Clay Shirky is an American writer, consultant and teacher on the social and economic effects of Internet technologies — at least, according to Wikipedia, the crowdsourced encyclopedia for which he serves as an advisor. Shirky is also the author of Here Comes Everybody (2008) and Cognitive Surplus (2010), two books examining the results, ramifications and potential of aggregated individual action.
I recently spoke with web guru Clay Shirky about the JOBS Act, which President Obama signed into law on April 5. In the transcript below, Shirky explains why he “would love to be able to offer essentially wholehearted support of the crowdfunding law,” but has several reservations about the regulatory relief embedded in the bill. (Spoiler: Much comes down to the SEC’s interpretation of the law, which is ostensibly scheduled to conclude in the first few days of 2013.) Shirky also discusses Kickstarter’s present dominance in the crowdfunding space, the vagaries of pre-JOBS Act law in relation to crowdfunding, and the effect of the JOBS Act on the current startup ecosystem and traditional venture capital.
Eric Blattberg, Crowdsourcing.org: What is the JOBS Act about, and why do we need it?
Clay Shirky: The JOBS Act is about kicking off a startup economy. The abundant theory [driving the JOBS Act] was lack of cash instruments, particularly given that the credit crunch is still very much in place at the banks, coupled with [business] owners’ regulatory requirements. And that theory seems to me to be basically false, because those two ideas target very, very different ends of the business ecosystem, right? I mean, you’re raising the money in the beginning — or in an early stage — but the reporting requirements don’t appear until a much later stage. As so often happens with Congress, I think we would have been much better off if those two theories were put forward and debated separately.
Blattberg: They initially were, in fact, but the JOBS Act is actually a conglomeration of six different bills, several of which were largely unrelated to crowdfunding.
Shirky: Yeah, exactly. People looking to reduce some of the burden of Sarbanes-Oxley saw the JOBS Act as a platform to piggyback on. And it’s a shame, because I would love to be able to offer essentially wholehearted support of the crowdfunding law, but this freighting of it with this alternate theory of what the obstacles are by saying, “We’re going to push regulatory relief into this same bill” — that is too bad. On the other hand, that is always the way Congress works. Nobody gets what they want entirely without having to give up something to somebody else.
So where do you stand on the final bill given these competing factors?
Where I stand on the final bill is, well, I hope that the Obama administration and the SEC takes the narrowest possible interpretation of the altered reporting requirements. I think the overall bill could be a net positive provided the regulatory relief is delivered in as narrowly targeted a way as possible so it doesn’t become another source of opaque business practices of the sort that, in my view, led us into the worst recession in 70 years.
The bill essentially legitimizes something that’s already an important part of the startup ecosystem that I think people have not sufficiently recognized. When you go Kickstarter, and you look at Glif, or Double Fine, or the company that makes custom jeans, or the company that makes flip-flop sandals… the flip-flop sandals people asked for $12,000, and they got $50,000. You look at that and you think, that’s not patronage, and it’s not even just people buying flip-flops in advance and on-spec; that’s enough funding to actually launch a company.
In the old days — all the way back in 2009 — raising money, marketing a product, and acquiring customers were three very different phases that required three very different kinds of expertise and effort. Kickstarter makes them a single operation. If I succeed, I have raised the money by marketing my product to my potential customers. It’s all bundled there. The value of Kickstarter that people focus on is getting the money, but the huge value to the business environment is reducing uncertainty and frontloading knowledge of a potential customer base.
So the thing I’m most bullish about regarding the JOBS Act, separate from the regulatory relief, is that this method of aggregating demand isn’t a new way to do the old stuff; it is a new model of the business ecosystem, full stop. I think, in retrospect, we will look back five years from now and we will recognize Kickstarter not just as a fund-increasing mechanism, but also as an uncertainly-decreasing mechanism. That is going to be so, so vital, because uncertainty is a big obstacle to small business formation of two sorts. First of all, is there a market for Product X at all? And second, how can I learn from feedback what the right model for talking to people about my flip-flops, video game, or whatever is going to be like? Kickstarter is now the platform to do that.
