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Growthology- Developments in Crowdfunding

January 27, 2013


Developments in Crowd-funding

There’s a glimmer of hope that Congress and the Administration might be able to agree on one piece of legislation this year—the JOBS Act introduced in the House last week by Majority Leader Eric Cantor—that could do something significant for startups, and in turn the broader economy. This legislation combines a number of proposals that would change various SEC rules so as to lower the costs of raising capital by new businesses. Most of these have already separately passed the House by large bipartisan majorities. The Obama Administration also has endorsed most of the ideas in the bill, and reportedly is willing to work with Cantor and like-minded (on this issue) Democrats in the House to get the bill passed.

There is one provision in the proposed Act that is unusually controversial that I’d like to address in this post, because it sure to get some attention in the Senate (assuming the House passes the bill, which is a good bet at this writing). It is the “crowd-funding” idea championed both by the bill and the Obama Administration, which would exempt from SEC registration and disclosure rules investments up to $10,000 per individual in firms raising no more than $1 million per year through crowd-funding platforms like Kickstarter and more recently, Facebook (more on the latter below).

Valid concerns have been raised that this provision would open the way for scam artists to fleece unknowing investors of a lot of their hard-earned money. That is a legitimate worry. So is the concern that investors who make these investments may be getting nothing more than “Green Bay Packer wall certificates”—pieces of paper like the stock issued to the fans of Green Bay to help fund their football team that pay out no profits and are essentially non-marketable.

Even my own initial reaction to the crowd-funding idea was a bit skeptical. Who would be crazy enough to part with up to $10,000 of their own money over the Internet to some little or unknown startup on highly uncertain terms?

What began to change my mind on these matters was a little noticed piece in the Wall Street Journal several weeks ago about Facebook’s fbStart program. Facebook is proposing to provide inside access to some of its platform to a select group of startup partners (startups housed in accelerators such as TechStars and Y Combinator) in exchange for Facebook staking some share of the startup’s revenue. Imagine the possibility of these startups launching on Facebook and using the near 845 million users as a crowd-funding source. Such an initiative has the potential for turning crowd-funding into a really big breakthrough for companies needing several hundred thousand dollars to get off the ground, either without further funding or as a way station to more serious angel or venture financing.

As for the scam artist possibility, which is very real, I also think back to the early days of eBay when skeptics claimed that few would ever trust other people to deliver the goods they bought on the site. Then the market proved the skeptics wrong. eBay came up with a way of getting users to verify the trustworthiness of their counter-parties and the rest, as they say, is history.

I believe that if given the opportunity to take off through the proposed legislation, crowd-funding platforms and their users would develop similar, or perhaps very different, ways of giving would-be investors some comfort that the firms or individuals seeking to raise money aren’t crooks, and even cranks. I anticipate that, at a minimum, many firms seeking money will post YouTube-like videos on these platforms (or links to them) so that investors can see who they are investing in. Further, I suspect that many of these individuals will include others in their video, likely some respected individuals who can easily be checked out on the Internet, who will vouch for the entrepreneur. And perhaps the platforms will find ways of allowing or encouraging investors to vote thumbs up or down on entrepreneurs seeking money. I don’t know yet how the validation market will work in the crowd-funding space, but I strongly suspect that validation methods will emerge because there will be a market for them.

If nonetheless legislators remain worried about the scam problem, they might consider giving the crowd-funding exemption a limited time trial, perhaps two or three years, during which we and everyone else will be able find out whether people patronize the scam artists and whether the market will find ways of pushing them aside. The time trial might also give the SEC authority to abort the crowd-funding experiment if the scam problem proves very real, and with costs that outweigh the benefits of new firms funded in this way.

But at some point, it seems to me that the government should give new technologies a real shot at solving the very real funding problem that a lot of new companies face, especially now that banks pretty much have exited the market for funding them (either directly, or indirectly through credit card or home equity lines of credit, which have been cut back since the financial crisis). There is a compromise to be had here, if one is needed.


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