By Mike Baliman on Thursday 26 March 2015
Insiders tell me that equity crowdfunding is like the wild west and that there are – what’s a polite phrase – “varying standards of professionalism” out there right now.
As always I am not aiming these articles at specific firms but at industry practices – and for investors it’s certainly caveat emptor right now.
I’ll assume you can spot the shysters and conmen (who throughout history have flogged equity) but what about the mid-tier and upper-tier? What should you be looking out for?
The answer to this question is not always obvious in a clap-happy world of panglossian, almost new agey, sugar and spice, positive thinking, “Fintech”, “thought-leader” articles and propaganda.
The great thing about those rare occasions when the modern world breaks out from its factoryised approach to business is an outpouring of human creativity and a pre-Cambrian explosion of ideas and business models.
So that’s the good news.
On the other hand there are always some obvious evolutionary mistakes.
In the ever-lagging regulatory culture plenty of racy practices take place (until something blows up and then we have ye olde “stable door shutting”.
In a legalistic/bureaucratic world if you are following the rules you can always claim that as a defence – an approach that even Basil Fawlty saw through:
“Hors d'oeuvres... vich must be obeyed at all times vitout qvestion!”
So plenty of folks following the very lax orders right now and so “doing nothing wrong”.
Trouble is this “wait for something to blow up then ban it” approach means plenty of folks get blown up in the meantime before the rulebook bans selling bombs.
It’s very hard to write about equity crowdfunding risk.
Not because there aren’t all sorts of interesting minutiae, developments, course corrections and evolution taking place. There are and many worthy of close attention.
Rather there is an elephant in some (not all) of the rooms in the Crowdfunding Palace of Platforms. It’s pooped all over those floors and the odour is rather wafting around the whole place.
A good dictionary definition of equity is “the quality of being fair”.
Being fair is a good thing isn’t it…
Hopefully we all learned that before the age of five.
Trouble is everyone isn’t fair – then or now.
Which is why one needs the right legals in place when playing with equity qua “shared ownership” in something.
But legals are a minutiae when it comes to the elephant.
I vividly recall receiving my first email from a buddy with a crowdfunding “opportunity”. Of course whether it was an opportunity or a threat was an exercise for the reader to which we shall return.
I had a full inbox and was really busy so didn’t have much time to apply myself.
I got as far as “B shares” and gave up – no time to dig into the minutiae to find out what that really meant in this case.
I gave up not just due to lack of time but I know what it means in principle – “do you want to be a second class citizen who can be done over by the first class citizens in this little republic?”
Er … “no ta”.
I was told recently that one can now see C, D shares out there … no doubt one day we will get to Z.
I was about to suggest this is a bit like old-fashioned railway carriages – luxury, comfy and uncomfortable. But it’s not. At least they all get to the same destination.
This is different … much more like the Shogunate in Japan where the samurai (“A shares”) were allowed to test the sharpness of their swords by chopping peasants’ (“B shares”) heads off.
It’s that kind of class difference – a tad more material in the upholstery in the first case and a tad more material full stop in the second.
Nor is this excessively technical - there are some nice clear articles out there talking to not just this Big Picture of 1st and 2nd class citizienship but more legalistic phrases like pre-emption/tag-along/voting-rights [eg here are a couple by platforms that issue A shares: here and here].
Nor is this academic - I am glad to say I never saw “The Social Network” – the film about the origins of Facebook but one key part of the tale relates to some jiggery-pokery which led to Eduardo Saverin one moment owning about 30% of Facebook and the next moment about ten times less. Ouch.
So let’s cut the crap.
Buying B, C, D shares is perfectly legal. Selling them is perfectly legal.
I am not for a moment making any moral judgement about those platforms with perfectly legal businesses selling such.
I am however saying it’s a recipe for disaster.
Someone sooner or later will get f-ed over and that really won’t help the development of the industry as a whole
Or perhaps it will –for those who were kosher in the first place. Doubtless the outcome will inevitably be tighter regulation, higher standards.
However those who read my 3rd article “Deja-Vu All Over Again” will know that I rate “Aircrash Investigates” as great food for thought on FS risk. The great thing about the aviation business is they put lots of work into trying to make their planes safe before putting them into passenger service.
In our wild west equity world it’s the opposite – the tech vibe of “just get out there and strengthen as you go along” is all too prevalent.
