
New Crowdinvesting Rules Mean Everyone Can Play VC - jc4p
http://betabeat.com/2012/06/amateur-hour-new-crowdinvesting-rules-mean-everyone-can-play-venture-capitalist/?show=all
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steve8918
If there are initial investors into a startup via crowdsourcing, are there any
protections given to these investors against the tricks that veterans would
play, like dilution, preferred shares, etc?

It seems pretty easy to me for someone to set up a startup, get initial
funding through crowdsourcing, and then as it needs another round of cash
infusion, it lets a bigger VC come in and dilute the hell out of the initial
investors.

It's actually less of a risk for VCs because they can let retail suckers take
on the higher risk during the initial round, and if the startup survives, then
they can swoop in and invest in a more promising company, and dilute the
initial investors into nothingness.

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itg
VC's were pushing hard for this bill under the guise of "job growth" and every
politician bought into it. There were numerous folks who said it allows for
fraud and the bill was pushed without looking at the can of worms it opens. It
benefits the VC's while reducing protections for investors.

I wonder how long before we start hearing stories about retail investors
getting screwed over by VC's in the media and makes people even more wary
putting money into the crowd-sourcing fad.

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damoncali
I don't think the VC's like the crowd sourcing parts. That does nothing but
cause them headaches. They like the other bits that let them stretch the truth
about IPOs.

I don't expect crowd sourced deals to get crammed down by VC's - there is too
much risk in those deals to deal with a bunch of non-professionals. I expect
crowd sourcing to be a red flag that kills your chances of raising
professional rounds.

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dllthomas
I think it depends on how it's done. If there's a whole bunch of individual
deals for small amounts, I don't expect a VC to want to clean up the mess. If
there's one or two deals for small amounts of money and equity, I expect them
to get bought out of it - what's $20 thousand on a $5 million round? But I
also expect there to be organized consolidation of crowdsourced money into a
single package with a single set of terms, which would make it less hairy for
a VC (and the terms could be set up to help limit dilution) - in particular, I
expect this is where the "Raise your crowdfunding here!" startups will go.

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tptacek
The buyout might be $20k, but from experience I'd bet that the legal fees to
resolve that buyout _even if nothing janky happens during the closing_ is
going to be low-mid 6 figures --- just for that one issue, not counting the
rest of the closing costs.

And if jankiness occurs, I'd assume that's curtains for the round.

You'd want to watch and see whether VCs and VC-friendly lawyers like WSGR and
Orrick come up with standard documents for crowdfunding, but I'm with
'damoncali in thinking that selling equity on something equivalent to
Kickstarter is going to be the kiss of investor death for the next several
years.

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damoncali
To make things worse, it's a mess to try to find former employees/contractors
with .5% to try to buy them out. Can you imagine trying to find the 20 guys
who each put in $250 and aren't answering their email? The jank required (and
+1 for appropriate use of the word "janky") to derail a professional round may
be nothing more than "can't find everyone".

~~~
waterlesscloud
I'm pretty sure the professional VCs and the law firms that represent them
will find an efficient way to deal with the issue. That's what they do.

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tptacek
No they don't. Any kind of complexity at all in M&A and major investment
closings gets insane expensive no matter who's involved.

Have you ever closed a VC round? I did (with 2 cofounders) during the bubble.
There was nothing remotely interesting about our paperwork. It was _insanely_
expensive.

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waterlesscloud
I didn't say anything about the cost.

I said they'd find an efficient (for them) way to deal with it.

The point was made that this could derail later rounds, and my response is
that methods and approaches will be developed so that is not the case, because
solving problems is what these people do.

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littlegiantcap
I think the author is overlooking one very important thing. Crowdfunding for
startups or small business isn't only about the financial return. Yes some
people are going to put $100 into a company claiming to be the next facebook
thinking they'll be rich. However, many, many more people will invest in these
companies to be a part of something or support their friends and families etc.
All of the satisfaction isn't derived from the return.

That being said, protecting investors and maximizing their likelihood of
return is going to be largely about the platform. What kind of deals do they
facilitate? How do they vet? etc.

The next year is going to be very interesting, and I'm excited to see how this
pans out, especially because I'm one of those guys working on a crowdfunding
platform.

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_delirium
I agree on motivations, but if that really _is_ someone's motivation, can't
Kickstarter already handle that? You put in your $100 just to help out and
support your friends/family, and in return you get some swag or recognition or
future product, but not an equity stake.

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rprasad
Kickstarter is essentially a form of prepayment triage: if enough people want
to pay for your product in advance, you get the money to make the product.

Crowdfunding is simply cash for equity. The investor is not getting a product,
so the Kickstarter model does not work.

