Simple Verity

October 9, 2012

More funding, less crowd: business credit scores for all

Here at SimpleVerity, we’ve recently made an important decision: we’re peeling off from the “crowdfunding” focus, in favor of a broader focus on business funding. I’d like to take a minute to explain our thinking.

Speaking in rough orders of magnitude, there are 50,000 angel deals per year, and 5,000 venture deals per year. Both of those are about $10-20 B annual capital flows. (These numbers swing pretty widely when there’s a bubble or a recession, but those are decent averages.) Heady stuff. There’s reason to believe that a mature crowdfunding ecosystem will rival the dollar size, and exceed the deal count, of either angel or VC.

But, in a critical item for consideration for us — crowdfunding is stuck in the regulatory mire. Some commentators on this very blog are of the opinion that it might never be fully realized under the 2012 JOBS Act as written. (We are somewhat more optimistic.) But it became clear as day over the course of summer 2012 that even the preliminary “stepping stones” to business crowdfunding — things like publicizing raises to accredited investors — were dangerous to depend upon as gatekeepers to earning our first dollar.

A company that’s a going concern, adding a new line of business, and can keep the lights on while waiting another month here, another quarter there — such a company could plan to serve that market. But not a bootstrapped startup needing that first dollar.

Furthermore, market size considerations struck home. Crowdfunding will get large, we think — though it could take a few years to mature. Where’s the money at today? Well, small-business bank lending along is on the order of $700 B in outstanding loans and lines. And trade credit — the name for when a business ships goods on “open account” and waits for payment in 30 days — is estimated to be 2-3x that number. So we figure that the dollar volume affected by small-business credit reporting has what we like to call a “T-handle” on it.

We’re clear about our core values: we’re data and finance guys, we hate unnecessary complexity, and we love small businesses. So we knew we wanted to stay focused on providing data services that help small companies get financing. That’s why we feel strongly about our current direction: building meaningful business credit reports for the “Fortune five million.”

There’s a lot more to it, which will come out over the next weeks and months. But we hope you’ll stay tuned to SimpleVerity as we move towards more funding (but less crowd). And for our friends who are pioneering in the crowdfunding space, bon courage! We hope to see you again in a prosperous future.

July 30, 2012

How to Verify Accredited Investor Status: A Proposal

In this post I examine some of the issues with verifying accredited investor status (net worth or income) for purposes of a Reg D, Rule 506 offering. The viewpoint I take is strictly a pragmatic one: how can the industry and regulators get a workable solution in place that gets the job done?

Note: this post addresses the new, higher standard for checking accredited investor status in cases of general solicitation or general advertising in Title II of the JOBS Act. It is my understanding that in cases without general solicitation, the higher verification standard, and hence, the following post, will not apply.

1. Being “certain” is too hard, and overshoots the goal.

The gold standard for checking income is to verify against tax returns. There are several problems, though, with requiring tax returns: it is intrusive, somewhat costly, and also fails in several cases (for example, when someone has a large Schedule C “paper loss” they might seem not to meet the threshold, despite having plenty of cash income).

There really is no gold standard for checking net assets, except an audit-type inquiry (verifying assets is somewhat easier, but verifying the absence of liabilities is impossible). Other methods shy of an audit include an accountant’s letter or a self-provided balance sheet, all of which are intrusive and time-consuming (and, due to the uncertain value of illiquid assets like business holdings or partnership interests, hardly conclusive).

Besides, the verbatim text of the law doesn’t require being certain, or even mostly certain. It merely requires that the issuer “take reasonable steps to verify.” So we should set aside the “gold standard” methods and see what lesser steps can still give a “reasonable” assurance that the investor is accredited.

2. Just taking “reps & warranties” doesn’t achieve the goal.

However, you can’t just take the investor’s word for it with a perfunctory “check the box.” Why not? Two reasons, both based on the law itself.

First, the text clearly requires a higher standard. The previous standard was that an issuer must have a “reasonable belief,” whereas the new standard (in cases of general solicitation) is that an issuer must “take reasonable steps.” If someone tells you “I am accredited,” and you have a general belief in their trustworthiness, you can today claim a “reasonable belief” even though you’ve taken no steps to verify that. But, obviously, that mere belief is no longer sufficient, unless you take further steps.

