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Crowdfinance: Banks’ friend or foe?

As crowdfunding expands under JOBS Act, banks must assess position of this upstart for startups

Crowdfinance: Banks’ friend or foe?

Dara Albright says she laughs every time she thinks of a recent New Yorker cartoon showing two panhandlers. One whispers to the other: “Remember, we’re not begging. We’re crowdfunding.”

Albright, chief strategy officer of consultancy Crowdnetic, thinks bankers should be looking seriously into crowdfunding, or, “crowdfinance,” as she and some other players are coming to prefer.

You may have heard about Kickstarter, the crowdfunding website where artists, inventors, and others seek capital from the public in the form of donations or in exchange for various rewards. Since launching in 2009, the service has enabled 4.9 million people to back projects to the tune of $805 million in pledges from, as the site states, “friends, fans, and inspired strangers.”

But chances are you’ve never heard of Sparkmarket, and, if your bank is based in Georgia, co-founder Jeff Bekiares very much wishes you had. You may have heard of Fundrise, which has already had some interest from bankers.

More about them in a moment. In the U.S., most crowdfunding activity has been in the donation and reward phase, but that is on the verge of changing. Under the JOBS Act—the same legislation that achieved banks’ long-sought changes to shareholder counts that trigger public reporting status—two significant milestones were set up. In late September, companies were permitted to make general public solicitations—from a TV commercial to a billboard—to raise capital for a business from accredited investors, under Title II of the act. Later, after securities regulators issue rules, Title III’s provisions will go into effect, which will enable companies to raise equity or to offer debt through crowdfunding.

Georgia on his mind

Jeff Bekiares, a Georgia banking attorney, says his platform will be able to offer such services to businesses sooner. That’s because Georgia, using a longstanding federal securities provision available to states, has implemented its Invest Georgia Exemption. The law permits states to allow intra-state capital raising through mechanisms like crowdfunding.

Bekiares has tapped his banking connections to raise awareness of Sparkmarket and crowdfinance’s potential, “but getting commercial banks to pay attention to that has been very challenging.”

The attorney isn’t looking for their cash, but for their referrals. “I see this as a partnership,” explains Bekiares. “I see no measure of competition. It’s really a complementary business.”

Banks don’t generally finance startups. “There’s a lot of risk, and you are only getting your interest rate,” says Art Johnson, chairman and CEO, United Bank of Michigan, Grand Rapids, $467.1 million-assets.

But Bekiares sees banks in the position to say, “We can’t lend you money out of the gate. But if you raise capital through something like crowdfunding, that can collateralize a loan.”

“Everybody wins with this scenario,” says Bekiares. “But nobody wants to be the first to brand themselves with a crowdfunding platform.”

Only Georgia and Kansas have such exemptions at present. But as the JOBS Act provisions kick in, more startup companies will be able to make their case to the public for debt and equity funding.

Local hopes rise, one brick at a time

Sparkmarket isn’t the only operation doing business under an exemption. A different provision in securities law, under Regulation A, enables a real estate investment crowdfinance platform called Fundrise to raise money for urban construction and commercial real estate projects. These projects are called “direct public offerings” or “local public offerings,” according to Fundrise co-founder Ben Miller. With the clearance of local regulators, Miller explains, firms like his can offer what are essentially syndicated real estate deals—except they can be done in units of $100.

“We’re not offering developers the whole capital stack,” explains Miller, but the opportunity to tap a fresh source as part of the finance mix through a tech platform. Most of what Fundrise does is very local, promoting opportunities in local projects through its site to local investors. From the investor viewpoint, Fundrise offers the opportunity to invest online in property—in about 30 seconds.

While he has worked with some banks already on aspects of the deals that the site promotes, Miller believes “banks will be slow to recognize this technique.” He believes community banks represent the best potential partners, “because they are more agile and more local.”

Should banks take crowdfinance seriously?

With the myriad of immediate issues facing banks today—from bulging compliance duties to skinny margins—crowdfunding may not seem too meaningful or pressing. But an industry facing as much competition as bankers do can’t afford to ignore the trend.

