Ordinary American investors finally got permission to invest in startups and other private businesses last month. Equity crowdfunding, as this form of investment has come to be known, has been a reality in Britain for almost four years.
Seedrs, the London-based platform I co-founded, became the first regulated equity crowdfunding platform in 2012.
Since then, alongside our competitors, we have redefined early-stage investment in the UK (and, in our case, elsewhere in Europe), transforming the space from a small, clubby grouping of hobbyists to an open marketplace for investors of all shapes and sizes.
Read more: What motivates a crowdfunding investor?
Crowdfunding’s journey into the US has been far less straightforward. The original legislation permitting it was passed in 2011, but regulatory holdups meant that it has only become reality now.
So will the floodgates open, and the US quickly overtake us in this area of the capital markets? For better or worse, the answer is no. The sound of American equity crowdfunding will, for now, be far more a whimper than a bang.
This is because the law that came into force last month, known as Title III of the Jobs Act, is so deeply flawed as to be almost unworkable.
One of the biggest problems with Title III is the huge burdens in places on companies seeking to raise capital. While these are intended to protect investors, many of them are unnecessary or even absurd for early-stage businesses.
These burdens have the effect of making crowdfunding far more expensive and time-consuming than raising money through other channels, such as institutional or private angel investors. Businesses will turn to crowdfunding as a last resort after more efficient capital-raising methods have failed.
This is the adverse selection problem that we have successfully defeated in Europe: because equity crowdfunding here is a reasonably straightforward process for companies, many choose it in lieu of (or in combination with) institutional or angel investment.
That will not be the case in the US. Instead, only those businesses that cannot raise capital elsewhere will use equity crowdfunding. Ordinary retail investors will have access only to lower-quality investment opportunities.
A second issue is that, despite all the burdens it imposes, Title III gives insufficient protection to investors.
While Title III focuses heavily on limiting investors’ losses, it is also important that investors be protected in the case of a business’s success. A successful business can see its valuation increase 100-fold or more, but if the investment has not been properly structured or monitored, investors may receive nothing.
Where restrictions interfere with crowdfunding platforms’ ability to provide those protections – which is precisely what Title III does – investors will be significantly worse off in the long run.
A final problem is that the American legislation reduces the likelihood of businesses succeeding in raising capital.
One of the key lessons from the growth of equity crowdfunding in Europe is that raising capital in this way is a dynamic process that requires the business to build momentum behind its campaign.
Successful campaigns tend to require active outreach, ongoing and multi-modal engagement with prospective investors, and the participation of one or more “anchor” angel or institutional investors, who can lead funding rounds.
A viable future
Title III’s significant marketing restrictions mean that companies will be very limited in their ability to create momentum, which in turn will make it exceptionally difficult for their campaigns to succeed. Combined, these flaws in Title III will make it exceedingly difficult for equity crowdfunding to have anywhere near the impact in the US that it has had on this side of the pond.
But all hope is not lost. In late March 2016, Congressman Patrick McHenry, who authorised the original crowdfunding bill in 2011, introduced a new piece of legislation called, aptly, the Fix Crowdfunding Act.
Focusing on investor protection, I think this is a strong piece of legislation that goes a long way toward addressing the concerns above. The question is whether it will become law, or will languish in bureaucratic delays for another five years.