Second, the clear intent of the Congress is a trade-off: loosen the strictures around advertising and general solicitation, but in return, tighten the requirement for accreditation. And that makes sense; after all, permitting general solicitation but requiring only a rep & warranty about accreditation would be equivalent to dismissing the accreditation requirement wholesale with a wink and a nudge.

3. What characteristics would an ideal solution have?

You might think a perfect solution would never let a single unaccredited investor slip through the cracks, but I suggest that would be overkill. Why? Even if you think the accredited investor standard is meant primarily to protect “widows and orphans” (and there is reason to think not), it only applies to a particular exemption from registration. Scammers are still free to push registered securities which may be risky or worthless onto unaccredited investors. So, in an echo of the adage about running faster than a grizzly bear (don’t need to do it; only need to run faster than your hiking buddy), you need not “catch” every single unaccredited investor, only raise the bar enough to discourage issuers from pursuing unaccredited persons.

A succinct way to describe the ideal, therefore, is this: an ideal process for verification of accredited investor status need only be sensitive enough to make it uneconomical for issuers to target unaccredited investors.

A corollary is this: an ideal process for verification should never exclude a bona fide accredited investor.

A process that has these two characteristics should satisfy regulators (by creating an economic, as well as regulatory, disincentive for lawbreaking) and the industry (by ensuring that capital formation isn’t stopped).

4. What process fulfills these requirements?

My proposal is one of “reasonable escalation.”

(Full disclosure: my company, SimpleVerity, sells a service offering that is capable of the following.)

Begin with self-reporting and the assumption of truth: presume that an investor is accurately describing his income or net assets, and that we merely need some according external evidence. Then, begin conducting progressively more intensive steps, only as needed.

If an issuer conducts some passive external verification which concurs with the self-report, we have success. Such passive external verification might be a statistical model (based on e.g. zip code, profession, age, etc.) or it might be a personal data profile (based on e.g. land holdings, public records of stock holdings, etc.). “Passive” here means that the lookup can be performed with only the directory information already provided by the investor. Both of these types of verification are commercially available, and a record of having done either type of check with a concurring result would be a “reasonable step.”

Otherwise, if a passive external verification cannot be found to agree with the self-report, a second stage of escalation may occur. In the second stage, the investor provides documentation, such as tax returns or a personal balance sheet, and if it concurs with the self-report, we have success. Although this will involve more expense and hassle than a passive lookup, this documentary verification, too, can be streamlined and automated.

Finally, if neither passive verification nor documentary verification are successful, the door remains open for the issuer to conduct its own non-standard, individualized diligence. Since this is the least streamlined and automated, it will be used most sparingly. However, it need not be particularly burdensome if the investor’s status is easy to establish.

For example, let us imagine that the Sultan of Brunei offers to invest in a startup. It is unlikely that he will have been established in the databases consulted by passive verification, and he may justifiably not want to be bothered with submitting a tax return. In this case, the issuer may simply look in the annual list of the Forbes 400 in order to take a “reasonable step.”

(I also suggest that SEC should allow issuers to fall back on an “actual” standard in order to preserve their Reg D exemption in the absence of taking “reasonable steps.” In other words, if you don’t take reasonable steps, but your investor turns out actually to be accredited, you are OK.)

5. How and how much?

How can such a regime of “reasonable escalation” be implemented, and how much would it cost?

First off, intermediaries should handle this for issuers. Although the law places the burden on the issuer, verification will be something an issuer does perhaps once, ever, while it is will be a standard part of all Reg D, generally-solicited deals an intermediary conducts.

The intermediary would then either run its own process in-house, or contract out to a third party (like SimpleVerity). The choice will probably depend upon the nature of the intermediary entity. If the intermediary is a broker-dealer who is distributing shares to its network of clients with whom it has a deeper relationship (and hence financial knowledge), it will probably want to handle verification in-house. If the intermediary is not a broker-dealer, it will probably want to contract out the verification.

