If reward and donation-based crowdfunding has taught us one interesting lesson, it is that investors have an innate predilection to believe in the integrity of the team and the company they give their money to. They invest with aspiration, anticipation and most certainly a set of expectations. Ultimately, investors have faith the company behind the curtain is working hard on their behalf to succeed and provide a favorable ROI – not take their money and run.
The stakes of crowdfunding are about to take a radical shift. The moment crowdfunding will become available to the average person in exchange for equity is getting closer by the day. So with this long awaited crowdfunding revolution at our doorstep, the question is: How safe is equity crowdfunding?
The First Checkpoint – The Smart Crowd
If you were a scammer seeking to pocket money through equity crowdfunding, you’d need to have fool-proof plan to deceive an entire crowd. Any group’s ability to spot a fraud pitch is as potent as its capacity to estimate the odds of success for a startup. In his book, “The Wisdom of Crowds,” James Surowiecky tells the story of a British scientist who spent most of his life trying to demonstrate that very few people have the characteristics necessary to keep a society healthy. One day in his later years, Francis Galton – the scientist – took part in an experiment that hosted an interactive contest. A group of 787 people had to make their own individual estimate of the weight of an ox. After collecting the estimates, Galton made the assumption that putting together the approximations of a few smart people, some average-minded people and a vast majority of less intelligent participants would result in a highly inaccurate judgment. Much to his surprise, he discovered that the mean of the estimations was 1,197 pounds, whereas the ox weighed 1,198 pounds. The crowd’s estimate was essentially flawless.
This conclusion proves a crowd doesn’t have to be sophisticated to be smart. The most thorough checkpoint of a crowdfunding pitch is the crowd. In crowdfunding, just like in Galton’s experiment, each potential investor makes his own calculations about the investment. These are reflected, first, in the decision to invest or not, and secondly, in the amount invested. A crowd where each member uses his own mind and then unites forces with other documented individuals is a powerful scam spotter as well as an efficient success predictor. The wisdom of the crowd is the first solid brick that makes equity crowdfunding a safe gamefield.
The Sixth Sense of Social Media
A crowdfunding campaign, in its very essence, requires social momentum. The first circle of investors is most likely formed by close friends and family. When hearing about a pitch via social media, the first thing a potential investor will do is examine the list of people who already support the product or idea. They will base the company’s credibility on the amount of followers it has and its relationship to the initial investors (i.e. if the product has thousands of followers including the entrepreneur’s direct family members, it is most likely legit). Social media provides transparency to so many markets, it’s virtually impossible for crowdfunding to be an exception from the rule.
Take Crowdcube (www.crowdcube.com) for example. As the largest equity crowdfunding platform in the UK, Crowdcube has lawfully operated within Britain’s securities framework since 2011. In its entire three years of existence and more than £4.25 M raised, not a single account of fraud has been reported. While Crowdcube is still in its infancy years, the lack of fraud attempts so far proves the system works. As entrepreneurs market their pitches using social media, we can correctly assume that social networks are pretty good scam detectors that make equity crowdfunding a safe type of investment. How does the law protect equity crowdfunding investors?