
Equity crowdfunding is doomed as an asset class - jbreinlinger
http://acrowdedspace.com/post/59414059068/crowdfunding-is-doomed
======
gbelote
Cofounder of Wefunder here. I disagree with the author. He makes a few
assumptions that I believe to be false and makes a strong conclusion that
crowdinvesting as a whole is doomed to low quality startups.

Some points of disagreement:

\- Startups choose either crowd-funding -or- VC. It's not VC or crowd. Nor is
it angel or crowd. High quality startups can raise traditional seed rounds and
allocate a slice of that round for a crowd of investors. One example is
Zenefits (YC W13), which is an awesome company that's kicking ass (IMO). They
raised part of their round on Wefunder even though they had tons of investor
interest after Demo Day.

\- The author assumes the investor selection will be inherently poor with
crowd-funding. I disagree with this, too. The universe of great investors
isn't a subset of investors active enough to angel invest. Imagine being an
API company and having 50 developer-investors.

Plus, crowdinvesting platforms allow investors to invest smaller amounts in
many companies. Imagine investing $5k in 20 of your favorite YC companies.
Good luck trying to get one-on-one meetings for $5k checks. Especially if you
don't live in San Francisco.

\- The author assumes that raising from a crowd means you'll have to wrangle
thousands of investors. It doesn't have to be that way, especially with the
common practice of using LLCs to group many small investors into one item on
your cap table.

\- I do agree with the author that too much adverse selection can create a
marketplace for lemons. I worry about that all the time. However I think we do
a pretty good job of mitigating that.

There will absolutely be a lot of mediocre crowdinvesting platforms and
companies trying to raise on them, but it doesn't mean the whole industry is
doomed. I encourage the author to check us out in a month once the general
solicitation ban is lifted and reconsider his view of crowdfunding as an asset
class. :)

~~~
fixxer
Are blue sky laws no longer applicable?

~~~
Daniel_Newby
They seem to be going away. Restrict one asset class amd people just find a
different rat hole to fling their money down.

------
mediaman
A lot of folks are making ad hominem arguments that because it is a VC arguing
against crowd funding, he must be wrong because of who he is.

Let's see if we can focus on the reasons why his arguments are wrong, not just
that he is a VC.

Valid reasons why he may be wrong:

\- He argues that good startups have no trouble raising VC. On the contrary,
many VCs have poor ability to determine what is a good investment, and many
good startups have war stories to tell of how difficult their first financing
round was. Therefore, crowdfunding could benefit good startups because raising
money from VCs is not easy even for quality startups, because VCs are (as a
class) not particularly good at identifying quality.

\- Investor selection: sure, getting top-tier VC has soft benefits. But there
are costs as well: VCs have more board power, can often force a founder to
step aside, or will force a sale to liquidate equity to distribute returns to
LPs. Yes, individual investors may not add as much "soft value". But the power
dynamics are different and in some ways there may be lower risk to the
founder.

\- Later stages: so what if crowdfunded companies don't turn to crowdfunding
for second rounds? Crowdfunding will work best for early stage. If the
business turns out great, and the company needs large amounts of follow-on
funding, then getting $20mm from institutions will be more feasible. But it is
difficult to understand why that's a serious problem for earlier stage
crowdfunding.

\- Marketplace for lemons: information asymmetry also exists for VCs with
startups, so the lemon argument against crowdfunding is not unique versus VC.

In short, these are interesting ideas against crowdfunding, but none stand out
as particularly compelling, or they can at best make a claim against
crowdfunding for certain types of deals, rather than against crowdfunding as
an asset class.

~~~
ganeumann
_VCs are (as a class) not particularly good at identifying quality_

The question is: why is that? Having been an investor and an entrepreneur, I
certainly agree that VCs miss many good companies and fund many bad ones. But
that's not for lack of trying, expertise, time spent, or motivation.

If you think that crowdfunding will do better than VCs (as a class), then you
must either believe that the crowd has some ability that VCs can't develop
(and what is that and why can't VCs develop it?) or that the crowd will simply
fund everything regardless of quality.

I personally don't believe the first and am not sure the second is the best
answer.

Personally, I think crowdfunding--especially as AngelList does it--could very
well be the future of the seed/early A round. I don't think the crowd will get
better returns than VCs, but I also think the crowd won't care very much about
okay-but-not-great returns; that may be the reason it works.

------
gfodor
First, I think it deserves mentioning that this post is _not_ about things
like Kickstarter, as far as I can tell, but about _equity_ crowdfunding like
AngelList. Kickstarter backers do not get equity in the company.

I don't really think the "good startups will opt for VCs, ergo only bad
startups will go for crowdfunding" line of argument is really convincing. The
reason being that how good or bad a startup is isn't really a knowable
quantity both because it's an incredibly vague, meaningless concept and
because at the funding stage not much about the future of the company is pre-
determined.

That said, I do think the crowdfunding movement (equity and otherwise) has a
major, often overlooked, negative. It's much better to have to deal with one
or two VCs than be beholden to a dozen, or in the case of Kickstarter, tens of
thousands of stakeholders. A good VC will let you drive the company and only
provide high-level guidance and a rolodex, but an active community of a few
thousand backers who don't want to lose their money will put your head on a
pike if you don't deliver exactly what they were promised. (And odds are many
of them have a completely different idea of what they are paying for than you
do.) Good luck to you if you want to pivot once you have 10,000 backers on
Kickstarter, for example.

However, if you have a very straightforward project that is well specified and
has a concrete way to measure when it is completed or failed, like shipping a
piece of hardware that is completely designed, if lack of capital is a
blocker, crowdfunding seems to make sense. For more open ended projects like
games or software applications I see Kickstarter has a horrible idea unless
there are literally no other options. And even then, it might be worth it to
just die instead of having to become beholden to thousands of people on a
project you may lose interest in or won't be able to kill even when the
writing is on the wall since it will destroy your reputation.