For a third party verifier, the favored approach will probably be to use an API integration, whereby the intermediary first passively queries, and escalates the interaction as needed.

Regarding costs, Joseph Bartlett of Sullivan & Worcester speculated that verification could cost as much as $500 per investor.

That price point would have some pretty serious effects — for the worse — on who could use Reg D and how. However, we believe the costs could be radically lower, by perhaps an order of magnitude, if a “reasonable escalation” standard is established, and once volume and competition are established.

6. Conclusion

SEC should strongly consider a “reasonable escalation” standard, and build in a safe harbor for verifications conducted in this manner.

SEC should not assume that the problem is intractable or will not yield to technology or business process; intermediaries should be free to choose methods and vendors to solve the problem. SimpleVerity, among others, stand ready to provide this service.

Furthermore, and contrary to some public commentary to the contrary, SEC should extend the safe harbor to the entire offering’s exemption; that is, if every investor was verified as accredited according to the safe harbor, but one unaccredited investor slips through, that should not jeopardize an otherwise exempt offering.

2 comments

July 6, 2012

Announcing SimpleVerity

Today we’re pleased to announce the name we’ll be going to market with: SimpleVerity.

We think the name SimpleVerity — quite simply — conveys the core of our vision: it should be simple and fast for all parties to a funding transaction to verify the basic facts.

Those of you among our partners and potential customers who’ve helped review names — thank you. Consider this our promise to you to make getting deals done as simple, trustworthy, and straightforward as possible.

We are also indebted to some brands and companies we respect: no, we’re not the love-child of SimplyMeasured and BrandVerity In seriousness, though, we do love their straightforward approach to branding and marketing (maybe it’s something in the water up here in Seattle).

We will fondly remember the name “Applied Dynamite” — because we’re still concentrating powerful forces to break through the barriers that hinder funding. But expect to see the name SimpleVerity more and more in the world of crowdfunding, online intermediaries, and specialty finance.

(And for the legal eagles: SimpleVerity™ is a trademark of Simple Verity Inc.)

June 12, 2012

Ten Things You Can’t Do With Crowdfunding Investment

This post was inspired by a throwaway line in the comments on this Cringely blog post — the comment suggested that folks would “lose their life savings” with crowdfunding. Of course, that’s impossible, which inspired this list of ten things you can’t do:

1. You can’t lose your life savings.

Well, you can, if all you have is $2,000. But otherwise, you will have to lose your life savings over at least 10 years, because you’re limited to investing 10% of your net worth (OK, the true calculation is slightly more intricate).

The law is quite strict about per-investor dollar limits, and both the regulators and the industry are under intense pressure to see to it that the limits are adhered to. Nobody is going to “lose his life savings” on one drunken crowdfunding investment spree.

2. You can’t get railroaded or boiler-roomed.

The old way of pushing stock onto people was with teams of brokers on the phones — a “boiler room.” Get enough hungry, amped-up, over-aggressive d-bags working the phones and you can “convince” some quantum of the market of anything. (By the way, they do this with other things too; I once got a very amusing boiler-room call — complete with escalation to a “closer” — selling SEO services.)

In Crowdfunding, there’s going to be *all kinds* of opportunities and mechanisms for backing out of deals. Nobody’s going to “slip up” and accidentally fund a company. Everything is going to be tracked and logged, and shenanigans on the part of a funding portal will be caught in very short order.

3. You can’t invest in the next Facebook.

Sorry. The guys who are going to become super-mega-successful tend, first, to become merely very successful. And when they do, they will find that “premium” investors — angels, VCs, etc. — will continue to welcome them with open arms, just as they always have. Furthermore, those startups that aren’t yet even just “very successful” — but which have the right pedigree — will probably be funded by old-line sources.

As a corollary to #3 …

4. You can’t “compete with the VCs.”

Anyone who *can* raise a Series A round from VCs would be foolish to raise a (probably smaller) Crowdfunding / 4(6) equity round. It’s insanity to think that this “levels the playing field.” VCs don’t even “compete” with other VCs on price and terms (in the vast majority of cases) — they compete based upon reputation, personality/fit, and other non-financial “value-add.”

