The federal government doesn’t like to be pushed to try new things. Agencies like to push the market. They hate it when the market pushes back. Crowdfunding is just that.
Seal of the U.S. SEC
The SEC is regulating crowdfunding heavily out of fear. The SEC fears fraud. The SEC fears failure. Unfortunately, this is something that is impossible to be regulated out of the market by a government agency. The participants of the crowd have to take care of it.
Proposed new rules require that funding portals register with the Securities and Exchange Commission and the Financial Intermediary Regulatory Authority. In addition, investors must have access to a business plan, use of proceeds, a valuation of the company, and financials, so Certified Public Accountants may be needed. The SEC estimates that for amounts under $100,000, the fees will be 12.9% to 39% of the money raised, though it may drop to under 8% for higher amounts
Crowdfunding is the free market. It is amoeba like. Groups of people come together on their own terms to fund something that they believe in. It doesn’t matter why they are writing the check. Almost every deal is unique. The crowd changes and rolls and remixes constantly. Crowdfunding is based on Coase Theorem and Game Theory.
It doesn’t matter if crowdfunding is considered “good” or “bad”. Transparency and information flow are key. It should be supported if the people engaged in funding are going in with their eyes open and are free to choose what they do with their money. The SEC is just Big Brother coming in to throw its weight around where it shouldn’t. More regulatory over reach.
The best way to support crowdfunding is not with regulation. It’s with transparency. Information is the best way. If there are “sheisters” that are trying to raise money, it’s up to the crowd to call them out. If enough scoundrels get in the game, crowdfunding will die. If enough investors get burned and are honest about it, crowdfunding will die.
Crowdfunding platforms can have clear, transparent, and open standards, just like a well run exchange that every one can see. Companies or projects are listed there based on those standards. The potential projects become a curated community.
The other thing I have noticed in crowdfunding is that it’s quickly becoming very Bayesian among investors. For example, if I get a notice from a crowdfunding platform like Angellist that a big name investor is investing in a company, then the probability is higher for that company to get their round filled. It’s the opposite for a company that has no name investors. People are naturally followers and investors are no different.
Name investors have an effect on curating deals. This isn’t a lot different than what I witnessed for 25 years in a commodity trading pit. When bigger traders took a position, other traders tried to follow them into the trade. In trading, it’s a lot harder because unless you know the traders exact position, you don’t know if they are getting in or out. Angel investing is linear. Anytime a check is written they are getting in. When there is a publicized exit, you know they are out.
At commodity exchanges, trading was ruled by Rule 514. It was two pages long. It covered around 8-10 points. It was up to the crowd in individual pits to use peer pressure to enforce the rule. Some pits had different interpretations of certain finer points of the rule. But, the core principles were unchanged from pit to pit. Crowdfunding is very similar.
Does it matter to me if a CPA has looked at the deal or not? No, because in startups the numbers rarely make sense anyway. Does it matter if they have a business plan or not? No, because most business plans at an early stage don’t work out anyway. What about valuation and use of proceeds? It’s up to me as the individual investor to make sure they are using the money for the appropriate things. We establish a board of directors to assure that happens. As far as valuation goes, that is always in flux. I have been involved in financing where the valuation changes as interest comes in. Valuation isn’t hard and fast, and is more about supply and demand than wrote multiples of revenue or net income.
The SEC regulations won’t propel crowdfunding to new heights. It will kill it.
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