Innovation from the Bottom Up

There’s a very interesting pair of bills working its way through Congress right now around protecting the ability of companies to raise money through crowdfunding. Crowdfunding, popularized by Kickstarter and Kiva, has been around for a couple years now and even with some very sizeable start-up success stories, the start-up investment world has been dismissive. At least in the venture community, there’s been more than one VC/Angel/Lawyer warning entrepreneurs about the pitfalls of crowdfunding claiming impending regulation would soon take it off the table for any ‘serious’ start-up. ‘Too much fraud risk’ is the standard line.

Thanks to Rep. Patrick McHenry (R-NC) and Sen. Scott Brown (R-MA), bills have been introduced in both the House and the Senate protecting crowdfunding from outright prohibition. The house bill already passed 407-to-17 in a highly uncommon show of bi-partisan cooperation; the Senate bill is held up.

The appeal of crowdfunding comes from its bottom up approach. Start ups are facing similar struggles to small businesses when it comes to finding capital; whether it’s seed investment or growth capital, traditional methods of funding are falling short. Crowdfunding could help fill this gap by tapping into “individual” money that would otherwise be gathering dust. It empowers more people to participate in the economy and share in the gains. The irony is that this idea is really not all that new in its core concept. From US war bonds to mutual funds the common theme is one of aggregating capital from individuals to deploy it for a common objective. Crowdfunding is a financial innovation that can do some real good by harnessing “a million points of light,” directing them in a common direction, and mobilizing “micro” capital. Crowdfunding passes the Mr. Shirakawa test for innovation by filling market and social needs; therefore it should be thoughtfully nurtured, not prohibited.

Any financial innovation comes with some risk of abuse; the risks of mortgage backed securities have become painfully obvious and the risk of crowdfunding becoming a magnet for fraud is a real concern. However, the risks should not scare us away from the advantages. Just as peer-to-peer lending or micro-finance are valuable and require intermediaries and rules, so will crowdfunding. The infrastructure for intermediation is already there; we just need to harness it and maintain adequate oversight. Facilitating this kind of oversight is one way WAIN Street’s BCH Index can help; it provides data and insight into how businesses are performing which is critical to developing meaningful regulations. A rational regulatory framework can allow the crowdfunding ecosystem to evolve so it continues to serve its core purpose: matching individuals with capital to businesses that need it.