A closer look at Startup Equity Crowd Funding

Crowd Funding is a way new projects aim to get funding from (typically many) people (per funding campaign) that are not professional investors (hence the word “crowd”), e.g. at Indigogo and Kickstarter (or services such as GoFundMe, CrowdRise, RocketHub and many others)  . The diversity of crowd funding projects is very high, e.g. charity funding of people and organizations as well as funding of startups (typically for product development) in an early phase (by buying the product before it is ready). Probably the most well-known startup that got crowd funding was Virtual Reality startup Oculus VR that raised 2.5 million USD from Kickstarter in 2012, and was acquired by Facebook for 2 billion USD in 2014

1. Equity Crowd Funding

However, from a financial perspective the people or companies that help fund crowd funding campaigns get very little returns (note: not to discount the feeling of helping and making projects happen). With Equity Crowd Funding this is different, it is similar to Crowd Funding that people invest moderate amounts (at least compared to what an angel investor, venture capitalist or private equity would do), but it also gives the funders equity (stocks, options or equity-guaranteed convertible loans) in the startup. Startups are an incredibly risky investment since most never succeed hence provide zero returns (just loss and not to forget opportunity loss).  In a quickly moving world (due to accelerating technology change, e.g. in areas such as AI/Deep Learning and Robotics) with very low interest rates getting any kind of return on investment is very hard (without taking risk).  

Let me give you examples of hard it is to get high return of investment (ROI) with low risk:

a) In the 1980s the Norwegian postal bank had a “Gullbok” (Gold Book) savings account that provided around 11-13% interest rates – which seems almost unbelievable today – but had probably relatively high risk at the time – Norway did significant devaluations of the Krone currency relative to other currencies both in May 1986 and 1993 (the latter when the Norwegian bank sector almost collapsed)

b) Recently saw an ad for a regional bank’s savings account where you had to lock more than 50 thousand USD for more than a year to get less than 2% interest rate (Norway’s Bank target inflation rate is 2.5% which roughly means that you get -0.5% annual ROI from a purchasing parity view instead of 2%) (This ROI estimate is probably less risky than the one in the 1980s)

2. Crowd Equity Funding is Very Risky

For those that are willing to take a much higher risk of loosing all their invested money Crowd Equity Funding can be an approach, but please keep in mind that Crowd Equity Funding should be considered in a similar way of considering buying tickets in the lottery, doing any kind of gambling, giving away money or as regular crowd funding, i.e. only surplus money that you can afford to loose entirely and never get any ROI from. The U.S. Securities and Exchange Commission proposed crowd equity related regulations to protect people from gambling away their money, for most people the upper bound would be maximum of either $2000 or 5% of annual income or net worth.

3. Examples of ROI of Startup Investments

US early stage investors Angel List (angel.co) and 500 Startups have reported on ROI for their funds (note that none of these are currently supports Crowd Equity Funding but requires you to be an accredited investor to be allowed to invest), they both report Internal Rate of Return (IRR)

  1. Angel List’s 2013 syndicate had a 46% unrealized returns (IRR) by the end of 2015 (source: Angel List – angel.co/returns), and
  2. 500 startups’ 2010 fund had 18.5% IRR, the 2012 fund had 23.1% IRR and 2014 fund had 20.3% (source: Wall Street Journal – www.wsj.com/articles/500-startups-seeks-broader-acceptance-reveals-return-data-1469014201).

4. Examples of Equity Crowd Funding Platforms

As opposed to regular startup funding done by angel investors and venture capitalists – where Silicon Valley is absolutely leading, my impression is that crowd equity funding is so far most common in Europe and in particular in Nordics and UK (probably due to the novelty of the previously mentioned SEC regulations for crowd equity funding, see SEC’s update from May 2017). Examples of Equity Crowd Funding platforms are:

  1. Seedrs (United Kingdom)
  2. Invesdor (Finland)
  3. FundedByMe (Sweden)
  4. MyShare (Norway, focus on live crowdfunding for conferences/events)
  5. OurCrowd (Israel)
  6. MyMicroInvest (Belgium)
  7. Shadow Foundr (United Kingdom)
  8. WeFunder (USA)
  9. Fundable (USA)
  10. CrowdFunder (USA)

Investor – based in Finland – claims to have Europe’s first (equity) crowd funding exit via Initial Public Offering (IPO) at the Nasdaq First North Helsinki stock market (source: home.invesdor.com/en/blog/2016/11/10/the-first-crowdfunding-backed-public-company-starts-trading-today).

