5 myths whitepaper

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Wall&Main Knowledge Exchange Whitepapers November 7, 2013 DEBUNKING THE 5 LEADING MYTHS ABOUT CROWDFUNDING

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Reading articles in the news and on crowdfunding forums can seem like sifting through advertisements and scary stories. A lot of content is either announcements of new crowdfunding campaigns or interviews with traditional investment organizations arguing that it is too scary to invest in private companies without an investment manager by your side. Much of this content has recently resurfaced with the release of the Securities and Exchange Commission’s proposed rules for implementing...

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Wall&Main Knowledge Exchange Whitepapers

November 7, 2013

DEBUNKING THE 5 LEADING MYTHS

ABOUT CROWDFUNDING

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INTRODUCTION

Reading articles in the news and on crowdfunding forums can seem like sifting through advertisements and scary stories. A lot of content

is either announcements of new crowdfunding campaigns or interviews with traditional investment organizations arguing that it is too

scary to invest in private companies without an investment manager by your side. Much of this content has recently resurfaced with the

release of the Securities and Exchange Commission’s proposed rules for implementing Title III of the Jumpstart Our Business Startups Act

(JOBS Act) and regulating public crowdfunding in the United States. The scary stories are just that – “stories” – but when they are repeated

often enough they become the stuff of myth.

The website of the National Crowdfunding Association of Canada (NCFA) is running a series of articles to address the most common myths

being perpetrated against the crowdfunding industry. We recommend that you read this excellent series in its entirety. We have

shortened and summarized some of the myths discussed in the NCFA series for use here:

1. THE CROWD I S MADE OUT OF DANGEROUS FOOLS

2 . CROWDFUNDING CANNOT P OSSIBLY WORK

3 . TRADIT IONAL FUNDING SOURCES WILL NOT TOUC H CROWDFUNDED COMPANIES FOR SUBSEQUENT R OUNDS

4 . DEN OF THIEVES (FRAUD AND FAI LURE )

5 . THERE IS NO REASON TO MAKE EQUITY CROWDFUNDING AVAI LABLE TO THE GENERAL PUBLIC

These “myths” make for harrowing headlines and great talking points, but none of them hold up to much scrutiny. We have addressed

each of them in turn, providing analysis and examples. Read on to learn more.

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MYTH 1: THE CROWD IS MADE OF DANGEROUS FOOLS There are two roots to this myth. First, in order to believe this myth, you have to fundamentally believe that people will always do

incredibly stupid, self-destructive and dangerous things when left to their own devices. Second, you also have to believe that there is

special knowledge possessed by investment professionals that cannot be transmitted to, or

understood by, the general public.

To be sure, large groups of people have done some incredibly destructive things. Then

again, large groups of people have done incredibly noble and beneficial things. People

arguing that the crowd is inherently dangerous will offer cherry-picked examples of crowds

becoming violent or acting against their own interests. For every Nazi Germany example,

there is an Allied Forces example to offer a counterpoint. For every witch-hunt, there is a

community rallying around a barn-raising.

Rather than rely on such anecdotes, let us determine a relevant path to

answering this myth.

CROWDFUNDING ENABLES A DIVERSITY OF VIEWS TO WORK TOGETHER

The crowd, as it turns out, is not a gigantic teeming mass. It is made out of people. The crowd is comprised

of separate individuals who each have the ability to quickly adapt to changing market conditions.

Individuals also have the ability to fuel innovation and creativity through the cross pollination of ideas.

Moreover, the crowd can learn from and evaluate the views of experts, benefitting the crowd and

furthering market knowledge. The SEC proposed rules for the JOBS Act includes specific analysis and

acknowledgement of the crowd’s wisdom and evaluative capabilities.

D IVERSITY BREEDS ADVANCEME NT

A crowd of people, drawing on the breadth and depth of their collective experiences and backgrounds, has

deeper and broader industry and market knowledge than any single expert.