Crowdfunding issues will be viewed early on as “negative-value-add” because of the extra uncertainties they bring, meaning that no VC-fundable company will eschew VC for crowdfunding.

5. You can’t expect to get “rich.”

Genentech was the “fund maker” for Kleiner
Perkins back in the 1980s, and it returned something like an 80x (I’m going
from memory). That’s great, but it’s not going to change your social class
and your lifestyle, based on a $2,000 investment. Even the very best venture
investment of maybe all time, Teh Googlez, posted around a 420x return for its
first investors. In other words, you’d have to pick the very best
crowdfunding investment of all time — not just the “Google of crowdfunding,”
but actually Google — to make a $1 M return from your $2,000.

So: make a good return? Yes. But, “get rich?” Sorry.

That said, if you want to get those good returns …

6. You can’t ignore non-equity deals.

Nobody’s talking about it, but the best returns in crowdfunding, on a risk-adjusted basis, are likely to be OUTSIDE of the realm of equity (stock) sales.

There’s a gigantic gap in the funding market for small businesses between the extreme safety that banks require (anywhere from 3.0% to 0.25% expected loss) and the extreme risk of equity investing. Think “extra-junky junk bonds.” These instruments could yield 10%, 15%, or 20%, and still be a good deal for both parties.

7. You can’t expect to be treated like an “investor.”

This will rankle some hides, I’m sure. But as a crowdfunding investor, you’re much more like, say, a member of a credit union, rather than a Warren Buffett. The private equity Investors’ role is, in many ways, cushy and desirable, due to the power that comes with controlling a large chunk of capital. You won’t get that. Don’t expect to have the CEO answering your phone calls, or to be diving into financial statements with the accountant. That’s not realistic. You should, however, expect to be treated fairly *as a group* with your fellow investors.

8. You can’t ignore your co-investors.

It will be very important — in crowdfunding as in any private investing — to get to know and get aligned with your co-investors. Why, do you ask? Simply as a corollary of #7 above: any single individual won’t be sufficiently influential in the round to exert the sometimes crucial influence needed to protect the investment. It’s likely that some form of group voting will be necessary at some point (and, unfortunately, those necessary points often have to do with downside protection). Making sure you at least have some ability to influence your co-investors to do the right thing can help you cover your backside when you most need it.

9. You can’t take the lawyers all that seriously (for a year).

With due respect to our lawyer friends, most every legal eagle who’s taken note of crowdfunding comes from the securities law field. And, by necessity, anyone who’s been practicing securities law is beholden to the old ways of doing things. After all: a securities lawyer has been getting paid by doing legal (one hopes) securities transactions, and crowdfunding has heretofore not been legal.

For the first year or so, then, we can expect the lawyers to be super-skittish about crowdfunding. To them, it won’t be worth the trouble, and in a way they’re right: there’ll continue to be plenty of money to be made facilitating legacy securities transactions, and crowdfunding will, early on, bring only uncertainty to their lives.

(After a year or so, the lawyers will start to ease into it.)

10. You can’t ignore crowdfunding’s potential.

Given the mix of positives and negatives I’ve described in this list of “can’ts,” the reader might be forgiven for harboring some doubts about crowdfunding. How big of a deal can this weird, misunderstood, and yet-to-unfold corner of securities law actually ever *be?*

The fact is, it could be huge and transformative. The big picture here isn’t how to make a smaller, adversely-selected, less-pedigreed clone of the angel/VC world. The big picture is using technology to enable extremely cheap and relatively fast issuance of any kind of security, the most interesting of which haven’t even been invented yet.

For example: I desperately want to see a company appear to let amateur inventors pitch micro-investors on the chance to help fund their patents. Such a company wouldn’t just be contributing to the wealth of inventors and investors — it would actually be encouraging more and better invention. Today? Illegal.

