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The Wild Wild West of Startup Crowdfunding

WildWildWest

Editor’s Note: This article is a revised version of an article that appears in the May 2012 issue of The Social Media Monthly. If you like it, you might want to download The Social Media Monthly iPad app or iPhone app and subscribeor order a print subscription.

If you believe the naysayers, 2013 will usher in an age of snake-oil salesmen masquerading as high-tech startups and duping ignorant investors. Real startups will become bloated with funding, another tech bubble will burst, and we’ll all lose a boatload of money.

And, as usual, it’s Congress’s fault – this time, for not bickering enough. In March, both the House and the Senate passed versions of the JOBS Act with bipartisan support, opening up a new avenue of funding for entrepreneurs: crowdfunding. Crowdfunding allows businesses to raise money from non-accredited investors – i.e., you and me, not just venture capitalists or angels. (To be an accredited investor, you must make over $200,000 per year or have a net worth of over $1 million, excluding your primary residence.) President Obama signed the JOBS Act with a flourish on April 5, giving the Securities and Exchange Commission (SEC) 270 days to collect comments and detail the rules around crowdfunding – although the SEC will likely miss that deadline.

The JOBS Act includes provisions about general solicitation, shareholder caps, and IPOs, but crowdfunding is the core. Startups can raise up to $1 million per year through SEC-approved platforms, with limitations: individuals can contribute 10 percent of their income up to $100,000 (if you make or have a net worth of $100,000 or more), while those of us with under $100,000 can contribute $2,000 or 5 percent of our income (whichever is higher).

Which companies will be affected the most?

Startups outside the in crowd. Many crowdfunding critics claim that it’s easy to raise money for a solid idea, but they may have a skewed perspective. According to Thomson Reuters data from a National Venture Capital Association report, investment in Silicon Valley was nearly 12 times more than in 17 other US regions in 2011 (on average). “Access to capital is not as broadly dispersed around the nation as it should be,” said Startup America chairman and crowdfunding advocate Steve Case, days before the act was signed.

And even within Silicon Valley, the investment doors are often closed to startups without the right connections. Silicon Valley “kingmaker” and VC Jeff Clavier separates pitches into three tiers: “We have a huge pile – we get 200 to 300 opportunities per month, roughly. And so the cold emails go at the bottom,” he explained matter-of-factly. But an introduction won’t necessarily get you on top: that only happens when the referrer knows the startup well, Clavier told me. So entrepreneurs can either spend weeks networking and building relationships with a VC’s friends, or sign up for crowdfunding and focus on the important stuff: building a stellar product and team. They will, however, miss out on the mentorship many angels and VCs offer.

Startups expecting modest returns. Clavier also explained that his firm passes on deals where they don’t expect to make 10 times the money invested. This is typical of venture capital firms, which have to balance out the failure of most portfolio companies. On the other hand, individual investors can benefit from startups paying out a little extra cash under crowdfunding. And traditional retailers – like small shops or restaurants – can use it to raise some capital, get off the ground, and create a few jobs.

Startups who want better funding terms. By opening up new sources of funding, the JOBS Act creates more competition among investors and, thus, sweeter deals for startups. But that doesn’t just mean bigger investments; it also means better terms: more control for founders and fewer restrictions on future rounds of funding.

As for those shadier, snake-oil investments, we should trust in other entrepreneurs to find a solution. And they’ve already begun: crowdsourcing.org has set up Crowdfunding Accreditation for Platform Standards, or CAPS: a system that gives accreditation to crowdfunding platforms for protecting investors and startups. Criteria include transparency and security, and will be reviewed annually. So far, a handful of platforms have already been accredited, including Grow VC, FundRazr, Crowdcube, and Crowdfunder. CAPS is part of the new CrowdFund Intermediary Regulatory Authority, a leadership group that plans to help the crowdfunding industry self-regulate.

Other platforms are getting a head start: WeFunder, for example, is already signing up “crowd investors.” AngelList, the go-to platform for tech entrepreneurs to meet investors, could take the lead if it decides to handle transactions. And an incubation program called Story Stock Exchange is launching to mentor startups and incorporate crowdfunding.

But beyond these initiatives, which entrepreneurs will hone and refine and iterate upon – beyond the back-and-forth about whether crowdfunding will spell disaster or opportunity, doom or boon – is the simple truth that preventing regular people from investing goes against the spirit of entrepreneurship.

Investment regulations are rooted in the Securities Act of 1933, which was put in place after the stock market crash to protect investors – and the economy – from undue risk. But that was a time of fear, whereas entrepreneurship is about opportunity.

“One of the great things about America is that we are a nation of doers – not just talkers, but doers,” said President Obama, before signing the JOBS Act. “We think big. We take risks. And we believe that anyone with a solid plan and a willingness to work hard can turn even the most improbable idea into a successful business. So ours is a legacy of Edisons and Graham Bells, Fords and Boeings, of Googles and of Twitters. This is a country that’s always been on the cutting edge. And the reason is that America has always had the most daring entrepreneurs in the world.”

Those entrepreneurs are daring because they operate outside the corporate world, and now the rest of us can be daring by investing in their startups; investing has been democratized. If we don’t believe in preventing entrepreneurs from wasting their time (and money) on crazy ideas, we shouldn’t prevent everyday people from voluntarily giving them money. The JOBS Act may usher in a Wild Wild West, but it’s a Wild Wild West of passion, exploration, and trailblazing innovation.

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About the Author

Kira M. Newman is a Tech Cocktail writer interested in entrepreneurship, work-life balance, and positive psychology. Since 2011, she has been traveling around the world interviewing entrepreneurs in Asia, Europe, and North America. Follow her @kiramnewman or contact kira@tech.co.

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