😱 Crowdfunding Investments gone bad

All investments are risky, which means some of them don’t turn out the way we planned. That’s normal! And a great way to learn. Help your fellow investors by sharing your experience with a crowdfunding investment gone wrong:

  • What was the investment?
  • What were you expecting to happen?
  • What actually happened?
  • What would you do differently next time?

I’ve made investments of varying amounts in more than a dozen investment crowdfunding platforms, and while most are performing as expected (or in the case of startup investments are too early to expect any return), there are a couple that haven’t performed as expected:

  • A $5,000 debt investment in a commercial real estate project in the Chicago area with Patch of Land. The loan was scheduled to mature on April 29, 2017 and despite an initial series of quite positive status updates (including one that the renovations were complete and a refinance was in progress), the maturity date came and went. The borrower made interest payments for a while, but unfortunately those are being held by Patch of Land and not distributed to investors (more on that below). The loan was foreclosed, and they’ve been trying to find a buyer ever since. The last update I have (as of November 2020) is that the property is likely to go to auction.
  • A $5,000 debt investment in a ride-sharing fleet expansion with YieldStreet, offering a 13% interest rate and secured by the vehicles. About 6 months in to my investment, the borrower defaulted. On the positive side, the loan was amortized, so there were principal payments along the way, though now going on 4 years since any payments were made I’m not holding my breath.

I posted some overall thoughts in this blog post, but the main lesson I learned from these is that I’m personally just not comfortable with the level of risk investing in individual debt deals. I’d rather spread the money out through a fund or other means of diversification, and save my due diligence energy and attention for opportunities with more upside potential.

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Andrew - I am fairly new so have not had any catastrophes yet, but it has been helpful to have a staged approach to the investment process on portals and a community like yours. I had initiated an investment in GenesisAI but after further review of the financials and I did not like the accounting of an owner draw, through a separate owned company, Palatine Analytics
Corporation. Palatine was run by a founder of GenesisAI, for “CEO services” at 80k in debt. You can review the exchange: https://wefunder.com/genesisai/ask Eric Chase notes the same issue a few weeks later. It has been helpful to discuss irregularities observed in the due diligence process in the networking session at the panel event. I share stories from several founders about issues they ran into with platforms and review some of the routes to reduce risk associated with these investments Reducing Risk with Equity Investing Portals | Fund Wisdom

The open Q&A on platforms has been huge, but a private review group is something I would find helpful as I continue to dig in.

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Welcome to the community, @FundWisdom-B!

I totally agree with you that the public Q&A for Regulation Crowdfunding offerings can be incredibly valuable, not only for the actual information that comes out, but also just to be able to observe how a particular founder/issuer interacts with investors. I do wish the platforms made it a bit easier to see the full history (getting to the actual interaction you cited required quite a few “load more” clicks).

Thanks for the article you shared from FundWisdom, and very interesting to hear about insurance companies getting into the mix (especially a big one like AIG).

I love the idea of a private review group to dig a bit deeper and share info from due diligence, and would be happy to host something like that here.

Thanks for starting this topic, @andrew. I think it’s extremely helpful to learn from the mistakes of others in the hopes of not repeating the same mistakes!

Similar to you, most of my investments are going pretty much as one would expect (given that most are still far too early to expect any type of significant exit).

The one negative outcome (that may not seem to be negative) was in a SAFE investment that had “repurchase rights”.

Repurchase rights (sometimes also referred to as a redemptive clause, I believe) basically give the issuing company the option to buyback all the crowdfunding investors at the issuing company’s discretion (although each set of deal terms likely has differences).

One thing to note: I have even seen repurchase rights on Common Stock and equity on some platforms, so it isn’t necessarily a SAFE that is the issue in this case, but having the repurchase clause.

In the case of this company I invested in, I knew going in that the SAFE had repurchase rights and had highlighted that as a potential risk. However, I decided to move forward for two reasons:

  1. I still really liked the company, and the “downside” of a company exercising their repurchase right means that you’d still likely get at least your original amount invested back, and
  2. The repurchase rights would be at the greater of either A) The Fair Market Value of the security, or B) The original investment amount.

In the case of 2, I figured that the “Fair Market Value” would mean that if my company was doing really well, while I’d miss any potential upside after the repurchase, I’d at least get a good return up until then.

Well, it kind of played out as anticipated. On paper (and in my opinion), this company was probably one of my best performing and future potential investments that I had made. However, shortly after COVID hit in 2020 (which wouldn’t have negatively impacted, and may have even drastically helped, this company’s business model) - they decided to exercise the repurchase.

So I held the SAFE for ~11 months and made 1.5X my money. Great, right!? Not quite.

As I mentioned, while I did technically make a gain, I still believe this was one of my highest potential investments.

What’s even worse is that the “1.5X” return is far, far less than I feel the true valuation of the company was worth at the time. While they claimed to have done a “Fair Market Value” assessment with a third party, I honestly think they timed it during COVID to coincide with a massive temporary (and non-real) drop in many other valuations, so they effectively got a much cheaper paper valuation than the company was worth.

As you know, it’s often the very, very small minority of investments in a startup portfolio that generate most of the returns. So it’s absolutely CRUCIAL that when you do get that one investment, the company doesn’t buy you out.

I probably won’t be investing in any more repurchase rights deals in the future. Although I don’t really see them much (if at all) anymore, so I wonder if platforms are strongly discouraging issuers from issuing securities with these terms since they are so unfriendly to investors.

Thanks for sharing your story @brian1, and for highlighting a really important investment term that many investors probably wouldn’t know to look for. While 1.5X is pretty good for 11 months, obviously it’s not what you were expecting when you signed up.

Do you have any sense of how often repurchase rights are included? (And/or whether it’s specific to certain platforms – I’m guessing many of them share contract templates among issuers)

I’ve seen repurchase rights across different platforms (Republic, StartEngine, etc.) and even across security types (e.g SAFEs, but even on Common Stock).

That being said, I haven’t seen any offerings with repurchase rights in over a year now.

I hope that this is because platforms realized the extremely negative impact this can have on investors and so won’t allow it on their platforms anymore. But I still check by opening the legal docs and doing “CTRL+F” and searching for anything like “repurchase” or “redemption” in every deal I invest in.

Thanks brian1 and andrew. As Andrew mentioned, I am one of those investors that did not really understand the potential impact of ‘repurchase rights’ until I read through brian1’s explanation. I appreciate you sharing your learnings.