Insights into the next phase of crowdfunding: tearing down legal constraints and building reputation systems


The post I wrote on the weekend, SEC opens the gates to crowdfunding and a new structure of capitalism, was on Techmeme for over 24 hours and was ranked by Topsy as one of the 100 most tweeted links , so this seems to be a topic of general interest.

One of the best things about doing blog posts is that you uncover interesting perspectives, especially through comments and reactions to the post, and thoughts provoked by those. Here are a few follow-on thoughts and references:

Changing SEC regulations
Startup Exemption is a petition to the SEC to change the rules on crowdfunding to allow crowdfunding of capital. Currently 1,618 people have signed it. If you’re a US voter please add your name to the list.

Some of the articles on the site give a solid rationale for the crowdfunding case. See in particular:
How risky is Crowd Fund Investing (CFI)? Capital Flow & Investor Protection
The Sweet Smell of Progress

Existing players
There are already some players in crowdfunded capital that are moving into the spaces between the regulation:

GrowVC aims to invest globally and is registered in Hong Kong for regulatory purposes. It is able to invest into the US market as a foreign entity, effectively bypassing SEC regulations on crowdfunding. According to a BBC article last year, it had 2,500 registered users in 108 countries putting in a minimum of $20 per month, with $12.8 million having being raised. See the slideshow for an overview.

CinemaShares and MediaShares offer “single-share internet investments” through a “reecntly patented technology”. The basic mechanism for the movie version is that ‘shares’ cost $20 and you get a DVD of the movie in return plus any profits from the movie. They say it has been cleared by the SEC, but it’s not clear precisely how this works. Presumably this is not real equity but quasi-equity, in which you are essentially buying a DVD, but also given rights to part of the profits.

For an entertaining take on this, see Sarah Lacy and Paul Carr interview founder Gene Massey on TechCrunch.TV and vehemently disagree on whether this is a good thing or not.

Crowdfunding and reputation systems
As mentioned in my original post, it is important to understand that this is all about crowdfunded capital, not crowdfunding as run by companies such as Kickstarter, which do not give you any equity for your money, just products or things that make you feel good.

The SEC’s raison d’être is protecting investors. Its regulations are designed to prevent investors getting fleeced, as they have regularly throughout human history. It is a laudable goal. It isn’t a good thing at all if companies find it harder (or impossible) to raise money, as is certainly the case as a result. However we must acknowledge that greed is such a powerful human force that many people probably need to be protected from their own foolishness and gullibility.

Which brings us back to one of my very favorite themes: reputation.

When there are no reputation measures then you need highly detailed and extensively monitored disclosure of information relevant to investors. Otherwise fast-talking individuals could get you to put your money into something worthless (which they can do anyway – penny stocks are potentially valid investments, just sold badly).

However in a world in which effective reputation measures have emerged around individuals and companies, it is far easier to make an informed decision about whether to invest. We are fairly early on in the development of the reputation economy, but we are getting closer to a time when the authorities can consider investors informed, and from that point in charge of their own destiny.

As the global economy is increasingly driven by new ideas and swift execution, it is crazy to have such rigid restrictions on people investing small amounts into companies. Why is it OK to put $50 into your favorite project on Kickstarter when you can never get a financial return, and wrong to put $50 into a project to get a possible financial return?

Yes some fools will lose some money they would have lost anyway. And many ideas will come to fruition that would have otherwise remained barren.