Tech Startup Crowdfunding Isn’t All It’s Cracked Up to Be
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That, and a few other arguments, here as well: https://news.ycombinator.com/item?id=10481136
A $3,000 computer purchased today will depreciate to zero in 3~4 years, leaving you with hopefully some happy memories and a paperweight. Three $1k crowdfunding investments may do likewise. Do we distinguish them because they don't guarantee the paperweight?
I get the social purpose of e.g. preventing boiler room operations from extracting "investments" by retirees into businesses which are not actual businesses, but for businesses which are actual businesses which just happen to have 90% failure rates, "Distribute the risk among a group of people guaranteed to be at least middle class; and cap it at a figure lower than what they could reasonably spend on e.g. a wedding dress" seems to capture most of the social benefits of outlawing outright scams while also not outlawing middle class people from owning startup shares other than those they receive as compensation for services rendered.
To expand on this analogy - gambling is legal because, as a society, we've decided that the upside of "entertainment value" outweighs the downside of "unsophisticated 'investors' (gamblers) may lose more money than they can afford to." If this is the case, it seems obvious to me that we should also accept crowdfunding, which has exactly the same downside, but infinitely more valuable upsides: normal investors get more opportunities for investment and businesses get access to more capital.
Securities regulations should protect investors from shady businesses doing illegal things, not from themselves.
Gambling is legal in only a tiny handful of places and in the few places where more casinos have recently been authorized, NY state (my state) included, it has been a hugely controversial decision. In NY State, the rationale was certainly not that gamblers benefitted, but that the added tourist attraction of creating casinos in depressed communities will boost the local economy. I think this was a patently bad decision and I'm certain that history will bear me out, that the local economies will not suddenly prosperous and quite to the contrary, all of the low grade crime associated with risk seekers, substance abusers and the profligate will now infect these communities as well.
The whole reason we have the SEC in the first place is to protect the credulous from the sharks.
I don't anticipate this type of crowdfunding taking off, quite honestly, and I don't know that this is a problem. We want the middle classes putting their assets in places safer than just betting them on papa's mustache in the third - which is what unsophisticated startup investing basically is. Except there is a much greater chance that a random horse picked with a dartboard is going to have a return than a random startup will.
Similarly, GNC can sell all sorts of useless nutritional supplements, but the FDA is all up in the business of anyone trying to sell a new medication.
Reminder: you can take money from non-accredited investors; it's just so complicated that it's not practical to do so at scale and with strangers.
Relatedly, I had the idea to sell small shares of (legit, regulated) far-out-of-the-money options as lottery tickets. As investment products, they're legal, but work like lottery tickets in that you have a tiny chance of winning big (e.g. if the underlying security has a sudden, sharp shift in price).
My understanding is that it's only legal if investors approach you, or if you solicit individual investors on a one-by-one basis. It's illegal to simply announce that you're publicly accepting investment. I wholeheartedly agree that the marketing of these types of offerings need to be tightly regulated, but as it stands today, it's effectively impossible to participate (as an investor) without having a personal connection to the business.
Many of the games at a casino are required by law to payout at a certain rate, though.
As someone else pointed out - the SEC should be protecting investors/general public from unethical and illegal acts by the businesses, not from themselves and their own lack of knowledge. If you don't know what you're doing, you probably shouldn't be investing in the first place. Put your money in an ETF/savings account and only gamble what you're willing to lose in the equity crowdfunding market.
It's a good point, though. "Normal" people should be protected against themselves in their financial decisions.
My desktop contains many parts manufactured more than four years ago and it is still useful. In fact, it no longer matters how many dollars of value you think it is worth, it is still effective, consuming only electricity and my time.
Your thesis is incorrect.
Perhaps the "crowd" model would allow the creation of smaller, lower-growth companies that could dominate a niche or region, and generate long-term dividend returns for investors rather than immediate capital gains. It could fill the space between debt and growth equity for companies that have ambitions beyond the lifestyle small business, but no potential to be breakout hits. Is there already a name for this kind of funding?
Barber shops and restaurants tend not to do this - they follow low-risk, low-reward paths. One reason for this is how they are funded - a bank giving a business loan for a restaurant might want to see a conservative plan to make one restaurant profitable within a few months of opening, to maximize the likelihood that their loan is repaid.
If there was a VC backed restaurant with equity financing, they might instead try to grow rapidly to a thousand locations to try to displace/disrupt McDonalds, all while losing money for several years, in the hope that they end up a multi-billion dollar chain. Obviously this is much more likely to fail and be worth nothing.
By adding a new form of funding that sits between a business loan and a VC equity deal, the hope is that you also create a new space of business plans that are more aggressive than the single-restaurant with debt plan but less aggressive than the "try to take on McDonalds" plan.
Only if you invest in startups they way you play craps. The statistical distribution of outcomes is not predictive of the chances of a particular startup succeeding or failing. Some founding teams are virtually guaranteed to fail; some have a better than even chance to succeed. If you are willing to give up on the unicorns you can also eliminate most of the duds. Valley VCs are not willing to do that.
