possess decades of experience selling “story stocks”. In 2014 brokerage firms will quickly discover additional revenue streams emanating from corporate crowdfinance products such as PIPRs (“Private Issuers Publicly Raising) and crowdfinanced IPOs. Instead of leaving money on the table, BD’s will embrace these new products that not only contain more attractive commission structures, but mitigated compliance risk.

3. OTHER CROWDFINANCE STRUCTURES WILL PROVE MORE VIABLE THAN TITLE III CROWDFUNDING.
Despite what most crowdfunding enthusiasts would like to believe, Title III Crowdfunding, as proposed by the SEC, will not be the holy grail of capital formation. There are more feasible and cost-effective options available to issuers such as PIPRs, intrastate crowdfunding and even rewards-based crowdfunding. Title III Crowdfunding will likely undergo a number of legislative iterations, such as increasing the $1M offering threshold, before it becomes practicable for most emerging businesses. While national securities-based crowdfunding remains in flux, “locavesting” or intrastate crowdfunding will be a better way for most regional businesses to raise funds. As more states follow Georgia and Kansas in bypassing the SEC and implementing their own crowdfund legislation, more businesses will have an opportunity to reach out to their community for growth capital.

4. VENTURE CAPITAL WILL CHASE CROWDFINANCE INFRASTRUCTURE PLAYS

Venture capitalists, looking for ways to capitalize on crowdfinance, will recognize that a vast amount of wealth will be generated in infrastructure plays. In 2014, venture capital will flow into those companies that provide settlement & clearing functionality, supply market data to the global investing community, and facilitate secondary transactions of crowdfinanced offerings and p2p debt.Finally, it must be asserted, that no nation has ever succeeded, or will ever succeed, by printing or taxing its way to prosperity. Nor can a nation stimulate its economy by restricting its middle class investors and entrepreneurs from accessing portfolio yield and growth capital. However, employing the doctrines of crowdfinance – granting all citizens the ability to freely invest in the ingenuity and invention of fellow citizens – has proven to be a winning formula. In fact, it is what enabled a simple farmland to become a global innovation leader and the greatest economic superpower in the history of the world. And it is crowdfinance that what will fund the innovation that will fuel the next economic boom. As the crowdfinance industry crosses these new milestones in 2014, it will be paving the way for new medical cures, technological advancement and greater wealth equality.

It is this last prediction which we're seeing happen already and we absolutely, 110% wholeheartedly agree.

The early signs are evident. We have a dedicated staff member who's job is to provide us with a weekly data dump of all that is new in the world of crowdfunding, p2p, etc... Naturally, out of this we hear about a lot of "experts" popping up. Bloggers who clearly know close to nothing about private equity, and nothing about investing in-fact, entering the space touting how you too can make millions in private equity. Yes, you too can become obscenely rich investing in the next Google. Let the games begin. A bubble here we come.

I think we are still a ways off the sector really gathering momentum. To front run this inevitable bubble, Mark and I, together with our CPAN members, have just made our first investment in this space. It's an infrastructure play, per Dara's 4th prediction above.

I think 2014 will be a banner year for equity crowdfunding and push us further towards bubblicous territory, which will likely peak in a few years time. Just a guess. An educated one, but a guess nonetheless.

I'll add another couple of predictions to the pot.

  1. We'll see a new version/s of "Shark Tank";
  2. Much like co-ops in the third world aggregate community projects, I can envision local communities crowdfunding social projects such as playgrounds, theaters and even community gardens.

Let us know what you think in the comments section. We'd love your feedback!

- Chris

"Venture capital is a bad business" - Fred Wilson (well known venture capitalist and partner at Union Square Ventures)

 

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Wed, 02/12/2014 - 11:18 | 4427886 sakayama
sakayama's picture

This is the basic idea behind the stock market.

Then, fraud after fraud, came regulation after regulation, until we have the stock market we have today, where any company that needs to get funding from the public has to jump a extremely high entry barrier. Small companies cannot afford that. So "for the protection of the people", they are effectively out of the public funding market.

Crowdfunding may work if it is completely clear that the system operates on an "investor beware" basis and that due dilligence rest only on the shoulders of the investor. If not, the following sequence will happen:

- some investors get ripped off

- they get into activist mode

- politicians feel there is some redit in "doing something" and "regulating for the protection of the people".

- Game Over.

 

BTW: a company that "provide settlement & clearing functionality, supply market data to the global investing community, and facilitate secondary transactions of crowdfinanced offerings and p2p debt"... is actually an stock exchange. The first fraud that happen they will have the SEC breathing on their necks.

Wed, 02/12/2014 - 08:09 | 4427383 Sudden Debt
Sudden Debt's picture

It's totally unregulated and reminds me to much of the pinksheets.

 

Wed, 02/12/2014 - 04:06 | 4427194 kurt
kurt's picture

This reminds me of the run up to bitcoin-o-mania.

