Don't be a dead antelope Thursday 29 Oct 2015

I’ve been a bit disappointed by equity crowdfunding (ECF) so far.

In theory it’s a lovely idea.

A business puts a slice of its equity up for sale on an ECF platform. Ordinary investors get to ask questions before deciding whether to buy a stake in it.

I’m sure there are diamonds in the rough. And I do hope that it continues to evolve and learn from the inevitable teething troubles ahead.

Overall though ECF has underwhelmed me. If I had to point to one reason, it’s this: so many of the pitches seem to be bloody drinks companies!

Are the potential rewards worth the risks?

Maybe those are just the ones the platforms promote most heavily. Most of us like a drink, after all – so maybe the platforms think that will get our attention when they advertise on public transport.

Nonetheless, it’s typical of many of the businesses on ECF platforms. Small. Niche. Almost lifestyle businesses in some cases.

Given the high likelihood that each given investment has of failing, these businesses need to scream Mega Opportunity. Something that, in the unlikely event they succeed, could actually achieve world domination.

Mostly, they don’t.

Take the craft brewers, distilleries and other drinks companies. Now, I like a beer. And as a long-time ale drinker, I’ve loved the micro brewing explosion that’s happened over the last decade and more.

The range of choice is great. Competition keeps quality up and prices reasonable.

As a customer, I love it. But that’s exactly why I wouldn’t rush to invest in a craft beer producer.

I have no brand loyalty (there’s always something new to try). I know I can get a good beer for the going rate – which makes the producers price takers.

There are viable businesses to be built in the space. But will any of them make me enough as an early stage investor to justify taking the high risk of losing everything I put in?

For me, the answer is no.

Fancy reading some barbed criticism?

There are other risks to be aware of. I recently came across a blog called The Truth About Equity Crowdfunding.

Its main raison d’être seems to be to give Crowdcube a kicking. Have a browse though and you’ll read about a lot of issues you as an investor need to think about.

One is that the time limit on investments may not be all it seems. ECF platforms tend to give businesses a fixed amount of time to raise a set target – or else get nothing.

Except, it appears the targets and the time limits sometimes move. This matters because, as any marketer knows, perceived urgency can influence behaviour.

If a pitch is in its last day, you may feel it’s now or never. And in practice, that may not be the case.

The blog offers this tongue-in-cheek advice:

…our advice is to sit tight – all of you – until the pitch gets near to its end date. Post a few queries about the over valuation. [Ed note: overvaluation is where the company keeps raising money beyond its initial target, allowing for more investment] And wait.

As with so many of the completed pitches recently, the founders will move the equity offer in your favour, often by as much a 50%. Crowdcube will oblige by extending the pitch ad infinitum – it’s their only way of paying their £2m annual administration costs and you will end up with a far greater share of nothing.

Don’t be a dead antelope

Before I wrap this up, I’ll share a great analogy a friend came up with last night.

He’s a software developer who’s spent much of his career in or around tech start-ups. We were talking about the money start-ups raise from venture capitalists, the crowd and elsewhere – and what happens to it.

Here’s his take on how some of these businesses work:

“A lot of the time you’re raising money to pay people, not so much for the work they do as to keep them in the game,” he said.

“So I might get a big chunk of investment cash and use it to employ people to work on the business. If the business takes off, great. But if it doesn’t, the guys I’m paying are more likely to bring me on board for the next venture they get funding for.”

I laughed.

“It’s like killing an antelope,” he continued.

“You can’t eat a whole one, so you share it with the group. Then the next time someone else kills an antelope, you get some of that.”

“Sounds great,” I said. “Unless you’re the antelope.”

We laughed, and ordered another round of craft ales.

Posted by Ben Traynor on the Daily Reckoning UK website, 28th October 2015