On Crowdfunding in Start-Ups

Yesterday, federal legislation went into effect to allow small start-ups to ask for equity investments publicly, such as through social media sites or elsewhere on the Internet, without having to register the shares for public trading. Business owners will now be able to raise any amount, though only, at this point, from accredited investors—those individuals deemed wealthy and sophisticated enough to understand and withstand (tremendous) risk (basically, if you make $200,000 in income per year or have more than $1 million in assets, excluding your primary residence).

I was thinking about this for some time, but I’m glad I read Felix Salmon’s piece “The Idiocy of Crowds” about this latest news. Basically, he thinks it’s a terrible, terrible idea and an easy way to part with your money:

Today’s a big, exciting day for anybody who has found it simply too difficult, to date, to throw their money away on idiotic gambles. Are you bored with Las Vegas? Have you become disillusioned with lottery tickets? Do micro caps leave you lukewarm? Does the very idea of a 3X ETF fill you with nothing but ennui? Well in that case today you must rejoice, because the ban on general solicitation has been abolished, and the web is now being overrun with companies like Crowdfunder and RockThePost and CircleUp which offer a whole new world of opportunity when it comes to separating fools from their money. You can even lose your money ethically, now, if that’s your particular bag. The highest-profile such platform is probably AngelList: as of today, founders like Paul Carr (alongside, according to Dan Primack, over 1,000 others) are out there tweeting at the world in an attempt to drum up new investors.

It is conceivable that over time, these equity crowdfunding platforms will learn from their inevitable mistakes, and the few which survive will learn how to be something other than a hole in which to pour millions of dollars…

I thought the email that Felix received from an anonymous angel investor was particularly wise:

These guys are building their business on the notion/dream that somehow the internet can disintermediate social and relationship capital. I’d argue that this is precisely what the internet can not do: if you’re going to invest in a startup, you’d better know the founders, and you’d better know something that most people do not know. Information asymmetry is the only way to lower the risk profile on such crazy risky investments.

Disclosure: I am staying on the sidelines; I just thought the news was interesting.

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