Thread by @dunkhippo33

Yesterday I talked about my vision for crowdfunding -- where it can go, how the system can be really great, and how we can democratize fundraising.

Today, I'm going to talk about all the pitfalls that will happen before we get there.

Read on >>

https://twitter.com/dunkhippo33/status/1371562873680318465?s=20

1) Retail investors will get hosed.

There are two ways to get hosed.

a) The companies didn't succeed
b) Retail investors were not set up to succeed

2) A common q / critique I often hear about crowdfunding is "has there ever been any CF company who has done super well?"

And the answer is that honestly most startups *in general* don't do well. I do think we will see some CF companies emerge as big winners.

3) But if most companies are not going to do well, then how do investors do well?

I wrote a blog post on portfolio construction for early stage investing:
elizabethyin.com/2020/05/20/why…

Hint: you need to be shooting for 100x returns in your winners for early stage companies

4) And what is an early stage co? To me, it's any co without product-market fit. This means a co that doesn't yet have a REPEATABLE sustainable customer acquisition process.

This will be most of the startups on crowdfunding platforms IMO.

5) So if retail investors want to seriously be investing in this asset class AS AN INVESTMENT, they need to level up their knowledge on *how to invest* so they can set themselves up for success in a world where most companies aren't going to lead to positive liquidity.

6) Of course, as a microangel, I think there are many other reasons to invest as well besides returns.

Social good. Wanting to support people. Etc. So if you think of crowdfunding more like a donation than an investment, then leveling up is irrelevant.

7) But if you want to make money, you need to be thinking about your entry points and exit points and whether you can even potentially make 100x in between those two valuations.

E.g. if you get in at $3m post money valuation in a co, the co needs to exit for $300m+.

8) These are rough rules of thumb but after dilution and 3 rounds of additional funding, investors are often diluted down by 50% (or more). So this is why the bar is so high.

9) A $300m exit for many internet cos is doable these days, but one of the things I often see on crowdfunding platforms is the valuations are often quite high.

Take whatever post-money valuation they are raising at and multiply it by 100x. Do you think that exit is possible?

10) E.g. if a co is raising at $50m post-money, then do you think it could exit for $5B+?

In a frothy mkt like this one where valuations are often not based on revenue, then maybe. But could this outcome happen in a down mkt? (At least that's how I think about things)

11) Search for the # of exits that occur every yr at the $1B mark and above. That # has certainly gone up a lot in the past few years.

But, it's still not super common. Not as common as the # of < $1b outcomes.

12) This is obviously a subjective exercise -- who knows if a co can exit for $1B or more? But, it's something you should think about even if your decision ends up being a completely gut call.

That's just the outcome level you need to hit in order for this to work out.

13) And maybe you write the check anyway but you think of it as a donation -- and that's ok too. But it's impt to be crystal clear on what your goals are.

14) In addition, in the current iteration of crowdfunding, you don't really get a lot of information to make a truly informed decision. You don't get to ask the founder questions.

I can understand that it's impractical for a founder to meet w/ 1k+ investors.

15) But I think technology can solve for this -- perhaps a townhall of sorts would be helpful to get a sense of what is being pitched.

16) The other thing to consider is that many of the companies on crowdfunding platforms did try to raise from VCs. And maybe the VCs were wrong and missed out and that's a retail investor's opportunity.

But the valuations are often WAY higher on these platforms than what VCs see

17) You're not getting the best deal on these CF platforms. It's because you have no leverage to negotiate, & no one is negotiating the valuation price for you. It's set by the startup.

And that's just something that you need to build into your mental model (w/ the 100x).

18) Now let's talk about the pitfalls of crowdfunding in itself. Let's say you're all set up as a microangel investor to invest methodically and with structure and thought.

There are still hurdles to overcome.

19) You need to read the fine print and really understand what exactly you are investing in. This is not fun. Most ppl don't read the fine print. But you can get really hosed if you don't. I've seen it happen to friends.

20) Even if you are getting into a co at the same valuation as professional investors, you may not actually be getting IDENTICAL TERMS which is critical to understand.

A co can have a highly successful outcome & the crowdfunding group may make a LOT less $$ than other investors.

21) This happens because the legal docs are often written by the co and are not negotiated at all. There is no one to go to bat for the retail investors. And most of the time crowdfunding platforms are not investing themselves, so the alignment isn't there.

22) I 100% believe that crowdfunding platforms need to be raising their own funds and putting money into EVERY deal so that incentives are aligned.

This is the #1 problem IMO right now with crowdfunding. There's no guide / leader to represent the group.

23) Examples of types of legal structures I've seen on these platforms are

-either extremely convoluted -- unclear how the investor makes money at all or what is being invested into
-a convertible note that allows investors to only get their $$ back even upon successful exit!

24) So even as we improve the perception of crowdfunding, these issues are going to set us ALL back. A lot of ppl are going to lose their $$ and crowdfunding will take a hit.

But I'm confident in the long run, crowdfunding will evolve to look different & will prevail.