Crowdfunding - Good Idea or Really, Really Stupid Idea?
Last week, the House of Representatives passed the Entrepreneur Access to Capital Act (H.R. 2930), commonly referred to as Crowdfunding. Since small businesses are responsible for the vast majority of new jobs, legislators believe that these new rules will make it easier for entrepreneurs to raise capital and ramp up hiring. In theory, this sounds like a great idea. However, in practice, this will be very bad.
I won't go into the details of the bill, but at a high level, it allows entrepreneurs to raise funds over the Internet up to a maximum of $1M annually (or $2M with audited financials). Maximum investment from each individual investor would be the lesser of $10K or 10% of annual income and investors do not need to be sophisticated. These investments would be exempt from registration under the 1933 SEC Act.
There is a reason the SEC exists. I can't remember if the SEC was one of the government agencies that Rick Perry wants to get rid of (but neither can he), but it seems like this is the exact type of investor that the SEC was set up to protect. Angel investments are highly risky and I would estimate that over 90% provide no return to equity investors. This is why 25-30 investments are required to achieve proper diversification as an angel. 10% of an individual's income is a very high amount and there will be many scenarios where non sophisticated investors will invest in multiple companies and going over the limit by simply checking a box in an internet form.
You may be thinking, "Ah, ProfessorVC is concerned about more competition in his angel deals". I like the way you are thinking, but not true! At the end of the day, very few entrepreneurs say "I wish I had raised less money"...and very few angel deals are truly oversubscribed, no matter what the press release says. More funding at the seed level is a great thing! Just not from investors who can't afford to lose the cash.
I often speak on panels and am often asked questions about what are the qualifications to be an angel investor.My response (only partially tongue in cheek), is to hold a $100 bill on one hand and a lighter in your other.Light the bill.Are you calm?If so, do it another 5-10 times.If you are still ok, then you are probably fit to be an angel.
However, I'm just not comfortable with where this legislation is going. Crowdfunding will likely be well received by scam artists and lead to many startup investment pitches in your spam folder along with those for viagra and male enhancement. More importantly, this could lead us down the road we've already traveled with day traders and real estate flippers...At the very earliest stage, this is the realm of friends & family and if you are comfortable taking investment from your fraternity brother, not so rich uncle or brother-in-law, be my guest.
The best way to describe my work is probably start-up CFO guy. I spend my days working with cool start-ups in a variety of capacities. I am an active angel investor and on the board of Sand Hill Angels. I take CFO roles in early stage companies and participate on the management team during the early financings and business model development phases. I typically stay anywhere from 6 months to 3 years depending on a number of factors, not the least important being that I do not have the temperament or attention span for a full time gig. I also teach Entrepreneurial Finance at San Jose State.
On the personal side, I live in Palo Alto with my wife, two daughters (one who started blogging way before I did and the other who runs faster than I do), dog, and crested gecko.
On the 3rd Saturday of the month, you can find me on the links at Half Moon Bay.