Equity Crowdfunding Rewiring Goals-Based Investing with Equity Crowdfunding

FEATURE | Rewiring Goals-Based Investing with Equity Crowdfunding Rewiring Goals-Based Investing with Equity Crowdfunding

By Jamie McIntyre, CIPM

he syzygy of crowd-empowering keeping more than 50 percent of their funds to teams of professional advisors and technology, the surge in fintech, assets in cash (Robinson 2016). money managers. The purpose of clients’ T and regulation changes present an • Entrepreneurs who have sold their busi- money is distilled into a tool solely to fund opportunity for advisors to change clients’ nesses and retirees have pent-up intellec- future money. Today’s investors are not apa- perspectives on wealth and value creation. tual and financial capital that advisors thetic, they just never learned to raise the As access to quality portfolios has become can channel in a high-value and intrinsi- question. This is about to change. commoditized, advisors are moving cally meaningful manner. beyond analytics for deeper connections Crowdfunding— with clients. The adoption of goals-based The Corruption of Market Intent Chomping at the Bits planning has upgraded advisor-client Our markets have foundations in the provi- Crowdfunding is the use of small amounts conversations and resulted in wealth man- sion of capital to further innovation and of capital from a large number of individu- agement advice that’s hewn more closely growth. Investors have been rewarded for als to finance a new business venture, and to core individual and family needs. As taking risks in funding the advancements of it’s done most often through the Internet. basic life goals are satisfied, new impactful the companies and industries they invest in Its initial objective was to provide exposure objectives emerge. These extensions of and participating in the upside of the growth. and encouragement in the arts. One of the goals-based investing can deepen value But today, investing and wealth management first crowdfunding projects, ArtistShare, and catalyze change. have strayed from this initial premise. was founded in 2001 as a way for fans to back musicians’ creative works. This paved This article addresses the following: An overwhelming share of individual assets the way for reward-based crowdfunding is deployed in vehicles in which the investor portals such as Indiegogo in 2008 and • How reward-based crowdfunding has has little or no awareness of the underlying Kickstarter in 2009. These sites have tapped into collective demand and set investments. These include mutual funds, become sources of initial capital for new the stage for new markets exchange-traded funds, hedge funds, private businesses that can pre-sell a product • Regulation changes that have redefined equity funds, and separate accounts. One of before creating any inventory. public and private security offerings the most powerful modes of advocacy and • How early stage investing incorporates a support that an investor can have is off- Kickstarter alone has provided for more goals-based framework based on loaded to multiple third parties that have no than 12-million people to spend almost Maslow’s hierarchy of needs concept of how an individual’s desires are $3 billion among more than 100,000 proj- • Why the next generation’s first invest- reflected in the investments. As advisors and ects.1 This money is donated, and the proj- ment will be in a private security money managers we have to ask ourselves, ect owner has no legal obligation to did we do this by design? Does the disasso- complete the project. Crowdfunders are Why are these things important? ciation between clients and their money investors who are funding passions and make us more important? More needed? dreams, and their returns are the resulting • Robo-advisors are offering extremely accomplishments of the crowdfunded. This low-cost diversified portfolios directly As an industry, our clinical treatment of type of crowdfunding flips the supply- to consumers. Advisors’ value-add money and wealth has obfuscated invest- demand construct and has a company increasingly will be tied to how they ments to the point that people don’t know focus on what is important today—break- can connect and serve the needs of how their money is being used or where it is ing through the noise and creating a market clients above and beyond a commod- deployed. We inundate investors with charts for its product or service before starting itized portfolio. and graphs and theories of asset-allocation- any manufacturing. This process weeds out • Millennials are not connecting with cur- powered Monte Carlo simulations that myriad ineffective offerings; 65 percent of rent wealth management offerings. They create distance between clients and their Kickstarter product campaigns fail to reach desire more purpose behind their invest- wealth. This, in turn, has clients dutifully their funding goals and therefore never risk ments of time and money, and they are abdicate responsibility for the deployment of the capital of backers.2

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Here are a few examples of how a power- Figure 1: Private Companies Postponing Public Offerings (valuations in USD billions) fully engaged crowd can bankroll a new business: Uber 68

