Paul Fine – Consultant
In an environment where the traditional means of raising capital for start-ups is far from buoyant, the momentum behind equity crowdfunding is accelerating – there’s a distinct exuberance among entrepreneurs and their supporters. Increasingly, the Internet is becoming the preferred medium in which to raise money so that creative ideas and dreams might actually stand the chance of becoming reality for those that believe in them. In the USA, even President Obama has called equity crowdfunding a “game changer” and there’s no doubt that it is.
Yet, we only have to look to history to remind ourselves that investment exuberance is a good thing if, and only if, we’re rational about it. After all, the ‘90s showed us that investing in tech stocks just because everyone else was doing so didn’t exactly mean that the underlying fundamentals of so many of those ‘new economy’ businesses justified the valuations the market placed on them. Eventually, like all honeymoons, this one came to an end when the tech bubble burst.
So, what’s the lesson for equity crowdfunding?
Crowdfunding owes part of its attractiveness to the fact that capital can be raised without the burdens and stringencies of traditional securities regulation. And for worthwhile ideas and projects that’s all well and good. There are, though, some thoughts to bear in mind, to temper investment enthusiasm.
It is trite that the decision-making organs of a company are the board of directors and shareholders in general meeting, respectively. In the crowd funded company, however, a widely dispersed investor base runs the risk of fragmenting shareholder participation, resulting in a lack of both cohesion and the collective thinking required for effective governance in the venture. These factors – in combination with less disclosure of useful information and an inevitable tendency for remoteness between the venture’s managers and its investors – means that accurate and timely investment decisions may not be taken as and when required.
The risk inherent in the crowdfunding model is that inexperienced investors may end up being connected with the most speculative projects that conventional venture capitalists might have evaluated and decided to avoid. [1]
The message for investors is clear: when considering a crowdfunding opportunity, be careful to evaluate the project’s viability before you invest your cash. While an assessment of the project’s risk/reward profile must take centre stage, be sure to also understand the terms and conditions that attach to use of the crowdfunding website as well as your intended participation in the project. This is a case where investors bear a greater risk for what’s not disclosed to them, rather than for what is.
