Crowdfunding for Start Ups

Jeff  Carter
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Posted: Mar 11, 2012 12:01 AM

Last week I was at the ACA conference in Austin, TX. It gets less fanfare than the SXSW show going on there right now, but I think it’s probably more important. It was a group of angel investors from all over the country talking about issues that confront them with regard to things that should matter to each and every person in America.

A lot of issues that we covered had to do with things like, how do we do a better job of funding technical companies that come out of university research? How do we get angel groups to work together in a syndicate to form larger blocks of capital to spur innovation? How can angels become better mentors? Accelerators. How can we screen deals better? These are very important topics because the next company angels fund becomes the next engine for job creation.

A study in Washington state showed that for every job Boeing ($BA) created, four more were created in the start up world around that one Boeing job. For every job Microsoft($MFST) created, eight more were created in the start up world around Microsoft. This start up stuff is critical to the American economy.

One issue that was touched on is pretty current. Crowdfunding. Crowdfunding, inspired by crowdsourcing, describes the collective cooperation, attention and trust by people who network and pool their money together, usually via the Internet, in order to support efforts initiated by other people or organizations. Crowdfunding you are already familiar with would be donating to a political campaign, donating to a disaster relief fund. Because the internet can do away with a lot of the transaction costs of fund raising, crowdfunding has become very popular for charity. Giveforward is a great example of how crowd funding can work to make something pretty cool happen.

Other websites you might be familiar with do crowdfunding. FundAGeek, Kickstarter are some examples. Angel List is a place accredited investors gather and talk about companies. Gust is a place where angel groups handle the operations of investing in companies, and it’s possible to share deals across the platform.

The issues become a lot stickier when it comes to companies that are for profit. First, the IRS limits who can invest in these companies. You have to be accredited. As a firm, how do you know all your money came from accredited investors? Second, as the CEO of the crowd sourced firm, how do you deal with all the investors? One of the most difficult jobs of the CEO is dealing with the individual demands of the investors in their company. One investor might want to exit and sell the firm, others might not. There are financial reporting issues. How do you show a capitalization table when you have 500 investors, and what does that mean for private/public reporting?

There is a bill pending in Congress that probably will get passed to allow crowdfunding for start ups. I back the fervor for investing, but I am not sure that crowdfunding will be beneficial to start up companies. They need more than money. Money is only one piece of the equation. Good angels don’t write a check and walk away. They get actively involved in supporting (not running) the company by mentoring, creating opportunities, and making introductions. There is a lot of responsibility that comes with being a good angel and crowd funding ignores them.

Should a person that put $100 in a company off a website be entitled to have any input into the company at all? I know how ticked I’d be if I was with an angel organization that invested 250K or more and a band of investors from all over the country was taking CEO time and focus away with their demands or requests. What about board seats? How does a crowd sourced company pick a board, and how does that board member perform their fiduciary responsibilities to the crowd funded group? These are not small issues, and I don’t have the answers.

What about fraud? There will be cases where companies will raise money and be total frauds. How do we deal with that? I am afraid that once that happens, and it will, the government response to that fraud will be worse than anything we have today. You think Dodd-Frank and Sarbanes-Oxley are bad. Wait until some elderly person gets swindled out of a few thousand bucks on some start up fraud scheme. I am afraid that in it’s effort to appear to be doing something about jobs, Congress and the President will act without thinking through all these issues.

However, the Coase gene within me wants people to do the best that they can for themselves. Americans ought to have an opportunity to invest in innovation. I suspect that websites and groups could form around the crowdfunding so that good due diligence could occur. I have confidence that independent investors putting their own money at risk will make good decisions for themselves. So I don’t dismiss crowdfunding out of hand.

I just wish we would take a while to think it through. Either pass a bill that is one page and simply allow it-letting the private community figure out how to regulate and implement it. No regulation or regulatory agencies set up to oversee it. Let’s use what we already have. Or wait, and think through these issues without passing a bill at all.