This article covers specifically the crowdfunding of startups now that’s it’s permissible in the US. Below are some of the thoughts by the author –
1. Startup financings are generally to the extreme degree from being oversubscribed or undersubscribed. If investor’s interest were graphed, then it would look like a U –shaped curve. This can be principally the results of signaling – once a few investors entrust a business (especially excellent quality ones), other people heap on. If investors do not show interest, then other investors also get tentative. So, it is important to segregate the oversubscribed cases from undersubscribed ones.
2. Peter Thiel talked about how start-up investing has followed a power law. If you look at most of the successful start-ups, these were oversubscribed and competed well for the investor’s money. If novice investors were to commit their funds to those particular new companies via crowdfunding internet sites, they would have been squashed out. If all these investors had participated via a consortium, the consortium head would have forsaken them for more profitable deals. However, a contradictory viewpoint is that the power law is caused by short-sighted behaviour of impatient investors looking for the next Google.
3. If the investors have the knowhow specific to the project then it leads them to fund the project, which could otherwise have been missed out by the traditional investors. The case in point is the Kickstarter video games category, where most of the project supporters are game aficionados. The customers of a product could also support a project like Fund managers who may support a trading platform. The start-up founders also have less probability of losing money as a result of the investments by the potential customers [Adverse Selection].
4. It is evident that non-professional investors make losses if they gamble with individual stocks and in fact mutual funds would be a better bet for them. Regulators try to control the rouge elements in market with more rules and regulations. If this gets true in context of private companies then the advantages of private companies would no longer be there
5. Individual professional investors tend to invest in great people. The problem is that it is very hard to evaluate people even after in-person meeting. Even if the founders meet online the evaluation mechanisms should reflect their true picture. The counterargument is that despite these advantages the online crowd has in past outsmarted the professional investors while investing in start-ups.
6. The start-ups can provide additional signals to make themselves look more credible. For e.g. – a start-up may raise money from a few offline investors and raise remaining money through a crowdsourcing site. Although this gives them an authority to reject many of the interested investors but also allows them to meet a few useful ones which otherwise they wouldn’t.