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 …