Robert Shiller is worried about crowdfunding.
But the SEC could do more than just avow its belief in “uncensored and transparent crowd discussions.” It should require that the intermediary sponsoring a platform install a surveillance system to guard against interference and shills offering phony comments.
Pointer from Mark Thoma.
My thoughts:
Amateur investing in start-ups is per se a really bad idea. I did it a few times as an “angel investor” and got screwed. Founders made promises to me about how they would handle finances, and they quickly broke those promises. And once, when the start-up managed to do well, the founder obtained follow-up funding that amounted to legal blackmail against those of us who were early investors, so we got nothing. I came out of that experience convinced that unless you have top-notch lawyers working with you, investing in start-ups is a no-win game. As a small investor, you would need to score a home run just to cover your legal bills.
I see two possibilities for crowdfunding.
1. Suppose that people are only asked to invest in companies where they want to buy the company’s offering. Then, it seems like an interesting way for start-ups to do early market testing.
2. Suppose that the crowdfunding platforms provide some of the legal protection that venture capitalists and other high rollers are able to give themselves against subsequent misbehavior by founders or follow-on financiers.
If one of these, or preferably both, are in place, then I think that crowdfunding could last. Otherwise, I expect it to produce very negative average long-term returns and die a natural death.
Seems like the one million dollar fundraising limit discussed in the article will only exacerbate the problem you’re talking about. It may also create adverse selection problems, too, where only firms that couldn’t get funds elsewhere decide to crowdsource.
Wouldn’t it make more sense to just make it easier for traditional venture capital firms to raise money from small investors?
In terms of online platforms, I’d say your suggestion #1 dominates. We’re also seeing a shift away from the advertising model to the “patron” model (see patreon.com), though this is primarily due to changes YouTube is making to its core business.
I don’t see how problems in a market automatically justify gov’t coercion as Shiller and Thoma seem to imply (on a regular basis).
I would say that you are extrapolating way too much from your small sample of a Pareto distribution (Nassim Taleb, call your office). There’s actually a dataset of angel investments from around the period you invested. Aggregate IRR of 30%:
http://possibleinsight.com/2011/01/17/angel-investing-returns/
More recently, my tiny little firm has done ~100 angel or earlier investments per year for the last 4 years and the problems you cite are not an issue overall. Our marginal legal expenditure per deal is precisely zero, so fancy lawyers are not necessary.
The key is to make a lot of investments. If you randomly pick a handful of penny stocks, you’ll probably get hosed too. But that’s a result of the shape of the distribution, not the fact that the asset class itself doesn’t have returns commensurate with the risk. I’ve plotted the left side of the reverse cumulative distributions of different portfolio sizes from the aforementioned dataset here:
http://possibleinsight.com/2013/04/25/visualizing-angel-diversification/
I submit that it’s a mistake to get overfocused on why your particular investments failed. Of all portfolios the size of yours, the vast majority were losers for some reason or another just due to the overall outcome probabilities.
As far as crowdfunding goes, if it lowers transaction costs and bite sizes, it enables investors to have larger portfolios, which is good. If some people chose not to build large portfolios, well, we don’t stop people from buying lottery tickets. And startups are _positive expected value_, a distinct advantage over most lotteries.
Robert Shiller wants comments moderated?
Yeah, the principal-agent problem in angel investing (and early-employee “founders’ stock”) is brutal, as I also learned from experience. The next-round finance guys invariably condition their investment on the freezing-out of nearly all the early investors, and the start-up managers always agree (they want the money and figure they can get new friends with it). You can’t get around this by investing in aggregators (venture-capital or angel firms) because their principals invariably cream off all the profits for themselves and bonuses for their office help.