This is the third and final part of my series on crowdfunding. In part one we learned how important crowd funding can be for helping tech startups and the economy. In part two we worried about how criminals and con men might game the eventual crowdfunding system when it starts in earnest next January. And in this final part I suggest a strategy for crowdfunding success that essentially comes down to carpe diem — seize the day!
Crowdfunding done right will have a huge positive impact on any economy it touches. But by done right I mean done in a manner that maximizes impact and minimizes both corruption and unnecessary complexity. This is not something that must be accomplished specifically through strict regulation, either. I’m not opposed to regulation, just suspicious of it. I’m suspicious of any government policy that purports to be so elegant as to accomplish economic wonders at little or no cost. That just hasn’t happened in my fairly long lifetime so I see no reason to expect things to change.
Left to their own devices regulators will either make the system too tough to function or too loose to protect. So I propose a different approach, one that sidesteps the regulators to some extent simply by preempting them.
Understand there are no crowdfunding regulations yet, nor is there even a designated U.S. crowdfunding regulator. That’s all coming in the next few months on a timetable that will most likely be dictated more by Presidential election politics than anything else. So I expect to see little progress until after the November election.
Most crowdfunding startups will use this time to raise funds and sit on their hands as they wait to see how they’ll be allowed to make money after January 1. I see this as a perfect time for moving forward, though, to seize the day and attempt to define the regulatory conversation. This is possible since anything that already exists when the regulators are chosen and the regulations written must be taken into account, as opposed to secret or yet-to-be-written plans that can have no impact at all.
Bill Gates told me something back in 1990 that I’ve always remembered. “The way to make money in technology,” he told me in Redmond the day before he took over as Microsoft CEO, “is by setting de facto standards.”
MS-DOS was a de facto standard as are Windows and Microsoft Office. Those three products created the greatest concentration of wealth since OPEC.
Bill knew what he was talking about.
With crowdfunding nascent and only next year appearing in anything like its grownup form, there’s a chance right now to define those de facto standards. Some of this has already been done by sites like KickStarter that have defined crowdfunding as project-based, for example. While it may seem minor or obvious for individuals to put money in projects that excite them, for U.S. investors that’s generally a new thing. We traditionally bought shares in GM, not in the Chevy Volt.
See? Things are already different.
I see a huge opportunity in defining the way crowdfunding projects are presented to investors. This format — not regulations — will be what keeps the crowdfunding business honest and will allow it to be successful. Regulations, remember, exist mainly to deter bad guys by defining how regulated activities are not supposed to be done. Regulations are used to justify lawsuits, not build fortunes, so we can’t expect regulators to become our crowdfunding coaches.
We have in business a fundamental tug-of-war between companies and regulators. I see this with my kids (where I’m the regulator) and can see it emerging already in the crowdfunding space. The question comes down to how much businesses will be allowed to get away with? Remember the very essence of the JOBS Act was removing regulatory restrictions, so this has been on the menu all along. If crowdfunds are allowed to get away with a lot there will be plenty of action in the space until the bubble eventually bursts and investors are hurt. Or if the regulators are wary then strict regulations may scare crowdfunds away entirely so this opportunity will have been squandered and the JOBS Act will be seen entirely as having been election grandstanding.
The trick is to get beyond this concept of how much or how little to regulate and simply install a system that works well on its own and can function in virtually any regulatory environment through the simple expedient that this one part of the system isn’t even regulated.
Huh?
I’m not describing a crowdfund here, because crowdfunds will inevitably be regulated and should be. I’m describing the medium through which crowdfunds communicate with investors — a medium that ought logically to be run by uninterested third parties.
Say you are a crook who wants to start a crowdfund to steal the savings of elderly but adventurous investors. The essence of that crime would be failing to deliver on the investment — taking the money but giving back little or nothing in return. This could be accomplished by selling something the crowdfund had no right to sell or it could be accomplished by selling something that wasn’t as it was portrayed — a bad investment or perhaps no investment at all — in which case it would be pure theft.
