
If Crowdfunding is the New Day Trading, Look Out - smit
http://blogs.hbr.org/2013/09/if-crowdfunding-is-the-new-day-trading-look-out/
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ig1
Crowdfunded equity investments should be treated as gambling, don't do it
unless you're willing to lose money.

Over half of traditional angel investments don't return the investors money
and 90% of the returns come from 10% of the companies. These are traditional
angels who are well connected, do due diligence, etc.

With crowd-funding from the start you face an adverse selection problem, a lot
of the "best" looking startups are going to take money from well respected
angels and are going to fill up their seed rounds long before they need to
turn to crowd-funding. So with crowd-funding you're left trying to find the
good companies (which there are significantly less) which aren't obviously
good from a surface analysis.

So rather than 10% of the companies returning 90% of the returns with crowd-
funding it might be closer to 5% or 1% of companies (only time will tell us
the exact numbers).

~~~
jonnathanson
Exactly, and it is really hard for me to see a scenario in which this whole
thing ends well. It's basically inviting a huge pool of suckers to the table,
gambling on terms set by the dealers, with payouts engineered and controlled
by the dealers.

Just about the only way for this to work, without causing a ridiculous
speculative bubble, would be to force increased transparency of the financial
documents of private companies (thus blurring the lines between private and
public, which is opening a can of worms in its own right).

Success in angel investing is predicated on two things: 1) access to the best
deals on the best terms, and 2) enough capital to absorb losses in search of
outsized hits. Retail investors have neither of these things going for them,
so what they're doing amounts to little more than playing roulette.

~~~
ig1
I still think it should be legal. After all you can take $10k and spend it at
a Casino, there's no reason you shouldn't be able to gamble it on a company.

Although there are other reasons for investing other than financial returns,
for example you believe in the mission of the company or you want to be a
customer of the business.

~~~
jonnathanson
I'm not arguing against its legality; I'm arguing that it's dangerous as
written. It needs more enforcement of transparency on the side of the
companies. The difference between gambling and "investing" of this sort is
that at least gambling is 100% transparent. You know exactly what the odds are
at the roulette table. And most people who gamble (barring those with
addictions, of course) _realize_ they're gambling; most of the new people who
will "invest" probably won't believe they're gambling.

 _" Although there are other reasons for investing other than financial
returns, for example you believe in the mission of the company or you want to
be a customer of the business."_

Sure, but that's what services like Kickstarter are for. Let's not kid
ourselves into thinking that most Mom & Pop retail investors are going to be
day-investing in small businesses out of high-minded principle. They're going
to see dollar signs and dream of getting rich quickly. And there will be
plenty of people ready and waiting to sell them those dreams.

Maybe it'll take a bubble or two to get people to realize the dangers
involved, and eventually, it'll normalize into sort of what day trading has
become. But there will be pain before then.

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breckinloggins
The nice thing about Crowdfunding is that, like traditional trading,
motivations vary.

For example, I recently backed the Infrared Human Vision study on Microryza
[1] simply because it sounded like cool research. I backed the Ubuntu Edge
even though I knew it would most likely fail to reach its funding goals
because I wanted to send a message that there's a market for a "pocket to
desktop" convergence device. I sent a few dollars to Oculus on Kickstarter
because I wanted to see that become reality.

I'm not naive... I know that as this gets bigger there is going to be room for
technical trading, abuse, and an emergence of some myopic thinking similar to
the "quarter-by-quarter" tunnel vision that plagues public companies on Wall
Street. But the thing I like the most about crowdfunding is that it takes this
long-standing idea of "principled investing" and really lets you put your
money where your mouth is.

[1] [https://www.microryza.com/projects/can-we-biologically-
exten...](https://www.microryza.com/projects/can-we-biologically-extend-the-
range-of-human-vision-into-the-near-infrared)

~~~
pcowans
From the article: "To be clear, Malik isn’t talking about Kickstarter where
funders make a donation that acts like a pre-order. He’s talking about the
public buying stock in private companies, something that may soon be legal
thanks to the JOBS Act..."

~~~
wmf
I think breckinloggins's point was that people may be willing to make _equity_
investments for reasons other than profit.

(Now I'm wondering whether startups will be allowed to offer rewards in
exchange for funding, leading to more "X is not a store" backlash.)

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fiatmoney
I see an interesting parallel of "crowdfunding" to MOOCs. The original
(private capital / high-prestige colleges - or their synthesis in Harvard, a
hedge fund with a university attached for tax purposes) is a clubby self-
dealing arrangement designed to preserve a certain level of oligopoly profits.
The cheap substitute gets held up as a way for the average person to buy into
that system, when it's really a way to dump an inferior product on the public
with the same brand and none of the private advantages that make it worthwhile
in the first place.

