10 ms·

Tech Startup Crowdfunding Isn’t All It’s Cracked Up to Be

41 points by mgav 11y ago

mgav 11y ago
Excerpt: 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."
- danieltillett 11y ago
  It is almost as though the SEC does not want anyone to use crowdfunding other than scammers.
  - Avshalom 11y ago
    Alternately the SEC just recognizes that "crowdfunding" a corporation is just exactly what IPOs were supposed to be for and doesn't feel super happy about having to write the loop holes to their own regulations.
    - danieltillett 11y ago
      Exactly. No regulator has ever actively worked towards putting themselves out business. If crowdfunding were to succeed then people might start to consider why we have all this regulation, on the other hand if the SEC structures the rules such that only scammers make use of it then they can say "we tried this and it was a disaster so it is time to bring in more regulation".
- swamp40 11y ago
  A comment below the WSJ article by a crowdfunding lawyer says that "or" should be an "and", and that makes a huge difference, since a startup doesn't have to worry about the disclosures until they hit $25M.
tptacek 11y ago
I haven't heard a rationale for equity crowdfunding that makes sense to me. It sounds straightforwardly dangerous. The whole thesis for startup investing is that investors build large portfolios where the winners pay for the losers. A 2x return is a out-of-the-park home run for a retail investment in a public company, but is, mathematically, a failure for a startup investor, because only 1-2 companies in a portfolio of 10 will succeed. That, and a few other arguments, here as well: https://news.ycombinator.com/item?id=10481136 https://news.ycombinator.com/item?id=10481136
- utnick 11y ago
  Couldn't an equity crowdfunding investor spread their money around hundreds of companies as well, making smaller sub 1000 dollar bets. Or is there a minimum investment amount for this? 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
  - URSpider94 11y ago
    It's not clear whether companies will be willing to take hundreds or thousands of small investments. Each one adds a non-negligible amount of overhead in investor communications, and at a certain threshold of investors, you trigger the same regulatory requirements as if you were actually a public company (issuing quarterly and annual financials).
  - HiLo 11y ago
    Are you just assuming an equity crowdfunding investor (retail investor) has the resources or sophistication to do proper due diligence on hundreds of investments? Maybe the interest rates are lower on these for borrowers because the cost of due diligence isn't included. Not maybe, actually.
- didgeoridoo 11y ago
  I haven't looked too much into this space, but what about this rationale: the existing model pushes startups into 1000x-or-bust behavior, which contributes to the low success rate, which reinforces the need for high-risk growth followed by a spectacular cash-out. This could be driven by many factors, not least of which is the "brand name VC" model in which venture funds need a couple household name home runs to attract the best deals. 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?
rdlecler1 11y ago
Pension funds and mutual funds are some of the largest crowd funded entities on the planet. The former lacks transparency and has too many middlemen, and the later is far more limited in it mandate and typically is restricted to public markets. 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).
- jb613 11y ago
  who are these "companies don't want to disclose IP"? 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.
waylandsmithers 11y ago
> The worry, voiced by many, is that the pool of startups using equity crowdfunding will consist mostly of lower-quality companies that couldn’t get funding by other means. 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.
pussinboots 11y ago
paywalled article `^`
- landonshoop 11y ago
  Google the title of WSJ articles and you get full access.
tbrooks 11y ago
I just don't seeing this ending well for inexperienced investors. 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.
bicknergseng 11y ago
I've been wondering for a while if it would be more viable to crowdfund VCs or angels in place of limited partners. That way there are full time people dedicated to due diligence, risk management via diversified portfolios, etc. Of course, similar risks still apply and bankrolling start ups may or may not be the best way to ROI.
zxcvvcxz 11y ago
Traditional product crowdfunding, a la Kickstarter, is meant to act as product pre-sales (debt financing). I think we're starting to move further away from flashy CGI promising us a concept (and subsequently squandering investment money) towards more mature companies able to actually deliver. Though this is taking the magic out for those makers with fewer resources, it's certainly better for the backers. 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.