Until we have the legal framework and the technological ecosystem in place, it’s impossible to predict exactly what will spring up. Looking at equity crowdfunding and thinking that’s the whole picture would be like looking at an physics paper marked up in some weird thing called “HTML” back in the early ’90s and thinking physics papers are the whole picture.

Later: what you can and *should* do with crowdfunding..

2 comments

May 23, 2012

How to steal $1 million with crowdfunding: Part I

(Although there are lots of ways to be a crook with crowdfunding, this Part I will focus on the Big Con. That is, how do you raise as much as possible in one go, by means of a confidence game that gets investors to willingly part with their cash, rather than something technical, like a hacker attack or money-laundering scheme, which we will address in future parts. The reader will kindly indulge the use of the first-person as a literary device: our purpose is, of course, to think a step ahead of where the bad guys are likely to try and go.)

—

Part I: The Big Con

We can rely on a time-honored formula for con games: they all have a few elements in common, which we can identify here:

The hook.
The mark.
The come-on.
The touch.
The cool-out.

The hook.

All great cons appeal to the baser instincts of the victims: particularly, greed and pride (though the skillful con man can often recruit envy, lust, and sloth as additional tools). We do it with the backstory and the offering, or the “hook.”

The hook must appeal to a sense of greed: outsized returns. And it must stoke pride: the hook resonates with the mark’s desire to be important and “in the know;” it explains why he is going to get such great returns in terms of his own imagined merit. Mining and technological innovations are good standbys, especially if they seem easily comprehended but their supposed mechanism of action is not.

Our hook will be about a garage-based scientist who’s come up with a means to increase cut gasoline costs by 80% by using some quantum-mechanical mumbo-jumbo. It’ll be important that nobody can challenge our science, so we’ll want to monopolize the communications to the mark, or else bury any challenges beneath heaps of boilerplate disclosures.

The mark.

While the old-school “long con” relies on capturing a single whale and wringing him out of as much as possible, the nature of the crowdfunding con means we need volume. Lots of minnows, or at least, say, halibut.

A good con man finds a group whose members are statistically or systematically easier than average targets. The elderly are traditional favorites, as are affinity groups (often tight-knit religious or ethnic communities, where you can exploit bonds of trust).

Another method is time-honored: lists of marks from other con men. It’s well know that you can go “back to the well” with a good mark over and over again. (We’ll want to make sure that every sucker who falls for this con makes our short list — complete with email address and financial details — for when we lather, rinse, and repeat.)

Our marks will be a bit of both: given the bait on our hook (quasi-scientific gasoline-saving), we’ll target the affinity group of environmentalists, especially “peak-oil” folks. The nature of the hook will play to these marks’ pride, confirming their prejudices about oil companies and the environment, plus, they have kindly self-identified into groups where mailing and phone lists will be easy to find.

The come-on.

While a legitimate crowdfunding deal requires the business that’s raising funds to reach out to its customers, fans, and community, that will be a problem with our con: after all, there’s no “there” there. (The hook is, after all, just a story, perhaps with a nice YouTube video and some fancy looking graphs to go along with it.)

For part of our job, we can get the marks themselves to help: the “true believers” will gladly evangelize the hook to their (Facebook?) friends.

But the real problem is that the Web is a terrible way to create new true believers. For that, we need to press the flesh, or at least the eardrums, and so we’ll turn to the time-honored method: the boiler room of shady phone operators.

We’ll buy a phone list of Sierra Club-types, and start dialing for dollars. The come-on certainly won’t be a straightforward pitch, though: the best come-on is that which stokes the “little larceny” in the heart of the mark.

Our operators’ story will be that they, too, are peak-oil enviros, and that we’ve been given an inside track: the Sierra Club is secretly planning to buy 2 million units for its members next year. (We might even have a PDF of the signed contract we could send you, if you give us your email address.)

The company needs money to build the first production run — the factory we’ve contracted with in China is tooled and ready, but demands payment — but the big Wall Street banks are in the pockets of Big Oil and are refusing to extend credit. This will let our marks both feel like they’re getting the best of it, while at the same time stoking a do-gooder glow in their cockles.

The touch.