~~~
ig1
That's a straw man arguments, I don't think anyones claiming that doing
courses on Coursera is the equivalent to a Stanford degree. Certainly the
universities aren't.

~~~
shubb
But they are charging plenty of money for University of Phoenix Online
courses.

The statistics, that a disproportionate number of graduates from Phoenix and
places like that are unable to make student loan payments, tell you that they
are not returning on investment for those students.

If you are poor, and study very hard, it is possible to win a scholarship at a
reputable college, and achieve social mobility that way. Pretending that
people who have not worked hard enough to win a scholarship can become middle
class by taking out a loan is a dupe. They would do better to join the army
for that purpose.

~~~
ig1
MOOC != University of Phoenix

~~~
dvanduzer
MOOC == Hey, those guys might be on to something?

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showerst
I disagree that just because most people who day trade lose money, that wider
access to the markets is a bad idea.

I'd rather have the option to enter a market when the odds are against me than
not have that option at all.

~~~
badman_ting
Well, I'm not sure if the author is saying that the access period is a bad
idea, or that availing oneself of it is a bad idea.

I would certainly agree with the latter. As for the former, we already have a
lot of ways for people to throw their money away, so why not one more. Literal
actual gambling is legal in many places, perhaps even most, so I don't think I
could argue against this form of gambling being available too.

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chamblin
This disdain for "common" investment is over the top.

A much bigger concern than the potential for poor decisions by individuals is
the creation of financial instruments that are, by government fiat, only
available to an elite group of institutional investors and the otherwise-
wealthy.

~~~
cowsandmilk
> This disdain for "common" investment is over the top.

Completely agree. After pointing out that the institutional investors are
clueless and lose to the market, he then says that only the little guys should
stay out of the startup space. Honestly, many of the reliable indicators for
Venture Capital are available to the public (eg past success). No reason to
keep the little guy out.

~~~
cowsandmilk
Expanding a bit, HBR argues:

> pouring more capital into VC has historically led to lower returns

Why this is unexpected is beyond me. More money should mean more competition.
He's essentially arguing that we should allow VCs to keep exclusivity on the
market because historically their returns have gone down as exclusivity has
decreased.

There may be argument that the startup market may have more scams than the
public markets and so on, but the author at HBR is not arguing that. He's
arguing that a natural function of opening up a market is a bad thing because
it provides less returns to the existing players.

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sharemywin
Non-acredited investors are only allowed to invest 5% of their income. If
grandma aint't got no income she ain't losin' alot of money. As long as all
transaction go through marketlaces and the marketplaces are forced to validate
the limits. Then no one is losing their life savings. Personally, The better
option is to force the state lottos to inact the 5% limit and worry about the
crowdfunding.

------
brey
If you don't know who the sucker at the table is, it's you.

~~~
JonSkeptic
Exactly. Crowd funding is an ideal source of capital for con artists.

"We are a team of Nigerian Bankers, and with your donations we will raise
enough money to give you double what you contribute!"

"We are a team of scientists who have discovered this one wierd trick that the
medical community doesn't want you know about. If we meet out goals, you can
receive the new wonder pill that adds 3 inches to your penis!"

The future's gonna be interesting...

~~~
ISL
It'll be much like the past.

------
ChuckMcM
Wow, this editorial exactly parallels my concern. Basically people chasing
outsized returns getting fleeced by the bottom of the barrel type pump-n-dump
types.

Here is my thesis, there exists a significant number of people who attempt to
exploit people's desire four outsized returns using illegal "pump and dump"
schemes where they pump up the value of a penny stock and them dump their
shares to the unwitting victims. This is illegal and they get hunted down and
sometimes caught. Now we'll have a "perfectly legal"[1] way for these same
folks to create the illusion of an outsized opportunity. And that will create
dark versions of wefunder type companies which are focused not on enabling the
next generation of entrepreneurs but instead in fleecing the next generation
of technology "investors".

[1] "Perfectly Legal" \- code for a way to take money from someone where they
cannot get it back, and yet had they known all of the facts would never have
handed it over in the first place.

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abalone
I'm a little surprised at HBS, this is not a very well thought out commentary.

People like to say startup investments are "like betting" and it's true to a
certain degree -- it's very risky and odds are against you. But what separates
it from more popular forms of betting (casinos, lotteries) is...

You have to hold on to your investment for many years.

The timeframe on returns is a huge difference between day trading and early
stage investments. Day trading was a very close approximation of off-track
betting. It had similar psychological dynamics driving it. You win some, you
lose some, you keep coming back for more, you think you can beat the odds
tomorrow if you just get some money together.

Those addictive dynamics don't play as well over a timeframe of 5-10 years.
It's like buying a lottery ticket for 2020. Not as addictive.

I'm not saying there are no downsides to unsophisticated investing. Just that
day trading is a poor comparison.

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presidentender
I'm worried that crowdfunding will lead to serious malinvestment, with large
numbers of naive investors throwing money at a thousand Fakeblocks and Colors.

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bayesianhorse
What they are describing doesn't sound like crowd-funding at all. It looks
more like advertized private equity with dramatically lowered quality
standards.

It does not sound as if "accredited investors" would necessarily include a lot
of people, especially when people know that the risk is worse than in the
usual stocks.