Seedrs – based in UK – also reports an IPO at the London Stock Exchange (source: www.crowdfundinsider.com/2016/11/92618-seedrs-funded-company-freeagent-trades-london-stock-exchanges-aim and www.bloomberg.com/news/articles/2016-10-31/u-k-to-see-another-tech-ipo-as-freeagent-aims-to-list-in-london for more about the IPO itself).

In addition to Startup-oriented Crowd Funding there are increasing amounts of Crowd Funding for Real Estate – source: A Review of Spanish Real Estate Crowdfunding Platforms

What the Equity Crowd Funding platforms have in common is that they want to provide easy-to-use and transparent platforms for doing investing with relatively high security for both the crowd equity investors and the startup, i.e. there are quite stringent requirements for registrations (for investors) and documentation about the investment round (for startups). However, there is still significant risk involved in investing.

5. Realize Returns of Startup Investments

A challenge investing in startups is how to realize returns (despite having grown), since you typically can not sell shares directly as you could with publically listed companies on a reasonably liquid stock exchange (note that Angel List reported unrealized returns for their 2013 Syndicate, see above). 

A few years back there were massive amounts of startup acquisitions – some at very early stage – performed primarily by public tech companies (e.g. Alphabet(Google), Facebook, Apple, Microsoft and others) or large late-stage startups (e.g Uber, Airbnb and other unicorn startups) – (try a web search for: list of startup acquisitions by PutCompanyNameHere to get an overview) this meant that for a lucky startup investor there was a chance for a quick realized return, however in most cases – even for successful startups (some big unicorn startups have strict regulations on share sales/purchases) – it is very hard to realize returns unless the startup does an IPO or get acquired by a bigger company (in some countries startups can be traded at listed smaller exchanges – Over The Counter (OTC) – which has less regulations than the large public stock exchanges and are typically considered much riskier than the larger exchanges wrt liquidity and pricing)

The Crowd Equity Funding platform Seedrs (see previous section) aims to increase liquidity of startup investments to allow for easier realisation of returns by introduction of a secondary market (source: techcrunch.com/2017/05/07/equity-crowdfunding-platform-seedrs-to-launch-secondary-market/) and they claim that the first sales on the secondary market have been successful (source: www.forbes.com/sites/davidprosser/2017/06/16/seedrs-claims-success-for-first-secondary-market-sales/).

Secondary markets (e.g. SecondMarket – that later got acquired by Nasdaq) got a lot of attention prior to the Facebook IPO. These secondary markets might be parts of the reason why later unicorn startups have had strong regulations of share sales and purchases. (According to Fortune – SecondMarket did a pivot of their model – source: fortune.com/2014/07/25/secondmarket-pivoted-after-facebooks-ipo-now-volume-is-higher-than-ever/). Examples of secondary markets for startup shares (or entire startups as for ExitRound) of varies types are:

  1. SharesPost
  2. ExitRound
  3. Equidate
  4. Nasdaq Private Market

Conclusion

Startups want and need funding, and despite being very high risk investments Equity Crowd Funding aims to make it easier to get funds for startups and to invest for investors (and perhaps realize if there are returns in secondary markets), and it is a very interesting area to follow. But please take into consideration the immense risk if wanting to take the step into becoming a crowd equity investor, being involved the startup world can become addictive, but remember that you are playing with real money. If you want to learn more about the topic I recommend the book Equity Crowdfunding: The Complete Guide For Startups And Growing Companies (by Nathan Rose)

Best regards,

Amund Tveit

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