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Spectacular failures, new opportunities to be expected from equity crowdfunding, says Rotman paper aimed at U.S. policymakers

July 16, 2013

TORONTO, ON — Equi­ty crowd­fund­ing is not yet legal, but when it is, experts say to expect a peri­od of “chaos” before those involved learn how to make the most of its ben­e­fits and min­i­mize its risks.

“There’s no ques­tion that there will be fraud and that some investors will lose mon­ey, but that’s true in every mar­ket. This is a new mar­ket and we sus­pect there will be a steep learn­ing curve for all par­tic­i­pants – entre­pre­neurs, investors, crowd­fund­ing plat­forms, and reg­u­la­tors,” says Ajay Agraw­al, an asso­ciate pro­fes­sor of strate­gic man­age­ment at the Uni­ver­si­ty of Toron­to’s Rot­man School of Man­age­ment who has writ­ten a paper on the top­ic with two oth­er Rot­man researchers.

The paper, to be includ­ed as a chap­ter in an upcom­ing vol­ume pub­lished by the Boston-based Nation­al Bureau of Eco­nom­ic Research, is aimed at U.S. pol­i­cy-mak­ers as they con­tin­ue to con­sid­er reg­u­la­tions that will gov­ern equi­ty crowd­fund­ing.

While main­stream media news sto­ries have often paint­ed equi­ty crowd­fund­ing as either a panacea for strug­gling busi­ness start-ups, or a dan­ger­ous finan­cial threat, the paper seeks to lay out a rea­soned frame­work to assess its poten­tial risks and ben­e­fits.

“Our objec­tive was to put some struc­ture around this inno­va­tion in finan­cial mar­kets,” says Prof. Agraw­al, who wrote the paper with Chris­t­ian Catal­i­ni, a Rot­man PhD stu­dent, and Avi Gold­farb, a pro­fes­sor of mar­ket­ing.  “It’s not often that we get a chance to spec­u­late on the advent of a new mar­ket. It’s excit­ing. ”

There are already more than 200 non-equi­ty crowd­fund­ing plat­forms, which allow peo­ple to finan­cial­ly con­tribute, often in small amounts, to anoth­er indi­vid­ual or group’s project via the inter­net, either as a dona­tion or in return for a reward. Projects range from dis­as­ter relief to tech­no­log­i­cal Inven­tions to artis­tic works.

But U.S. reg­u­la­tors have moved cau­tious­ly on allow­ing the mech­a­nism to be used to raise busi­ness cap­i­tal, cur­rent­ly lim­it­ed to only accred­it­ed Investors. The Oba­ma admin­is­tra­tion’s Jump­start Our Busi­ness Star­tups (JOBS) Act In 2012 paved the way for equi­ty crowd­fund­ing but is still await­ing reg­u­la­tions to be set by the Secu­ri­ties and Exchange Com­mis­sion (SEC) to open the mar­ket to any­one.

Despite reg­u­la­tors’ best efforts, equi­ty crowd­fund­ing will expe­ri­ence inevitable grow­ing pains, says the Rot­man paper, and many of these may be solved by the mar­ket itself, through inno­va­tion.

Set­ting mech­a­nisms that would make entre­pre­neurs face costs for fraud, incom­pe­tence, and cre­at­ing unre­al­is­tic expec­ta­tions; and mak­ing it eas­i­er for fun­ders to learn about entre­pre­neurs and com­pa­nies that inter­est them will also help mit­i­gate poten­tial risks, it says.

Nev­er­the­less, “a fool and their mon­ey are quick­ly part­ed in any set­ting,” says Prof. Agraw­al.

“It feels like we are being far more pro­tec­tive of peo­ple mak­ing mis­takes buy­ing small amounts of equi­ty through crowd­fund­ing than we are of peo­ple mak­ing mis­takes buy­ing oth­er goods and ser­vices on the inter­net that are some­times fraud­u­lent, of low­er-qual­i­ty, or over­priced.”

The com­plete study is avail­able at

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