There is much to be read about the SEC’s delay in drafting and ultimately implementing the crowdfunding rules. Public comments to the SEC can be found here. Some are predicting that it will be 2014, at the earliest, before we see implementation.
While we are waiting, I started thinking about the risks of crowdfunding to the investors. This firm usually represents issuers, and so I have already spent considerable time thinking about and advising clients on the risk to issuers. Some of my thoughts can be found here, here, and here. But what about the investors?
Diversification. Crowdfunded deals will likely be ultra risky. A high quality venture capitalist knows that 3 out of 10 of his deals fail, and crowdfunded deals will probably fail at a higher average. Alternatively, and especially if you believe in the risk/reward analysis, some of the crowdfunded deals will be hugely successful. As with any investment strategy, the key is to invest in a variety of crowdfunded deals in order to spread the risk. If you have a set amount of money set aside for crowdfunded investments, I would spread that over at least 10 different companies.
Information flow. Crowdfunded companies will be private, not public, and won’t file information with the SEC. This means investors will be at the mercy of the company in terms of what, if any, periodic information is disseminated to investors. Also, since crowdfunded companies will likely have a large number of investors, one-on-one communication is unlikely. And ultimately, unless you group together to exert influence, a small investor isn’t going to have a lot of leverage. The squeeky wheel is likely to get the grease.
Enforcement of corporate formalities. Similar to the flow of information, if an issuer isn’t following the rules, such as holding shareholder meetings, etc., a small investor is not going to have a lot of influence over management. If you invested $1,000, are you going to hire a lawyer to sue the company and force it to hold a shareholders’ meeting? Company’s that don’t want to follow formalities know the answer to that question.
Confusion over crowdfunding will continue. There is a lot of confusion now, and you should expect it to continue, and increase, once crowdfunding starts. The SEC will continue to adopt rules. States will all have their own regulations. And you can bet that the plaintiff’s lawyers will get involved early, and courts will be deciding cases and (gulp) shaping the law in this area.
As with any investment strategy, the key is to do your homework, diversify, and trust your instincts. And most of all, have some fun, its going to be a wild ride, and it is a unique opportunity to get in on the ground floor of a variety of cutting edge companies.
