The right way to get money from large numbers of people is to sell them your product, like Inpulse did, not to sell them your stock.
But isn't investment about spreading risk? The more risk you spread, the less founders would have to a) give up in ownership and b) answer to anyone but their own vision.
I think the reason why kiva (and even prosper) works is that risk is spread widely to individuals with common vested interest and enough skin in the game to make it sting but not be completely in-shambles devastating; as opposed to rich people trusting a richer VC to make them foo% return and putting it all in Color.
"The right way to get money from large numbers of people is to sell them your product, like Inpulse did, not to sell them your stock."
What if the product isn't one? What if it's a service like Facebook or (gasp!) Instagram? If you believe in a vision, and you want to contribute to it monetarily -- perhaps even see a return on that money -- why is that bad?
I have had the freedom to do that with my own websites. In spite of audience interest which led to their creation, they have dismal traffic, are not profitable, and have helped only a paltry few people. Having that kind of "fuck you" decision making autonomy was critical to my ability to get well when doctors claim it cannot be done but it has not been a good basis for a business model. I am currently working on getting feedback to change that. It is clear to me I need more connection, not less, to make a viable business model. Yes, I am leery of the type of connection which can be strangulating but I am also leery of being so autonomous as to be isolated.
I remember someone posting here with an anonymous account who expressed similar concerns because he had $400,000 in savings and was thus free to pursue his vision to his heart's content. He worried he would go broke before he got his act together and created a solid business model simply because he didn't have to before that. "Duke Nukem Forever" comes to mind as well.
The idea of crowdfunding a startup to "spread risk" focuses on the wrong reason for raising money. You also do not give up less ownership just because you spread the risk farther. You would give us less ownership for equal funding if your backers are more naive, maybe (this assumes that we are not talking about experienced investors calculating the right price for a round and valuing it based on competing internal theories - reasonable considering the average knowledge level of the likely crowdfunders), but that would not serve your company in the best way.
Spreading risk is only one factor. It's like selling a car and only factoring in fuel efficiency and ignoring safety. Having a larger number of people, and this is important, with a megaphone that are like minded that can cause you trouble would be hard to control. While you could say that companies now have a large number of investors (stock owners) and they have little control, they also aren't the age group using the megaphone of the internet to amplify their voice.
Something like Kiva might work for a startup, but perhaps more in a donation bootstrap sense. Not as a serious investment.
That said, isn't "crowdfunding" your startup the same as charging $9/month for a service they need -- except in advance, before there is a service?
This is in contrast to Kickstarter is crowdfunding where you pre-order the product.
My first impression of Kickstarter was "Cool, I get to buy this and support the first batch being built and get a product", not "I am a shareholder and get a product".
The fact that I was some kind of shareholder came as a total surprise to me, and didn't seem to make sense. I was helping kickstart a project by buying one of the first batch, like a group buy, instead of getting the company off the ground.
That's the example pg gave about InPulse. And hell it worked great.
http://www.kickstarter.com/projects/597507018/pebble-e-paper...
If there was a beta available, all the better.
Either way, the customer knows exactly what they're getting into.
I'm not saying he's wrong, but as a matter of principle, people should take his position with at least a grain of salt.
Same with VCs who are opposed to incubators like YC (in favor of VCs).
Here's a conversation which will never happen:
"Hey, YC company! This is Bob at Endowment Management at Harvard. I've decided to forget my 20 year career in finance while simultaneously hopping straight over our trusted partners at KP and ask you directly about our investment. As you'll recall, we dropped a whole Benjamin on that software whatsamahoozit of yours, and we want to know you're working hard on protecting our investment. It shouldn't have cookies, or crackers, or whatever the trace your Facebooks on the Googles thing the WSJ was talking about this morning. You should probably give me your cell phone number so I can call at odd hours with spurious requests. By the way I hear Steve at Stanford says you're a dick for not answering your phone -- not cool! Steve paid 20 perfectly good dollars for your stock, you OWE it to him to take his questions."
Which means that the investment professionals aren't loose canons and they've been around the block and understand what their role is. Publicly at least they don't operate like that.
Who says that it has to be large numbers. In kickstarter they are $1 pledges and $1000, $5000 pledges.
You could have thousands of people around the world hear your pitch and decide investing on you.
"and having inexperienced investors is bad"
Who says that they have to be inexperienced. Do you really believe that the people in Bay Area is the smartest and only experienced people in the world?. Maybe they are the smartest and more experienced in USA, but the world is bigger than USA.
Who says that startups could not decide who they let invest on them?. (investors also pitching their selves). And pick experienced ones?.
Crowfunding is not only about large numbers of people, but also about removing frontiers.
Even if they are inexperienced, Paul, Did you were born knowing it all? People could learn like you did.
This generally goes beyond just knowing that there's a risk involved but also understanding the risk profile and where the risk comes from and any liabilities and responsibilities that might come with the investment and being able to afford the downside risk involved as well (for example, if you buy a cross currency interest rate swap you might find that extreme FX moves blow the position out of the water and leave you on the hook for far larger payments than anticipated).