There are other platforms, other platforms will arise, but Kickstarter is plainly the dominant one. I think that, in a way, having the law catch up with practice is a good thing — because what happens right now is if I can pretend that this is a donation and that my shipping you the product is a “thank you” gift, then I get to use Kickstarter, but if I say explicitly, “you are buying my sandals and helping me start a company,” suddenly it’s illegal. I think the JOBS Act clearing that up is terrific. And then the criminality argument — criminogenic, crimogenic, however you pronounce it laughs — is probably true; in fact, is almost certainly true. Whenever you lower the inputs and restrictions, more people do these kinds of things.
Have you taken a look at the Merkley-Brown amendment? It includes a number of safeguards for investors, like scalable investment caps based on yearly income.
This I think is the smart way to do it. Unsophisticated investors become sophisticated investors by making mistakes. It’s not like you’re born and genetically, some place on chromosome #17, there’s a bit that says you’re either a sophisticated investor or an unsophisticated investor. Giving people a chance to play in these pools will be educational.
I was always struck in the IPO market, friends would write and say, “I’m launching a company, do you want in on the IPO?” And there was a minimum of $10,000, and I was like, “No, I’m not going to give you $10,000…” And they’re like, “We’ve got big VCs coming in for half a million.” Now there’s a way to aggregate more reasonable investments, like from $50 to $500, and let people learn from their mistakes and experiences.
In a way, the value of these systems is to lower the damage from failure, rather than to lower the likelihood of failure. I mean, let’s be clear: the goal of the JOBS Act is to have more companies fail faster. This isn’t a side effect, this is really the main effect of improving the startup economy: getting more people to try more ideas, which inherently means more failure. But it also means more experience, it means more surprises, it means lower cost. In a way, the criminogenic argument seems to me to get halfway towards what the JOBS Act is actually targeted for in that it recognizes this lowering of the threshold to participation — but it also lowers the cost of participation. I think that the regulatory bias should be in the direction of protecting investors from the downsides of failure, rather than protecting them from entering into the pool in the first place because they might fail.
What crowdsourcing and crowdfunding do in general is exactly that. This is true of Wikipedia edits, of changes to the Linux kernel; there is no real distinction here. When you aggregate many small sources of participation, you lose robustness but you gain resilience. You lose the ability to supervise the participants from above and in advance, but you gain the ability to take advantage of unforced and unpredictable participation, which can often produce better — and certainly produces more surprising — results than the classically managed system.
So how do you think the JOBS Act is going to affect the traditional venture capital world? And also, perhaps you could address the potential guidance a small team of investors can offer as compared to the wisdom of the crowd.
Well, in general, crowdfunded companies are going to be companies that can’t get VC funding. When we hear “startups” in our part of the world, we envision somebody coming up with the next blockbuster tool — the next eBay or something — using a funding approach like crowdfunding, when in fact it’s mostly going to be people making eco-friendly tote bags, people whose local bank won’t give them the time of day. It’s going to be people launching businesses with $50,000 as the seed round, rather than $1.5 million. I don’t think there’s going to be almost any overlap — in the early days — between the VCs traditional targets and crowdfunding.
And this always happens with systems that unleash new sources of participation. When [Meetup Co-founder and CEO Scott] Heiferman launched Meetup.com, he assumed that they would get classic American interest groups: poodle owners, muscle car people, that kind of thing. They got Slashdot, Fark, ex-Jehovah’s Witnesses, wickens — people for whom the traditional society didn’t provide any alternate mechanism for coordinating themselves in the real world. So I think the JOBS Act, inasmuch as it leads to a boom in successful crowdfunding, will — perhaps a year or 18 months from now — reveal itself to be a source of all kinds of startups that just weren’t part of the current ecosystem.
