Is crowdfunding the way to get in on the ground floor of the next Xero or Facebook?

Our first equity crowdfunded business, Renaissance Brewing, has gone bust. But Richard Meadows writes that rather than being a canary in the crowdfunding coalmine, it’s a reminder that early stage investment is ride-or-die. 

2014 was a piquant, joyous year; easy on the palate, with just a hint of botanicals to make things interesting. For Renaissance Brewing, the future was looking very bright indeed. The Blenheim craft brewer had just made history as the first Kiwi company to raise funds using the power of the crowd, taking $700,000 from hundreds of punters keen to buy a slice of their very own brewery. Cue much quaffing and smacking of lips.

Fast forward to 2017; a toxic dumpster fire of a year hell-bent on desecrating all that is good and pure in the world. Renaissance went into administration last month, leaving investors with the sour taste of warm, flat Lion Red in their mouths. The usual case of free beer for investors was cancelled, so the poor buggers couldn’t even drown their sorrows.

The failure of crowdfunding’s poster child doesn’t exactly inspire confidence in what is still a very new and unfamiliar market. But even while Renaissance has fallen flat, there’s never been more effervescence in the crowdfunding scene. Fellow craft brewer ParrotDog is coming back for another round after thirsty investors tapped out the maximum $2 million in two days last year. That was a record, but Dunedin chocolate maker Ocho have just claimed the title from them, hitting the same limit in a mere 30 hours.

Ocho’s tasty offer won the hearts and stomachs of 3570 pledgers. Image: Screenshot

The Financial Markets Authority (FMA)’s first report on crowdfunding counted $72.2 million raised in the year to June 30, with new investors making up a full two-thirds of those who took part. That trend has no doubt accelerated in the second half of the year: PledgeMe founder and CEO Anna Guenther was wading through a sea of investor verifications from the Ocho raise when The Spinoff got in touch (“It’s a good sort of problem, though it might be prematurely aging me and my team a bit!”).

Crowdfunding seems like exactly the sort of thing that would appeal to Kiwis. Most of us have contributed to a Givealittle campaign to help someone fallen on tough times. We’ve loaned money to boost the production of custard squares to an industrial scale, which is doing God’s work if you ask me. And who could forget the time the whole country pitched in to buy an entire beach?

Equity offers are part of the crowdfunding family, but they’re more like the awkwardly formal cousin who doesn’t really like hugging. There’s a lot more at stake compared to a Kickstarter-style project, where you’re basically just pre-ordering a space-age beach towel or salted-caramel jockstrap or whatever. Giving campaigns are even more straightforward – throw a few bucks to a panhandler raising $10,000 for a “spiritual journey around the world”, and the best you can hope for is that the cosmic wheel of Karma turns in your favour.

Equity offers are a bit more transactional. Some are driven by fans or communities rallying to support a beloved company, but others are totally impersonal investment pitches. In either case, people are putting their hard-earned money on the line in the expectation of receiving something a little more tangible than a basket of warm fuzzies and goodwill to mankind. After all, they’re taking on a pretty big risk. Here’s the warning that platforms and issuers have to display:

Basically the modern equivalent of ‘BEWARE, HERE BE DRAGONS’ (Screenshot)

Investors hand over money to companies in their most vulnerable growth stage. They do so on the basis of very little information. There are fewer legal protections if things go wrong. And the whole thing is ride-or-die: There’s no market to trade shares, which usually means sticking it out until the company sells, goes public, or busts.

The crowdfunding platforms don’t give any assurances about the specific claims being made, or make recommendations. That doesn’t mean it’s a total free-for-all: there were 50 offers during the period the FMA report covered, but another 263 would-be issuers were declined.

Snowball Effect’s head of private capital Cowan Finch says only around 5% of those who approach the platform make it all the way through to placing an offer. The companies have to meet certain screening criteria and pass muster with a small group of experienced investors. Unless cornerstone investors are interested, the offer won’t go out to the public.

Then there are all the anti-fraud measures – reference and background checks, trawling through criminal records and insolvency registers. It’s rigorous enough that Guenther was once told by a policewoman that PledgeMe was the last line of defence against terrorists.

