Crowd funding, Trade Me and Network Externalities

Very exciting news last week that New Zealand’s first two equity crowd funding platforms have been licensed. See PledgeMe’s (henceforth PM) blog announcement here and Snowball Effect’s (henceforth SE) FB announcement here and the FMA’s announcement here.

Exactly what role crowd funded equity will play in NZ is going to be very interesting to watch:

• Will it fill a gap in the market and mean businesses get funding that they otherwise wouldn’t have? or
• Will it merely substitute existing funding channels but provide a ready made army of brand ambassadors for the companies that receive funding?

I imagine it will be some combination of the two, but that’s not what I want to talk about. I wanted to briefly touch on how the market structure for crowd funding platforms might evolve.

We’ve had two licensees accepted and I have read somewhere that there are another two before the FMA (plus one combined peer-to-peer lending/equity crowdfunding platform). The question I have heard a few times is whether we can sustain 5 platforms and if one will rise to the top. In this regard, I have heard TradeMe given as an example that one platform will win out.

I’m not sure this is right.

TradeMe, seek and ye shall find!

The reason we only have one TradeMe (henceforth TM)  is because of what economists call network externalities (it is also a “2 sided market” but I’m not going to get too hung up on lingo for the non-econ geeks). In a nut shell, because TM provides a “matching service” (I want to buy a fridge, TM  helps me find people who want to sell fridges), the value of the platform to an individual user is greater the more people that use it. I.e. I am more likely to find a match on TM than one of it’s competitors, so I browse TM. Likewise the seller lists on TM instead of one of its competitors because it knows lots of buyers will look on TM.

When network externalities are really important, as they seem to be for auction sites, it’s probably normal to expect one to rise to the top. And it can even happen by historical accident (i.e. whoever was first).

Crowdfunding, BYO crowd?

Now you might characterise crowd funded equity as matching companies with investors. And to a certain extent that is probably true. But for the network externalities/2 sidedness to lead us to one major platform, we might expect it to be the case that people hop on crowdfunding sites looking for projects to participate in. I’m sure this happens, and being a featured project on the front page of Kickstarter probably gives projects a big jump. Without delving into Kickstarter’s policies I would posit that projects which get featured already have a substantial backing so the promotion it brings is somewhat of a windfall.

Every project I have personally crowdfunded has resulted from reading a blog or seeing someone I know mention it on social media. I don’t often hop on Kickstarter to see what cool stuff is happening, except when I am already on the site to back a project.

My understanding, though I haven’t researched this myself, is that this pattern is common. I.e. most people who back crowdfunded projects know about the project before they land on the crowdfunding site. So the crowdfunding site isn’t performing a matching role, it is performing a transactional role (collecting payment, enabling communication between the project and funders etc…).

So for crowdfunding you can effectively “bring your own crowd”, which suggests the platform itself isn’t the important factor, it’s whether you can mobilise/build your crowd. There are even consultants who specialize in marketing crowd funding campaigns

Can there be only one?

So will all five of the planned equity crowdfunding platforms last? If network externalities/2 sidedness aren’t incredibly important as I posit above, then normal competition will drive the market structure. If one firm rises to the top it may be because they offer a superior service to founders and backers. Economies of scale could also mean that the NZ market isn’t big enough to support 5 platforms.

We could also see the platforms speciliase in different types of raisings: firms with a social slant might use PledgeMe for example.

Interestingly, it sounds like SE and PM are taking polar opposite approaches to who gets on the platform. SE are going the curated route and are currently only working with 14 out of the 250 companies that applied (link):

We wouldn’t approve companies to go on the platform if we didn’t think they had a good chance of reaching their funding target, so we’re keeping our fingers on the pulse and watching how the market develops…we’re being careful on how many we put on the platform at any time.

Whereas in Anna Guenther ‘s own words

We’ll do checks to ensure the companies meet our eligibility requirements, but we’re not deciding what a quality company is – that’s the power of the crowd

This is interesting in that pre-screening of companies partially removes the ability of the crowd to determine what is good and what is bad (i.e. good companies may miss out because they can’t get past the gatekeepers). Which to me slightly defeats the purpose of crowd funding (though this is really a whole post in and of itself, opinions vary on whether crowdfunding is actually good at discovering quality projects or if people participate to get warm fuzzies).  The flipside is that crowd funded equity is a new product and I imagine SE want to get some “runs on the board” so that there is confidence in crowd funding, which I can see the merit in.