Crowdfunding and Common Sense

by Jon Follett

On Thursday, the US Senate passed the Jumpstart Our Business Startups (JOBS) Act (73-26), which allows start-up companies for the first time to solicit early stage investments from the general public. The Senate version added some protections and requirements to the original bill previously passed by the House on March 8. For instance, in the Senate version, the Securities and Exchange Commission (SEC) will now have the authority to review and register Web sites that wish to act as start-up investment platforms. Start-ups can raise up to $1 million via this crowdfunding method, with individual investments limited to a range of $2,000 - $100,000, depending on annual income.

Besides crowdfunding, the bill has two other significant provisions. It raises the ceiling on the number of shareholders a private firm can have — from 500 to 2,000 — before registering with the SEC. And it creates an "emerging growth" category for new public companies with less than $1 billion in revenue, exempting them from certain financial disclosure requirements —like hiring an independent outside auditor — for up to five years. The bill will make one more stop at the House of Representatives for reconciliation before crossing President Obama's desk, where it almost certainly will be to be signed into law.

Depending on who you read, the JOBS Act is either the greatest thing going for the US innovation economy, or the end of the world as we know it. The New York Times editorial board falls into the latter camp, as does Senator Bernie Sanders, Independent of Vermont, who joined with 25 others to vote "No" on Thursday.

The New York Times had this to say in its editorial from March 10, entitled "They Have Very Short Memories": "House Republicans, Senate Democrats and President Obama have found something they can all support: a terrible package of bills that would undo essential investor protections, reduce market transparency and distort the efficient allocation of capital."

And here's Senator Sanders' "Statement on Con-Job Bill":
"At best, this bill could make it easier for con artists to defraud seniors out of their entire life savings by convincing them to invest in worthless companies," he said. "At worst, this bill has the potential to create the next Enron or Arthur Andersen scandal or an even worse financial crisis. Have we learned nothing? Deregulating Wall Street led to the worst financial crisis since the 1930s. Now the same people who caused this horrible recession are telling us that more Wall Street deregulation will create jobs. Give me a break. I strongly support providing small businesses with the tools they need to create jobs. Sadly, that's not at all what this bill will do."

I find the hyperbole filled rhetoric cringe-worthy at a time when American technology innovators and other start-ups are actively contributing to an economic renewal. Let's parse the second sentence in Senator Sanders' statement a bit to see just how inaccurate it is. Enron, at the time of its implosion was, of course, a publicly-traded company, operating what amounts to a fraudulent shell game, by hiding its debt using hundreds of "special purpose entities". It's worth noting that when Enron collapsed it would neither have qualified as an "emerging growth" company nor a start-up as defined by the JOBS Act of 2012; Enron claimed revenues of $101 billion in 2000. But, let's follow the argument through to its bitter end. Shareholders lost $65.5 billion when Enron's stock tanked, which is 65,500x the maximum $1 million that can be raised per year by a start-up under the bill. So, for the Senator's statement to be true, 65,500 of these crowdfunded start-ups would need to fail, or maybe 65 of the "emerging growth" companies (with a 1/1 price to sales ratio and $1 billion in revenue), or some combination thereof, in a roughly simultaneous fashion, to approximate the Enron collapse.

Anyone who's contributed a small amount of funds to a Kickstarter project, seen the inside of TechStars or MassChallenge or a similar business incubator, or participated in a start-up company, knows that crowdfunding is actually more of a Main Street phenomenon than a Wall Street one. I don't see Wall Street clamoring to fund start-ups where other investment is not available. I'm not even sure how crowdfunding would interest a major Wall Street financial institution. The amounts of money are far too small. Regarding "emerging growth" companies, you could argue that relaxing the financial disclosure rules for the first five years of a public company's existence is bad policy that will lead to scenarios where fraud is more likely to happen and shareholders are more likely to lose out. But that's not what the Senator is arguing. Or, at least, I can't tell if he is.

When it comes to creating and funding start-up companies, it's one thing to disagree on how best to do it, it's another thing entirely to have limited knowledge of the ecosystem, and attempt to pin it to anti-Wall Street populism. Thankfully, that side of the argument lost on Thursday.

Topics: investment, techstars, crowdfunding, kickstarter, MassChallenge, start ups, Ideas, Analysis, Blog, innovation