Crowdfunding, as an instrument for the non-sophisticated investor (II)

This financing mechanism is modeled after a stock exchange. Why, then, regulate something so similar to an exchange in a different way—redundantly—than an exchange itself?

The regulation of these platforms is justified because they would allow a low-cost method of raising capital from the public. Substantively, it seeks to foster entrepreneurship. Legally, it seeks to prevent this type of issuance from falling within the regulatory perimeter of stock exchanges.

It is also justified to break down the barrier between a qualified or institutional (sophisticated) investor and the retail (non-sophisticated) investor. The aim is for minority investors to have, as far as possible, the same opportunities as sophisticated investors.

Countries that aspire to build great civilizations need to feed on ideas, innovations, and execute them. It is, or should be, a matter of public interest. The problem is usually economic, since platforms that aim to showcase these companies are scarce, most likely because of the risks they represent.

Thus, collective financing platforms (PFCs) attempt, for early-stage companies, to raise modest amounts, with lower legal, regulatory, and registration (enrollment) costs.

Traditional securities laws require shares, bonds, or any other security to be registered in certain registries. This is a necessary requirement in order to offer these assets to the public. But such registration is in no way a substantive examination of the company, such as a valuation or analysis of its commercial prospects. Financial law is based on “formal information,” leaving everything else to freedom of contract. The objective, instead, is that the future issuer provide full and clear disclosure of risks, benefits, and all other material information. Then, once enrolled, the rules require that this information be provided on a continuous basis. This obligation is never extinguished, postponed, conditioned, or subject to any modality, notwithstanding legal exceptions.

Over time, these registration requirements in traditional markets have become truly demanding. The request for information requires companies to provide it or even to create it. This, in turn, demands reforms within companies. It even reaches the extreme of studying changes in business models (think of oil companies in the ESG era).

Today, the evidence clearly shows how costly this process is in traditional markets, especially due to the fees of the many professionals involved. This is why companies no longer consider it a preferred option.

PFCs are not exempt from these types of obligations; they are simply minimized and, most importantly, the platform itself is bound, which in turn obliges the issuer to inform it. It is not that the regulator does not intervene, but rather that it does—having the PFC as the obligated party, and not the issuer directly. This allows for centralization and rationalization of the flow of information, and thus the initial and ongoing obligations become less costly for issuers compared to exchanges.

Put simply: an initial public offering in traditional markets is not designed for ventures seeking five hundred thousand dollars. PFCs are. At least they provide a realistic path. Moreover, failing in a PFC has fewer consequences than failing to raise funds in a traditional market.

Now, to make it completely clear: this does not mean that the value of capital decreases. In fact, given the type of risk, capital should be more expensive than in traditional markets. What changes here, instead, is the value—the price—of raising capital.

Obviously, traditional markets have not stood still, as can be seen in the options of the U.S. Securities and Exchange Commission with “Regulation D” (bearing in mind that the current SEC chairman, Paul Atkins, seeks to simplify barriers to entry into traditional markets today), or in Chile with Title XXXIX on the “simplified regime for debt securities” (or CMF General Rule No. 457). But these alternatives are usually pathways for those already in the traditional market. They are variables followed by some companies (Mid or Large cap), but they still do not cover nascent firms.

In the traditional market, there are two variables that raise the costs we have been referring to: compliance with securities regulations and promotion of the offering. In the first case, requirements can cover more than 30 areas with their respective pieces of information (e.g., CMF General Rule No. 30 in Chile). Each piece demands full commitment and great effort. It is extremely meticulous. And so it continues forward, from registration, especially in accounting matters. It is unfeasible for small companies.

The second variable, promotion (road show), becomes necessary if one wants to see results from enrollment expenses. It is necessary to organize highly attractive offerings if one wishes to catch the eye of investors.

Finally, what underlies here is that registering an issuance in the traditional market does not take into account whether the issuance is for one thousand dollars or one hundred million dollars. It is a fixed cost that everyone must bear.

It should also be noted that PFCs do not require an intermediary to operate in order to acquire the offered assets. The platform and the investor suffice. This eliminates significant friction, further reducing costs.

We also mention that these platforms seek to open new opportunities for retail investors. Private capital, including venture capital, has been reserved for high‑net‑worth investors. They are the ones who take advantage of the best opportunities, buying companies cheaply that will one day be worth high prices (where the retail investor will likely invest, once the company is already mature, at a high price, often through pension fund capitalization).

Whether offered through a private placement, via private equity, exempt from registering as a public offering, or simply through the “3Fs,” connections are necessary to access these types of early‑stage investments. PFCs aim to open up the investment landscape, leaving that behind.

Many startups fail, and many companies financed through crowdfunding will surely meet that fate. Returns may be much worse than in the stock market or elsewhere, but it seems fair to give everyone—not just the wealthy and well‑connected—the freedom to take risks and invest in what they hope will be the next Tesla.

PFCs are a public policy that seeks precisely not to treat startups as securities issuers; and, likewise, to treat retail investors as individuals capable of making investment and risk decisions.

Retail investors are not in a structurally different position from other investors (sophisticated or not). Many sophisticated investors lack bargaining power (think of Chilean funds or family offices facing giants like those in the S&P 500 or intermediaries of its components), just like retail investors. Moreover, all investors, absolutely all of them, depend on the information provided by the issuer, whether in the traditional market or in PFCs—this is not unique to retail investors. And, considering behavioral economics, it is clear that each person has incentives, shortcomings, and virtues that condition their decisions. The financial market, whether in the stock exchange or in a PFC, is materially quite even in terms of the information analyzed by investors. There are no general or structural justifications to separate one group, except for rare exceptions. In other words, the general rule is that everyone can participate in the markets, which is the structural basis of the market, save for limited exceptions.

That is why it is not possible to wish for investors to be tutored, as consumers are. Such a claim goes exactly against what PFCs intend to create.

Investors. They are fully aware of their status as investors, not consumers. The Fintech Law is based on financial law and therefore seeks that investors act on the basis of formal information and in accordance with personal responsibility. It simply recognizes human agency.

In financial markets it is assumed—indeed, regulation itself takes this as a given—that information asymmetry exists. Here that asymmetry is a market failure, but it is also the very justification for financial markets. By trading freely we discover prices, making mistakes and successes, and this is the only way to reach correction. Asymmetry disappears in that trading process, where some invest in one direction while others in the opposite. And it is in that process that we finally reduce information asymmetry to its minimum expression, or even to complete symmetry. By this path we arrive at the correct price, which excludes asymmetry. But for this, there is no better formula than all investors deciding freely, without any tutelage. That is how the market, and with it regulation, ends asymmetry.

When we suggest that consumer law could be applied to the above—which precisely avoids the search for prices and equilibria—what we are really doing is eliminating the essence of the financial market.

For all these reasons it is necessary, for example, to reject the possibility of withdrawal rights, additional information duties, or special contractual conditions (OTC). In PFCs there is no place for distinctions among investors. We are all equal, whether sophisticated or retail. It is an opportunity for everyone to achieve, through a new investment channel, their life projects.