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The Coming Startup Crash?

I’m heartened by the number of people who have reached out with questions since the publication of the first three installments of this column. I’ve done my best to respond individually to specific questions and I will tailor future installments to try to address questions that I think many people will be interested in hearing the answers to. One of the topics people have asked about most is equity crowdfunding.

Equity Crowdfunding

People are starting to hear radio commercials advertising the ability to invest in startup companies the way the “big boys” do, if the person listening is an “accredited investorcrowd.” And if you do an internet search for information about doing this, you will find plenty of websites offering to help you- whether or not you are an accredited investor.

Try it, just search for terms like:

  • where can I invest in startups
  • invest in startups online
  • invest in startups crowdfunding
  • invest in startups with little money

But do yourself a favor and do not look at any of the websites that pop up – at least not until you read this installment to the end.

Accredited Investor-Only Equity Crowdfunding

Federal securities laws, until September 23, 2013, generally prevented anyone trying to raise money for a startup from doing so by advertising the opportunity to people with whom the startup didn’t have a substantial pre-existing relationship. So, startups couldn’t advertise on the internet or other media.

Title II of the JOBS (Jumpstart Our Business Startups Act) Act changed this. But wait, that’s not all the JOBS Act did.

Equity Crowdfunding for the Masses

Title III of the JOBS Act allows anyone, regardless of income or net worth (that is, whether or not the person is an accredited investor), to invest in startups. Title III offerings may be listed only through intermediaries known as funding portals and broker-dealer platforms that are registered with the Securities and Exchange Commission. You can read more here.

Good or Bad?

Like a lot of technology, equity crowdfunding is neither good nor bad. It just is. Before the JOBS Act was signed into law there was a lot of debate over the potential for its abuse. But make no mistake, there is a huge potential for abuse and, even in the absence of outright fraud, there is a huge potential for a lot of people to lose a lot of money.

I’m not saying that you can’t make money investing in startups. And I’m not saying you can’t invest in startups using equity crowdfunding. I’m simply suggesting a few reasons to be careful.

Startups are Inherently Risky

Most startups fail. It is that plain and simple. Read this for more.

Angel Investing Groups and VC Funds May Be a Better Way to Go

Before you decide to go it alone as an online angel investor via equity crowdfunding, consider whether a better way to go may be to join an angel group. Accredited Investor Markets published a fairly compelling piece on the advantages of first joining an angel group here. I wrote an article on the topic back in March, 2014 as well, and it is here.

Everybody Seems to Be Talking About It

There is an old saying: when everybody’s getting into the market and even the shoeshine boy (or the barber/hairdresser or the taxi driver or the waiter or the bartender) is giving stock tips, then it’s time to sell. It may have its origins in a quote attributed to Bernard Baruch:

Taxi drivers told you what to buy. The shoeshine boy could give you a summary of the day’s financial news as he worked with rag and polish. An old beggar who regularly patrolled the street in front of my office now gave me tips and, I suppose, spent the money I and others gave him in the market. My cook had a brokerage account and followed the ticker closely. Her paper profits were quickly blown away in the gale of 1929.

Too Much Money Chasing Too Few Startups?

I’m sure that the reason so many people wrote asking me to elaborate on equity crowdfunding was because my most recent installment, Has the Startup Scene Jumped the Shark?, skewered one particular startup as being, not to mince words, stupid.

Another Stupid Startup

Here’s another investment idea (which I received an email about from WeFunder on August 5th): Everipidia. Its WeFunder page describes it as:

[T]he next stage in the evolution of the internet – we combine the best parts of Wikipedia, Reddit, and Google into one massive encyclopedia of human knowledge and searchable content. First we’ll make what Wikipedia tried and failed to do: a completely open platform where anyone – not just a few thousand editors – can contribute text, sources, images, and videos for a much richer encyclopedia experience.

Perks for investing include (a) getting to be a “master editor” for a $100 investment; (b) getting to create your own Everipedia page for a $500 investment; (c) getting a verified account on Everipedia and either getting the company’s founders to write a rap song about you or being able to promote your Everipedia page to the Everipedia community; (d) getting the company’s founder to treat you to dinner next time you are in Los Angeles for a $5,000 investment; and (e) getting a personal phone call once a year from the founders.

It’s raising money based on a $22 million valuation and it currently generates banner ad revenues of about $150-$300 per day

My take: I don’t get it. It seems like the classic solution in search of a problem.

More Stupid Startup Shenanigans

One of the things I like to read regularly is an e-newsletter written by Dan Primack (of Fortune Magazine). It’s called Term Sheet. The August 5th edition (written by Erin Griffith) included this little tidbit:

Egg on Face: There’s no confusion over what to make of the news coming out of mayonnaise startup Hampton Creek this week. It’s really, really bad. Bloomberg reports the company dispatched undercover teams of contractors to buy up its product in stores to create the impression of booming sales and strong demand.

Even in the era of Zenefits and Theranos, this is shocking behavior. If true (and Bloomberg presents ample evidence that it is), Hampton Creek deceived investors and its retail partners.

It’s an especially egregious example of a startup founder mistaking “growth hacking” and “hustling” for unethical, and possibly illegal, activity. How does this keep happening? Well, the startup world has a way of promoting creation myths and glory stories of its most successful founders doing similar things. We hear about the times that Successful Founder X that conned her way into conference or Founder Y bent rules he didn’t fully understand to get his product to market. For inexperienced leaders, the line between innocent “hustling” and fraudulent behavior can be hard to grasp.

Conclusion

My point here is simple: when stupid idea after stupid idea attracts investors, it’s a forward indication that a market is too frothy. When a market sees repeated examples of industry participants making things up, it’s a forward indication that a market has become dangerous.

I’m not suggesting no great companies went public in 1928 that would have been fantastic buy and holds. And I’m not suggesting that investing in startups cannot be a smart aspect of a diversified investment portfolio. But I am urging caution and I am urging you take the time to get smart about this stuff before you put your money into it. It is not difficult and it does not even have to be that time consuming. If your financial adviser suggests otherwise, it may be time to change investment advisers. (For some solid pointers on how to select an investment adviser, check this out.)

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