A Warning About Crowdfunding
Crowdfunding is something you’ve probably heard of. It’s where a large group of people who don’t know each other come together and all contribute a small amount of money to fund something. We wrote about a solar crowdfunding platform last year called Mosaic which allows you to participate in a diversified portfolio of solar projects.
Arguably the most visible form of crowdfunding over the past five years has been the Kickstarter platform. Potential startups tout their latest cool product and everyone commits to purchasing the product and then the product is brought to market and everyone wins. If you are a 3D printing investor, you probably have seen some of the many 3D printing startups being launched on Kickstarter. While the idea sounds good on paper, the platform has become the target of scammers and many people have lost money in failed ventures. In these cases it didn’t matter if the people running the operation were scammers or just poor business people, you still lost all your money. In the case of scammers, they have realized that the genius part about this platform is if you are attempting to fund a product with a low price point, most investors who ponied up for one would just think “oh it’s just $25” if the company failed to deliver. Fortunately, the “crowd” is also organizing themselves to police these scams.
But what about crowdfunding platforms that allow you to purchase equity in a company as opposed to their completed products? There are a number of companies out there that offer this service. A company called Sharespost actually offers a platform that allows you to trade shares in many popular startups including two companies we wrote about before, Bloom Energy and Harvest Power. Investing in companies on this platform typically requires a minimum investment of $25-50 thousand USD. While this may seem like a large purchase for most retail investors, the platform is legitimate, has liquidity, and the last time we checked, all companies on offer were already backed by venture capital firms. However, this is a dangerous business model if not policed closely. It reminds us of the value proposition of most OTC companies which goes something like “put money in my great idea and if the business doesn’t work out I still get paid handsomely but you lose your entire investment”.
Let’s take newcomer equity crowdfunding platform Onevest as an example. They are currently soliciting funds for smaller startups through their platform and while most of the companies on offer aren’t necessarily disruptive, a few looked intriguing enough to ask a few more questions. We first inquired as to what percentage of equity you would receive for an investment in this company:
The answer was that there were a large number of variables to take into account including whether or not the round was oversubscribed. Only upon closing would the amount of equity be revealed. We were told we could always connect with the founder(s) to discuss this further. It’s hard to see anyone blindly making investments in any venture without knowing exactly what they get in return. Having to inquire about this amount with each individual company seems like a daunting task. Just how much leverage do I have in negotiating more equity for my “measly” $10,000 investment (the minimum required amount)?
This does not appear to be a common concern though. Onevest has successfully raised over $14 million so far to fully fund 13 companies on their platform and they are being very selective about which startups they pick. The firm conducts a two-tiered due diligence process on each startup they add to their platform including background checks, product testing, and a competitive landscape review. In exchange, they charge a 7.5% commission fee on funds raised. While it’s hard to go in blind on an investment in any of these companies, we can probably assume that these potential investments represent fair amounts of equity.
There’s also the subject of liquidity of which there is going to be very little given how new the platform is. Onvest acknowledges this risk stating that “the investments may not be liquid until the exit event” and “most investments don’t see an exit event for 2-5 years”. Part of the reason for this is that most the startups on the Onevest platform seem to be taking in their first round of crowdsourced “angel funding” whereas, with the more established startups on Sharespost, most have already seen multiple funding rounds by venture capital (VC) firms. One of the key value adds that a VC firm provides is representation on the board in many cases and direction to the company founders who may be leading a company for the very first time. Venture capital involvement in startups is a critical factor that drives a company to an exit event consequently rewarding shareholders. Our primary concern isn’t so much the amount of equity we’re buying, it’s the risk that startups with no VC representation (yet) may never see a successful exit. It will be interesting to see when the first liquidity event on this platform is announced and then, what sort of inflation-adjusted returns are realized on that exit.
All equity crowdfunding platforms should be evaluated extensively prior to making investment commitments. Before investing any money in a particular startup, make sure you understand exactly what it is you are purchasing. Some of our MBAs use services such as Lending Club for consumer loan crowdfunding and have found this alternative asset class to be transparent, the returns to be “what it says on the tin” and the overall platform to be solid. Now, we’re on the lookout for a platform that allows us to purchase known amounts of equity in disruptive startups alongside known venture capital firms with more lenient initial investment minimums.
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