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Wisdom of the crowd or herd mentality? A crowdfunding lesson

There are risks involved when investing in crowdfunding platforms so due diligence is crucial.

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We’ve all heard the story of Skully’s striking collapse. In 2014, the tech startup set out to develop promising artificial reality-powered helmets that would spur a motorcycle tech revolution. Yet by summer 2016, the idea and the company had unceremoniously disappeared. While the company is trying to make a comeback—and everybody loves a good redemption story—it remains to be seen whether Skully will rise from the ashes.

The story of Skully is about more than technology; it’s a cautionary tale for investors everywhere. The company raised a staggering $2.5 million through Indiegogo and later secured an additional $11 million from investors. Instead of using those funds to spur growth, that money was allegedly squandered on personal expenses. Skully crumbled, and its backers were left to eat their losses.

This is the problem with investing blindly in crowdfunding platforms. There’s no guarantee that those behind such campaigns know what they’re doing or that they’ll even be around tomorrow. Just because a company can put together an impressive webpage doesn’t mean it can deliver on its promises.

Behind the crowdfunding curtain

Back in 2014, I started Coastr, a technology company that used mobile apps and Bluetooth technology to help retailers better connect with their customers. After my personal investment and a small friends-and-family round, I turned to Fundable, the equity crowdfunding portal.

Unlike rewards-based crowdfunding platforms where investors contribute money in exchange for future products or services, equity crowdfunding platforms enable accredited investors to buy shares in startups—essentially, crowdfunding securities. Once the campaign reaches a minimum investment threshold, the deal is closed among the pool of investors, the platform, and the company.

The platform we used charged monthly hosting fees to post any materials and shared opportunities with relevant investors. But no due diligence was done on anything I sent in. Even though my documents were factually correct, it was unnerving to realize that Fundable didn’t have anybody reviewing financial statements, performing background checks on management, or reviewing the board of advisors. It was a sign that transaction volume was a bigger priority than the quality of the offerings.

It’s absolutely crucial to remember that not every company is what it seems, particularly when the business is being presented through an online platform with limited ability for an investor to meet management or see a product. Typically companies using crowdfunding platforms have already exhausted other financing paths—meaning that friends and family, angel investors, and venture capitalists have already invested or passed on the opportunity.

If you’re participating in an equity crowdfunding platform, you’re likely just seeing the opportunities that sophisticated investors have passed on—in other words, the leftovers.

We’re now starting to see the same reality play out—particularly with the hype around initial coin offerings (ICOs) in cryptocurrencies and blockchain. ICOs are similar to initial public offerings, except backers purchase “tokens” instead of shares. Take Tezos, a controversial blockchain startup, that recently raised $232 million during its ICO through a token offering to the crowd—only to fail to deliver the tokens. A similar story played out in August with PlexCorps’ investment scheme, which was also charged by the U.S. Securities and Exchange Commission for its ICO-based fraud.

While there may be public enthusiasm for these ventures, it’s important that would-be investors look past the promise of outlandish rewards and understand the risks of investing money in unregistered offerings.

Investing in a crowded marketplace

You wouldn’t step up to bat at the World Series with no information on the pitcher you’re about to face, so why would you invest your money that way?

To ensure you’re investing in thoroughly vetted companies, look to the public market ecosystem, where companies are forced to disclose financial statements, management teams must undergo background checks, and brokerages and investment banks perform thorough due diligence on the companies they choose to support.

There will always be nefarious characters, and even investing in public markets has a risk of fraud. However, because the public market ecosystem forces companies to maintain continuous, transparent disclosure, there will be structures in place to ensure a level of proper due diligence.

When looking at investment opportunities, one can follow market indexes like the Dow Jones, S&P 500, and FAANG (Facebook, Amazon, Apple, Netflix, Google)—however, sometimes that popularity from index inclusion can result in a company being overvalued. By comparison, companies outside these indexes may be undervalued, or there may be an opportunity to get involved before that explosive growth phase has run its course.

crowdfunding investment

Investing in any campaign should go beyond the initial enthusiasm. (Photo By CafeCredit via Flickr. CC BY 2.0)

 

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The platform I manage now—the TSX Venture Exchange, a subcategory of the Toronto Stock Exchange—couples the benefits of a fully regulated stock exchange with the mechanisms and structures that ensure transparency for investors. Our platform for venture stage capital formation brings many of the standard Wall Street values to venture and growth stage companies.

As a fully regulated exchange, we balance investor protection with a level of regulation that enables companies listed with us to grow. Entrepreneurs use us to raise money and leverage share currency to make acquisitions or incentivize employees. Through the Exchange, we facilitate the secondary trading of those securities. Through the Venture, investors can get in at the ground level, then sell shares as a company executes on its business plan.

Hold your friends accountable

Sometimes, rather than following the latest investing trend, it’s good to stick with what you know—or, rather, who you know. Instead of following the crowds, look to entrepreneurs and business owners who you trust especially experienced go-getters and thought leaders. If you leverage your own network, there’s a greater chance you can make sure that proper due diligence is performed—after all, your colleagues have personal incentives for delivering on the products and outcomes they’ve promised you.

Of course, not everyone has experienced CEOs and investors in their inner circle. If you’re looking to invest in early-stage companies that aren’t included in an index, I recommend finding a network of people with ample experience distinguishing between good and bad investments. One of my favorites is the Keiretsu Forum, where more than 2,500 accredited angel investor members perform due diligence on companies for its local chapters.

Communities like Keiretsu facilitate close relationships between investors, venture capital firms, and partner organizations to help build quality deal flow. Participating in these groups can mean the difference between making informed, strategic investments versus jumping on the “next big thing” bandwagon only to walk away empty-handed.

Trust will always be a factor in the investment world. You need to trust the people you give your money to, and investing within a community—rather than handing over money to an anonymous entrepreneur—can help add a level of accountability to the process. After all, while that AR motorcycle helmet may have seemed exciting back in 2014, there are a lot of people who still have nothing to show for it.

(Featured Image by MediaLab Prado via Flickr. CC BY-SA 2.0)

DISCLAIMER: This article expresses my own ideas and opinions. Any information I have shared are from sources that I believe to be reliable and accurate. I did not receive any financial compensation in writing this post, nor do I own any shares in any company I’ve mentioned. I encourage any reader to do their own diligent research first before making any investment decisions.

Brady Fletcher is the managing director of TSX Venture Exchange, the world’s premier public venture market. Every year, hundreds of early and growth-stage companies raise billions of dollars via the TSX Venture Exchange. With a background in computer engineering, Brady spent almost a decade in investment banking, primarily focused on financing and advising technology and diversified issuers through strategic transactions. Throughout his career, he has advised hundreds of companies on business strategy, capital raising, public and private markets, and exit strategies. He has successfully executed more than $500 million in growth equity financings, secondary transactions, and sell side advisory mandates. The views, opinions, and advice provided in this article reflect those of the individual authors. This article is not endorsed by TMX Group or its affiliated companies.

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