“The crowd, as it turns

out, is not a gigantic

teeming mass. It is

made out of people”

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Crowds enable risk to be spread in small amounts across the entire population, reducing risk to any single individual. Moreover, the crowd

also tends to be leery of outlandish offers and, when coupled with excellent fraud detection tools, can help to identify and isolate

fraudsters.

Crowds are more than just a class of investors, as they provide some specific long-term advantages for entrepreneurs. While large-scale

investors make great board members, crowd investors are a word-of-mouth channel capable of magnifying any fundraising effort. Crowd

investors, when convinced, can be enlisted to increase the reach and strength of a company’s message and rally other supporters to

spread the word about that company’s mission, products and crowdfunding campaign. In addition to being instrumental in successful fund

raising, crowds have a tendency to become an installed user based for companies seeking to offer goods and services to the public.

Because of the feedback and insight from the members of crowd, the crowd can be instrumental in the period between the funding stage

and full operation. As they process and respond to product and marketing information, the crowd can help refine messaging and product

design to ensure the best possible product and communications for bringing in new customers.

ENRICHMENT BY P ARTI CI P ATION I S NOT ABO UT P RI ZES

Crowdfunding rebalances the funding landscape by distributing negotiating power and knowledge away from entrenched traditional

funding organizations. When companies can crowdfund themselves, they have more power over their capitalization process and the

destiny of their company.

D ISTR IBUTION ENHANCE S KNOWLEDGE

What happens when investment knowledge and power are distributed to the public? For starters, public participation in entrepreneurship

and investment will give the general public direct insight into the process of building companies and more generally into the underlying

dynamic process of market capitalism. Engagement between the general public and the entrepreneur community will also provide

entrepreneurs with greater visibility, helping great ideas spread faster than ever before.

Crowdfunding makes it possible for governmental entities, companies and universities to work together to strengthen community,

regional, and national economic goals. Crowdfunding also allows individuals to invest in their local or regional community.

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On a societal level, widespread participation in crowdfunding will lead to greater transparency into (that is, understanding of) private

companies because such widespread participation will require the standardization of collecting and disseminating financial information,

like reporting and valuations.

On an individual level, people will have access to a broader and more diverse range of potential investments to include in their portfolios.

For individuals with investment strategies that include high risk and high reward investments, early-stage private companies (like those on

crowdfunding portals) are an attractive option.

Finally, access to a broader funding pool lowers the funding entry barrier for disruptive companies that need to be able to scale quickly to

the point where they can sustain themselves on narrow margin, technology-leveraging business models.

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MYTH 2: CROWDFUNDING CANNOT POSSIBLY WORK As with any innovation, some people simply cannot accept that a different way of doing

something might be feasible, functional or useful. The “crowdfunding can’t work” myth can

be tricky to overcome because you first have to get the critic to define what he or she means

by “work” – that is, you have to get the critic to offer his or her metrics for crowdfunding

success. There are three ways to consider whether or not crowdfunding “works” or is

successful. Are crowdfunding portals sustainable? Are people able to use crowdfunding

portals to start sustainable businesses? Are there measurable ways to determine what makes

a campaign successful?

The answer to all three questions is “yes.”

CROWDFUNDING WORKS WELL ENOUGH FOR PORTALS TO BE SUSTAINABLE

The presence of myriad thriving crowdfunding portals – with many different funding models like debt, equity, rewards-based and

donation-based – indicates that this is an industry sustaining viable, stable and sound companies. In the United States alone, crowdfunding

is a $3 billion business. Billion.

CROWDFUNDING SUPPORTS THE CREATION OF VIABLE BUSINESSES

If crowdfunding does not work, there should not be any examples of portals

that have successfully raised funds for entrepreneurs and then watched (or

helped) as those entrepreneurs ran successful businesses. But there are plenty

of examples of successful crowdfunding campaigns. (Because equity-based

crowdfunding from the general pubic is not yet permitted in the U.S., many

examples are from other countries.)

