Crowdfunding – same wine different bottle?

We had an article recently about crowdfunding.

It made me think about the whole area of investment, in terms of social media, globalisation (link to Globalisation the world turned upside down), etc.

Imagine, if you will, to 18th Century London.

You’re a merchant venturer, with your argosies plying the waves to far Cathay. You’ve raised the seed money from a number of investors.

Perhaps you’ve gone to your friends, family or religious group, perhaps to one of the banks to raise the money.

Of course, these type of “bankers” are the descendents of the Italian traders who would provide loans at their “banca”, a type of table.

At the banca, you would perhaps have given a share in the venture, in return for the loan.  You would probably share the profits, if any, with your friends, family, group etc. if they put up the money.

Someone might have insisted, or recommended that you take out insurance against the loss.

You might think that a good idea, after all, you don’t want to have to pay a pound of flesh if your argosies sink.

So you go along to Mr. Lloyd’s coffee house, where you know that a number of merchants who, rather than chance their own ventures, will effectively gamble on yours.

You describe the quality of your ships, their captains etc. and they give you a price to guarantee your cargo, the ship etc.  One person may not be prepared to take all the risk, so several may sign the insurance slip, writing their name under the risk described (so you call them underwriters).

And most of this would be done personally, among people you knew or would come to know, in the social atmosphere of a tavern, a coffee house or over a “banca” in the street.

But it’s laborious raising large amounts of cash that way.  You can’t do much if you’ve got to have the gold to back every investment, every insurance.  After all, if the insurers underwrite 10 ships, it’s unlikely that all 10 will go down, so they’ll win on some and lose on others and as long as they get their sums right, they’ll win.  And if you, as the merchant, have several ships out there, don’t pay too much interest on the money borrowed, don’t pay too much for insurance and the bottom doesn’t fall out of the Chinese spice market just at the wrong time, you’ll have made profits, but you may wait two years to get them.

So you borrow against the bigger profits to come, and to use multiples of the gold that you actually have, rather than limit yourself.

That requires other mechanisms.  You have to have sophisticated banking techniques to allow you to use money more effectively, more sophisticated insurance arrangements, more ways to raise finance.

You don’t want to be limited in your investments, so if you have some spare cash, it makes sense to invest it straight away.  You don’t want all your eggs in one basket, so it is handy to spread the investment around, by putting money into other people’s ventures as well.

By chance, a friend has the opportunity in part of the trade in gold from South America.  As a friend, he lets you put up 10% of the money for a 10% share.

But then you hear of another venture, to bring tobacco from Virginia, but you don’t know anybody inside that deal.

Great, they are selling “shares” in the venture.  So you go to buy some “shares”, but unlike Lloyds, and the banks etc. there isn’t a ready market in these shares.

But fortunately there is a market developing – it’s called the “stock exchange” because you can exchange stock (the working capital of the companies).

Unfortunately, some companies lose, and one of your merchant friends goes bankrupt.  He loses his house, his fine carriage, his country estate, everything.

You and your other friends get together and decide that the logical thing is to have a company to run ventures where the liability you have is limited to the amount you put in, your “share”, and you can’t lose your whole wealth.

And you, and your friends, start paying regular payments to your “shareholders”, because you are running lots of enterprises now and it makes more sense to pay out regular amounts than pay a big dividend when a ship arrives home and you can sell the cargo.

The Government get in on this, and start offering to borrow your spare money, which will allow them to finance wars.  As they are the Government, you know they can pay you back, so they won’t pay as big a “dividend” as your and your friends businesses, since there is less risk in these Government bonds (which have a gilt edge to them).

By now the system is far more complex.

You have bankers lending at different rates depending on their perception of the risk, and limited liability, and yield gaps (and then reverse yield gaps), and the more rules and ways to develop funding we wanted, the more complicated it got.

We now have stock markets, an OTC market, options, short-selling, hedges etc.

But every step of the way, each complication seemed like a good idea at the time and made sense to deal with a perceived problem.

And now we’ve got peer to peer and crowdfunding.

We have funding appeals on social media, rather than going round to your family or religious group to get interest free loans,

We now go on social media and crowdfunding sites instead of to Lloyds coffee house or Lombard Street to meet potential investors etc.

We have limited liability, but we also now have rules about “unsophisticated investors” who might be able to claim from the Directors of the company if it goes wrong.

Basically, we’re starting over again.

I suspect that is because shares, instead of being an investment in a promising company, which, if it worked would pay you a dividend as a reward for your faith in them and the risk you took, have now become an intellectual exercise in “are income stocks better than growth, what is the P/E ratio compared to the sector average” etc.

It’s the human ability to take something that is a good concept, overcomplicate it, make it unwieldy and expensive in the process of trying to improve it, and then have to start again.

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  • Anonymous

    Excellent Kim. May I give you my “take” on this?
    It happens to us all; at certain points in our lives we need to approach our bank probably to buy a significant purchase. It is almost a ritual as we are faced with those
    controlling the money we need. We are asked about our life-style, previous
    lending history (even though this is usually on file), our ability to repay over a certain period of time and our employment prospects into the future (which nowadays is rather like looking into a crystal ball for many).

    But don’t worry – all this may soon be a thing of the past, at least according to one new company in a certain country I will not name. Their model will not involve the
    agonies of going to the bank and suffering all the anguish of an interrogation.
    No, their model is much simpler (?) and merely involves giving them a list of
    names (and maybe other personal details) of your “friends” on ‘FaceBook’,
    ‘Twitter’, ‘LinkedIn’ and even ‘eBay’.

    They have the programs that will then review the credit-worthiness of these “friends” and based on their findings you get the financing (or not). The assumption is that if
    your “friends” are credit-worthy it is more than likely that you will be since people with similar tastes and habits tend to be cohesive in this respect.

    I said above ‘don’t worry’. This was deliberately misleading since in my opinion I find it almost disgusting that a company somewhere can dig through the private lives of
    other people in order to evaluate my financial standing and to me it does not add up, as well as being a gross intrusion on both my privacy and theirs. There are too many assumptions built into this approach; what if one of the “friends” through no fault of their own has missed a repayment (perhaps through a long-term illness) and has been ‘downgraded’; does this mean that I would be similarly?  Or, conversely, if my
    “friends” have high level of credit-worthiness it does not automatically follow that I am the same.

    Basically, I find the whole concept alarming and extremely worrying, and this is one reason for my NOT having anything to do with any ‘social networking’ sites – my
    privacy is sacrosanct and will remain so.

    In a few words – include me out!