INTRODUCTION In his 2004 book The Wisdom of Crowds, James Surowiecki popularized the notion that large numbers of people express preferences that, in aggregate, can be “smarter” than the views of any one individual.1 Today, social media companies mine for meaning (and hope for monetization) in this kind of “collective intelligence.” In that sense, crowds are like markets, and, the theory goes, the larger the crowd the more powerful the signal. The power of crowdsourcing also has to do with breadth, enabled in large part by Internet technologies and the networks they create, which have the potential to unearth innovative ideas and solutions previously untapped or uncombined.

It turns out that crowds are not only wise; they are potentially wealthy, too. In recent years, a second crowdsource phenomenon, crowdfunding, has emerged as a new kind of capital market. Like idea crowdsourcing, crowdfunding relies on the power of large numbers. Aggregated donations or investments can supply much-needed capital to projects or organizations, particularly in their early stages. Although the first crowdfunding “peer-to-peer” (P2P) experiments appeared in the nonprofit sector, they have paved the way for a rapidly growing industry of for-profit lending models, garnering the interest of investors and policymakers alike. By some measures, $2.7 billion was raised on more than 9,000 crowdfunding platforms in 2012,2 approximately an 80 percent increase over 2011.3 Estimates for 2013 project close to $5 billion will be raised.4

This policy note will explain what crowdfunding is, how it works, and how new platforms – nonprofit and commercial – have evolved over time. It will also explore a number of the policy and political implications of crowdfunding as both a new source of capital and model of civic engagement.

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Will Crowdfunding Kickstart an Investment Revolution?Policy and Political Implications of Peer-to-Peer Financing

Policy Note: Georgia Levenson Keohane, September 5, 2013

Georgia Levenson Keohane is a Fellow at the Roosevelt Institute, where she works on a range of issues in economic policy, including poverty and inequality, employment and job growth, and social entrepreneurship and the role of firms in society.! She is an adjunct professor in the Social Enterprise Program at Columbia Business School, and is author of Social Entrepreneurship for the 21st Century: Innovation Across the Nonprofit, Private and Public Sectors (McGraw Hill 2013).! Georgia holds a BA from Yale University, an MBA from Harvard Business School, and an MSc from London School of Economics, where she was a Fulbright Scholar.

To contact the author, call Tim Price at 212.444.9130 ext. 219 or e-mail tprice@rooseveltinstitute.org. The Roosevelt Institute is located at 570 Lexington Avenue, 5th Floor, New York, NY, 10022.

The views and opinions expressed in this paper are those of the author and do not necessarily represent the views of the Roosevelt Institute, its officers, or its directors.

EXECUTIVE SUMMARY

In recent years, crowdfunding has emerged as a financing model that allows smaller funders to invest in projects and organizations in their early stages – particularly those that would otherwise struggle to obtain capital. Peer-to-peer funding experiments first emerged in the nonprofit sector, but have since expanded to the realms of for-profit investment and political activism. The proliferation of crowdfunding models and uses requires a nuanced policy response, one that balances the imperative to support the growth of small businesses and new jobs with safeguards for investor protection.

1 Surowiecki, James. The Wisdom of Crowds. New York: Anchor, 2004.2 Gri!th, Erin. 2013. “While Crowdfunding Waits for the SEC, Companies like DietBet Close Seed Rounds on SeedInvest,” PandoDaily (blog), 12 April.3 MacLellan, Kylie. 2013. “Global Crowdfunding Volumes Rise 81 Percent in 2012.” Reuters, April 8.4 Barne", Chance. 2012. “Top Ten Crowdfunding Sites for Fundraising,” Forbes, May 8.

Crowdfunding’s Nonprofit OriginsMuch of what we think of today as crowdfunding has its origins in the nonprofit sector. Some of the first “laboratories of giving behavior,”5 pioneered by places like the Case Foundation, aimed to test the power of social networks to raise both awareness about causes and money to support them, a kind of “participant philanthropy.” Case’s first Giving Challenges (2007, 2009) o"ered a kind of test case for a number of other online contests and fundraising competitions, at the same time that other peer-to-peer lending and crowdfunding entities were beginning to emerge.

