What's So Bad About Crowdfunding?
On Monday in our normal Coffee & Markets podcast - which you can listen to here - my colleague Wall Street veteran Francis Cianfrocca made a strong case against the crowdfunding elements of the JOBS Act. It surprised me, and the conversation got pretty heated. We had dozens of emails from listeners after the show, with the vast majority disagreeing with Francis. So we followed up with another episode this morning on the topic, sharing some of their emails.
The chief disagreement was a philosophical one about the role of government and the regulatory state which brings out my more libertarian impulses. Should the American people be barred from participating in crowdfunding/Kickstarter projects as anything more than, essentially, locked in pre-orders of a product? What great social ill is prevented by barring these small businesses and projects from offering equity?
Here's one email I received from Transom subscriber Tim, a small businessman who relies overwhelmingly on seed capital from family and friends:
“Francis argued the Federal government should regulate crowdfunding based on the need to "save" the rubes (as you call them) from themselves in making bad investments and losing their money. I assume this is meant to prevent some sort of bubble in the economy. My question for Francis is if indeed the Federal government should exercise this power what is preventing it from regulating private citizens investing their own money (and/or family members’ money) in their own private small businesses? Francis and others might discount this as silly comparison but why is it? It is the logical extension, the inevitable slippery slope, of the stated motivation of regulating crowdfunding. Many Americans start small businesses that they have little or knowledge about, like restaurants, or they have knowledge about a product or service but have no idea about running a business day-day. What is preventing the Federal government from requiring that anyone starting a new business must have a certain amount of money in reserve, beyond the necessary startup capital, in order to save the unwashed masses and their families financial disaster when the business fails? In the end this seems to be the typical guild mentality, something Walter Russell Mead writes about often. Create artificial barriers that at best are meant to minimize risk and competition.”
The impression Francis seems to hold is that there are 10,000 rubes ready to be fleeced by someone who sells them the next Google – while my impression is that this is rather small groups of people looking to put small investments in products they want to exist, where the top-line success perhaps looks like the next Crocs-like creation.
While I understand the critique that this could preclude institutional investment later on, the fact is that there are very few options for projects of this size to turn to for early-stage funding, and being cash poor can preclude hitting the right window with your idea. As venture capital has moved up the chain to deal in bigger figures, the crowdfunding aspect here is designed to foster new startups chasing down interesting ideas. Given the limitations of the law, I just don’t see the prospects of a crowdfunding bubble as particularly real or particularly dire.
What’s more, the motivation is in part fueled by perspective from the American layperson that deal creators and plugged-in investors do nothing but scratch their friends’ backs, barring the common man from the game until after the biggest pie has already been divvied up. And that's hardly an element of democratic capitalism I would support. What about you?
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Dec '10
Re: What's So Bad About Crowdfunding?
One effect of expanded crowd funding will be more independent feature films. A lot of people will be happy to put up for a piece of what might be the next Blair Witch Project, especially if they know that on the downside they will at least get a DVD of the movie.
Nov '11
Re: What's So Bad About Crowdfunding?
By all means, let's regulate this economic avenue out of existence.
I love the notion of crowdfunding. You know, old habits die hard. I should know better (especially since Chuck Schumer is my US senator) that whenever people use their freedom in a novel and creative way, there will always be some nanny ready to regulate it out of existence.
Oct '11
Re: What's So Bad About Crowdfunding?
Federal regulation of crowdfunding is a horrible idea.
Nov '11
Re: What's So Bad About Crowdfunding?
I'd agree if you changed the word "crowdfunding" to "anything."
No federal regulator is going to be able, at the speed government moves relative to the economy, to ever keep up. It's stupid to even try.
Edited on April 26, 2012 at 6:31pmJul '11
Re: What's So Bad About Crowdfunding?
I guess it depends on which crowd. Clearly this group needs some brains to help them.
Aug '10
Re: What's So Bad About Crowdfunding?
Ben Domenech:
While I understand the critique that this could preclude institutional investment later on,
Proper response: so what? Institutional investment is not a necessary component of any enterprise; it is just one option.
Let the entrepreneur decide where he gets his funding. If he wants a business model that encourages crowd sourcing, venture capital, angel funding, private investment, or institutional investment... how is it the fed's business to force his choice in one direction?
Small business ventures are vastly dissimilar from each other. They are not one-size-fits-all entities. There is no "one great route" to success. Unless crowdsourcing involves some element of fraud--which could be easily handled by existing fraud statutes--there is no benefit either to business or to consumers/micro-investors in regulating it.
Oct '10
Re: What's So Bad About Crowdfunding?
Bernie Madoff. Webvan. Just because you're a 'qualified investor' or a Sand Hill Road genius doesn't mean you can't be dumb.
Regular folks understand stuff. Water is wet. Fire is hot. The value of your shares may plummet as well as fall. Keep the government out of the way.
Mar '11
Re: What's So Bad About Crowdfunding?
What is the diffrence between this and giving money to Church other than I expect to get money or a product under one and pay less (amoung other things) on the other. So it is only when I actually am getting something from my money I need to be saved from myself.
So how about we first regulate how much money I am allowed to give to the goverment in order to save me from supporting bad investments by govermental bodies for thing I am curretnly promised but best case will get a fraction of what I am promised but most likely nothing (Social Security ect.). After that maybe I might be willing to listen to saving me from poorly spending less than 1% of my income on a "bad" investment" via kickstart.
Edited on April 27, 2012 at 2:33pmMar '11
Re: What's So Bad About Crowdfunding?
Ben, I listen to C&M everyday. Love it, and keep it up.
