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.
Follow Tim Berry on Twitter: www.twitter.com/Timberry
There are huge differences between boiler-room scam artists and crowdfunded entrepreneurs: Boiler-room scammers operate hidden in the dark, in secret and private, whereas there is little privacy and fewer secrets on the Internet (WikiLeaks?). Even Nigerian email scams were outed so quickly they became the world's first viral jokes. Boiler-room scammers are NOT the actual company - but brokers. Crowdfunding is about investing directly in a company - not in some third-party. Finally, scam artists reach out and prey on victims who are uninvolved and unengaged. Crowdfunding is unique in that people actively log on and engage with companies, founders and each other. People are *looking* for companies to share their enthusiasm (and money). They are investing not just for an ROI, but to be involved emotionally and intellectually with something exciting and with a lot of potential.
Wait for the day when a new company is a huge success, and 'everyday' investors complain because they were DENIED their chance to invest because of antiquated securities laws: Laws that were invented when we had more out-houses than automobiles.
Equity crowdfunding is a new concept (like social networks once were); the objections are to be expected. The new generation will prevail, however, perhaps before the laws catch up.
Incidentally - when the House and Senate were holding hearings on the bills, while I noticed all the "broker" organizations objecting to the bills under the guise of protecting the public (since when were these guys concerned about the public: ) ... but - not ONE investor who had been scammed or disappointed by Crowdfunding had been produced (and Crowdfunding had existed in the US in one form or another for 10 years), Not one.
While "restricting stupidity to the rich" is a hilarious thought, the current system of crowdfunding-through-donations is giving entrepreneurs a free ride to riches without any recourse to checks and balances.
When in history has so much money been given to so few commercial hopefuls without any payback or comeback? At least with shareholders and equity-based crowdfunding, there is some modicum of reporting, communicating and due diligence taking place.
If I were an entrepreneur today, I would definitely prefer to launch my business through donations-based crowdfunding, then match-fund it from traditional sources for the 2nd tranche of development. It's a no-brainer!
That way, when I the investor, have to show how much I bring to the table, I can claim the entire amount raised through donations-based crowdfunding is actually mine, all mine, muhahaha!
My contention is that today's donations-based investors are getting ripped off. It's a bonanza for the entrepreneur to try and raise $15k and receive almost $1m (vis. Kickstarter and LunaTik) and they still report to nobody.
Donations-based investors are getting short-changed with merely a 'feel good' social return on their investment. Start-up companies can take that ‘feel-good’ to the bank and declare the bar is open and the drinks are on me!
This is assuming that the same is not true with big investors in the current stock market. I believe the tech bubble in the 90s is good evidence that the "few big winners and lots of losers" dynamic exists regardless of how it is funded.
In the real world, though, an idea not executed has no only potential value at best, if that. The value comes from execution. Which means hard work, risking more money than what you've already spent, building a company, developing a product, getting it built, and distributed. When you say "I have done all the work," no investor I've ever met would want to look at it. Unless you have a company built and a product manufactured and shipping, and revenue, then no, you haven't begun to do all the work. All that takes time, money, effort, and experience. Either do it yourself or respect the people who could help you.
Under the present rules, you could get investment by convincing accredited investors your deal will give them a fair return on investment, which you're not doing. When you get other people's money under the new crowdfunding idea, if you do, how will they ever get their money back? Who's going to execute? What if nobody ever does? How much do you care about rewarding and respecting the risk that others take?
Americans are waking up to realize that Barrier to Enrty Laws prevent Competition.
When will many of them realize that the Groups that get Barrier to Enrty Laws passed and funded by the large Corporations ? Like most Enviormental Groups. Sure they do a few good things but the also get Corpotations Billions in Tax Write Offs in return for a $150,000 donation.