The Australian Small Scale Offerings Board (ASSOB) has raised over AU$133

million for more than 180 companies. More than 80% of those companies are

currently operation, and there have been no reports of fraud through the five

“In the United States

alone, crowdfunding

is a $3 billion

business. Billion.”

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years ASSOB has been operating.

Britain’s CrowdCube has raised £13 million for 73 companies, generating hundreds of jobs and fueling growth in the UK.

There are many successful crowdfunding sites using donation-based or accredited investor-based models, including: Kickstarter,

IndieGogo, CircleUp, AngelList, Seedrs, Symbid and the like.

THERE MUST BE DEMONSTRABLE REASONS FOR CROWDFUNDING SUCCESS ; OTHERWISE , IT IS ALL JUST

LUCK

For some, the proof that a fundraising vehicle (like crowdfunding) is viable lies in being able to demonstrate common traits among

companies that successfully use crowdfunding. According to one study, successful crowdfunding efforts include these common elements:

EDUCATED AND SUCCESSF UL BOARD MEMBERS FOR THE COMPANY

S IGNALED THEIR INTEND ED EX IT STRATEGY

PROVIDED F INANCIAL F ORECASTS

OPERATED THEIR BUSINE SS USING THE ENTREPRENEUR ’S OWN INVESTMENT CAPITAL BEFORE COMING TO SEEK FUNDS

OFFERING A L IMITED AM O UNT OF EQUITY FOR SALE

Crowdfunding has shown itself to be a viable means of securing funding for entrepreneurs who can make a good case for themselves. Not

all campaigns or crowdfunded companies will be successful, but this is also true for companies seeking other means of funding. The

entrepreneurs who succeed have something to say, something to back them up, and a solid plan for how to get where they are going.

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MYTH 3: TRADITIONAL FUNDING SOURCES WILL NOT TOUCH CROWDFUNDED

COMPANIES FOR SUBSEQUENT ROUNDS The root of this myth comes from a tiny grain of truth. Companies that use equity crowdfunding will indeed have

more investors than if they had raised their money from a small group of wealthy investors, which could complicate

the process of doing a subsequent traditional funding round. Additionally, there is a common impression that only

weak companies (who could not otherwise fund themselves) resort to crowdfunding. Both of these suggestions are

flawed in light of the availability of collective-agent legal structures, proof that crowds do indeed make smart

fundraising decisions, and the limited pools of funding available from traditional funding sources (venture capital,

angel investors, and private equity).

MANY INVESTORS , ONE VOICE

If the prospect of a large number of investors is seen as a problem for

traditional funding sources, there are legal strategies that remove this

problem by aggregating large groups of investors into a single agent

or entity. Two models immediately come to mind: investor co-ops

and nominee structures.

Investor cooperatives (co-ops) provide a model where crowd

investors are combined into a

single cooperative entity,

which can act as a single,

large shareholder and

Board member

when negotiating additional funding rounds. This method is currently being proven by a

company called Symbid, operating in the Netherlands.

Nominee structures refer to a model where the ownership interests of crowdfunders are actually

controlled by the crowdfunding platform itself, allowing investors to vote for their preferences while relieving the individual investors from

the responsibility of administering their investments. This method is being employed by Seedrs in the UK.

“Crowdfunding enables early stage

companies to build and develop the

traction necessary to make a strong

case for subsequent funding rounds

from VCs, angel funds and private

equity organizations.”

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FUNNELING THE BEST UPWARD , FEEDING THE VCS

First and foremost, the task of venture capital, angel investment, and private equity funds is to identify and invest in companies that will

increase the wealth of their investors. These traditional investment organizations will actively benefit from crowdfunding’s ability to initially

vet and support early-stage, high risk opportunities. Crowdfunding enables early stage companies to build and develop the traction

necessary to make a strong case for subsequent funding rounds from VCs, angel funds and private equity organizations. In fact, a strong

case has been made by James Surowieki in his book, The Wisdom of Crowds, for the accuracy of insights derived from the aggregation of

information and viewpoints of large groups of people. The companies made successful through crowdfunding will have a unique pedigree

when approaching traditional funding sources for their follow-up rounds of funding.

