An equity crowdfunding research agenda: evidence from stakeholder participation in the rulemaking process

While we focus on US-based equity crowdfunding, this focus is uniquely relevant, given the scale of entrepreneurial finance in the USA and the potential for equity crowdfunding to play an important and influential role in it in the future (Estrin et al. 2018). A significant advantage of the US context and this regulatory process in particular was the existence of relatively unique and transparent data from a variety of stakeholders who formally participated in the creation and modification of administrative rules governing equity crowdfunding. The USA is a relatively litigious society, so risk-mitigation strategies were perhaps more clearly thought out from the beginning (and observable to the researchers ex-ante). Nonetheless, we acknowledge that by focusing exclusively on US-based equity crowdfunding and the perceptions of US stakeholders, the generalizability of our results and accompanying research questions may be limited. However, the equity crowdfunding ecosystem in the USA shares many similarities with other crowdfunding ecosystems, suggesting that our research agenda is likely to be relevant for researchers examining equity crowdfunding in a variety of countries and jurisdictions.

We gratefully acknowledge the concerns raised by a referee about whether a single-country qualitative study of equity crowdfunding is meaningfully generalizable, given that it may represent a “special case.” As with many studies of entrepreneurial finance, where each jurisdiction and institutional context has unique as well as common elements, one could argue that any setting is in this sense a special one, and no single-country dataset has value. We find that perspective limiting. Equity and in particular crowdfunding markets differ, and even cross-country results may be incapable of generating generalizable conclusions which hold for every country or the whole crowdfunding market.

A business can participate in equity crowdfunding as long as it has a specific business plan in place and is not already considered a publicly traded company or investment company. However, there are certain “disqualifying events” aimed at prohibiting “felons and other bad actors” from participating in equity crowdfunding transactions (e.g., issuers with a felony or misdemeanor conviction within the past 5 years related to false filings with the SEC) (SEC 2016b, p. 341).

This focus allows PE investors to apply their knowledge and experience, economizing and capitalizing on the large information asymmetries.

To limit potential losses for less sophisticated investors, the amount that can be invested annually by an investor is limited to the greater of (1) $2000 or 5% of one’s annual income or net worth if these amounts are less than $100,000; and (2) 10% of one’s annual income or net worth if these amounts are $100,000 or more (SEC 2016b, p.20).

This approach is appropriate in our context, given that prior knowledge and theory related to equity crowdfunding is somewhat limited.

The SEC released its proposed rules regarding equity crowdfunding on October 23, 2013 and received comments from “professional and trade associations, investor organizations, law firms, investment companies and investment advisors, broker-dealers, potential funding portals, members of Congress, the Commission’s Investor Advisory Committee, state securities regulators, government agencies, potential issuers, accountants, individuals, and other interested parties” (SEC 2016b, p. 10).

We refer to intermediaries as a broad category of entities that facilitate the matching between entrepreneurs and investors. This is related to, but distinct from, traditional entrepreneurial finance definitions that focus on “intermediation” of financial capital because our definition is not conditioned by the financial transaction. Furthermore, while there are various types of intermediaries involved in equity crowdfunding, we choose to focus primarily on crowdfunding platforms (or “portals”). We limit the scope of intermediaries discussed in our paper not only for brevity, but also because crowdfunding platforms represent a new type of intermediary, whose multifaceted role in entrepreneurial finance is just beginning to be examined and understood by researchers. Thus, we see value in focusing our research agenda on this important intermediary group.

Note that the categorization of the comment need not necessarily align with the identity of the commenter. For example, a potential investor may make an observation or prediction about how the incentive structure of crowdfunding market intermediaries will influence their ability to accurately screen issuers. This datapoint would likely be classified as “intermediary.”

These are generated by the 3 × 3 matchup of each dimension: issuer/relational, issuer/behavioral, issuer/technical, investor/relational, investor/behavioral, etc.

For all stakeholder comment references, we adopt the numbering system used by the SEC internally and include each comment number within brackets [XXX]. See Appendix for more details.

Issuers’ advertising notices are intended to be similar to “tombstone ads” and may only include: (1) a statement that an offering is being conducted, along with the name of (and/or link to) the funding portal, (2) the terms of the offering, and (3) factual information about the business (including contact information) and a brief description of the business (SEC 2016b, p. 136).

The UK platform Crowdcube reports that 11 VCs invest in their marketplace, while SyndicateRoom requires that at least 25% of the target capital be committed by institutional and other professional investors.

While the majority of recent IPOs have been offered exclusively to institutional investors, crowdfunding investors are likely to be much more diverse. Over the last two decades, three quarters of the IPOs in Europe took place in secondary markets, such as London’s Alternative Investment Market (AIM). Most of these IPOs were offered exclusively to institutional investors (Vismara et al. 2012). Although institutional investors are being allocated the largest fraction of IPO shares (Aggarwal et al. 2002), equity crowdfunding is likely to attract a much more diverse set of investors.

In the “Intermediary curation of the offerings” section, we highlight the heterogeneous set of activities and services provided by equity crowdfunding platforms.

Signori and Vismara (2018) use the population of 212 firms that successfully raised initial equity crowdfunding on the UK’s largest equity crowdfunding platform, Crowdcube, from inception (2011) to 2015. They find that 18% of the firms failed by the end of April 2017. For firms that raised financing between 2011 and 2013, the failure rate was 32.1%. Walthoff-Borm et al. (2018) examine the failure of equity crowdfunded firms in the UK. They show that the failure rate of equity crowdfunded firms is significantly higher than the failure rate of a matched sample of UK non-equity crowdfunded firms.

In fact, such disclosures are permitted as part of the “brief description of the business” included in crowdfunding issuers’ advertising notices (i.e., “tombstone ads”) (SEC 2016b).

Knechel et al. (2010) conduct an experiment to reveal how auditors’ mental models can be influenced by performance benchmarks and the use of analytical strategies, which in turn influence auditors’ risk perceptions.

Furthermore, although funding portals must be registered with the Financial Industry Regulatory Authority (FINRA), the individuals running these portals are not subject to any licensing, testing, or qualification requirements (SEC 2016b, p. 158). This creates the risk that funding portals may be run by individuals who do not have the skills and education necessary to effectively facilitate the issuance of equity securities.

Crowdfunding platforms must disclose the manner in which they will be compensated at account opening as well as the amount of compensation received (both monetary and securities) on transaction confirmations (SEC 2016b).

Some of the required disclosures include a narrative discussion of the company’s financial condition, annual financial statements (which may require a review or audit depending on the amount of the offering), the business experience of directors and officers over the past 3 years, names of individuals holding more than 20% equity in the company, a description of the business and business plan, purpose of the offering, intended use of the offering proceeds, price, and material factors that make investment in the issuer speculative or risky (SEC 2016b).