As startup heating up and fin-tech gaining popularity in the past few years, equity crowdfunding started to draw attention from the public. On the entrepreneur side, equity crowdfunding provides an alternative source of financing over institutional venture capital, which is often the time associated with undemocratic investment decision making and intensive control over startups. On the investor side, equity crowdfunding is likely presenting a new asset class to invest and an opportunity to somehow involve in the entrepreneurial world. As a result, equity crowdfunding platform emerged worldwide to match demand and supply from both sides.
In just a year since established in 2015, JD Equity Crowdfunding platform helped 89 startups raising over 1.1 billion RMB (~162 million USD)[i] and became a leading player in this area in China. The platform leveraged rich resources provided by its parent company JD.com, the second biggest Chinese e-commerce firm, and reached its peak in 2016. Yet a few significant challenges to its business model were revealed at the same time. Today, users can not find any new investment opportunity on the platform. The platform either is going through a tough time in deal sourcing, or has pivoted to other business. A new website page for wealth management targeting high-net-worth users has replaced the entrance for Equity Crowdfunding website on JD.com’s homepage.
Originally, JD Equity Crowdfunding platform’s business model is, to a large extent, similar to the deal-by-deal model of its counterparts in the U.S., such as AngeLlist and Wefunder. More specifically, the platform operates in the following way:
– Startup qualification
Startups that are interested in raising fund on JD Equity Crowdfunding platform need to go through a pre-selection process that is done by the platform’s dedicated deal sourcing team. Just like Kickstarter choses to do more due diligence work and thus holds higher qualification criteria for product or idea crowdfunding teams on its platform than Indigogo does, JD’s platform designed this process to help investors collect information and control risks.
– Lead plus individual investor
For each startup that successfully attracted enough investment interest, a lead institutional investor (usually a VC firm) together with a bunch of individual investors will form a limited liability company to be qualified legally for executing equity investment.
Unlike in the U.S., JOBS Act specified the criteria and process to be a certificated individual investor, no such a strict regulation existing in China. To become an investor on JD equity crowdfunding platform, individuals only need to answer a few questions about their dispensable income and investment preference. And for individual investors, the maximum investment amount in each deal is 200,000 RMB (~29,500 USD), caped by the platform.
– Value capture
JD Equity Crowdfunding charges a commission for each deal made on the platform. And if the platform takes the lead, rather than the lead institutional investor, in forming and operating the LLC, it will take a carry in a successful exit.
Though the platform grew fast to a leading position in China in 2016, it has been struggling to scale up due to several challenges.
– Ambiguous regulatory environment
Equity crowdfunding is a newly emerged activity in the broader finance sector, a generally high-risk and heavily regulated area. The Chinese government is conservative (and slow) in dealing with such a matter, and the regulatory ambiguity hinders growth of platforms like JD Equity Crowdfunding. Compared with the U.S., no JOBS Act equivalent regulations exist, and no regulatory body plays the role SEC does that the platforms could consult with when dealing with uncertain issues. To give another example, JD Equity Crowdfunding gave up the idea to adapt a fund model, like AngelList Access Fund, to help investors diversify risks by investing their money in a broader portfolio of startups and release the platform’s operation burden under the deal-by-deal model.
– Startup reverse selection
Entrepreneurs seek for not only capital but other resources, such as network and operation advice, from their investors. Unlike sophisticated institutional investors, the help that individual investors are capable of providing and the effort that lead investor and platforms can dedicate to each individual startup are very limited. As a result, high potential startups don’t prefer to raise fund on equity crowdfunding platforms in general.
– Unsophisticated individual investors
The crowds can release power of collective intelligence, but they sometimes can also create hassles collectively. In the case of JD Equity Crowdfunding, each individual investor in an investment group of ten to twenty desires to know the day-in-day-out operations of his/her invested startup, thus the groups bombard entrepreneurs with questions almost on a daily basis. Besides, individual investors did not necessarily know the risk and time span of venture investment when they put their money in, more problems might surface as time goes by.
– Operation burden
Due to the challenges noted above, JD Equity Crowdfunding platform has to bear a heavy operation burden in order to keep the business running. This poses questions on its profitability, and legitimacy as an internet-based demand-supply matching platform.
Most of these challenges root in the nature of equity crowdfunding business. The amount of money at stake for each user is significantly more than that involved in transactions on currently well run crowdsourcing platforms, as well the task it tries to accomplish is much more complicated than to simply deliver a ride on demand.
I am more optimistic about the fund model of equity crowdfunding, which sufficiently democratizes the high hurdle asset class and spreads out operation cost, especially when investors are allowed to trade their equity ownership on the secondary market. Otherwise, I incline to believe that equity crowdfunding platform can only serve a niche market.