In this week’s Fintech Spotlight, I share my gripe against the equity crowdfunding industry. Just to put my cards on the table, I happen to be a huge crowdfunding bull. All things being equal, I believe the net gain of retail investors to invest in startups is superior to that of leveraged assets such as forex and CFDs. Both come with tremendous risks, but my belief- and it should be clear that I speak for myself and this isn’t necessarily the view of my employers or colleagues- is that supporting startups and innovation in the world has greater benefits than forex and CFDs.

Why I am telling you all of this? Because I want to be clear that despite my favorable bias towards equity crowdfunding, there is one aspect that worries me about the industry- the way it is marketed.

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Conflicting interests

One built-in risk of startup investing is the fear that the founders are defrauding their investors and will run away or misappropriate investments. Investors in equity crowdfunding campaigns similarly face this risk. However, investors can mitigate their risk by diversifying their funds as well as focusing on companies where the founders or the main product has a reliable track record.

What is harder to be careful about are platform providers that knowingly market investments that aren’t in the best interests of their investors. The rationale behind such actions is that most platforms are compensated based on a percentage of the funds raised. Therefore, there is an advantage to bring to market startups with so-called ‘sexier’ businesses that will be easier to pitch to investors.

What are the returns?

The ramifications of the potential conflict of interest between platform providers and their investors is such that rather than only having to conduct due diligence on startups, it is also required of the crowdfunding platform operators.

In terms of analyzing operators, one way is by taking a look at the returns to investors. Unlike stocks which trade daily and profits that can be calculated in real time, with startup investing this is more difficult. However, processes do exist such as publishing returns from exits as well as valuations calculated from further fundraising. One of the best examples is TechStars who shows a very detailed list of the performance of the portfolio from their accelerator investments (list here).

Neither Crowdcube or iAngel disclosed exit returns

While some crowdfunding platforms such as OurCrowd and AngelList have shown that they do a good job of marketing themselves while still disclosing failures and successes, others are limiting the available data. Recent examples, and the impetus of this article, are CrowdCube and iAngels. Both have published this year of successful exits.

In CrowdCube’s case, the firm announced in July that E-Car Club was its first exit after it was acquired by Europcar Labs. However, investor returns on the deal were withheld. Subsequent queries to E-Car Club, Europcar Labs and CrowdCube drew either ‘no comments’ or silence. In a contributor article from Rob Murray Brown of the blog Fantasy Equity Crowdfunding, he provided whisper estimates of investors realizing 3X returns on their equity.

Similarly being silent was iAngels. The firm announced that portfolio companies Flayvr and Big Blue Parrot were acquired by AVG and Playtika respectively. However, in both cases iAngels withheld requests for disclosure on how investors made out in the deal.

Transparency

The point of this post isn’t specifically to be picking on iAngels and CrowdCube. Many startups have raised funds to help them build great products and grow their firms. Along with other crowdfunding platforms, they also operate in a capitalistic market that requires them to generate revenues and profits to survive.

That being said, the reality of this new industry, and one that I personally am rooting for, is that it still needs to prove itself. Part of that process is transparency. An example would be easy to understand scoreboards that mimic that of other retail facing asset classes to help them understand past performance and just how risky startups as an asset class are. Firms should also provide existing returns on exited businesses to portray to investors what a success really is.

Beyond the platforms, transparency should also arrive in the form of operational updates from startups along with financial filings. While such information could hamstring their competitive position by revealing too much to the public, it is an important proxy used to provide ongoing valuations. This becomes especially important as secondary markets for private company shares aren’t far behind and will offer needed liquidity to investors.

To address the fine line between transparency and secrecy while maintaining competitive advantages, a potential solution would be some sort of third party rating that is backed by the crowdfunding industry. Companies such as Mattermark already exist that are equipped to aggregate financial statements and provide investment rankings for private firms.

Overall, much of the private company equity market is based on trust and relationships. With equity crowdfunding, it is opening this world up to a wider group of participants which is potentially an amazing thing for both investors and startups. But, to succeed, part of building these new online marketplaces means adopting transparency practices that are accepted and being used by this wider investor population. Without it, a lack of suitable trust will go a long way towards degrading this burgeoning industry.

Fintech Spotlight is a new column on Finance Magnates devoted to reviewing innovative financial technology companies and sector trends.