08/14/2013 06:24 pm ET Updated Oct 14, 2013

Crowdfunding's Slippery Slope

Something has gone very right and very wrong with crowdfunding. By now we're all familiar with it -- the open platform that solicits contributions or tiny investments from the 99 percent to fund creative projects, philanthropic endeavors, R&D and your band's music video. Most people agree that it has been a boon -- another solution to the lack of credit in our economy -- but it's also treading some disturbing waters.

First, some context. In 2012, crowdfunding raised $2.7 billion and that's expected to practically double this year to $5.1 billion, according to Massolution. That's about a quarter of what the U.S. venture capital industry raises annually. Impressive when you consider that V.C. goes back to the late '50s where modern crowdfunding is a product of the grunge era. It's clearly on its way to becoming a serious capital source if it can avoid some of the headwinds and headaches which presented themselves over the last year.

The Crowdfunding No-No

Let's start with what has gone very wrong with crowdfunding. On one side of the Chinese wall, is the do-gooder, old fashioned patronage side of crowdsourcing; the side that gets all the press. By now, we all know someone who's used Kickstater, Indiegogo or RocketHub. In May, Zach Braff, star of the NBC sitcom Scrubs, raised $3.1 million to fund a follow-up to his indie film, Garden State. Rob Thomas raised $2 million in one day for a film version of his Veronica Mars. Then there was James Franco who wanted half a million dollars for a series of small feature films (he raised $328,329).

What's also being raised are some serious ethical issues. The notion of highly paid actors soliciting money from working people to fund their pet projects. Even The New York Times' ethicist got involved. While I agree that there is nothing in their pitch that violates Aristotelian ethics or the tenets of the law, it is a gross misappropriation of public goodwill. The problem is really twofold. Firstly, celebrities have an unfair advantage, skewing the meritocratic equation that has sustained patronage for the arts for centuries. The idea that the most innovative, moving, challenging, pleasing artists deserve to be supported is upended by the warped impulses of fans who are motivated not by merit or virtue but by the compulsion of celebrity worship. The best analogy to crowdfunding like this is microcredit. There, legions of good-hearted people band together to provide the seed money for low-income people to launch small, informal businesses. It is a grand idea and one propelled by its graciousness -- we get nothing back except the karmic value of having helped someone who was deserving and had few other options. What would we think about serial entrepreneurs or Internet highflyers usurping the microcredit space to launch their businesses? Wouldn't it suck the oxygen out of the room and leave the grain farmer or village tailor stranded? That is essentially what is happening with crowdfunding.

Artists since the dawn of time have practiced great sacrifice to create and promote their work. It is part of the artistic creed and the idea of insulating oneself and parsimoniously guarding your cash by leveraging the money of common people is, while not illegal, shabby and vulgar. One wonders why Mr. Franco, who, after all, slammed Braff for using his celebrity to raise funds and is reportedly worth around $20 million, couldn't have self-funded his project. I've done it, as have many of my friends and colleagues who understand that bootstrapping is what you do to support your art and your passion. For all its claims to be philanthropic, Mr. Franco's campaign is ultimately in service of promoting his own book of short stories. Clearly, we are a long ways away from the original intent of artistic benefaction -- like Nadezhda van Meck who allowed Tchaikovsky to give up law so we would have the time to write music; or John H. Johnston, a Manhattan jewelry store owner, who gave the financially troubled Walt Whitman a place to stay when he needed it. It's no wonder that a flurry of stars have invited derision for their campaigns.

It's Getting Better All The Time

Now to what has gone very right. The concept of crowdfunding has now entered the realm of big business. In real estate, sites like Realty Mogul, Collaperty, Globerex and iFunding offer investors the chance to participate in individual properties or portfolios. Prodigy Network, for example, has kicked in $172 million to build the tallest building in Colombia. For real estate, it provides a new capital source at a time when the bond market is still rebuilding; when the banks are requiring more equity; and narrowing to Class A deals in primary markets like New York, San Francisco and D.C.; and when the pension funds and life insurance companies are seeking only the creamiest investments. Crowdfunding is essentially an extension of the underlying concepts of REITs and Tenancy-in-Common funds -- both innovations that allowed the people on the street to be a part of the real estate boom of the 1990s and early 2000s. Investment or equity-based crowdfunding won respect within the JOBS Act passed by Congress in April of 2012 and now the SEC should open the door fully in the fall with a legal framework and regulations.