Can Crowdfund Investing Bring Zombie Capital Back to Life?

Here’s a Halloween tale sure to leave you awake at night.

It’s the tale of Zombie Capital… the scourge of the American economy, sucking the very life out of the public equity markets.

(Okay, we all know zombies normally eat brains, but for the sake of the story, humor me.) So, where was I? Oh yes, Zombie Capital…those dormant dollars that lay moldering in low-yield CDs, interred in dark bank vaults across America. Oh yes, dear reader, let me tell you of the horror of cold, hard cash, still breathing but only half alive, buried deep in U.S. Treasury bonds, or listlessly languishing in the mire of bond mutual funds.

Cash that once walked Main Street USA and invested in business and commerce now lies unused, simply taking up space, stashed away in “safe havens” throughout our country. Zombie capital is the dark spawn of Americans’ loss of faith in traditional equity markets. The growing distrust among savers and investors that has been growing in the last decade has led to the accumulation of “zombie capital”–capital invested in securities with nearly zero yield. As a result, we have a growing pool of dead capital that yields nothing and does virtually nothing to awaken the U.S. economy.

Declining Trust in Equity Markets

The formation of “zombie capital” is a result of declining trust in equity markets and the evolution (or de-evolution, as the case may be) of what investors expect from companies that take their money. One look at the Chicago Booth/Kellogg School’s Financial Trust Index from May of 2012 and you’ll see that only 15 percent of Americans surveyed said they trusted US equity markets. And, with good reason–in addition to a general district of Wall Street, according to FactSet, a data provider, the estimated rate of growth in earnings per share (EPS) for the S&P 500 index in the third quarter of 2012 was -2.7 percent. a data provider, the estimated rate of growth in earnings per share (EPS) for the S&P 500 index in the third quarter of 2012 was -2.7 percent. And if those numbers aren’t scary enough for you, let me add this frightful fact: the U.S. market price earning ratio of 13.1 times is the lowest since 1985. With a rating nearly identical to that of the first quarter of 2008 (which preceded a S&P meltdown of 39 percent) it’s a sheer miracle even more of the country’s cash reserves haven’t “turned” into zombie capital.

In response to those losses in earnings and accompanying abysmal ratings, Americans are moving their money away from equity mutual funds to bond mutual funds and other “safe havens”. Recent statistics reveal assets held in equity mutual funds compared to bond mutual funds are at its lowest ratio since the mid-1990s. Scarier still, data from the Investment Company Institute’s 2012 Investment Company Fact Book revealed that between 2006 and 2011, $500 billion was withdrawn from US equity markets and re-allocated to savings accounts and other “safe” asset classes like treasury securities—which offer savers virtually no (and sometimes even negative!) yield. Currently, a 10-year Treasury note yields a pitiful 1.70 percent, while bank CD’s are offering little more than 1 percent interest (but that’s another horror tale altogether titled “The Disappearing ROI, not suitable for all audiences.) As bleak a future this paints for savers, even more horrifying is the fact this flight of capital away from equity markets will result in an overall increase in the cost of capital for US-listed businesses. So, while zombie capital simply puts savers into a state of stasis, it could become the death knell for countless businesses looking for cash to launch, grow or expand.

Could a New Financial Paradigm Save us from Zombies?

So what can a crowdfund investment policy framework do to bring zombie capital back to life?

Hard-working American dollars turn into zombie capital when they see only two options in their immediate future – be assimilated into the Borg that is Wall Street, or silently slip into a state of hibernation in “safe havens”, where the money never dies but it never helps awaken the economy, either.

Crowdfund investing (CFI) creates another option—an asset class that offers investors equity or debt securities in main street businesses and startups. Why is this important? Well, contrary to common belief, investors aren’t a completely fearless breed. If investors are putting their cash on the line by backing a new venture, they prefer to invest their money with companies they understand and can easily monitor.

This 2009 report from the MIT Sloan School says that even venture capitalists (those adventuresome souls!) often make their investment decisions based on the geographical proximity of the target company’s headquarters to their own.

Connecting the dots, the creation this new asset class that offers investors the chance to diversify easily, to invest in what they understand and often, to invest with people they personally know, is likely to breath new life into “zombie capital” This is supported by the data. Recently, an industry self-regulatory body conducted a survey of would-be crowdfund investors and when asked what the most important feature of the crowdfund investment asset class is to them, while 33% said the obvious answer of investment returns, 20% said their biggest driver was helping companies get capital where they couldn’t before, 20% said “being part of something greater than myself,” and 17% said the ability to make a difference in the life of an entrepreneur was their biggest driver.

So crowdfund investing offers an attractive investment alternative for those investors with “trust” issues regarding large, publicly listed firms and represents the beginning of a paradigm shift in the American financial system. And, as an excellent externality, crowdfund investors’ capital will be directed towards smaller enterprises, which are known to create the lion’s share of new jobs—65 percent, according to the Small Business Administration.

Make no mistake, zombie capital is not just a U.S. issue—there is unproductive capital sucking away at nearly every economy across the globe. This is money that, put back into play in the global economy, could launch innovative new companies and help to keep nations competitive in the global marketplace. This is money that could be busy increasing GDP, creating jobs and stabilizing economies. In short, this is money that could be solving real socioeconomic issues of hunger, poverty and unemployment—all while offering investors the opportunity of a real return on investment.

Realizing the value of crowdfunding as a way to offer investors an alternative to traditional equity markets, Italy has begun the work needed to legalize crowdfund investing and Columbia has taken the old community barn-raising idea to a whole new level by building skyscrapers financed through crowdfunding. Meanwhile, the chaps in the UK and blokes in Australia have had their own versions of legalized crowdfund investing in place for seven years.

Meanwhile American entrepreneurs and investors eagerly await the SEC’s much-anticipated regulations on equity and debt-based crowdfund investing after its legalization in the U.S. by the JOBS Act in April 2012.

Through crowdfunding, policy makers can bring money back to life. CFI could breathe new life into literally trillions of dormant dollars, transforming zombie capital into working capital once again for entrepreneurs, small business, and investors.

Will the SEC meet its Dec. 31st deadline and bless CFI with its regulations to redeem zombie capital and bring it back into the fold of the American economy?

Will the regulations safeguard investors but not be so onerous or burdensome to entrepreneurs and small businesses as to virtually neuter CFI and leave zombie capital to multiply unchecked while our economy burns?

Unfortunately, that, dear reader, is a chapter as yet to be written, and as much as we regret it, we must leave you with this cliffhanger.

 

 

Jason Best and Sherwood Neiss led the U.S. fight to legalize debt and equity based crowdfunding. They work with governments, NGO’s, investment funds and family offices to help them develop crowdfund investment strategies — as part of a comprehensive early stage investment strategy—to increase overall deal flow. Jason serves as an Entrepreneur-in-Residence at the Center for Entrepreneurship and Technology at UC Berkeley, where they author some of the newest data on crowdfunding available. Best and Neiss co-authored “Crowdfund Investing for Dummies” and founded Crowdfund Capital Advisors , where they provide strategy and technology services to those seeking to benefit from crowdfund investing and the JOBS Act.

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