• Pre Apple-Watch, a group of entrepre- Airbnb 30 neurs in Palo Alto, California, created Wework a digital customizable wristwatch that 17 runs apps. The team sought $100,000 Pinterest 11 in pre-orders to warrant further develop- DropBox 10 ment of the watch. When the campaign ended two months later, it had raised Spotify 8.5 $10,266,845 from more than 68,000 back- Source: https://www.cbinsights.com/research-unicorn-companies ers. The Pebble smart watch set records for what was possible in donation-based crowdfunding.3 Table 1: The Path to Equity Crowdfunding • A re-envisioning of the card game UNO April 5, 2012 President Obama signs the JOBS Act into law with cartoon pictures of cats in various SEC IMPLEMENTS TITLE II forms of distress would be a tough busi- September 23, 2013 Private offerings can be solicited publicly for the first time in ness proposition using traditional retail 80 years (accredited investors only) methods. Exploding Kittens re-wrote the SEC PASSES TITLE IV – REG A+ rules of social marketing to entice more March 25, 2015 Private companies can publicly raise up to $50 million from accredited and non-accredited investors than 220,000 backers to spend almost SEC PUBLISHES RULES FOR TITLE III $9 million on a deck of cards not yet October 30, 2015 Private companies looking to raise $1 million per year from 4 produced. small investors • Palmer Luckey, age 18, has a vision, duct TITLE III COMES ONLINE tapes some screens together, and creates a May 16, 2016 Investment portals enable small businesses to sell equity marketing video selling the future of vir- directly to retail investors tual reality. His still-not-invented product generates $2.5 million in pre-sales.5 Years in late 2011 introduced legislation that based on who you knew and where the later backers finally got their goggles, but became the Jumpstart Our Business company lived; local angel investment clubs with no participation in the budding Startups Act (JOBS Act). Initially envi- would hear pitches, conduct their own due company’s upside. Oculus was sold to sioned as an economic accelerator and a fix diligence, and invest in local startups. Facebook for $2 billion dollars. for tightened traditional bank financing, the JOBS Act ultimately may lead to a Title II allowed online portals such as The third example has some backstory: At democratization of our equity markets. SeedInvest, CircleUp, and AngelList to the time, an average investor had no ability The most groundbreaking aspects of the openly solicit private investment deals to participate in Oculus’ gain. Securities bill are Titles III and IV, which address across the Internet. Building on the same laws prohibited any kind of equity partici- crowdfunding and small-company capital crowd-based infrastructure that powers pation from a non-accredited investor and formation, respectively, and allow unac- reward-based platforms, companies general solicitation of a private offering to credited investors to invest alongside exposed new investors to radical new accredited investors was not allowed. But accredited investors in private and “mini” opportunities. Crowdnetic’s CrowdWatch increased regulation and expense has made public offerings. For the first time, anyone platform analyzed the private offerings from it unattractive for budding companies to can invest in early stage startups that align the 16 leading Title II platforms for the first use the public markets for funding. In fact, with their interests and passions and par- three years since implementation. Its data the majority of gains in some of the most ticipate in the potential growth. show more than $1 billion of equity and coveted companies are occurring in the convertible debt raised over the period.6 private markets as public offerings continue The JOBS Act paved the way for fundrais- Of 6,000 offerings, 1,500 were deemed suc- to be postponed beyond their primary ing disruption; the U.S. Securities and cessful. The high failure rate represents the growth spurts (see figure 1). Exchange Commission (SEC) formulated crowd collectively culling offerings to find regulations to enable each of the provisions those with enough merit to warrant invest- Equity Crowdfunding or and protect consumers (see table 1). In ment. Over the three years, the number of Democratizing Investing 2013 Title II, which addresses access to new attempted raises has decreased dramat- In response to a challenging economic capital for job creators, came online. Before ically and the success rate and average per climate for small businesses, lawmakers that, seed-level funding for companies was successful issuer has increased. Today’s

