Small businesses are dead capital

Often, when I’m reading a Forbes article and I think to myself, “This is a darned fine article,” I look at the byline to find it is another good article by Daniel Fisher.

That happened recently while reading, How the Government is Helping Hedge Funds Make Billions off IPOs.  This paragraph caused me to glance at the byline:

Hedge fund managers can thank Congress and the SEC for the opportunity [to buy early stakes in companies before they go public]. Some call it “regulatory arbitrage”: well-meaning but inherently flawed laws such as Sarbanes-Oxley that were designed to protect small investors from the next Enron have imposed such heavy costs on public companies that many private ones are delaying their initial public offerings. Venture capitalists, employees and early investors who want to sell out have little choice but to sell their shares to lightly regulated funds, which can buy stock in the next IPO at a steep discount to what retail investors ultimately will pay.

Innovation has a lot of headwinds these days. Most of it caused by (to borrow Fisher’s words) ‘well-meaning but inherently flawed’ ideas.

But I find the well-meaning and inherently flawed ideas around investing in small businesses especially annoying.

In this country you can easily sign up for an online brokerage account and buy and sell slivers of ownership in thousands of publicly traded companies on the various stock exchanges for as little as $4 per trade, with some assurance that the presence of the Securities and Exchange Commission has lowered your chances of being defrauded.

You can just as easily make personal loans to people who need cash now using Prosper.com.

You can donate money to loan to small businesses and create jobs (and make money). Well, at least you get a bracelet with that one.  Or you can lend money to entrepreneurs all over the world. You can also donate to individuals who need help funding the creative projects like a large tortoise that looks like a trading post.

But, if you want to invest with entrepreneurs here at home, it’s not so easy. You need to know somebody who wants to start a business. Or know someone who knows someone. Or you need to know a venture capitalist. Start-up investing is an opaque network of angel investors and venture capitalists.

This, folks will tell you, is for our own protection because there will be too many con men out to get you to invest in their bogus company.

But, I’d rather make it easier for everyone to invest in start-ups and let the market develop solutions to help people from being defrauded. The SEC currently makes trading equity in unregistered companies very difficult. This basically makes small businesses dead capital.

Prosper.com and Kiva.org use simple approaches to limit your risk.  First, you lend in small amounts to individual borrowers — for example, $25 — and you can diversify across many borrowers. So, if you lend to one deadbeat who doesn’t repay you, you’re not out your life savings.

Second, these sites act as an SEC and rating agency of sorts by qualifying borrowers and setting appropriate interest rates based on credit risk. Kiva.org works with organizations that administer the loans with the entrepreneurs with full disclosure on that organization’s track record.

We could use the Prosper/Kiva/Kickstarter models bring start-up and small business capital alive. A similar service could act as registration agent of sorts and market maker to connect investors and business owners and allow users to invest as little as $5 directly with entrepreneurs.

Why not? I’d rather invest directly in an entrepreneur with a chance, even if it is ever so slight, of getting a return on that investment than donate it with the assurance that I won’t.

Crowd source venture capital, please

I read this Wall Street Journal story about a Silicon Valley startup, Loyal3, with great interest.  This paragraph describes its business model:

Loyal3 has created an online app that would let companies sell, or even give, shares of stock directly to the public, with no brokerage fees, through a website or on Facebook, in increments as small $10. Small investors wouldn’t even have to buy a whole share. Loyal3 would let them buy and sell fractions of a share.

I thought it might be a step toward crowd sourcing venture capital.  Prosper.com has made it possible to crowd source loans.  I think crowd sourcing startup equity investments would be another good idea.  Essentially, to have a Shark Tank that you don’t need to be a billionaire to participate in.

I’m no expert, but I believe SEC regulations do not make this easy, or maybe even possible, mainly to protect small, unsophisticated investors like myself from being bamboozled by snake oil salesmen.

As I read on in the Wall Street Journal article, I realized that Loyal3 wasn’t the Prosper.com of equity investing.  Rather, it’s a bit more like a Sharebuilder.com, looking to fill a specialty niche in the investing market for small investors and for companies wanting to give out stock as a marketing campaign. A while ago, I believe you could buy shares in beer maker, Sam Adams, from the boxes of its 12 packs. Loyal3 basically helps with that.

I wish we could crack the crowd sourced venture capital nut.  Given low-interest rates and equity investments that do not seem all that diversified anymore, it would be nice to have another market for our investments.

And, with lotteries and casinos where you are almost assured to blow your money, I don’t buy the argument that we need to be protected from snake oil salesmen.

We shouldn’t have to donate to create jobs either.

A crowd sourced venture capital market might produce a few jobs and a few products and services that make our lives better in the process, as well as give investors access to early stage, higher reward (and admittedly higher risk) investing.