Herd Investing vs. Crowdfunding

At the moment, we cannot say that crowdfunding will be substantively different from herd investing, but we should have a better idea when the crowdfunding impact is felt in a year or two.  Herd investing is not the same as buying lots of cattle or alpacas, an investment that might one day find a welcome reception in farmcrowdfunding.com (don’t forget to give us a shout out if you’re certifiably crazy ambitious enough to pursue that).

What is herd investing? That’s when the so-called smart money piles into the deal du jour, an orgiastic money eruption led by venture capitalists and angels who can’t believe they unearthed the 23rd social/mobile/geolocated/game-changer thingy that might be snapped up for 10x returns in five years . . . as long as the 22 preceding startups with nearly identical attributes and better management teams don’t find a buyer first.

Alexis Madrigal of The Atlantic indirectly pokes the titans of private equity investing in The Jig Is Up: Time to Get Past Facebook and Invent a New Future:

Certainly, some of the blame for tech startup me-tooism is just the tendency of startups to cluster around ideas that seem to be working. Social networks? Here’s 500! Mobile social plays? Here’s another 500! Social discovery apps? Behold 1000! Perhaps that’s inevitable as dumb money chases chases smart money chasing some Russian kid who just made a site on which men tended to flash their genitals at web cameras.

His point is that we arrived at an innovation lull, the tech convenience store where incremental improvements and copycats loiter while nothing very interesting happens. Meanwhile, robust funding activity masks a lack of originality. Where to go from here? Crowdfunding might be different from herd investing if Main Street investors stay away from chasing the smart money love affair with all things shiny in Silcon Valley.  Or crowdfunding might just flood the party with more money–until the party ends.

Tagged: , , ,

OMG, crowdfunding would be, like, the biggest boiler room operation ever. EVER!

As the the Senate contemplates the future of crowdfunding as early as this week, the Wall Street Journal published a pro/con-style debate that framed the debate around the question of whether equity-based crowdfunding should be legal. CrowdFunds believes that some investor safeguards are worth considering, and some of the claims supporting a liberal crowdfunding bill are dubious, but much of the hand-wringing is comedic.  We’ll replay our favorite three laughers here:

  1. No audited financials? Must be a scam. Critics are quick to point out that the proposed legislation doesn’t require businesses seeking less than $1 million to provide audited financials. They then conclude that without this magic safeguard in place, no financial statements can be trusted. Boiler-room fraud galore! What the critics invariably fail to mention is that the cost of a financial audit can be a major expense for a fledgling business, and that money would be better allocated to sales and marketing, IT costs, research & development, and  . . . just about anything other than elaborate spreadsheets, consultants, and accounting firms.  Want to require that tax returns and K-1 statements be prepared by an independent accountant? Fine.  But audited financials (for whatever those are worth) are not suitable for the small fry. We’re encouraging business growth, remember? Sarbanes-Oxley can wait.
  2. Illiquid = Bad. Critics seize on the fact that there is no trading market for private equity securities, and anything that can’t be sold easily is hazardous to investors. But liquidity is only an issue if you need to sell soon. Private equity investing demands patience, and a risk of total loss is present at all times. Investments are going to be inaccessible for an indefinite period.  There will be very clear and conspicuous warnings about all of this. The money applied to groceries or car payments should not be invested in private equity. It’s that simple.  Until the day arrives when private securities can be freely traded on a open market like the NYSE, the illiquidity of private equity will be with us. By the way, what’s worse than illiquid securities? A sluggish, opaque, and distorted finance market for businesses that need access to capital, the very problem that crowdfunding might help solve.
  3. “Dumb money” will repel the sage guides.  Torrens raises this issue in the WSJ piece as if the mere presence of so-called unsophisticated investors is malodorous. Smarts and experience are nearly always part of the VC pitch when they are clamoring to snap up private equity deals. Entrepreneurs are right to be wary. Forget for a minute the fact that all dollars invested spend the same. Forget that entrepreneurs today have easier access than ever to a network of fellow entrepreneurs, advisors, and mentors. Forget also the imbalance when there are way too few professional investors chasing too many deals to provide the wise counsel and hand-holding they advertise. The truth is that savvy investors aren’t paid to babysit. They need to convert deals from young-and-full-of-potential into a return on investment, hopefully a big enough one to make up for all the earlier losses. A company can always hire a sherpa with money raised from the most efficient sources, but it’s probably time to give up on the outdated notion that the “smart money” is inherently better.

There you have it, the CrowdFunds.com short list of some of the popular objections to crowdfunding.  Chuckle away.

Tagged: , , , , ,