Sen. Scott Brown: Creating A Nation of Venture Capitalists Through Crowdfunding | Hacker News Reader

Sen. Scott Brown: Creating A Nation of Venture Capitalists Through Crowdfunding

wired.com

42 pointsevo_925 comments

I am not a lawyer and have not reviewed the text of this legislation so I can't speak to the precise details, but I have agented venture capital and private equity transactions and thought I'd add a few considerations that others haven't mentioned.

One of the major problems with raising money from individuals, rather than institutional venture capital funds, relates not to these peoples' ability to make smart financial decisions, but relates to information asymmetries. When a Company is publicly-traded, a significant amount of financial information is disseminated to the public markets. Since public company businesses are relatively more stable, this historical financial information and guidance is sufficient to come to a reasonable valuation of the company (reasonable in the sense of being accurate to a factor of 2, rather than an order of magnitude like a VC deal).

When venture capitalists make an investment, they have face-to-face meetings with the entrepreneurs, and, critically, the ability to request follow on due diligence materials to their own satisfaction. If members of the general public are going to make venture capital investments, is it really reasonable for them to be able to meet the entrepreneurs face to face? ALL VCs will tell you this is of critical importance, although skeptical minds may disagree. Is it likely that companies will satisfy follow-on due diligence requests from a large number of individual investors? No, highly unlikely. Without these two critical factors, it will be difficult for individuals to realistically assess the risks and rewards of a particular company.

A second critical factor in a venture capital transaction is the negotiation between the VCs and the company. If the result of this legislation is that transactions are consummated without protections, such as liquidation preference, information rights, control provisions, that will not be a positive for the investing public. These terms are required if you are to have any hope of having good risk/reward tradeoffs.

In light of these concerns, I would think that the easiest way of protecting the public would be requiring that any particular investment round include at least a certain percentage coming from a qualified venture capital or private equity firm who would negotiate price and terms on behalf of the investors. Critically, the investing public and this person would have to get exactly the same economic deal, otherwise the whole thing breaks down. If they instead put this program in the casino and don't provide proper structure and incentives, it will be a wealth transfer just like the other casino games.

I would like to point out that I am all in favor of individuals having the opportunity to invest in these companies, in general, I just think that careful consideration needs to be given to how the market works "on the ground" in opening up any such market.

I agree their needs to be a way for a mass of small investors to "negotiate" a valuation and terms but setting up "qualified venture capital" firms as a proxy is not the way to go. Who qualifies the venture capital companies?

How about the terms are posted and a dutch auction takes place to fill the round. In a dutch auction every potential investor who bids over the price required to fill the round gets in at the lowest price.

A dutch auction can't work for some of the other reasons I mentioned. The terms in a venture capital transaction are as critical in making fund returns as the valuation, and a formal auction can only optimize one variable at a time. The terms are too complex for the average $1000 investor, really. You'd end up with investors getting burned.

I believe you already addressed your second concern. For your first concern, an individual can make an assessment of the VCs and investors already tied to the project instead of the entrepreneur.

As someone with libertarian leanings I find puff pieces like this pretty frustrating. I generally sympathize with the idea of opening up private equity markets to more participation, but I also recognize that there are reasons for these restrictions.

The Senator's article doesn't bother acknowledging why those restrictions were put there in the first place. This sort of thinking give free-market policies a bad name and leads to bad results (like the financial crisis).

Let's take this quote as an example:

"Americans are allowed to gamble unlimited amounts at casinos, and can send donations to charities halfway around the world with one tap of a trackpad. Yet, we are legally prevented from making even modest investments in job-creating small businesses."

This is a bad comparison: Casino's and charities aren't marketed as investments, so people shouldn't have the illusion they're going to get their money back.

The article would be much better if instead drawing a false analogy the Senator would have explained just how the legislation plans to vet the crowdsourcing firms to ensure they're not scams.

Personally, I support the general direction of this legislation, but I object to the pseudo-populist slant of the article. It really weakens the case for freeing up capital markets.

I like the idea, but I'm unwilling to trust it. Why were those restrictions put there in the first place?

