
Tech Startup Crowdfunding Isn’t All It’s Cracked Up to Be - mgav
http://www.wsj.com/articles/tech-startup-crowdfunding-isnt-all-its-cracked-up-to-be-1449464460
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tptacek
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)

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patio11
It's certainly more dangerous than investing in IBM or Chipotle, but not
obviously more dangerous than a number of things which we let adults purchase,
including casino chips, time share properties, houses in California (which
we'll subsidize your 5X leverage on), art history degrees (where capping it at
5X leverage would be refreshingly conservative), etc etc.

A $3,000 computer purchased today will depreciate to zero in 3~4 years,
leaving you with hopefully some happy memories and a paperweight. Three $1k
crowdfunding investments may do likewise. Do we distinguish them because they
don't guarantee the paperweight?

I get the social purpose of e.g. preventing boiler room operations from
extracting "investments" by retirees into businesses which are not actual
businesses, but for businesses which _are_ actual businesses which just happen
to have 90% failure rates, "Distribute the risk among a group of people
guaranteed to be at least middle class; and cap it at a figure lower than what
they could reasonably spend on e.g. a wedding dress" seems to capture most of
the social benefits of outlawing outright scams while also not outlawing
middle class people from owning startup shares other than those they receive
as compensation for services rendered.

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tptacek
Normal people don't buy computers because they anticipate the returns will
help fund their retirements.

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dandelany
No, but plenty of people (stupidly) gamble at a casino and hope for returns to
fund their retirement, and no one is clamoring to outlaw gambling.

To expand on this analogy - gambling is legal because, as a society, we've
decided that the upside of "entertainment value" outweighs the downside of
"unsophisticated 'investors' (gamblers) may lose more money than they can
afford to." If this is the case, it seems obvious to me that we should also
accept crowdfunding, which has exactly the same downside, but infinitely more
valuable upsides: normal investors get more opportunities for investment and
businesses get access to more capital.

Securities regulations should protect investors from shady businesses doing
illegal things, not from themselves.

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lawstudent2
Many, many, many people are clamoring to outlaw gambling in the very, very few
places it is currently legal, myself included. Right now Draftkings and
whatever that other one is are in the process of getting worked over by
multiple state AGs for violating anti-gambling prohibitions.

Gambling is legal in only a tiny handful of places and in the few places where
more casinos have recently been authorized, NY state (my state) included, it
has been a hugely controversial decision. In NY State, the rationale was
_certainly_ not that gamblers benefitted, but that the added tourist
attraction of creating casinos in depressed communities will boost the local
economy. I think this was a patently bad decision and I'm certain that history
will bear me out, that the local economies will not suddenly prosperous and
quite to the contrary, all of the low grade crime associated with risk
seekers, substance abusers and the profligate will now infect these
communities as well.

The whole reason we have the SEC in the first place is to protect the
credulous from the sharks.

I don't anticipate this type of crowdfunding taking off, quite honestly, and I
don't know that this is a problem. We want the middle classes putting their
assets in places safer than just betting them on papa's mustache in the third
- which is what unsophisticated startup investing basically is. Except there
is a much greater chance that a random horse picked with a dartboard is going
to have a return than a random startup will.

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tptacek
I really don't think we need to concede the equivalence between restricting
equity crowdfunding and outlawing gambling. Gambling is legal because, as
marketed, it's an entertainment product. Equity crowdfunding is restricted
because it's an investment product.

Similarly, GNC can sell all sorts of useless nutritional supplements, but the
FDA is all up in the business of anyone trying to sell a new medication.

Reminder: you can take money from non-accredited investors; it's just so
complicated that it's not practical to do so at scale and with strangers.

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SilasX
So, let's say I market the crowdfunding shares as an entertainment product.
Then it could become a legal model?

Relatedly, I had the idea to sell small shares of (legit, regulated) far-out-
of-the-money options as lottery tickets. As investment products, they're
legal, but work like lottery tickets in that you have a tiny chance of winning
big (e.g. if the underlying security has a sudden, sharp shift in price).

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tptacek
Yes. That is, for instance, how Kickstarter works.

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rdlecler1
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).

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jb613
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.

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zxcvvcxz
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.

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waylandsmithers
> 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.

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bicknergseng
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.

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tbrooks
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.

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pussinboots
paywalled article `^`

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

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mgav
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."

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danieltillett
It is almost as though the SEC does not want anyone to use crowdfunding other
than scammers.

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Avshalom
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.

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danieltillett
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".

