The screwy logic of crowdfundingMay 11, 2012: 2:43 PM ET
Why can't VCs use crowdfunding?
By Charlie O'Donnell, contributor
Fact: Thanks to the new crowdfunding legislation, it soon will be easier for any entrepreneur trying to build Instagram for Cats to raise $10 million than it is for an experienced venture capitalist to raise a new fund.
In fact, thanks to increased scrutiny of investment funds in a post-Madoff world, this imbalance will probably get bigger and bigger. The laws are written with the view that it's worse to lose your money from fraud than it is from your run-of-the-mill, poorly-executed bad idea. You know, because sometimes startups just simply don't make it [shrug] but you gotta watch out for those financial hucksters who are looking to take your money and run off to kick it in Fiji.
Trust me, if you lose all your money on your brother-in-law's Arizona tanning salon, it's not going to hurt any less than if you lose it in his seed fund. (Hmm... tanning salon/seed fund combo... Jersey Shore Ventures anyone?)
I would say something like, "You should see the number of complicated disclosures I had to had to pay a lawyer tens of thousands of dollars to put into my fund's legal docs," that is, if I could say anything about the fundraising status of any fund that I might have at all. I can't tell you anything about it thanks to the SEC. I can't put up my track record on my blog, which I'd happily do--whether I have any exits (even though it is theoretically public what I've worked on and who might have sold to a company that rhymes with hype) and how the other companies are doing. I can't tell you about the... oh, I dunno, let's make up a number that doesn't tie into any living people, real or imagined... 25 people I've actually placed at companies as part of a message of how I help startups.
But crowdfunding investments in startups is the answer to all our worries in life, right? It's a beautiful thing we're all supposed to get really psyched about--Main Street helping Main Street.
Until you realize that vetting and helping companies is actually really hard--or did you not notice all the news that venture capital as an asset class doesn't beat the market. Only the people who do it well produce returns, and when they do, they trounce the alternatives.
So, to recap, it's fine to let people who don't know anything about startups invest directly into them, but we're putting tons of restrictions around people with actual experience helping those people out and vetting the good ideas from the bad ones. [scratches bald head]
16k+ Twitter followers, 5500+ e-mail subs a week, 6th most read VC blog, appearences on Bloomberg and CNBC and I can't use any of it to market any kind of financial product--but if I wanted to sell you a watch or build a video game, I'd be set. Personally, I think it would be pretty awesome if all of the people who subscribe to my weekly newsletter could put $2,000 towards supporting the early-stage tech ecosystem in NYC. At least it would be diversified across 25-30 companies--there's no such requirement in crowd-funding. Who wouldn't want in on the next Union Square Ventures or First Round Capital funds? I certainly would! If venture funds could be supported by the local communities they invest in, you'd create a fantastic dynamic.
Instead, you create a dynamic where it's actually easier for bigger funds to raise money from big institutions. The big institutions are more visable--you know who they are. You can get a list of the biggest pension funds and endowments and it wouldn't take that much legwork to figure out who manages their venture programs. Or, as a bigger fund, you could hire a placement agent--someone who specializes in helping you raise a fund. Placement agents, obviously, want to work with bigger funds because they get paid more to raise them--for the same amount of work. If you're raising a few million, it isn't worth their time.
The investors for small funds are much more random and hidden. They're pools of partners capital from hedge funds you've never heard off, family offices that don't maintain any kind of a web presence or some entrepreneur who sold some airport runway cleaning service in Latvia for like a billion dollars who now just jetsets around the world buying up soccer teams. You can't exactly look those people up on Angel List.
You also create an insider's game. Want to know why there aren't more female partners at VC funds? A huge number of the people who make partner create one by starting a new firm--Fred Wilson, Josh Kopelman, Marc Andreessen, Rob Go and Josh Kushner all became partners when new funds were created. Raising money for a new fund is harder than raising money for a new company. At least startups have accelerators, incubators, etc. and now croudfunding sites. For new fund creation, you essentially have to already be tied into existing networks of capital. It's really not fair that I'm potentially able to get investors through my existing network for any theoretical entity that I may or may not be putting into place which I'm not allowed to talk about if I was. Good luck doing it if you're not already tied into that world--which is a different world than just the startup ecosystem. It will be a long time before you see diversity in this big money world because of the barriers to getting started--and if you don't get diversity on that side of the table, its going to be tough to get it on the entpreneuer side. (Says the white guy...)
I could, however, raise money for a Facebook-killer which I may or may not have the technical capability to build.
If there was more transparency into this world, and more liquidity in this end of the funding markets, I think you'd see the better fund investors rise to the top--just like you see in the startup world. Lots of companies are getting seeded, yet a smaller percentage of them are making it to the next round. They're failing faster and with smaller dollars.
This kind of quick vetting doesn't happen in the venture world. The current structures create a scenario where you're incentivized to go big with a fund and it takes forever for big venture funds to fall apart--yet we potentially miss out on the dealflow of up and comers that we'd back to put our money to work for us. If Mike Galpert, Frank Denbow, Amanda Peyton and Brad Hargreaves all had little kickstarted pools of money attached to them to invest, I'd back them, because they're smart, they get great dealflow.
Of course, that doesn't negate the need for people who do this on a fulltime basis at all. I'm a believer that someone needs to lead a round, sit on a board, and go to sleep at night thinking about how they can help the companies they're invested in.
Call me old fashioned.