Hyperfunding is the Harbinger of New Corporate Finance

Hyperfunding is the fundraising of large sums of money in a brief campaign by a company that directly targets consumers or investors via the Internet. In my latest research paper, Hyperfunding, I argue that Hyperfunding is a new type of corporate finance. Indeed, Hyperfunding is the harbinger of a new era of disintermediated finance fueled by technology, personality, and scarcity. Unlike crowdfunding, Hyperfunding does not use a central portal or intermediary; these portals and intermediaries provide some gatekeeping, anti-fraud, policing, and trust functions in crowdfunding that may be lacking in Hyperfunding. However, from a regulatory perspective, Hyperfunding does not exist.

Tesla’s massive pre-sale campaign in 2016Q2 is the best example of a successful Hyperfunding campaign to date. In this campaign, CEO Elon Musk revealed a prototype of Tesla’s forthcoming Model 3 car in a simulcast web event that was reminiscent of Steve Jobs’ keynote unveiling of the first iPhone. But Musk went further than Jobs by allowing ‘consumers’ to reserve a spot in line to purchase the Model 3 when it will be developed. However, paying $1,000 to Tesla now only gives someone a priority opportunity to purchase the car when and if it is developed. Production of the Model 3 was projected to begin sometime the following year, roughly 18 months after payment. This phenomenon was unusual for many reasons, but here are two:

(1) The Model 3 campaign was the largest pre-sale event of all time. Tesla received almost $300,000,000 in ‘deposits’ within the first 48 hours of the campaign and has now pre-sold over $10,500,000,000 worth of cars. To put the magnitude of this sale in perspective, Toyota sold only $9,000,000,000 worth of Camry automobiles, the most popular car in America, during all of 2015.

(2) Large corporations rarely engage in pre-purchase crowdfunding, which I define as raising a large amount of money from many people via the Internet to develop, produce, and sell a new product. Musk leveraged the feel-good environmentalism of electric vehicles with his charismatic personality and showmanship to sell via a channel usually reserved for startups and charities.

Why did Musk create and use a new financial technique when conventional financing is also available?

I argue that Hyperfunding is a sort of accelerated crowdfunding that can solve pesky economic problems such as the chicken-egg problem. Jean Tirole and Jean-Charles Rochet (2003) were the first to recognize that platforms in two-sided industries like software, payment systems, and video games will compete to get both sides of the market on board simultaneously. For example, in video games, Sony has to simultaneously sell PlayStation consoles to players while convincing developers to make games for that system. No one wants to buy a console on which you can play no games, and no one wants to build games for a console that no one owns. Which comes first? This is the chicken-egg problem in economics.

While Eisenmann, Parker, and Van Alstyne (2006) note that the market for gas-powered vehicles is a two-sided market that includes vehicles and fueling stations, I am the first in the legal literature to identify the market for electric vehicles (EVs) as a two-sided market with a chicken-egg problem. In my research, I argue that the EV market is two-sided with EVs and charging stations. No one wants an EV that cannot be charged, and no one wants to build charging stations for EVs that don’t exist. Thus, the EV market has a chicken-egg problem.

Musk cracked the chicken-egg problem with Hyperfunding. By pre-selling the Model 3 EV, he generated the hype needed to convince market participants to build charging stations and the funding needed to develop Tesla’s own charging station network. Hyperfunding thus solved the two-sided market problem that heretofore held back EVs by pre-selling huge volumes of Model 3 EVs, a product on one side of the market to subsidize and encourage investment into the other side of the market, EV charging stations.

Despite Hyperfunding’s awesome power to create new markets, in the wrong hands, this financial tool could be used to perpetrate massive frauds. Hyperfunding is not subject to securities laws. Consumers and investors are protected primarily by their contracts, which will generally favor the corporation drafting them. Popular entrepreneurs can attract funding for vaporware and other products that may never exist and slick shysters can pre-sell snake oil via the Internet. If history is any guide, lawmakers and regulators will then swoop in and develop retrospective rules designed to prevent the failures and frauds of the past at the expense of opportunity and innovation in the future.

As Internet-mediated finance and commerce evolve at exponential rates, our legal system seems ill equipped to keep up. Moreover, a heavy-handed legal prohibition would forestall the progress that Hyperfunding can bring. Fortunately, a return to first principles can make short work of this issue. The problem with Hyperfunding is mainly around liability and disclosure: (a) corporate structures can limit the personal liability of promoters who use Hyperfunding without ever intending to make or distribute a product, and (b) crowds have a hard time obtaining and processing information regarding market risk.

The solution, therefore, is simple: (a) companies shall be adequately capitalized when Hyperfunding, else the company’s management shall be personally liable in the event of failure (much like how veil-piercing law operates in the US today); and (b) companies shall disclose risk factors in bringing the proposed product to market (much like the material omission rule under Section 10b-5 under the US Securities Exchange Act of 1934). These rules might make good sense for pre-purchase crowdfunding as well. Until then, caveat emptor.

Seth C. Oranburg is an Assistant Professor at Duquesne University School of Law, and a Fellow of The Classical Liberal Institute at New York University School of Law.