In 1996, Spring Street Brewing Co. launched the first direct public offering of securities over the Internet. It was an enormous success, raising millions of dollars for the company. Spring Street pioneered a new frontier in capital formation that, until recently, was rendered practically useless by regulators who sought to protect investors from the likes of Jordan Belfort, the ruthless stockbroker portrayed by Leonardo DiCaprio in The Wolf of Wall Street.
Regulators have since changed their tunes. Soon the Internet will officially open for equity crowdfunding in the United States. While it may prove a boon to some entrepreneurs and investors, this bold new marketplace will have all of the risks prevalent in the world of penny stocks. You can bet the wolves of Wall Street are buying second homes on Spring Street.
The SEC has spent decades warning investors about the perils of investing in penny stocks. These securities are speculative in nature and there is often little or no information available to investors attempting to make an investment decision. In addition to carrying substantial risk, penny stocks are often used by wolves to defraud investors.
Like the penny stock market, the equity crowdfunding market may only give an army of dogs the capital they need to operate long enough to fail. The Federal crowdfunding rules were drafted with this likely result in mind. Unlike their Federal counterparts, state law makers are pursuing an almost complete deregulation of intrastate offerings. Fortunately, both sets of rules contain investment caps that mitigate concentration risk.
Investment concentration rules provide the only distinction between the penny and equity crowdfunding markets. Such rules are designed to limit losses to ordinary folks, the “unsophisticated” investors. While you are free to invest in crap, you are not permitted to put all of your money into one crappy basket.
Equity crowdfunding grants regular people the right to take financial risks, a hallmark of financial democracy. The success or failure of equity crowdfunding is, therefore, in the hands of the average Joe. If the market tanks, Joe’s on the hook because he made the investment decision. Blaming wolves for a market’s failure is insincere.
Investors should assume that equity crowdfunding is merely a pig in lipstick, the penny stock market reinvented. Investors must operate under the presumption that equity crowdfunding opportunities are nothing more than cheap long shots. A low expectation of legitimacy will demand heightened vigilance, resulting in better investment decisions.
The wolves of Spring Street will hunt. Caveat emptor.