Getting the money — taking off the touch — is the crucial (if not quite final) element in any big con. We’ll need the help of an intermediary, a crowdfunding portal, in order to seal the deal and get paid.

It’s unlikely we’ll get an out-and-out crooked funding portal to help us directly; after all, even the shadiest pawn shop won’t actually help you to burgle. Rather, we’ll want to look for a funding portal whose operators are an nice balance of lazy and stupid. We’ll want them to have an obvious, and obviously lax, process for vetting the issuers.

Since we want to identify the suckers, we’ll want a portal that tells us exactly who invested, along with how much, and their contact info. (This will let us keep drawing from the well.) They’ll also be too slapdash to keep up with any kind of centralized list of fraudsters, or of vulnerable potential investors (e.g. elderly or disabled folks whose families put them on a no-invest list).

(It would be too much to hope for, that the funding portal would allow us, or our favored bank, to handle the money transfers (or collect checks) directly … the implications send a con man into a reverie of larceny.)

We’d love it if they are so cowed by the regulators and lawyers that they won’t take a stand on any question about the deal. In fact, they shouldn’t even allow users to chime in and share meaningful due diligence work, for fear of passing along “investment advice.”

We’ll prefer a portal that lets us keep “negative votes” hidden (or which was too lazy or stupid to allow negative voting). We want to control that communications channel, strictly.

And finally, we’d love it if the slothly dullards at our funding portal of choice turned a blind eye to how our marks arrive there. (Square businesses might be sending email solicitations to a customer list, but our boiler-room operators will be tuning in marks to type-in a redirected URL, most likely.)

For this privilege, we’d be happy to pay a hefty fee (at least the going market rate). We’d delight in the longevity of this funding portal; nothing would suit the con better than if the portal’s (self-)regulators were just as dull.

The cool-out.

Traditionally, the cool-out required scaring or shaming the mark into taking his lumps, and not going to the cops — although a con man of great finesse will leave the mark not even realizing that he’s been conned.

The beautiful thing about the equity crowdfunding con is that the “cool-out” is already taken care of: everybody knows most startups fail. Our fake-fuel-economy device has a great built-in narrative as well: the machinations of the oil majors, or their allies on Wall Street, can always be pointed to as reasons for the failure. The real suckers we can always go back and fleece again (maybe even with the same game).

But there’s always a squeaky wheel: someone, somewhere, threatening a lawsuit. Since we’ll probably have to put forth legitimate, clean identities (with social security numbers, etc.) to run a single con, we’ll make sure that those identities are not only clean, but judgment-proof (no real assets to seize) and that the company itself dumps the cash offshore as soon as it reasonably can (perhaps that Chinese contract manufacturer gets paid in a lump sum?). The lawyers will circle over a gutted corpse of a company.

The first couple times around, we’ll use the identities of girlfriends, nephews, and low-level members of our confidence team. But those will get burnt quickly, so we’ll probably end up buying new identities from Russian hackers for each successive go-round. When those identities get sued, the trail will dry up.

Total time: perhaps 3 months from inception to cash. Team size: two key men, plus a crooked assistant or two (and a solid 15 or 20 hired guns who can work the phones for a month during the come-on phase). Portal expenses, bogus company incorporation work, and hired guns’ share will probably come to $200-250k; that gives our crooked principals a solid $375-400k a piece. Not bad for a quarter’s work.

Lather, rinse, repeat.

—

Later: Part II

May 17, 2012

Top Ten Irrelevant Statements About Crowdfunding

Late last night I got an email from a banker friend of mine, with a link. In the email, he says (paraphrasing), “if this guy is right about crowdfunding, aren’t you nuts to be targeting that industry?”

All this fun was kicked off last night when Andrew Ledbetter, of business law powerhouse DLA Piper, published a provocative “Top 10 Reasons to Avoid Crowdfunding” post on Asher Bearman and Megan Muir’s blog, “The Venture Alley.”

Now, DLA is a fine firm, and I have friends and former colleagues there to this day. Ledbetter, what’s more, has given us a well-reasoned, readable outline of the skeptical attorney’s perspective.