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equity portals have learned to put money stage venture capital returned 22.65 percent level investments. To discover how behind the businesses that will successfully compared to 9.93 percent for the S&P 500 we can articulate these attributes better, fill a round, ultimately creating more pro- and 6.57 percent for the Barclay’s Credit we can investigate how one of the pioneers tections for the investor. Bond Index (see figure 2). of motivational psychology updated his own models. The companies that are taking advantage of The connected technology that has enabled equity crowdfunding today are vanguards. this new type of exposure to private invest- Maslow’s Hierarchy Redefined It’s too soon and there isn’t enough data yet ing outdates modern portfolio theory. as Goals-Based Investing to effectively model this democratized ver- Attempting to delineate a new slice in a In the 1940s and 50s, psychologist sion of early stage investing as an asset mean-variance-optimized portfolio will Abraham Maslow studied top performers class. The closest proxy is venture capital, fail due to errant assumptions of expected to understand what motivated them. This which can include later-stage investments. risk and return. Relying on risk versus was revolutionary at the time because However, even after substantial fees and return as the sole determinants of optimi- his peers were focused primarily on carried interest, the return potential is zation ignores the attributes of intention, researching mental illness and sympto compelling: Over the past 30 years, early innovation, and purpose found in seed- matic diagnosis. His findings often are represented in the pyramid recognized as Figure 2: Venture Capital Returns vs. Stocks and Bonds, 30-Year End-to-End Maslow’s Hierarchy of Needs. Pooled Returns as of March 31, 2016 Ashvin Chhabra (2015) used Maslow’s 22.65% hierarchy as the foundation of his Wealth Allocation Framework, which buckets portfolio risks for an individual investor. Chhabra asserts that every individual or 9.93% family needs a framework that delivers on 6.57% the following three objectives that corre- spond to Maslow’s hierarchy (see figure 3):

Barclays Credit Bond Index S&P 500 Index U.S. VC Early Stage Index • Safety: The certainty of protection from Data from Cambridge Associates LLC, March 31, 2016. U.S. Venture Capital Index® and Selected Benchmark anxiety and poverty Statistics Report. The Early Stage Index includes pooled end-to-end return, net of fees, expenses, and carried interest; past performance is no guarantee of future returns. • Stability: A high probability of maintain- ing your standard of living

Figure 3: Psychology and Goals-Based Hierarchies

Transcendence Transcend Catalyze change

Self- Aspire actualization Enhance lifestyle Morality, creativity, High risk, illiquid, spontaneity, high alpha investments acceptance, experience purpose, meaning, and inner potential Stability Self-esteem Maintain lifestyle Confidence, achievement, respect of Diversified, global, strategic, market others, the need to be a unique individual participation, passive and active Love and belonging investments Friendship, family, intimacy, sense of connection

Safety and security Safety Health, employment, property, family, Preserve lifestyle and social stability Capital preservation, inflation protection, insurance, annuities, Physiological needs primary home, portfolio protection investments Breathing, food, water, shelter, clothing, sleep

Maslow's (Enhanced) Hierarchy of Needs Chhabra's "Wealth Allocation Framework" Rewired