Now here’s where it gets interesting. It is possible, through the use of financially uninterested third parties with completely different business models, to keep both types of corruption from happening, while lowering costs for all parties.
Crowdfunds selling securities they have no right to sell can be preempted by having a registry of which crowdfunds can legally sell which investments. The SEC could do this, but the New York Times could do it just as well (and with a lot more style), since it comes down to simply validating the identity of the investment, the crowdfund, and their business relationship.
The crime of misrepresentation (claiming an investment is better than it really is) can be regulated, too, but it’s easier and intrinsically better to create a standardized, publicly available, and perfectly transparent archive of due diligence materials held by a third party. If that third party determines everything that has to be disclosed about every crowdfunded investment and those requirements are pretty comprehensive, then it becomes extremely difficult to misrepresent the deal, cheating investors.
Crowdfunds and investments alike would register with the uninterested third party. Information disclosed to potential investors would be comprehensive, standardized (nothing left out) and completely public, somewhat like a really well done Multiple Listing Service for real estate. And while crowdfunds presumably make their money from fees paid by startups, the uninterested third party would make his money in some way that is economically decoupled from the investment transaction, like advertising.
I like this idea a lot — so much that I’ve decided to do it myself.
My third-party crowdfunding due diligence service will be cleverly disguised as a YouTube channel called the Startup Channel.
When will the Channel go live?
The problem with intermediate parties, extreme due dilligence etc is that it will turn crowd funding into just another form of VC. Kickstarter works because most of the projects on there are looking for small amounts of money, 10k to 250k is pretty much the extent of the funding sought. Once you start adding intermediaries with a vetting step that needs to be satisfied you basically make the system unusable to the 10k level person.
In many ways what is good about crowdfunding is the feedback that most successful projects give, they update, keep in touch, allow access to their funders etc, exactly the kind of stuff that most businesses frown upon. It works mainly for artistic endeavor where the payee pays because they want the product to exist as there is no alternative. It works because the money needed is available from the fan base whereas VC is pretty much the opposite, people do it precisely because they can’t get the money from anywhere else and the amounts they need is too great to borrow.
Isn’t the danger that something that works for a small, creative projects could end up being regulated to the point that it is no longer viable for those projects?
Big Money will corrupt the disinterested 3rd-party if big profits are potentially gained. They’re no more “disinterested” than our Congress which is supposed to represent the little guy. Big Money is good at finding the choke point.
Crooks will always find a way to game the system.
I think the biggest issue with investors losing their money with crowdfunding will be with the horde of overzealous and eager entrepreneurs and “inventors” who will go in with the best of intentions to deliver a result, but will be incapable of delivering in practice.
Delivering is always the hard part. Too many artists, and not enough real artists who can ship.
More and better investor info really only helps the smart investors smell a rat, it will never help the clueless average joe investor who doesn’t understand the technology or market.
So you will always end up with a ratio of funded projects being spread among:
1) The winners
2) The ones who limp through and deliver something, but it was less than promised or envisaged.
3) The ones who end up delivering nothing because the money got frittered away, or they didn’t know how to deliver, or the idea was always flawed, or they didn’t factor in enough contingency, or they got trumped, or just rotten bad luck.
Pick your ratios.
Uninterested third party? Like what Congress is supposed to be? People are only uninterested until lobbyists start shoving huge piles of money their way…
Clownfunding can be regulated, but safety can’t. It’s basically gambling on inspiration, confidence on an individual(s), and knowing a market better than the next guy. As always, a successfully demonstrated concept will attract investment, and an unproven concept will attract less or none.
What crowdsourcing WILL do is promote better. I don’t see more considered risk-takers coming out of the woodwork, only more fools.
Yeah, I have to agree with the comments here regarding the inevitable invasion of crooks and interested 3rd parties in the “middle person tools.” As this occurs, the natural reaction (regardless of whether one feels it’s right or wrong) will be governmental regulation of the middle persons.
