New Book on Investment Crowdfunding

Today I publish my first book, Investment Crowdfunding (Oxford University Press), the definitive guide to the law and regulation of this new venture capital market, based on ten years of on-the-ground research, including as a Fulbright Scholar. The book compares the legal regimes governing investment crowdfunding in the United States, UK, Canada, Australia, New Zealand, and the EU, and provides a roadmap for policymakers to enact an effective regulatory framework for investment crowdfunding. It’s also funny.

In the Jumpstart Our Business Startups (JOBS) Act of 2012, signed into law by President Obama, federal securities laws were amended to authorize investment crowdfunding, an inclusive new way for entrepreneurs to get the capital they need to build and grow startup companies. Entrepreneurs now have the ability to solicit up to $5 million directly from the broad public—the ‘crowd’—simply by posting an idea to an online investment crowdfunding platform and asking each person to pitch in a small amount. Unlike traditional venture capital and angel investing, which are legally limited to wealthy, accredited investors, investment crowdfunding is open to all, and the idea has spread around the world over the past decade.

The book defines investment crowdfunding as ‘the public offering of unregistered securities through an independent online platform,’ which differentiates it from other types of fintech, such as initial coin offerings and non-fungible tokens. Those types of transactions, although they take place online, are not conducted through independent online platforms. It also highlights that investment crowdfunding offerings are legally exempt from the usual duty to register securities (and provide mandatory disclosure) prior to offering them to the public.

In the book, I identify three primary policy goals of investment crowdfunding: (1) to provide a simple and inexpensive method for startup companies and other small businesses to raise business capital from the public; (2) to create an inclusive market where all entrepreneurs—regardless of location, gender, race, or anything else—have an equal opportunity to access investors; and (3) to democratize the market for startup investment by allowing ordinary people to make investments that have traditionally been limited to the wealthy and connected.

Investment crowdfunding is less than ten years old, but it is already making progress toward these goals—in the United States and around the world. In the US, half a million investors participate in it each year, from coast to coast, with an average check size under $1,000. More than one thousand American companies raise money every year this way, with each one raising about $400,000, on average, for an annual total of more than $400 million. The UK, Australia, and New Zealand have (per capita) numbers that are even more impressive, as I report in the book.

Investment crowdfunding is also succeeding in creating an inclusive and democratic market for startup finance. Female and minority entrepreneurs have found a receptive audience that is not only open to investing in their companies but affirmatively seeking out such opportunities. Looking at the largest offerings—those raising $1 million or more—nearly half have women founders, roughly 40% have minority founders, and 70% of the capital goes outside Silicon Valley and other traditional hubs.

There was widespread fear in the early days of investment crowdfunding that, by exempting the market from the usual disclosure and registration rules of a public offering, the market would evolve into a snake pit full of fraudsters and thieves. In practice, however, things haven’t been nearly so bad! We have seen very few allegations of fraud or other illegal behavior, across all jurisdictions. Consider that the SEC has only ever brought one single, solitary case alleging fraud in the context of investment crowdfunding.

How has investment crowdfunding achieved such a clean record? The market is governed both through so-called ‘private ordering,’ meaning economic incentives and the like, as well as formal law and regulations. In the book, I first discuss a number of effective private ordering mechanisms and how they play out in different jurisdictions.

‘Gatekeeping’ is probably the most important method of private ordering I identify in the book. Recall that entrepreneurs cannot solicit investors directly and are required to act through an online platform. The platform—like a medieval gatekeeper—stands at the metaphorical gate between entrepreneurs and investors and is expected to only allow legitimate and promising companies to list on the platform. We can count on the gatekeepers because they want investors to come back again tomorrow (and because they can lose their license), so it is in their self-interest to be a diligent, if not strict, gatekeeper. Anecdotal experience in all jurisdictions suggests that the platforms take this responsibility seriously, as I report in the book.

Finally, I turn to the law and spend the remainder of the book describing and critiquing the legal regimes adopted in the United States and five comparative jurisdictions. I sort the legal regimes adopted in these various jurisdictions into two types, which I call the ‘standard’ model and the ‘liberal’ model: The standard model depends primarily on legal regulation, while the liberal model depends primarily on private ordering, supplemented by a light-handed set of regulations. This is not a binary distinction, but rather a range of possibilities, with shades between them.

The United States created the standard model when it passed the JOBS Act, and many countries around the world have followed its lead, including Australia, Canada, and the EU. The UK and New Zealand, in contrast, went their own way and adopted a much lighter set of regulations that are specifically designed to harness the power of private ordering, which I call the liberal model.

As I report, countries that adopted the liberal model tend to have larger and more impactful investment crowdfunding markets than the United States and other jurisdictions that followed the standard model—and without higher levels of fraud or failure. In the UK today, there are more investment crowdfunding deals each year than there are angel rounds, and numerous British crowdfunding companies have gone on to an IPO or have been acquired.

I do not advocate for a laissez-faire approach to the regulation of investment crowdfunding. There are certain aspects of the form that do call for legal regulation, where private incentives will not lead to the optimal outcome. However, because investment crowdfunding only allows companies to raise a limited amount of money, the best choice is a simple and light-handed legal regime that imposes very low costs. Rather than depending on legal regulation to police the market, we should rely primarily on the powerful methods of private ordering I describe in the book, and shape our laws to enhance their effectiveness. We should, in short, follow the liberal approach.

Andrew A Schwartz is a Professor of Law at the University of Colorado.