Conning the Crowd

Equity crowdfunding allows companies to sell their stock or debt offerings directly to investors by placing the offerings on a website platform. No stockbroker or stockbrokerage firm is needed.

An industry of crowdfunding platforms, experts and attorneys has emerged to help these companies raise the capital they seek.  Some do it better than others.  There are several that I would recommend without reservation.  But at the same time, some people do it so poorly that they make a mockery of the whole idea.

Some of those who do it poorly are now suggesting that that equity crowdfunding is a failure.  In reality, those people were never equipped to do it correctly in the first place and never really understood what selling stock to investors entails.

The one idea that these people and others in the crowdfunding industry never embraced was that “no one wins unless the investors win”.  There will never be a shortage of companies looking for capital.  Connecting those companies with people willing to invest takes more than the passive approach that many of the crowdfunding platforms have adopted. If a platform says “we list any company” I would recommend that you find another platform.

There are a small number of platforms that are licensed brokerage firms or run by people who have experience in the mainstream brokerage industry. They seem to appreciate what it takes to make equity crowdfunding work. These platforms offer demonstrably better investments.

The better platforms take the time to carefully consider each company that comes to them seeking capital.  They will not just allow any company to list their offering on their website.  Funding only companies that have a chance of success and providing investors with a return on their investment is the key to success for any crowdfunding platform.

One of the assumptions that people who lobbied for the JOBS Act put forward was the idea that a crowd of investors has the ability to review the offering materials being put out by a new company, evaluate that information and make intelligent decisions about which companies to invest in and which to pass on by.  The crowd never had that ability. Unless you have a working knowledge of accounting, analyzing the balance sheet and income statements of any investment will always be difficult.

When I first looked at crowdfunding I wrote two separate articles about Reg. A+ offerings that I thought were deficient in a number of ways. My primary argument in each case was that the numbers just did not add up. I thought that each company was promising more than it likely could deliver to the investors.  If I owned the platform where these two offerings were listed, I would not have allowed either to list because if they smell like they may be scamming investors, they probably are.

Both of those companies, Elio Motors and Med-X were subsequently the defendants in regulatory actions.  There have not been that many Reg. A+ offerings to date and the fact that there have been several other regulatory actions concerning Reg. A+ offerings should raise the eyebrows of any serious people in the crowdfunding industry.  I have looked at a few other offerings that were clearly suspect as well, but which the regulators have not yet publicly questioned. For the most part, many in the crowdfunding industry just do not care if investors get a fair shake.

A great many people who own and operate crowdfunding platforms simply do not know what they are doing.  If the platforms do not reject these scams, how will they ever build the long term trust of the investors that the industry cannot live without?

Finally there was an idea that websites would develop where the crowd could share its evaluations of various offerings and where the issuers could respond to comments and clarify what they were offering to investors. A true give and take of information so that investors might make informed decisions.

In most cases this has not really happened.  For all the talk about the wisdom of the crowd, there are people who are so foolish that they will not listen when someone makes a cogent analysis of an offering that would lead anyone with an ounce of common sense to invest in something else.

Case in point.

Both Elio Motors and Med-X were listed on a crowdfunding platform called StartEngine.  As I said, neither should have been allowed to come to market because it was pretty obvious that neither was giving investors the whole story.

StartEngine (SE) is currently offering its own shares to public investors under Reg. A+. I wrote an article about StartEngine’s offering as well. I questioned why it was not making a profit in an industry that should be enormously profitable.  As with all my articles, I asked some hard questions, but I always try to be polite. That cannot be said for everyone.

