The JOBS Act – what it really means for the future of Crowdfunding.
So, my assumption here is that you already know about Crowdfunding, either because you have been following my blog or just because. But, maybe everyone on the planet doesn’t know. In case that’s true, let me explain. Crowdfunding is a mechanism that takes advantage of the reach of the Internet to offer opportunities to invest in startup enterprises to anyone with Internet access and a credit card or a PayPal account.
The whole idea is to bring the world of startup investments to ordinary citizens who would like to gamble some of their money on what might become the next Google. In addition, it provides a simple platform for entrepreneurs to post their business plans and raise money to launch their businesses. The JOBS Act is legislation that was passed recently in the U.S to kick-off a startup economy. The Securities and Exchange Commission has 270 days to examine and propose regulations that will support this legislation when it becomes law in February of 2013. The JOBS Act will have thrown 80 years of SEC laws relating to securities under the bus, so the SEC needs this time to temper the Congressional zeal for this passage.
The original driving energy really came from the credit markets that are still broken and would appear set to remain that way for a long time to come, and the regulatory requirements governing most businesses, which usually come later in the lifeline of a startup project. Congress seems to have wanted to find a way to reduce the regulatory oversight while still offering a modicum of risk management by establishing rules that govern the offerings of startup businesses on these Internet platforms. In early discussions, the SEC seems focused on education and not so much on risk warnings. In fact, the JOBS Act turned out to be the result of a conflation of six separate bills, all trying to put forward the same rough objectives.
Congress did what Congress always does, and ended up with a compromise bill that reduces the burden of some of the regulations found in the Sarbanes-Oxley act while still inffusing the new act with some form of regulatory relief. As is always the case, we never get a pure solution to a simple problem from these guys. It isn’t in their DNA.
The main issues are around education, risk management and the scope of these offerings. Congress tried to reduce the reporting requirements and corral the size of individual and overall investments in a single project, by suggesting some limits for investors and some basic reporting requirements by the businesses. Presumably, the Obama administration and the SEC will take the narrowest possible interpretation of the reporting requirements, so it doesn’t become another source of opaque business practices of the sort that led us into the worst recession since the 1930s. I mean, really sophisticated investors clearly had no idea what they were buying when they purchased the top-trench of a collateralized CDO in the mortgage market, yet they were heavily vetted and qualified as to their level of “sophistication”. We know where that led. So, the SEC argument to focus on the education component of these investments rather than the risk disclosures seems silly, and I hope they see the light before they implement something that failed so miserably on Wall Street only five years ago.
If anything, the financial advice the SEC should require should be along the lines of “Do you understand that most startups fail and that you could lose all of your investment?” And, “It is a really good idea to spread your investment across a broad portfolio of startups, so that if a few fail, you are protected by the one or two that might succeed.”
One of the cool things that has happened in the CrowdFunding space as (I believe) an unintended consequence of the Kickstarter phenomenon, has been this notion of aggregating a built-in customer base WHILE one is in the process of creating product, and the result, which is often squeezing out the failed attempts through the initial market response inherent in the project funding. So, in other words, if your project gets over-subscribed, there is probably a market for what you are trying to produce, and if everyone hates the end-result, you get instant market feedback long before you have committed lots of capital to a failed design.
And, to be clear, Kickstarter is NOT a CrowdFunding platform, even though at first glance it may appear as such. Kickstarter helps aggregate donations for projects. If in return for your donation, you get a coffee mug or an invitation to a film party, then cool. It does not raise money for people to build companies. That indie film is not being produced in a distribution environment. Kickstarter is very careful about which projects it approves. And, it may never choose to participate in the SEC-regulated Crowdfunding space next March. If it ain’t broke, don’t fix it and who wants the SEC breathing down your back?
So, at the end of the day, I think the SEC will err on the side of education vs. risk management, there will be far greater funding restrictions than the JOBS Act intended, the Crowdfunding space will look really different in 24 months than we envision it today, with perhaps far more entertainment related endeavors (games, music, video, films, TV pilots) getting funded in much the same way as the music business became more indie in the last 10 years, and the venture capital community will basically remain unaffected one way or another, as entrepreneurs learn how difficult it is to round up all the devils in all the details.
There is a unique opportunity for the VC community to form an incubation-like support structure to provide infrastructure nourishment for all these startups, but I would be surprised if that happens. It seems more likely to me that the platforms themselves will look to provide these sorts of services as part of their service suite. There is also an opportunity to form a “Startup University” to prepare young entrepreneurs for this new “industry” in much the same way as MIT prepared young software engineering students for the computer technology evolution.
And, lastly, the nascent industry’s attempts at self-governance, while really well-intentioned will likely have little or no real impact on the space. People tend to do what they want.
Whatever forms all of this takes, I think we will have lots of job creation, a new rapid-development technology revolution, and the beginnings of an expansive and exciting world of commerce within the U.S. economy. And, it is really cool!