Is Crowdfunding a good model for capital formation?

Soon you will be able to raise capital and float shares using sites like Kickstarter. The effective date for the SEC’s Reg Crowdfunding (they gave up on finding a single letter) is close upon us. I’ve funded things on Kickstarter, but color me skeptical about using it for capital.

Like many things, it sounds good in theory. Going back to Michael Millken and the junk bond empire of Drexel Burnham Lambert, there is a theory that backing lots of risky businesses will succeed because the few winners will more than make up for the many losers. For example, I could have invested in every PC maker from 1977 onwards and made up for all the losses with one winner, Apple.

Wash, Shrink, Repeat.

If it worked for small and risky companies, the theory goes, it will work eversomuchmoreso for even smaller, riskier companies. Never mind survivor effects that have already winnowed the field, etc.

Also running in favor of the idea is the desire to even out income inequality. Very large fortunes are made today by being in on the start of small companies that grow big. Crowdfunding capital formation would spread that opportunity across many more individuals than have it today. This is a very positive and valuable goal.

The SEC stripped me of investor protection, and all I got was this lousy T-shirt

The fly in this ointment is that capital formation has historically been a way to rip people off. It is easy to forget that the SEC set up all the rules about floating shares in the first place to protect potential investors, not prop up investment banks. (Full disclosure, I used to work for one.)

Go public without audited financial statements? Fine! Who needs independent confirmation of facts when we want rampant speculation?

No. No. No. The rules are there for a reason. We learned our lesson, and I would rather not unlearn it.

 

 

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