The problem is, that perspective is so off the mark that it’s not even wrong.

Ledbetter makes ten bullet points in his post, but they reduce down to three grand errors in his vision. I call them “Who moved my cheese,” “Let them eat cake,” and “Five computers should do it.”

—

“Who moved my cheese?” (Regulatory enforcement likely; No “backup” exemptions.)

This is the objection that, essentially, the new law is merely different from the old law, and therefore the new regime will be unfamiliar to lawyers (and everybody else). Well, duh.

“Let them eat cake.” (Limits M&A exits; Civil suits likely; Limits future financings; Foreseeable optics problems.)

Like Marie Antoinette’s suggestion of brioche for the starving masses, this is the idea that companies who fundraise via crowdfunding will expect to be treated like kid-glove, VC-financed darlings. But VC is Pan Am in the 1960s, while Crowdfunding is going to be Southwest Airlines in the 1990s, so fretting about what kind of Champagne will be served in first class just doesn’t make sense.

“Five computers should do it.” (Expensive to use; Administrative hassle; Not currently usable; Selling unusual securities.)

The head of IBM famously (if apocryphally) suggested that the world market for computers was “about five” — and given the price and size of those things, he was probably right for a while. But markets and competition have a beautiful side-effect of squeezing out costs and delays, so concerns that crowdfunding will be expensive or a hassle are misplaced.

—

Ledbetter wraps up with a very lawyerly conclusion: he urges caution and careful consideration. But if you take his ten bullet points at face value (and unbalanced by any other arguments), you can only come away thinking that C.F. only stands for Cluster F***.

But those ten points are so far off the mark of what really matters, they aren’t even properly wrong. They’re just irrelevant. The people and companies who will use for-profit crowdfunding are, for better or worse, today:

raising dubiously legal friends-and-family rounds;
hemorrhaging cash to advisors, lawyers, brokers, and facilitators to find legal sources of capital;
paying jaw-dropping rates to specialty finance companies; or
just not raising capital at all.

They already are at risk of civil suits. They already lack “backup” exemptions. They are already dumbfounded at the expense and administrative hassle when they try to do it “right.” And if they try to do it on the cheap, they are closing off whatever slim chance they might have had at future “legit” rounds.

So Ledbetter can apply his ten points to a potential Splunk or Redfin or Etsy, and he’ll be completely on target — they should indeed steer clear. But the world of issuers under the new crowdfunding law is like a different dimension, a parallel universe where his ten points go off completely orthogonal to the target.

—

The important thing here isn’t to rag on Andrew Ledbetter, nor to claim that crowdfunding is a panacea or a paradise. Far from it. In fact, I can almost guarantee you that if crowdfunding “works,” it will be used by issuers who are, on average and as compared to VC/angel funded companies today:

in less prestigious industries;
in less prestigious ZIP codes;
pursuing smaller markets, with lower gross margins;
more likely to be managed by entrepreneurs who are non-white and/or non-college-educated;
more likely, as individual businesses, to wipe out (return zero); and,
less likely to have an IPO.

That’s right, I’ve said it: the “unfundable” companies of today are the target market for crowdfunding. (Some might later become “fundable” … because a certain magic happens when even a non-prestigious company starts minting enough money: white-shoe private equity guys suddenly decide they like … waste management companies, or whatever)

This same pattern happens time and time again. The “gold standard” way of doing things is expensive, fraught with regulation, and lubricated with healthy doses of cash and professional services. Then, an innovation occurs, sparked by technology, business process, or regulatory change, and the new way of doing things is “worse but cheaper.”

“Worse but cheaper:” What do you mean there’s no first class on this flight? What do you mean this hard disk drive will fail within a year? What do you mean this flimsy cassette only has two tracks instead of eight? (Sometimes “cheaper” isn’t about the price, but about the convenience or the availability: What do you mean I check these groceries out myself without a cashier?)

At first, the new way is dismissed as a joke or as infeasible. Then, as it’s adopted by a few, it gets viewed as a niche or a fringe phenomenon. But as (and if) it catches on, the scale it achieves forces efficiencies (of time and money) into the process, until it becomes radically cheaper and easier than the old “gold standard,” which it soon replaces.

