The Due Diligence Process in a Crowdfunding Raise

The international expansion and increased successes of the equity crowdfunding have owed, in part, to its removal of traditional barriers to investment. By allowing companies to more easily source investors, and by democratising investment for new investor types, it has become an appealing fund-sourcing alternative.

The issue of due diligence (DD) is still at the front of many investors’ minds, however. Who conducts the DD in an equity crowdfunding raise? How am I protected? Should I stay away from raises and leave them to more experienced VCs if I am unable to conduct my own DD? The answers are not what many expect, and this DD is misunderstood by both retail investors and their more experienced counterparts.

Typically, there are two key considerations for any investor – performing due diligence and profits.  Equity crowdfunding does not guarantee these, and the industry’s detractors initially rang the alarm bell in relation to this approach.  What these naysayers fail to acknowledge is that maintaining a high quality investment platform is essential to the survival and image of equity crowdfunding.  While equity crowdfunding platforms are not under obligation to conduct due diligence on behalf of investors, there is an innate motivation to promote and assist viable companies. These are the ones more likely to go on to have subsequent funding rounds, and gain traction with investors.

Investors opt for their equity crowdfunding platform on this basis, that the platform will curate businesses of a high quality, that are financially viable prospects. Although this is true, individuals nonetheless need to appreciate the inherent risks of early stage investment. To encourage this, many governments have enacted regulation that demands company prospectuses. These are incredibly valuable and recommended reading for any investors, whether angels, VCs, or retail, before proceeding with investment via an equity crowdfunding platform. Such regulations have been put in place to limit fraud and reduce risk for investors, and have helped quell initial concerns of ‘platform fraud’ within the industry. Indeed, having such intermediaries as equity crowdfunding platforms have proven to be successful deterrents for blue collar fraud, and added hoops like the prospectus requirement further prevents fraud. Likewise, investors are able to examine the marketing materials of a company, which offer another view.  If this is insufficient, there is always the option of contacting the company’s existent customers and investors to ascertain their experience with the business. With the highly transparent nature of an equity crowdfunding raise, fraudulent behaviour would be an absurdity, given the deals are so public and visible to both the financial sector and mum and dad investors. Nonetheless, by assessing a company’s prospectus alongside an independent advisor, investors have full security and piece of mind.

The above preliminary checks are the minimum expected, but go a long way to revealing essential information about a company. Individuals have the power to go further through assessing financial statements, doing a corporate registry check or carrying out marketing assessments. However, the democratic nature of equity crowdfunding – i.e. knowing you’re investing alongside more experienced investors – often provides the requisite faith and encouragement needed for some investors. Nonetheless, the above advice demonstrates why a combination of existing measures and individual research can make sure you feel assured when making your investment – without the need for a costly and lengthy due diligence process.

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