By Kurt Wagner, reporter
FORTUNE -- Investing successfully in startups takes more than a pocketful of cash. That's the message venture capitalists and securities regulators hope to transmit to those interested in equity-based crowdfunding, a new form of investing currently awaiting regulatory approval. Ordinary investors will soon have the opportunity to invest in early-stage startups in exchange for company stock. Today, only a small percentage of investors, those who meet certain income and wealth requirements, are effectively able to invest in startups in exchange for equity.
The change is part of the JOBS Act -- a.k.a. the Jumpstart Our Business Startups Act -- a law signed by President Obama last April. One of its aims is to increase early stage startups' access to capital. Crowdfunding sites like the wildly popular Kickstarter currently permit prospective ventures to raise funds through what is essentially a donation system. No doubt, millions have been raised to fund the development of gadgets, movies, art projects, even small businesses. But in exchange for their donations, supporters receive small gifts, future discounts, or perks -- not a stake in the company. The new law could make this type of fundraising process more appealing to investors because they will receive partial ownership in exchange for their investment.
The new equity-based system is unprecedented. Both securities officials and venture capitalists aren't shy about expressing concern. The potential for fraudulent campaigns or illegitimate crowdfunding platforms tops the list. "I spend my days dealing with the crooks and the thieves," says Heath Abshure, the Arkansas securities commissioner and president of the North American Securities Administrators Association (NASAA). "If you think they're not going to use crowdfunding to fleece investors, you're crazy." Congress has charged the Securities and Exchange Commission with the responsibility of coming up with the law's logistics, but a January deadline set by President Obama has already come and gone. When exactly the SEC will finally offer proposed rules remains unclear, though most observers believe it is likely to be this year.
In the meantime, potential crowdfunding platforms are champing at the bit. A review by NASAA found more than 9,400 web domains, nearly 10 times as many as 2011, contain the term "crowdfund," says Jake van der Laan, director of enforcement for the New Brunswick Securities Commission. With no shortage of crowdfunding websites seemingly waiting in the wings, only the SEC stands between entrepreneurs and a fresh group of investors. For those interested in testing the equity crowdfunding waters, here are a few things to keep in mind:
1. Get to know the entrepreneur. Understanding the individual or team of entrepreneurs behind a company you may invest in is essential, says Kevin Rose, a general partner at Google Ventures (GOOG) who invested early in Facebook (FB), Twitter, and Square. "I absolutely won't invest in something unless I have sat down with the entrepreneur," he says. "That's obviously extremely difficult to do online, so if anything I'd just be cautious." It is still unclear how much information entrepreneurs will be required to share alongside campaigns once equity crowdfunding becomes an option, but that doesn't mean investors can't do some digging. Don't be afraid to make contact over social media or even request a video interview, says Ronny Conway, a partner at Andreessen Horowitz (and son of famed investor Ron Conway). Knowing an entrepreneur's business background, education and industry experience can help investors minimize the gamble. "Invest because you're backing an entrepreneur that you think can do great things," says Conway. "It's all about investing in the people."
2. Stick to what you know. In a recent interview with Fortune, Marc Andreessen and Ben Horowitz, founders of VC firm Andreessen Horowitz, admitted that they invest primarily in a specific type of startup: software companies. "We're interested in what we understand," says Horowitz, who co-founded software company Opsware in 1999 with Andreessen. "We understand that product cycle. We understand those people. And that's what we're best at." Funneling money toward industries that you are familiar with will allow for more educated, and therefore successful, investments.
3. Seek professional assistance. Each investor has his or her own background, expertise, and level of disposable income. There's no shame in seeking out financial assistance to determine how to most appropriately allocate your funds, especially when making a risky early-stage investment, says Rose. A 2010 survey from the Certified Financial Planner Board of Standards, Inc. found that only 28% of Americans use financial planners. "I think it's really important to work with a professional and get the right kind of advice," says Rose. "Don't just go at it alone."
4. Diversify your portfolio. Startups fail more than they succeed. A lot more, in fact. Experts haven't settled on an exact number, but studies peg startup fail rates anywhere from 75% to as high as 90%. To combat these risks, professionals hedge their bets by diversifying their investments across multiple companies, says Rose. "When someone goes out and becomes a professional angel, they're allocating a certain percentage of their net worth to go out and make 10, 15, 20 different bets," he explains. "They have a large enough pool that hopefully they'll find some winners in there." Investors can also minimize their financial risk by teaming up on investments with friends or colleagues.
