Crowdfunding Chickens Come Home to Roost

Investing in early stage companies and startups is exciting and can deliver handsome returns.  No debate about that.
But, there is a right way and a wrong way.  The right way is to do what smart, professional angel investors do.  They do good due diligence.  They actively work to add value to the company to help it succeed.  They monitor the activities of the company and they make sure good corporate governance is in place.

The wrong way, in my view, is to invest passively and select the companies from a crowd funding website.
Case in point. Recently the UK's booming crowd funding industry hit a rock.  A number of companies funded on platforms such as Seedrs and CrowdCube, the two leading platforms, went belly up.  Hundreds of investors collectively lost more than GBP 2 mn.

Anyone who knows me can tell you I have never been a fan of equity crowdfunding platforms. My view is that the risks far outweigh the reward and investors will be disappointed in the end.  The platforms, on the other hand, will profit handsomely.

I wrote about this nearly two years ago to the day on my Angel Blog.  Here's a snippet from my post on March 18 2014.

"There will be disasters in the crowd funding space sooner or later. There will be cases of fraud.  There will be lawsuits brought by angry investors who feel they are not treated fairly in a corporate action.  Inevitably there will be cries for tougher regulation."

I won't bore you with the detail here. One article  in the Telegraph I found suggested there have been 70 crowdfunded companies, about 20% of the number funded so far, have gone bust while only 1 has delivered handsome returns of about 3 times investment.

I'll concede the glass maybe half full.  The jury is out on the other 80% of the companies.
Still, the news flow is alarmingly predictable. I did a search on google recently and found a chorus of articles in the popular press talking about potential disasters waiting to happen.  Seems I was not alone in my concerns.

My esteemed colleague  Gonçalo de Vasconcelos,  CEO of Syndicate Room, sent me an e-mail this week.  He pointed to the failure of Rebus as evidence that the industry is prone to problems that go beyond simply the normal business risks of crowdfunding.

Goncalo runs an equity financing platform that takes crowdfunding to a higher level and helps remove some of the risks.  At Syndicate Room, each deal posted has a lead investor who is putting money at risk and who and has a track record of success and who supports the transaction.  Investors in the deal go in on the same terms as the lead investor.

Syndicate Room is not the perfect solution, but in my view it is a far better alternative and will yield far better results than CrowdCube and Seedr's will.  Incidently, I don't have any money invested with Syndicate Room and I have not done any research into Syndicate Room's due diligence process or the due diligence process and integrity of the lead investors on their site.

The conclusion I still can't dismiss is that the keys to successful investing in startup and early stage companies are in the hands of the investors themselves.

Investors should invest in companies where they know the entrepreneurs, they understand the industry and the business and can draw conclusions as to the company's genuine prospects for success.

Investors can increase their chances of success by actually adding value to the company they invest in - introducing the company to clients, opening the doors to financing, structuring company governance, serving on the board of directors.

It is of course impractical for each investor in the crowd to do these things.  However, it is practical for investors to join syndicates, invest in portfolios run by dedicated Angel investors, ask critical questions of companies, do some of their own homework to assess the real propensity for the crowd funded company to succeed.

Call me biased.  I'm an angel investor. I run an angel investment fund. I'm an investment manager.  So naturally I have to stand on this soap box. Or call me practical, wise, full of good old fashioned common sense.  You're the crowd.  Judge for yourselves.

Crowdfunding and the Bad Dancer

Dance contests usually follow a predictable pattern. Bad dancers are eliminated early in the competition. Good dancers progress through the rounds. Eventually one of the best pairs wins.

But something funny on the way to the forum happens when the crowd vote is counted. Bad but popular dancers can reach the finals at the expense of much better dancers who, but for the crowd, would have progressed.


Crowd funding websites are the modern day equivalent of this new breed of reality TV shows. Very often the business that gets funded is not the best business, but merely the most popular business.


This, is where the parellel ends, however. The success of the bad but popular dancer is certainly not someting fans of good dancing approve of, but at the end of the day TV is entertainment. Realty TV is in some ways more of an illusion than a reality anyhow. Who wins and who loses really isn't so important.


