Over the last few years there has been a dramatic growth in equity crowdfunding as a mechanism for early stage companies to raise capital as the funding from traditional lenders such as banks has reduced, and founders have seen a way to obtain funding without having to give a Personal Guarantee on their home or assets.
As a Founder
Looking at equity CF as a founder it can be very attractive as a small amount of funding raised from friends and family can be used to ‘seed’ a fund raise of up to maybe 10 times that amount using one of the regulated platforms.
The costs involved in this are very low, a few hundred pounds to incorporate and get a set of documents together and a business plan and the opportunity to raise a significant amount to get to an MVP level or more.
The levels of Due Diligence carried out in relation to the presentation of the offering are generally weak and the ‘crowd’ tend to be more influenced on PR activity than business fundamentals resulting in an opportunity to raise significant capital at a very attractive valuation.
As an Investor
The two common models are via a Nominee Structure where the underlying investors rely on a regulated professional nominee to manage corporate decisions on their behalf, or a model where the investor holds direct equity and the Founder gets a shareholder register 10 pages long and an administrative nightmare.
It is common to hear that a benefit of crowdfunding is that there is a relationship between the company and the investors where the wisdom of the crowd can add value to the company.
Personally, I have found that of my 12 or so CF investments the communication form the company slows up very quickly once funding is done and have seen the benefit of the crowd in only 1 out of 12. Maybe I have been unlucky.
It staggers me to see ‘investors’ making an investment of 10 or 20 pounds into equity of a company via CF when they have certified themselves as investors by a quick 5 or 6 questions quiz. I consider that the regulated companies that manage CF are negligent if they do not put a minimum amount of at least 100 pounds in as an investment. With such low amounts success stories can result in losses for the mini investor as the broker fee to sell shares when AIM listed can costs more than the value of the equity so the investor has to pay to get out so you can actually lose more than your original investment!
There is a general lack of transparency in the reporting of basic information by companies that have received investments that can prevent the ‘wisdom of the crowd’ being available to the company as there is radio silence. It would be very easy for the regulated CF companies to have standard quarterly reports on basis numbers such as cash in hand, run way, etc that are key to monitoring an early stage company. The lack of transparency has I think moved people away from CF as it has become clear that there has been miscommunications and lack of diligence on some marketing materials. Trust is lost.
The CF regulated companies rightly advise to have a diversified portfolio, but do not look to take performance fees based on the investor’s portfolio which would be the case with the NAV in a VC Fund. It would be more equitable for the CF companies to net gains and confirmed losses (administration or liquidation) when charging performance fees that really is industry standard.
Equity CF will continue to have founders lining up to raise funds as it is attractive , but I believe that there will be ‘investor fatigue’ where investors lose interest due to the overall weak performance, but more critically the lack of transparency and weaknesses in some of the promotional and marketing materials that were used to induce investments.
With the period since CF really started now being a few years, investors are seeing more and more failures, lack of progress and unusual business activity. Once trust is lost, it can be hard to recover. Of course, we all know that 80% or more start ups fail and that is normal, but the transparency issues need to be addressed.