Are There Rocky Seas Ahead for Crowdfunding and Startup Investing?

There’s no question that Crowdfunding has become a big business. The 800 pound gorilla is Angelist, which was founded by a very good VC himself, Naval Ravikant. Angelist has become more than just a crowdfunding platform. It’s now a place where startup employers and potential employees can tie the knot. Without picking on a specific Crowdfunding platform, I believe there are rocky seas ahead.

Crowdfunding has recently exploded in popularity, especially with the passing of the JOBS Act. Now, any investor, qualified or not, can invest in private companies. This both is a positive and a negative. The popularity of crowdfunding and the ability of any novice or seasoned to invest in a startup feels eerily similar to the late 90’s/early 2000 day trading frenzy. Electronic trading was new and provided unparalleled access to the public markets for any seasoned or novice trader. It opened the floodgates and no one really knew what to expect. Well, we knew what to expect when the majority of those novice traders and many seasoned traders got wiped out when the tech bubble burst. I saw it first hand.

This similarity pushes me to believe that it will take a similar occurrence to understand the negative consequences of this new-found opportunity. Personally, I think it’s an amazing way for smart, seasoned investors to invest in early or late stage startup companies. It’s also a great way to find successful startups and invest alongside some big name VC’s. Here’s the problem: there’s going to be those novice investors that think they can make a quick buck, just as we saw in the day trading tech bubble. Unsophisticated investors are going to pile money into these private companies without understanding the risks. It could be because they feel the safety of investing alongside a big name VC. Whatever the reason, the result is going to be the same: unsophisticated investors are going to lose a lot of money because they don’t do their homework.

Private startup companies are raising stupid amounts of money. The valuations of many are sky high. Investing in startups is not for everyone. The investing time frame can be anywhere from 8-12 years. It’s not a get rich quick scheme. Mark Suster ofBothsid.es blog has a terrific explanation of the current state of the startup market. He says:

“If the market is driving up prices beyond intrinsic value the main new entrants to the market that have taken a less rational view of historical prices are a series of “non VCs” including corporate investors, hedge funds, mutual funds and crowdsourcing. Note that I’m not absolving my industry, venture capital, from bad behavior. I’m merely pointing out that price drivers are more strongly correlated with outsiders. On the chart below, 78% of the rounds of 80 $1bn+ companies were led by non VCs.”

Startups_valued_at_1_billion

Mark goes on to say, “To give you some perspective of how quickly we’ve created a “subprime Unicorn market” (as Michael Moritz called it) consider that in the last 18 months in the US alone we’ve gone from 30 privately held technology companies worth more than $1bn (already considered high by some) to more than 80 companies just 18 months later. Either we’ve discovered magical beans and elixir or perhaps we’ve gotten ahead of ourselves on valuation.”

Just remember that history repeats itself. There’s always a boom and bust cycle. Today, there is an overvaluation of private companies. The seasoned investing pro’s know that, but all the unsophisticated public investors just see dollar signs. This is exactly the type of scenario that occurred in the day trading tech boom and occurs in any other investing marketplace. Unsophisticated investors follow the trail of money for dreams of grandeur. Most of those individuals will blow out just as many day traders did during the tech bubble. I feel that this scenario will play out sooner or later with the startup world. The investing public will keep pouring money into these companies until the next bust. The government will rethink regulations associated with crowdfunding and startup investing. It usually takes a catastrophic event for everyone to understand the risks. I guess humans will be humans…

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