For the past several weeks Czech TV audiences have been wintessing a battle between style and substance.  At the moment, style seems to be winning, much to the dismay of purist dance fans.
The unfolding drama can be seen on Saturday nights when Czech TV airs the popular series "StarDance."

For those of you who may be unfamiliar with this show, StarDance is based on a British TV series called Dancing with the Stars.   The show pairs a number of well known celebrities with professional ballroom dancers. Each week the dancers compete by performing one or more choreographed routines that follow the prearranged theme for that particular week. The dancers are then scored by a panel of judges.


Audience participation plays a pivotal role. Viewers are given a certain amount of time to place votes for their favourite dancers, either by telephone or (in some countries) online. The show format is highly popular and has been licensed to over 42 territories over the last ten years.

 The protaganist in this drama is a comedian named Lukas Pavlasek.  He is perhaps best known for his appearances in a series of commericals promoting cellular communications provider T-Mobile.  In addition to his regular appearances as a stand-up comedian he's had numerous film and stage credits and he is a prolific writer and song lyricist.















By almost any measurable standard Pavlasek is a poor dancer.  My colleague Jitka Rombova calls him the "anti-talent."  He's not graceful by any stretch of the imagination and he's often out of rythm.  Out of a possible score of 40 points he consistently gets below 20.

Yet what Pavlasek lacks in substance, he makes up for with unbridled character, enthusiasm for dance and his comedic wit.  For this reason up to now he has defied conventional contest logic.  On the strength of his scores he would have been gone several episodes ago.  But week after week he's received enough votes from the crowd to progress to the next round. He's now among the final 4 contestants.

Catering to the popular will of the crowd is profitable.  TV advertising revenues are driven in large part by the number of people watching.  Viewers like Pavlasek, so they vote for him and many viewers look forward to his upcoming performance the following week.  He's what we in the investment world call a "disruptive business model" - one that challenges the status quo and changes the way manner shape and form that products and services are delivered.

The duel between style and substance certainly makes for an interesting program.  All in all, everyone wins.  TV producers get advertising revenues and viewers get an engaging entertainment experience.

But when it comes to investing popular will of the crowd the dynamic of mutual success between supplier and customer breaks down. Crowdfunding websites dangle in front of investors the prospect of investment rewards and the satisfaction that comes from helping an entrpreneur get started.  The companies raising money couple that appeal with presentations that are long on style and often short on substance.

Dancing is a transparent business.  You see the presentation and you can instantly tell if the product or service is good or bad.  Predicting who will win the contest usually isn't so hard, particularly as the field narrows.  Pavlasek is surely the exception rather than the rule.

This is not true with startup and early stage companies.  Presentation is the surfacce.  It is at best only the cover on the book.  You can only judge the real quality by drilling down into the detail.  What drives the success of a crowdfuning campaign is often not the detail of the company, but the packaging and the presentation, combined with the fact that people are naturally more willing to risk a small sum of money for the sport of it than to drill down into the detail and risk a larger sum of money.

The successful crowd funding campaign ends with money in the company's treasury and profits for the website provider.  I've yet to see hard evidence that investors benefit, however. In the investment business when form takes a back seat to substance investors usually wind up losing their money.

The math I see is that at least half of startup and early stage companies fail within five years. An investor who gets an average return of 25% annum will see $100 turn into $244 in five years.  If, however, half the companies fail the other half of the companies much produce each a return of 4X in order for investors to clear the 25% hurdle.

My advice is as follows: Investors should approach crowd funded investments with a healthy dose of scepticism.  Ask questions - lots of them!  Be selective. Select only the companies who you believe really can succeed AND provide the possibility for an exit within five years.

As for our friend Mr. Pavlasek.  I actually think he is improving from week to week, I enjoy his performance and I think the judges have been perhaps a bit too harsh on him in recent weeks.
But my view is that substance and form will win over style.  He'll be well remembered as the guy who almost won StarDance.