41 points by mgav 11y ago

mgav 11y ago

Excerpt: 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."

danieltillett 11y ago
It is almost as though the SEC does not want anyone to use crowdfunding other than scammers.
- Avshalom 11y ago
  Alternately the SEC just recognizes that "crowdfunding" a corporation is just exactly what IPOs were supposed to be for and doesn't feel super happy about having to write the loop holes to their own regulations.
  - danieltillett 11y ago
    Exactly. No regulator has ever actively worked towards putting themselves out business. If crowdfunding were to succeed then people might start to consider why we have all this regulation, on the other hand if the SEC structures the rules such that only scammers make use of it then they can say "we tried this and it was a disaster so it is time to bring in more regulation".
swamp40 11y ago
A comment below the WSJ article by a crowdfunding lawyer says that "or" should be an "and", and that makes a huge difference, since a startup doesn't have to worry about the disclosures until they hit $25M.

tptacek 11y ago

I haven't heard a rationale for equity crowdfunding that makes sense to me. It sounds straightforwardly dangerous. The whole thesis for startup investing is that investors build large portfolios where the winners pay for the losers. A 2x return is a out-of-the-park home run for a retail investment in a public company, but is, mathematically, a failure for a startup investor, because only 1-2 companies in a portfolio of 10 will succeed. That, and a few other arguments, here as well: https://news.ycombinator.com/item?id=10481136 https://news.ycombinator.com/item?id=10481136

utnick 11y ago
Couldn't an equity crowdfunding investor spread their money around hundreds of companies as well, making smaller sub 1000 dollar bets. Or is there a minimum investment amount for this? 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
- URSpider94 11y ago
  It's not clear whether companies will be willing to take hundreds or thousands of small investments. Each one adds a non-negligible amount of overhead in investor communications, and at a certain threshold of investors, you trigger the same regulatory requirements as if you were actually a public company (issuing quarterly and annual financials).
- HiLo 11y ago
  Are you just assuming an equity crowdfunding investor (retail investor) has the resources or sophistication to do proper due diligence on hundreds of investments? Maybe the interest rates are lower on these for borrowers because the cost of due diligence isn't included. Not maybe, actually.
didgeoridoo 11y ago
I haven't looked too much into this space, but what about this rationale: the existing model pushes startups into 1000x-or-bust behavior, which contributes to the low success rate, which reinforces the need for high-risk growth followed by a spectacular cash-out. This could be driven by many factors, not least of which is the "brand name VC" model in which venture funds need a couple household name home runs to attract the best deals. 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?

rdlecler1 11y ago

Pension funds and mutual funds are some of the largest crowd funded entities on the planet. The former lacks transparency and has too many middlemen, and the later is far more limited in it mandate and typically is restricted to public markets. 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).

jb613 11y ago
who are these "companies don't want to disclose IP"? 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.

waylandsmithers 11y ago

> The worry, voiced by many, is that the pool of startups using equity crowdfunding will consist mostly of lower-quality companies that couldn’t get funding by other means. 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.

pussinboots 11y ago

paywalled article `^`

landonshoop 11y ago
Google the title of WSJ articles and you get full access.

tbrooks 11y ago

I just don't seeing this ending well for inexperienced investors. 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.

bicknergseng 11y ago

I've been wondering for a while if it would be more viable to crowdfund VCs or angels in place of limited partners. That way there are full time people dedicated to due diligence, risk management via diversified portfolios, etc. Of course, similar risks still apply and bankrolling start ups may or may not be the best way to ROI.

zxcvvcxz 11y ago

Traditional product crowdfunding, a la Kickstarter, is meant to act as product pre-sales (debt financing). I think we're starting to move further away from flashy CGI promising us a concept (and subsequently squandering investment money) towards more mature companies able to actually deliver. Though this is taking the magic out for those makers with fewer resources, it's certainly better for the backers. 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.