Let me start out by saying that the SEC hasn’t finalized all of its rules on crowdfunding. Under the JOBS Act of 2012, the SEC is to set rules allowing businesses to attract investments from small investors. The model is Kickstarter, but with one huge difference: Kickstarter does not raise investment capital. Instead, the funds are considered to be gifts.
Crowdfunding will be very high risk. Stakes in these companies will be somewhat more like a lottery ticket than an investment, suitable only for discretionary funds after your basic financial security is in place. I suspect that a lot of people are going to lose a lot of money on this, and that there will be a hue and cry before it’s all over. In fact, part of the reason that the rules have been delayed is that no one is sure how to balance people’s desires to invest with their desires for protection.
There are two concerns for the companies raising money, too. The first is that they will now have to handle investor relations for a whole bunch of small investors (although the investments may not be small to them.) That’s very different from sending out a t-shirt or offering a tour of the microbrewery. The second, though, is that many venture capitalists have looked for a strong “friends and family” round. They reason that if a new business can’t raise money from the people who are closest to it, then maybe there’s a problem. An entrepreneur who turns to the crowd before turning to relatives may have trouble in later rounds.
It’s going to be fun to watch. It will probably evolve to look like microfinance, with the small investors putting money into larger funds, with professional managers controlling where the money ultimately goes. Maybe we’ll even see affinity funds, such as those for a given region or alumni of particular university. The microfinance model changes the dynamics of venture capital and adds a layer of fees on investors, but also reduces investor risk and entrepreneur headache.
