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?