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.

Amazon as a Charitable Organization

Following the dismal 4th quarter earnings announcements by Amazon, detailed below, Amazon’s share price shot up by more than 10%.

  • Q4 revenue of $21.27 billion missed expectations of $22.23 billion
  • Q1 EPS of $0.21 missed expectations of $0.27;
  • The firm guided top-line lower, seeing Q1 sales of $15-$16 billion, below the estimate of $16.5 billion
  • The firm guided operating income much lower, seeing Q1 op income of ($285)-$65 Million on expectations of $261.4 MM
  • The firm said the its physical books sales had the lowest growth in 17 years
  • Total employees grew by 7,000 in the quarter and 32,200 Y/Y to a record 88,400
  • Worldwide net sales Y/Y growth was the slowest in years at 23%, down from 30% in Q3 and 34% a year ago
  • And, last and certainly least, LTM Net Income is now officially negative, or ($49) meaning as of this moment the firm with the idiotically high PE has an even more idiotic N/M PE.

The question is why? Matthew Yglesias has a great thought: Amazon is a charitable organization. To wit:

The company’s shares are down a bit today, but the company’s stock is taking a much less catastrophic plunge in already-meager profits than Apple, whose stock plunged simply because its Q4 profits increased at an unexpectedly slow rate. That’s because Amazon, as best I can tell, is a charitable organization being run by elements of the investment community for the benefit of consumers. The shareholders put up the equity, and instead of owning a claim on a steady stream of fat profits, they get a claim on a mighty engine of consumer surplus. Amazon sells things to people at prices that seem impossible because it actually is impossible to make money that way. And the competitive pressure of needing to square off against Amazon cuts profit margins at other companies, thus benefiting people who don’t even buy anything from Amazon.

It’s a truly remarkable American success story. But if you own a competing firm, you should be terrified. Competition is always scary, but competition against a juggernaut that seems to have permission from its shareholders to not turn any profits is really frightening.

Sometimes (often) the markets are a fool’s game.

Profiting from Hurricane Sandy

Mark Gimein has a short post on Bloomberg, explaining that a typical investor doesn’t really have a chance to profit on Hurricane Sandy:

Another way to take advantage of the downside risk might be to put buy put options on the S&P 500 index. If a lot of folks were doing that, you might expect November put options with a strike price of 1350 or 1375 — that would represent a three or four percent decline in the S&P 500 — to spike upwards. They haven’t.

Recent years have been blockbusters for catastrophically deadly and expensive extreme weather events; Munich Re has some very useful data on this, which show 2011 as a record-setting year for costs of natural disasters (this includes Japan’s Tohoku quake). While a lot of ink has been spilled about the possibility of hedge funds betting on high-impact, low-but-meaningful-probability events like the storm, that’s easier said than done. It’s possible to make a fairly general bet against the insurance industry, or to bet on a sharp drop in the markets.

In practice, however, making a specific bet that would hedge against — or profit from — a weather disaster, is a lot more difficult. There’s not a substantial market for, say, put options on the insurance companies with exposure to Sandy.

If you want to hedge the financial risks of a hurricane, there are not a lot of market tools at your disposal. The main hurricane option for investors, whether ordinary stock pickers or hedge fund traders is the same as for other New Yorkers: shut the windows, turn on the news, and watch the storm’s progress on TV.

Not mentioned: even if you wanted to trade stocks or options, the entire stock market (NYSE, NASDAQ) is closed today and tomorrow. Good luck with that.

A Brief History of Trading on Wall Street

You don’t get to read about history in the Dealbook blog, but we get a great one today about the history of trading on Wall Street. It’s pretty crazy to think that in the early days of Wall Street, stock prices were communicated by runners:

Even after the introduction of the trans-Atlantic cable in 1865 and the telephone in 1878, brokers still relied on manpower over gadgetry. Market prices were listed on slips of paper, and runners, most younger than 17, would deliver letters between brokerage houses, according to a report by Alexandru Preda at the University of Edinburgh. The new technologies were not seen as reliable. Problems ranged from typographical errors in the closing stock prices listed by newspapers to outright forgery.

In the days after the Civil War ended, traders seeking a timely edge still relied upon foot speed. The fastest man on Wall Street was William Heath, a celebrated runner with a huge drooping mustache, who was nicknamed “the American Deer.” Standing an inch taller than the Olympic sprinter Usain Bolt of Jamaica, Mr. Heath was reported by The New York Times to have been “as quick in his locomotion as in his operation.”

On the invention of the first ticker symbol, which was unreliable:

In 1867, Edward A. Calahan, a draftsman with the American Telegraph Company who previously worked as a messenger on Wall Street, unveiled the first stock ticker. The device, which earned its name from the unique sound it created, featured two wheels of type placed under a glass jar. The ticker printed off company names and stock prices on a narrow strip of paper, which was read aloud by a clerk.

Mr. Calahan’s machine was the first step in a major technological revolution of Wall Street, but it was also slow and unreliable. Twice a week, the batteries had to be filled with sulfuric acid, which was carried around in buckets. More important, the wheels of type would not always print in unison resulting in a mash of letters and numbers.

Catch up on the rest of the history lesson here.

The Knight Capital “Glitch”

Yesterday, The Knight Capital Group lost $440 million when it sold all the stocks it accidentally bought Wednesday morning because of a “computer glitch.” According to Dealbook:

The losses are greater than the company’s revenue in the second quarter of this year, when it brought in $289 million.

The company said the problems happened because of new trading software that had been installed. The event was the latest to draw attention to the potentially destabilizing effect of the computerized trading that has increasingly dominated the nation’s stock markets.

Until this week, Knight had been one of the biggest beneficiaries of the evolution of the market, helping clients trade in and out of stocks at high speeds.

