Would You Rather Have 10 Angry Investors, or 68,000?

Occasionally, we republish blog posts, press releases and other commentaries of interest to our community. This piece by Hannah Miller, appeared on Triple Pundit 

About ninety-five percent of the projects on Kickstarter are non-industrial: movies, video games, food products. For the five percent that comprise the technology and design categories, the open nature of crowdfunding can create flurries of agita usually hidden behind the curtain of private investing and venture capital.

It came out last week that star Kickstarter project Pebble – the highest raiser on the site – had failed to ship their 85,000 e-paper watches on time to their donors/customers, without any explanation or new expected ship date.

Photo by StickerGiant.com. Used with permission.

This prompted a little party in the “Comments” section, now at over 8,000 remarks, on everything from comments on features (“PLEASE! PLEASE! Make sure that the point of connection to charge the phone is stabilized & hardened,”) to dyes and paint, and suggestions that the company perhaps transfer operations to Mexico.

For the more furious Pebble backers, there is no redress for their average $148 donation, at least until the U.S. Securities and Exchange Commission starts regulating crowdfunding at the end of this year.

Even though Kickstarter requires durable goods manufacturers to produce a prototype and a business plan, Pebble is just one of the projects that have faced manufacturing problems or slow distribution. For those considering the jump, A.J. Kumar of the Young Entrepreneurs Council gives an excellent “count your toes” checklist of things to think about in “5 Reasons Your Startup Isn’t Ready for Crowdfunding.”

The new crowdfunding investor-protection rules as mandated by the passage of the Jumpstart Our Business Startups (JOBS) Act last April are still being written (and the SEC has until 2014 to finish them), but the basics were spelled out in the law:

• Limits on size of securities: a company may issue up to $1 million worth of crowdfunding stock in a 12-month period.
• Investing limits: Individuals can invest up to $2,000 or 5% of their net worth if their income or net worth is less than $100,000, or 10% of their net worth if their income is higher.
• Intermediaries and platforms must register with the SEC, and brokers must follow all current rules.
• Companies must file financial returns including tax returns and financial statements, business plans, annual reports, and more.
• A company issuing stock can be liable for “material misstatements.” Ahem.

Though these promise solid investor protection, these may be a lot to bear for very small startups. “Enterprises raising less than $1 million will likely not be able to afford significant expenditures on due diligence, legal and accounting reviews, and ongoing compliance requirements,” the Milken Institute/Georgetown University writes in their Aug. 20120 report Crowdfunding: Maximizing the Risks and Minimizing the Peril.

Ironically, the new rules won’t apply to Kickstarter, which does not currently plan to go into equity crowdfunding. But what they will do for many of the other 450 crowdfunding platforms out there is forge an entirely new type of investing. A traditional, small group of angel investors or VCs will be replaced by a large, chatty, far-flung and anonymous social blob, many of whom would post a comment publically sooner than they could pick up the phone – visible to the public, the press, and of course, other potential investors.

Although crowdfunding has been discussed as a possible supplement to traditional investing, the possibility of adding a large, boisterous online community of shareholders may at first irk some traditional investors, who might not like their influence diluted.

However, write the authors of the Milken report, we are more likely to see change on both sides:

…Coupling securities crowdfunding in a joint-investment structure with accredited investors like angels, VCs, banks, or CDFIs could benefit all involved parties. These partnerships would allow the crowdfunded businesses and crowdfunding investors to benefit from the due diligence and management expertise of sophisticated investors. Likewise, the crowd approval would provide these sophisticated investors with a strong indication of market demand for the business’s goods or services, which is invaluable information.

The fact is, a lot of these investments are quite small – less than $100 (with a $5 return), even if their total adds up to an estimated $4.8 billion globally this year. It’s a tremendous area of opportunity for the 98 percent of the applicants for angel investing or venture capital who don’t receive funding.

The need to express one’s rage about a faulty iPod case may only apply to the few, for such small investments. But regardless, the entrance of increased transparency and democracy into capital markets will bring unpredictable alterations, especially when secondary markets emerge.