KAZAN –
Americans are great believers in the value of entrepreneurs and small business.
That faith underlies the JOBS (Jumpstart Our Business Startups) Act, a new law
that will make it easier for small companies to raise money and bypass the
regulatory “friction” that firms encounter when they go public. The law assumes
that people who can't find jobs may be able to find investors instead, and that
small companies will be able to get the financing they need to grow bigger and
hire more people. Angel investors, friends, and family will boldly go where
banks may fear to tread.
The JOBS Act is an extreme example of Americans’ belief in
people’s essential goodness, and everyone’s right to self-fulfillment. Every
entrepreneur should be entitled to raise funding from willing investors. It is
a uniquely American approach, and capitalistic in the best sense of the word,
for it encourages (and democratizes) investment, rather than fueling
consumption.
Small (under $1 billion) companies can raise money directly
from small investors in a formalization of the “crowdfunding” approach, whereby
a project’s principals post their plans on a Web site and ask for money,
essentially opening up the initial public offering (IPO) market. The theory
underlying the law is that a new set of accredited third-party marketplaces,
rather than the overburdened Securities and Exchange Commission (which missed
Bernie Madoff’s monster Ponzi scheme), will ensure that entrepreneurs tell the
truth, and that investors know what they are buying. (Of course, that begs the
question of how thoroughly vetted and reliable those third-party marketplaces
and their vetting systems will be.)
While this initiative was born in the United
States, many countries are wondering how to
jumpstart their own entrepreneurial sectors, and may be tempted to follow America’s
lead. So why do I hope that they resist that temptation?
Unfortunately, the JOBS Act is as likely to be successful as
the US
government’s earlier attempts to ensure that American families could buy their
own homes. Low down payments, deferred interest, and other enticements made it
attractive for people to buy their own homes (or to speculate with second
homes) whether they could afford to or not.
Mortgage brokers were happy to get in on the act. Some were
driven by an honest mission to expand property ownership; others were driven by
greed. Some knew that the people to whom they were selling houses could not
afford it; others simply did not want to know. Some played by the rules; others
forged documents. The banks that originated mortgage loans sold their
portfolios to investors who didn't really understand what they were
buying.
In the same way, the JOBS Act will ease life for some
deserving people – and most likely attract many more who are less deserving.
The new system will attract scam artists and promoters who will encourage
unsuitable companies to seek investment and oversell the companies to
individuals who can't afford to lose the money that they invest.
Yes, there are some wonderful, honest companies that deserve investment and can’t get it, but they are not that common. I see a lot of start-ups. Many are appealing and have good ideas, yet most of them fail. Now the quality of even the honest start-ups is likely to decline as more of them are established, and they will spend more of other people’s money before failing.
For example, with more start-ups, it will be even harder for each of them to find management talent and the right employees. Indeed, many people whom an entrepreneur might have hired will probably become CEOs of competing start-ups. Meanwhile, all of them will be competing for a finite number of customers, and those companies that make progress will then have to compete for scarcer scale-up capital.
Many investors in these startups are likely to lose their money. Even under the current system, many angel investors lose money. The best route to success in angel investing is to invest in, say, ten or more separate companies, so that you have the chance of at least one big winner. But, again, a broader investor pool is likely to reduce the average number of investments per investor, with inadequate diversification leading to many more losers than winners.
The faith that drives the JOBS Act is the same magical thinking that drives many Internet phenomena: people are good and everyone means well. But the Internet’s easy accessibility and low entry barriers have led to spam and malware and bad behavior; each new service starts out “clean,” but then ends up requiring its own regulations.
Just ask eBay, Google, or Facebook how much they spend on security, fraud detection, and the like. They don’t want to tell you, which says a lot. As on the Internet, so in real life: sometimes friction has a purpose.
Esther Dyson is one of the world’s leading entrepreneurs focusing on
emerging digital technologies. As Chairwoman of EDventure Holdings, she has
been at the forefront of analysis of these technologies’ impact on business,
privacy, security, creativity, and politics. She has served as a board member
or early investor in numerous startups, including Cygnus Solutions, Flickr,
del.icio.us, ZEDO, Medstory, and Medspace, and currently focuses on startups
related to medical technology, aviation, and space travel.