Experienced in this sense doesn't really mean that you've done it before, it means something far closer to "can read and understand the whole prospectus and afford to lose the money".
Under traditional methods of capitalization you don't want a large number of investors because each investor is another person that you need to clear important business decisions with (for example if you wanted to raise another round of funding). In this system you can almost view an investor as a partner in your venture.
However there is no need to carry this over to the crowdfunding domain. It can be quite easy to reserve a class of shares with the typical rights that traditional investors would require while creating a new class of shares (with much more limited shareholders' rights) to be distributed to crowdfunding investors.
I think if the product requires a crowd to complete a sale, it might make sense to crowdfund. What if those game developers on Kickstarter had tried to directly sell their games for $50 today with no working product for two years later without any proof that the game was funded and could exist. People would rightly call it a scam.
The legal mechanics of relating kickstarter-style funding to a share issue would add cost and complexity.
If a prospective company thinks it has a case for kickstarter-style crowd funding, it should probably make that case... on kickstarter.
Fact 2) If you need to sell Stock (crowdfunding or not) it is that you product needs a few month to deliver.
--> strategy 1(sell product) is not versus stategy 2 (sell equity). Not, those two strategies answer different needs.
Thierry
I will speculate that crowd source funding is more likely to generate headlines for dissatisfied investors from the middle class than for successful ones. The economics of startup investing require a sufficient pool of capital to:
1. Have access to quality opportunities. 2. Sufficiently capitalize each opportunity. 3. Invest in a large number of opportunities so as to increase the odds of hitting a homerun.
Few people have that much money. And crowdsourcing will attract both people with little inhibition toward spending other people's money and investors without the knowledge or resources or inclination to conduct due diligence.
To put it another way, real investors have a track record already. They don't need crowdsourcing.
A large number of naive investors as partners increases the risk of an investment.
It's the reason that professional investors tend to put together deals with other investors they have previously worked with. It's the reason they form groups.
As I've said, crowdsourcing will attract dumb money. Smart money will tend to prefer not to become legally entangled with it. People with lower inhibitions will enjoy a feeding frenzy.
Don't misunderstand me. There will be widely trumpeted crowd source success stories.
It just won't change the fact that most people will lose their investments - heck that's even the rule for smart money investing in startups.
Seems like a "curated fund" where organizations like YC pick the companies and crowdsource funds would be one of the better applications of the new legal permissions (the potential "worse applications" being boiler rooms pushing hot new photo sharing startups to midwestern pensioners).
However, it's not like YC and other funds are hurting for cash so what's the incentive for PG to need to crowdsource funds in tiny amounts like this when they have plenty of institutional funding? The limits are 2,000 investors and $10k/investor for a max of $20m of crowdsourced funding per company (assuming every investor makes $100k+ and maxes out on one company which would be stupid).
It'd be like Scrooge McDuck stepping outside his money bin to pick up pennies off the street.
I'm very interested to see how established VC firms react to JOBS Act. It's not like startups are finding it difficult to get funding right now, so doesn't this just create a subprime market for companies that the big players have no interest in? Coupled with the lifting of advertising restrictions and the appeal to amateur investors, this seems like the potential makings of the next big bubble...
OT, but that's a pretty bad example, because he does do exactly that. A lot.
The JOBS Act prohibits intermediaries from offering investment advice or recommendations on investments.
See Section 304.b
Dot-com bubble, real-estate flipping, tulip mania...
Hence, there will be large amounts of advertising aimed at encouraging the mass population to put money into risky investments that the mass population (seeing Instagram/Facebook/etc) think will make them rich beyond their wildest dreams.
Historically, this does not end well.
Could you expand?
Add the 1930s crash to that.
advertising securities to the general population isn't guaranteed disaster.
We saw this with the policies the Bush Administration adopted to further encourage an ownership society via home ownership as well as ongoing incentives to own a house. We also saw that the changes to Glass–Steagall contributed to the economic meltdown.
I'm not arguing that we are or aren't in a bubble, but instead the legislative changes are common leading up to a bubble. Some would argue that the house bubble has been building via legislative change since the 1950s.
However, it's not true that Glass-Steagall contributed to the economic crisis. If anything, it served to mitigate the problem. I think the argument here [1] is pretty slam-dunk:
<quote>
The 1933 Glass-Steagal Act [] prohibited commercial banks from owning investment banks ...
Just look at which organization’s have failed:
* Bear Stearns was an investment bank before it was sold to JP Morgan Chase (which includes a commercial bank).
* Fannie Mae were Freddie Mac were government sponsored entities before the government bought them.
* Lehman Brothers was an investment bank before it want bankrupt.
* Merrill Lynch was an investment bank befor it was sold to Bank of America (which is a commercial bank).
* AIG is an insurance company with no commercial banking division.
Remember, Glass-Steagal was passed to protect commercial banks from failure by forbidding them from investment bank practices like trading in securities and underwriting stocks and bonds. As you can see above non of the failed institutions are commercial banks that got in trouble through risky investment banking. Instead, it is the commercial banks that are providing some stability to the system by purchasing troubled investment banks.
