25 November 2013

Should we Crowdfund?

Angel List is one of the hottest capital sources around today. The benefits of crowdfunding sites like it are many - they offer a wide number of startups access to funds, gives small investors opportunities previously not available to them, and adds transparancy throughout the process. I am one of the biggest proponents of democratizing closed networks (Venture Capital is certainly on the list), but I can't help but wonder if the timing of the JOBS act could not be worse. Loosening regulations in a time of frothy valuations, high risk, and oversupply of undeployed capital reminds me of the Clinton-era push to make home financing more widely available. Will crowdfunding leave common investors in financial straits like those that were affected by the housing bust?

For one, early stage investing is hard. Even the experts get it wrong. According to some recent articles I read from Fortune's Dan Primack, almost 2/3 of tech Angel investors lost money and some 40% of early stage VC investments end up worthless. And remember - these are the professionals. Despite their expertise, exhaustive diligence, and access to exclusive deals, they still bet wrong more times than they do right. In fact, because of this difficulty, VC firms have systematically been shifting focus to later stage companies over the past few years. If the pros are moving away from this asset class, how do we expect individuals to fare better ? In the VC world, only 10-20% need to succeed for them to generate their required returns; there's not quite the same risk tolerance for Joe the Plumber who is investing his retirement funds.

Also, for the few that haven't noticed, we are in the midst of a capital bubble. Outsized pre-revenue valuations are back (really Snapchat, $3B wasn't enough?) as is hot public markets fueling a pace of IPO filings that hasn't been seen since the dot-com days. Large investors like corporations and private equity groups have never been flushed with more cash. Smaller companies have more choices as new angel groups, accelerators, and incubators compete fiercely for them. And if that isn't enough, the Fed continues to crank money into the system ensuring the record low interest rates remain. We are in an unusual environment in which capital is aplenty; if there was a shortfall in the market, it certainly isn't now.

On the other hand, before crowdfunding, a typical entrepreneur had very places to go. Local banks were out of the question given the risk. VC's and Angels were almost impossible to connect with. Friends and family, which is the typical route, is limited and sometimes complicated. As social, sharing, and mobile drive rapid efficiency in communication, it's only natural that those benefits extend to the investing world. Kiva brought microfinance to the masses helping millions of entrepreneurs; so why shouldn't Angel List do the same in the for-profit world? The notion of the Facebook next door that can't get funded should not be a reality nowadays.

In some ways, democratizing capital should level the playing field for entrepreneurs that aren't tied exclusive clubs like the Silicon Valley network or NY elite. But on the other hand, the landmines of early stage investing may not be well understood by smaller investors. I personally think the pros of crowdfunding outweigh the cons, but i hope the timing of its incubation during the capital boom doesn't shorten its life cycle. Buyer beware - just because your teenage kid is allowed to take the keys to the car doesn't mean you should give them to him.