My rationale is perhaps naive. The way I figure, the majority of the TV viewers want to see the quality dancer win.  Each week there are fewer good dancers to choose from, so the majority that want to see the good dancer win will finally be able to cheer for the substance and form it desires.

After all, dancing is certainly not the same as crowdfunding.  Is it?

What Crowd Funding Sites Won't Tell You

What Crowd Funding Sites Won't Tell You

Today I was surfing various crowd funding sites. I was curious to see how the crowd funding sites promote themselves to investors.  What I was surprised to learn was that basically - they don't.

Can't be true you say?  Go to the homepages of the leading crowd funding sites.  Really read the homepage. Pay careful attention to the attention grabbing slider and the large print headlines.

Here's a summary of the content that dominates the homepages of crowd funding sites:

a) How many hundreds of companies have received funding via the site

b) How many millions of dollars have been raised for companies

c) How many thousands of investors are registered users

d) How many investors invested how much money into each company

e) A warning to investors that there is risk in investing and the website does not make recommendations.

 My guess is that probably nearly 90% of the headline content on crowd funding sites is designed to appeal to companies seeking financing - "list your company with us and you will raise money" is the resoundingly loud message.

During my nearly 20 years as a securities analyst one thing I learned is that the most important information is almost always missing from the conference call, missing from the earnings report, missing from the annual filings.  Companies will almost always present the good news loud and clear. Example - sales in 2Q were up.  Great!  Good news.  The key information missing, however is that some of those 2Q sales were 1Q sales that had been delayed or 3Q sales that materialised early.

Why do the crowd funding sites spend so much time and energy promoting themselves to sellers of equity and not to buyers?  One reason might be that crowd funding sites assume implicitly that the crowd of buyers is really smart.  The crowd understands the self-evident and they come to the table convinced they will find diamonds. Evidently, the crowd is picking these diamonds up as fast as they get listed on the sites. The companies that promote themselves on the sites have great stories, great investment plans. Plus, the sites claim (usually in somewhere in the FAQ section) that are very selective, so only really compelling companies actually get listed. This we will call the "Smart Crowd Theory." Now let's look at an alternative theory.

Perhaps, sites spend so much time and energy promoting themselves to the sellers because ultimately the crowd funding industry is all about selling investments, not buying investments. I've yet to find a crowd funding site that makes a clear compelling case for investments in early stage and startup companies on its homepage.  The closest thing to a case for investing I saw was presentation of a statistic that venture capital investments can generate returns in excess of 25%.  That's a good argument for the asset class.  But what I still miss are the arguments that justify the case for each individual company.  When I invest in a company I want to assess the quality of the management team, I want to assess the market for the company's products. I want to understand the company's business model.  My investment team usually spends three to six months getting to know a company and its business, structuring deal terms, identifying the company's strengths and weakness and figuring out how and if our investment and the work we will do after our investment is made can reduce the weaknesses and capitalise on the strengths. I call all of these things, collectively, the investment process.

Dig a little deeper into the crowd funding sites and some of the sites really do start to talk about investment process.  They talk about how they evaluate each company that applies to be listed on the site.  They talk about how the make sure the company offers deal terms that protect minority investors. They talk about how the vet each company. All of these statements I think generally are true.  Any serious group of professional running a crowd funding site would have the incentives and the desire to select companies that will succeed and to eliminate companies that will fail.

I had an professor in business school who used to say "...here's the rub."  I didn't understand that expression so in my infinite wisdom I asked and he said - "the rub is hole the argument - the part the just doesn't make sense..."  So, in dedication to the good Professor Cliff Smith..."Here's the rub."  The crowd funding sites at are stock brokers, not angel investors.  They stop far short of standing behind the companies they promote.  They dedicate much more space to their disclaimers than they do to their investment process and to explaining to investors the fundamental merits of each company.  Their documentation makes it clear that their compensation is derived from how much is invested.  Usually their compensation structure is something on the order of 5% - 8% of the capital raised.  Sometimes they also provide the investors a nominee holding structure and they take a carried interest in the capital raise.  The carried interest, they say, gives them an incentive to select good companies.  Maybe so, but the skeptic inside me says the carried interest can also be looked at as a lottery ticket, a free ride.