That said, though, Cringeley is correct, I believe, here in a critical regard: if some early huge brokerages take off, in addition to Kickstarter which already is, well, the de facto standard at least for project-based support, which are all uninterested and relatively ethical, then this will assist in defining what kind of regulation will be put in place as well as discourage some level of absurd regulation as the crooked or unethical element will be relatively sporadic and smaller attempts, necessarily contained as all would be playing niche or start-up roles compared to those early established de facto standard brokerages.
Techcrunch had an article about Solar Mosaic yesterday. They are doing crowdfunding for solar energy projects. They are in a ‘silent’ mode right now and provide few details but it sounds interesting. They did get $2mill from the DOE to get started.
I’ll be honest, Bob, I can’t tell which – if any! – part of that piece was tongue-in-cheek.
Better sit firmly on whatever funds I have and go nowhere near crowds!
🙂
[…] makes a good point in part3 of his series on crowdfunding today. New financial markets that are about to go mainstream will require new tools to make the systems […]
Bravo Bob. The one word that jumped out at me was “standardized” because that’s what colleges and universities are wrestling with in terms of financial aid award letters. And as always the devil is in the details. How do you make all the required information transparent and understandable. Is a disinterested third party sufficient to avoid a repeat of mortgage backed securities for example?
The key as I see it is both sides have to pay for this service, the investor and the project that wants funding. In the bond world the originator paid the rating services to rate the bond issue being brought to market. This lead to the issuer shopping for the best rating. If the investor does not have skin in the game then I see this failing just like the bond rating scheme.
To quote a old adage, you get what you pay for.
The big problem aren’t the purposeful crooks, but the accidental ones. You already see this in Kickstarter.
Someone has a great idea, but no idea how much time and effort will be really involved. They want to make a new type of widget. They’ve worked with widgets before, and they know how they’re built. They think that they can make a fat blue widget with the latest technology for only $12.95 instead of the $30 – $40 that most companies charge.
They make their pitch on Kickstarter. The tell everyone they can do their work, but need $50,000 in seed money. Success! They raised $150,000! The fun begins.
The prototype they made can’t be made on an assembly line. It needs to be redone. They work with an industrial designer. Then, they need to make a sample set of widgets. Whoops, the quality is low. They try to contact a Chinese manufacturer about building them, but the manufacturer tells them that it’ll take $1,000,000 to build an assembly line, and probably no more than 50,000 will be sold. That’s $20 per widget.
Then, there’s marketing. They never thought of that. Marketing costs are astronomical.
In the end, not a single widget is built and the entire $150,000 is gone.
I look at people like Preston Tucker as the type of “crooks” who will take unsophisticated investors. Tucker dreamed of building an exciting new car and compete with the big boys. He even sold dealerships to raise money, but never had enough. The specially designed engine was troublesome, and the suspension snapped under the weight of the massive car. Thousands of investors lost all of their money. People promised dealerships that never materialized. Tucker was investigated by the SEC and charged with fraud.
In the end, Tucker was found “not guilty”. Tucker wasn’t a crook Tucker was a salesman and not an engineer. He had little executive experience. He was a big dreamer, and understood what would make a really cool car. He raised a total of about $20,000,000 would would be equal to about 1/2 billion in today’s money. All of it lost. Like many Crowdsourced opportunists, he just didn’t know what he was getting himself into.
I completely agree – the biggest enemy to crowdsourcing will be those who sell a plausible dream, but crash into a wall of reality.
At the very least such actions will teach pledgers to ask for more information about company plans than going, “That sounds like a good idea!” and throwing money at it.
“My third-party crowdfunding due diligence service will be cleverly disguised as a YouTube channel.”
Ugh. Video seems like a really really bad fit for this sort of service. It’s difficult to browse, difficult to print for archival, impossible to quickly scan for highlights and unnecessarily resource intensive. Plus it’s blocked on many major corporate networks by default.
Otherwise it seems like an excellent idea… I’d even suggest that there should be many such services, competing for reputation and possibly differentiating themselves by focusing on projects within a certain area of expertise.
