Playing the long game: investing in and exiting equity crowdfunded startups

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Because equity crowdfunding is still a relatively new method of investing, statistics on actual returns aren’t as abundant as with many older asset classes, such as stock market investing. Equity crowdfunding only started to hit its stride around a decade ago, but with average ‘time to exit’ periods being between 5 and 10 years, we’re only just starting to see the true potential of its returns.  

While statistical data is still being generated, anecdotal cases of big CSF wins are getting easier and easier to find. The market has seen several strong contenders that have landed successfully and rewarded investors generously. Facebook’s $2 billion acquisition of Oculus in 2014 being one example. General Motors’ billion-dollar acquisition of Cruise Automation in 2016 being another.

The potential is vast, but investors are needing to learn whole new methods to balance risk and reward. Here’s what to consider when investing in - and exiting - CSF campaigns.

How to mitigate risk when investing in startups

Spread risk across multiple startups.

The idea here is that over time, a handful of big winners overcompensates the losses of the liquidations. The most difficult part of this strategy is removing emotion - and preferential treatment - from the selection process. It can be tempting to overfund “next big thing” startups and the likeable entrepreneurs who give a good pitch, while underfunding the quieter campaigns with less hype. Allocating equal funds across several startups makes it less like trying to pick a winner at the races. VC Fred Wilson presents a great model of this here.

To put it another way: an entrepreneur, by definition of what they do, puts all their eggs in the singular basket of their company. As an investor, your position should be adjacent to theirs - in support, but not “all in”. The startup takes the biggest risk for the biggest reward. If they succeed, you’ll profit, but you’ll still only get a portion. All the risk and only part of the reward is never a good investing mantra.

Diversify, but slowly.

As Jason Lemkin explains in this (really useful) Quora thread, many venture capitalists will only invest in 1-2 startups per year. This is because of the extreme selectivity, research and vetting that must be employed with investing in such a high risk asset class.

Read the exit strategy section of the business with maximal care.

Your investment will amount to nothing without solid, inbuilt plans for payday. Is the startup aiming for a merger or acquisition, or to make an IPO (more on these terms below)? How will they transition? And crucially, what are the timescales?

The 2 key exit strategy types for equity crowdfunded campaigns

Mergers and acquisitions

One of the most common exit strategies for crowdfunded start-ups is either merging with or being acquired by a larger company. In this scenario, the bigger company will take over, sometimes keeping on staff to smooth the transition, streamline operations, and allow them to cash out. The larger firm may have a controlling stake, as in the case of PayPal’s recent acquisition of Honey, in which the Honey co-founders continue to work on product integrations and scaling technology, or total control.

Initial Public Offering

An IPO is where a crowdfunded startup in the more mature stages of development will float on the stock market. It’s an investor’s dream, due to the large sums of capital that can be achieved when a company goes public. Wall Street remains the emblematic market for IPOs, as well as the NASDAQ, but there are increasing numbers of startups floating on ASX, with the average ASX IPO in 2020 up 58% since listing. In recent years, however, the IPO process is becoming more protracted. At the height of the dotcom bubble, 486 US companies went through an IPO. Ten years later in 2019, the number of was just 190.

One of the reasons for this could be cost. Nowadays, the operational costs of a publicly traded company are often between $1-2 million, largely due to the major jump in the level of reporting and compliance required, as well as increased employee compensation. And that’s after the application costs in the thousands. If your investment is promising an IPO exit strategy, make sure they know exactly where the required funds are going to come from.

If you’re a founder, STAX offers a much more cost-effective route to IPO via the Sydney Stock Exchange (SSX), with lower ongoing costs. This route is particularly suitable for smaller companies as only 50 shareholders are required. Read more here.

We wouldn’t be crowdfunding market leaders if we didn’t practice what we preach. The easy diversification enabled by STAX is one of the biggest draws for our clients. We enable you to browse and compare live campaigns, and manage multiple investments within one singular platform. See our current live offers here.

James Brannan

Director of Operations at STAX

All views, investment or financial opinions expressed are those of the author and do not necessarily reflect the official policy or position of STAX. The information contained in this post is not investment advice or a recommendation to buy or sell any specific security.

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