I thought Francis' hostility to the very notion of crowdfunding was, well, weird. I don't quite get it. Crowdfunding, though faddish, is one of those ideas that will do some good while not replacing the current paradigm. What's wrong with another bullet in your bandoleer? I'm all for new and innovative ways of funding outside of the death-lock that banks and VC outfits have on startups and businesses. I'm just wary of ... dunh dunh dunhhhh!... the government getting too involved.
Jan '11
Re: What's So Bad About Crowdfunding?
You know what was awful? The Gutenberg press. If government had regulated printing we wouldn't have all this dissension and disagreement 500 years later. The little people are just too stupid to be entrusted with sacred texts, or any texts for that matter...
While I lean towards the unregulated side, the only argument that Francis provided which gave me pause was the average ratio of success in startup investments. Was it 7 out of 10 fail, 2 break even, and 1 is a fantastic success? Maybe if people knew the chances of success were so slim, they'd look to crowdfunding less as an investment.
That was a very interesting podcast.
Dec '10
Re: What's So Bad About Crowdfunding?
I am pretty sure this is an ideal crowd for crowdfunding, say, a zombie movie. Especially if their $100 apiece comes with a walk-on role as a zombie.
See, these folks have the time, inclination and spending money to put into a hobby, and have expertise about that hobby. So a crowdfunding opportunity that plays directly to their hobby is a very good fit between them and the entrepreneur.
Dec '10
Re: What's So Bad About Crowdfunding?
A person who might not be a suitable investment candidate for a $10,000 traditional investment -- who might need protection against blue sky promises that fleece him out of his ten grand -- may be well able to put up ten $100 investments in smaller crowdsourced opportunities and take advantage of reduced portfolio risk (depending on how much true diversity there is in his ten picks).
Mar '11
Re: What's So Bad About Crowdfunding?
Is there really substantial opposition to crowdfunding? The JOBS Act was passed by the Senate by 73-26 and signed by Obama.
Oct '10
Re: What's So Bad About Crowdfunding?
How would crowd funding work in practice? I've used something similar for an open-source project, but non-profit activities don't seem the same to me (for one thing, you don't have to worry about making and delivering future profits).
Dec '10
Re: What's So Bad About Crowdfunding?
I've crowd funded projects in the past (though it wasn't called that then), in the form of pre-selling the product I'd developed in order to raise the capital to actually build it.
You just have to be up front with people that there is always risk involved. All my customer knew up front that as soon as they paid, their money was gone, spent on raw materials and tooling, so that there could be no refunds.
They signed on the dotted line, paid their money, and then I built the products and delivered them. Everybody wins.
Usually I'd gather a list of interested parties and when I had enough to pay for the batch to be made, I'd send out the letters and collect the payments.
One time I had a project go sideways because an outside supplier of indispensable parts (an electronic control board mfg) went belly up without filling my order (they took my money though).
That put everything in a huge bind, and that project went off the rails bigtime because of it.
Continued . . .
Dec '10
Re: What's So Bad About Crowdfunding?
Eventually, I was able to find a new supplier and retrofit their board into the product, but the timeline was blown all to hell. Think years late, not months.
Since they knew that no refunds could be had, the customers that wanted out started to sell their spots in the pre-order line like stocks or bonds to other people who were willing to wait.
Toward the end, I think that many of the guys who pre-ordered that one thought they just weren't going to get anything for their money, because it had taken so long.
They were mightily surprised when their stuff finally showed up. Not exactly as promised (because of the change in board mfg, some things worked differently than I'd originally planned), and certainly not on time, but at least they got something for their money.
I, on the other hand, totally lost my shirt in the deal. Since I got to buy the control boards twice (and the interface boards three times), I ended up losing money, not to mention how much time and energy the project consumed.
I have never been more happy to be done with something in my life.
Continued . . .
May '10
Re: What's So Bad About Crowdfunding?
One of the most irritating situations I've ever encountered is the "accredited investor" rules of the 1934 and follow-on securities laws. We face financial risk all over the place- all the current rules do is save the goodies for the rich and connected people.
Disclosure rules, fine. Even ceilings on investment levels in some cases, no borrowing to invest. But otherwise, go to it- and if the second round VCs don't like the dilution factors, screw 'em.
Dec '10
Re: What's So Bad About Crowdfunding?
All my previous attempts at crowd funding had been for stuff I could do totally "in house", where the only responsible party was me.
That worked fine, because I could depend on me to do what I told me I was going to do.
Not so much with the outside vendors.
Lesson learned (the hard way, of course).
Now I don't crowd fund anything I can't 100% control the outcome on, because I will not be party to a repeat of my previous debacle.
I still have to draw from my customer base for capital, but I'm just a lot more careful about how I do it and for what projects I do it.
None of this would be necessary if the bankers would lend money, but around here, they'll only lend you money if you can prove that you don't need it.
C'est la vie.
Apr '11
Re: What's So Bad About Crowdfunding?
I had lunch today with a wealth manager whose firm primarily manages money for clients with net worth of between 1 and 15 MM. His clients have a great deal of money sitting on the sidelines waiting for a good opportunity to invest.
Crowd funding eases the barriers to investing and will likely increase investment. This would be good for the economy.
However, if like the penny stocks of the 80's and 90's, crowd funding becomes a pit of fraud and misrepresentation, it will fade away and likely result in giving micro investing a bad name.
I do not want heavy handed federal over site, because that will kill this market. But with the poor track record of prosecutions on big fraud, I am not sure much will happen to those who commit fraud on a small scale.
I share Francis Cianfrocca's concern, but not his prescription.
May '10
Re: What's So Bad About Crowdfunding?
Ben, Coffee and Markets and the Transom continue to be my must-have morning news fix. Thank you and keep up the good work.