We have a fundamental failure in the accounting profession. This is evidenced by the fact that even the big boys were unaware of the financial obligations of their close business partners and creditors, especially as regards insurance and credit default swaps. Ultimately ALL potential obligations need to be disclosed without ANY off-book liabilities.
If creditors assert compliance to a comprehensive, fully transparent set of de facto standards, they can be held liable. If a bond is required by a 3rd party they have it in their interest to do the hard specialty work of ensuring compliance.
This trick is coming up with a set of honest standards where the system can’t be gamed.
At one time the accounting profession was self-regulated and honest. It needs to get back to that state.
It’s not that they didn’t know. It’s that they didn’t want to understand or recognize the true risk. In part, it was aided by mortgage sellers (e.g. banks) that wanted to sell more mortgages so they started relaxing who they would give mortgages to, and marked people as being a surer bet at paying it back then they really were so it also undermined the risk evaluation hirer up, and the system fed back on itself in part due to the fact that it was more or less numbers on paper that no one really cared about.
If not set up properly, crowdfunding will do the same thing. People won’t understand it, or want to, and make bets they couldn’t afford or deliver on.
Many people use “disinterested” when they mean “uninterested”, but you’ve hypercorrected and use “uninterested” to mean “disinterested”. There’s no reason the third parties should be uninterested in what they do for a living; they’d be bored and likely to get into trouble. 🙂
“I’m not opposed to regulation, just suspicious of it. I’m suspicious of any government policy that purports to be so elegant as to accomplish economic wonders at little or no cost. That just hasn’t happened in my fairly long lifetime so I see no reason to expect things to change.”
Well, ahem Bob, you HAVE lived long enough to see what happens when policy/regulation is abandoned. And since we’re talking about financial endeavors here, let’s look back at government policy that purported to accomplish economic stability (a genuine wonder compared to economic catastrophe).
President Reagan wiped out those stifling goofy regulations on the Savings & Loan institutions. I know you remember that. We all paid dearly and we paid for years.
President Clinton thought he would fire up some real growth and dumped that stuffy old Glass Steagall Act. Boy are we paying for that.
Regulations, like traffic lights, don’t come until a lot of people have been hurt. And regulation, by definition, is there to keep the fire from burning too hot.
The JOBS Act is certainly a double edge sword of promotion and reasoned regulation. Perhaps an appropriate comparison would be experimental aviation. Promoted as “The 51 Percent Rule”, new ideas, methods, a whole industry sprang up like weeds. Many disappeared, some blossomed, but all of aviation has been touched by that little policy. In fact, it is a gold standard of government working the way it should. Haggling, arguing, but in a positive direction while at the same time thoughtful of public safety.
How is this disinterested third party any different from Moody’s or Standard & Poors ratings services that played a role in the recent financial meltdown?
I agree there will be some fraud, but I don’t think it will be as massive as people expect. I agree with the commenters here: The most likely “fraudsters” will be well-meaning but naive people who over-estimate their own ability to follow through.
A lot will come down to the information demanded by the crowdfunding platforms: What kinds of disclosures are available online, and how verifiable are those disclosures. If the platforms provide enough information to make reasoned economic choices between new companies, then economics and practice will set the de facto standards.
Personally, I’m excited as hell to see what develops.
[…] early) predictions. He wades in on the JOBS Act: what’s right, what’s problematic, and how to make it work. Worth a read. This entry was posted in DWS. Bookmark the permalink. ← What Crowdfunding […]
The problem with having the third-party being theoretically disinterested, is that they will always become interested.
For example, they’ll be interested in hosting more crowdfunding so they’ll approve more crowd funds and investments so more people come through their website and they get more money for ads. They’ll get around the regulation by using the fudge factor and approving them based more on human intuition than on reality; and they’ll say nice things about what was provided to them to get around it.
So long as humans are involved, the fudge factor will existing, and people will figure out a way to get around it.
