21 March 2012

Equity-Based Crowd Funding

Speaking of crowd-funded equity investments, the WSJ hosted a "debate" about that last weekend.

I find the arguments made against it, by John M. Torrens, of Syracuse University's Martin J. Whitman School of Management, to be egregiously foolish. So much so that I will spend the next few decades discounting anyone with an MBA from Syracuse.

At their core, all of his arguments boil down to "some people will make errors, so everybody must be prohibited from doing this." You could use this logic to ban, well, everything. It completely ignores the very, very basic fact that all human activity carries risk, and that some balance must be struck between risk and reward not only to maintain a free society, but to carry on life itself.

Every argument Torrens advances is daft. Let's start where he starts:
The proposed law would not require audited financials on capital raising under $1 million, meaning people in the crowd could buy something that's valued based on potentially flawed numbers. And there could be hidden liabilities—such as workers' compensation claims, lawsuits and back taxes—in the company that the crowd now owns.
Yes. And a used car may have hidden liabilities. There is asymmetric information. Buying a car that has had improperly done frame repairs or faulty tie-rods is potentially fatal. And yet we allow people to buy cars not only from used car dealers, but from strangers on craigslist who have had absolutely no vetting or auditing at all! Somehow civilization rolls on.
And the crowd would be stuck with those problematic holdings, since there's basically no way to sell the investments. They're about as illiquid as you can get.
And yet we not only allow people to buy very illiquid real estate we encourage it.
From the entrepreneur's perspective, meanwhile, equity-based crowd funding raises just as many problems.

Let's start with a basic issue: Yes, small businesses need capital. But they need a lot more than that. And by focusing simply on capital, equity-based crowd funding would rob small companies of access to everything that traditionally comes with capital.
What? What?! No. Adding a new option does not preclude the old options. This is not even a business or finance or policy matter. This is basic, child-level logic.

Also, if these deals were such a bad deal for companies, why can't we trust them not to make them? Are the managers too stupid to do what's in the best interest of their firms? Are they insufficiently greedy to strike good deals? If so, why are we letting them manage the firm at all?

I was going to pick this apart one witless 'graph at a time, but to hell with it. I'm not wasting any more effort on this feeble-minded pablum. The entire piece boils down to "I'm a paternalist who knows more about what you should do than you do yourself, and since this law makes some unwise decisions possible we must prohibit everyone from being able to make these decisions for themselves."


Wait — I have one more thing to say I just remembered. This is a great example of policy makers and pundits needing to think more like engineers and scientists. This decision is not being made in a vacuum. Europe already allows these sorts of investments. If crowd-equity is really so dangerous, why isn't Torrens presenting actual evidence to back that up? Where are the actual disaster statistics? Or at least disaster stories? It's all hypothetical boogeymen. Sometimes we have to just imagine what the effects of a policy change will be, but sometimes we can look around and actually gather information and make informed predictions based on other, similar policies. Torrens speculates:
Instead, that crowd of investors could bring a whole host of new problems that were never contemplated. For example, managing investor relations and communications with a larger number of potentially unsophisticated investors will take time away from running the business, making sales and executing on strategy.
We don't have to be content with idle speculation here. Look over at Europe and tell me how much productivity is lost by crowd-funded enterprises due to an increased load of investor relations. (Or any of the other lame specters Torrens invokes.) Speculation is fine, but it's no substitue for actually observing the world and weighing data.

There are going to be bad investments out there. People already have access to them. The SEC and other regulators have not exactly done a sterling job of preventing people from offering bad investments or making them. (*Cough* Madoff *cough* Enron *cough* Ephren Taylor *cough cough cough choke* the Hellenic Republic.) The world is risky. Some people should not be making these deals. (Some people should not be handling money at all, or making any decision more fraught than which shoe to put on first.) That's no reason to outlaw everyone from considering such deals and making such decisions for themselves.

1 comment:

  1. Maybe I'm being a little hard on Torrens. I don't know. I've written things that newspaper editors have mangled into far, far worse versions. Perhaps that's what happened here. Space constraints are often involved. But somehow Don Boudreaux manages to writes letters-to-the-editor that contain logic, evidence, quotations and references all in ~200 words. Is it really so much to ask for some of that from a business professor?

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