Crowdfunding is the New Microcap
Because of the nature of our business we’ve been giving keen attention to the crowdfunding market. In fact, we’re convinced that crowdfunding will fuel many more reverse mergers and APOs in the coming years. We’ve also been noticing an interesting trend. We’re starting to see a great deal of negativity on the horizon in the equity crowdfunding arena than I had expected. Much of this is due to the somewhat stained reputation of those in the capital raising business. Unfortunately, the Wolf of Wall Street reputation still follows some of the Sheep of Wall Street. Much of the argument swirls around the fact that crowdfunding is replacing microcap stocks as the modus operandi for screwing investors, but that it’s even more pernicious. Here are some of the arguments I’ve heard and some of my commentary.
Boiler-Room-Enabling
A recent discussion I had with a pretty conservative investor had him badmouthing the crowdfunding hype, saying that, “crowdfunding is nothing more than boiler-room enabling.” I couldn’t argue. He was right. The shell companies with just an interesting story and no real business are those of greatest risk to investors, which is exactly what equity crowdfunding is. And, if a promoter really wanted to run up the value or oversubscribe a private offering on one of these crowdfunding portals, they literally could get a boiler-room going. It wouldn’t be extremely difficult.
All Hype, No Revenue
Crowdfunding may be a complete bomb, just like the dotcom bubble that occurred in the late 1990’s. Overvalued public stock caused a major run-up in public company valuations immediately after it spurred a bunch of public offerings for companies with no revenue and a simple .com after their brand name. Luckily rewards-based crowdfunding’s filter is the reward itself, which is usually a consumption-based product, but what of an untested medical device or a B2B product with no tested market? What if that particular business is pitching would-be retail investors? What protection is there against flat out lies, lies and damned lies if no product is ever shipped directly to the investor him/herself? Is it any wonder the SEC has been so slow at releasing the rules.
Is crowdfunding nothing more than a rebrand of the microcap public offerings of a couple of decades ago? There are some similarities. But there are also some differences. Here are a few.
1. Crowdfunded firms will remain private & illiquid. This is a good thing, but can also prove a very bad thing. The illiquidity may make some investors sweat as they see the company in which they invested flounder and they’re unable to pull any money out of the deal. At least if the company is public, they can get something back, even if that something is pennies on the dollar. The upside is that the value is what it is and there is less exposure to pump-and-dump manipulators who screw businesses and investors just to make a quick buck.
2. Crowdfunding puts limits on the amount of capital invested from non-accredited investors. Unlike public offerings where the amount any single individual can invest in a deal is unlimited, crowdfunding places a cap either at a dollar amount or at a percentage of income amount. This is ultimately aimed at protecting investors from themselves. Irrational exuberance in a single deal, can create lack of diversity risk and put an investor in a very bad place financially.
3. TBD. There are some aspects, many regulatory, that have yet to be implemented or discussed. Once the regulatory authorities decide the complete rules, I’m sure there will be other difference areas that could bode well for investor protection or swing the other direction in favor of boiler-room enabling. We’ll know soon enough.
Which camp are you in? Do you adhere to the words of Jim Saksa that equity crowdfunding is a disaster waiting to happen or is it the economic savior promised by the promoters? Personally, I’d like to take a more pragmatic approach and assume it’s somewhere in between. This process of “getting it right” will likely be iterative on the part of the dealers and the regulators. As time progresses, the industry will figure out what works, what doesn’t and how we can ultimately protect investors from the downside risk of wolves, while still creating an environment that allows for equity participation and upside potential by all who bring some chips to the table.
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