To limit the ability of scam artists setting up sham companies and fleecing inexperienced investors. Presumably, if your net worth is pretty high, than you probably have enough financial savvy to spot these scams (although plenty of wealthy individuals manage to get fleeced).

The obvious (and fun) solution is to force these private equity markets to operate EXCLUSIVELY inside casinos. This would be the best way to get the masses to understand the realities of angel investing.

> Have you ever wished that you had somehow invested in Facebook, Twitter, or Google before those companies became billion-dollar brands, back when they were first getting started?

Replace those company names with Color, Pets.com, and Webvan.

Do you really think the public is capable of properly assessing the risk of such investments? The qualified investor regulations were put in place for a good reason. I believe there are also loopholes for domain experts who do not meet the financial qualifications, so most HN users are not actually barred from investing in startups.

So really, it's just a matter whether unqualified investors should be allowed to risk a substantial portion of their net worth on a startup. Keeping in mind that a large number of people still fall victim to Nigerian 419 email scams, I am not so sure this capability is really a benefit to society.

>Do you really think the public is capable of properly assessing the risk of such investments?

No, but now ask me if I think the government should get to tell me if I'm capable.

What I'm reading in your sentiment is that you believe that such regulation prevents the "hard sales" approach of getting people to invest wonderfully demonstrated by the junk bonds and Boiler Room movie. And I agree with you - such crap tactics are what ruins it for the rest of us.

But I also don't believe that simply barring access is the right way to go. In an environment where barriers to entry are falling everywhere, the funding aspect still remains the most difficult. A talented small group of engineers can put together solutions that rivals the best of fortune 100 companies, but those same engineers are usually not capable of marshaling the resources they need to execute, often more efficiently than their big company counterparts.

Start-ups are super risky. If people understand that, and have means to diversify, than we have a good model. To me, Kickstarter is an awesome way to crowdfund for a product or a finite project. By promising something in return, you essentially get a head start on sales revenue, and use it to fund the development.

Do these boiler room operations hurt any more people than what is going on at big banks? Bank of America tellers are only too happy to suggest that a retiree who happens to have a few thousand in the their checking account speak to the nice Merrill Lynch representative.

To be fair to big banks (this doesn't sound like me...), the boiler room operator steals all of your money and the bank doesn't. You might not get the return you're expecting but at least they won't straight up steal from you. It is different.

I understand your concerns, but much of this risk could be mitigated by using a smart platform to root out scams. Beyond this, I reject this idea that people aren't smart enough to figure out what to do with their own money. The government should not be in the business of telling people whether or not they can invest in startup, and as long as there's a smart platform on which to facilitate such transactions that stresses due diligence on the part of the investor I fail to see the problem.

Crowdfunding could spark a culture shift. Right now much of society is uninspired and doesn't think about building things or making things better because they know they have little chance of getting the funding needed to make their ideas happen.

Making crowdfunding available to the masses could inspire a culture of possibilities that leads to more ideas and hard work from people whom would normally be watching TV or playing video games.

And this cultural shift could reach beyond entrepreneurship. Joseph de Maistre said, "In a Democracy, people get the government they deserve".

Right now many of us are frustrated with the political spectacle. But the media is simply giving the public what it wants -- entertaining candidates, not the best and the brightest (http://www.quora.com/Why-are-Americans-so-fond-of-presidenti...).

In a 1996 Wired Magazine interview, Steve Jobs said:

"When you're young, you look at television and think, there's a conspiracy. The networks have conspired to dumb us down. But when you get a little older, you realize that's not true. The networks are in business to give people exactly what they want. That's a far more depressing thought. Conspiracy is optimistic! You can shoot the bastards! We can have a revolution! But the networks are really in business to give people what they want. It's the truth."

Inspiring a widespread culture of ideas could lead to a mindset where people care more about truth and the purity of ideas than entertainment. Crowdfunding could change our culture, change our values, and change the world.

Full disclosure up front: I work for IndieGoGo. I can't speak for other crowdfunding platforms, but I assume that they're similar on this topic.

A lot of people bring up the possibility of fraud with these crowdfunding sites (IndieGoGo, Kickstarter, Rockethub, etc.). While fraud is definitely a concern with crowdfunding, it turns out to be a much smaller problem than you would think.