As I say hard to focus on anything else.
A bit like standing around watching samurai chopping heads off and starting to discuss whether smoking is bad for one’s health.
However let’s just note a few points … especially to stop those shiny-shoed pupils in the front row who always hand their homework in on time and are sniggering right now a little too much behind their well-manicured hands :)
It’s all in the DD dude.
By which I don’t mean Vietnam war slang for legging-it (although that might be relevant at some stage).
How you know what you own is non-trivial even at the institutional level (at least behind the scenes … no-one ‘fesses up in public).
I recall visiting Hong Kong in the late 80s when it was still part of the Empire … now we have to make do with the Isle of Wight. The investment head of the office had just returned from a trip to Thailand.
“How did it go?” I asked.
“Bl**dy hell!” he replied. “That company we owned and thought was in one sector actually turned out not to be in it at all but actually owns hotels!”
In the ‘90s Kleinworts was doing the IPO for Gazprom. We weren’t quite sure how many oil wells they owned. Nor whether the accountants had counted them correctly. So we sent a corporate financier off to count them (or at least check the process). He never came back – don’t think he ever finished counting them (decided to leave mid process and work in PR instead – you see my point? :) ).
So, look, the issue here is that even if mega-money, institutional clout has problems around this one you can be sure it’s a challenge for smaller platforms than a global investment bank.
One of the tech buzzwords that AltFin as a whole is enamoured with is “marketplaces”.
No one quite makes the next step to the quality of the marketplace…
Well one could write a nice student essay in the role of different DD standards in the LSE and AIM – and the consequences. And in the future no doubt students will write essays about the fact that at least one “marketplace platform” doesn’t do any but just “takes on trust” the companies details. Say what? Wow.
The phrase “conflict of interest” also springs to my mind for some reason. Hmm. After all excessively high standards will reduce the flow of deals to our platform won’t it. Don’t want that in a tech world obsessed with growth and unable to measure risk do we?
Well, look I think these standards are a bit impractical, I mean I believe in investor protection and all that, but lets lower them a tad so we do some business.
And another tad.
So the question here (to all platforms) is:
“Hey that’s cool you do do DD (sic :) ), but what do you do exactly?”
“Do do DD, do u do” – someone should make a song out of that.
This actually-finding-out-what-is-going-on is part of one of the conceits of Fintech in general - transparency.
Trouble with that is it’s a bit like John Major’s “Back to basics” campaign – you do rather risk being caught (as he was with Ms Currie) with your trousers around your ankles.
In my article on whether P2Ps communicate lender risk well (I’ll save you time, “they don’t” :-D) I was critiquing the P2PFA standard performance table.
Well – hey – at least they have one.
There is no standard performance reporting in crowdfunding – some platforms don’t even tell you how many deals they have done!
Does any platform tell you how many of the firms raising funds have subsequently gone bust?
“You might lose the lot” conveys no useful information. “How often it has happened” does.
What are the relevant stats across the industry, independently assessed and collated?
Answer – “non-existant”.
Which platforms have had the highest percentage of bankruptcies already?
I think by now you are getting my drift and my sense of etc etc.
Having covered the twin angles of:
…everything else seems a little trivial.
But to throw a few more bones out there … what about “risk warnings”?
- the vacuity of “you might lose all your money” – you have to be brain-dead not to realise that … more to the point what processes (eg & esp, but not only, DD) are in place to minimise the risk and protect the investor?
- the vacuity of selling shares with “appropriate” (ie derriere-covering) warnings about the nature of B to Z shares – should you really be selling bombs?
- politically-correct warnings about diversifying investments. This only makes sense if you are investing in an asset class with a good performance. But not for lottery tickets. Returns from very early stage equity [I know platforms are doing various capital stages these days] have been poor for decades [ask 3i]. It’s a bit like suggesting folks buy lots of lottery tickets – in the limit that guarantees underperformance.
What about the modern world of spin? Are mini-bonds bonds or equity? How come convertibles suddenly appear with a zero coupon (etc etc)?
Last but definitely not least.
What about pricing?
Even if that first ever crowdfunding email I received had been selling A shares how on earth could I tell (and I have a hell of a lot more experience in valuation than most punters) if 125p was too expensive (unlikely to be too cheap)?
Let’s give Basil the last words:
“Listen, don't mention the war. I mentioned it once or twice, but I think I got away with it.”