Crowdfunding could become a crucial source of funding – and business intelligence – for small Canadian ventures, but regulators will have to step up to make sure fraudsters are squeezed out.
That's the thesis of a new study to be released Wednesday by Toronto-Dominion Bank senior economist Sonya Gulati, who argues that crowdfunding will fill a widening gap in small-business financing.
Startups and "microenterprises" are particularly starved for financial resources, Ms. Gulati said in her report, and crowdfunding could represent a "fundamental transformation" in the way they access money.
Crowdfunding, where huge numbers of supporters make small contributions to a cause or venture through Internet sites such as Kickstarter or Indiegogo, is estimated to generate $3-billion to $5-billion a year globally right now, although that is likely to expand sharply in the coming years.
So far, most crowdfunding is in the form of donations, but if the market can be opened up for loans or equity financing for small businesses, the economy will gain, Ms. Gulati said in an interview. "People have difficulty getting off the ground," she said, especially if they are tiny and at the very earliest stages of a startup. "A lot of these businesses are innovative and creative based, and that is where you get some really good economic benefits."
And the benefits of crowdfunding are not just financial. Gleaning guidance and market intelligence from hundreds of contributors can broaden entrepreneurs' support networks, Ms. Gulati said. "With a crowdfunding network, you are able to tap into people who might actually be useful from a business perspective. If you are making leather-bound books, for instance, you might be able to connect with a distributor of leather. That might be a good support person."
Regulators are now grappling with the idea of using crowdfunding to raise equity. The U.S. Securities and Exchange Commission is in the process of loosening up its rules to allow equity crowdfunding, with strict limits on the amount of money any individual can invest.
Canada's key regulator, the Ontario Securities Commission, has also proposed new rules. These would limit the amount a company could raise through crowdfunding to $1.5-million a year, restrict an individual's investment in a single company to $2,500 and force crowdfunding "portals" to register with the OSC.
"Fraud is really the elephant in the room," Ms. Gulati said. "It is a real stumbling block to allowing crowdfunding to reach its potential." People who are otherwise willing to part with their money won't do so unless they have some recourse if an investment goes bad, she said.
While is it very valuable that regulators such as the OSC and SEC are getting involved, other bodies – such as the federal finance or industry ministries – need to jump in as well because crowdfunding will go far beyond the equity markets, she said. There needs to be a collaborative effort among regulators, she said, because "one bad apple or one big example of fraud could really derail the progress of the global crowdfunding market."
There are other unresolved issues, including the problem of dealing with intellectual property rights. If an entrepreneur canvasses the Internet for features to add to a product, or to get input on a movie screenplay, who owns those ideas? It may also make it harder to get a patent, if a product or idea has been widely disseminated on the Web, Ms. Gulati said.
And more broadly, entrepreneurs need to be a bit leery of the "wisdom" of the masses, she said. "The crowd is not always right."