First of all, the very nature of crowdfunding seems to act as a natural brake on fraudulent behavior. While it's easy to fool one person, most campaigns have dozens or hundreds of contributors. It's trivially easy for any of those contributors to sound the alarm (to the crowdfunding platform and other contributors) if there's anything fishy.

To reinforce this point, it's also been shown that "outside contributions" (contributions from people not personally connected to the campaign or campaign owner) generally don't happen until a campaign's received around 30% of their target amount. Social proof is really important, and it's hard to get if you're a scammer.

Secondly, we (IndieGoGo) take fraud very seriously and invest a lot of resources into preventing it. We've got several layers of automated fraud detection, as well as a couple sets of human eyes on every campaign. While we can't guarantee fraud won't happen, we make every effort to make it vanishingly small.

In a nutshell, we're working pretty damn hard to make crowdfunding a safe and trustworthy marketplace. So far, the results seem pretty positive.

As for the specifics of this legislation: No comment, other than "We're looking at it."

It will be interesting to see who ends up using this type of funding. For things like "buy a second delivery truck", i fell like getting a bank or auto loan would probably be the best method. For patent applications, I am not sure if it makes sense to announce your patent idea on a public crowdfunding website, before you have filed, in order to raise money. That seems risky. Same for startups, a lot of them are in 'stealth mode' in their early days, and I am not sure how they could convince a ton of people to give them money without disclosing sensitive information.

Seems to me, the best solution is to have a higher cap, say $10,000. That way you wouldn't need to raise money from a ton of people on a public website, but rather could tap into a group of trusted friends or acquaintances, and NDA's are probably more feasible at the level as well.

I love this trend of decentralizing everything, even VC funding.

"Should it be allowed?" is the wrong question.

A better one is "Will it work?" I'm betting the fraud on such a system would be both rampant and painfully opaque to the victims.

Wait until the lawyers get a hold of that.

Good companies would steer clear, defeating the entire effort. Send this back to the drawing board. Hint: The internet is not a requirement to ease the funding burden.

Unfortunately this bad article does not fix the problem.

One of the major aspects of the problem is the decoupling of the investors from the firm receiving the investment..Let me explain...

You see once upon a time years ago, when you invested money if it was large enough you would demand a board seat. In my town if you were a big farmer you invested in the local bank and get a board seat to help over-see that investment.

With the passage of certain laws allowing pooling of funds we get to the point where those rights are no-longer awarded thus learning how to over-see an investment for long term gains never gets passed on to someone..

In other words we a investment knowledge transmission problem not a investment problem.

Big difference!

Yikes.

The SEC certainly has its flaws, but if SEC regulations are stopping anyone from becoming more wealthy it's certainly not the small guy.

"The SEC certainly has its flaws"

Can you name any successes? Most recently the settlement they proposed with Citibank was so laughably one sided a judge threw it out.

Most people know about the Madoff case being handed to them on a silver platter and they did nothing.

Why not disband the SEC?

Interesting.

So you think that with no SEC the public will be safer from people like Madoff?

Do you think that investors would be able to make sound investment decisions without companies having any reporting requirements? Not every country in the world has such requirements and I think the SEC in that regard alone (call it a "success" if you will) is something to be commended.

It's one thing to say people at the SEC are not doing their jobs. But it's another thing to question the rationale and purpose behind the regulations. Are you doing both? Or just one?

If I'm not mistaken the senator is only doing the later.

Yes - the public would be better off with no SEC.

The agency has undergone "Regulatory Capture" and therefore does nothing to stop insiders like Madoff and hassles law abiding companies. The fact that they exist gives people a false sense of security that anything you can buy from a stock broker is not an outright fraud. Without them people would do the due diligence on their own. Any outright frauds could be handled by local police or FBI if it crosses state lines. Again, the whistle blower in the Madoff case thought he was done by sending info to the SEC; he might have gotten farther with a local DA or the FBI

So where does the investor obtain the information to perform due diligence? Are companies required to file reports? If so, with whom do they file them?

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