Today the first equity based crowdfunding site in Estonia launched, and while I fundamentally like the idea of investing into growing companies (more than giving them loans!), then I will probably not be investing through Fundwise for a while still, since I see some key issues in their whole model of working.
Is equity funding smart money?
In the world of investing there exists an idea that some of the money invested is so-called “smart” money. This generally refers to angel investors or venture capital in terms of the investment being linked together with know-how. The problem with Fundwise being, they (either team or the businesses) believe that they are gathering up smart money, but inherently accessible-to-all crowdfunding will never be smart money. Especially in their model where the people who buy a piece are absolutely “silent” owners.
So, there is a fundamental issue here as to the actual plan of how Fundwise should work. Smart money investments are generally bigger in therms of the sum due to the investor knowing more, or being more aware and therefore trusting the project to be a bigger % of their overall portfolio. However, since crowdfunding is fundamentally accessible to all, then you can’t consider it smart money, therefore the large buy-ins for Fundwise start to work against them. (They buy-ins are as high as 600€ per piece).
How to diversify in equity?
This is obviously a trick question – you diversify like in most other crowdfunding investments, reasonably widely. This is where the problem arises with big buy-ins.
Let’s assume that they have 2 projects every month, the buy-ins are an average of the current projects, let’s say 300€. The person might not like all projects, so let’s say the invest into 20 projects per year. The projects last about 5-7 years, meaning that to run 20 investments per year for even 5 years, that makes the total portfolio value 30000€ before the money starts to recirculate. (Yes, I know this is very oversimplified)
This is why Fundwise will likely struggle to include small scale investors such as myself. To achieve meaningful diversification you have to invest so much money, and the delay for returns is so much longer than other similar investments (like social lending or the current real estate projects).
Especially when we talk to people who are just starting and have like a 5000€ portfolio – completely respectable after a couple a years of investing. Just a few investments into Fundwise would very quickly make up 10% of your whole portfolio. I don’t think that’s a reasonable risk level.
What I would invest in
Since it’s currently somewhat unreasonable for me to aim at building a portfolio (since in theory a diversified portfolio would work well enough), then I’d only invest if I saw a project that I’m personally in love with. For example I like the game building project, and that’s something I’d support but in terms of investing it’s a bit closer to a Kickstarter type investment than an actual make-money investment.
Also, I would make a portfolio if the buy-in was sooooo much smaller. I don’t understand why the pieces have to be so big since the people who buy into the project are absolutely silent partners anyway. Also, since you use crowdfunding such as this partially as a marketing tool, then why would more investors be a bad thing?
Expectations vs investor capability
I’d say that the easiest theoretical fix for them would be to realign the idea of who their ideal investor is. If they want so-called smart money they should be heavily marketing towards medium-portfolio investors (100K+), who wouldn’t care about the bigger buy-in and also bring some know-how to the table.
Another option would be to go truly crowdfunding and drop the buy-in like they have in some other crowd-funding portals to like 10-50€, max 100€. That would make it accessible to small scale investors in a way that it isn’t right now. This would also make more people invest – investing 600€ into a project might be above a lot of people’s comfort level, but investing 100€ into something you think is cool, would be a lot more viable.
Also, more work in marketing and communication would definitely help, but that’s the case with all current crowd-related investment portals.