Equity crowdfunding is doomed as an asset class(acrowdedspace.com) |
Equity crowdfunding is doomed as an asset class(acrowdedspace.com) |
Some points of disagreement:
- Startups choose either crowd-funding -or- VC. It's not VC or crowd. Nor is it angel or crowd. High quality startups can raise traditional seed rounds and allocate a slice of that round for a crowd of investors. One example is Zenefits (YC W13), which is an awesome company that's kicking ass (IMO). They raised part of their round on Wefunder even though they had tons of investor interest after Demo Day.
- The author assumes the investor selection will be inherently poor with crowd-funding. I disagree with this, too. The universe of great investors isn't a subset of investors active enough to angel invest. Imagine being an API company and having 50 developer-investors.
Plus, crowdinvesting platforms allow investors to invest smaller amounts in many companies. Imagine investing $5k in 20 of your favorite YC companies. Good luck trying to get one-on-one meetings for $5k checks. Especially if you don't live in San Francisco.
- The author assumes that raising from a crowd means you'll have to wrangle thousands of investors. It doesn't have to be that way, especially with the common practice of using LLCs to group many small investors into one item on your cap table.
- I do agree with the author that too much adverse selection can create a marketplace for lemons. I worry about that all the time. However I think we do a pretty good job of mitigating that.
There will absolutely be a lot of mediocre crowdinvesting platforms and companies trying to raise on them, but it doesn't mean the whole industry is doomed. I encourage the author to check us out in a month once the general solicitation ban is lifted and reconsider his view of crowdfunding as an asset class. :)
I think Zenefits is an awesome company as well. With regards to allocating a slice to the crowd, I don't know how often that will happen. At least for me personally, if I commit to invest, I typically want to invest as much as possible (trying to learn from Buffett). That would likely mean that if I was investing in a round I would prefer that no slice is allocated to non-value add investors. Could certainly debate whether or not the "crowd" is a value-add investor.
Why?
Let's see if we can focus on the reasons why his arguments are wrong, not just that he is a VC.
Valid reasons why he may be wrong:
- He argues that good startups have no trouble raising VC. On the contrary, many VCs have poor ability to determine what is a good investment, and many good startups have war stories to tell of how difficult their first financing round was. Therefore, crowdfunding could benefit good startups because raising money from VCs is not easy even for quality startups, because VCs are (as a class) not particularly good at identifying quality.
- Investor selection: sure, getting top-tier VC has soft benefits. But there are costs as well: VCs have more board power, can often force a founder to step aside, or will force a sale to liquidate equity to distribute returns to LPs. Yes, individual investors may not add as much "soft value". But the power dynamics are different and in some ways there may be lower risk to the founder.
- Later stages: so what if crowdfunded companies don't turn to crowdfunding for second rounds? Crowdfunding will work best for early stage. If the business turns out great, and the company needs large amounts of follow-on funding, then getting $20mm from institutions will be more feasible. But it is difficult to understand why that's a serious problem for earlier stage crowdfunding.
- Marketplace for lemons: information asymmetry also exists for VCs with startups, so the lemon argument against crowdfunding is not unique versus VC.
In short, these are interesting ideas against crowdfunding, but none stand out as particularly compelling, or they can at best make a claim against crowdfunding for certain types of deals, rather than against crowdfunding as an asset class.
I don't really think the "good startups will opt for VCs, ergo only bad startups will go for crowdfunding" line of argument is really convincing. The reason being that how good or bad a startup is isn't really a knowable quantity both because it's an incredibly vague, meaningless concept and because at the funding stage not much about the future of the company is pre-determined.
That said, I do think the crowdfunding movement (equity and otherwise) has a major, often overlooked, negative. It's much better to have to deal with one or two VCs than be beholden to a dozen, or in the case of Kickstarter, tens of thousands of stakeholders. A good VC will let you drive the company and only provide high-level guidance and a rolodex, but an active community of a few thousand backers who don't want to lose their money will put your head on a pike if you don't deliver exactly what they were promised. (And odds are many of them have a completely different idea of what they are paying for than you do.) Good luck to you if you want to pivot once you have 10,000 backers on Kickstarter, for example.
