Caveat Emptor! Caveat Venditor, too!
If you’re opening a champagne bottle to celebrate Title III of the JOBS Act, which opened up venture capital investing to everyone, including those who are not accredited investors, don’t let that champagne cork hit you in the eye or get lodged in your throat. Our advice to investors: caveat emptor, let the buyer beware. Our advice to entrepreneurs with really high-potential ventures: caveat venditor, let the seller beware..
If you’re an accredited investor (net worth of $1 million+ excluding primary residence or income of $200k+/$300k+ for couples) – and there are almost 10 million of you – stay away from these new crowdfunded offerings. You don’t need to go there . . . and you don’t want to. If you’re not an accredited investor, we’d advise that you, too, stay away from these new offerings. You really shouldn’t be taking that kind of risk.
Yes, we know that when President Obama signed the JOBS Act into law, eventually enabling this democratization of venture capital investment, he said, “For the first time, ordinary Americans will be able to go online and invest in entrepreneurs that they believe in.” We doubt President Obama has much experience investing in venture capital. Frankly, we wonder how much real venture capital experience many of these crowdfunders have either.
Venture capital is tough – high potential reward, but high risk too. The majority of new ventures fail; some estimate that as many as 85% don’t generate a positive return for their investors, with most of those returning nothing at all. While accredited investors can presumably afford that risk as they search for the few that will win big and make it all worthwhile, if you’re one of those affluent people, it makes sense to risk your capital on the ventures with the greatest chance for success. Those highest-potential start-up ventures are turning to VC firms accepting investments only from accredited investors. So why consider the leftovers offered by the crowdfunders?
Title III JOBS Act Not Attracting Top Entrepreneurs
Why are the more worthwhile ventures sticking to the traditional route? The crowdfunded ventures open to non-accredited investors are limited to raising $1 million/year. But the highest potential ventures usually need a lot more than $1 million/year to have a shot at big-time success. As dreams of investing in the next Facebook, Uber, PayPal, or whatever dance through your head, remember that those successes have needed lots more than $1 million/year. Some have required tens if not hundreds of millions of dollars before investors could cash in. So don’t count on seeing potential homeruns on those crowdfunding sites.
You might be thinking, “But those crowdfunding firms offer access to lots of interesting ventures. Surely one or more that I select can win.” Think again. Successful VC firms tend to review perhaps 100 ventures for every one they select to invest in. They do lots of screening and due diligence before committing money. Do you really think the crowdfunding firms can possibly do that sort of disciplined analysis when they can’t put more than $1 million/year into any of these ventures and so have to offer dozens of deals?
The crowdfunding firms also don’t have the experience of traditional firms that deal only with accredited investors. As an accredited investor, I’d rather invest through a firm that has the experience to help advise management when the startup hits a rough patch . . . which most do at some point. The crowdfunders aren’t likely to have that experience or the resources to help the struggling young company. When the startup flounders, chances are that the crowdfunding firm will just have to let it drown.
That’s a good reason why the entrepreneur who has something with real potential should also want to stay away from crowdfunders. When your venture hits that rough patch, you’d like to have experienced counsel on your side. When your venture is making terrific progress, you may need more money to realize its potential, but you might feel pressured to stay with your crowdfunder and the reality of no more than $1 million/year.
Finally, if you’re an entrepreneur with the next home-run venture, do you really want to deal with hundreds of small individual investors putting up $1k or $2k apiece? If you’re going through crowdfunders, you’ll have to deal with those hundreds of investors and their disparate and perhaps unrealistic expectations. And when early success means the need for lots more dollars to realize the potential you always knew existed, it’s going to be difficult to convince a more traditional venture capital firm to invest in your venture and have to deal with the reality of hundreds of other existing (and often inexperienced) co-investors.
We’re convinced that the Title III JOBS Act crowdfunding champagne just isn’t so sweet. When you’re ready for venture capital champagne, stick with the good stuff. If you can’t afford the good stuff, stay away. You won’t like the hangover.