Hank Barry, the former CEO of the early music-sharing service Napster, is encouraged by the Securities and Exchange Commission’s proposed rules for crowdfunding as they set the stage for this nascent form of investment.
The SEC commissioners voted unanimously last week to propose rules for financing startup companies through so-called “crowdfunding,” as part of their rulemaking for implementing the Jumpstart Our Business Startups Act, or JOBS Act, of 2012 (see SEC Proposes Rules for Crowdfunding for Financing Business Startups). Crowdfunding has become a popular means of funding various projects, particularly in the fields of music and film, through sites like Kickstarter and Indiegogo. The JOBS Act that was passed by Congress last year, and the SEC’s proposed rulemaking, are expected to open up the crowdfunding field to regular investors, but could also bring fraudsters as well. Meanwhile, the concept is attracting cautious interest in Silicon Valley.
“Crowdfunding is going to be very important in the future of the Valley,” Barry told me in an interview Monday. “It’s relatively narrowly defined under the JOBS Act because of the limitations of $1 million a year. Because of the limitations, I don’t know that many people will take advantage of it right now. It seems as though both Congress in the law, and the SEC in their proposed rules, are taking a bit of a wait-and-see attitude. They’re going to see how this works out on a relatively small scale and then see if they can expand it.”
Barry is a veteran of the technology and venture capital industries in Silicon Valley. He was appointed as interim CEO of Napster by the VC firm Hummer Winblad Venture Partners in 2000 as the music-sharing site came under legal attack from the Recording Industry Association of America, which accused the site of rampant music piracy. Despite the legal threats, Hummer Winblad took an interest in the nascent technology that had been developed by a young computer programmer, Shawn Fanning, spotting its potential and huge popularity. Barry departed the CEO job in 2001 after music executive Konrad Hilbers from the German media giant Bertelsmann AG was tapped to run Napster, and he became a member of the board. As an attorney, he later joined the law firm Sidley Austin, founded its office in Palo Alto, Calif., and is now co-chair of the firm’s Emerging Companies and Venture Capital practice group.
Barry acknowledged objections raised by some investors like the angel-funding group AngelList to some of the crowdfunding rules proposed by the SEC. “They’re basically saying we don’t think this is a big enough opportunity to make a lot of investment,” he said. “We’ll just have to wait and see what happens under these rules. Certainly for small companies who don’t need to raise a lot of money, I think it’s perfectly appropriate. It’s going to look a lot like Kickstarter for equity. That’s what was intended by Congress for the JOBS Act. I think actually we’re in a very appropriate place right now.”
Barry is not worried about the potential for stock fraud, as some opponents of the JOBS Act have warned. “The rules are designed to minimize any fraud,” he pointed out. “Certainly securities fraud as a crime carries a heavy penalty. I think people will be aware of that. Is there potential for abuse? Sure, there is a potential for abuse in many things, and this is just one of them. But people have wanted to be able to get equity in many of these projects, the sort of things that are on Kickstarter, and the companies have wanted to be able to give equity, so this is a great framework for beginning that process. We’ll see. It’s like anything else that’s new. We don’t know what all the good things are going to be and we don’t know what all the bad things are going to be. We just have to work through it. But I give a lot of credit to Congress for passing this because it gives us a chance to try some new things.”
He sees potential for accountants to help startup companies navigate the rules to make sure their financial statements are in order.
“We’re very fortunate that accountants have been willing to get involved in small companies and startup companies,” said Barry. “One of the great things about the Valley in particular, which is where I live, is that the big accounting firms have been willing to get involved at an early stage with companies, especially venture-backed companies, at a reduced rate so that they can have good accounting services as they grow. I don’t know whether that will track into the space of crowdfunded companies, but I hope it does because having professional accounting help is so important to companies as they form their revenue models and decide how they’re going to do business. For example, at a software company revenue recognition is everything, and a lot of companies don’t get advice about that until too late sometimes. I hope accountants will get involved with some of these companies, particularly the high-growth ones. It’s really an exciting time and I’m looking forward to everyone’s participation.”
Venture capital firms may also get more involved as they see more competition from new crowdfunding sources. “Crowdfunding and angel funding and convertible debt funding—all these early startup sources of money—have really changed the venture business,” said Barry. “The venture business used to do a lot of seed-stage investing where it was really two people and a dog. Now most venture is later stage than it used to be. Your first professional institutional round of venture funding is coming at a later stage when there is less risk in these companies. What’s happened is that the really risky seed-stage funding is now being done for the most part by individuals, by angels, by incubator groups and accelerator groups. I’m sure crowdfunding will fit into that same equation. It already has and will lead to more disruption in the venture capital business because eventually some of these companies are going to do extraordinarily well, and historically in venture the best returns came when you made that initial startup investment because your stock price was so low. Whether the returns to venture will continue to improve, as they have been improving over the last five or six years, we’ll see.”