Crowdfunding is positioned to feed a wider array of potentially lucrative deals to the traditional funding

community than they currently see, providing an incentive for these organizations to partner with crowdfunding

portals rather than shun crowdfunded entrepreneurs. As well, traditional funding sources must turn away the vast

majority of potential opportunities because they have limited funds to invest or the entrepreneurs seeking funds

are not quite ready for a multi-million dollar investment round. This is not to say that the companies (who do not

receive traditional funding) are bad companies, or even to suggest that they are somehow weak. Rather, it

suggests a significant need unmet by traditional funding sources.

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MYTH 4: DEN OF THIEVES (FRAUD AND FAILURE) The most common complaint against crowdfunding – the threat of fraud – appears

over and over in the press. This view is repeated by the securities administration

lobby and venture capitalist bloggers. This myth begins and ends with the assertion

that crowdfunding will be some sort of “Wild West” of lawless and unscrupulous

actors conning ‘unsophisticated’ investors out of their nest eggs. Without

diminishing the real threat posed by fraud to all investors, the impression of

crowdfunding as uniquely dangerous is unfounded.

Fraud is a threat across all levels of and vehicles for investment and is not in any way

unique to crowdfunding. Fraud committed by Enron, MCI Worldcom, Sino-Forest,

Stratton Oakmont, Bernie Madoff and Fabrice Tourre affected millions of people and

cost trillions of dollars, and the graft represented by these examples in no way

reflects the vast majority of players in the traditional funding market. Since no single

investment vehicle is fraud-proof, the investment community’s primary focus should

be eliminating or minimizing fraud throughout all levels of business rather than

finger-pointing at any one type of investment platform or vehicle.

The SEC’s regulations regarding the implementation of the JOBS Act were slow in coming because the 585 page document is so heavily

weighted with rules and requirements to protect investors from fraud. This proposal includes specific requirements for crowdfunding

portals to educate investors and potential investors to help them avoid making poor decisions, know what limits the law places on their

investing activities and understand the process involved with investing through the portal.

In fact, the most dangerous threat to investors is not fraud but ignorance. Fortunately, as the SEC and several industry leaders

acknowledge, there are multiple tools available to help protect and educate potential investors who want to use crowdfunding portals,

including, but not limited to: educational content and disclaimers, online testing for investor comprehension, cooling off periods and wait

times, as well as double opt-in consent for any online activity.

“Crowds can prod

opportunities from

hundreds and thousands

of directions at once,

helping to more quickly

identify and report

potential fraud before it

can do damage.”

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Indeed, crowdfunding represents a powerful new anti-fraud tool. When the crowd pokes and prods companies – that is, when thousands

of individuals actively examine potential investment opportunities (like those on crowdfunding portals), these individuals are helping the

market to more quickly identify and report potential fraud before it can do damage.

Rather than fraud, the more credible threat to the future of crowdfunding is the potential for companies to fail. Companies will fail.

Companies will fail no matter what vehicle is used to fund them. Since failure is a recognized concern among entrepreneurs and early-

stage investors alike, reputable crowdfunding organizations communicate the risk of company failure clearly. Moreover, investors are

urged – by investment professionals as well as crowdfunding platforms themselves – to diversify their portfolios to minimize the impact of

a single company’s failure. A balanced investment portfolio spreads risk across many investments to diminish the damage when a single

investment fails.