5. Understand the platform. Doing a background check on your entrepreneur is not enough. With thousands of potential crowdfunding sites, which may soon be referred to as "portals," it's important to ensure you are dealing with a legitimate and safe platform, says Rory Eakin, founder and COO of CircleUp, a site that helps accredited investors find legitimate investment opportunities. Investors should understand who is operating their platform, as well as how diligently investment opportunities are filtered. "Is the platform accepting any company that wants to post investment opportunities," asks Eakin, "or are they involved in the curation process?" Platforms that hope for long-term success will be doing their best to weed out the fraudulent campaigns. Ryan Feit, CEO of SeedInvest, a new equity-based crowdfunding site tailored toward accredited investors until the JOBS Act rules are finalized, understands the importance of curating his site's offerings. "Getting deals done is great," he says, "but not if you don't keep customers happy."
DataGravity wants to automate big data for small companies.
FORTUNE -- The hottest big data startup may not be in Silicon Valley. Or New York or Boston.
Try Nashua, New Hampshire.
That's the home base of DataGravity, which today announced $30 million in new VC funding led by Andreessen Horowitz. The company is basically designing an automated platform that would help small and mid-sized businesses get value from the reams of incoming data. MOREDan Primack - Jan 29, 2013 12:26 PM ET
Physical retailers aren't long for this world
By Jeff Jordan, contributor
If you're a physical retailer and you sell the same SKU's as Amazon, you will not have a Happy Holiday this season.
Starting with the hoopla around Black Friday and Cyber Monday, the media has been full of stories on how physical retailers plan to beat back the competitive pressure from online retailers. They detail a number of strategies, such as expanding their MOREDec 13, 2012 2:23 PM ET
Andreessen Horowitz names Dixon as its seventh general partner.
FORTUNE -- Serial entrepreneur and angel investor Chris Dixon is joining venture capital firm Andreessen Horowitz as its seventh general partner, the firm confirmed today.
News of Dixon joining A16Z was first scooped over the weekend by Kara Swisher, leading some to wonder if it meant that the Silicon Valley firm would finally be opening an East Coast office. After all, Dixon is MOREDan Primack - Nov 19, 2012 6:00 PM ET
Zulily raises new money from Andreessen Horowitz.
FORTUNE -- Zulily, a deals site for moms and kids, is putting the finishing touches on a new venture capital round that values the company at approximately $1 billion, Fortune has learned.
Andreessen Horowitz is leading the round, which is believed to be for around $100 million. Some of that money will be used to provide liquidity to early Zulily shareholders. This may be Andreessen Horowitz's MOREDan Primack - Nov 15, 2012 3:55 PM ET
A better model, or a pretty face on an ugly business?
FORTUNE -- Payday loans are considered a dirty business, both figuratively and literally. Corner stores in rough neighborhoods, bulletproof glass and the quiet desperation that leads someone to borrow $200 at a 400% APR.
But a new startup called LendUp is hoping to change all that. And yesterday it announced a seed round of venture capital from backers that included Andreessen MOREDan Primack - Oct 11, 2012 4:35 PM ET
Ex-DC mayor joins Silicon Valley venture capital firm.
FORTUNE -- Adrian Fenty, the former Washington, D.C. mayor known for his education reform strategy, has joined venture capital firm Andreessen Horowitz as a special advisor.
It's a part-time position, but Fenty says that it could be the precursor to a new career. "What I'm really interested in is big solutions to problems, whether it be in education of elsewhere," Fenty says. "I think MOREDan Primack - Sep 26, 2012 6:00 PM ET
Silicon Valley firm hits major milestone.
FORTUNE --Warning: What follows may appear to confirm today's New York Times insinuation that I blindly carry water for Andreessen Horowitz. We'll deal with that a bit below...
Andreessen Horowitz has returned its debut fund two times over, following news that VMWare (VMW) will acquire Nicera Inc. for more than $1 billion in cash, Fortune has learned.
This is the $300 million fund that Andreessen Horowitz raised MOREDan Primack - Jul 23, 2012 10:03 PM ET
Venture capital goes an ugly shade of green.
FORTUNE -- Want to get a venture capitalist to roll his eyes dismissively, but don't have a pet food delivery start-up to pitch? Then just mention how much you admire Andreessen Horowitz.
Never before has a new VC group grown so quickly, raising nearly $2.5 billion in its first three years of existence. Nor has another VC firm become the industry's undisputed media darling, MOREDan Primack - May 3, 2012 11:17 AM ET
Venture capital firm makes a bold philanthropic pledge.
FORTUNE -- The general partners of Andreessen Horowitz have pledged to donate at least half of their future venture capital earnings to philanthropic causes. And, to begin, they have sprinkled $1 million on Silicon Valley nonprofits that focus on everything from urban forestry to homeless families.
Here's how it will work: Each of Andreessen Horowitz's six general partners -- Marc Andreessen, Ben Horowitz, Jeff MOREDan Primack - Apr 25, 2012 4:45 PM ET
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