The greatest risk of crowd investing lies within the unvalidated business model of the company. When making an investment decision, it is worth considering the following aspects:
- The management of the company – experiences and dedication of the founders and managers
- The vision- how do they envision the company in 5 years’ time
- The business model – considering profitability and risks
- The size and dynamics of the target market, which defines the potential of the company, as well as the competition on the market and the bargaining power of the company
- If the company would like to go to market with something brand new, then the demand for that product/service should be demonstrated (the so-called product-market fit)
- The strategy ensuring sustainable development and its risks
- Corporate governance, transparency of decision-making and a scheme to motivate employees
As opposed to other forms of capital increase, crowdfunded companies go through a thorough examination, including the following:
- during the preparation for the Campaign the portal checks the validity of the campaign documentation
- the Lead investor conducts a due diligence process
- during the Campaign users can raise their questions about the company via the online forum (crowd diligence).
Consequently, since equity-based crowdfunding launched in Europe (which we count from the launch of the largest British portals – Seedrs and Crowdcube – in 2011) frauds are very rare: among the 750 successful campaigns on Seedrs or the 115 campaigns on the Austrian platform, Conda, there has been none. The aforementioned study of the World Bank explains it with the fact that crowd diligence is even more efficient than usual due diligence. When prospective investors raise their questions and in case the answers of the Campaign Initiator are not satisfying or cause uncertainty, the campaign will not pass. However the greatest risk is not fraud but the failure of the business model. Numerous studies detail the reasons why companies fail; among which the most often cited is that the company cannot realize its business model within its runway (the number of months, when the funding of the company is granted). (In case of reward-based campaigns the most common problem is that the product is not manufactured until the given deadline or is not of appropriate quality or it is not realized at all – but frauds are quite rare, especially in proportion to the number of campaigns.)