</quote>
[1] http://blog.heritage.org/2008/09/22/the-glass-steagall-myth/
I'd like to think that VC's and the judges at YC have quite a lot of experience knowing who to pick, what characteristics to focus on, among other things. I also think money is one of the least important factors into joining YC, as what's more important is the mentoring, along with the network you become a part of. Finally, PG and the other mentors have put their name behind YC, but when you start to allow in companies that win popularity contests, you diminish the brand.
I do like the idea, and it's why I've helped people build websites that can do this (although I need to wait for the JOBS act to finish its evaluation by the SEC), and I've also signed up for Wefunder, a site dedicated for stuff like this. I just don't think this is a good fit for an incubator with the prestige of YCombinator.
Obviously, I would want the crowd sourced company to be a part of YC. The mentoring and the contacts are what make their companies successful.
But all that work takes energy and costs money, so we (the HN community) has to assume the risk. PG could structure it so that YC gets a stake in the company we fund. YC puts in the energy and the mentoring, and in exchange gets a stake. We put in the money and assume most of the risk.
Its a low-risk way to fund another applicant. I say low risk because there still are risks, namely that having more investors spells trouble and there are legal costs associated with us. But that's not a hurdle, merely part of the equation into how the profit would be distributed.
As it stands, it's exceptionally hard to buy the startup market. The closest thing we have to an Index fund is Ron Conway, and he's not selling shares of himself. This is a huge missed opportunity.
HNWIs and institutions have varied and limited access to deals, and are constrained in the number of investments they can make. This exacerbates the problem that early-stage angel investing has sickening variance unless you're able to build a sizable portfolio.
The general public can't get in on these deals at all.
Because of this, I'd love to see top investors accept, as a limited partner, a crowd-sourced, retail-accessible "Fund of Funds" that operated on something akin to the Vanguard business model, charging a fairly minimal fee to buy the startup market. If that existed, I'd joyfully invest in it.
edit: this would also provide an interesting benefit the startups, particularly if they're consumer-facing, as it would dramatically increase the number of people who have a reason to care about them, their product and their continued success.
For VCs, I'm suggesting investing as an LP, and paying management and performance fees.
As it stands, the asset class is completely inaccessible to most retail investors. Even for HNWIs and institutions, it's difficult to build a reasonably diversified portfolio.
I feel as though with some work, the model could provide value to all participants.
- Startups get a broader range of individuals who care about their success
- Angel Groups effectively get more power.
- VCs get an LP whose whole business is structured around new venture investment, so sales and management would likely be simpler than with LPs that might be more fickle depending on who's running finance and treasury, and what else has happened to their endowment in the past twelve months.
- Retail investors and institutions get to buy a portion of the market that's currently inaccessible, which should provide a better overall allocation of funds.
Voted up.
I'm genuinely confused how people think it is a good idea to open up a class of investment with no controls. Why not just buy stocks where the companies have transparency and solid corporate governance?
As to simply buying stocks, IANAFinance Guy, but I believe there is an upper limit on the amount you can invest before having to be certified as an investor. Could anyone contribute a proper explanation of that?
Personally I am worried that 10000 is way too much for an asset class this risky.
Overall, it will happen, and there are people trying to make it so right now, but it's going to take a little while to sort everything out fully.
Maybe we could start it out as a crowd-pledging venture where the community can pledge a commitment to contribute to the success of a product without the need for the creators' consent. If the creators accept the commitment, they can hash over the details with the committers subsequently.
One way to go about it would be to create a separate "pledge" economy from karma that still utilizes HN's default interface (for, say, karma>1000). Very flattr-like, I guess.
Honestly, I think there's a role for a Kickstarter-like fund for startups (as opposed to Kickstarter's focus on creative projects). Still no equity--the "prizes" generally would be promises of receipt of future products. But without equity, there's none of the legal wrangling associated with going public.
For new companies, such an entity would give: 1) market validation based on the number of financial contributors, 2) market research based upon feedback of pre-sale customers, and 3) relatively strings-free funding. In fact, I thought heavily about announcing my current project on Kickstarter until I read their terms and conditions. I'd definitely be using it to fund a new company, and funding one that would be difficult to call "creative".
In addition full SEC filings are not required under the new crowdfunding exemption.
Any company that does this will need to take various safeguards to prevent fraud or unqualified people from raising money. KickStarter and LendingClub seem to have been doing OK managing related issues, but it will be harder with actual investments.
It will also be interesting if crowd-funding expands to crowd-companies, so people also contribute to a startup like they contribute now to open-source software. You will probably still need a core team of people committed full-time to the venture.
I'd see more value if the HN community itself were to pool together money and invest in the various classes, though this benefit may be completely negated by what the Start Fund does.
This really jibed with coders we surveyed as they would love to be approached with ideas that are validated before they wrote any code. This could be a tool that finally empowers the non-technical business guys to vet their idea, get a critical mass behind it, and finally build enough value in the idea itself to build a team around. If anybody is interested in pursuing this I can put you in touch with the team that is running with this concept.
Add: there are already equity based crowdfunding sites - for example Symbid.com