34 Pages Posted: 15 Sep 2013
Date Written: September 13, 2013
The JOBS Act opened a new frontier in start-up financing, for the first time allowing small companies to sell stock the way Kickstarter and RocketHub have raised donations: on the web, without registration. President Obama promised this novel form of crowdfunding would generate jobs from small businesses while simultaneously opening up exciting new investment opportunities to the middle class. While the new exemption has its critics, their concern has largely been confined to the limited amount of disclosure issuers must provide. They worry that investors will lack the information they need to separate out the Facebooks from the frauds. This is the wrong concern. The problem with equity crowdfunding is not the extent of disclosure. The problem is that the companies that participate will be terrible prospects. As a result, crowdfunding investors are virtually certain to lose their money. This essay examines the data on angel investing – the closest analogue to equity crowdfunding – and concludes that the majority of the issuers that sell stock to the middle class over the internet will lose money for investors, with many failing entirely. The strategies that help the best angels profit will not be available to crowdfunders. Plus, the losses most issuers inflict will not be offset by a few huge winners. Investors will not find tomorrow’s Googles on crowdfunding portals because they will not be there; instead, start-ups with real potential will continue to use other programs, such as the newly expanded Rule 506 exemption. This outcome is the inevitable result of the nature of start-up investing and crowdfunding. No amendments to the Act or rule-making by the SEC can prevent it. The only solution that will protect investors is to abolish equity crowdfunding for the unaccredited.
Keywords: start-up, finance, financing, crowdfunding, kickstarter, exemption, securities, securities act
JEL Classification: G18, G30, G32, G38, G39, K20, K22
Suggested Citation: Suggested Citation
By Daniel Jeng