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Tim Berry

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What Worries Me About the Crowdfunding Initiatives

Posted: 03/ 8/2012 6:43 pm

Today we have the news that the House has passed a new bill based on crowd funding.

On first glance, it seems like a great idea: end legal restrictions on outsider investments in new startups. The current securities law limits the number of non-accredited investors in a startup to 10 at most. Beyond that, only so-called accredited investors can invest. If they lift that constraint, startups can turn to the newly open world to find investors willing to put a few dollars into their new business. That's called crowd funding. Basically, it means that instead of finding a few wealthy people to invest six figures, startups can find a few thousand to invest a thousand each.

The idea's been gaining strength. The premise is that many more people can invest smaller amounts in startups. Entrepreneurs are drooling. While there are a few advanced experiments in crowd funding at present, those are mostly for artists and creative projects (such as on kickstarter.com), and are mostly loans (such as on kiva.org). If these laws pass, if I'm understanding it right, restrictions are torn down and virtually anybody reading this post can invest a small amount (maybe a few hundred dollars, maybe a few thousand) in that slick new startup they just heard about. Scott Edward Walker has a good piece here on Huffpost in which he explains some of the details in the house bill and the two Senate bills.

Why does everybody in entrepreneurship want this? Scott quotes entrepreneur-guru Jason Calacanis, founder of 37 Signals:

[Crowdfunding] is so critical for our country right now because innovation is not limited to the folks in New York or Silicon Valley... And because people who are not millionaires should be free to spend -- or gamble -- their money however they like: be it betting on sports, playing poker, gambling on a mutual fund, speculating on gold coins or -- gasp! -- investing in startups! Anyone who has used Groupon, Farmville, Facebook, Angry Birds or LinkedIn in the first year knew they were good investments and should have been allowed to invest. Only the rich were allowed to invest. How is that fair?

Finally, there are thousands of people out of work who also have a great idea for a sustainable business who would give it a shot if they could just get their hands on $10k to try. What's the harm in letting those folks swing the bat?



I think that's a great summary of the rising sentiment in favor of crowd funding.


However, while it's fun to talk of startup investments as the bonanza of a few big winners, like Facebook and Angry Birds, for every startup winner there are several hundred thousand losers. The good news is that all of the various versions of crowd funding have some safeguards to prevent pure fraud and to limit the investment levels in proportion to annual income.  But I shudder to think of what happens when startups start soliciting on Facebook and Twitter. Is documenting risk enough? Have you read a software license agreement lately, before you clicked "I agree?" Does anybody?


Much as I love the irony of a government attempting to restrict stupidity to the rich -- delightful thought, indeed -- I hope the safeguards in the new rules actually work to protect people from stock scams.


Jason asks "what's the harm in letting those folks swing the bat?" I admit, in a society that allows lottery gambling everywhere, that maybe there's no harm in adding startup gambling, too. So what's the harm of allowing a few thousand people to lose a few thousand dollars sharks prey on dreamers?  At least the lottery gamblers know they're gambling, and the odds are posted. And to be fair, the proposals would require disclosure. If anybody reads it. After all, there are reasons for banking laws to protect depositors and food and drug laws to keep the snake oil off the shelves. There are safeguards there and I just hope they work.


And there's another potential harm here. If the new safeguards don't work, as what might have been startup money gets siphoned off into slick marketing scams and dream weavers, that's not going to help create more startups or more jobs. It's going to glut the process with sticky swamp mud, and get in the way of funding for real startups that offer real investment potential.


Believe me, I am for startups getting funded and entrepreneurship. I've been there. I've built a company to multi-million dollar sales and no debt without outside investment. I've also sought and landed outside investment, and I've been an outside investor in several startups, and I've taught entrepreneurship to college students and night-school adults. I'm certainly not arguing for the status quo. I do worry, however, that the corrections may end up making things worse, not better.

 

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