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• Aspire: The possibility of achieving Later in life, Maslow noticed something Chhabra allows for some transcendent upward wealth mobility and creating the missing in both himself and his hierarchy goals in his aspirational bucket, but the potential to meet your aspirations that was beyond self-actualization. He innovation is in creating a discrete fourth decided that his original model was incom- bucket dedicated to transcendence, the This type of solid construct around why a plete and he created a new stage deemed purpose of which is to catalyze change. The portfolio is developed and the purpose of “transcendence” (Maslow 1999, 117): “the subject of that change is deeply personal each asset class within it provides a founda- greatest attainment of identity, autonomy, and its discovery can involve multiple con- tion to guide clients through irrational behav- or selfhood is itself simultaneously a tran- versations that strengthen the advisor- ior that can lead to financial mistakes. By scending of itself, a going beyond and client relationship. The front lines of bucketing investments in alignment with the above selfhood.” change—where an investor can have the client’s core needs, advisors can guide clients most impact—are in helping to power early through turbulent markets because client loss Maslow’s definition of transcendence can stage companies and their passionate entre- aversion is constrained to the portions of be broken into two parts: preneurs. By utilizing crowd-curated assets aligned with appropriate market risks. investments, investors are immediately part 1. Transcendence seeks to further a cause of a community that shares a common Welch (2015, 15) described the advantages beyond the self: service to others, devo- transcendent purpose in alignment with of designing portfolios using a goals-based tion to an ideal (e.g., truth, art) or a cause their own personal gain. approach such as the Wealth Allocation (e.g., social justice, environmentalism, Framework: the pursuit of science, a religious faith) The work done by Chhabra (2015) and 2. Transcendence seeks to experience a Welch (2015) can be extended by applying 1. The portfolio has been built to address communion beyond the boundaries of the framework of goals-based investment specific investor objectives. the self through peak experience. The criteria to the new bucket (see table 2). 2. The portfolio is proposed and reported person experiences a sense of identity on in the same intuitive way the investor that transcends or extends beyond the The Next Generation’s First thinks about his/her money rather than personal self (Koltko-Rivera 2006). Investment Will Be Private in advisor-centric MPT-speak. Young, high-income earners are the 3. From a reporting perspective, the focal Even though goals-based portfolios align highest adopters of fintech applications point of advisor/client communication with the core motivations of clients as (see figure 4). This demographic is using moves away from client-irrelevant defined in Maslow’s original hierarchy, the mobile phones to transfer assets into market benchmarks and individual investments often are not deployed in accor- robo-advised investment portfolios with manager performance and more dance with this elevated need. Most portfo- no custodial paperwork or in-person con- toward a client-centered progress-to- lios are designed with investments used as versations. These platforms will continue plan approach. opaque tools that obfuscate the underlying to innovate rapidly as they compete for securities. This can lead to many portfolios market share. Hedgable, a robo-advisor Maslow (1943) defined the peak of the unaligned with the clients’ undiscovered that specializes in alternative investments, hierarchy as the need to “self-actualize”: intentions. Platforms do exist to screen offers equity crowdfunding exposure investments for criteria, socially responsible through funds from many of the leading It refers to the person’s desire for self-fulfill- or otherwise, but a disconnect remains as to platforms such as AngelList, CircleUp, ment, namely, to the tendency for him to what an investor can achieve with direct OurCrowd, and the startup accelerator become actualized in what he is potentially. purposeful funding of investible causes. Y Combinator.

Table 2: Sample Investment Criteria for a Rewired Goals-Based Framework

Safety Stability Aspire Transcend Wealth allocation framework Preserve lifestyle Maintain lifestyle Enhance lifestyle N/A Preserve capital and Diversified market expo- Stated investment goal Increase wealth Catalyze change purchasing power sure to maintain lifestyle Defined time horizon 2 years 10 years 15 years 5–7 years Desired rate of return 2% (inflation) 8% 13% 18% Acceptable loss 0–1% 16% 50% 100% Liquidity Highly liquid Liquid Liquid / Illiquid Highly illiquid Benchmark CPI MS World HFRI N/A Dollar allocation ($10 million) $5 million $3 million $1.5 million $500,000

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intrinsically fulfilling and potentially fiscally Figure 4: Fintech Current and Intended Future Usage by Age and Income Group rewarding for boomer clients.

INCOME The role of a wealth advisor itself can be 11% 31% 6% 18% 3% 9% Less than US $30,000 transcendent. The fiduciary advisor directly 24% 49% 15% 35% 6% 16% services others and their hierarchies of US $30,001–$70,000 needs while creating a community of 33% 57% 26% 45% 10% 24% US $70,001–$150,000 clients whose combined goals enrich soci- 52% 65% 51% 65% 13% 30% US $150,000+ ety. As advisors look to differentiate them- 18 to 34 35 to 54 55+ selves from thousands of peers, the ■ Current ■ Future opportunity to purposely connect clients with their invested wealth yields strong Source: http://www.ey.com/gl/en/industries/financial-services/ey-fintech-adoption-index relationships and impactful gains.

