The Real Threat to Equity Crowdfunding
Published: 5/23/2014 11:11:27 AM
There are many critics of the nascent equity crowdfunding industry.
Some cite the risk of fraud being perpetrated on unwitting investors, but I don't think that fraud the real threat to the ongoing viability of the industry.
The real threat is a potential dearth of returns commensurate with the illiquidity and high risk of equity investments in very early-stage technology companies.
The number of high quality, successful early stage technology companies that are "investable" by equity crowdfunding participants will be extremely small.
Secondly, crowdfunding stage investors will likely be diluted as the few companies that do gain traction require significantly higher investments in follow-on rounds from established venture capital firms and other professional sources. This occurs to Angel investors as well.
Lastly, given the high death rate of early stage startups, successful equity crowdfunding investment will require a portfolio theory approach with many investments spread out among the startups.
Most early-stage crowdfunding investors will probably not have the time or inclination to spread their risk among a large enough portfolio, probably on the order of 30-50 investments.
As a result, I foresee comparatively unexciting returns for a large portion of equity crowdfunding investors. A few will have great success, but the vast majority will not, due to a variety of reasons.
"Democratizing" investment is a nice concept in theory, and it will certainly increase the amount of funds available to entrepreneurs, but whether it results in an investment return commensurate with the risk and illiquidity of tiny investments in early stage startups will determine the long term viability of the industry.