Crowdsourcing funding for consumer loans has been a reasonably successful space with Lending Club, the leading player in the space has lent over $1B since inception in late 2008. Provisions in the recently passed JOBS Act now allow public solicitation of private companies for fund raising which opens the doors for crowdsourcing of equity funding (not just loans). The development begs the question, will there be a viable equity sourcing platform (single or multiple)? To answer this question, let’s start with looking at the source of success for Lending Club.

The business model of Lending Club is one of classic disintermediation through new media. Consumers are getting maximum 1.5% return CD’s while having to pay interest rates of 14% or higher for unsecured consumer loans with banking costs and margins taking up the spread. Lending club allows consumers to directly lend to each other. For this to work, the platform needs to have large numbers of lenders as well as borrowers and needs a way of providing security to the transactors. Because the value to both sides of the platform is large and obvious, building a network is not difficult from that perspective. The key issue to address here is the risk element, especially for the lenders. Lending club does this by obtaining credit scores and other important information from borrowers and rejecting ~90% of applicants only accepting those with higher credit scores. They then sort the borrowers by risk and assign rates while trying to educate borrowers on default rate statistics. Moreover, they mitigate lender’s risk by unbundling loans and forcing diversification of lenders for each loan.

To replicate this model for equity, we need customers on both sides of the platform. An investor can be anyone looking for another asset class to boost yields and/or to diversity their portfolio, while a typical fund-seeker would likely be a company who might otherwise seek equity from founders’ friends or angel/venture capital type investors. The question arises why this company would want to crowd-source equity funding. An answer could be that they are not a VC investment target and they don’t have friends that can fund them or they don’t want to deal with mixing business and friendships. However, another obvious answer that will strike would-be investors is that the company is either a lemon or run by shrewd owners who want to reduce their funding costs by offering unsophisticated investors a lower stake for a risky investment. While it is reasonably easy to diligence a person’s credit-worthiness, it is much harder to ascribe value to fledgling business. Would the platform take on this time and effort intensive diligence obligation? Would investors be able to trust the platform to do this as easily? Furthermore, the amount education required for investors to understand the implications of an equity investment versus debt is high: how will they have liquidity? What are the true range of outcomes for their investment? Finally, it will be difficult to ensure investors are being treated fairly in liquidity events with likely no personal recourse, one can imagine owners paying themselves handsomely while the companies go bankrupt. In short, there’s a reason the US congress has long had standing laws barring such solicitation. It is difficult to disintermediate the function performed by venture capital companies and the complex role played by personal relationships in equity investments. Hence, despite the proliferation of equity funding platforms, I don’t think space is going big anytime soon.


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