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Crowdfunding: More Than Just Another Innovative Financing Strategy

Kate Gasparro
Thursday, February 4, 2016

Many of you have probably seen campaign announcements on social media sites such as “Help Send me to College”, “Let’s Create a Foldable Kayak” or “Donate for a Better App” and clicked through the links to give financially to a cause.  Such support by an expanding number of citizens has helped grow a blooming industry known as crowdfunding.  Over the past six years, crowdfunding annual revenue grew from $.5 billion to nearly $35 billion in 2015 [1].  The industry now boasts almost 450 platforms [2] , where entrepreneurs, artists, innovators, and community leaders vie for attention to bring ideas to life.  

Within the last few years, the industry has started to showcase civic projects to provide public goods to communities.  The civic crowdfunding sphere has been successful at fundraising for community bike lanes, recycling networks, and community center renovations.  Similarly, specific platforms, such as ioby and Citizininvestor, are beginning to work hand-in-hand with cities to help deliver public goods via crowdfunding mechanisms and grassroots movements.  Although this may seem like a radical change to the way projects are being funded, “crowdfunding” is a new term for an age-old funding mechanism. The idea of amassing small amounts of money from a large pool of individuals to pursue a common goal was the foundation for collective tax systems and philanthropic fundraising campaigns.  The same idea has been used as the cornerstone for the municipal bond market and even the stock market.  Currently, traditional crowdfunding web platforms follow fundraising strategies and some have become 501(c)(3) non-profits to entice individuals looking to give tax deductible donations. 

With the success of traditional crowdfunding campaigns, sponsors are starting to realize the opportunities to use crowdfunding for larger projects.  Whereas before project sponsors could only use platforms to reach potential supporters and aggregate donations, perhaps in exchange for first access to a product or entrance to a VIP event, there is now potential for crowdfunding to be used as a financing tool.  In other words, individuals can now invest dollars in a project or venture and expect a financial return.  The shift from donation to investment has opened the doors to a wide variety of public goods projects.  On January 29, 2016, the Securities and Exchange Commission made regulations regarding Form Funding Portals effective [3].  For the majority of the world this does not mean too much, but if you’ve been following crowdfunding and its entry into the market as an innovative financing tool, then you are well aware that crowdfunding opportunities are becoming more accessible to the public and more regulated.  The SEC refers to regulation crowdfunding as a type of crowdfinancing strategy.  Similar to traditional crowdfunding, crowdfinancing still targets a large group of individuals to raise funds for a common cause; but, crowdfinancing has mainly been limited to accredited investors who earn an individual income of more than $200,000 per year or have a net worth exceeding $1 million [4]. 

Crowdfinancing for infrastructure projects is making a splash in the real estate market, where companies like Fundrise and CrowdStreet are reaching out to accredited investors to take a preferred equity stake in community real estate projects.  With the Jumpstart Our Business Startups Act of 2012, the pool of potential investors is growing and the SEC is due to release more regulations that allow crowdfinancing platforms market to unaccredited investors. In a time of fiscal restraint and limited infrastructure funding for new construction, let alone rehabilitation and maintenance, forward thinking cities are beginning to see opportunities for using crowdfunding and crowdfinancing as avenues to raise capital for public works projects.  Initially, the idea of raising funds through online platforms is enticing.  But, the political, social, and economic concerns of partnering with the crowd have left cities hesitant to include the community during project development.  Similar to the effect that public-private partnerships have had, where both the public sector learned how to include the private sector in project development and the private sector had to perform its own project due diligence, projects that include the crowd as a funder or financier must learn to navigate this new relationship.  As a first step, SEC regulations as well as best practices among crowdfunding sites call for increased transparency and accountability for project sponsors.  And, therefore, the implications of change orders or misallocation of funds during project development carries more weight under these partnership arrangements. 

The first question to ask a sponsor organization when they decide to crowdfund a project is: what is the purpose of crowdfunding?  Some organizations see crowdfunding as a way to raise funds for project implementation.  But, a large contingent of the civic crowdfunding sector is using crowdfunding to increase community engagement and public participation in the delivery of a public goods.   Although both sides of crowdfunding have their own merits, the implications of participation and raising funds from the crowd are inexplicably intertwined.  This makes sense, because the birth of the crowdfunding industry was not only a way to raise funds for a venture, but also served as a market diagnostics tool: if a sufficient number of individuals supported a product enough to fund its first production, then there was less demand risk for the product once it reached the market.  Similarly for infrastructure projects, the crowd is able to vet the project and provide support for project development.  Currently, the National Environmental Policy Act requires community stakeholder engagement prior to a project’s Environmental Impact Statement submittal and researchers have continued to explore the relationship between public participation and project sustainability.  Although many projects tout the extent of public participation, the community is often only consulted (not engaged) during short-term, early decision-making actions.  Public participation processes that lead to better project outcomes are those in which the community is seen as a true partner that is able to contribute local knowledge, take part in policy decisions, and increase accountability throughout operations and maintenance phases.  Crowdfunding has the potential to make the public participation process less superficial and produce more sustainable projects. 

Despite crowdfunding opportunities that allow for true public participation, there are concerns that these benefits can fall by the wayside if sponsors pursue projects carelessly.  Firstly, there is concern that crowdfunding civic projects only concentrates projects in areas of high wealth, where individuals with the financial capacity can readily give resources for project development.  Secondly, crowdfunding critics have claimed that projects only need a small number of unrepresentative individuals to fund a project, regardless of the community’s concern.  This would in effect, annihilate the essence of public participation and might increase distrust between the project sponsor and the community.  Thirdly, accountability mechanisms could lead to further distrust between the community and the sponsor if a project is conducted haphazardly.  These concerns are valid and should not be handled lightly.  The expertise of the Global Projects Center is well situated to explore the governance and implementation of crowdfunding for infrastructure projects.  Currently, we are working to understand the various facets of crowdfunding and relevant best practices, so that cities and organizations who are considering similar innovative financing tools for infrastructure can be assured they are best serving their communities.