Equity crowdfunding fueling innovation

By Nathan Rose

The way we're investing needs to change to fund the explosion in innovation. It is a cliché to say the world is changing fast – people have been saying so for at least the last 200 years. But with drones, electric cars, 3D printing, hover-boards, cryptocurrency and the sharing economy either on the way or already here, all of us can sense that this time, it really is different. Technology is unleashing innovations that will touch every aspect of our lives.

Being involved in a startup is now seen as a legitimate career choice for young people, and they doing so in huge numbers. With this step-change in entrepreneurship so obviously visible, it is striking that how most of us are allocating our investment dollars has barely changed at all. We still pump billions of dollars into portfolios made up, largely, of the debt and equity of large corporations – or keep it locked away in the bank at near-zero interest rates.

Any time the wisdom of stock ownership is questioned, fund managers will invariably trot out their well-rehearsed trump card: "over the long-run, equities have performed well", probably accompanied by a chart of the S&P500 over the last 100 years that backs up their claim. But when it comes to investing, we shouldn't care about the past, we should care about the future – and they're not the same thing.

Why has stock ownership performed so well over the course of the 20th century, and what evidence says that this good run may be coming to an end? Ron Davison's book The Fourth Economy conceptualizes Western economic growth over the last 700 years. In a wide-ranging study, he argues that economic progress up to the year 2000 has been defined by three distinct phases:

• A land-based economy until 1700, where the powerful were the kings and lords who could raise armies and acquire territory.

• When the industrial revolution took hold, capital became the most important factor for growth, making the banks that controlled it extremely wealthy.

• Around 1900, capital became easier to access and the knowledge-based economy of the 20th century took its place. Corporations and the educated workers became the driving force of progress.

The 20th century was exceptionally kind to big corporations. Company laws changed in all kinds of favourable ways, they were able to benefit from things like globalization to expand their reach. And the bigger they got, the more powerful they became. Economies of scale ruled the day.

Investing in the stock market generally means investing in large corporations. Fund managers simply don't have the mandate or the wherewithal to invest in small, non-listed companies in most cases.

I make the case that owning a share of a corporation in the 20th century was like owning land during the renaissance, owning capital during the industrial revolution… or owning information, big data and web traffic today – therefore the returns we saw to corporate equity in the 20th century are unlikely to be repeated in the 21st.

Davison goes on to argue that the advent of the internet at the turn of the millennium marked another transition point to a fourth phase – an entrepreneurial economy. The advantages that corporations enjoyed are now being dissipated among many more entrepreneurs, targeting many more niches, with very low startup costs breaking down the barriers to entry. As Silicon Valley's Paul Graham put it, innovation has become more important than scale.

During this time of unprecedented disruption, would you rather invest in the disruptors or the incumbents?

What is equity crowdfunding?

With all these startups being formed – hungry for capital – equity crowdfunding has stepped into the breach. In case you don't know what equity crowdfunding is, think of it as being a hybrid between Kickstarter and angel/VC funding.

Kickstarter and other such platforms offer up creative projects, causes to donate to, and pre-orders for new products. Conversely, with equity crowdfunding, pledgers become owners, not donors. Shares in the company are on offer. Therefore, if an investor puts money into an equity crowdfunded company and it goes on to be the next big thing, they stand to profit. This is a game-changer.

Before equity crowdfunding rules were passed, early stage companies could only market themselves to sophisticated / high net-worth investors, and ordinary investors could not participate. In many Western countries, equity crowdfunding legislation has changed all that. Imagine if shares in Airbnb had been up for grabs to members of the public when the company needed its first $1 million. With equity crowdfunding, this is a real possibility.

Equity crowdfunding is investing in the growing companies with huge ambitions that need money to bring their plans to fruition – a domain formerly restricted to angel investors and venture capitalists. The idea: own dozens of these companies, accept a relatively high rate of failure, but trust that the wins will be large.

Veriphi – an example of effective equity crowdfunding

Medication error is one of the most common causes of patient harm in the hospital system, costing billions of dollars and thousands of lives every year.

New Zealand company Veriphi has developed a highly innovative laser-based analyzer to verify intravenous drugs and alert clinicians before the drugs have been administered. This prevents medication errors in hospitals.

Veriphi used equity crowdfunding to raise the money they needed to take their business to the next level. The company set out to raise NZ$400,000 on New Zealand platform Snowball Effect, and recently closed their offering, raising NZ$706,596 — almost double their initial target.

Equity crowdfunding is an exciting development for startups and investors alike. It will bring technology companies the funding they need. And for investors, an entirely new asset class has been opened up, giving them the chance to add exposure to the innovation economy to their portfolios.

Get ready, because equity crowdfunding is becoming a powerful medium for moving capital in a more efficient, transparent way, and making sure it ends up in the hands of the innovators that need it.

Nathan Rose is director of New Zealand-based Assemble Advisory, a finance agency for companies wishing to pursue equity crowdfunding.