Another early innovator was DonorsChoose.org, a website that allows teachers to post classroom or project needs and donors to supply funding directly to those projects. Founded in 2000 by a teacher in the Bronx, DonorsChoose.org went national in 2007 and has since raised over $180 million to support 360,000 projects and 60,000 schools.6

Organizations like Kiva helped nudge participant philanthropy toward participant lending. Founded in 2005, Kiva is an online nonprofit that allows donors to lend to people in developing countries (and now in the United States) via field partners including microlending institutions, schools, and other community organizations.

Technically, Kiva is neither for-profit nor peer-to-peer (Kiva lends through intermediaries, rather than individual to individual, and 70 percent of Kiva lender/donors use their principal, if and when it is returned, without interest, to make another loan or to give directly to Kiva itself). Yet Kiva’s model and popularity created a roadmap of sorts for true peer-to-peer and profitable lending models and the emergence of an entire crowdfunding industry where “market makers” like Kickstarter and Indiegogo match large sums of philanthropic capital with innovators across the world. Although neither Kickstarter nor Indiegogo promises financial returns to project supporters, these companies are themselves profitable. Kickstarter earns 5 percent of the funds raised for each project, and Indiegogo between 4 and 9 percent.

Nonprofit Crowdfunding ProfilesDonorsChoose.org• Founded in 2000, DonorsChoose.org is a platform

where public school teachers in the United States can post requests for classroom supplies or materials.

Donors review these proposals and give money to support specific needs in return for project updates, student thank-you notes, and reports from teachers. As of August 2013, $187,138,027 has been raised for a total of 369,697 successfully funded projects.7 (This model has since been borrowed by numerous organizations and campaigns, like Occupy Sandy, which created an Amazon.com Wish List to secure supplies it needed for hurricane recovery e"orts.)

Benevolent• Benevolent is a much smaller-scale nonprofit platform

that connects individuals in cities or local communities with donors who help fund their projects. Focused on low-income individuals, Benevolent requires that a request or project – $750 for vocational school tuition, $330 for regular bus fare to get to a new job each day, $400 for a freezer or lawn mower for a small business – be sponsored by a local nonprofit that can vouch for the individual in need and disburse funds. Founded in 2011, Benevolent has helped match over $45,000 in donations to fund 80 needs.8

Kiva• Kiva is an online microlending nonprofit that connects

people in the developing world (and now the United States) with independent lenders. Loans are distributed through local field partners, which can be schools, community groups, or microfinance institutions. As of August 2013, Kiva has facilitated $463,430,425 in loans to 1,106,120 borrowers in 73 countries.9

MicroPlace• Like Kiva, MicroPlace facilitates microlending, but in

this case investors can earn between .5 and 4.5 percent interest. Unlike Kiva, MicroPlace is a for-profit company (since 2007 a PayPal company, which itself is owned by eBay), but its revenues are mostly directed toward strengthening the lending platform and funding other socially oriented initiatives. As of 2012, MicroPlace has facilitated $50 million in investment from 13,000 investors to issuers that in turn fund microfinance projects around the world.10

Kickstarter• Founded in 2009, Kickstarter describes itself as the

“world’s largest funding platform for creative projects.” The site explicitly bans cause-related funding, allowing projects to be posted only in

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5 Keohane, Georgia Levenson. 2008. “The Facebook Philanthropos,” Slate, February 11. 6 Donors Choose. “Impact.” Accessed 19 August 2013. (h"p://www.donorschoose.org/about/impact.html)7 Ibid.8 Benevolent. “Factsheet,” Accessed 12 July 2013. (h"p://www.benevolent.net/index.html)9 Kiva. “About Us.” Accessed 19 August 2013. (h"p://www.kiva.org)10 MicroPlace, “MicroPlace Stats,” Accessed 12 July 2013. (h"p://www.microplace.com)

categories including art, fashion, food, technology, or design. As of July 2013, Kickstarter had raised over $600 million in donations for 44,732 successful projects, ranging from a water purifier for a floating pool in New York City’s East River to a movie sequel to a popular television show (Veronica Mars). Kickstarter itself is a for-profit entity, earning 5 percent of total funds raised from each project.

