From the Chinese government’s crackdown on Ant Financial beginning late last year to U.S. banking agencies’ recent rumbling they will take a closer look at banks’ outsourcing business partners, heightened scrutiny is coming to financial technology companies, which style themselves as “fintechs.”

“Fintech” has positive connotations—innovative, sleek, deserving of lofty stock valuations and, most of all, is not to be confused with stodgy, outmoded and financially lackluster banking institutions. This perceptual map is now coded into investors’ outlook. Anything with “tech” in its name is worth a gander. That is where the game is. Bill Gates, Peter Theil, Elon Musk and others are our Michaelangelos, and now our Medicis.

Contrary indicators surface occasionally. The 2008 banking crisis occurred because bankers, lawyers and accountants were too clever by half. Without fancy algorithms to slice and dice subprime mortgage loan portfolios, they could never have wrought the havoc they did. Facebook, now Meta, has been revealed to serve mammon at least as well as God. And PayPal founder Peter Thiel has made it his mission to repeal New York Times v. Sullivan,[1] having failed to enlist fellow billionaires to help him create a man-made island cum tax haven in the Pacific Ocean, where he planned to rule wealthy residents’ lives using software algorithms as a substitute for civil laws.

Crowdfunding is a fintech innovation that still wears a halo. Championed as a Woodstock-like festival of neighborly capitalism, it uses the Internet to connect borrowers with lenders, and entrepreneurs needing equity with people willing to provide it. Unlike platforms such as LendingClub and Prosper, which make no claim of altruistic purpose, crowdfunding’s promoters cloak their offerings in populist rhetoric.

Congress in 2012 included crowdfunding in the JOBS Act. The SEC finalized Regulation CF in 2016, laying down crowdfunding rules of the road. Based on five years of data, crowdfunding’s most ardent adopters reside in metropolitan New York City, California and Texas. The table below shows activity in Ohio and Pennsylvania.[2] No Regulation CF offerings have been made in West Virginia. In the tri-state region, Pittsburgh has the highest number of offerings, while Philadelphia and Cleveland rank 1 and 2, respectively, in the amount of funds raised.

Hospitality (e.g., restaurants, microbreweries) and personal service businesses (e.g., hair salons) predominate when it comes to types of crowdfunded enterprises. Although the SEC raised the maximum amount of a crowdfunding offering to $5 million from $1 million, most campaigns raise modest amounts, $824 on average.[3] For campaigns that reach their goal, the average amount rises to $28,656.[4]

Crowdfunding serves a useful purpose; but it is a niche play only, enabling entrepreneurs to attract funding from a wider universe of people than immediate family and close friends. More capital-intensive businesses and non-consumer-oriented ones continue to be better served by Regulation D offerings. These offerings require more effort, cost more, and are made to “accredited investors”—those with a personal net worth greater than $1 million or annual income greater than $200,000 ($300,000 for couples) for the last two years and the expectation of earning at that level in the current year.

Mirroring practices followed in IPOs and Reg D offerings, crowdfunding platform operators profess to have conducted due diligence on the entrepreneurs they sponsor. Investment risks though are relegated to fine print on crowdfunding websites. No oversize, bold type disclosures here, as in Regulation Z truth-in-lending bank loan documents. Nor is any disclosure typically made about (i) whether platform sponsors have any funds invested in the businesses they sponsor and, if so, whether they stand to get their money back before crowdfunders do, (ii) the one, three and five year survival rates for businesses that source capital through the platform, (iii) the high failure rates generally of restaurants, microbreweries and other business types that gravitate to crowdfunding, or (iv) the reality that what are sold as high yield loans will become illiquid equity investments if the businesses do not succeed as planned.

Crowdfunding remains a work in progress. The inherent limitations of using social networks of middle-income individuals are the best protection against fraud, if not business failure and consequent loss of principal. In a former time, community bankers, ward politicians and even clergy served as intermediaries between people needing capital and those who had it to invest. If capital providers and users approach crowdfunding as an economic utility, rather than as manna from heaven, then all can help one another prosper. Realism is the key ingredient.

[1] 376 U.S. 254 (1964). The case held that a newspaper or other media outlet did not libel a “public figure” unless the statement made was known to be false or was made with reckless disregard for its truth or falsity. PayPal co-founder Peter Thiel funded WWE star Hulk Hogan’s Florida lawsuit against website Gawker, which was bankrupted by the judgment Hogan won at trial. Public figures including Justice Clarence Thomas and ex-President Donald Trump have called for the U.S. Supreme Court to reverse its decision in the Sullivan case.

[2] https://www.crowdfundinsider.com/wp-content/uploads/2020/09/Regulation-Crowdfunding-by-Congressional-District.pdf

[3] https://www.fundera.com/resources/crowdfunding-statistics

[4] https://thecrowdspace.com/how-much-can-you-raise-through-crowdfunding