Traditionally, early stage companies have fundraised purely through angel investors, venture capitalists and sophisticated investors. But recent law changes have allowed the general public to invest in them through crowdfunding platforms such as Equitise.

Companies with less than $25 million in consolidated assets and annual revenue can raise up to $5 million a year in equity. Aspiring neobank Xinja has done this twice, successfully raising $2.4 million on its first attempt and $2.6 million on its second.

Xinja already has its cloud banking platform, an app and prepaid card as well as an Australian Credit License.

In December it received its restricted banking license from APRA, allowing the company to call itself a bank and hold up to $2 million in deposits. It wants to launch accounts in the second quarter of this year and has plans to also add home loans.

Inevitably, companies who open investment to the public will win more attention in the media and perhaps among their customers.

Even if you don’t want to partake in crowdfunding, it will nonetheless be interesting to watch the development of crowdfunded companies.

 

So what are the potential risks and downsides?

While crowdfunders will talk up the opportunities, there are risks and downsides that are not publicised or if so, not outside the fine print of their prospectuses.

Liquidity

It will be difficult to sell or transfer your shares unless you can find an off-market buyer, unless of course the company becomes listed on a public exchange.

But that could be a fair while away, and even if they are successful, every future capital raise will dilute current holdings unless shareholders ‘top up’ their stakes.

Capital risk and dilution

Remember, businesses rarely seek capital raisings when they have no need of cash – but hopefully the company’s reason for raising funds is to expand and grow its sales.

If they don’t raise the capital required in the offer you may get a refund, or equally it may be topped up by an underwriter, although it will depend from offer to offer.

In the future, if the company runs out of money, it is likely your investment will be lost – depending on where you rank on the list of creditors.  

Returns are slow to materialise

Of course, it is rare for aspiring tech companies to pay dividends in any case — but it’s easier to sell shares in a public listed company on-market and make a return from a (hopefully) rising share price. 

Limited shareholder rights

Want a say in how the company is run? Again, you could be left wanting. Shares issued via a crowdfunding campaign may not have voting rights, and if they do, how frequently and how they will be exercisable could be anyone’s guess.

Building regulatory burden

Also, as companies continue to grow they will be subject to further regulation. Australia’s crowdfund laws will require companies to meet the same laws as public companies within five years.

These are well-intended, to protect investors, but can be burdensome on businesses – restricting its expected growth

For example, The Commonwealth Bank (ASX: CBA) alone will need 800 full time staff just to ensure the bank complies with Royal Commission recommendations – in addition to the staff they already have.

A lack of analysis

But the biggest concern investors should have with companies seeking crowdfunding cash is that there’s usually no public timeframe on when the company will reach profitability (and be in a position to offer dividends).

Savvy investors will be mindful of looking at the current revenue and valuations.

The estimated  post-valuation for Xinja for example was ~$100m. No doubt it has made progress and tech companies can reach big valuations, for instance fintech Xero (ASX: XRO) has a $6 billion market cap — but its worth comparing this to some others.

Mortgage Choice (ASX:MOC) has a market cap of $110 million based on recent NPAT of $23.4 million and revenue of $217 million.

Similarly, Yellow Brick Road (ASX:YBR) has a market cap of $15 million with an NPAT of $885,000 and full year revenue of $227 million.

Xinja has a valuation of $100 million, but booked revenue of just $41,000 in the last financial year. Xinja’s valuation is more than six times YBR, despite generating 21 times less revenue.

It’s this kind of sector analysis which tends to go missing in the world of crowdfunding, as analysts aren’t employed to run the rule over companies seeking to raise money from investors on crowdfunding platforms.

But if Xinja was to try and raise via an IPO or on-market raise, there would be a lot more scrutiny of the numbers.  

Just ask Uber, which survived off several capital raises without being profitable. But now that they are seeking a public listing, its cash flow has never been more heavily scrutinised.

Crowdfunding is here to stay

Nevertheless, it is clear crowdfunding is here to stay as a method of capital raising — and how it plays out could be interesting

On the one hand, there could be a whole bunch of collapses and a mini ‘dot com bubble’.

On the other, these companies may end up being successful and have a fantastic growth story to tell and some very happy and rewarded shareholders.

But the telling day will come if any of these companies (Xinja included) end up pursuing a public listing.

Many shareholders would have lacked the chance to sell for years and it could be fair to say there could be more selling than buying on those first trading days.

 

This content does not constitute financial product advice. You should consider obtaining independent advice before making any financial decisions.