Online marketplaces have already eliminated so much inefficiency in our world. Dating (OK Cupid, Match.com), restaurant reservations (OpenTable), buying most physical goods (eBay) and countless other marketplaces serve both sides of the marketplaces (i.e. buyers and sellers) and provide value- typically making it more efficient to transact (or date!). Other marketplaces are eliminating inefficiency we didn’t even know existed. Uber and other taxi utilization apps are bringing efficiency to the $10 billion taxi market. That market is dwarfed by the size of the market for individual equity investments in private companies, which is $50 billion per year.
The market for individual equity investments into private companies, or “angel market” is huge but has few participants–less than 10% of accredited investors make private investments. Why? Because the cost to participate in this market is just too high. It takes months to network into a deal and then investors are typically required to invest a minimum of $25,000.
Crowdfunding has the potential to dwarf the most disruptive marketplaces we have ever seen. By lowering the cost to participate in the market, crowdfunding will expand participation in the market. Sourcing good deal flow is a full time job for those in the investment community, so how is someone with a day job supposed to source great deals if they cannot spend their waking hours building relationships with intermediaries and companies? In the old world, they couldn’t. Additionally, minimum investment sizes of $25,000 to $50,000 spook all but the wealthiest investors. Enter equity crowdfunding, which we at CircleUp believe will turn the antiquated traditional angel investing model on its head.
Today CircleUp and other sites can curate high quality deal flow sourced via industry relationships that span decades (at CircleUp, we only accept 2% of companies the apply). In addition, equity crowdfunding sites streamline the investment process and sometimes allow check sizes as low as $1,000. Why is that good for investors? 1) It allows you to more easily evaluate deals and 2) you can now achieve the necessary diversification in this high-risk asset class that offline might have required you invest $200K across 8 deals. In addition, investors have access to more deals. Instead of picking 1 investment from the limited options angel investors see now, your opportunity set increases and you can pick multiple investments across the hundreds (or thousands) that are available on curated platforms. As we’ve seen in our early days of CircleUp, by lowering the cost for investors to participate in private investing, we are expanding participation in the market. Clayton Christensen, renowned Harvard Business School professor and author of The Innovator’s Dilemma (and investor in CircleUp), noted:
I would say that for now the areas where [crowdfunding] has the most opportunity to disrupt is by taking root in these underserved areas that traditional financiers have traditionally found unattractive. This is a classic entry point for disruption–expand participation in the market by lowering cost at the low end of the market, where incumbents don’t see profit opportunities.
Finance is one of the last major marketplaces to be largely free from disruption. Every conceivable market from retail (Amazon, eBay) to music (iTunes) to sports tickets (StubHub) to dining (OpenTable) has been subject to massive disruption at lightning quick speed over the last decade. However, despite contributing mightily to the worst financial crisis since the Great Depression, finance has largely avoided the kind of industry-altering disruption that dramatically lowers participation barriers. Angel investing still relies on an old-boys network and closed-door conversations. We believe the massive benefits crowdfunding offers will finally be the straw that breaks the finance industry’s back. First, crowdfunding is great for early stage non-tech companies, especially in industries like consumer products where institutional investors are scarce. Crowdfunding give these companies the ability to raise money more efficiently, saving their most valuable resource—the entrepreneur’s time—which would otherwise be spent conducting 12+ months of investor meetings. Not only is this time lost for the entrepreneur; it is time lost for the business itself.
No marketplace can be successful without adding value to both sides- and crowdfunding will be great for thoughtful investors that understand that private investments are an illiquid, high-risk asset class. At a time when returns on five year Treasuries are below 1%, home values are still depressed and equity markets are incredibly tough to predict due to the Fed’s intervention vis-à-vis quantitative easing, investors need other asset classes to park their money where they can earn strong risk-adjusted returns. While crowdfunding is risky as all early-stage investing, angel investments in sectors like consumer have performed well historically (as I wrote last week, the Kaufmann Foundation notes the average return on angel investments in investments is 3.6x an investor’s capital over 4.4 years).
On top of its benefits to investors and companies, crowdfunding provides the broader societal benefit of job creation—if companies can raise money quicker and easier, they can use this capital to invest in hiring, which is critical given the nation’s lackluster progress on trimming the unemployment rate. All told, if equity crowdfunding lives up to just a fraction of its potential, the finance markets will experience a level of disruption that almost no other industry has ever experienced.
Source: FORBES – Ryan Caldbeck