I don’t think the VCs will suffer much — suffering is not something VCs do particularly well in any case — but I think the surprise is going to be the growth in little businesses. When you looked through those P2P lending platforms [temporarily] shuttered by the SEC a few years back — Prosper and Lending Club — you didn’t see the Diaspora kids; it was mostly people buying a new pizza oven and stuff. The high-tech veneer that’s been put on this is mostly not true.
The one place where you’re going to see a significant overlap between crowdfunding and technology is going to be — in fact, thanks to Kickstarter, has already been — games. Games, because the process looks like Microsoft but the economics looks like Hollywood, nobody knows how the hell to invest in a gaming company. It’s just always been this weird space where neither investor group knows how to effectively approach and evaluate these companies. But then Double Fine came in — and BAM.
But look at the gamers — they know which companies are valuable.
Exactly. Everybody is focused on aggregating money — but actually, aggregating demand and therefore squeezing uncertainty out of the system [is just as important]. To have a group of gamers sign up and say, “Hell yeah, I’ll play that,” takes some of the risk — not all of the risk, it’s still a hit-driven industry — but takes some of the risk out of cultural production. And that, I think, is going to be remarkable.
So everybody looking at crowdfunding as some alternate source to VC funding doesn’t understand how many obstacles there are to traditional sources of business income, in making a game or in making a pizza. There are a significant number of obstacles in the way that are ordinary and basic parts of the business environment.
So are we going to see this aggregated demand — this new realm of cultural production — transfer over to television, movies, short films and the like?
Yes, definitely. I mean, you see it on Kickstarter already. But right now, what Kickstarter is limited to is a kind of bankshot. If I go and I say, “I’m making a film about the reintroduction of wolves into upstate New York, and you are funding my work,” then it’s ok. But if I say, “You are funding my production company, this is my first film, but I actually want to create some structure around this,” all of the sudden, I can’t say that. Some former students of mine put up Glif, the flexible tripod designed specifically for the iPhone. [With an original funding goal of $10,000], they got more than 10X oversubscribed. They got enough money to start a company — it turned into their seed capital for their design firm — but they couldn’t say that.
So, in a way, what is freed up isn’t crowdfunding for cultural production — that’s already out there — what’s freed up is the ability for an artist or a creator to say, “I actually intend to create infrastructure for doing this kind of work over the long haul.” That can now happen essentially by accident and under the cover of darkness on Kickstarter. Again, this is the great thing about the JOBS Act, if it’s implemented the way it seems to be written: it brings out into the open people who are interested in saying, “I’m actually building infrastructure, I’m not just doing ‘a project’.” Given that that’s what’s actually happening, it seems to me a good idea to line up peoples’ public perception and awareness of it with what the reality is behind-the-scenes.
So do you think Kickstarter is going to come out and say, “Alright, you know what, it makes sense to shift to an equity-based model,” or perhaps launch an equity-based enterprise separate from the main Kickstarter brand?
Kickstarter is in an ambivalent position about this. It was not one of the early supporters of the JOBS Act for at least two different reasons: one, who needs the scrutiny, right? I mean, there’s a seriously high degree with regulatory scrutiny that comes with this. So, although on some level, Kickstarter is the great source of much of the visibility of crowdfunding — much more than the explicit crowdfunding-for-business platforms are — the structural difficulties that come with that shift are significant. Second, Kickstarter is very explicitly a patronage platform. Frankly, the Kickstarter team is a little bit uneasy with a form of cultural production that can easily be resold as objects, because in a way it puts them in competition with eBay and Etsy and so forth, and that’s not what they set out to be. So, in a way, they are really pretty emphatic about cultural production.
My guess, on the other hand, is given that Kickstarter is “the brand name” for crowdfunding — in part because they didn’t try to solve the hard problems first — they will launch something like a sister business or a parallel brand, because they do have an in-house platform and in-house expertise. Again, as a guess, they will want to segment staff so that the success or failure of a business-focused venture and a cultural production-focused venture don’t get too tied up in one another. It will probably be “Kick-something” in the manner of trying to get that penumbra of their original and well-known name out there…
Right, exactly. But Kickstarter is very explicitly on the side of the project backers, of the payers. There was an analogous situation in the music business when everybody tried to set up to replace the A&R department. You’d go to a band and say, “You can get out from under the thumb of the Man and go directly to the listeners,” ignoring the fact that most music is bad. Most people don’t like most music. So, it turned out to be impossible to get large numbers of ordinary citizens to sign up to listen to bad music. Every one of those platforms tanked, whereas the platforms that said “we’re on your side” to the listeners [did much better].