Wed, 02/12/2014 - 06:49 | 4427306 SAT 800
SAT 800's picture

http://www.citigold.com/  Try this as a remedy. it might not be a the next big thing; maybe it'll be the next big thing after that. You can read all about it. It's a gold mine. It's completely overlooked by the analyists and the public. The Soverign fund of Bahrain bought 18% of it a couple of years ago; for a higher price; but they're not complaining. Basically you're buying an interest in 100Tonnes of gold in the ground. In Australia, a politically stable country. the mine has its own smelter and ships bars every month. The shares are a nickel a piece. it's the most undervalued producing gold mine on the face of the Planet.

Wed, 02/12/2014 - 10:21 | 4427689 Cow
Cow's picture

Don't know if it applies, but can't stop thinking of this:

What's the definition of a gold mine?  Big hole in the ground with a thief on top.

Wed, 02/12/2014 - 02:14 | 4427069 merchantratereview
merchantratereview's picture

People who use the word "space" are ......

Wed, 02/12/2014 - 08:07 | 4427384 Sudden Debt
Sudden Debt's picture

spacemen?

Wed, 02/12/2014 - 04:07 | 4427195 kurt
kurt's picture

Dick Heads.

 

I hate the twisted shits who sell "solutions."

Wed, 02/12/2014 - 02:25 | 4427082 Jadr
Jadr's picture

probably paid upper middle to upper class wages?

Tue, 02/11/2014 - 23:23 | 4426640 bilejones
bilejones's picture

How long before the political filth step in to protect their masters?

Tue, 02/11/2014 - 23:01 | 4426561 The Wisp
The Wisp's picture

Where is the Lenders Protection..  Question Number One..

Wed, 02/12/2014 - 08:08 | 4427385 cossack55
cossack55's picture

If one CFs locally, well, your protection is either shoulder, hip, or small of the back mounted.  Always good to stress your seriousness up front.

Tue, 02/11/2014 - 22:34 | 4426458 illyia
illyia's picture

Hey - it's a positive, look-over-the-horizon piece on ZH !

Are we about to crash?

 

Tue, 02/11/2014 - 23:14 | 4426613 LongMarch
LongMarch's picture

Definately. More five years people on this site have just been handing the people on the other side of the trade their money. Gotta be right sooner or later.

Tue, 02/11/2014 - 21:45 | 4426262 ZeroFreedom
ZeroFreedom's picture

So what is the trade?

Tue, 02/11/2014 - 20:58 | 4426092 logicalman
logicalman's picture

All markets are manipulated, so for me, once there is a 'market' I lose faith.

Crowdsourcing is an awesome idea, theoretically, but it's back to the old trust thing.

I'm finding it difficult to find anything/anyone I can trust (I include myself in this!)

Wed, 02/12/2014 - 00:06 | 4426773 TheReplacement
TheReplacement's picture

Trust me when I say that I don't trust you either. 

Wed, 02/12/2014 - 07:12 | 4427332 SAT 800
SAT 800's picture

Trust me when I tell you that when nobody trusts anybody; they buy Gold and Silver.

Tue, 02/11/2014 - 20:51 | 4426063 Clowns on Acid
Clowns on Acid's picture

Ahmmm... kind of an old idea that was rampant in London like 5 years ago. The companies fell apart from defaults after 2008 crash. The article doesn't communicate the strategic difference between what is avail from a bank and from the "new:" crowdfunders.

Tue, 02/11/2014 - 19:41 | 4425769 delivered
delivered's picture

Chris,

I understand your interest and excitement with the crowdfunding/finance (i.e., "CF") space. From what I can gain from your summarized article presented, it appears that your focus will be on the larger or upper end of the CF space (i.e., deals north of $1 million, primarily equity based but probably some hybrid debt deals as well). No doubt this will be an attractive market and one that the traditional funding/capital channels will need to take notice of including VCs, PEs, alternative/risk based lenders, etc., etc., etc.

However, I would offer you a word of caution on the CF space. While most parties are highlighting its significant potential, let me play devil's advocate on this subject matter to keep everyone's feet grounded.

- The Gold Rush: As most know, the real winners in the gold rush era where the infrastructure/logistic based companies supporting all of the "wanttobe" prospectures as they pursued their dreams to strike it rich. As for the miners, well let's just say that while their were a few success stories, the masses failed miserably. So your focus on the "infrastructure" side of the business makes sense but you don't want to get so consumed in the hype of CF that your independence and transparency are questioned/challenged. The bottomline is that it's one thing to raise money, its something completely else to deploy the capital raised and execute a successful business model.