Indiegogo• Founded in 2008, Indiegogo operates similarly to

Kickstarter, but is host to a broader array of projects, including those that are explicitly political or cause-oriented. Unlike Kickstarter, which returns donations for projects that do not raise their full funding objective, Indiegogo allows those seeking funds to keep whatever they raise. Indiegogo retains 9 percent of donations raised by non-fully-funded projects, and 4 percent on successfully funded endeavors. In August 2013, the British so#ware company Canonical set the record for the most money raised – more than $10 million – in a crowdfunding campaign for its latest smartphone, the Ubuntu Edge. Although pledges on Indiegogo came from around the world, with more than 25,000 donor/investors, they fell short of the company’s ambitious $32 million goals and the project will not proceed.

COMMERCIAL CROWDFUNDINGThe nonprofit crowdfunding industry has helped pave the way for the emergence of more commercial crowdfunding models, as investors and start-ups have begun to look to crowdfunding as an important source of project or company finance, with the expectation, unlike on Indiegogo and Kickstarter, that investments need to be repaid.

In this view, crowdfunding represents a potentially innovative solution to a larger set of market failures: insu$cient capital, particularly in early stages, to sustain small businesses and start-ups. Over the years, policymakers have a%empted to address this market failure in various ways, from incentivizing the growth of the venture capital and private equity industries, to creating numerous programs to support small business. However, the problems of market liquidity remain, particularly for small businesses and start-ups. It is not

surprising, then, that entrepreneurs have seen crowdfunding as a potential source of capital. In recent years, enthusiasm has also spread to potential investors, as they have observed the demand for these kinds of exchanges and the profits from funding platforms like Kickstarter. Accordingly, for-profit “crowd investing” platforms have emerged to channel both debt and equity investments into commercial businesses.

Investment Crowdfunding ProfilesLending Club• Now one of the largest lending platforms in America,

Lending Club began in 2007 as a Facebook app.11 In 2013, it is projected to earn $100 million in revenues through fees charged to borrowers and lenders.12 In May 2013, Google invested $125 million in Lending Club, which has been valued at approximately $1.5 billion.13

Prosper• Like Lending Club, Prosper was founded in 2007 and

targets credit card debt. Prosper has created two loan pools, one which contains whole loans that institutions can claim entirely, and one which divides loans among lenders (and therefore more closely approximates the crowdfunding model).14 The company has over 1.6 million members and more than $500 million in funded loans.15 Prosper’s largest and most recent investor is the venture capital firm Sequoia Capital.

Dealstruck• Dealstruck o"ers an alternative to bank loans for small

businesses by crowdfunding debt. It connects businesses with accredited and institutional investors to provide them with more a"ordable loans and less red tape, while promoting higher returns for lenders than similar “short-term, fixed-income investments.”16 Dealstruck has raised more than $1.5 million in lending capital from individual accredited investors, and made its first loan in May 2013.17

MicroVentures• Founded in 2006, MicroVentures is an equity-based

crowdfunding platform (and broker-dealer) that c o n n e c t s a n g e l i n v e s t o r s a n d p r o m i s i n g entrepreneurs. Self-described as an “investment bank for start-ups,” MicroVentures matches ve%ed businesses seeking between $100,000 and $500,000