~~~
arbuge
AngelList has an invest online feature which groups smaller investors into a
single LLC. Those investors also get fewer information rights than regular
direct investors, IIRC. Not many startups there seem to be using this feature
yet but it seems to me it could be an effective way to deal with the issue of
many small backers if that changes.

And at the end of the day it's equity. Your clout is generally proportional to
the number of shares you hold, share classes aside.

~~~
gfodor
Yeah I guess I wasn't thinking about this clearly enough. Equity crowdfunding
doesn't really seem to have much of an issue since investors aren't really
promised anything tangible other than some possible return. My general
aversion to non-equity crowdfunding (is there a name for this) like
Kickstarter is that sure, you get cash in the bank, but you now have a massive
hidden liability on your balance sheet: an angry mob who will post horrible
screeds on the Internet about you if you don't execute perfectly.

~~~
thomaslangston
You mentioned games in a previous post as being bad for Kickstarter, but I
think this post proves you wrong.

An angry mob will post horrible screeds on the Internet about you if you don't
execute perfectly on a game _regardless if you used KickStarter or not_. The
developer's reputation is on the line whether you have KickStarter funding or
not. The only real extra opportunity cost to under performing on KickStarter
is closing off that source of funding in the future.

~~~
gfodor
Maybe, but consider two scenarios. In scenario 1, I use Kickstarter, get
10,000 backers, and release a shitty game, and predictably they blanket the
internet with hate in every nook and cranny. The hate is just as much about me
as it is the game, since my face and reputation are plastered all over the
Kickstarter, and I was actively engaged with these 10,000 people during the
entire process. They are personally invested not just financially but
emotionally in the product over a span of months or even years.

In scenario 2, I self-fund or get a few angels, build a shitty game and
release it with little hype or promises beforehand. It garners a few bad
reviews from early adopters and gets 1-star ratings on all the gaming sites,
but really it ends up just staying off the radar since it never builds an
audience in the first place. This is typically what happens when a company
releases a bad product, it just dies without much noise at all and is quickly
forgotten about. Also, the negative feedback is largely about the _game_ and
not about _me_. If anything, the hate is directed towards my company but not
me personally.

In other words, sure, releasing bad work is always bad. But in the case of
Kickstarter, I feel you are exposed to a larger surface area of potential
damage to your personal reputation. Kickstarter is a much more intimate and
personal thing, and you are basically "putting yourself out there." The only
real upside to using it is that it makes it incredibly easy to open a possible
channel for funding, but it has crazy asymmetric risk in return compared to
the traditional route IMHO.

edit: I guess one thing in Kickstarter's favor is if you actually get your
10,000 audiences and you deliver, you have some solid momentum coming out of
the gate. The more I think about it the more it has the flavor of financial
leverage: you magnify your outcome in either direction but have reduced
flexibility (in the case of Kickstarter, due to the audience's expectations,
in the case of financial leverage, due to the fact you are borrowing money on
margin and can't make any big moves from there.)

------
minimax
This is probably a stupid question, but how does a crowd funded equity round
actually work? If I'm trying to raise $1MM for a 10% equity stake (picking
number out of the air), is it a first come first served thing (as soon as we
reach $1MM the round closes), or is there an auction where investors can place
bids? Also is there any secondary market once you take a position in one of
these companies?

~~~
minor_nitwit
It will depend upon how the sale is set up. Anything is theoretically
possible, but the biggest obstacles are SEC regulations put in place to
protect small 'retail investors' from 'speculative' products.

------
gluejar
tl;dr A VC thinks VC works better than equity crowdfunding ever will. As if VC
is the answer to all problems.

~~~
riggins
yep.

It's also worth making one of the key assumptions of the post explicit.

the author says

 _If the funding platforms cannot attract the best deals, then investors will
not make any money._

the key assumption that's baked into that statement is that everyone
universally recognizes the 'best deals'. Of course that's not certain. The
wisdom of the crowd may be better than VCs at recognizing the 'best deals'. I
can easily imagine 'best deals' that the crowd identifies that VCs wouldn't
fund.

~~~
jbreinlinger
>> the key assumption that's baked into that statement is that everyone
universally recognizes the 'best deals'. Of course that's not certain. The
wisdom of the crowd may be better than VCs at recognizing the 'best deals'. I
can easily imagine 'best deals' that the crowd identifies that VCs wouldn't
fund.

Wholeheartedly agree with your statement - but keep in mind that VCs typically
get access to way more information than what's available through a
crowdfunding site.

~~~
vasilipupkin
Yet VC industry as a whole has been underperforming.
[http://www.avc.com/a_vc/2013/02/venture-capital-
returns.html](http://www.avc.com/a_vc/2013/02/venture-capital-returns.html)

My guess is this is because most VCs cannot really discern trends, predict the
future, etc - even though that is what they claim to do. ( The best ones can,
to some extent )

So I would guess, based on this data, that crowdfunding equity will perform
just as well as average VC or better, net of fees

~~~
kansface
The best VCs just have good deal flow. IE, the wildly successful startups go
to them first. I don't think the VCs with great returns are better at
guessing.

------
jchimney
There will always be fans of a product willing to put a few bucks down to see
it happen. Not going away

------
moron4hire
Kickstarter is not a pre-order system. It is a patronage system.

------
NonEUCitizen
VC denying reality, hoping it'll go away.