The glitch occurred over a span of 45 minutes, during which Knight Capital lost $10 million per minute. The stock tumbled 30% yesterday and is down 60% today to a low of $2.75/share.

For a specific glance at the stocks that were affected yesterday, check out this blog post. The blog post begins appropriately “What follows should strike you as crazy. If it doesn’t, read it again, because it is.”

Incredible how much value can be wiped out in a company because someone on the High Frequency Trading desk didn’t do his/her homework.

Readings: Facebook MD, Trading, Rainbow Toad, Tweeting Birds, Dominion of Melchizedek

What I’ve read online today:

(1) “How Facebook Saved My Son’s Life” [Slate] – amazing story of how Facebook friends of one mother, Deborah Kogan, recognized symptoms of the rare Kawasaki disease in her young son, all while doctors missed the initial diagnosis…

(2) “How Hard Is It To Become the Michael Jordan of Trading?” [The Big Picture] – if you’ve ever wondered the statistics on what it takes to become a professional athlete, this post provides some numbers:

The talent pool gets much more competitive at the college level. The NCAA estimates approximately 3% of HS basketball players, and 6% of HS football and baseball players make an NCAA team.

If those number look daunting, the cut is far more challenging at the professional level. In basketball, only 1.2% of NCAA senior players get drafted by an NBA team. NFL drafts 1.7% of NCAA senior football players; Baseball holds the best odds, where 8.9% of NCAA baseball players will get drafted by a Major League Baseball club — but that includes minor league farm teams.

There’s a handy chart at the bottom of the post which summarizes the statistics. Now, what does it take to become an all-star trader?

(3) “After 8 Decades, Tiny Toad Resurfaces in Asia” [New York Times] – very cool discovery of the Borneo rainbow toad (click through to see the picture):

The Borneo rainbow toad, with its long spindly legs, looks a bit like an Abstract Expressionist canvas splattered in bright green, purple and red. But when this amphibian was last seen, in 1924, the painter Jackson Pollock was just 12, and the only image of the mysterious creature was a black-and-white sketch.

(4) “First Evidence that Birds Tweet Using Grammar” [New Scientist] – fascinating evidence suggests that birds tweet using proper grammar

First, they played finches unfamiliar songs repeatedly until the birds got used to them and stopped overreacting. Then they jumbled up syllables within each song and replayed these versions to the birds.

“What we found was unexpected…” The birds reacted to only one of the four jumbled versions, called SEQ2, as if they noticed it violated some rule of grammar, whereas the other three remixes didn’t. Almost 90 per cent of the birds tested responded in this way. “This indicates the existence of a specific rule in the sequential orderings of syllables in their songs, shared within the social community.”

(5) “The Strange Tale of Alleged Fraudster Pearlasia Gamboa” [San Francisco Weekly] – probably the most bizarre story I’ve read all week. It’s about the Dominion of Melchizedek, which, according to Wikipedia, is a micronation known for facilitating large scale banking fraud in many parts of the world. The SF Weekly story profiles its president, Pearlasia Gamboa, and her confessions.

The Dominion [of Melchizedek] eventually expanded beyond its underwater seat of government to claim more land: three more tiny Pacific islands and portions of Antarctica. After annexing its polar territory, the Dominion began listing among its senior officials a figure with the surname “Penguini,” a touch that a veteran California fraud investigator describes as “cute.”

What was the point of such a lovingly detailed fiction? The Dominion of Melchizedek, according to government authorities, was intended to act as a sort of mothership for con artists worldwide, issuing fake banking licenses, passports, and other documents to lend a veneer of official authenticity to fraud schemes. “Everything about it is phony,” says John Shockey, former head of the fraud unit for the U.S. Comptroller of the Currency.

A fascinating read.

Links of the Day (02/01/10)

Here’s what caught my attention today:

(1) “But Who’s Counting?” [Los Angeles Times] – a great op-ed in the Los Angeles Times on the confusion that journalists make between the number million and the number billion. The author goes into some theories on why this mistake occurs so often (or, at least, more often than it should occur). According to the author:

I did some calculations and found that The [Los Angeles] Times’ mistakes totaled about $1.4 trillion, or about twice the amount the U.S. spent on the TARP bailout. Our brethren at the New York Times did even worse, making 38 million-billion mistakes in the same three years. Oddly, they were far more likely to overstate the case, doing so almost one time in four. The total of all their errors was $6.5 trillion, or more than half the amount of the national debt.

It’s a very interesting piece, and perhaps the most reasonable explanation for this error is that our brain can’t comprehend the sense of scale between one million and one billion. If I told you that I have a million paper clips vs. a billion paper clips, would you be able to tell the difference in the volume the two occupy? Probably not. Also, can you visualize one billion dollars? I found this infographic helpful. Also of note is how vastly different one billion dollars is from one trillion dollars; see this telling infographic, for instance. In any case, the author of the op-ed has a dismal conclusion:

More diligence would probably have prevented many of our million-billion slips, but after observing The Times newsroom for decades, I can’t avoid the conclusion that our collective numeric literacy — like that of most of America — is appallingly low.

(2) “News Photos, on the Move, Make News” [New York Times] – The Magnum photo collection (a massive archive of over 180,000 images) is moving to a permanent, public display at the University of Texas at Austin.

(3) “Risks Lurk for ETF Investors” [Wall Street Journal] – a short, informative piece which describes the risks (liquidity, pricing) inherent in investing in certain ETFs.

(4) “Timeline of the LOST Universe” [New York Times] – this isn’t an article, but a wonderful interactive graphic which lets you discover when the events in the LOST universe have occurred. It’s a must-see for any fan of the show.