Can Crowdfunding Level the Playing Field for Investment? – Next City
The Equity Factor

Can Crowdfunding Level the Playing Field for Investment?

(Photo by Wouter Engler)

President Barack Obama recently challenged us to think about why we call Johnny back for a job interview, but not Jamal. Johnny and Jamal are competing for more than jobs, however; they’re also competing for investors. You can probably guess who’s winning.

It’s more difficult for minority-owned (not to mention woman-owned) firms to raise venture capital than non-minority-owned firms. Only 1 percent of venture-backed firms are founded by African-Americans, and only 13 percent of all venture-backed firms are founded by any ethnic minority, according to CB Insights. Minority-owned firms are less likely to receive loans, and they receive lower loan amounts and smaller equity investments, and pay higher interest rates than non-minority-owned firms, according to the Department of Commerce.

The challenge of leveling the investment playing field for minority-owned firms, as many cities and states know, is particularly urgent for creating jobs in our nation’s largest cities. Forty percent of minority-owned firms are located in just 10 of America’s largest metropolitan areas.

Could the Internet and crowdfunding, which have helped level the playing field for so many other aspects of life and the economy, do the same for investment?

Not All Crowdfunding Is Created Equal

Online crowdfunding is skyrocketing, from just $2.7 billion in 2012, forecasted to be $34 billion in 2015. There are different kinds of online crowdfunding, however, and not every kind qualifies as a real source of investment capital.

There’s debt crowdfunding, through peer-to-peer lending sites like Lending Club, the first crowdfunding site to go public. But over the course of nine years fewer than 2 percent of Lending Club loans have been business loans. Other familiar crowdfunding names, such as Kickstarter, GoFundMe or IndieGoGo, raise what’s called donation or reward-based crowdfunding. These sites are great, and there are creative ways that startups as well as established businesses can use this kind of crowdfunding, but aside from a few exceptions, donation crowdfunding is just too small to be a game-changing source of capital. According to Kickstarter’s own data, most of its listed projects raise less than $10,000.

The best chance for crowdfunding to transform investing lies in a lesser-known but rapidly growing slice of the crowdfunding pie known as equity crowdfunding. In equity crowdfunding, just like regular equity investments, entrepreneurs sell shares of their business to private shareholders, shares that can potentially be sold later at a much higher price per share. That’s how you attract real investment capital, and that’s why some already predict that equity crowdfunding will eclipse venture capital funding as the leading source of startup capital by 2020.

An Unexpected Revolution

Now imagine that in 2020, the new leading source of startup capital is one in which there is a level playing field for minority-owned firms. Based on the experience of at least one equity crowdfunding platform, it’s quite possible that will be the case. In an internal sample of 5,000 companies using EquityNet, the world’s largest equity crowdfunding platform, 32 percent were minority-owned, including 9 percent owned by African-Americans. What’s more, minority-owned firms surveyed on EquityNet, which is based in Fayetteville, Arkansas, were achieving the same funding success rate (20 percent) and seeking similar amounts of capital on average (around $1 million) compared to non-minority-owned firms on EquityNet.

EquityNet hasn’t done anything to actively court minority-owned firms. “It just happened,” says EquityNet Founder and CEO Judd Hollas. “We have a very broad marketing portfolio, as inclusive as possible. We don’t single out any [business owner] demographics with our adwords or anything like that. The early adopters of equity crowdfunding have just been those who previously were at somewhat of a disadvantage raising capital.”

Crowdismo, in Santa Barbara, California, directly aims to use equity crowdfunding to level the playing field. It started out as a donation-centric platform to support Latino entrepreneurs. “We’re moving into debt/equity to provide minority entrepreneurs with access to capital and growth resources expanding the value and utility of our platform,” Crowdismo Co-founder José Huitron writes via email. “Equity crowdfunding and P2P lending provides a pathway for the democracy of the crowd to level the playing field. And, when you invite serious capital into the mix via accredited investors, things get serious.”

Breaking Even More Barriers

Of course, white men still dominate the venture capital industry. So as long as equity crowdfunding remains limited to accredited investors — as mandated by the government, people who earn more than $200,000 a year or have a net worth of at least $1 million — Johnny Sr. will still be the one doing all the investing, even if Johnny Jr. and Jamal are on a more equal footing.

“People are more inclined to invest with people that are like themselves,” says Georgia Quinn, a securities attorney specializing in crowdfunding.

If the Securities & Exchange Commission would implement a pending part of the JOBS Act (legislation that enabled today’s equity crowdfunding platforms), non-accredited investors could participate. If that happens as planned in October 2015, then just about anyone with extra cash and an Internet connection could get into the game.

Such a change could have even more potential to level the playing field for minority-owned startup firms. “When you open up the world of investors to every single individual, you are automatically going to get a more diverse body of investors, hence a more diverse body of investments,” says Quinn.

Not everyone is convinced it will work. Some say the rules of the JOBS Act are still too complicated to really encourage Main Street investment, but Quinn may have a solution. She recently co-founded LawBot, a legal technology company that assists small and startup businesses with raising capital. LawBot has developed a technology called iDisclose, which reduces the time and legal counsel costs of compliance by walking entrepreneurs through the process of creating the necessary legal documents for equity crowdfunding.

“It’s similar to TurboTax, but for equity crowdfunding,” says Quinn. Right now, it’s only developed for use with accredited investors, but Quinn plans to have it updated to be ready for use with non-accredited investors when the time comes.

An Equal Opportunity to Fail, and to Succeed

Quinn plans to continue working with the SEC as well as state regulators to make sure that equity crowdfunding regulations are sensible and do what they were meant to do.

“I am such a firm believer in crowdfunding from both a social aspect and from an economic aspect,” Quinn adds. “I grew up in a place where nobody invested, people literally put money in their mattresses, nobody owned stocks or bonds, everybody thought that was for rich people. I think investing is something everybody should understand and be a part of.”

Equity crowdfunding won’t work by itself, of course. There is plenty of work needed to ensure minority-owned firms can take full advantage of it as it grows. That’s why Huitron also recently became president of the Latino Startup Alliance. “Together with the support and leadership of the Latino Startup Alliance,” he writes, “we can work to expand the discussion, celebrate novel ideas, and provide key access via networks, mentorship, and platforms for Latino entrepreneurs to showcase their ingenuity.”

There’s also plenty of education to do around the dynamics and risks of equity crowdfunding, particularly for startups — the riskiest kind of investing, the kind of investing that is most slanted against minority-owned firms today, and the kind of investing that equity crowdfunding promises to transform. Nothing’s likely to change the fact that three out of four startups will fail, but by changing how we invest as well as diversifying who is doing the investing, maybe we can get to a point where Johnny isn’t the only one who gets that one in four shot to succeed. Jamal deserves that shot too.

The Equity Factor is made possible with the support of the Surdna Foundation.

Oscar is a Next City 2015-2016 equitable cities fellow. A New York City-based journalist with a background in global development and social enterprise, he has written about impact investing, microfinance, fair trade, entrepreneurship and more for publications such as Fast Company and NextBillion.net. He has a B.A. in Economics from Villanova University.

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