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.
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.