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?
- Comment (25)
- · Quote
- · UnfollowFollow (3)
- Pages:
- 1
- 2
Comments:
Sep '10
Re: What's So Bad About Crowdfunding?
Duane Oyen: 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. · 6 hours ago
I will "out" myself as the subscriber Tim quoted by Ben and let me say thanks to Ben for choosing my email out the many I'm sure he received.
Duane, I completely agree with you. This is what I meant in my email to Ben about the guild mentality these regulations represent. Investment regulations are at best the creation of do-gooders (to quote Milton Friedman) who are arrogant enough to believe it their role to regulate markets and that they actually understand them well enough to minimize risk. At worst (and I believe predominantly) investment regulations are created by the Gatekeepers who create artificial barriers in order to eliminate competition.
May '10
Re: What's So Bad About Crowdfunding?
I agree with Francis that there should be clear, understandable and true reporting with regards to what should be called an investment. The problem I see is that our own govt. ignores this transparency need and willfully distorts the investment picture. Sophisticated investors like Francis adjust accordingly, understanding (at least somewhat) the disparity.
However, if the main game is a distortion, where does one draw the line? It would appear to me the the Rubicon has either been crossed or is about to be.
Feb '11
Re: What's So Bad About Crowdfunding?
Thank you for this post Ben, I find this so fascinating and will likely be participating in Kickstart soon. Two of the biggest benefits - at the national economic level - are (1) the decreased odds of building a giant bubble, and (2) in the event a bubble does occur these investors are not "too big to fail." Rather than a large investment by one or a few 'certified investors' these ventures need to convince many small investors they are going to be successful, kind of like the competition fostered by federalism rather than everything going through one governing body (the federal government). The investments appear to be much smaller by each individual, for example the Wasteland 2 game has $2,933,252 pledged from 61,290 backers, averaging only $47.86 per backer.
May '10
Re: What's So Bad About Crowdfunding?
Every start-up has the principals maneuvering to keep control and majority benefits for themselves at the expense of the silent investors. The only difference between crowdsourcing and classic RAIN or VC investors is that the VCs and principals try to outmaneuver each other to lock up the majority control and benefits for themselves, both of them, still, at the expense of the silent investors.
As long as there are enforceable full disclosure rules requiring this stuff to be accessible by all investors or any decisions are set aside (if necessary by petition), the crowd is no worse off, and is less diluted, by eliminating the first two round of insider investment levels.
More bootstrapping needed? Probably. But you are always better off going that route anyway if you actually have anything there of value.
May '10
Re: What's So Bad About Crowdfunding?
In principle I certainly agree with Duane and Ronaldus, but as someone that works in this heavily regulated industry, I can tell you that this attitude has been built up over generations. And every time there is another scandal, Congress goes back to the well and attempts to make everything "safer." It's all well and good to say caveat emptor here, but the reality is that there are an unending number of lawsuits from investors that feel they were cheated in some way when they lose money. I don't agree with the result, but I understand the impulse. If you are going to permit crowd-funding then in fairness you should unwind a whole slew of rules intended to prevent fools from being parted with their money.
Edited on April 27, 2012 at 10:11pm