Simple Verity

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..