Ultimately, there is risk to investing in early-stage businesses. In the early days of crowdfunding, it is likely that there will be several

crowdfunded companies and crowdfunding portals that fail. This is part of the growing pains for any industry, but the net result will be the

same kind of improvement and innovation (drawn from the crowd) driving the best entrepreneurs to succeed. The crowdfunding portals

that do survive these growing pains will be those providing the best resources, showcase the best companies, and do the best job of

aiding their investors and entrepreneurs to make the best decisions possible. The responsibility owed to investors by crowdfunding portals

is to provide enough education to help investors make informed decisions as they consider different investment options.

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MYTH 5: THERE IS NO REASON TO MAKE EQUITY CROWDFUNDING AVAILABLE

TO THE GENERAL PUBLIC The final myth is that there is no reason to provide equity crowdfunding opportunities to the general public (that is, non-accredited

investors). The reasoning behind this myth is simple: if there are already viable ways to fund companies (like VCs and angels), why is there

a need for another method (like crowdfunding)?

Crowdfunding has the potential to address several critical issues hampering the US economy: the funding gap, missed opportunities, and

the transfer of experience.

THE LADDER ’S MISSING RUNGS

There is an enormous gulf between small pools of capital from friends,

family, and credit cards and significant investments from the VC

community, angel investors and incubators. This gulf stifles the

growth of potentially lucrative businesses.

This funding gap is negatively affecting more companies than ever, as

fewer companies are receiving funding for early stages. Equity

crowdfunding by the general public is ideal for bridging this gap.

Because the demand for funding is so high, and the pools of capital

from traditional sources are so limited, the supply-demand imbalance

gives great power to large investors and banks who use their leverage

to require businesses (seeking capital) to provide significant personal collateral or agree to lopsided legal terms in order to secure funding.

Moreover, because accredited investors make up such a small portion of the population, and accredited investor portals turn away most

companies seeking funding, there is a large unmet demand for funding.

THE GREATEST VALUE-ADD AVAILABLE

The benefits of opening equity crowdfunding to the general public also include broadening participation in investment and

entrepreneurship, improving the public’s financial literacy, providing visibility into companies and markets that are currently opaque,

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setting private investment benchmarks and best practices across a wide swath of businesses, streamlining financial transactions,

standardizing investor communications, and enabling better investment administration. To be sure, there are many benefits of

crowdfunding. Crowdfunding is fueling entrepreneurialism worldwide. Opening a broader base of investment opportunities will help

obtain more capital for investment in American businesses.

SUCCESS TAKES MORE THAN MONEY

Unlike many “money-only” or “funding-only” crowdfunding portals, many accredited investor crowdfunding portals offer resources and

business services to aid companies in developing their campaigns and building their business after a successful fundraise. General public

equity crowdfunding platforms – especially those already working with accredited investors – are uniquely poised to give entrepreneurs

the same access to resources and business services that help to develop their campaigns and then build their businesses. Because of the

wide-reach of crowdfunding, platforms that want to bring resources and services to entrepreneurs have access to large numbers of

potential mentors, board members, employees, and partners who can help drive potential success for companies in the long term.

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CONCLUSION While there are risks to crowdfunding – which the forgoing myths exaggerate – those risks come from the high failure rate of young

businesses rather than any weaknesses endemic to crowdfunding itself. Crowdfunding is poised to take its place as part of a continuum of

funding options for businesses, helping to vet ideas and prepare businesses for greater growth later in their life-cycles. Indeed, where it is

currently practiced, crowdfunding has shown a diversity of ways in which a community of individuals can come together to help a great

idea and a great entrepreneurial team succeed. This is the great hope of crowdfunding.

About Wall&Main: Wall&Main, Inc., is the nation’s most innovative crowdfunding portal. Wall&Main is the only crowdfunding portal to

have successful crowdfunded itself using a rewards-model campaign, and will soon be open to offer investors and backers early access to

great early-stage companies. Wall&Main’s platforms, tools for entrepreneurs and knowledge resources are geared to help companies

across all industries grow, prosper, and generate value for their investors, communities and customers. Follow us on Twitter

(@WallandMainInc), Facebook, and YouTube. For more information, visit http://www.wallandmain.com.