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Tim Rowe

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The Wisdom of the Crowd

Posted: 03/20/2012 10:39 am

Congress is expected to pass a bill, supported by the president, that would open the door for everyday Americans to invest in each others' businesses. Unfettered investment by everyday citizens in everyday small businesses has not been legal for nearly a century. The culprit: well-meaning concerns about fraud. Yet in 2012 society has new answers. It's time to return to a world in which we can help each other get to work. This new law will substantially increase business and job growth in ways we can only begin to imagine.

After the dark days of boiler-room stock scams of a century ago, a great deal of red tape was wrapped around us all to prevent fraud. This meant, in practice, that ordinary individuals could not invest in each others' new businesses. "Unsophisticated" investors were simply considered too gullible to be allowed to take this risk. We have come to accept this as normal. Money for new businesses must come, we thought, from rich people: angel investors, venture capitalists and the like. Today's laws literally define rich people, referred to as "accredited investors" -- whom they assume to be sophisticated, and open this door only to them.

Yet local businesses have a hard time attracting the attention of these rich, professional investors who are mostly seeking the next Facebook. If you are a local entrepreneur it is more likely your social network -- friends, neighbors, church and school acquaintances and the like -- will be be the ones willing to take a risk to see you succeed. These people aren't stupid. But they are willing to risk their money -- a $100 here, a $1000 there -- for the joy of helping you succeed.

I recently saw how all this plays out. Some entrepreneurs in my innovation center had a quintessential "light-bulb" experience. A friend had been hurt in a bike accident after his light was stolen. They came up with the idea to make a bike light that would be hard to steal. They went on a website called Kickstarter, and asked individuals to give them $50 to help them start their company, Gotham Bicycle Defense. In return they promised to send each "investor" a light if it worked out. A few days later 1,000 people had answered the call. They were amazed at the warm response from the bicycle community. This netted them $50,000 -- more than three times what they thought they needed to launch the business, and they are off to the races.

As a society, we need more such new companies. Data from the Kauffman Foundation shows that over the past several decades new companies have been the source of all the net jobs created in the US. Existing companies, 5 years old and older, collectively lost jobs.

But what about the fraud problem? Websites, like eBay, have shown that it is possible for strangers to transact across a continent and not have it end in the tears. Indeed, prototypes of crowdfunding websites exist, and show that fraud the "sunshine" of the Internet does indeed weed out fraud. Crowd-lending site Prosper.com, accredited investor crowdfunding site AngelList, and UK-based true crowdfunding site CrowdCube have all gone on record with their fraud statistics to-date. The fraud percentage so far? 0.0% in each case. Nobody expects fraud to be eliminated, any more than it has been for credit cards. But early data says that the benefits far outweigh the costs.

Today the Senate will vote this legislation as part of the JOBS Bill. It has already passed in the House. Entrepreneurs across the country are crossing their fingers in anticipation.

 

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