Actually — there already is an industry trusted company that does that kind of stuff all the time for the rest of the (US) financial industry. They manage as a Central Counterparty for many classes of investments, and as a central registry of information for others. They’re called the Depository Trust and Clearing Corp (dtcc.com) — this sounds right up their alley.
What crap what drivel!
You don’t know history and because you dumb and want to be a rich dumb bastard you will repeat mistakes and not learn!
In 1880’s USA people were missing their trains — all owned by rich dumb bastards why?
Because the rich dumb bastards all set their train time tables to their own time. GPS is the crown of the legislation started then to define time.
In Australia it was even worse, the states legislated their own gauges and the people had to change trains at the boarder in the middle of the night. It is still not fixed 150 years later — costing millions because some wanker thought their idea to be the best – stuff you! As some executive said to me “My time is too important to fix your problem” soto voce “Yours is OK to waste” And so thousands if not millions suffer because they have the same problem. What loss of productivity and other economic metrics.
I will never accept Bill Gates’ stuff because he made my life miserable just to become the richest man in the world. Well Stalin, Mao, and other DICTATE-ors knew what was good for me to! It is the birth principle of good ol’ USA. NO TAXATION WITHOUT REPRESENTATION.
I will not pay the Gates tax for crap as he loughs all the way to the bank, even if he has control of “… setting de facto standards.” In the 1930’s a state knew what “de facto standards” were good for me and my DNA.
Apple was in the thick of CPU development — Motorola, IBM, and ARM*. The Monopolists Wintel only followed. I studied CPU design in the 1980’s Wintel was obtuse, unclear and difficult, just so high priests could intercede with the gods!
In the Imperial years of Gates Empire Apple wasted $250 million in legal fees and got no where against the evil giant. Only the might of YOUR TAXES Robert X ( what does X mean) could bring the monolith to heel and the Caligula of USA history, Bush43 gave Microsoft a $500 MILLION FINE!! What Microsoft flushes down the dunny yearly!
But you want to sanctify a criminal as the perfect model for all people to emulate.
This is what USA has become – idealize dictators.
Music and Napster was the beginning of the end. I won’t pay for my music FU! Well musos want bread on their tables too!
Its gone into The Apple Patent Wars — Apple commits atrocities too. Every one stealing everything just for market share or dominance!
The umpire — your friendly congresswoman — tries to keep the fighting to Queensberry rules, otherwise its Libya today where power comes from the barrel of a gun, and USA thinks that is OK.
A person deserves the fruits of his labor and not have some wanker think he is better because he has more bullets, dollars or bent lawyers.
That is why we make laws.
Heaven know ignorance, bigotry and ego are killers to ideas!
I have patented one idea but let it lapse because I don’t care for the above profiting at my expense.
I’ll let the world go to hell! The effort to save is not worth it!
* Motorola and IBM found the efforts too expensive for the reward thanks to Wintel monopoly. Forget the advancement of knowledge and picking the best.
Darwin for technology companies is “survival of the richest” The Animals had a song in 1960’s that showed we’re all in the same boat, no matter how rich we are!
Why not just use the existing network for Validated SSL certificates? Require a website with a validated (not an anonymous quick cert) for each fundraiser.
Done!
Very nice well done
Personally, I predict that small issuers seeking crowdfunding will wind up disclosing a lot more than they’re required to disclose. The point you made in your second article is, I think, the point worrying most people right now, especially those who are market savvy enough to know what crowdfunding is in the first place (at this juncture–if this becomes the sexy new thing, I suppose you will get a glut of less sophisticated investors hitting the web). This means that the earliest forays into crowdfunding will include a lot of non-required information, just to ally investors’ concerns that the small companies are just scam artists.
It’s the second wave of crowdfunders that are likely to engender the most vicious fights…
I also agree with your point about de facto standards ruling the day. I won’t be surprised to hear that the crowdfunding platforms develop certain standards at least to verify who’s seeking investments on their platforms.
This is mostly rank speculation on my part, but it seems reasonable from here on my couch.