Jamie McIntyre, CIPM, is founder and chief The same social virality that has propelled offering was the initial shockwave of crowd- executive officer of Rewire Capital, which funds reward-based crowdfunding campaigns is funded investment. Blockchain is a distrib- startups that leverage technology to disrupt being retooled to reach non-accredited uted ledger that verifies every transaction their industries and rewire legacy inefficiencies. investors. It is easy to imagine the next across a network of computers; it is fully He is a founder of both Lydian Wealth and generation of investors tinder-swiping transparent and without a centralized Fortigent. He earned a BS in computer science seed-capital private deals and matching authority. Computers complete a set of com- with a minor in mathematics from Virginia up their diversified portfolios against plex calculations to validate that the ledger Polytechnic Institute & State University. Contact their friends’ portfolios. Companies will of recorded transactions should be part of him at [email protected]. embolden investors as participatory evan- the master chain. Blockchain was designed gelists to help them expand. At the same as the foundation for Bitcoin, the digital cur- Endnotes time, platform companies are investing in rency that has no backing institution, bank, 1. See https://www.kickstarter.com/help/stats. 2. See https://www.kickstarter.com/help/stats. technology to remove some of the most physical good, or country—but does have an 3. See https://www.kickstarter.com/projects/getpebble/ common obstacles, as shown in the fol- aggregate market cap of more than $20 bil- pebble-e-paper-watch-for-iphone-and-android. 4. See https://www.kickstarter.com/projects/elanlee/ 7 lowing examples: lion. Skeptics question a digital currency, exploding-kittens. but financial institutions are embracing the 5. See https://www.kickstarter.com/projects/1523379957/oculus-rift-step-into-the-game. • In October 2016, SeedInvest launched power of the blockchain technology to move 6. See https://www.crowdwatch.co/hosted/www/down- auto-investing, which slashed minimums money and, in Overstock.com’s case, securi- load-report?report_month=oct_2016. 7. See http://www.coindesk.com/price/. in individual companies to as low as $200 ties. Bitcoin and blockchain were introduced and provided much-needed diversifica- by an anonymous author in a paper in 2008 References tion for early adopters. and deployed in January 2009. So, in fewer Chhabra, Ashvin. 2015. The Aspirational Investor: Taming the Markets to Achieve Your Life’s Goals. New York: • On November 15, 2016, Indiegogo, a top than eight years, a company that was started HarperBusiness. reward-based crowdfunding portal, to liquidate merchandise from failed compa- Koltko-Rivera, Mark E. 2006. Rediscovering the Later Version of Maslow’s Hierarchy of Needs: Self- launched equity crowdfunding in part- nies is issuing, trading, and settling securi- Transcendence and Opportunities for Theory, nership with MicroVentures. Indiegogo ties on the first SEC-approved alternative Research, and Unification. Review of General Psychology 10, no. 4: 302–317. http://academic. provided its suite of proven social- trading system. Watch out Wall Street. udayton.edu/jackbauer/Readings 595/Koltko-Rivera solicitation tools to millions more back- 06 trans self-act copy.pdf. Maslow, A. H. 1943. A Theory of Human Motivation. ers worldwide. Millennials and their descendants may be Psychological Review 50, no. 4 (July): 370–396. • At the end of 2016, Overstock.com the earliest adopters, but advisors also need ———. 1999. Peak-Experiences as Acute Identity Experiences. Chapter 7 in A. H. Maslow, Toward a raised a $10.9 million Series A offering to explore this asset class with boomer Psychology of Being (3rd ed., New York: John Wiley & with 20 percent of the shares sold on a clients. As boomers sell businesses or retire, Sons, Inc.: 113–126). Robinson, Keith. 2016. Managing the Millennial blockchain platform, effectively creating many of them are confronted with difficult Generation. IMCA Investments & Wealth Monitor 31, its own market. The use of crypto tech- questions of “what’s next?” A study by the no. 6 (November/December): 5–7. Sahlgren, Gabriel H. 2013. Work Longer, Live Healthier. nologies such as blockchain can acceler- Institute of Economic Affairs shows that Institute of Economic Affairs Discussion Paper No. 46 ate development of secondary markets retirement increases the risk of clinical (May), http://iea.org.uk/sites/default/files/publications/ files/Work%20Longer,%20Live_Healthier.pdf. and create liquidity for crowdfunded depression by 40 percent because retirees are Welch, Scott. Managing Client Relationships in a Goals- securities. doing less problem solving and contributing Based Framework. IMCA Investments & Wealth Monitor 30, no. 6 (November/December): 9–13 less to society (Sahlgren 2013). An introduc- For stock exchanges, brokers, and central tion to early stage companies in need of securities depositaries, the Overstock.com guidance as much as capital can be To take the CE uiz online, visit www.IMCA.org/IWMuiz

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