Saturday, November 12, 2011

, , , , ,

What H.R. 2930 Means for Startups


We recently finished our seed round of fundraising, and I admit there were a few moments in there when I wondered if I was crazy. Fundraising, especially with VCs and Angels, is a time-consuming and exhausting endeavor. The stress, the legal documents, pitching the same thing over and over again...It adds up over time.

Crowdfunding is an alternative to that model that's been kicked around a lot lately, and last week the House of Representatives passed H.R. 2930, the crowdfunding bill that allows startups to legally begin selling their securities through crowdfunding and social media sites.

This is a big deal for a couple of reasons. First, it is a major change to the federal securities laws that have been essentially the same since the 1930s. Also, this alternative investment poses a new and very complicated alternative that I think many unexperienced entrepreneurs might choose without quite understanding it.

If you want to learn more details about what the bill specifically changes, read my post "Breaking Down H.R. 2930."

Let's talk about why I think this is a terrible idea for startups.

The problems I have with crowdfunding start with the number of investors involved. Having hundreds of small investors involved seems like a quick way to fill out a round on the surface. When you dig a little deeper though, you see that it also means you have hundreds of people with rights, and hundreds of voices now involved in your company. Keep in mind that under state law, even minority investors have rights to things like seeing the books, voting rights on certain issues, and can make claims against the company.  They also all need paperwork made up for stuff like stockholders' agreements, etc. (I shudder to think of the legal bills). Think of the effort involved, it's hard enough keeping a VC and a few major angels in the loop on your company. With many small investors, you also run a higher risk of having someone become disgruntled when their voice isn't heard, and that's potential for a lawsuit.

Also, these investors don't need to be accredited, and because they are writing small checks (less than $10,000  or 10% of their income under the new bill) they will probably end up being inexperienced ones as well. Part of the benefit of VCs and experienced Angels is what they bring to the table for you. Advice, connections, their own experiences in starting companies, maybe even their endorsements among the community. These first time, small check writers mostly won't have that. They're what you might call "dumb money," and don't really add to your company other than with some cash in the bank. Now, maybe that's fine for some people, but most entrepreneurs I know want to know that they are giving away stock for cash and help.

There are more reasons as well, but these two I think are the most severe.

I admire that Congress is attempting to do something to promote startups in this country, but I really don't think this is the answer. I feel like crowdfunding is going to seem most appealing to first time entrepreneurs with few connections, and I worry that these folks are going to get in over their heads with this. The truth is, I think this is going to hinder new blood in the entrepreneurial world, and bring out a new crop of people who want to do things the easy way. Frankly, I think we can all agree that when it comes to starting a company, lazy is never the right answer.

I encourage every entrepreneur out there to do their homework about the real costs and potential hazards of each form of funding, and to make the best decision for their company.