CrowdFunding Startup Investment – Democratization Writ Large Or Dangerous Hysteria?

Source: Forbes


Recently UK based SaaS accounting product vendor ClearBooks decided to raise capital in a new and interesting way – by crowdfunding a quasi IPO. Essentially Tim Fouracre, the founder of ClearBooks, is looking to raise money by publishing a share offer document outside of the usual IPO process. In doing so Fouracre hopes to raise money at a significantly lower cost than with a traditional IPO. Fouracre estimates that a “real” IPO would cost the company around 15% of funds raised. Dennis Howlett has an extensive commentary on the fundraise itself in which he comments on the chutzpah of ClearBooks in going down this route The company is something of a minnow in its home market, and virtually unknown elsewhere. While lack of market penetration is the norm for startup fundraising, ClearBooks is trying to raise at an £18 million valuation. Add to that the fact that they haven’t exactly scaled their customer base thus far and you have a difficult goal for the company to achieve.

The documents make interesting reading, in selling the idea to potential investors, the company pushes a few points:

Tried and tested product. We have developed cloud accounting software and a brand supporting 5,000 small business customers and accounting practices. The software is ICAEW andICB accredited.

Track record of growth. Our organic growth has led to monthly recurring revenues of £60,000 (as of August 2013). There are four million small businesses in the UK and 35,000 accounting practices representing a potential opportunity to scale up sales.

Support UK businesses. Help us fulfil our mission to be the champion of small British businesses. Our customers have invoiced more than £1 billion through our system. Clear Books itself has grown from a one man startup working from home, to a team of 19 based in our central London office.

In his commentary Howlett contrasts this approach with the more commonly seen crowdfunding campaigns where companies raise funds to create a product or service and individuals can “invest” in exchange for tangible goods at some point in the future. While this move to open fund raising definitely lowers the barriers to raising, it does introduce some risks that people need to think about.

The reason that significant compliance barriers are put in place for equity raising is so that companies looking to raise funds will ensure that prospective investors make a decision with as much information as possible – it tends to weed out the snake oil merchants and Ponzi-scheme shiesters. A model such as the one ClearBooks is attempting means that essentially anyone with any kind of idea or business can raise funds, regardless of the validity of the idea, their ability to execute or broader factors. While many would say it’s simply a case where caveat emptor is called for, I’m not sure that removing the fetters of control is such a good idea.

The ClearBooks approach comes around the same time that US regulators opened up, via the JOBS Act, the ability for startups to publicize the fact that they’re raising funds. The new Syndicate and Backer functionality on Angellist means that investors can take a lead position, and get other investors to come in alongside them. Already we’ve seen just how powerful that concept is as high profile individuals such as Tim Ferriss, merely by virtue of his “anointing” startup Shyp, gained significant amounts of “ citizen investment”.

Now clearly this is a positive move in some regards. rather than early stage investment opportunities being closed to a very select group of individuals, at last the average Mom and Pop investor will have access to some of these opportunities. But here’s the thing – those select group of early stage investors have two things going for them:

  • They often have specific domain knowledge in the area in question
  • They often have free cash to burn on these speculative deals

Those are two traits that general investors don’t share and, while it may seem that by broader funding models less aware investors can share in the domain knowledge of subject matter experts, there is little robust process to ensure they know just how speculative those investments are. Ferriss devotes only a couple of lines to the risks when he says:

  1. Startups are speculative, and this is gambling. You shouldn’t invest anything you’re not comfortable kissing goodbye. Treat it as casino money.
  2. If you are going to invest in startups despite this high risk, plan on building a portfolio of dozens, very slowly and carefully. This should be just one of many.

And judging by the frothy excitement on Angellist about this opportunity, there is a lot of “throwing caution to the wind” going on. Which brings us back to ClearBooks’ fundraising attempts. The accounting software market is pretty complex – there are a number of incumbent players trying to innovate, there exists much competition amongst the new entrants and the go-to-market is made more complex by the difficulty of reaching a broad SB audience. These are all factors that take domain knowledge to understand, and directly have an impact on ClearBooks future potential.

In his post Howlett broadly details the specific reasons he has questions about ClearBooks valuation and potential as an investment:

We have no way to test value because there is no independent assessment of the declared value, neither is there a competitive market for the shares. ClearBooks will argue that the direct comparison with Xero is valid. That’s plain wrong on many levels. For starters, Xero has achieved its current position by aggressively investing in marketing and sales. This seems absent from ClearBooks predictions. Recent history is teaching us that a large war chest is essential for upstarts to take on the big boys with any real prospect of success. [xero] has very bold plans for functional expansion that I believe will prove far harder to execute against than ClearBooks is indicating. Developing a functional payroll for example is a mammoth task that should never be taken on unless you can make it a differentiator. I’ve never seen that happen yet other than in large cloud implementations that are directly connected to HR.

All very valid points and almost invisible to anyone outside the industry. And this is the risk with democratizing investment – sure it opens it up to a far broader audience, but in doing so I suspect we’re going to see a high degree of collateral damage. And in this culture of transparency and risk-mitigation, we might just see the pendulum swing back from such open processes.