Public Policy Benefits of a Crowdfunding Enhanced P3 Model
Public Policy Benefits of Crowdfunding Investment in Public-Private Partnerships for Infrastructure Development By Brian Ross, MSE, MBA, LEED AP
Increasingly investors are seeking investment opportunities that provide a financial return in addition to a social return. The desire to impact society through investment has historically been done through the voice/exit framework where investors either remove certain offending stocks from their portfolio, or try to influence companies through shareholder activism. While this framework is effective at reducing negative externalities (violence, gambling, alcohol, pollution, etc.) without sacrificing financial returns, it does not promote positive social externalities (job creation, education, health, community development, financial equality, etc.). This paper seeks to outline an investment strategy that yields positive financial and social returns through crowdfunding private investment in public infrastructure.
Crowdfunding, the sourcing of small amounts of funds from a large group of individuals, has become increasingly popular for raising donations to a cause, program, or business venture. While donation based platforms are the most prevalent crowdfunding schemes, the recent 2012 JOBS Act changed the restrictions on public offerings of securities allowing for crowdfunding equity and debt investment in new ventures. While the SEC is still finalizing rulemaking on how crowdfunding to un-accredited investors will be implemented, there has been an explosion in crowdfunding platforms offering crowdfunded investment opportunities to accredited investors. Through 2013, over $5 billion had been invested globally through crowdfunding (See appendix A); and Deloitte estimates that accredited investors will invest over $3 billion in US investment crowdfunding opportunities in 2014.
The Need for Investment in Infrastructure
The American Society of civil engineers estimates that, given current public investment rates, there will be a $1.6 trillion gap in infrastructure investment by 2020. That equates to $202 billion annually that needs to be invested above what is currently planned through traditional public investment (see appendix B). This lack of investment in public infrastructure results in deteriorating roads, bridges, schools & hospitals creating a drag on GDP and an overall reduction in the quality of life for Americans. Abroad, the lack of investment is even more critical where underdeveloped infrastructure leads to political instability, pollution and unsanitary living conditions. Furthermore, recent studies on infrastructure spending indicate that every one dollar spend on infrastructure creates over three dollars in GDP growth. Unfortunately, the public agencies that traditionally funded public infrastructure projects don’t have the funds or political will to make the needed investment in basic infrastructure. Increasingly, public agencies are turning to partnerships with private developers to finance, design, build, operate & maintain needed infrastructure assets (see appendix C). So called Public-Private Partnerships (P3’s) are essentially development projects that use private equity and debt investment to finance construction while revenues from long-term user fees are used to pay for operations and pay back investors. Investment in P3’s has historically been limited to institutional investors such as private development companies, pension funds, insurance companies and PE firms; with virtually no direct investment by the public.
Benefits of Crowdfunding for Infrastructure
So, given that investors are increasingly seeking socially impactful investments, that investment in infrastructure can yield financial as well as social returns, and that crowdfunding direct individual investment in P3’s is allowed by recent changes in securities law, what are the public policy benefits of crowdfunding individual investment in P3’s? Crowdfunding investment in infrastructure P3’s creates positive social impact by increasing investment in assets critical to social development, democratizing the infrastructure investment allocation process, reducing the cost of capital associated with privately financed infrastructure, providing access for retail investors to investment opportunities previously limited to institutional investors, and adding resiliency to the broader economic system.
The primary benefit of crowdfunding investment in P3’s is the democratization of capital. Instead of the P3 development process being limited to closed door negotiations between public agencies and private developers, the public is involved through their financial investment. This benefits the developer and public agency by introducing more market forces into negotiations, lowering capital costs, adding social proof, and providing project due-diligence from the crowd. The investor also benefits from personal engagement with the development of their community, low-cost portfolio diversification, crow sourced investment due-diligence, and an ongoing voice in operations of the asset.
For private developers, crowdfunding offers access to a new source of funds by attracting retail investors to their offerings through online crowdfunding platforms regulated by the SEC. Private developer’s also benefit from raising funds through crowdfunding at a lower cost of capital due to technology efficiencies and lower return demanded compared to traditional institutional investors. A lower return is justified by the lack of pursuit risk taken on by the crowd investors. Most importantly, because P3 developers are often perceived as generating super-normal returns for “Wall Street” and foreign companies, the developer is able to garner greater community and political support for the project by offering investment to the general public.
For public agencies, crowdfunding for P3’s provides social proof and reduces the risk of political opposition and community opposition during operations. Having public investment also increases P3 transparency, a major issue with past P3 projects, by ensuring funding terms are market-driven instead of traditional negotiations marked by information asymmetries and exclusivity. Post financial close transparency is increased as well because investors are provided ongoing disclosures and shareholder voice (although investors may not have voting rights as limited partners).
The public agency also benefits financially from the lower cost of capital which typically dictates the level of user fees or availability payments to the Private developer. Also, keeping investment local puts money into the community and drives economic growth along with the new infrastructure asset. The high returns that otherwise would have gone to institutional investors flow back to the “crowd” reducing income inequality. Long-term, crowdfunded capital could become significant enough to replace institutional investment for some projects, providing funding diversification to public agencies.
For investors, crowdfunded investment in P3’s provides access to a new asset class that was previously limited to institutional investors. Direct equity investment in infrastructure typically yields returns in the range of 9-11% for retail equity investors (see appendix D), and can often be tax advantaged, making it a very attractive security. In addition to competitive returns, investment in infrastructure adds diversity to investor portfolios with long-term, stable cash flows that have low correlation with the broader equities market. Currently, retail investors are limited to investing in infrastructure through listed funds that charge high management fees and do not provide the true portfolio benefits of direct investment.
The investor also benefits from the service provided by online funding platforms. In addition to the curating of projects posted on a crowdfunding platform, investors are typically provided educational resources, analytical tools, and customer support to help them understand the assets and make the right investment decisions. The investor also benefits from being able to quickly compare investment opportunities and see due diligence questions posted by other investors. After an investment has been made, the platform acts as a tool for investors to manage their interaction with the project, voice operational input, and receive on-going disclosures related to finances, construction and operations.
In addition to the competitive, diverse, stable, long-term and un-correlated returns that infrastructure investing provides, investors get a sense of engagement and contribution to societal development. Because the investment opportunities are direct investments in specific assets, investors get to choose individual projects that they care about in their community or in a region they want to support. This emotional connection engages individuals with their community and fosters a sense of ownership.
There are also theoretical advantages of equity and debt crowdfunding for economic systems in general. By expanding the concentration of wealth from traditional financial services to inter-connected crowdfunding networks, future financial shocks may be mitigated. Rates and prices on crowdfunding platforms vary according to public demand rather than the estimate of a few financial experts. As mentioned above, crowdfunding allows for funding diversification across source and geography, reducing funding risk, spreading value among a broader base of investors, and avoiding credit shortages. Also, crowdfunding allows for disruptive and innovative P3 projects to access funding that would not have been available through traditional sources.
Overall, crowdfunded investment in public infrastructure provides an opportunity for individual investors to create tangible benefit to society, generate healthy financial returns, and engage in an investment strategy that promotes global economic resiliency.