Regulators are extremely nervous about equity crowdfunding. But crowdfunding compares quite favorably to something another arm of government loves: the lottery.
Entrepreneurs like the idea of equity crowdfunding. Once it’s up and running, equity crowdfunding should allow business owners to easily sell shares in their company to anyone who wants to buy them, without going through the cumbersome Regulation D process or spending tens of thousands of dollars on legal fees.
The U.S. Securities and Exchange Commission does not like equity crowdfunding. The commission worries that crowdfunding will become an invitation to fraud and abuse. They note that even legitimate companies have high failure rates. Anyone--no matter how poor or financially unsophisticated--could put money into these risky ventures. It’s a disaster.
By that same reasoning, you know what else is a disaster? The lottery. And no one's anticipating new restrictive federal regulations on the lottery any time soon. Quite the opposite: State governments spend hundreds of millions each year promoting the lottery, trying to get more people to play the games. The Minnesota lottery has a $15 million marketing budget.
So why do we love the lottery and look askance at crowdfunding? Is it because the lottery is framed as a game, no riskier than bingo played in church basements? Is it because we haven't quite got over our cultural suspicion of entrepreneurs who can't get a job at a 'respectable' company? Is it because regulators are scared to death of change? You tell me. But if you gave me a hundred bucks, I'd put it in a new company before I'd spend it on MegaMillions.
Risk? We'll give you risk
Although equity crowdfunding isn’t a reality yet, I’ll bet the odds of at least breaking even on your crowdfunding investment are going to at least match those of winning Powerball.
Your odds of buying a winning lottery ticket are approximately seven percent. That includes small prizes, where you essentially break even, such as winning a dollar or a free ticket. The odds of winning a jackpot in one of the big PowerBall or MegaMillions drawings are about one in 175 million. In other words, zero. You’re gonna lose your two bucks.
What are the odds of getting fleeced by a shady crowdfunder? Granted, there’s no way to know, right now, how many attempts at crowdfunding will be turn out to be frauds.
But let’s say, just for argument’s sake, that the new crowdfunding platforms result in an astonishing rate of fraud. Let’s say that a full half of what appear to be legitimate companies attempting to crowdfund turn out to be rackets. And let’s say 60 percent of the remaining companies die within five years, which is in line with U.S. Small Business Administration estimates.
In this extremely unlikely scenario, your crowdfunding investment will still maintain its value, or grow in value, 20 percent of the time. That’s a nightmare for most investors, and a nightmare for the crowdfunding industry. But compared to the lottery? It’s a gold mine.
More money than it seems
The lottery may still appear benign compared to crowdfunding, because most tickets cost only one or two dollars. And the SEC is concerned about people who don’t have a lot of money losing thousands to crowdfunding scams. But the low price of lottery tickets is illusory. In 2012, lotteries sold a total of $69 billion in tickets. That means the average U.S. adult spends about $287 on the lottery each year.
The average kickstarter pledge is $71.41. So even if you limit your consideration of kickstarter to those who actually make pledges through the site, you’ve got much less money at risk here, per person, than in the lottery.
Meanwhile, despite the fact that virtually everyone, rich or poor, loses money on the lottery, most states enthusiastically support their lotteries. They don't put up barriers to make it harder to play. And lottery players certainly don’t have to show that they understand the risks or that they have money to burn: in most states, they just have to be 18.
This isn’t to say that we should outlaw the lottery or that we should eliminate all regulations on crowdfunding. But crowdfunding doesn’t need to be nearly as scary as we’re making it out to be. It’s already underway in Great Britain, where investors actually get a generous series of tax breaks in return for taking a risk and helping to encourage entrepreneurship.
Or we could combine the two: Win Powerball, put the proceeds into your favorite startup. Any takers?