Why Angels Should Keep Their Distance from Crowdfunding in 2014
There’s certainly been a lot of uncertainty in the angel and venture capital arenas over the past decade, and understandably so. Add to that, the lure of crowdfunding—a nearly $3 billion business in 2012—and it’s led some angel groups to consider if there is a role for individual investors in crowdfunding their deals.
My advice to my colleagues: There could be, but stay on the sidelines for at least another year.
Why? For starters, it’s unclear how crowdfunding will affect company valuations. The Jumpstart Our Business Startups (JOBS) Act, requires startups to publically disclose a laundry list of items if they choose to raise capital by crowdfunding. These include entity formation, background checks, shareholder listings, financial statements, share valuation and a business plan. That might seem all well and good on the surface, but angels and VCs look at many other important metrics to determine the true potential worth of a newly formed venture. These include total available market, intellectual property, management team, and other key performance indicators that, from our perspective, are at least equally important in determining the fundability of a company. The investment risk multiplies if crowdfunding portals do not address these important metrics, and this is one place where angels and angel groups can help reduce the risk.
Second, a crowdfunding platform disclosure might actually give away too much information—foiling the chances for a company to gain a “first mover” advantage in the market. Think about it for a second—what better way for an established rival to usurp a newcomer than to watch a Kickstarter campaign take off, grab enough details to mimic the product’s features, functions, and benefits—and get production rolling at a lower price point before the startup can get out of the gate. Even if the IP is protected, the litigation costs to defend it will drain whatever capital the company raised.
All of this is not to say that crowdfunding is a fad that will ultimately fade away.
There will undoubtedly be aspects of crowdfunding that will eventually make its way into the mainstream venture investment community. However, I do feel that its current form leaves a lot to be desired for both investors and entrepreneurs. Moreover, there seems to be an oversupply of crowdfunding services coming online that reminds me of the “Dot Com” boom of the late 1990s. There are currently more than 1,000 that have filed for approval by the SEC.
One way to improve the situation would be for crowdfunding platforms to affiliate with an angel group that could lead the fund-raising effort. The angels would provide the needed screening and due diligence. However, it will take time to work out the exact nature of the relationship. So for now, I’m advising my fellow angel investors to watch how well this crowdfunding idea progresses, but only from the sidelines.
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