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11 Luzar, Charles. 2013. “Google Bets on Crowdfunding, Invests 1.25 Million in Lending Club,” Crowdfund Insider (blog), 2 May. 12 “Crowdfunding in America: End of the Peer Show,” 2013. The Economist, 1 June. 13 Luzar, Charles. 2013. “Google Bets on Crowdfunding, Invests 1.25 Million in Lending Club,” Crowdfund Insider (blog), 2 May.14 “Crowdfunding in America End of the Peer Show,” The Economist, 1 June.15 Prosper. “About Us.” Accessed 12 July 2013. (h"p://www.prosper.com)16 Grant, Rebecca. 2013. “Dealstruck takes on banks with its ‘Lending Club for small businesses,’” VentureBeat Business (blog), 4 June.17 “San Diego Entrepreneurs Launch Dealstruck Lending Marketplace for Businesses Seeking Expansion Capital,” 2013. Wall Street Journal, 4 June.

in capital with accredited investors. As of May 2013, MicroVentures reported that over $16 million had been invested in 34 start-up companies in the areas of Internet technology, media, so#ware, green technology, mobile and social media, and gaming.18

SoFi• SoFi connects students and alumni of the same

university through dedicated lending pools to help finance student loans. Alumni earn a “compelling double bo%om line of return,” while students receive loans at lower rates than from commercial or federal alternatives. Founded in 2011, the company had facilitated $140 million in loans as of August 2013.19

CommonBond• Like SoFi, CommonBond focuses on student loans,

connecting student borrowers and alumni investors to o"er students lower-rate loans. Launched at Wharton in 2012, CommonBond plans to expand to 20 graduate business schools in 2013 to fund as much as $100 million in low-cost loans and to other graduate and undergraduate programs in 2014.20

CROWDFUNDING POLICYSmart public policies – those that foster the growth of the crowdfunding industry and protect investors in the process – are still evolving. Prior to 2012, equity-based crowdfunding was generally illegal under federal and state securities law, particularly when it involved a large number of investors. Increasingly, policymakers are recognizing that relaxing some of the earlier investment restrictions on crowdfunding could help increase flows of capital to small and start-up businesses. The rationale is one of job creation and economic growth: in the last 30 years, start-ups and young companies have been the primary engines of new job creation in the United States.21 This is particularly true in recent years, when firms less than five years old have accounted for more than 60 percent of new jobs.22

Accordingly, policymakers have looked to make legislative and regulatory changes to loosen investor restrictions, while also ensuring consumer protections are in place. For example, the 2012 JOBS Act exempts equity-based crowdfunding from federal securities law and a%empts to expand crowdfunding opportunities beyond accredited investors (typically defined as those worth $5 million or more) to their unaccredited investor brethren. 23 Although the SEC has not yet implemented all the regulations required for these JOBS Act provisions to go into e"ect – and there is debate about just how democratic (and “crowd”-friendly) the new investment opportunities may be24 – the legislation is ultimately intended to enable investors of all sizes and net worths to crowdfund potentially profitable projects via debt or equity investments.25

Managing RiskThere are, of course, ample risks to investors in P2P lending. Companies like Prosper and Lending Club project robust profits, but to date have a limited track record in the marketplace. Most financial advisors are proceeding with caution and recommending limited exposure to P2P investment companies.26

On the consumer protection side – consumers in this case being small investors – regulation of the P2P market must balance the imperative to protect small investors with the need to expand the pool of capital for small businesses, a problem the SEC is currently grappling with as it develops alternative standards for accredited investment. Although regulators are eager to enable investment27 in young companies in an e"ort to spur job growth, it is clear that they must also develop safeguards to shield small investors from complex investment risks they might not fully understand. This has long been the logic underpinning the “accredited investor” designation, first outlined in the Securities Act of 1933, which limits investments of a certain size, scope,

