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Saturday, June 27, 2015

Thoughts on Crowd Funding Platforms as a Business

Have been exploring and evaluating this area from the pov of an investor in the platform. Here is a summary of what I learned and think about the segment. Feel free to comment. In summary, I think crowdfunding works and there will be companies that do well. But the market is not as big as say ecommerce and growth will take a while. To me, it is not immediately obvious that it will scale like groupon clones or social media or sharing economy firms. Anyway, there are 3 types of crowd funding. Some players do only 1, some do all 3.

1) rewards crowd funding

This segment makes good sense to me as a platform and for the businesses who crowdfund. The downside is that it encourages sleek marketing and over promising at the expense of proper prototyping and testing. Improperly executed crowd funding can end up in pr disaster for the company and platform and consumer end getting nothing. Eg 3d pirate still can't fulfill all its orders up to today if the papers are right.

Perhaps a good tweak would be to escrow all the monies and only give the money when the product is delivered as promised. The firm can then use the promised sales to raise interim capital at their own risk. If terms are breached, platform returns escrowed funds so consumers are protected. Too bad for the company in this case but at least only they suffer which is fair.

2) debt crowd funding

Will end up attracting mostly middle class and high income professionals who may not fully understand the risk they are taking. People with more wealth to buy bonds direct will not be attracted to the 10-20% yields as junk bonds of >100m cap listed companies are yielding 10-15%. The extra few percentage of yield is not worth the risk. Don't forget, the companies that raise crowdfunding probably are at 1m to 20m market cap at best with couple of million revenues at most.

So if I were the authorities I would be very cautious on debt crowd funding. If companies fail, it will hit the crowd creditors who may have the wrong impression that debt is safe. Debt to small unlisted firms is not safe. I don't think the crowd funding platforms will warn people to fully understand the risk they are taking.

3) equity crowd funding

This is the most complex and interesting one. Somewhat similar to debt issue in that rich investors would probably do better sticking to Angel, vc or pe funds esp for tech area. Will attract income professionals who always wanted to angel invest but had no deal flow / smaller capital so can't do the min 50k angel bite sizes. I hope the platforms don't target middle class as early stage private equity is not a suitable asset class for average joe. It is telling that mas only allows accredited investors to invest in equity crowdfunding in sg. It is the right move.

On the company side, my feel is that good tech companies probably can raise seed (500k -1m) to series A (3/5m ) from vc funds. Why would a strong tech company want to raise passive crowd money compared to a brand name, value add vc? So perhaps non tech firms who need to raise will find the platform useful. This area may work.

Another group that may find equity crowdfunding useful is deals that require syndication. Say a company has already found its lead and raised 600k. They want 400k more. Crowdfunding could be a good choice here. Crowd Investors will feel safer that there is a lead who negotiated price , terms etc.. and it is not the platform or worse the company who unilaterally decided. This point about lead investor also applies to debt funding. 

Beyond 5m for all types of companies, pe funds, later stage vc and ipo on main/secondary boards are better alternatives for their strategic value and liquidity (in ipo case).  

Another reason running around which crowdfunding players say is that having many shareholders add user base but it seems like a roundabout way to do it. Maybe for some consumer oriented startups.... But I am not convinced.. the max shareholder cap at 500 means too little advocates.

So my guess is equity crowdfunding will revolve around mainly non tech companies and maybe some consumer tech, raising anything from 50k-1.5m. Beyond that, there are cheaper and easier options for the company. Below that and it is not worth the platform time to do it. 

Same as debt funding, crowd investors need to understand this is an angel investment they are making with a 5-10% sales fee paid to the platform. Most angel investments at such early stage fail. I doubt the platforms will warn investors about this. Also the investment is illiquid. It cannot be sold or transfered easily. Most equity platforms plan to offer an exchange or work with one to allow some liquidity but all that are just plans at present.

From a portfolio allocation point of view, I encourage crowd investors to view this as highly speculative positions in their overall portfolio. This means for equity, view it as angel investment with high chance of getting nothing back. For debt, may end up having to be party to debt collection process. As mentioned before, private investment should be no more than 20% of total investible assets.  

Also be careful on how the deal is structured. Special purpose vehicles could be set up for such deals whether debt or equity and both can have detrimental terms. Eg. Can't sell or transfer equity as you wish. This is where a deal where there is already a professional lead will help a lot.

Summary
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Make no mistake, I think crowdfunding is a viable way to raise money and for some suitable people (probably Hnwi up to 5m net worth) it is a new way to invest and offers deal flow. Angelist and kickstarter are good examples with the former being relatively high quality and have attracted vc money too.

But as is the case with any new channels, the industry wiil over promise and some clearly unsuitable people will buy in. And over time it will seesaw until a balance and a place is found in the entire funding ecosystem for it. My guess is that it will take 5 years to determine what the stable market state is for our region. My bet is on it being much smaller than what people think unlike the ecommerce/ social/ sharing economy boom. The big danger for the industry is too many negative stories of joe average losing money on such platforms due to badly represented risk reward!



3 comments:

  1. I like reading your blog, but if there's one thing that irks me, it's all of the grammatical/typo/formatting errors I have to read through (e.g. Point #3 is a good example).

    I think it looks more professional if you either hire a professional to proofread/edit or just take the extra time to do it yourself. It's worth doing as it will reflect well on your personal brand.

    I think Strunk and White's 'Elements of Style' is a great book that will definitely improve your writing.

    Other than that, I enjoy the blog! Keep up the good work Der Shing!

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  2. Thank you for your comment tommy. Do feel free comment on content too. Need more points of view.

    ReplyDelete