An Unexpected Innovation for Equity Crowdfunding [Update]

Update: Thomas Vass, the author of the guest post below, recently spoke with Folio's Blaine McLaughlin on an episode of Cape Fear Capital Connections, Vass's weekly radio show. Check out the episode below:

Editor's Note: The following is a guest post by regular contributor Thomas Vass, the owner and manager of The Private Capital Market, a fee-based subscription crowdfunding site. Vass writes in to discuss Folio's Private Placement Platform, and the effects it can have on the crowdfunding industry. As always, guest contributors' opinions are their own and do not necessarily reflect the views of Crowdsourcing.org.

In an earlier article for Crowdsourcing.org (How Radical Innovations in One Sector Unexpectedly Affect Distant Markets), I described how the emergence of crowdfunding could be placed within a theoretical framework of evolutionary economics. With the use of Leontief’s method, crowdfunding proponents have ability to predict the future path of technological evolution within a specific geographical region that results from a crowdfunding initiative.

For example, advocates of crowdfunding could answer the question: “If we use crowdfunding to invest $10 million in a small biotech company, located in Raleigh, what other parts of the local Research Triangle Park economy would be stimulated?

In the earlier article, crowdfunding was seen in its economic role of providing capital, which allowed crowdfunding to be seen as a factor of production.

But, crowdfunding itself is causing further capital market innovations. In other words, crowdfunding, as an economic factor, was caused by an innovation in other parts of the capital market. As crowdfunding evolves, it is causing more, unexpected, innovations, in a type of cumulative causation whose outcome is not certain.

In another article, I used this same theory of evolutionary economics to explain the SEC delay in issuing crowdfunding regulations. In that article, I described how an incumbent species (the SEC) in an economic environment attempted to kill a new species, before it could become established.

For most of crowdfunding, it is too late for the incumbent special interests to kill crowdfunding. There was a small evolutionary window of opportunity for the SEC to kill it, but they missed their chance. As the new species became adapted to the environment, other species took advantage of the new genetic material to implement even more evolutionary change.

One such change is the completely unexpected development of an internet automated closing process for private placements, recently unveiled by FolioFn.

THE FOLIOFN PRIVATE PLACEMENT SERVICE

Before explaining why this evolutionary development is so important to the entire capital market, it is useful to describe the new process.

In the older venture capital model, the closing transaction was cumbersome and paper-based. An escrow agent held the capital, or held the promise of capital. At some point, the escrow agent delivered the capital to the company, and the securities attorney issued some form of certificates to the new investors.

Just like crowdfunding tended to move capital transactions to the internet, there was no barrier, technologically, from moving the entire closing process to the internet.

The FolioFn closing process offers different modules, or functionality, to conform to the type of offering, be it debt, equity, or certificates of revenue participation.

From the perspective of the company, the modules include:

Online automated offer creation
Offer management and document distribution
Back-end clearing
Custody and settlement services from Foliofn Investments, Inc.
Back office operations support with built-in regulatory compliance
Online accreditation, offer review, and subscription process, including verification of Accredited Investor status, if required

From the perspective of the investors, the modules offer all of the benefits of book entry for positions held in the FolioFn account. In other words, when the investor opens the online FolioFn account, they see their private securities in book entry form, just like they see their public securities.

The benefits for investors include:

Reduced costs and risks of certificates getting lost or becoming obsolete
Automatic transfer restrictions management
Omnibus street name holding at the custodian
Increased account access and convenience, flexible account funding and withdrawal options, transaction history, tax lot reporting, and monthly statements
Enhanced corporate communications and actions (e.g., proxy distribution, returns of capital)

These investor benefits will lead to the most important innovation in the private capital markets for trading private securities, that connects up to both Title One, (OnRamp to public markets), and Title Four (known as Reg. A+).

SECONDARY MARKET EXCHANGES: THE NEXT BIG THING

The new rules for public solicitation and marketing extend to the 144 A regulations, where large institutional bankers buy and sell private securities to each other. There was no good reason, technologically, to prohibit this same type of trading to occur for the smaller players.

This is where the OnRamp and Reg A+ come in for the smaller players.

Without the development of the FolioFn automated process, the private secondary market could not attain its full potential for all parts of the private capital market. Now, when an emerging growth company uses the OnRamp, or when a company that wants to raise up to $50 million with a Reg A+ offering, those securities will be sitting in a FolioFn account, after the closing process is completed.

Securities will be available for private exchanges, either between individual small investors, or as a part of a bigger block trade, effected by an institutional banker.

This will lead to increased liquidity for investors, which will, cumulatively, lead to bigger demand for more private deals, which will lead to a greater rate of technological innovation, all made possible by crowdfunding.

In other words, an innovation in one part of the capital market is likely to cause unexpected innovations in completely unrelated markets. From an evolutionary economic perspective, this will lead to much greater rates of future economic growth in economic regions that avail themselves to the possibilities.