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START-UP ... REALITY

Equity Crowd Funding – are you sure?

Governments are involved in a lot of things that they probably should not be. In fact, much of what they touch turns bad despite best intentions. Unless you are a hardcore libertarian, however, one legitimate role is saving people from themselves. It’s why governments intervene in health issues (drug taking, gambling, self-harm for example) and why we have societal rules which go some way to regulating who can do what to who.

Saving people from other people who are smarter than them (or equally as naive as them) that want to use their money in high risk activities fits under self-harm. Putting an overly optimistic, albeit honest, entrepreneur with someone who wants to make more money with their existing money is not always (read as rarely) going to end well. Allowing crowdfunding of very early stage private companies is fraught with danger.

This is not about ‘crowdfunding demand’ (selling product) but rather crowdfunding investment. There are in fact issues with selling product also of course. Kickstarter states that 9% of people don’t get what they paid for and only receive a refund 13% of the time. So, 7-8% approximately of kickstarter pledges seem to ‘disappear’.

This is a separate issue, and the physical product development and delivery focus of much this platform probably somewhat accounts for the relatively low rate of loss. Although, the people who put their money down I’m sure don’t realise they only have a 92% chance of getting their ‘reward’ / product.

Back onto the topic which is crowdfunding investment that is generally used for operational costs not for ‘production phase’ expenses.

Cynically called ‘dumb money’ in early stage circles, the average person has no idea of the risk of these companies. Giving them easy access even to a filtered list of high-risk early stage investments is likely to be a disaster unless investors at a minimum are made aware that:

  1. these are often very long term plays that lock up your money for long periods with 8-10 years not uncommon;
  2. your money won’t be available any more and you generally can’t sell your holding;
  3. you need to be in around 25 or more of them to be reasonably sure you won’t lose any money;
  4. mostly these companies fail (pick a number but best case 90% and up to 99%);
  5. their valuations are based on the assumption that that not only are are they the 1 in x companies that isn’t going to fail, they are going to be spectacularly successful;

If these new investors were really aware of these things, would they still be interested? Maybe, but probably not, which makes the odds that potential investors will be fully informed likely to be about the same as odds of the companies succeeding.

With AU startup Guvera raising $180m of this type of money and now being in administration, hopefully fresh in everyone’s mind, let’s not forget that the risk profile of these companies. Even when filtered by people with experience, and in a nice user friendly ‘Pay with Paypal’ type format, is still off the charts.

It’s objectively true that the risks often include complete loss of capital unlike many other alternatives. These companies aren’t going to be suitable for people who don’t have money to actually lose OR have enough capital to do 25 investments and possibly 25 follow-on rounds to avoid excessive dilution. There are no capital guarantees, it’s all or nothing.

After 12 years involved in startups both directly and in advisory capacities, it’s clear that this space is not for most people.

The wisdom of opening up investment in the space to ‘everyone’ is questionable.

-end rant-

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