So - what with crowd funding?  Bad? Good? A disaster in the making?  My answer is d - all of the above.

The downside to crowd funding equity platformS is that while all the investors in the crowd are together in reality they are very much alone.  The nominee structure many sites offer is little more than a holding vehicle.  The nominee has no mandate to anything more than transmit information between the company and investors.  The nominee has no obligation or even the resources to take legal action or to ask questions or management or to attend board meetings.  If anything the nominee has the incentive to do as little as possible, lest it expose itself to legal risks. The second downside is that the investors, either collectively or on their own, usually have very little sway or influence on the governance of the company. They are usually in a weak minority position and rarely can negotiate particular terms to protect their interest.

There will be disasters in the crowd funding space sooner or later. There will be cases of fraud.  There will be lawsuits brought by angry investors who feel they are not treated fairly in a corporate action.  Inevitably there will be cries for tougher regulation.

Not all is bad, however.  There will be success stories.  There already have been.  Good companies will get funding that might not have gotten funded in the past. Crowd funding sites will start to differentiate themselves by their success stories. Some will develop a particular skill of bringing good companies to investors, companies who genuinely care about their investors and treat them well.  Perhaps also the crowd investors will band together and appoint one or more of their own to take on a more active role.

The conclusion I still can't dismiss is that the keys to successful investing in startup and early stage companies are in the hands of the investors themselves.  Investors should invest in companies where they know the entrepreneurs, they understand the industry and the business and can draw conclusions as to the company's genuine prospects for success.  Investors can increase their chances of success by actually adding value to the company they invest in - introducing the company to clients, opening the doors to financing, structuring company governance, serving on the board of directors. It is of course impractical for each investor in the crowd to do these things.  However, it is practical for investors to join syndicates, invest in portfolios run by dedicated Angel investors, ask critical questions of companies, do some of their own homework to assess the real propensity for the crowd funded company to succeed.

Call me biased.  I'm an angel investor. I run an angel investment fund. I'm an investment manager.  So naturally I have to stand on this soap box. Or call me practical, wise, full of good old fashioned common sense.  You're the crowd.  Judge for yourselves.

Equity - Crowdfunding - The Good, The Bad and The Ugly

Anyone who knows me well knows that I am not the sort of person that makes foul noises at tea parties.

But investing is a serious matter. An investor takes hard earned money and puts it to work in hopes of obtaining a return on investment. An investor who puts money to work and doesn't expect a return on investment is not investing, at least not in my dictionary.

Where did the term "Angel Investor" come from anyhow?  Are we angel investors really angels or are we simply investors who might happen to be in the right place at the right time and make an investment when  it is sorely needed or wanted?

I manage an Angel Venture Fund which I creatively named Symfonie (that's my company) Angel Ventures.  The fund is great fun to manage.  I get to look at all sorts of interesting projects, I get to meet creative, dynamic people and I get to work with a team of dedicated smart professionals each of whom brings enormous value to the fund.

The investors who put their hard earned money into my fund most certainly did not tell me they didn't expect a return on their investment.  On the contrary, each of them told me in no uncertain times that they want my colleagues and I to do our best, select good companies and make investments that will pay off.   No dollar in my fund is allowed to slack off.  Each dollar must work.  No dollar is allowed to just wander off on its own without agenda or mission.

Recently the Ministry of Finance here in the Czech Republic offered me the honor of presenting some thoughts on crowd funding to an audience at a conference hosted by the Prague High School of Economics (not high school like what we have in America, but high school meaning a school where people earn higher level degrees).

