On equity crowdfunding portals and platforms, you will have an opportunity to collaborate on deal selection and due diligence with other investors. Like social networks, the portals/platforms will show profiles of the investors who participate in these discussions, so you can assess their expertise, credibility and getting a sense of the wisdom of the crowd.
The SEC declared in October 2013, when it released its proposed rules for Title III (on page 376): “A premise of crowdfunding is that investors would rely, at least in part, on the collective wisdom of the crowd to make better informed investment decisions”—which is why the SEC requires intermediaries “to provide communication channels for issuers and investors to exchange information about the issuer and its offering.”
When you sign up for and become a member of an equity crowdfunding portal (or equity crowdfunding platform operated by a broker-dealer), you have the ability to collaborate with other members through three methods:
How will these online collaborations among non-accredited investors (who are presumed by the U.S. government to be less sophisticated in the private securities markets) compare with angel group collaboration? Equity crowdfunding on a national level is too new in the United States to provide data for empirical studies or even much anecdotal evidence. But we have anecdotal evidence from Australia, where equity crowdfunding has operated for years successfully with participation of “unsophisticated” investors.
The Australian Small Scale Offering Board (ASSOB) is an equity crowdfunding platform that allows all investors to participate in private offerings, regardless of income or net worth. From its launch in 2004 to April 2014, around 300 issuers raised more than AU$138 million (about US$128 million) on the platform. ASSOB reports that about 50 to 60 percent of the firms that received funding in its first five years (2008–2012) are still “operational” in 2014 [source: Paul Niederer, CEO of ASSOB 6/15/14]. There have been no reported incidences of fraud (as defined by Australian securities regulators) in that period. It should be noted that ASSOB accountants conduct reviews of the issuers’ financial information, and the platform performs substantive due diligence on potential offerings before accepting any.
Even if all of the crowd members are non-accredited investors, inexperienced in the private securities markets, can an equity-crowdfunding crowd really offer advantages comparable to those offered by angel groups? We propose that the answer is yes, under certain conditions—three conditions, to be exact. The premise of James Surowiecki’s book The Wisdom of Crowds is that:
Under the right circumstances, groups are remarkably intelligent, and are often smarter than the smartest people in them. Groups do not need to be dominated by exceptionally intelligent people in order to be smart. Even if most of the people within a group are not especially well informed or rational, it can still reach a collectively wise decision. [from page xiii–xiv]
Looking at investors particularly, Surowiecki shows that even if “investors, as individuals, are irrational, it’s still possible that when you aggregate all their choices, the collective outcome will be rational and smart.”
The circumstances have to be right, though. Under the wrong circumstances, the crowd can be an irrational, destructive mob. Scottish author Charles Mackay wrote a book about mass manias and collective follies, the classic Extraordinary Popular Delusions and the Madness of Crowds, published in 1841. Mackay described stock market bubbles and riots where “aggregating individual decisions produces a collective decision that is utterly irrational.” And the American financier and adviser to U.S. presidents Bernard Baruch (1870–1965) famously said, “Anyone taken as an individual is tolerably sensible and reasonable—as a member of a crowd, he at once becomes a blockhead.”
So what are the circumstances under which a crowd—specifically a crowd of average investors on a Title III funding portal—will be wise rather than mad? Surowiecki identifies three such conditions: diversity, independence, and decentralization.
Theoretically, at least, crowdfunding portals can be ideal environments for crowd wisdom when they encourage those three conditions. In addition, portals should require investors to use their real names, and their identities should be verified, when they participate in on-platform discussion forums. Keep in mind that, in some instances, if a crowd member suspects a scam, he or she may tend to abandon the offering rather than voice concerns—so expressing such concerns should be encouraged.
David M. Freedman has worked as a financial and legal journalist since 1978. He has served on the editorial staffs of business, trade and professional journals, most recently as senior editor of The Value Examiner (National Association of Certified Valuators and Analysts). He is coauthor of Equity Crowdfunding for Investors, published in June 2015 by…
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