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June 21, 2011 / David Lang

The Myth of the Crowd

Crowdfunding, like crowdsourcing, is appearing in the mainstream internet lexicon with increasing regularity. But what does it mean? The prevailing assumption is that crowdfunding is the aggregation of small amounts of money from a large number of people. The term is used most commonly to describe these aggregated fund collections for movies, music or other creative projects. However, the term is also being applied to similar processes for political campaigns, advertisements, and even business investments. At ProFounder, as we learn new things everyday, we are discovering new ways to define what crowdfunding means for investing in small businesses and startups.
Most notably, we have learned that the word “crowd” is misleading. We believe the more accurate word is “community,” which is why we refer to ProFounder as a community-based crowdfunding platform. Entrepreneurs succeed on our platform when they reach out to those with whom they have a specific, identifiable connection or affiliation – and when they identify in their outreach how the connection can be relevant to that individual’s participation in their fundraising pursuits. While the idea of reaching out to the masses is exciting, and new connections can of course be formed, we’ve found that existing communities continue to step up and be more than adequate for most entrepreneurs to reach their goals. Turning to certain family, friends, customers, and colleagues for support is legal, secure, and effective.

As legal background, all securities (whether they are the revenue share-based or equity-based investments that ProFounder entrepreneurs offer to potential investors) must be either registered with the SEC, as well as the states in which they are sold – or, alternatively, the securities must be exempt from registration. The SEC has designed a series of exemptions designed for everyone’s protection, and in particular, with a focus on protecting investors from fraud. Because we at ProFounder believe so much in the value of community-based crowdfunding, we have focused our tools for entrepreneurs around compliance with the laws and regulations that make an offer of securities to close friends and family – people with whom an entrepreneur has a “substantial, pre-existing relationship” – exempt from registration.  This means that the entrepreneurs (or, technically, the companies issuing the securities) need not incur the same amount of time and financial costs of full registration if they offer their securities only to their close community.  This is exactly what ProFounder allows entrepreneurs to do, empowering entrepreneurs to offer securities to the people that know them best, and who they know best.  Because the investors and entrepreneurs share a substantial relationship, the risk of fraud is low and investors are protected.  As a result, they get to participate in the business of an entrepreneur who they believe in.

Aside from legal questions, many entrepreneurs who come to ProFounder highly value the security of the information they provide and the transactions in which they participate online as they use the site. One thing we’ve heard is a concern about posting sensitive company information online, which if viewed by just anyone would put companies at risk. We agree, so on ProFounder’s platform, the only way for a potential investor to view an offering is through a link in a secure email that’s been sent by the entrepreneur. Investors then have to login and create unique accounts verifying their information before they can see any details. Not only does this system provide a safe way for an investor to see the offering, but it provides a personalized and professional channel to communicate with potential investors.

The final and perhaps most important reason we champion community-based crowdfunding is that it’s effective. Earlier this year, we ran a guest post from Del Smith, President and CEO at D.A. Smith & Associates and Assistant Professor of Management at the Rochester Institute of Technology, describing the importance of trust on early stage ventures. Del’s research enlightened us with the idea of affective and cognitive trust: how the two differ and why each are important. Del states:

“When you look to leverage your social capital during a crowdfunding raise, you are tapping into two dimensions of trust: an affective trust rooted in emotions and a cognitive trust rooted in rationality. Affective trust occurs when individuals emotionally invest in relationships, resulting in genuine concern for a person’s welfare and a belief in the relationship’s intrinsic virtue. Cognitive trust occurs when individuals make a conscious decision to trust based upon knowledge and evidence of trustworthiness (e.g., everything seems in proper order or the other party appears to possess required capabilities).”

As you can see from the graph above, the most effective way for early stage and small businesses to build the trust necessary to attract investment is by leveraging the affective trust of others. Commonly, those with the most emotional connection to entrepreneurs are those closest to them: friends, family, coworkers. Del’s research reinforced our experiences with the entrepreneurs who were successfully raising money on ProFounder. Success was closely tied to the ability and dedication to reaching out to their personal networks.

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