How the Global Stock Market Selloff Will Affect Crowdfunding

Crowdfunding has been celebrated as the grand democratization of finance -- a mechanism for anyone with a business idea to raise money from their peers, outside the bureaucracy and nepotism of more traditional fundraising paths. But while this “of the people, for the people, by the people” approach to raising money may see itself as divorced from anything happening on Wall Street, that’s hardly the case.

On Monday, the Dow Jones Industrial Average ended the day down 588 points after opening with a terrifying 1,000-point plunge. In the last five days, the major U.S. indexes have lost more than 9 percent of their value as global-growth concerns roil the markets. That’s the kind of volatility that should worry investors of all stripes.

It’s also just the beginning, according to Anindya Ghose, professor of IT and marketing at NYU’s Stern School of Business. Ghose says recent stock market volatility is indicative of a bear market that is likely to last about three years. “I am pretty confident this is the beginning of a much needed correction,” he says. The Dow had been steadily climbing since February of 2009.

For entrepreneurs looking to raise money on sites like Kickstarter or Indiegogo, the volatility could result in fewer or smaller donations. After all, watching the Dow dive off a cliff doesn’t do much for consumer nerves. And investing in the next creative, neat gadget on Kickstarter falls into the category of discretionary spending that is first to go when a person is feeling anxious about his financial life.

Related: Déjà Vu 2012: A Zombie-Frankenstein JOBS Act 2.0 Is in the Works

“People are four times more likely to react negatively to 1,000-point drop in the stock market than 1,000-point gain and that psychology and mentality is going to spread across the markets,” says Ghose.

Kickstarter declined to comment for this story.

An even more immediate concern, perhaps, is in equity-based crowdfunding, where investors put down cash in exchange for a portion of a company. Currently, to participate in equity crowdfunding, an investor has to be “accredited,” meaning that he or she meets certain wealth requirements. These investments are much larger than the $25-for-a-tote-bag donations that populate Kickstarter.

“If we think about the equity crowdfunding market -- so people investing in startups or small businesses -- what may happen if the market continues to go down is, of course, that there will be less liquidity available and so less investment,” says Christian Catalini, assistant professor of technological innovation and entrepreneurship at MIT's Sloan School of Management.

Unlike Ghose, however, Catalini is much less certain that this recent turbulence on Wall Street is indicative of any larger trend just yet. “It is too early to say if this is a situation that will deteriorate or get worse or if the market will be able to correct itself,” he says.

Related: 7 Secrets From the Man Who Turned a Kickstarter Flop Into the Most Successful Campaign Ever

Some investors may see a prolonged downturn as an opportunity to double down on their investment in startups. In a three-year bear market, an accredited investor may determine that investing in startups has the potential to pay off more quickly than investing in stocks. As Ghose explains, investors may determine that investing $1 million across 10 startups might make more sense than investing $1 million in stocks during a bear market.

“For some, it will make more sense to invest in the stock market, but for some it will actually make more sense to invest in startups,” he says.

To be sure, equity crowdfunding only attracts a sliver of the population to begin with: only 3 to 3.5 percent of the 8.5 million accredited investors in the U.S. put any of their money in startups, according to Ghose.

It’s no surprise that crowdfunding platforms see the recent stock market volatility as a good time to promote the benefits of crowdfunding. Rory Eakin, co-founder of the online equity-crowdfunding platform CircleUp, says that the consumer-products startups his platform features are safe bets compared to volatile stocks and tech startups. “We believe a correction in prices in the public market will push investors to quality companies and sectors with proven business models and rational valuations.”

Meanwhile, Slava Rubin, co-founder of the donation-based platform Indiegogo, says that continued turmoil in the markets could make it harder for entrepreneurs to get access to capital in more traditional ways, pushing them toward crowdfunding.

Related: What's to Prevent Someone From Ripping Off Your Crowdfunding Campaign? Not Much.