Venture capital firms aren't competing for "unicorns" simply out of vanity. They need to bet on firms with outsized returns because even in a cohort of pedigreed startups with plausible business plans and some degree of traction, most are going to fail.
Many of those failures are capable of generating reasonable incomes for employees and founders for years, but those incomes are not proxies for investment returns. That's another reason crowdfunding is dangerous: we have a skewed idea of "success", because to us, starting a company that lets us control our own destiny, build our resume, and earn a competitive salary for 10 years is a huge success. To a crowdfunding investor, the returns to investors are the only thing that matters.
That's part of my point. The current VC model causes failures of businesses that are viable going concerns, but not growing fast enough. They know they can make more overall by pushing a subset of those business to explode at the cost of killing most of the others. This also allows them to increase the velocity of their investments, further pressuring their startups to grow or fail fast. Their "cohort of pedigreed startups with plausible business plans and some degree of traction" should yield enough moderate successes to make investment profitable, as long as they are willing to play the long game.
Also, those incomes become proxies for investment returns once the company is stable enough to start paying distributions to its owners. Again, though, that ties up capital for the long term, which is anathema to the current VC crowd.
There is in fact very little value of a "going concern" to outside investors. These "going concerns" are successes for people directly involved, but are not successes for investors. Consider that distributions are the normal way partners and LLC members get paid, and also a huge source of lawsuits, because when management is just a small fraction of ownership, their incentives are to minimize distributions.
You will find few people on HN more pro-boostrap and anti-VC than me. My last company bootstrapped and ran 10+ years. We're bootstrapping this one. I agree with everything Pinboard says about investment versus funding from customer revenue.
But those arguments only have merit as long as you aren't taking outside money to build the business. As soon as you take outside money, your business plan must make sense to the investors.
Would locking in dividends in the business plan allow the investors to become "directly involved" and make investment in a "going concern but not a unicorn" a rational choice for an investor?
> I haven't heard a rationale for equity crowdfunding
> that makes sense to me.
(edit: Crowdfunding seems to me like an attempt to allow "retail" investors to participate in pre-IPO investments.)
The main reason I'm skeptical of this approach is that I think the most promising companies won't do it, so the pool of companies doing equity crowdfunding will be low quality
Maybe the interest rates are lower on these for borrowers because the cost of due diligence isn't included. Not maybe, actually.
For example, a person that has applied for a patent - no VC would call that a startup, but perhaps those with intimate knowledge of what the patent will lead to may indeed call that a startup.
Another example are "stealth startups" - we explicitly refer to them as startups yet many are merely patents with maybe a partially working prototype but no product yet.
There are instances where both of those examples are combined (sole inventor + operating in stealth). Just because the entity doesn't fit the profile of "startup" for VC's doesn't mean there isn't room for that type of "startup investing".
But for vast majority of people, I don't think they should be going in more than $1-5k per company.
If congress wants to bring small non-accredited investors into the private markets and increase access to capital for small companies, there needs to be mechanisms in place to do it as a pool vehicle that invests in one or more underlying companies managed by a platform because companies don't want to disclose IP, not deal with a lot of small investors.
Moreover, the regulatory, compliance, and accounting overhead single investor needs to be very low (sub $100). Any broker-dealer model will carry a significant tax unless the SEC/FINRA lighten the regulatory burden for broker-dealers (which is very high).
Software startups disclose their IP whether through traditional IP protection (copyrights, trademarks, patents) - or open source. Those relying on trade secrets do not disclose their IP to investors.
Equity crowdfunding is... very risky business. This is where mom and pop can get involved. If professional investors routinely lose out of the majority of their investments, Joe Everyman is in for a ride. But should he be protected? The first line of investment are usually the 3 F's -- family, friends, and fools. By making these type of investments more networked and liquid (particularly the fools part), more startups could raise capital at the expense of fools. I guess we saw that didn't work out too well about a decade-and-a-half ago, because there will always be more swindlers than legitimate entrepreneurs.
Yes, of course. When you can't get the "smart" money, you try to go public or raise money from someone who won't or can't be involved with the actual business, right? The highest quality funding comes with expertise and guidance and is more than just a check.
There's not the same amount of visibility and accountability in startups as with companies on a publicly traded exchange.
Someone will lose their shirt, sue, and set precendent for how startups should now behave with unsophisticated investors.
The SEC, responsible for creating the rules designed to fulfill Congress’s mandate in Title III of the JOBS Act, included rules—known collectively as the 12g rule—that are a powerful disincentive for high-growth startups to use what the SEC calls “regulated crowdfunding.”
These rules stipulate that any company that takes on more than 500 individual investors or grows to a size greater than $25 million in assets must start filing regular disclosures just like a publicly traded company. It is all the pain of an IPO without the benefits of the IPO."