“If you think that crowdfunding just means smaller companies that launch games and device projects on platforms like Kickstarter, think again,” wrote Carl Esposti in 2013CF: The Crowdfunding Industry Report. “Crowdfunding has now emerged as a viable, scalable alternative to public and private finance.” Esposti is CEO and founder of Massolution and crowdsourcing.org.

Esposti and others in the field point to the phenomenon of Pebble Technology, a startup that makes a wrist-mounted watch that interfaces with iPhones and Androids, which raised over $10 million from over 68,000 backers on Kickstarter after seeking only $100,000. Esposti predicts that crowdfunding of all kinds will raise $5.1 billion in 2013, nearly three quarters of that in the U.S.

There are five kinds of crowdfunding platforms now: donation based, including such projects as backing novelists, artists, and kids looking for educational travel; rewards based, where you get something in exchange for a pledge; lending-based; equity-based; and royalty-based, the newest. The field has matured to the point where a growing group of suppliers—one web ad promises “a platform in a box”—is emerging to serve the industry.

Disruptive methodology

Earlier this year, the securities arm of BBVA, the international financial company that owns BBVA Compass, issued an economic outlook report titled Crowdfunding: A Disruptive Technology for Commercial Banks? The report took crowdfunding quite seriously. A key comment:

“Crowdfunding platforms are not banks, and yet they offer loans and brokerage services to individuals and small businesses like any other bank would do. They currently serve ‘the bottom of the market,’ but that doesn’t mean they cannot reach upper segments. In fact, by the time crowdfunding platforms appeal to mainstream customers it will be too late for banks to catch up with the new trend. And there is a real risk that banks stop being the primary source for personal and small business loans. Therefore, it is important that commercial banks devote resources to understand and potentially benefit from this kind of disruptive technologies.” [Emphasis added.]

Banks at present enjoy a wealth of deposits, though observers say that crowdfunding with returns could become an attractive alternate place to put funds, especially versus today’s deposit interest rates. Already, backers are promoting the idea of self-directed IRA holders putting funds to work on crowd platforms.

Warns the BBVA report: “Perhaps, for the first time in history, business and individuals have access to an unprecedented source of capital created from the small contributions of millions of individuals around the world. This is good news for individuals and entrepreneurs, who may never have to worry about not being able to access traditional lending sources or using more expensive funding solutions to finance their projects. It is also good news for small investors seeking a higher return than conventional investment products.”

The report says that for banks the challenge will be competing with a mechanism with much lower operating costs. Indeed, Sally Outlaw, co-founder of Peerbacker.com, and an industry author and consultant, says that crowdfunding sites don’t take all that much to operate once they are up and operating. Much of the activity to make a successful request for funds hinges on promotional efforts to drive people to the listings.

What banking is thinking

But what about the view closer to banking, and among bankers themselves?

John Barlow, whose firm, Barlow Research Associates, studies commercial lending extensively, has concerns about crowdfinance. “Our research in the small business market shows that the single biggest driver of satisfaction is how easy it is to do business with a bank,” says Barlow. “Between compliance and risk management, the credit process is burdened with costs and customer frustrations.”

Barlow says that one measure he finds relevant is the speed at which a credit decision is rendered.

“Our research says the customer expects a decision in 2.6 days,” he says. “Until we meet that metric the industry will be vulnerable to new players with faster processes.”

Massolutions’ Esposti points to ABN AMRO’s 2012 pilot, Seeds (www.seeds.nl), as an example of what large banks can try. ABN AMRO spokesperson Karen de Vries says that the four-month pilot has been declared a success—three of the five businesses posted were financed through the platform. And 350 entrepreneurs expressed interest in the next round. Recently, de Vries adds, ABN AMRO decided to make the site permanent. “This should continuously result in 10 to 15 companies seeking investments through Seeds,” she says.

But community bankers interviewed about crowdfunding frequently hadn’t focused much on it—testimony to the fires in their inboxes that distract them. And there was some skepticism of crowdfunding’s trendiness and its concentration solely on funding.