(This isn’t my idea, by any means. All thanks are due to Clay Christensen who calls this general idea “disruption.”)

Look, there are plenty of reasons why crowdfunding may die on the vine. It could get regulated to death; it could be enacted at the beginning of a prolonged, decades-long Japan-style deflationary recession; or, it could fail to attract smart enough, aggressive enough entrepreneurs.

(This last point is really important. The market for for-profit crowdfunding will by tiny at first, and entrepreneurs will have to be some combination of extremely patient, lucky, foolhardy, and passionate about the sector to wade through the red tape. William Carleton makes a great point about the passions and ambitions of folks entering this sector.)

But for Ledbetter to knock crowdfunding because it’s “worse but cheaper” (or, perhaps, “worse but easier”) misses the boat by a mile. Paging Dr. Christensen …

7 comments

May 14, 2012

Explosives, APIs, and Crowdfunding: hello from Applied Dynamite

The first half of 2012 has been full of amazing news for the entrepreneurs, dreamers, and builders who drive our startup economy, but the best is yet to come.

At the very highest of ends, we’re seeing IPOs get “out the door” after a long drought. Whether that’s Splunk (SPLK), Yelp (YELP), or Zuckerberg’s own Leviathan — those listings are great news for employees and investors. Perhaps most importantly, these IPOs will stimulate more activity all the way down the line to raw startups.

At the very bottom end of pre-startups, there’s news, too: Kickstarter has enabled $150 M in donation-based crowdfunding. That’s found money for the visionaries from filmmakers to watchmakers, and most importantly it proves that we /can/ use the Web to team up to raise capital for charity and entertainment.

But these are lagging indicators. What excites us most at Applied Dynamite is what is on the cusp of emerging: a thriving, fundamentally disruptive, Web-based ecosystem for raising capital for businesses. Most are calling it “crowdfunding.” Two years ago I called it “Capital-as-a-Service.” Now at AppDyn, we call it “about time.”

The game is afoot — whether it’s making the all-important connections among players (AngelList, FundingPost), facilitating the financial exchanges that make the risk worth the reward (SecondMarket, SharesPost), or creating the targeted niches (CircleUp) that will be tomorrow’s equivalent of the Buttonwood Tree or The Pit.

So what on earth does a tiny startup with a name like a demolition company — and two geeks at the intersection of finance and big data — have to do with any of this?

In a phrase: Applied Dynamite is 100% focused on the back-end data services that enable crowdfunding.

“But crowdfunding is about people — about passion — about cutting out middlemen,” you cry. “What ‘data services’ could we possibly need?”

Well, we’ll all want to know who the “good guys” are, and make it easy for them to play. We’ll also want to keep out the “bad guys,” as we build up the industry. We all need to keep track of the limits in the laws and the contracts, and we all want to stay out of jail while we do it.

For the past 100 years, this function has been done by men in suits — handsome men in silky gabardines (I-Bankers) and dour men in worsteds (lawyers). We love our lawyers, but you can’t rely on the old ways of doing things when you’re processing investments of only $100 or $1000 a pop — they could barely pay for dry-cleaning with the pro-rata fees that would generate.

The only way we (as a crowdfunding ecosystem) can make this work is by radically crushing down the prices, and radically automating the processes. So call it blowing up barriers, or demolishing red tape — what we do at Applied Dynamite is ruthlessly hammer down the prices and process into something manageable, so that the companies, investors, and matchmakers of crowdfunding can get the job done.

In engineering, you don’t need tons of explosives to accomplish an amazing amount. What you need is to shape your charges so as to focus the force. Our focus at AppDyn is clear: enable crowdfunding to happen, by providing the data services needed.

So, hello world, from Applied Dynamite! Go forth and (crowd)fund! And when you hit a barrier, whether it’s background checks on promoters, or investor accreditation checks, or annual limits — call in the shaped charges at Applied Dynamite

2 comments

Follow “Simple Verity”