In the name of transparency, StartEngine posts the comments people make about its offering right on its webpage.  Several people sent me this comment which was posted on the StartEngine offering page which I re-publish here verbatim:

-StartEngine is paying its founders $400k apiece per year. This is INSANITY.
-StartEngine is paying all of its EXECUTIVES over $1,000,000 per year!! This is also insanity.
-Half of that pay was in cash bonuses. This needs to be addressed by their CEO especially as they have not made any profits and are taking investor capital.
-Investors are being offered Common Stock NOT Preferred Stock as they should be offered.
-What does that mean? That means that the founders have significant liquidation preferences over the investors.
-You are asking your investors to assign their voting rights to the CEO. This may not even be completely legal.
-The valuation of the company is unheard of,especially for a company that has continually lost money without any profit.
-There is no road map or path to reaching a revenue breakeven point where you can even sustain operations without SIGNIFICANT additional capital commitments.
-Investors will be HEAVILY diluted after this raise or worse there will VERY likely be a down round.
-The fund raise leaves the company with VERY little cash reserves. Guaranteeing the need for more cash.
-StartEngine has to be in the process of registering as a  full broker dealer for what it needs to accomplish the goals stated.
-The language of the offering circular makes it appear that SE is doing everything it can to shield investors from knowledge of its current and actual future plans as well as prevent them from having any ability to have a voice in the company.
-Over $5,446,367 has been spent to date in deficit without any profits.
-StartEngine does not include any listing or sufficient breakdown on its technology
-There is a significant lack of data and information that you would find in a standard pitch deck of a seed stage startup
-There is no timeframe for the ending of this campaign.
-There is no coverage of an exit strategy or potential for one.
-StartEngine does rolling closings and does not disclose when or how it will go about these, directly in conflict with the traditional “crowdfunding” model of get to your goal or get your  money back.
-StartEngine does not cover much on its competitors or the competing models or market.
                Please address these issues.

Certainly this list includes some issues that the company would do well to address. This commentator is no idiot and he is one person of whom it can be said that there are people who can read and assess a crowdfunded offering. He is exactly the type of investor that the crowdfunding industry needs if it is going to succeed.

So did the company respond with a point by point explanation?  It did not.  This is the company’s response which I also republish verbatim:

Thank you for your comment. We believe our offering describes our business effectively, and clearly shows our goals for the future. In fact, your critique of the offering is only possible because we chose to be so transparent.  If you have a specific question about StartEngine that will help you to decide whether or not to invest, please ask. We’d like to provide all the information we can.

Personally, I never would have let a client of mine publish that response.  It strikes me as arrogant and treats a potential investor who asked intelligent questions as someone who can be ignored. To me it smacks of the Wizard of OZ saying “don’t look behind the curtain.”  I would have counseled a carefully worded point by point response that demonstrated respect for the potential investor.

In truth I would never have suggested that StartEngine prepare a Reg A + offering or seek public investors.  As the anonymous commentator points out for any number of reasons investors are going to have a difficult time making a profit on this investment. This is not a charity. The executives are taking out a substantial amount of money ever year.  Because the company is not profitable, some of the money they are taking home is likely to be the investors’ money.

Despite this, the same web page notes that StartEngine has over 400 new shareholders as a result of this offering.  If an active crowdfunding platform can successfully make this offering despite its flaws, why would it care if any of the offerings that were listing on its platform had any value or could possibly offer a return to the people who are investing in them?

In my mind Elio and Med-X were strikes one and two against StartEngine and this offering is strike three. I would not advise a client to list on their platform and I certainly would not advise a client to invest in any company that does. In my opinion, investors deserve and should demand better.

As I said, this offering and the commentary was sent to me by an acquaintance who has toiled in the crowdfunding industry and the commentary was also mentioned to me by others.  They privately say tsk-tsk but do not want to publicly say what needs to be said.

I look at it this way, not every stockbroker is honest or competent. When they do bad things investors lose money. No one hates to see a stockbroker taken away from his office in handcuffs more than the honest stockbroker working across the street.  Bad actors and stupid people just demean the reputation of the whole industry and make it more difficult for honest people to make a living. That is true in crowdfunding as well.

In the past two years I have spoken with a lot of hard working people in the crowdfunding industry who are trying to help small companies find investors by giving investors a solid chance to make a return commensurate with the risk they are taking. You know who you are. Keep up the good work.




Leave a Reply

Your email address will not be published. Required fields are marked *