Kevin Lawton on Strategy

Entrepreneur and business writer Kevin Lawton has put together a great series of presentations about crowdfunding from an investment perspective. Here’s the last one (Part 3), which mentions our SEC petition campaign at the end: http://ow.ly/2cb7X

Recently I had a great conversation with Kevin, who’s excited about crowdfunded securities, but doesn’t think this petition is the way to get there. Here are the highlights:

* This exemption may help small local businesses or individual creative projects, but it’s too low to help 99% of the ventures that the business world would be interested in. The $100K cap “doesn’t even move the needle” for people involved in business startups, except possibly for some mobile or web application development.

* Ironically, this initiative may actually harm the chances for legal crowdfunded securities at any economically meaningful level. The SEC may eventually green-light this exemption as a way to throw a bone to the crowdfunding crowd (and avoid significant change). And because government is slow, it will be even more years before those numbers would be revisited. Meantime, other countries (like India with GrowVC, http://growvc.com), will support crowdfunded securities at more significant levels. As a result, their economies and business climates will benefit, and the U.S. will suffer and be left behind.

* For a rulemaking petition to the SEC, a better approach would be to hammer out a more inclusive proposal with a small, smart group that includes experts on community-supported entrepreneurship, the heads of the big crowdfunding sites, and people in the business investment world. Come up with a proposal that appeals to all of these groups, and then rally everyone to support this new proposal, retracting the current one and transferring its momentum to the new one. The SEC would be more moved by an explicit, “Here’s the one killer crowdfunding proposal that all of these diverse groups support,” than any possible implicit, “A bunch of competing pro-crowdfunding petitions have been submitted for your review by different groups– they all ask for slightly different things– good luck figuring it out!”

* The business world needs to lead on this issue, collectively, fully transparently, and with good intent– and then the SEC will catch up. One approach would be for securities offerors to start flouting the restriction on general solicitation, which the SEC has been fighting to maintain for over a decade already. Securities offerors could begin publishing and distributing investment solicitations to the public, while also registering them with a government-friendly database that’s maintained by a dedicated non-profit, in the “Self-Regulatory Organization” (SRO) model– see http://en.wikipedia.org/wiki/Self-regulatory_organization. The solicitations would remain retrievable in perpetuity, because sunlight is the best disinfectant. If just a few securities offerings did this, the SEC would nail them– but if it became a mass effort, involving large numbers of legitimate investments, it would change the rules and the SEC would have to adapt.

* Such a disobedience scheme wouldn’t address the separate issue of who could legally invest– that would presumably still be subject to the SEC’s existing framework of accredited / sophisticated / unaccredited investor classes (which likewise, sorely needs revisiting). But to move the “soul” of crowdfunding forward, to activate its ability to reach and leverage the greater talents and expertise of the many outsiders over the few insiders– the wisdom of the crowd– the prohibition against General Solicitation is the more important first target.

* A better way to set protective limits on crowdfunding investments, equally effective but more scalable than a simple, dumb cap (which resembles the current accredited/unaccredited distinction) is the following scheme: 1.) Let people put money into crowdfunding investment accounts, just as they can with other kinds of investment accounts, with the same restrictions, warnings, etc. 2.) From this account, allow them to keep only 1/N of the total invested in any one security, where N is probably some number like 5 or 6. In other words, mandate for diversification. That way, no one can lose all their eggs on one bogus crowdfunded security, but it gives people flexibility over the amounts they want to invest. (If you really just want to invest in one security, then the remainder of your account balance has to sit in some cash equivalent).

* A more profound point relating to this mandatory-diversification scheme is that failure is a greater threat than fraud. In early-phase investing, you expect 9 out of 10 investments to fail anyway, so if 1 in 100 is an actual, premeditated fraud, that just aliases as another failure and disappears in the wash. There is no clear distinction between failure and fraud anyway– there’s already plenty of shenanigans in the way startups spend their seed money, and if they fail (as most do), intent becomes hard to tease out.

Those were Kevin’s main points (it was a long conversation), and I agree with him on almost all of this. I’d never met him before, but talking to him, I immediately liked him and appreciated his enthusiasm as a like-minded comrade. I also like his scalable, mandatory-diversification scheme, and his related thoughts on fraud vs. failure. Plus, of course, he has a real and successful background in business startups, which I lack.

The notion of the “Self-Regulatory Organization” would ordinarily make me want to reach for my revolver, with visions of accounting scandals, financial collapses, and oil-soaked marine life jangling through my head. Moreover, a centralized authority doesn’t seem compatible with crowdfunding, which is inherently bottom-up and anarchic, not top-down. But I must agree that, to safeguard the future health of crowdfunding, some entity probably does need to set best practices for the sector, and work with / lobby government(s) on its behalf. And there should be only one such entity, rather than competing efforts– and ideally, it should have a global reach, since the money will go wherever crowdfunding law is most hospitable.