The Great Debate

A few weeks ago, President Obama signed the JOBS Act into law, making equity-based crowdfunding legal for businesses that want to raise capital in smaller amounts than traditional venture capitalists or accredited investors supply. Depending on who you ask, crowdfunding is either going to democratize access to capital and serve as a boon to small businesses across America, or it will be rife with con artists intent on bilking seniors out of their hard-earned savings.

Let’s hope the former is true. But concerns about fraud must be addressed so the emerging market can thrive without being spoiled by fraud and scams.

The Securities and Exchange Commission is currently writing rules that will govern crowdfunding and, it’s hoped, guarantee its success. (Disclosure: I worked as a securities lawyer at the SEC from 1986 to 1990.) To properly regulate crowdfunding without suffocating it at inception, the regulators at the SEC must strike the right balance between guarding against fraud and allowing the marketplace to work its will.

Here are five actions the SEC should take to help crowdfunding flourish:

Make crowdfunding easily searchable. Work with the industry and the applicable self-regulatory organization to create a standardized national database of crowdfunding intermediaries and businesses seeking crowdfunding that can be accessed by regulators and investors alike. Databases should include search capacity and filtering by characteristics of businesses (e.g., minority, women-owned, food-oriented, Baltimore-based, etc.).

Define social-media boundaries. Provide detailed guidance as to how businesses seeking crowdfunding may use social media. Companies are allowed to give notice of their offering and direct investors to the “funding portal” where it is listed, but the nature of that notice is not spelled out. Can they post on Facebook and Twitter? What impact does it have to encourage people to “like” the investment on Facebook? Is a pin on Pinterest an advertisement? Crowdfunding companies won’t be filing a prospectus with the SEC when they’re looking for funds, and information will be available through all sorts of different channels. Our new world needs new rules.

Allow crowdfunding portals to be selective. Thousands of wacky companies are going to spring up overnight, and portals have to be able to exercise judgment (for instance, declining groups that want to sell racist T-shirts). But if portals do exclude companies, they might be considered to be acting as “investment advisers” that have to be registered with the SEC. The SEC needs to give portals safe harbors to exercise common sense.

Let the private sector work. Acknowledge the important role that the private sector will play in policing crowdfunding. There are going to be companies that focus on due diligence and disclosure, like the one I cofounded, and others that try to measure the amount of risk involved. When such companies are performing a useful function in the market, they do not need to be regulated like a business seeking crowdfunding or a crowdfunding portal.

Don’t smother startups. The SEC must recognize it’s dealing with companies in the very early stages of development. That means it needs to accommodate the needs of startups. Startup culture is disorganized and resource-poor. The SEC should focus on the overall picture and minimize the amount of information required for investors. For example, startups should be asked to provide a list answering the question “what are the specific risks you face?” as opposed to the detailed analysis that is more appropriate for more developed companies that trade on the New York Stock Exchange.

Skepticism of crowdfunding is healthy, and it is entirely correct to assume that where money is changing hands, there will be some fraud.

But fraud is not the biggest risk that investors face. The biggest risk to investors is that most businesses fail. Investors who want to give legitimate businesses a chance, despite the very real risk of failure, are what crowdfunding is really about. It is such an American virtue: We want to give everyone an opportunity to do well, as long as they play by the rules. The SEC has about eight months left to write the rules. I do hope they work.

The startup had millions of users, but, from the beginning, just one customer.

The predominant way of interpreting Facebook’s billion-dollar purchase of Instagram, in light of the social-networking giant's forthcoming IPO, is that Mark Zuckerberg had to pick up the photo-sharing app to boost his company’s mobile engagement. That would allow him to guard the mobile flank against incursions from Google, Twitter, and whatever other social-media tools might next arise.

That may be true – and it may even be the way Zuck thought about the deal when he swallowed hard and ponied up the purchase price. But that way of analyzing Facebook’s pickup, and the pickup of dozens of other startups, not just by Facebook but by Google, Twitter, LinkedIn and others, is probably not telling the whole story. Here’s a different theory, one that better describes the tech world that we, the users of the Internet, now inhabit: Instagram may have had millions of us as its users, but it was really built for just one customer: Facebook.

Silicon Valley, for too long, has confused the issue of what it means to be a user of a website, service or app, and what it means to be a customer of the app. Intuitively, you’d think they would be one and the same: The person using the app is the person consuming the app. But increasingly, apps are being made to grab the attention of the hegemonic companies in tech. Whatever it takes to get bought.