In our recent blog Crowdfunding: As risky as we thought?” we compared the failure rates of companies that had secured seed-stage crowdfunding with those that raised from other types of funds. We found that companies that had crowdfunded more recently were less likely to be in trouble than those who raised funding a few years back. But this article did cause some controversy.
The main objection to our story was that were looking at very recent data – companies crowdfunded as recently as 2014 or 2015 – and that, essentially, it’s too early to tell if these companies are failing. However, we’d argue that thought-provoking conclusions can still be drawn from this data. Significantly, concentrating on 2014 data we can clearly see that companies on both sides – crowdfunded and funded elsewhere – have similar rates of trouble, in stark contrast to 2012 and 2013 data where the crowdfunded companies were far more likely to be having problems. We do admit, however, that it is too early to be looking at 2015 data.
One reader got in touch:
— Stephen Rockman (@shrock) January 26, 2016
So we decided to investigate. We looked into companies who raised seed-stage funding – crowdfunded or otherwise – and then went on to raise a subsequent round. We found an alarming down-round rate of over 50% for crowdfunded companies. This was in stark contrast with the down-round rate for non-crowdfunded companies, a relatively small 24%.
Clearly our reader has a valid point. But what could be causing this high subsequent down-round rate among seed-stage crowdfunded companies?
Looking at the sector-spread of companies that completed down-rounds after seed-stage crowdfunding, we can see that many are in sectors which require lower barriers to entry, and are usually less research intensive. Of this small data-set, the most prominent sectors were E-commerce and B2C websites – Mobile apps also featured.
This might suggest that the founders of these crowdfunded companies are more likely to embrace the ‘take a punt’ approach, rather than spend years of background research on a product. This, in turn, could impact the stability of the company, which consequently could result in a drop in pre-money valuation.
What’s more, these sectors are relatively young. Not only could this imply less market stability, but it could also mean there was an initial and unsubstantiated hype around them – which may have caused arbitrary boosts in initial crowdfunded valuations.
More generally speaking, crowdfunded companies are less likely to have experienced investors on board. Instead, they’re often backed a multitude of ‘average joe’ investors who, owing to the nature of crowdfunding, are more likely to have a smaller stakes. What we see then is less centralised guidance, which could result in worse performance and a drop in pre-money valuation. Looking to the future, our data suggests that while the overall risk associated with crowdfunded companies might be declining, there may still be some work to be done when it comes to value”