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Regulation Helps Legitimize Crowdfunding, Celebrities Burnish Its Image

As crowdfunding grows and fraudsters arise, portals are relying on celebrities and regulators to help lend credence to the industry.

Scottish tennis champion Andy Murray has given the U.K. much to cheer about over the years. The current No. 3 player in the world took Olympic gold at the 2012 London Summer Games and was crowned the singles champ at Wimbledon in 2013, ending the U.K.’s 77-year wait for a Wimbledon men’s victory on its home turf. Now Murray is hoping to use his expertise — and his estimated $70 million net worth — to support his compatriots and their small businesses through crowdfunding.

Murray, an active investor who set up his own management company in 2013, joined the advisory board of London-based equity crowdfunding portal Seedrs this year to inform its senior executive team on health, sports and wearable technology. The tennis professional is looking to invest in as many as 40 U.K. businesses over the next five years through the platform, having already made several undisclosed investments.

Since the announcement, Seedrs has noticed an increase in investors registering with the site — not to mention a boost in tennis-related businesses wanting to raise money — but the portal is looking for more than just quick hits. “For us, this is a long-term relationship where we’d like to build value over time,” says Ben Aronsten, the company’s chief marketing officer. Seedrs is receiving pledges of up to £4 million ($6.2 million) a month, according to Aronsten.

Crowdfunding, or raising capital from multiple sources generally through the Internet, took off after the 2008–’09 global financial crisis. With banks tightening lending criteria in the wake of the crisis, many cash-strapped small- and medium-size enterprises and start-ups — particularly in the U.S. and Europe — were eager to explore alternative sources of credit.

The global industry raised a total of $16.2 billion in 2014, up 167 percent from the previous year, according to Los Angeles–based industry research firm Massolution. Investors channeled $6.7 billion into business and entrepreneurship, the most popular crowdfunding category, whereas some $3.1 billion was raised for social causes. Much of the remaining money was raised for the arts and for real estate investment. North America was the largest market, raising $9.46 billion, followed by Asia, which eclipsed Europe for the first time. In its 2015 Crowdfunding Industry Report, Massolution forecasts a doubling of inflows this year.

Nonetheless, crowdfunding has its shortcomings. Some 60 percent of campaigns fail to raise the necessary capital. Scams threaten to give the industry a bad name, undermining the efforts of legitimate enterprises. Brooklyn, New York–based Kickstarter caught a group in Plano, Texas that called itself WeTag, which raised more than $500,000 from nearly 9,800 pledges to develop a business around a Bluetooth-based device for locating lost items, which turned out not to exist. Kickstarter suspended the campaign right as it was due to close, in June 2014. Greater oversight by regulators following the 2012 passage of Jumpstart Our Business Startups (JOBS) Act in the U.S. (of which Title III specifically pertains to crowdfunding) and by portal operators and users is helping to clean up crowdfunding’s image, though.

The equity crowdfunding market, where backers get a stake in the business, is policed by the U.S. Securities and Exchange Commission and the Financial Conduct Authority (FCA) in the U.K. In both the U.K. and the U.S., equity crowdfunding has generally been limited to “sophisticated” investors: those earning more than $200,000 a year or with a net worth exceeding $1 million in the U.S. The U.S. removed its investor threshold in June when the SEC promulgated Title IV of the JOBS Act, enabling small retail investors to partake in equity crowdfunding (although they face more red tape than do accredited investors).

“Kickstarter and its many imitators try to provide some due diligence because their business model will be ruined once people believe that there’s a lot of fraud going on,” says Mark Roderick, who heads the crowdfunding unit at Flaster/Greenberg, a law firm based in Cherry Hill, New Jersey. “But their ability to perform due diligence is limited.” Sites outline risks and security measures for potential investors and entrepreneurs, and many platforms use proprietary technology to monitor campaigns and detect violations. Community policing is also key.

Rewards-based crowdfunding, in which business owners offer perks like first editions of the product being backed, is less reliable than its equity-based equivalent, says Roderick. “There are almost no laws whatsoever governing rewards-based crowdfunding.”

As the industry expands, celebrities are becoming more involved, helping to quell fears about crowdfunding’s legitimacy. Retired National Football League quarterback Brett Favre joined the board of Sqor, a social sports network that launched a crowdfunding platform last October. Other celebrities are using crowdfunding sites, including Kickstarter and San Francisco–based Indiegogo, to raise money for their own causes and projects. Rock star Neil Young raised more than $6 million via Kickstarter to fund download service and high-resolution digital music player Pono Music, which launched in January. Through Prizeo, another crowdfunding platform, celebrities offer prizes such as a night out in Los Angeles with actor Kiefer Sutherland or a day on the set of Shark Tank with investor Mark Cuban in exchange for public contributions to their chosen causes.

The celebrity seal of approval is helping drive traffic to the sites and foster greater activity, particularly among new users, according to Kickstarter. Many backers of celebrity projects go on to fund other ventures. The Seedrs board, in addition to Murray, also boasts such names as Logan Green, CEO and co-founder of ride-sharing app Lyft, and Dave Morin, CEO and co-founder of social network Path and a former manager at Facebook. “These guys are top of their game in their own spaces and have made a great success of their own businesses and their own lives,” says Seedrs’ Aronsten. The platform was the first in the U.K. to be authorized by the FCA and to develop an FCA-accredited quiz to evaluate investors. Only 20 to 25 percent of proposed businesses will be listed on the platform, says Aronsten, who says that so far none have been hoaxes.

By their nature, early-stage equity investments are high-risk, says Roderick, and loss is a part of investing, but that shouldn’t slow the industry’s growth. “Crowdfunding is definitely a very legitimate vehicle both for raising capital and for investing,” he says.

Follow Georgie Hurst on Twitter at @Ghurst_iimag.

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