~~~
littlegiantcap
Don't forget securitized debt!

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durkie
How exactly is this bill different from just normal contract law? Is it not
already super common for small businesses to solicit money from friends/family
in exchange for a share of the new company?

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wtvanhest
There is a lot of regulation around raising money for businesses of any size.
In general if the investors are accredited you can raise the money, if the
investors are non-accredited you cannot.

In order for an investor to be accredited, they must make over $200,000/year
or have a liquid net worth of over $1m.

<http://www.sec.gov/answers/accred.htm>

This bill builds in an exception for non-accredited investors to invest in
much riskier companies. Before this bill, the only way for non-accredited
investors to invest would be if the company went public which is very
expensive.

~~~
gm
So is it illegal to have your acquaintances and family invest in your startup?
If not, then have all startups been breaking laws all along?

If not, then what's the difference? The link you mention does not address that
issue at all (it just defines what an accredited investor is)

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JumpCrisscross
No it is not, you just have to provide additional disclosure and follow your
state's "blue sky" laws. These are just a headache to keep up with which is
why it can make an exit or VC raise down the line a bit harder.

~~~
wtvanhest
Blue Sky laws typically require investors to be accredited unless there are
exceptions. Some states may allow for non-accredited investors to invest in
startups, but I don't know of any.

One area that may or may not work would be if your family member loaned you
the money personally. That isn't considered an investment since it is a
personal loan.

But, in a personal loan, they couldn't ask for equity since that would be an
investment.

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confluence
Yay! This is a great idea, isn't it everybody?

I mean, unsophisticated investors who barely have the time or inclination to
understand how financial markets work (because the have jobs/families) are
just about to get the right to invest in the "new new thing".

Now, I'm all for free rights, but that is just insane!

When people get a whiff of possible massive resturns - housing, stock,
emerging markets, options, lottery tickets, IPO issues, etc. - they "invest"
in them wishfully thinking that they have even the slightest idea as to what
they are actually doing (some do - but most don't). These are exactly the
wrong type people who should be running extreme risk capital (which is why we
have VCs in the first place). These people will get slaughtered.

If average people can barely handle relatively regulated and tested markets
like stocks, houses and IPOs - how the hell are they going handle startups
which have an insane signal to noise ratio in a rising market where
"successful" funding can hide business model "failure".

But hey! There's no bubble right? The IPO market is soft.

But who needs an IPO market when you have massive liquid pools of dark private
retail capital.

The lambs are coming in for the slaughter and the wolves are salivating with
glee!

If I understand this correctly, this new law may just be akin to the repeal of
Glass-Steagall in 1999
(<http://en.wikipedia.org/wiki/Glass%E2%80%93Steagall_Act>).

Let the games begin!

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dxbydt
The key phrase is "Play VC". Much like getting an etrade account lets you
"Play Daytrader". To do some serious damage you need a little more firepower.

~~~
damoncali
Do you remember the day trading centers back in the bubble? They managed to do
some serious damage.

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api
I have radically mixed feelings. On one hand, I'm all for democratization. On
the other hand, this is a little bit like democratizing a fish tank by dumping
in a couple of sharks. The average person simply has no concept or mental
framework to even imagine the sort of high-powered sociopath one encounters in
the business world.

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cmcewen
If you throw enough spaghetti against the wall, some of it will stick. That
doesn't mean you get to eat the spaghetti, nor does it mean the spaghetti on
the floor has no cost.

~~~
gm
wtf am I reading?

I did not get the analogy. If only some spaghetti sticks to the wall, it means
you have a messy wall, less spaghetti left to eat, and spaghetti that isn't
all cooked yet. Sorry, but I do not get what you're trying to say.

~~~
cmcewen
Sorry, should have been a bit more clear. Some of the spaghetti being thrown
against the wall (companies taking crowdsourced money) will stick (be
successful), but the people who threw it (people putting in crowdsourced
money) won't necessarily benefit the most, and there could also be damage from
the spaghetti on the floor (failed companies). I'll work on my analogies.

~~~
gm
Ah, makes sense. Thanks.