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18 “MicroVentures Reaches $16M in Equity Crowdfunding Investments,” MicroVentures press release, May 20 2013. See also MicroVentures. “Business Funding.” Accessed 18 June 2013. (h"p://www.microventures.com)19 Sofi, “About Us,” Accessed 19 August 2013. (h"p://www.sofi.com)20 CommonBond. “What We Do,” Accessed July 12, 2013. (h"ps://commonbond.co)21 See, for example, Stangler, Dane and Robert E. Litan, 2009. “Where Will the Jobs Come From?” Kau!man Foundation Research Series: Firm Formation and Economic Growth, November.22 Ibid, Special Tabulation by the U.S. Census Bureau for the Kau#man Foundation. 23 Braverman, Laura. 2013. “SEC delay on crowdfunding threatens job creation, leadership globally, activists say,” Upstart Business Journal, 19 February.24 See for example Gorfine, Daniel. 2013. “Whatever happened to the “crowd” in crowdfunding?” Washington Monthly. 23 July. 25 Guzik, Samuel. 2013. “Equity Crowdfunding - Google and the Venture Capitalists are Taking Notice.” The Corporate Securities Lawyer Blog. May 9.26 Light, Joe, 2012. “Would You Lend Money to These People?,” The Wall Street Journal, 13 April.27 See, for example, Monson, Michael A. 2010. “The Evolution and Future of the Accredited Investor Standard for Individuals,” Utah State Bar (blog), 2 November. Initial reforms of the 2012 JOBS Act have had to do with loosened restrictions on marketing and “public soliciting” of investment opportunities. Though firms can now solicit funds more widely, investments will likely remain restricted to accredited investors pending further legislation.

and complexity to investors of significant individual or institutional wealth and liquidity (who can therefore absorb substantial losses). 28 Today, most investments in private equity, hedge funds, or other “alternatives” are legally restricted to accredited investors.

While the SEC and other regulators address this tension in the crowdfunding space between greater access to capital for business and su$cient investor protections, for-profit P2Ps a%empt to mitigate some investment risk through due diligence. Not surprisingly, commercial crowdfunding platforms tend to screen investment opportunities more vigorously than their nonprofit counterparts. Nonprofit crowdfunding models like DonorsChoose, Kickstarter, and Indiegogo sometimes vet the authenticity of the individual or organization seeking funds, but do not widely safeguard or guarantee against fraud. Nor are there legal or regulatory protections in place for investors/donors. In contrast, commercial crowdfunding platforms that list investment opportunities typically have stringent ve% ing procedures for the companies or individuals soliciting investments or loans, and include caveats about return promises and probabilities. Not surprisingly, this risk has also created a market opportunity, and investment insurance products and companies have emerged, along the lines of the Baltimore-based Asurvest, which o"ers crowdfunding insurance for P2P investors.29 Asurvest promises “a"ordable risk management” to protect against “fraud, bankruptcy and unknowable loss,” a service that it imagines will serve both the nonprofit and for-profit crowdfunding arenas.30

CROWDFUNDING POLITICSBeyond the growth of crowdfunded nonprofit and commercial ventures, and the necessary public policies to foster responsible investment in both, crowdfunding has had important political implications.

Electoral PoliticsThe most obvious intersection of crowdfunding and politics takes the form of campaign fundraising. In 2008 and 2012, Barack Obama’s presidential races were famously and substantially supported by a groundswell

of small donors. Although there is debate about what fraction of total dollars raised actually came in small, “retail” increments, it is clear that this was one of the first national races that relied significantly on online, social media-driven and, in a sense, crowdfunded political contributions.31

Increasingly, crowdfunding is playing an important role in campaigns across the country. In recent years, a variety of platforms have emerged to facilitate donations of all sizes to electoral and ballot-measure campaigns, including sites and organizations like Rally and ActBlue, which aggregate donations for electoral campaigns and progressive political organizations and candidates, respectively.

