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The risk of fraud and the importance of alignment between parties in equity crowdfunding deals

By: Jeremy Colless

The equity crowdfunding industry will always face the risk of fraud. Unscrupulous operators and/or startups may derail the reputation of this increasingly popular and important alternative finance source.

US tech web publication Pando Daily recently published an article “Scampaign Finance” outlining such challenges.

At the heart of the current delays in Australian equity crowdfunding legislation is the regulator’s challenging task of finding a practical balance between protecting small investors and promoting investment in Australian’s innovation future.

Measures to protect retail investors may include limits on the amount:

  • A retail investor may invest in a year
  • A retail investor may invest in a single startup
  • A startup may raise in a year

Other measures may include requirements for:

  • The issuance of light form prospectus
  • Licensing and regulation of equity crowdfunding platforms
  • Education regarding the risks of early stage venture capital investing
  • Risk mitigation techniques including portfolio diversification

VentureCrowd believes a number of the above regulatory constraints and guidelines will be in place when Malcolm Turnbull’s coalition government reveals the proposed equity crowdfunding legislation (with probable bipartisan support from the Labor party) before the end of 2015.

However, despite the best intention of regulators, no amount of regulation will prevent the occurrence of fraud in future equity crowdfunding projects.

VentureCrowd believes that the most effective way for investors to avoid fraudulent equity crowdfunding projects is to invest via platforms that offer pre-screened deals and strong alignment between the interested parties.

VentureCrowd achieves these goals by:

  • Partnering with angel groups, accelerators, incubators, university programs and venture capital firms to pre-screen and avoid the vast majority of startups that are un-investable. This crowd-sourced analysis ensures that the deals on the VentureCrowd platform are sourced from a very large pipeline of startup opportunities and are scrutinized by experienced mentors, investors and eco-system participants
  • Aligning the interests of the crowd investors with the lead investors of the funding round. Neither VentureCrowd nor the startup sets the valuation for deals on the platform. Valuations are set via the external validation of experienced independent investors who are committing their own capital (and often extensive domain knowledge/experience) to the transaction
  • Ensuring that the crowd receives “most favoured nation” status in the deal and invest at least on the same terms as all the other investors in the round.

The combination of practical and appropriate legislation/regulation with informed investors accessing equity crowdfunding platforms that provide pre-screened opportunities and an alignment of interest between the deal’s participants will minimise the risk of fraud and maximise the potential of the Australian equity crowdfunding industry.

Twitter: artesianvc

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