The day of the conference I had a schedule conflict.  I had to be in Warsaw with Bruce Pales of 360 Cities (www.360cities.net) and Radovan Grezo of Click 2 Stream (http://www.click2stream.com)  and the best Symfonie partner in Warsaw, Ewa Chronowska.  Since I couldn't be in Prague and Warsaw at the same time (I'm only human, after all) I asked Pavel Kohout to attend the Prague conference and present his views on crowd funding. Pavel did an excellent job and I thank him for that.

All this leads me back to the crowd funding tea party, where I should be social and polite.  I can't help myself, however. I must be honest.  The entreprenuers in search of money and the crowd funding platforms in search of commissions would like to have you believe otherwise, but in my humble opinion, the investors at the crowd funding party are likely to wake up with a hangover.

Why?  I'll tell you why with my top 10 list of thoughts on crowd funding.

1. Most startup companies fail. To make up for the failures, the success stories must have hugely positive outsized returns to compensate. According to Harvard Business School, upto 75% of venture capital funded companies become loss-making investment.  VC backing comes only after lots of meetings and lots of research on the part the VC firm.  How can the crowd realistically expect to do better?

2. The surviving companies, those that don't fail, may have  to go through several capital raising rounds over several years before finally offering those initial investors an exit.  The returns at that point may be substantial in absolute terms, but when annualised are not likely to have been such great investments after all.

3. There are enormous information assymetries between the founder/manager/entreprenuers and the crowd of investors.  The crowd is simply not in a good position to make very informed judgements.  Either the information the crowd receives is way too little or the information is sugar coated, mainly because the investee company is in fund raising mode. The crowd in practice is likely to know very little about off-balance sheet financing, obligations the company may have to pay bills in arrears, the skills and ability of the management, or the competitive landscape the company faces.

4.  The crowd is not likely to be well represented in the corporate governance structure.  The crowd usually has a weak minority position with no liquidation preferences, no dividend stipulations, no particular ability to monitor and control the company and its activities.  Even if the crowd invests through a nominee holding structure, the nominee is likely to do little and will almost certainly refrain from attempting to act for and on behalf of the crowd or will not even be empowered to act for the investors.

5. The crowd can do little if anything to add value to the company or influence its development.  The crowd's message to the entrepreneur is basically - "here's the money, now go forth and multiply."  The problem is - the company might not simply have the tools and expertise to go forth and multiply.

6. The crowd funding platforms do little more than review the company's business plan and investigate the background of the entrepreneurs.  The crowd funding platforms don't have significant due diligence budgets, nor do they have the incentives to invest in due diligence.  Think about it! If a crowdfunding platform will sell $500,000 of equity and take an 8% commission (about $40,000) after it pays its staff and its marketers and its website programmers how many accountants and lawyers and smart researchers can the platform realistically engage? This is partially why crowd funding platforms have such broad disclaimer language in their terms and conditions.

7. Unless the crowd funding platform has a serious investment in the company, the crowd funding platform is not likely to work to add value to the company.  Rather, the crowd funding platform will have its eyes firmly focused on the next beautiful piece of merchandise to put in the front window of it's internet storefront.

8. Most investors don't have the benefit of day to day, week to week contact with the investee company after the deal is done.  They won't be able to effectively monitor or control or help lead the company to success.

9. The crowd doesn't get the benefit of proper quarterly, semi-annual, even annual transparent accounts and financial reports.  Few startup companies have the skills or staff required for reporting and even if they do, more than likely their lawyers will advise them to say as little as possible, lest they risk opening themselves up to lawsuits.

10. Crowdfunding and computer/internet technology have dramatically lowered the cost of starting a company and obtaining financing.  This means more startup companies are likely experiment and take on business plans without fully understanding or evaluating the risks.

I can go on and list another 10 things, but by now I've probably worn out the welcome mat.

Don't get me wrong.  I'm not totally against crowd funding.  On the contrary, I think crowd funding platforms have an enormous opportunity and can be successful if they invest heavily in selecting the companies for their platform, mentoring the companies, and finding ways to help the companies succeed.

In the next blog I will explain why (in my dramatically biased opinion) investors are far more likely to succeed by working with a good angel investment manager or a smart investor who arranges a syndicate.

Until then.....