The Revolution Will Be CrowdfundedBeyond organized politics, crowdfunding is beginning to make important inroads in political movements across the globe. In June 2013, Turkish protesters made headlines when they crowdfunded an advertisement that ran in the New York Times denouncing government violence in Taksim Square.32 In this case, the Turkish campaign used Indiegogo to raise the funds and relied on Twi%er to reach out to donors and crowdsource ideas for the ad’s design and roll-out. Just as Twi%er, Facebook, and other social media have been instrumental in helping to organize, galvanize, and shape political protest, it is likely that crowdfunding will become a regular component of this kind of activism.

Local Civic EngagementCrowdfunding has also begun to take hold at the community level, part of a tradition that dates back to at least the 1800s, when more than 120,000 Americans helped fund the construction of the Statue of Liberty pedestal. Today, civic crowdfunding has become an innovative way to supplement depressed local budgets in support of public goods and spaces like parks, libraries, local historical sites, public art, community gardens, and solar energy projects, to name a few. Not surprisingly, platforms like Citizinvestor and Spacehive have emerged to facilitate these kinds of initiatives. This is not a uniquely American phenomenon; crowdfunding infrastructure and utilities is catching on from Latin

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28 Although the $5 million threshold is the most commonly used for the “accredited investor” status, lower net worth ($1 million excluding primary residence) or income (exceeding $200,000 annually for multiple years) are sometimes allowed by the SEC. 29 Sandler, Kyle. 2013 "Crowdfunding Insurance Coming By Way of Baltimore Startup Asurvest," Nibletz, 4 February.30 Cruchbase. “Asurvest.” Accessed June 17, 2013. For further discussion of risk, and of the economics of crowdfunding more broadly, see Agrawal, Ajay K., Christian Catalini, and Avi Goldfarb. 2013. “Some Simple Economics of Crowdfunding.” Working Paper No. w19133. National Bureau of Economic Research. June. 31 Blumenthal, Paul. 2013. “Barack Obama Must Thank Small Donors for Fundraising Lead,” The Hu!ngton Post, 27 September; Jones, Rupert. 2013. “Crowdfunding O#ers Alternative to Traditional Investments,” The Guardian, 3 May; Luo, Michael. 2008. “Study: Many Small Obama Donors Really Weren't,” The Caucus: The Politics and Government Blog of The New York Times, 24 November. 32 Conrad, Alex. 2013. “Full Page Ad Inspired by Turkish Protests is one of Indiegogo’s Fastest Campaigns Ever,” Forbes, June 4.

America (in 2012, 3,000 Colombians crowdfunded $145 million for a new skyscraper) to Europe (Germans have been crowdfunding bridges) and the U.K. (residents of the city of Mansfield crowdfunded the equivalent of $55,230 for free public Internet access).33

With austere government budgets across the world showing few signs of fiscal improvement, some have begun to explore the potential of crowdfunding larger public goods and services, like education or public health. Advocates of this approach suggest that the public, particularly in local communities, may be willing to pay for certain goods or services despite large-scale aversion to taxation, and that voluntary payment may help solve this conundrum. For example, as of August 2013, Gunbygun, a San Francisco-based campaign, has crowdfunded over $10,000 for a gun buyback initiative.

While the rise in crowdfunding as an expression of increased civic participation is encouraging, we must be mindful of an a la carte or selective funding of public goods. Crowdfunding should not substitute for some of the basic functions of government, that is, ensuring that a range of public goods and needs are provided for in the face of market failure.

The emergence of crowdfunding represents a series of important new frontiers in the capital markets: social, commercial, and civic. The growth of the field, and of the opportunities for investors seeking financial, social, or political returns with their individual and aggregated funds, will also require nuanced public policies that can nurture these marketplaces and create the transparency, trust, and safeguards necessary for them to flourish.

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33 Quirk, Vanessa. 2012. “BD Bacatá: The World’s First Crowdfunded Skyscraper” ArchDaily, 26 September Curtis, Sophie. 2012. “Mansfield (UK) hits crowdfunding target for free WiFi network,” TechWorld, December 19.