So Kickstarter is very, very forward leaning and rigorous about policing and requiring of the participants in the system essentially basic user protections — and the investment thing is simply and necessarily going to be more failure-oriented. Because now, if I say, “I’m going to knit a bunch of scarves, please give me money to knit these giant scarves,” people are going to pre-order them and then I’ll mail them the scarves. If I don’t mail them the scarves, Kickstarter will drive over to my house and metaphorically punch me in the face. They really police non-deliverance.
Now, if I say, “I’m starting a business to bring Yorkshire pudding to the masses,” there’s a good chance that will fail and there’s nothing Kickstarter could do about that. Now, I don’t think as a brand they can afford to have one platform do both things, but I do think that the business opportunity there — especially the fees they could take while raising money for commercial ventures — would be potentially quite attractive, and they are in the pole position. I think they’ll be taking advantage of this.
I’m wondering about the various limits in place within the JOBS Act. There are a number of “educational” limits in place, like a quiz that drills certain points like, “Do you understand that most startups fail?” There are a number of monetary limits, too: a $1 million maximum for businesses raising capital through crowdfunding and a $10,000 maximum for individual investors, among others. But crowdfunding is less restricted in Europe. Let’s use the U.K. platform Crowdcube as an example. The smallest investment ever made through Crowdcube was £10 pounds — and, under the framework of the JOBS Act, one could certainly invest $10 — but Crowdcube’s largest-ever investment was £100,000, something the JOBS Act wouldn’t allow. Is that a problem or a good thing for this burgeoning industry?
Frankly, it feels like to me the best restrictions are going to be the ones that minimize the risk rather than try to maximize the education, because nominally sophisticated investors clearly had no idea what they were buying when the top-trench of a collateralized CDO in the mortgage market. I think the argument that the educated investor is the best defense against abuse — well, that wasn’t even true before the JOBS Act, so I don’t have much faith [in that working here].
I mean you certainly want to have something that says, quite basically, “Do you understand that most startups fail? That you will likely never see your money back? That, if you do, it will likely be a fraction of your investment rather than a factor of your investment?” Absolutely get those messages across. The crowdfunding platforms that seem to care about their users do say, “Inasmuch as you are trying to do this as a money-making venture, and not as a friends-and-family round to help people you know, spread out your investments across a portfolio of startups.” That advice, much more than the financial savvy advice, is really valuable.
There’s no system in the world that can have a very high-risk of failure and also do what people want it to do, which is return more money than they put into it. You can’t square those two things. But I think that the structural restrictions on lowering the risks the users have in terms of the money the put it is ultimately going to be the set of protections that matters more than the education stuff.
So, interestingly, this assumed self-regulatory environment is a large part of this bill. Every platform operator is required to be a member of a national securities administration. The more I think about these financial limits and the amount of communication and technological underpinnings that will have to be standardized between these various platforms, I wonder if they are really going to be enforceable…
Well, self-regulation in general has a very checkered history. But particularly in the early rush of excitement whenever the starting gun goes off, there’s very quickly going to be a separation between a small number of serious players and a large number of bullshit players. There will be lots and lots of stories written about the bullshit players taking your money and blowing up, as happened in the previous models. But really, I think what the SEC interprets as its mandate is going to matter a lot more than any industry code of conduct or anything like that. Financial industries, as we know them, do not self-regulate. So, we’ll see. The results will certainly be interesting.
I would like to thank Clay Shirky for speaking to me so extensively about the JOBS Act. Be on the lookout for more JOBS Act coverage from the Crowdsourcing.org editors in the coming days and weeks.