- Logistical Nightmares: In the tax world, one of the most feared acroynms is SALT - State and Local Taxation: Why, well dealing with the IRS is really fairly straight forward but when dealing with rules & regulations of 50 different states, all looking for tax dollars in any corner, from any source (e.g., income, sales/use, property, unclaimed property, payroll, etc.). This is an absolute nightmare for the unsuspecting business owners. Now if this same logic is applied to 50 different states, all establishing their own rules & regulations in the CF space, the complexities are going to compound to unseen levels. Just attempting to comply with multiple states rules and regulations will be extremely challenging not to mention the entire process of managing funding sources by inexperienced management. Again, this might represent a play in the infrastructure arena as service organizations will more than likely get formed to manage these issues (which will without question be significant) but its going to take years for this area to develop and stablize.

- Inexperienced Businesses: One of my biggest concerns with CF is based in one simple fact of life. The majority of companies looking to secure CF capital have inexperienced management teams that have limited understanding, knowledge, and hands-on experience in operating a business. To a certain degree, CF is already like the wild west with companies flocking to this funding channel with just about any idea or concept, for profit or not, that they can make a go of. The management teams are going to be a real problem in the CF space given that very few will have direct experience (let alone have been successful) in what it really means to operate a busineses and all of the responsiblities that come along with it (e.g., marketing, sales, HR, legal, logistics, accounting/finance, etc.). I have worked with small/medium sized businesses for 20+ years, from start-up raising equity to growth securing debt to exit and structuring acquisitions, and I will tell you that the qualifications of management with companies looking to the CF space is going to be a major, major problem.

- Confidentiality: Finally, I would like to make note of the problems that will eventually arise with confidentiality. However the NDA/CA issues are finally resolved from a legal perspective will most likely not matter in the end. There is going to be an entirely new problem that arises from parties simply trolling the CF space to locate, target, and for lack of a better term, hijack, the best ideas. Sure, there may be some type of legal protection present with executed NDA's/CA's but it will be very difficult if not impossible for companies that originated the idea to successfully defend their concept against parties with much deeper resources (especially when the company that originated the idea quickly realizes they don't have any resources left to defend their position). 

In the end, I have no doubt the CF will find its place in the market and become a viable additional alternative to traditional funding sources. But the CF space is suffering from some of the same problems plaguing Bitcoin. A sound idea and logically needed but ripe with pitfalls, buyer beware traps, immaturities (making it vulenrable to errors or worse yet, irregularities), and risks that if not proactively managed, could result in significant negative PR in the coming years. Sure, there will be some successes but the real damage will be in the vast number of failures that could erode capital source confidence very quickly (i.e., too many unqualified business owners, too much regulation, fraudsters entering the space, too many failures, etc.).

My advice to anyone in the CF space, whether it be an capital source, business looking for capital, or middle-man at the instructure level is to do your homework and follow three simple rules. First, if it sounds to good to be true it usually is. Second, if you don't understand it then don't enter into an agreement. Third, if you are being "sold" and not "educated or informed" then be very wary of the deal.

 

 

Tue, 02/11/2014 - 20:03 | 4425877 Freaking Heck
Freaking Heck's picture

Fantastic comments and all well thought out. We agree. The space will be chaotic. "service providers" will step in to fill the many voids, in skills, accounting etc. It is a fact that most of the businesses raising capital via CF will still fail.

What will also happen imo is that investors will get silly about the space. I think they'll get silly at investing in bad deals, this is due to them being unskilled in the space. I see it in the PE world even with folks that come out of Investment banking, brokering etc and being plain stupid in evaluating and investing in private equity. Take this to another level and that's what we'll be seeing. Where I think the VC world will step in is in buying up platforms. This I think will get silly too. Most of them have little idea how they'll make money and even fewer make any money.

The investment we've just made is not beholden to any one of the platforms but profits from an entirely different model. I can't and won't say who they are as its still private and confidential but smart readers who know the space may figure it out.  I do think that chasing the "miners" not the "levi jeans" of this world is the way to go.

Something else I'll throw out there. The current brokers at some point will see this as another asset class (private equity that is, crowdfunded or not) and want to push that to their clients. Who therefore is in the space to do that?

We know of one clearly leading the charge on this in the background and I mention it just to suggest how to take advantage of the sector while minimizing the risks in the multiple car pile ups that are coming.

Wed, 02/12/2014 - 05:27 | 4427248 OpenThePodBayDoorHAL
OpenThePodBayDoorHAL's picture

Gummint will definitely NOT let this space go anywhere. Too much of a threat to the people who OWN the politics in this country. Banks.

Wed, 02/12/2014 - 06:04 | 4427278 Oracle of Kypseli
Oracle of Kypseli's picture

I am intrigued that you actually want the crowd's reaction. Here is mine:

The world is so disenchanted, to put it mildly, with financial products that for such scheme (no pun intended) to take off, will require the most transparent ever bookkeeping and small print to be in plain sight, for all to see. That means online access by anyone spare the P/L statements only for participants to start and two separate audit firms in parallel.

I think my point is clear. 

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