The opportunities for crowdfund investing are as wide as they are deep. It’s one of the very reasons I’m certain that the crowdfunding industry is not yet overcrowded with players. In fact, I believe the true opportunities in the future of crowdfunding will occur in the niches–where people like to play with investments where they’re familiar. Real estate crowdfunding is a prime example. The real estate crowdfunding portals even have differentiation among the players with the types (residential vs. commercial) and the structure and management of the deals varying widely from platform to platform. I guess the short way of saying it is that there’s certainly plenty of room for growth. Because the niches are what will drive the growth of this nascent asset class, I’m super curious why we’re so obsessed with startups as the holy grail of investing through equity crowdfunding.
As the essential non-accredited and penny-stock equivalent of venture capital, I’m curious if we’ve overlooked some of the other huge opportunities that crowdfunding presents for raising capital for much more boring and traditional private equity plays–things like management buyouts, mergers & acquisitions and LBOs. My basic question is: why are we so overly obsessed with startups for equity crowdfunding? Aren’t there many more ______(fill in the blank) that could really use equity crowdfunding to raise capital?
Is it the sexiness?
Yes, startups are incredibly sexy. The returns of the best venture capital funds over the years have shown this, but we often forget the risks many of these funds endure and the pooling capabilities they have. The OculusVRs of the world are the wide exception to the rule. When people start using that as an example saying things like, “if only those that invested in the Oculus VR Kickstarter campaign had some equity, then things would have been sweet because they would have received some of the payday upside.” Unfortunately, even if that were the case, it’s more like gambling than investing. Because the failure rate of startups is so high, and it’s nearly impossible to pick the winners and losers, any investor is likely going to pick more losers than winners and without deep pockets (especially in the case of non-accredited investors and many accredited for that matter), losing nine out of ten bets is not good odds, especially when you’ve got investors who may not be able to spot discrepancies in a proforma or understand the deal term sheet.
Sexiness, hype, outliers and exceptions all certainly play a role in the obsession with startups as an asset class. There are also a great deal of wannabe entrepreneurs who see the explosion of the startup scene with it’s glittering and successful entrepreneurs and want to find their own slice of the American dream. There something to be said for knowing Steve Jobs started in a garage and it’s likely the next Facebook will come out of a dorm room–so why not find a way to invest in these businesses before they get really big.
We certainly have an obsession with finding the next big thing or whiz-bang idea. It’s where the headlines are made. There are even those who’ve built stock exchanges just for startups (see Startups.sx). But if you ask traditional investors how they earned their money, they’ll tell you it was in existing, cash-flowing companies, not startups. Warren Buffet is the perfect example.
Is it the retained equity basis?
Frankly I think one of the reasons is the fact that it’s much easier to get a large basis in a company that, as yet, has nothing–no balance sheet and certainly no profitability. Even after raising funds many startup entrepreneurs are still able to keep sizable portions of the stock. This is one of the reasons Sam Walton gifted large portions of Wal-Mart stock to his children when the basis was very low. As the basis and value of the stock grew, so did the family’s wealth, making them the richest dynastic family in the world. So, the answer is likely a resounding yes. If you can take a $1 million seed round and scale some random technology into the next $1Bln+ crazy Facebook acquisition, then it was much more worth it to have a larger basis, which typically automatically occurs in the realm of startups–not so much in traditional private equity.
So the returns can be better, but do me a favor and take a look at the difference in size of private equity vs. venture capital. The methods for investing, particularly the amount required for a single investment are much smaller in the VC world, which bodes more toward individual investors. The part that doesn’t make sense from an individuals’ perspective is that most of the crowdfunding-backed startups will not only be illiquid for a long time, but they’re likely not going to produce cash flows for months or in most cases years.
Contrast that with the thousands of steady-state, existing businesses in the United States, many of which may be up for sale in the next couple of decades. The opportunity for doing other, perhaps more boring deals using some of the existing platforms is immense. We’re hoping crowdfunding facilitates more mergers, acquisitions, IPOs, APOs, LBOs, roll-ups, consolidations and other creative financing options. Let’s be creative. When we talk about crowdfunding, let’s not make it all about investing in startups. The world is much bigger than that and we’re much more creative.