“Banks think they provide more services than just financing,” explains Craig Miller, co-chair of the banking and financial services practice at Manatt, Phelps & Phillips law firm. He believes bankers will see crowdfinance more as a one-shot deal, not the relationship business that banks try to develop with a company. And getting involved directly in crowdfinance, he suggests, would become a “regulatory morass” for a bank.

Along that line, referring would-be entrepreneurs, even possibly existing customers, to crowdfinanciers to raise capital injections “could be tricky,” according to Jeff Sumpter, co-president and CEO at Oregon City, Ore.’s $122.6 million-assets Lewis & Clark Bank.  “We’d have to be careful to not appear to be running the person’s business. I wouldn’t want to be too involved.”

“I see crowdfunding platforms playing more of an entrée role,” says Miller.

Among bankers, one point of skepticism was the monies involved. A million bucks gets used up awfully fast these days by a small business, and the success of the Pebble project mentioned earlier is not typical thus far. As JOBS Act provisions are implemented, and more traditional companies look into its usage, that might change.

Chris Nichols, a veteran banker, brings two hats to the table when crowdfunding comes up. Nichols spent more than a decade with the Pacific Coast Bankers Bank, including heading its capital markets subsidiary, and is currently chief strategy officer at CenterState Bank of Florida, N.A., Winter Haven, $2.3 billion. But he is also co-founder of a funding platform, Wall & Main.

Launching this month, Wall & Main’s angle will be that not any entrepreneur will be able to go on the site. Nichols and his co-founders hope that banks will come to see platforms like theirs as allies, not competitors.

“Our standards will be very high, and it will be harder to get on Wall & Main’s platform than on others,” says Michael London, president and CEO. Firms seeking funds will need to develop boards, financial plans, and financial statements in order to take part. In a sense, he says, a site like Wall & Main could be a filter for bankers.

Are there partnerships in the future?

Near term, crowdfunding should represent a source of cooperation, and even further on, a form of “co-opetition,” believes consultant and author Jason Best, co-founder and principal at Crowdfund Capital Advisors, and co-author of books on the technique, including Crowdfunding for Dummies. Best worked closely with legislators backing the JOBS Act crowdfunding provisions. He believes crowdfunding will help bring more small businesses into being, which will at some point become bankable customers.

“Banks should look at it as a net positive,” Best said. Crowdfunding holds more promise for startups, he thinks, than do venture capitalists. Some large investors are said to cruise crowdfund sites looking for “the next big idea.”

Best is among those who see crowdfunding having special appeal locally, with people being able to put their money directly into local business that they frequent or that they believe in. “For Main Street businesses, debt-based crowdfunding will be pretty common,” he predicts. Wall & Main, which Best advises, envisions arrangements where a local investor might initially obtain a reward—say 50 suits cleaned over three years by a dry cleaner that wants to expand. If an investment return comes later, that’s even better.

Michigan banker Art Johnson sees a potential role in making community reinvestment projects easier for smaller banks to take part in, through crowdfunding. And Massolutions’s Esposti suggests that crowdfunding could back local startups in business “incubator” arrangements. Community bankers frequently join, or even head up, such efforts, in the interest of fostering their local economy and jobs.

Further out there, perhaps, is crowdfunding as a source of investments. Some crowdfunding enthusiasts point to wealth management as the place where banks, clients, and crowdfunding could fit well together.

Steve Cocheo

Steve Cocheo’s career in business journalism has taken him to all 50 states and nearly every corner of banking in institutions of all sizes. He is executive editor of ABA Banking Journal, digital content manager of ababj.com, and editor of ABA Bank Directors Briefing. He coordinates the popular Pass the Aspirin and First Person features and wrote the booklet series Focus On The Bank Director. He is the only journalist to have sat in on three federal banking exams, was a finalist for the Jesse H. Neal national business journalism awards, and a winner of multiple awards from the American Society of Business Publication Editors.

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