THE APPLES AND ORANGES OF CROWDFUNDING
On May 16, 2016, Equity (Investment) Crowdfunding will be available in the United States meaning anyone can invest into a private company that is listed on a FINRA member funding portal. Investing is no joke and should be approached cautiously. There are no guarantees; Investors bear the risk of losing their entire investment.
If you are a loyal reader of my blogs, you know I keep harping on the importance of investors to thoroughly conduct due diligence and review all disclosures prior to making an investment. Issuers must not only release favorable information about their company. All information needs to be fair, detailed and balanced. It’s in the best interest of the Company (Issuer) and the Investor that all risks and conflicts are communicated. So consider this part of your general crowdfunding due diligence as I discuss about in my opinion) equity crowdfunding and the private market risks and rewards. Part 1 is below and Part 2 and Part 3 will be posted shortly.
Part 1: The apples and oranges of Crowdfunding
Reward/ Donation Crowdfunding is not investing
Kickstarter and Indiegogo highlighted the power of crowdfunding with successfully attracting millions of dollars for projects developed by some very talented and creative individuals. The Pebble Watch, the coolest cooler, and even the potato salad project exceeded their initial funding goals. But did they deliver their promised rewards to their backers? Reward Crowdfunding has sparked numerous projects into fully operational companies, while some projects have failed to deliver on their rewards.
On a reward crowdfunding site Backers donate to a project and receive a predefined reward as a ‘thank you’. The backer does not have any financial incentive in the project, creator or company. Therefore, a Backer’s reward is not linked with the longevity and success of the company, or its revenue and cashflow. The risk for backers in reward crowdfunding is minimal and the reward is predefined.
My favorite project that exemplifies how backers are not investors is the story of Oculus VR . In the summer of 2012, the creators of Oculus, a virtual reality headset, launched a Kickstarter campaign to raise $250,000 for product development. Oculus exceeded its goal; attracting $4.2 million from 9,500 individuals. The backer’s contribution dictated the reward to receive, from just a ‘thank you’ to a 1st version Oculus virtual reality headset. The Oculus team received proof of concept. The crowd wanted a virtual reality headset. Venture Funds and large companies took note of the demand. Then in March 2014, Facebook announced their acquisition of Oculus for $2 billion dollars! WOW! Articles began to hit the press that the Oculus VR’s Kickstarter backers felt frustrated; i.e how could Oculus VR sell itself to a tech giant? “Those donors weren’t looking for a payout; they wanted to support something they believed in, and maybe get a pair of virtual reality goggles to play with. But when Facebook bought Oculus a year and a half later for $2 billion in cash and stock, backers wondered: what if I’d asked for equity instead of a poster? “I would have rather bought a few shares of Oculus rather than my now-worthless $300 obsolete VR headset,” backer Carlos Schulte wrote. It is estimated if backers were able to invest, their return on investment could have been 145X.
“In the future, donors will be a lot more circumspect and skeptical about putting in money, especially in projects where they could have even an inkling of an idea that this might be bought out by a tech giant like Google, Facebook, or Apple,” says Anindya Ghose, a professor at New York University who studies the crowdfunding sector. “They do not believe in backing projects for financial, commercial reasons. For them it’s a lot about a cause or altruism.”
Oculus is a great example of the potential success for early private companies but equity crowdfunding is a different game. Equity Crowdfunding has rules, requirements and limitations set since being regulated by the SEC and FINRA. Reward crowdfunding has none.
Is the Oculus VR an example of a glorified gem of crowdfunding? What other projects turned into companies with similar financial upside? Does the success of some reward crowdfunding projects project the potential of equity crowdfunding? Only time will tell with Equity Crowdfunding and how the new private issuer public raise market will evolve. It is not about instant gratification but trust, wait and see.
This blog is a part of a 3 blog series. Check out Part 2 The Inconvenient Truth: Most Startups Fail –The Risk Vs Reward trade-off in the PIPR Market will be posted next week.