The technology that threatens to put bankers out of business

What’s the biggest threat to the City? There are plenty of candidates: tougher new European Union regulations, the chancellor’s addiction to ever higher banking levies and fines, and over-zealous regulators micro-managing every aspect of the sector’s activities in an attempt to prevent a repeat of the crash of 2008. But the greatest threat might be something that is not yet on anyone’s radar screen.

In the US it won’t be long before more money is raised for new companies from crowdfunding sites than from traditional venture-capital sources. Meanwhile, the booming industry is turning out to be a lot safer than many of its critics insist. It is effectively replacing what the City has always been there to do – raise money for investment. And if those trends continue, it is very hard to see how the mainstream corporate finance work done in the Square Mile is going to survive.

Entering the mainstream

Crowdfunding has been around for a while, but it’s only in the last 12 months that it has started to move into the mainstream. Five years ago, the total amount of crowdfunded investment in the US was less than $1bn – chicken feed in the context of the total amount of money raised by American businesses over the course of a year. But by last year that had risen to $16bn, according to research firm Massolution. In 2015 the total is likely to hit $34bn.

To put that in perspective, the venture-capital industry raises about $30bn a year in the US, and invests around $45bn once debt is added in. Traditional angel investors account for another $20bn or so of investment. Hence, on current growth rates, crowdfunding should overtake those totals by 2016, and then keep on growing. Indeed, the World Bank recently estimated that the total industry will be funding businesses to the tune of $90bn annually by 2020. That’s serious money.

British investors will be familiar with these developments. There are plenty of posters around London for companies such as Seedrs and Crowdcube that allow individuals to put cash into start-ups. That provokes the usual complaints about investor protection from the kind of people who don’t like any kind of innovation. Inevitably, there will be plenty of failures, and no doubt there will be some high-profile rip-offs as well. But then that is true of any kind of investment.

One recent academic study found that 75% of crowdfunded companies delivered on their promises to investors, although not necessarily in the time initially expected. Anyone familiar with new businesses will think that is a pretty decent hit rate.

The threat to the City

Even more interesting than the growth of crowdfunding is the potential impact on the City – and on other financial markets around the world. The core business of the City has always been raising capital for companies, and finding good quality businesses in which people who happen to have some spare cash can park their money. At the most fundamental level, that is what the capital markets exist to do, and for which banks and brokers charge lavish fees. And yet, it is hard to see that they are doing anything which a crowdfunding site can’t do just as effectively – and probably a lot more cheaply as well.

If an entrepreneur has a great idea for a new business, and needs to raise some cash to get it off the ground, then he or she can hawk their plan around the venture-capital firms. But they will be charged some heavy fees, and probably have to sign the kind of contract that even a Sicilian Mafia boss would think was a little one-sided. Alternatively, they could set out their ideas on one of the crowd-funding sites and almost certainly get the cash there instead – and at far lower cost and on far easier terms as well.

Bad news for brokers too

Start-ups simply don’t need the venture capitalists anymore. And quite soon they might not need the stockmarket either. It is still early days, but once the first generation of crowdfunded investments start to mature, investors will want to trade in and out of the shares.

Will they want to do that through the stock exchange, with its high costs, and mountain of regulations? Or will they be perfectly happy to trade the shares through the same low-cost, peer-to-peer platforms on which they raised cash in the first place? It seems a lot more likely they will simply use the websites – after all, the costs will be lower, and it is hard to believe companies that have grown used to crowdfunding will ever be willing to tolerate the complexity of a traditional listing.

The mainstream finance business is already being challenged by peer-to-peer lenders, who can do a far better job of matching up people who want to borrow and lend money. Technology companies such as Apple and Paypal are moving in on processing payments. Now the crowdfunding sites may well take over venture capital, and quite possibly buying and selling shares as well. It is very hard to see what will be left of the City after all that. Quite possibly not much at all.