Is Equity Crowdfunding Beating Adverse Selection?

Most new businesses are funded with a combination of debt and the owners’ savings; equity funding has traditionally been relatively rare:

Source: Kauffman Foundation

Partly this has been a regulatory issue. Raising equity adds all sorts of legal burdens. Traditionally businesses could only accept equity investments from accredited investors and a small number of friends and family unless they did a full IPO and became public (hard enough that there are less that 5000 public companies in the US out of millions of businesses). This changed with the JOBS Act of 2012, which allowed small businesses to raise money from large numbers of non-accredited investors without having to register with the SEC.

Following the JOBS Act, equity crowdfunding sites like WeFunder emerged to match new businesses with potential investors. But equity crowdfunding has taken off relatively slowly:

Total dollar amount raised by regulated CF crowdfunding campaigns. Source: FAU Equity Crowdfunding Tracker

Its seen more success recently with some additional regulatory relief and the overall market boom of 2020-2021. But at ~$400 million/yr, its still well under 1% of all venture investment (~$300 billon/yr), which is itself tiny relative to the public stock market ($40 trillion market cap).

Why has equity crowdfunding been slow to take off? Partly its new and most people still don’t know about it. Partly early-stage companies aren’t a good way for most people to invest a significant fraction of their money; you probably want to be at least close to accredited investor levels (~$300k/yr income or $1 million liquid wealth) for it to make sense, and those at the accredited investor level already have other options. WeFunder is up front about the risks:

The other issue here is with asymmetric information and adverse selection. Its hard to find out much information about early-stage companies to know if they are a good investment; part of the point of the JOBS Act is that the companies don’t need to tell you much. The companies themselves have a better idea of how well they are doing, and the best ones might not bother with equity crowdfunding; they could probably raise more money with less hassle by going to venture funds or accredited angel investors.

I’ve long thought this adverse selection would be the killer issue, but my impression (not particularly well-informed and definitely not investment advice) is that there are now quality companies raising money this way, or at least companies that could easily raise money elsewhere. WeFunder has a whole page of Y-Combinator-backed companies raising money there. This week Substack, an established company that has already raised lots of venture funding, offered crowd equity and reached the $5 million limit of how much they could legally accept in a single day.

Overall I think this model is working well enough that I’m no longer in a hurry to become an accredited investor. Accredited investors have many more options for companies they can invest in and aren’t subject to the $2,200/yr limit on how much they can invest in early-stage companies. But even if I completed the backdoor process of getting accredited without being rich, I wouldn’t want to put more than $2,200/yr into early-stage companies until I was a millionaire, at which point I’d be accredited the usual way. And while most companies aren’t raising crowd equity, enough are that there seem to me to be no shortage of choices.

Best Books 2021

I read 23 books in 2021, but none that were written in 2021. Tim Ferriss stopped reading new books deliberately but for me it just happened, something about this year made me want to hang out in the ancient world instead.

I read about how five thousand years ago the Indo-Europeans figured out how to ride horses and use wheels, and so ended up spreading their language to half the world. I read about the Bronze Age Collapse three thousand years ago. Also set three thousand years ago are the semi-mythical events of the Aeneid and the Odyssey; I particularly enjoyed Emily Wilson’s new translation of the latter. From two thousand years ago, Caesar’s Commentaries reads like an action-packed fantasy novel but gives real insight into history and strategy. It was also a good year to go back to the Biblical events of two to three thousand years ago, though I didn’t make it cover to cover.

The one book about the modern world I gave 5 stars in 2021 was The Dictator’s Handbook: Why Bad Behavior Is Almost Always Good Politics. The short version of my review is that it’s secretly a development economics book:

Bueno de Mesquita, author of The Dictator’s Handbook, is a political scientist but his analysis is very much economic, in both the methods (rational choice & methodological individualism) and in the focus on material incentives as the main driver of behavior. The book is good as a manual for aspiring tyrants, but suprisingly great as an explanation for why many poor countries stay poor.

So overall compared to 2020 I don’t have many good books to share, apart from things like The Odyssey that you presumably already know about. The best new writing in 2021 probably isn’t happening in books at all, but in Substacks. Many bloggers switched to the Substack blogging/newsletter platform last year because it makes it easy to monetize their writing, while many professional journalists switched over as a way to keep being paid to write while enjoying near-complete editorial freedom. I recommend Byrne Hobart on finance and business strategy, and Razib Khan on history and genomics. Probably my favorite writing of 2021 was the return of Scott Alexander to blogging, now at Substack as Astral Codex Ten. He is also a great demonstration of just how much the monetization game has changed, as less than a year into the new Substack he is making enough money to start giving large amounts of it away.