To begin with, the SEC final guidelines complexity is an unknown. The SEC is tasked with implementing the law as well as protecting investors. If the requirements from Issuers (companies seeking money) will be cumbersome and expensive to produce and/or maintain, the number of applicants may be too small to deliver on the promise that Crowdfunding holds in financing the capital starved small business sector. Furthermore, delivering less than simple and easy to read and implement SEC guidelines will have the same deadening affect as complex, expensive and cumbersome guidelines. If an army of lawyers and CPAs will be needed to provide guidance to the small business owner, many Issuers will avoid the process. Crowdfunding will be both too expensive and too clouded for Issuers to get involved with.
However, even if straightforward guidelines for Crowdfunding from the SEC would require little upfront cash from Issuers, we are still left with plenty of risks. Pre revenue companies, startups and small business that seek Crowdfunding represent a risky group. The rate of success is lower than that of larger businesses. So the mix of seed and early stage venture growth capital will greatly determine the level of return to investors. Regardless of how noble the idea of Crowdfunding is, negative or low returns will greatly dilute the number of investors.
If the tens of thousands of technology startups that fail to attract Venture Capital (VC) and/or Angel investors enter the Crowdfunding space, we are less likely to see long term success for Crowdfunding. Unlike VCs, Crowdfunding investors are less likely to spread their risk over 20 to 30 investments. Why is concentrating on tech companies a concern? VC’s return on investment in recent years has fallen below that of Private Equity who typically invest in late stage, lower risk companies. Lower VC returns have led to a substantial shrinking of the US VC’s available capital, which makes one think, why do technology start-ups fail? Is it the inherently high level of difficulty starting a company, exacerbated by the need to develop new technology? Entrepreneurs often blame their VC investors with not supporting the company’s strategic direction and/or execution efforts. (For more on this subject see http://www.thefunded.com/).
The Funded dot com displays entrepreneur’s rankings of VC firms. The highest score possible is 5. One of the best known VC funds, Sequoia US, was rated 3.7 out of 5 by 102 entrepreneurs. KPCB, arguably the biggest name among VC’s was rated 3.1 by 42 entrepreneurs. Benchmark Capital was ranked 2.9 by 39 entrepreneurs. The scores are not very complimentary, leading one to believe tech company saturation in Crowdfunding will increase investment risk.
Through relationships with several CIP’s, Navocate has learned that over 50% of Issuers interested in Crowdfunding are revenue producing companies. Revenue companies are a lower risk than pre revenue companies. They have proven their ability to deliver a product or service and engage with customers, two major risks pre revenue companies still face. A higher percentage of Crowdfunded revenue producing companies will lower the risk and increase the likelihood of higher return to investors.
Crowdfunding Investment Portals (CIP’s) pose another risk factor based on how well they select Issuers. VC’s have had a long run and still subscribe to the one out of ten formula (with that one company producing very high returns). Crowdfunding is not limited or focused on hi-tech risks, so the risk level is lower, yet the return on each issuer that meet success is low compared with the one out of ten that is successful in the tech space.
The CIP’s will be the gatekeeper of the Crowdfunding industry. They will go through a learning curve too. Some will specialize in certain industries, others will remain generalists, but all will improve their selection criteria and implementation process.
Will Issuers of Crowdfunding suffer the same fate of VC backed companies? Both have access to capital yet often still lack the management and execution support necessary to assure success.
How this will all come together remains to be seen.
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