However, if you have a very straightforward project that is well specified and has a concrete way to measure when it is completed or failed, like shipping a piece of hardware that is completely designed, if lack of capital is a blocker, crowdfunding seems to make sense. For more open ended projects like games or software applications I see Kickstarter has a horrible idea unless there are literally no other options. And even then, it might be worth it to just die instead of having to become beholden to thousands of people on a project you may lose interest in or won't be able to kill even when the writing is on the wall since it will destroy your reputation.
It's also worth making one of the key assumptions of the post explicit.
the author says
If the funding platforms cannot attract the best deals, then investors will not make any money.
the key assumption that's baked into that statement is that everyone universally recognizes the 'best deals'. Of course that's not certain. The wisdom of the crowd may be better than VCs at recognizing the 'best deals'. I can easily imagine 'best deals' that the crowd identifies that VCs wouldn't fund.
Wholeheartedly agree with your statement - but keep in mind that VCs typically get access to way more information than what's available through a crowdfunding site.
The question is: why is that? Having been an investor and an entrepreneur, I certainly agree that VCs miss many good companies and fund many bad ones. But that's not for lack of trying, expertise, time spent, or motivation.
If you think that crowdfunding will do better than VCs (as a class), then you must either believe that the crowd has some ability that VCs can't develop (and what is that and why can't VCs develop it?) or that the crowd will simply fund everything regardless of quality.
I personally don't believe the first and am not sure the second is the best answer.
Personally, I think crowdfunding--especially as AngelList does it--could very well be the future of the seed/early A round. I don't think the crowd will get better returns than VCs, but I also think the crowd won't care very much about okay-but-not-great returns; that may be the reason it works.
Sometimes, VC will even throw money at really, really bad ideas...
http://money.cnn.com/2010/03/26/news/companies/terralliance_...
And at the end of the day it's equity. Your clout is generally proportional to the number of shares you hold, share classes aside.
Disclosure: I'm a founder of Wefunder.
My guess is this is because most VCs cannot really discern trends, predict the future, etc - even though that is what they claim to do. ( The best ones can, to some extent )
So I would guess, based on this data, that crowdfunding equity will perform just as well as average VC or better, net of fees
An angry mob will post horrible screeds on the Internet about you if you don't execute perfectly on a game regardless if you used KickStarter or not. The developer's reputation is on the line whether you have KickStarter funding or not. The only real extra opportunity cost to under performing on KickStarter is closing off that source of funding in the future.
In scenario 2, I self-fund or get a few angels, build a shitty game and release it with little hype or promises beforehand. It garners a few bad reviews from early adopters and gets 1-star ratings on all the gaming sites, but really it ends up just staying off the radar since it never builds an audience in the first place. This is typically what happens when a company releases a bad product, it just dies without much noise at all and is quickly forgotten about. Also, the negative feedback is largely about the game and not about me. If anything, the hate is directed towards my company but not me personally.
In other words, sure, releasing bad work is always bad. But in the case of Kickstarter, I feel you are exposed to a larger surface area of potential damage to your personal reputation. Kickstarter is a much more intimate and personal thing, and you are basically "putting yourself out there." The only real upside to using it is that it makes it incredibly easy to open a possible channel for funding, but it has crazy asymmetric risk in return compared to the traditional route IMHO.
edit: I guess one thing in Kickstarter's favor is if you actually get your 10,000 audiences and you deliver, you have some solid momentum coming out of the gate. The more I think about it the more it has the flavor of financial leverage: you magnify your outcome in either direction but have reduced flexibility (in the case of Kickstarter, due to the audience's expectations, in the case of financial leverage, due to the fact you are borrowing money on margin and can't make any big moves from there.)