The following guest post is by Howard Anderson, the Bill Porter (1967) Distinguished Senior Lecturer of Entrepreneurship and Senior Lecturer, Martin Trust Center for MIT Entrepreneurship. He is founder of the Yankee Group and cofounder of Battery Ventures.
When Congress passed the Jumpstart Our Business Start-ups Act (“JOBS Act”) last year, the rationale sounded right: some “good ideas” don’t come to market because entrepreneurs often lack the necessary connections to privately raise significant amounts of capital. If they could get such funding, the argument went, jobs would be created. And that’s a good thing.
So part of the JOBS Act now permits private firms, including start-ups, to seek equity investments without registering shares for sale, though only from accredited investors. But if implemented, other provisions of the law would allow entrepreneurs and others to use crowd sourcing or social media to troll for money from virtually any would-be private investor. And that’s not such a good thing.
The economy has never suffered from a lack of good ideas. Anyone can come up with a good idea. I have an idea for a SCUBA wet suit that can keep you five degrees warmer, another for a cell phone battery that only needs charging once a month, and a car wax that makes your vehicle “stealth” to police radar. Anyone with even an idiotic idea can start a company, but it takes talent and experience to manage it and to make the business scale and grow. And consumers – who under the possible extension of the JOBS act will in essence become the Funding Source of Last Resort – are in no position to make such success calls.
Sure, the crowd may pick an occasional winner. At the same time, there will likely be instances of fraud, bad faith and substantial losses. In short, this will play out a lot like legalized gambling, but without the oversight. Consider last June’s Kobe Red (as in Japanese beef) ripoff, which Kickstarter finally put the kibosh on after the startup raised $120,000-plus. Or Ciang, the swordfighting game that has soaked up $500,000 in crowdfunding money and still isn’t ready for prime time. Brace yourself for lots more.
I have been an Angel investor, a member of an angel group and the co-founder of Battery Ventures, which has raised some $4 billion since its inception in 1985 and has invested in hundreds of startups. I know firsthand that it’s hard – and it should be hard — to invest with all the screening that sophisticated investors do. It’s hard to start a company and get it off the ground. And it’s hard and demoralizing to raise money.
We experienced VCs don’t always do such a great job with investors’ money. One VC I know posted hisearly evaluation of Microsoft MSFT -1.27%: “college dropout.. NBTD (No Brainer Turn Down).” Another passed on Facebook FB -1.69% because the partners couldn’t figure out why anyone would ever want to spend time on that site. Battery Ventures, of which I am a cofounder, is very proud of its stellar record, of the $4.5 Billion it has raised and the 300+ investments over the past 30 years, of Akamaii, and Blade Logic, of Focal and Metro PCS. Once I mentioned in a speech our investment in Petstore.com, where we blow a $9 million dollar investment in a company that went public and bankrupt in one year. That’s hard to do. The customer acquisition cost was about $300. A typical customer might spend $360/year of which the profit might be $70. So if the dog didn’t die, the firm would recoup its acquisition cost….in five years. The day after that speech, two of my partners came to see me…one with a horse’s head under his arm.
I have no problem with sophisticated investors dropping money on schemes with weak if any business plans. It’s a great way to do income redistribution. Not that sophisticated investors are any smarter than the crowd. (Take a look at who gave money to Bernard Madoff.). But investors are big boys and girls and their money is theirs to lose. My concern is that pitches may come to those who are easily bedazzled by tales of Facebook and Google GOOG -0.92%, to people who don’t realize just the long odds against such winners.
And we’re talking about not-so-sophisticated investors who can now take a flyer. Under the old SEC Rule 501, an accredited investor had to have an individual (or with spouse) net worth above $1 million and an annual income in excess of $200,000 in each of the last two years (or $300,000 with a spouse). Those qualifications are greatly relaxed now to allow lots more people, with smaller incomes, to crowdfund.
True, we allow people to buy all the Lottery tickets they want, despite ridiculous odds. But permitting anyone to raise money from the public for untried ideas and untested teams is to abandon fiduciary and regulatory responsibility. Good ideas combined with experienced teams are fundable. Sometimes with family, sometimes with friends, sometimes with sophisticated investors. But they should never be funded with naive investors who are playing the entrepreneurial lottery and who can quickly lose their entire investment.
posted from :http://www.forbes.com/sites/groupthink/2013/10/14/jump-into-crowdfunding-dont-be-a-greater-fool/