“I’m not sure that’s true, and if it is, I’d really like a badge,” she says.

As Guenther points out, our regulation is actually much less cumbersome than elsewhere in the world.

PledgeMe’s boss is currently exploring the opportunities in Australia, which is finally tiptoeing into the brave new world of equity crowdfunding. (Supplied)

New Zealand has gone for the sort of sensible light touch that economist Eric Crampton would say keeps us ’outside of the asylum’ – as opposed to America where investors and issuers are firmly bundled up in government-issued straitjackets. Regulators have finally removed the 80-year-old ban on startups soliciting public money, but among many other rules, mum-and-dad investors can’t contribute more than $2,000 USD to $100,000 USD a year, depending on their annual income and net worth.

So-called ‘sophisticated’ investors have had a freer rein, but they’re just as capable of being duped. In 2015, the authorities swooped in to shut down Ascenergy, a company that had crowdfunded $5 million USD from exempt investors for oil and gas projects. As it turns out, only $2,000 had gone towards the actual operations, with the funds mostly financing the founder’s penchant for fast food, supplements, and visits to the Apple store. So much for smart money.

Even leaving aside out-and-out fraud, investing in early-stage companies is a bit of a crapshoot. The venture capital approach is to place bets across a whole portfolio of potential hotshots. Most of them will fail but the occasional ‘unicorn’ will blast into the stratosphere, more than making up for the losses.

New Zealand’s own Rod Drury grew cloud accounting software firm Xero from a budding startup to a $4.4 billion company. (Supplied)

Until recently, only VCs and deep-pocketed angel investors had access to these sort of early-stage deals. Regular Joes and Janes wouldn’t get a look in unless they happened to get in on the pre-money ‘friends, family and fools’ round. Think Gareth and Jo Morgan, who pocketed a tidy $50 million from Trade Me.

We’re only three years in, so it’s way too early to say whether crowdfunding will turn up anything that bears any resemblance to the unicorns so beloved in Silicon Valley. On paper, some investors have already made up to eight times their initial investment, and plenty of the alumni companies are chugging along modestly. Is it possible that normal Kiwi investors could get in on the ground floor of the next Xero or Facebook?

It’s a long shot. Startups are often better off raising money from VCs or angels. It’s cheaper, simpler, more private, brings valuable connections and strategic advice, and doesn’t involve dealing with thousands of pesky shareholders. The implication is that companies only turn to crowdfunding because they’ve failed to get other funding, and the public is unwittingly picking among a bunch of rejects.

Fortunately, that’s not always the case. VCs have very little interest in most consumer goods businesses (like craft breweries and chocolate-makers), and crowdfunding might actually be a better fit because it instantly creates an army of brand champions.

Other companies have chosen to follow the timeless wisdom of the Old El Paso girl.

(Screenshot)

Social enterprise Ethique recently raised $500,000 from its angels and cornerstone investors, while simultaneously raising the same amount through PledgeMe. At Snowball Effect, most issuers have already secured some form of funding before they make a public offer, and Finch says they’ve found it works best when large and small investors invest alongside one another.

Crowdfunding may prove to be a great democratising force, giving regular people access to a whole new class of investment. Even so, we little fish shouldn’t fool ourselves into acting like wannabe venture capitalists. The big players have the scale to build a diversified portfolio, and the resources to evaluate companies properly. Even if everything goes to hell, they’re mostly investing other people’s money anyway.

If you are looking to dip your toes, the number one rule is to never invest more than you can afford to lose. Spread your risk between different offers if you can, but not if it means violating rule number one. Finally, be prepared to wait a very long time to get your money back, and quite possibly to never see it again.

Which brings us back to the sad story of Renaissance Brewery.

This is not a canary in the coal mine, warning that the world of crowdfunding is a crooked facade that’s about to come toppling down. At the same time, it’s not some crazy outlier to be brushed off either. It’s simply a reminder of the nature of this particular game: You win some, and you lose some. Hopefully, we’ll get to celebrate some big wins as the market matures, but there will be plenty more sad stories too. When they come, just make sure you don’t forget rule number one.


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